When Dallas buyout group HM Capital Partners and three other firms paid $4.5 million to settle New York Attorney General Andrew Cuomo's pay-to-play probe and abide by his code of conduct earlier this month, it raised the stakes in the face-off between the Securities and Exchange Commission and the private-equity industry. The quad join the Carlyle Group and Riverstone Holdings, other buyout firms that got caught up in a fundraising scandal involving political heavyweight Dick Morris and the New York State Common Retirement Fund, in refraining from using third-party fundraising professionals, or "placement agents" as they're known in private-equity parlance, to raise capital from pension funds.

In short, the SEC's Advisers Act Rule 206(4)-5 proposal, like Cuomo's conduct code, is designed to eliminate political contributions to officials that could influence investment decisions from public pensions. One measure within the regulator's proposal, however, stands to undercut the sea legs of an entire industry that has raised billions of dollars of pension money for buyout partnerships for almost three decades. It would restrict private-equity firms from hiring placement agents to solicit capital from government entities.

The survival of numerous, highly reputable and independent alternative capital-raising registered businesses, including some private-equity firms, would be at stake. While it's hard to pin down the exact number of companies engaged in raising monies for buyout, mezzanine and venture capital funds, a host of such firms include Atlantic-Pacific Capital, Benedetto, Gartland & Co., CapStone Partners, C.P. Eaton Partners, MVision Private Equity Advisers, Monument Group, Presidio Partners LLC, Probitas Partners and Thomas Capital Group. Additionally, a number of Wall Street banks like Credit Suisse, Greenhill & Co., Jefferies, Lazard and UBS operate fundraising groups, some with very large departments.

The Street banks, though, have largely exited the fundraising business in recent years. Bank of America Merrill Lynch is the latest to get out of the business. Its placement team led by Michael Ricciardi, Alan Pardee and Enrique Cuan spun out earlier this month to launch its own firm, sources say, and another veteran from the contingent, Loren Boston, is leaving to pursue other endeavors.

B of A officials declined to comment, and calls to Cuomo's office weren't returned.

Steven Standbridge, a partner at Dallas fundraising advisory firm CapStone Partners, says of the SEC proposal: "It would absolutely have an impact on business because pension funds make up a significant portion of where people raise capital. It's absolutely detrimental to our business."

Buyout firms generally pay fundraisers a fee of around 2% on the capital they raise, typically over a four-year period. Hence, there isn't a cost to institutions that receive placement agent-submitted fund offering memorandums.

For placement agents, public pension and municipal plans make up the lion's share of capital for private investors. The public sector accounts for $193 billion in private-equity allocations, or 38% of the aggregate capital committed to North American investment funds and 20% globally, according to data provider Preqin.

The California Public Employees' Retirement System alone, for example, has $42.4 billion parked in private equity, venture capital and mezzanine funds.

Industry observers say the attempt to stop legitimate private fundraising organizations from assisting buyout groups in raising capital bears little connection to the "pay to play" scandals.

"I think that using registered full-service placement agents that provide deep levels of services - due diligence, market assessment, and terms analysis - is very different than the political types that have gotten caught up in these scandals," says Michael Wolitzer, a partner at Simpson Thacher & Bartlett LLP, who has provided counsel to private equity firms Blackstone and Silver Lake.

If placement agents are unable to market limited partnerships to pension funds, the prospects for a wide swath of private-equity funds to tap into one vast reservoir of capital would be severely diminished. Accessing pension funds is a major challenge for many investment firms, particularly smaller and newly-formed buyout funds.

"The proposed policy will limit small and mid-sized funds from being considered for investment by public pension plans," says Michael Klein, president of Connecticut buyout firm Littlejohn & Co., in a letter to the SEC.

Ira Kustin, a partner at Akin Gump Strauss Hauer & Feld LLP who advises private equity partnerships and hedge funds, agrees. "One of the consequences I see is a lack of access to the government plans for smaller advisors that could be the star performers of tomorrow."

It would be a stretch to suggest that the entire private capital-raising industry would collapse if the regulator's measure is enacted. But there's little disagreement among private-equity industry participants that it would shake the foundations of the alternative-capital business.

CapStone, a firm that has raised more than $5 billion for 18 funds in the last nine years, says in its letter to the SEC that placement agents are legitimate small businesses that help private-equity clients articulate and market their investment strategies.

The SEC is seeking comment on measures to curtail pay-to-play practices by Oct. 6. Its recommendation to ban placement agents, coupled with the code put forth by Cuomo, has left some veteran fundraising professionals bristling.

