Avoiding Alcatraz

Earlier this year, when California Governor Schwarzenegger proposed a potential sale of the San Quentin State Prison, he probably didn’t intend to land anyone in that same prison.

But, as this week’s news that a California law is standing in the way of Los Angeles signing on JP Morgan as sell-side advisor for the city’s parking assets demonstrates, that is exactly what could happen.

The law, California Government Code Section 1090, states that public “employees shall not be financially interested in any contract made by them in their official capacity”. But because “employees” has been interpreted over the years to include consultants, a sell-side advisor could very well fall within the scope of the law.

And if that turns out to be the case, then JP Morgan’s financial relationships with prospective bidders for the parking assets, such as lending arrangements, could lead to a 1090 violation, which is a felony that could result in prison time.

Cezary Podkul

If this interpretation prevails, then the next question at a California-focused infrastructure conference might as well be: who wants to go to prison? And chances are that there won’t be any hands going up, just when the state needs them most.

Clearly, California, which only recently passed a statute to give state-wide and regional transportation agencies broad authority to pursue public-private partnerships (PPPs), would do well not to de facto isolate itself from potential advisors for its cities’ and state agencies’ projects. For PPPs to make sense and provide benefits to the public, the state will need the best advisors – whoever they are.

They can be big Wall Street investment banks, like JP Morgan. Or they can be boutique investment banking and advisory firms that may not have any financial relationships that would trigger 1090 violations. The point is not to limit the potential universe of advisors only to one group or the other.

But because 1090 would apply equally well to Morgan Stanley, Goldman Sachs, UBS, Bank of America or any other large financial firms who do business with infrastructure investors, this would effectively be the case.

Why? Because the infrastructure investor community in the US is still a small (albeit growing) crowd. Most participants know each other very well and more likely than not have had some financial, consulting, advisory or other relationship over the years. Code section 1090 is worded broadly enough that it would pick up on those relationships, creating serious legal hazards – prison – for much of the financial, accounting and engineering advisory community.

And contrary to what small-scale advisors might think, this wouldn’t mean a bonanza for them. Sure, it might make it easier for them in the short term to win advisory mandates in the state. But that success would force them to significantly limit their activities so that they don’t run afoul of code section 1090. And if they don’t, then they risk becoming victims of their own success.

So big or small, financial or not, all advisors looking to do business with the public sector in the state of California are in this together.