SEC Unanimously Agrees to Ban Pay-to-Play Practices by Investment Advisers

July 04, 2010

On June 30, 2010, the United States Securities and Exchange Commission (“SEC”) unanimously adopted Rule 206(4)-5 under the Investment Advisers Act of 1940 which is designed to curtail “pay to play” practices by registered investment advisers.  (Click here for a link to the SEC press release).  “Pay to play” is the practice of making contributions to public officials in exchange for the award of pension management contracts.  The SEC believes that these practices favor large investment advisors over smaller ones, reward political connections rather than investment skill, and give consumers sub par performances for superior prices.  Therefore, the SEC adopted Rule 206(4)-5 which is designed to eliminate the pay to play practice and to level the field for investment advisers so that management contracts are awarded based upon investment skill and quality of service.

The adopted SEC Rule 206(4)-5 contains three main elements:

  • First, the Rule prohibits an investment advisor from providing advisory services, either directly or through a pool investment vehicle, for two years if the investment adviser or its employees make a political contribution to an individual in a position to influence the award of a management contract.  There is a de minimis exception to this rule which allows for individuals to contribute up to $350 to a candidate per election if the contributor is allowed to vote for the candidate and up to $150 per candidate per election if the contributor is not allowed to vote for the candidate.
  • Second, the Rule prohibits investment advisors and its employees from soliciting or coordinating campaign contributions for candidates or political parties. 
  • Finally, the Rule prohibits investment advisers from paying third party solicitors, unless the third party solicitors is an SEC registered brokers dealer or registered investment adviser who will be subject to similar pay to play restrictions. 

In addition to these requirements, the adopted Rule 206(4)-5 contains a provision which makes it unlawful for an investment adviser or its employees to do anything indirectly, which if done directly would violate the rule.  This provision ensures that investment advisers can not use third parties to circumvent the new rule.  Also, with the enactment of Rule 206(4)-5, investment advisers will need to maintain certain records regarding political contributions and payments. 

The Rule, as originally introduced last July, would have banned the use of third party solicitors.  However, due to responses during the “Comments” period, the SEC backed away from this position and will allow the use of third party solicitation to continue, however the solicitors must be registered with the SEC as investment advisers or broker dealers.  Further, the SEC stated if third party solicitors continue to have a corruptive influence on the pension industry, then the SEC will ban the use of third party solicitors all together.

The adopted Rule 206(4)-5 applies to registered advisers as well as advisers who rely on the private adviser exception (less than 15 clients) and to unregistered advisers.  Investment advisers will need to be in compliance with the Rule within six months from the date the Rule is published in the Federal Register; except for the third party ban provisions which investment advisers will have to comply within one year. 

RIA Compliance Consultants recommends that all investment advisers implement politician contributions policies and procedures to ensure compliance with the adopted Rule.  Also, most investment adviser policy manuals will need to be updated because of new solicitor and record keeping requirements.  If you need advice or assistance in implementing procedures or updating policy manuals to ensure compliance with the adopted Rule, any of our compliance consultants are willing to assist you.

Posted by Bryan Hill
Labels: Political Contributions, SEC