"There is nothing conceivably good that would come from banning public funds from dealing with legitimate, appropriately regulated placement agents," says Phil Pool, a highly regarded former placement agent who established Donaldson, Lufkin & Jenrette's placement agent business in 1994. "What's going on here, simply put, is a witch hunt on the part of the New York attorney general, who couldn't care less how many innocent, law-abiding bystanders he tramples over in his quest for the governor's mansion," he says.

Cuomo's code of conduct, however, does not restrict investment firms from using consultants and investment banks to assist with preparing marketing materials or performing due diligence-related matters. Those activities, though, pale with the access to pension executives that well-established fundraising organizations can deliver. It is that access, and clout, that private fund placements run by reputable organizations bring to the table that are the principal benefits buyout sponsors derive from using alternative capital-raising firms.

Stephen Schwarzman, chief executive of the Blackstone Group, outlined the challenges for newly formed funds in his letter to the SEC. He recalls how he and firm co-founder Peter Peterson, who both carried senior executive credentials from Lehman Brothers after launching Blackstone in 1985, were turned down three times by General Motors Pension Corp. when raising capital for their first fund. When they subsequently hired CS First Boston for placement assistance, the GM plan committed $100 million to the New York firm's fund. "Without the assistance of CS First Boston and Bankers Trust, I can assure you that our fundraising efforts for our first private-equity fund would have utterly failed," Schwarzman writes, noting that $39 of every $100 invested by the private-equity group is derived from state and local pension funds.

Pension officers also benefit from their association with placement agents. As former California State Teachers' Retirement System alternative investments director Real Desrochers wrote to the SEC, fundraising professionals provide insights about a private-equity firm's culture, expertise, management team structure, portfolio holdings and investment strategy, which can help investment officers better analyze funds.

Banning fundraising professionals, Pool says, would destabilize the institutional investment community. "If placement agents are banned from doing business with public pension plans, it would hurt institutions in multiple ways. All general partners would have to build in-house placement teams, and investors would be overwhelmed by the volume of incoming sales calls, many from inexperienced agents."

For now, a handful of private-equity groups staff their own fundraising placement groups, mainly larger sponsors like Blackstone, Carlyle and Kohlberg Kravis Roberts being the most notable. Blackstone operates one of the largest internal money-raising units, known as Park Hill Group, which staffs 90 professionals that have raised more than $100 billion for 70 funds.

Kevin Albert, a managing director at Menlo Park, Calif., private-equity firm Elevation Partners who is widely considered to be one of the early architects of the private fundraising profession, thinks the deployment of in-house placement professionals at buyout groups is the next evolutionary step in the placement business. "It's the wave of the future. It used to be people wouldn't spend much time thinking about their investors as being a key part of their franchise."

That notion changed when the buyout industry began maturing in the 1980s, sprouting hundreds of firms with investment strategies that spanned growth capital to LBOs.

"By serving as a bridge between investment advisers and municipal investors, placement agents perform a critical capital formation role, just as they do in the context of corporate issuers and non-municipal investors," writes John Robertshaw, co-head of the private fund group at Credit Suisse, which provides four primary functions for its clients: due diligence, project management, distribution and road show organization.

Knowledgeable placement agents can save both private-equity dealmakers from having to go on road shows and institutional investment officers' time in selecting private-equity funds that best fit a limited partner's current investment interest. Reputable placement agents by and large turn away substantial numbers of prospective fund managers. The buyout funds that wind up being represented by fundraising organizations are left with an implicit stamp of approval. That, in turn, can be especially useful for pension fund managers inundated with private placement memorandums. For instance, data from Preqin indicates that 843 funds are presently on the road seeking $481 billion.

Institutional investors, also, don't seem to be throwing their weight behind the placement ban. A Preqin poll of 50 prominent U.S. institutional investors in August found 45% of respondents were against banning the use of placement agents.

Pension plans, though, haven't been passive on the issue. Several have moved towards greater transparency when it involves private equity fund matters, according to industry participants.

"A number of states and local governments have already put policies into place for more disclosure rather than flat bans on the use of placement agents," says Akin Gump's Kustin.

Robertshaw thinks placement agents that are registered as broker-dealers along with additional certification and disclosure requirements would help curtail the selling of access to municipal money.

The placement industry's genesis didn't always involve pension funds. Insurance companies were the primary source of capital when Beacon Hill Financial CEO Bob Johnston and ex-Merrill banker Jerome Green pioneered the private fundraising business in the early 1980s. Johnston raised money for LBO icon Theodore "Teddy" Forstmann, but it was Merrill that is widely credited with taking the business by storm in the late 1980s. It hired bankers to help craft private memorandums for buyout funds when public money started flowing into the market.

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