Last Spring, I wrote that the California Public Employees Retirement System was considering adoption of regulations governing personal trading by members of its Board of Administration and employees. These regulations are still under consideration. Recently, CalPERS gave notice of additional changes to the proposed rules. While I did submit a few technical comments on the proposed regulations, the logical foundation for these regulations continues to trouble me.
CalPERS is an agency of an issuer (the State of California). Thus, it is possible that CalPERS' board members and employees could, like the employees of any other issuer, become privy to material, non-public information about the state. In this way, CalPERS' board members and employees are in no different position than the employees of any publicly traded company. Remarkably, however, the proposed rules specifically exclude debt securities issued by state and municipal governments from the definition of "covered securities". Thus, the proposed rules do not apply by their very terms to the most direct and obvious situation in which insider trading could occur by CalPERS' board members or its employees.
CalPERS' proposed rules appear to be directed at the possible misuse of material, non-public information about securities that it buys or sells. In the case of publicly traded securities, it seems unlikely that issuers would be disclosing material, non-public information to CalPERS. Indeed such disclosures would, absent a confidentiality agreement, involve a potential violation of Regulation FD on the part of the issuer.
It seems more likely that CalPERS will receive material non-public information from issuers that are not publicly traded. However, it seems less likely that CalPERS board members and employees would be able to exploit that information due to the absence of a secondary market in which to purchase the securities. If a CalPERS employee purchases from, or sells to, the issuer, no insider trading would be likely because the issuer would presumably know the material, non-public information.
Another conceptual problem that I have arises from the fact that CalPERS has a limited ability to receive information on a confidential basis because it is subject to the California Public Records Act, Government Code § 6250 et seq. See "Can CalPERS Keep A Secret?" and "CalPERS Loses Public Records Act Fight". If CalPERS has affirmative disclosure obligations under the Public Records Act, how can either CalPERS or its employees have a duty of trust and confidence as described in SEC Rule 10b5-2?
A more plausible concern is that CalPERS' board members and employees may use the information that they acquire about proposed trading activity to "front run" those trades. This is more of a breach of fiduciary duty issue than the standard insider trading case. Coincidentally, the Financial Industry Regulatory Authority, Inc. (FINRA) recently submitted and the SEC approved a new Rule 5270 that will expand FINRA's current policy prohibiting front running by securities brokers. See SR FINRA 2012-25.
For all these reasons, I find CalPERS' proposed policy to be inapposite to its situation and legitimate concerns. The proposed rules are also overly complex and prolix. Although I recognize that CalPERS has already invested a great deal of work in developing these rules, my recommendation is that CalPERS start over with a clearer understanding of the potential problems that it is trying to address.
The comment period for CalPERS' proposed changes ends at 5:00 p.m. on October 30, 2012. Comments may be submitted to Regulation_Coordinator@CalPERS.ca.gov.
