New rules adopted by the SEC that regulate the political activity of investment advisers and seek to end the practice of “pay to play” went into effect this week. “Pay to play” generally refers to situations where individuals make campaign contributions to government officials who are in a position to influence the awarding of contracts to the contributor.
Under the new Rule 206(4)-5 of the Investment Advisers Act of 1940, as amended (the “Rule”), investment advisers registered with the SEC (or required to be registered) or exempt from registration under Rule 203(b)(3) (the “private adviser” exemption)1 are prohibited from:
- providing advisory services for compensation to a government entity within two years after a political contribution to an elected official that can influence the hiring of the investment adviser was made by the investment adviser or any person associated with the investment adviser;
- paying a placement agent or other third-party to solicit a government client for the investment adviser, unless the third-party is an SEC-registered investment adviser or broker-dealer subject to “pay to play” restrictions; and
- soliciting or coordinating campaign contributions from others for an elected official that can influence the hiring of the investment adviser.
The new rules also amend Investment Advisers Act Rule 204-2 to require that investment advisers with government clients maintain records of the donors and recipients of all donations made to government officials by the investment advisers and persons associated with the investment adviser.
Two Year Look Back on Political Contributions
Under the Rule, an investment adviser who directly, or through a “covered associate”, makes a political contribution to an elected official (or a candidate) in a position to influence the selection of the adviser for a government contract is barred for two years from providing advisory services for compensation to that government entity. Government entities include all state and local governments, their agencies, and all public pension plans and other government funds. In addition, investment pools (such as private equity funds or hedge funds) in which a government entity invests or is solicited to invest is treated as a government entity for purposes of the Rule.
A “covered associate” of an investment adviser is defined as: (i) any general partner, managing member or executive officer, or other individual with a similar status or function; (ii) any employee who solicits a government entity for the investment adviser and any person who supervises, directly or indirectly, such employee; and (iii) any political action committee controlled by the investment adviser or by any of its covered associates.
An important note is that when an employee becomes a covered associate, the investment adviser must look back in time and examine the employee’s prior political contributions. The Rule attributes to an investment adviser contributions made by a person within two years of becoming a covered associate of that investment adviser. The two-year look back does not apply to those contributions made by a natural person more than six months prior to becoming a covered associate of the investment adviser unless such person, after becoming a covered associate, solicits clients on behalf of the investment adviser.
There is a limited exception to the contribution rules: a covered associate who is an individual may make de minimis contributions of up to $350 per election per candidate if the contributor is entitled to vote for the candidate and up to $150 per election per candidate if the contributor is not entitled to vote for the candidate.
Under the Rule, an adviser and its covered associates may not pay a third party, such as a placement agent, to solicit a government client for the investment adviser, unless that third party is an SEC-registered investment adviser or broker-dealer subject to similar pay to play restrictions.
Solicitations of Contributions
The new Rule prohibits an investment adviser and covered associates from asking a third-party, such as a political action committee (PAC), to:
- make a contribution to an elected official (or candidate) who can influence the selection of the adviser; or
- make a payment to a political party of the state or locality where the adviser is seeking to provide advisory services to a government entity.
Indirect Contributions and Solicitations
The Rule further prohibits an investment adviser from engaging in prohibited conduct indirectly if that conduct would violate the Rule if the investment adviser did it directly (i.e. directing or funding contributions through third parties such as spouses, lawyers or companies affiliated with the adviser).
Record Keeping Requirements
The SEC also adopted amendments to Rule 204-2 of the Advisers Act to require registered investment advisers that have government clients, or that provide investment advisory services to a covered investment pool in which a government entity investor invests, to maintain the following records:
- the names, titles and addresses of all covered associates of the investment adviser;
- a list of all government entities (including investment pools with government investors) to which the advisor provides advisory services;
- a record of all contributions made by the adviser and its covered associates; and
- a list of the names and business addresses of each regulated person to whom the adviser provides or agrees to provide, directly or indirectly, payment to solicit a government entity on its behalf.
Investment advisers subject to Rule 206(4)-5 must be in compliance with the rule on March 14, 2011, except that provisions related to using third parties to solicit government business must be complied with beginning September 13, 2011.