In July 2010, the SEC adopted new rules to curtail the so-called “pay to play” practices by investment advisers. Pay to play is the practice of making campaign contributions and other payments to candidates and elected officials to influence the award of contracts to manage public pension plan assets and similar government investment accounts.

The new SEC rules affect all SEC-registered investment advisers, and certain private investment advisers currently exempt from such registration, that provide investment advisory services for public pension assets or similar government investment accounts. Specifically, the new rules regulate contributions to any candidate for, or incumbent of, a federal, state or local office that is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser by a government entity. For example, the rules cover contributions to a federal candidate’s campaign if that candidate is an incumbent state governor who can influence the appointment of a state pension plan investment adviser. Determining whether any particular elected office would fall within the pay to play rules is a facts and circumstances inquiry. The SEC has identified the determining factor in that inquiry as the scope of authority and influence of the particular office, not the influence actually exercised by the officeholder.

First, the new rules prohibit an investment adviser from providing advisory services for compensation—either directly or through a hedge fund or other pooled investment vehicle—for two years, if the adviser or certain of its executives or employees, or any political action committee controlled by such executives or employees, makes a political contribution to a candidate for, or incumbent of, an elected office having authority to influence the selection of the adviser. A contribution includes a gift, subscription, loan, advance, deposit of money or anything of value made for the purpose of influencing an election for a federal, state or local office. The rules provide a de minimus exemption for contributions of up to $350 per election per candidate for whom the individual can vote, or up to $150 if the individual is not entitled to vote for the candidate. Generally, investment advisers subject to this rule must be in compliance by March 14, 2011.

Second, the new rules prohibit an investment adviser and certain executives and employees from soliciting or coordinating campaign contributions from any person or political action committee—such as by “bundling”—for a candidate for, or incumbent of, an elected office having authority to influence the selection of the investment adviser. It also prohibits soliciting and coordinating payments to political parties of the state or locality where the adviser is seeking business. The rules provide no similar specific prohibition with respect to national political parties, such as the Democratic National Committee or the National Republican Congressional Committee. In addition, an investment adviser can directly contribute to a political party as long as the contribution is not a means for the adviser to do indirectly what would be prohibited if done directly. Again, generally, investment advisers subject to this rule must be in compliance by March 14, 2011.

Finally, an investment adviser may not pay a third party, such as a solicitor or placement agent, to solicit a government client on behalf of the investment adviser, unless the third party is generally otherwise subject to similar pay to play restrictions. The SEC has subsequently proposed limiting such third parties to “regulated municipal advisors.” A “regulated municipal advisor” includes any third-party solicitor, such as registered investment advisers and broker-dealers, seeking business on behalf of an investment adviser from a municipal entity, including a pension fund, that is subject to the pay to play rules adopted by the Municipal Securities Rulemaking Board. Investment advisers have until September 13, 2011 to comply with this rule.

Investment advisers, and certain executives and employees, may not, under a catch-all provision, engage in any pay to play conduct indirectly if the express provisions described above would prohibit them from engaging in that conduct directly. Examples of prohibited indirect practices include directing or funding contributions through third parties such as spouses, lawyers or companies affiliated with the investment adviser.