A California law aimed at eradicating conflicts of interest in government contracting is preventing investment bank JP Morgan from signing an engagement letter with Los Angeles to advise the city on a high-profile deal to lease its parking assets. The impasse signals a wider problem that could limit other Californian cities from hiring large Wall Street advisors like JP Morgan.
Mike Keeley, a senior advisor to Los Angeles Mayor Antonio Villaraigosa, said the city and JP Morgan have failed to reach agreement on whether California Government Code Section 1090 would apply to JP Morgan if it were to sign on as a sell-side advisor to the US’ second largest city.
Code section 1090 states that public “employees shall not be financially interested in any contract made by them in their official capacity”. Since its enactment, though, the law has been interpreted to apply not only to public employees but also to consultants hired by the public sector.
In 1992, for example, then-California Attorney General Daniel Lungren sent a letter to Los Angeles deputy city attorney Raymond Ilgunas opining that “an ‘employee’ under section 1090 includes persons performing services under a contract with a government agency”, including a consultant conducting a feasibility study.
Los Angeles is not clear whether a sell-side advisor would also be considered a consultant within the scope of the law, Keeley said. The question has eluded both the city’s attorneys as well as JP Morgan's legal counsel for months and jeopardises the firm’s ability to accept the plum advisory contract. That’s because if a sell-side advisor is a consultant covered by code section 1090, then financial relationships with prospective bidders for the parking meters, such as lending arrangements, could lead to a 1090 violation.
Frankly, we think this is a statewide problem in California . . . I don't think the world has woken up to that yet
JP Morgan, like many large financial institutions that lend to and advise on infrastructure projects, has financial relationships with many firms that routinely bid on infrastructure project in the US. In Texas, for example, the firm will underwrite a bond offering for a project being financed by a private consortium that includes Spanish toll road developer Cintra. If Cintra (which recently agreed to divest its parking operations) were to bid on a transaction in California on which JP Morgan is a sell-side advisor, JP Morgan would run afoul of code section 1090.
“[Code section] 1090 is drafted so broadly that it could potentially pick up on that relationship, which doesn't make sense,” said Kent Rowey, head of the Americas energy and infrastructure practice at law firm Freshfields Bruckhaus Deringer in New York.
“We don’t think the California legislature intended it to be that broad,” he added. “But Compliance departments of a lot of big banks are taking a very cautious approach.”
Violating code section 1090 is a felony punishable by a voiding of the contract or prison.
If the law is interpreted to apply to sell-side advisors and their relationships with other bidders, Keeley said it could have much wider implications for California, which just recently enacted general enabling legislation for public-private partnerships (PPPs).
“Frankly, we think this is a statewide problem in California. [Code section 1090] is a California statute, not a Los Angeles statute and therefore it could apply equally to any big investment bank, engineering or accounting firm trying to represent a public sector client in California. I don't think the world has woken up to that yet,” Keeley said.
Other cities have in the past been precluded from hiring specific firms because of code section 1090 conflicts. Last year, San Francisco deputy city attorney Andrew Shen advised the San Francisco Public Utilities Commission that if it were to hire engineering firm Parsons to manage a water system improvement programme that Parsons had advised the city on, it would violate code section 1090 “because of Parsons’ key role in developing the scope for those same services”.
“The grey area is the extent to which the advice you give influences the decision you make such that you should be treated the same as a government official,” Rowey, the Freshfields Bruckhaus Deringer attorney, said. He added that PPP advisors should not be treated as government officials under the purview of code section 1090 because “advisors are not decision makers”.
The grey area is the extent to which the advice you give influences the decision you make such that you should be treated the same as a government official
Still, there is little precedent that lawyers can look to when evaluating the issue. In 1989, the state passed a law, AB 680, which allowed four demonstration PPP projects. Over the next two decades, only two came to fruition. So up until this year, Californian cities and government agencies have had little need to hire sell-side financial advisors for big-ticket infrastructure deals.
That changed in February when, amid the greatest fiscal crisis in its history, California finally passed statute SB 4 to give state-wide and regional transportation agencies broad authority to pursue PPPs without limit to location or number.
At the same time, Californian cities like Los Angeles have been mulling PPPs of their own as a way to raise cash. In December 2008, former Los Angeles controller Laura Chick published a study to assess opportunities for PPPs in the city. The study outlined nine different assets as candidates for PPPs and monetisation schemes. Among them were the city’s Ontario Airport, seven animal shelters, golf courses and off-street parking lots.
The parking idea, already pursued in cities like Chicago, which has raised $1.7 billion from leases of its parking garages and parking meters, seemed the most promising. Los Angeles held a contest to select sell-side advisors for a long-term lease of its parking garages and 41,000 parking meters. Earlier this year, JP Morgan was selected from a pool that included, among others, investment bank Goldman Sachs.
In April, the city took another step forward in the process when the Los Angeles City Council approved $500,000 to study the financial feasibility of a long-term lease PPP for its parking assets. The move came as Mayor Villaraigosa warned of a $530 million deficit for the city’s 2009-2010 fiscal year. JP Morgan and two other advisors, Ramirez & Company and Loop Capital, now had the go-ahead to conduct the study.
In June, city officials advised Los Angeles' budget and finance committees that $1 million would be needed for the fasibility studies and that, while contracts had been executed with Ramirez, Loop and Chicago-based Scott Balice Strategies, final contracts were still pending with accounting firm KPMG, law firm DLA Piper and JP Morgan.
City officials familiar with the contract negotiations say engagement letters were not executed with JP Morgan because JP Morgan sought to include language in the contract seeking clarity on its ability to act as a sell-side advisor without running afoul of code section 1090. The two parties were not able to reach agreement and the Los Angeles city attorney has now referred JP Morgan to the California Attorney General Jerry Brown for clarification.
A spokesperson for JP Morgan declined to comment on the issue.
“The solution is the [California] Attorney General will need to issue some form of official interpretation on 1090 and I don’t know how that will come out but I’d like to think that rational minds will prevail here,” Rowey said.
Brown has not issued any public opinion on the issue. His office declined comment.
The Los Angeles City Attorney’s office declined to comment on the specifics of the case, citing attorney-client privilege.