The SEC recently proposed new rules under the Investment Advisers Act of 1940 (Advisers Act) aimed at curtailing “pay to play” activity. The proposed rules are intended to prevent advisers from making political contributions or other payments to influence their selection by government officials to provide advisory services for public programs such as public pension plans and 529 Plans (Plans). The practice is rarely explicit, and the result is that these Plans may be subject to inferior advisory services and higher fees.
Proposed rule 206(4)-5 of the Advisers Act has three prohibitions:
1) Two-Year Timeout. The SEC would prohibit investment advisers from providing advisory services for compensation to a governmental entity within two years after the adviser, any of its partners, executive officers or solicitors (including any PAC controlled by the adviser) made a contribution to an elected official who could influence the selection of the adviser.
Executive officers would include the adviser’s president, vice presidents in charge of a principal business unit or division of the adviser, and other officers or persons who perform investment advisory services, solicit for an adviser, or supervise, directly or indirectly, other executive officers. Contributions by non-executive employees would not trigger the rule’s prohibitions. Government entities under the proposed rule include all state and local governments, their agencies and instrumentalities, and all public pension plans and other collective government funds. An official would include an incumbent, candidate or successful candidate for elective office of a government entity if the office is directly or indirectly responsible for, or can influence the outcome of, the selection of an adviser, or has authority to appoint any person who could do so. Contributions would generally be any gift, subscription, loan, advance, deposit of money or anything of value made for the purpose of influencing an election, including any payments for election debt, or transition or inaugural expenses.
Contributions made would be attributed to any other adviser that employs or engages the person who made the contribution within the two-year period. Likewise, the two-year time out would continue in effect after the person who made the triggering contribution left the advisory firm.
The proposed rule does allow for an exception that permits advisers’ employees to contribute up to $250 to public officials if the employees are entitled to vote for that official. There is also an exception intended to address situations in which the adviser triggers the ban inadvertently, which would be available for contributions made to officials other than those for whom they were entitled to vote and which, in the aggregate, do not exceed $250 to any one official, per election. The adviser must have discovered the contribution within four months of it being made, and cause it to be returned within 60 days of that date. No adviser would be entitled to rely on that exception more than twice in a 12-month period. In addition, advisers could apply to the SEC for exemptive relief from the rule when imposition of it is inconsistent with the rule’s intended purpose or when it is triggered by inadvertent contributions.
2) Third Party Solicitor Ban. An adviser would be prohibited from providing or agreeing to provide, directly or indirectly, payment to any person who is not a related person of the adviser for solicitation of government advisory business on behalf of such adviser. The ban would apply to placement agents and consultants as well.
3) Ban on Coordinating/Soliciting Contributions. The third component of the SEC’s proposed rulemaking is a ban on coordinating or soliciting contributions or payments for officials of government entities to which the investment adviser is seeking to provide investment advisory services. This proposal also extends to political parties of states or localities in which the investment adviser is providing advisory services to government entities.
In addition, the SEC proposed an amendment to Rule 204-2 of the Advisers Act, which would require registered advisers with government clients to make and keep certain records of contributions made by the adviser, its partners, executive officers and solicitors. Specifically, the rule would require advisers to make and keep a list of its partners, executive officers and solicitors; the states in which the adviser has or is seeking government clients; the identity of those clients and the contributions made. The records would be confidential and reviewed by SEC staff only in the course of an adviser examination.
The SEC has also proposed a “catch all provision,” which makes it unlawful for investment advisers or their executives or employees to do anything indirectly which, if done directly, would result in a violation of Rule 206(4)-5. This rule would prevent advisers from circumventing the rule by directing or funding contributions through third parties such as attorneys or family members.
The SEC is recommending that the proposed rules apply to investment advisers as well as those who use the private adviser exemption (i.e., those advisers with fewer than 15 clients) available under 203(b)(3) of the Advisers Act. The proposed rule would not apply, however, to most small advisers that are registered with the state securities authorities, and certain other advisers that are exempt from SEC registration.
The SEC is recommending that the rule not distinguish if the government plan contracted directly with investment advisers for advisory services or by means of planned participation in pooled investment vehicles managed by the advisers. The proposals would also apply to government pension plans as well as government sponsored but participant directed plans, such as 529s, 457s or 403(b) plans.
The Proposed Rule can be found at http://www.sec.gov/rules/proposed/2009/ia-2910.pdf.