On May 9, 2012, the Securities and Exchange Commission (“SEC”) charged former Detroit mayor Kwame M. Kilpatrick, former city treasurer Jeffrey W. Beasley, MayfieldGentry Realty Advisors, LLC (“MGRA”)1 a registered investment adviser, and Mayfield the CEO and majority owner of MGRA, in connection with allegations that they were involved in a secret exchange of lavish gifts to peddle influence over Detroit’s public pension funds’ investment process. This is the SEC’s most recent pay-to-play action and it highlights the breadth of how “contribution” is defined under the federal securities laws.
The SEC alleges that Defendants Mayfield and MGRA violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, Sections 206(1) and 206(2) of the Investment Advisers Act, which prohibit an investment adviser from directly or indirectly defrauding, or otherwise deceiving, any client or prospective client. The SEC also alleges that Kilpatrick and Beasley aided and abetted the Sections 206(1) and 206(2) violations. Recent enforcement cases and amendments to the Investment Advisers Act have been aimed at curtailing pay-to-play practices by investment advisers that seek to manage assets of state and local governments. The pay-to-play rules address not only direct political contributions by advisers, but also other indirect methods designed to influence government officials. Specifically, under Rule 206(4)-5 of the Investment Advisors Act, an adviser is prohibited from receiving compensation for providing advisory services to a government entity for a two year time-out period if the adviser makes a contribution to an official of that government entity who is in a position to influence the award of the government entity’s business.2
Contribution under the Rule is defined as any gift, subscription, loan, advance, or deposit of money, or anything of value made for:
- the purpose of influencing any election for federal, state, or local office;
- the payment of debt incurred in connections with any such election; or
- transition or inaugural expenses incurred by a successful candidate for state or local office.
The SEC’s complaint, attached here, alleges that Kilpatrick's administration began to exert pressure on Mayfield because of Mayfield's prior support of another candidate. The SEC did not view the pressure exerted by Kilpatrick's administration as a mitigating factor, but rather alleged that Mayfield and MGRA "were only too eager" to provide the undisclosed gifts to maintain their relationship with the Detroit pension funds - a relationship which generated millions in fees to Mayfield and MGRA. According to the SEC, Mayfield and MGRA paid for trips and expenses for Beasley and Kilpatrick that included: (1) a trip for 6 to North Carolina amounting to over $3,000; (2) a lavish three night trip to Las Vegas which included round trip transportation on a private jet, rounds of golf, concert tickets, limousine transportation, dinners and spa services totaling over $62,000; (3) a private jet flight to Tallahassee, Florida; and (4) a long weekend in Bermuda for Kilpatrick and his wife including entertainment, all in an effort to obtain Detroit’s pension funds’ investments. According to the complaint, Beasley, Kilpatrick, and members of their inner circle improperly benefited from Mayfield’s and MGRA’s “contributions” unbeknownst to anyone else associated with the Detroit Pension Funds, and the Funds were defrauded as a result of this conflict of interest.
Key Considerations for Investment Advisers
- Ensure that you have an understanding of the relevant regulations - Many states and municipalities have their own pay-to-play rules. These regulations can be confusing because they can overlap or contradict each other. It is imperative to know who is subject to these regulations and to establish appropriate policies and procedures. Further, these rules require extensive record-keeping obligations and a look-back provision, which necessitates reviewing contributions made by certain new hires or lateral moves within the organization.
- Ensure that your compliance policy is adequate – Your compliance program must be broad enough to cover both non-monetary and in-kind contributions.
- Ensure that your procedures are appropriately broad and not too restrictive – Compliance procedures should educate employees about charitable and political contributions, but to comply with some states' employment laws, you should avoid an outright prohibition on political contributions.
- Ensure that you are adequately monitoring contributions – All solicitation activities, including both monetary and in-kind contributions, should be reviewed and cleared, and all other events must comply with the rules.