State Ethics Rules Lag in a New World of Finance

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SACRAMENTO, CA — Politicians weren’t getting rich off "secondary market" stock option sales and limited partnerships in secretive hedge funds when California voters approved some of the country’s most comprehensive ethics rules.

Those things didn’t exist in 1974.

Now, however, the state’s ethics and financial disclosure rules are showing their age. Government reform advocates and other experts say the rules are failing in their goal of informing voters about potential conflicts that wealthy candidates may face.

The complex financial maneuvers that some candidates have used to build their wealth have ethics enforcers scratching their heads. Opponents, meanwhile, complain about a lack of transparency over exactly which individuals and companies with business before the state may be lining wealthy politicians’ pockets.

"The ethics rules are not keeping up," said Bruce Cain, a professor of political science at UC Berkeley. "Some of these [potential conflicts] may be deeply embedded in financial arrangements that are not transparent, and that is a problem."

The issue affects candidates in both parties. Meg Whitman, the former EBay chief executive and Republican hopeful for governor, is the most obvious example because of the complexity of her billion-dollar portfolio. But some wealthy Democrats have also cloaked their financial affairs with complex structures that current financial disclosure requirements shed little light on. So, too, has Whitman’s rival in the GOP primary, Insurance Commissioner Steve Poizner.

Whitman has disclosed dozens of complex investments. But the statement of economic interest she is required to file reveals very little about exactly where her money is going.

The disclosure forms list the names of funds in which Whitman has money, such as AIF Private Investors and TCV V.

That doesn’t tell voters much.

The funds, open to only a small group of well-heeled individuals and institutions, take money from Whitman and other limited partners and spread it among business opportunities. The fund managers and limited partners typically keep secret where they invest. Whitman need not disclose that information to voters.

The potential conflicts arise when a private equity fund that has a candidate’s money invests in companies whose fortunes are tied to state policy.

A candidate in such private equity funds could, for example, have an ownership stake in a small startup that stood to make a windfall if the state opened the coast of Santa Barbara to new oil drilling or built a toll road across the Bay Area. Voters would never know.

Candidates typically say they would avoid such problems by moving their money into a blind trust. Ethics experts note that doesn’t necessarily make the conflicts go away.

The candidate knows what he or she was invested in at the time the trust was established. The conflicts don’t disappear until all those investments have been unwound, and that can take years.

Roman Porter, executive director of the state Fair Political Practices Commission, which enforces the ethics rules voters put in place through the Political Reform Act of 1974, says his agency is well aware that it is time to modernize. "There are clearly areas where the act needs to be updated to reflect the different investment vehicles individuals are using," he said.

The commission doesn’t have the power to make such changes on its own, however. That takes an act of the Legislature. And lawmakers are notoriously slow to impose tougher rules on themselves.

There is also disagreement over how far regulators should go.

The case of Chris Kelly, a Democratic attorney general candidate who amassed a personal fortune in stock options while an executive at Facebook, has some campaign finance watchdogs stumped.

Kelly has found a way to use his stock options in Facebook to bankroll his political campaign even though the company has yet to go public.

He is selling his shares in Facebook to a group of investors in Delaware who are willing to pay cash for Facebook stock options, perhaps gambling that they will increase in value by the time the company goes public.

The question raised by Kelly’s strategy is whether the investors are paying the market price for the options or a higher price in order to do him a favor.

Kelly’s spokeswoman and the owner of the Delaware private equity firm FBI Investments, which bought his Facebook options, both deny that Kelly got any special deal.

The candidate sold his options at the going rate, and he has already disclosed everything the law requires, spokeswoman Robin Swanson said. "Anyone else could buy and sell Facebook stock options this very same way."

But the law does not require Kelly to disclose how many options he sold or the price. In the absence of any disclosure requirement, voters have no way to confirm his statement.

Doug Heller, executive director of Consumer Watchdog, a Santa Monica nonprofit group, says it is unfortunate that the law does not require Kelly to disclose more.

"When you keep that detail shrouded, voters don’t know what is happening," he said. "If Kelly is unwilling to reveal that information, you have to wonder what is really going on."

Heller adds: "There should be a millionaire’s amendment to the Political Reform Act to account for this new world."

Contact the author at: [email protected]

Times staff writer Shane Goldmacher contributed to this report.

Consumer Watchdog
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