On August 3, 2009, the Securities and Exchange Commission (the “SEC”) proposed new Rule 206(4)-5 under the Investment Advisers Act of 1940 that would limit “pay to play” practices by investment advisers that seek to provide investment advisory services to government entities.1 The proposed rule would limit pay-to-play practices of advisers by, among other things, prohibiting an adviser’s receipt of compensation from a government entity for two years following any contribution by the adviser or certain of it personnel to an incumbent, candidate or successful candidate for elective office of a government entity (an “official”) with the ability to influence the award of advisory business and prohibiting payments by an adviser to third-party solicitors for their solicitation of government entities. The proposed rule is modeled on similar pay-to-play rules of the Municipal Securities Rulemaking Board and is a follow-up to the SEC’s failed attempt to adopt similar rules in 1999.
Discussion of the Proposal
A. Two-Year “Time Out” for Contributors
The proposed rule would prohibit registered investment advisers and certain unregistered investment advisers2 (“investment advisers”) from providing advisory services for compensation to a government entity3 for a two year period after the adviser or one of its executives or restricted employees (“covered associates”)4 makes a contribution5 to an official in a position to influence the award of advisory business. The proposed prohibitions would not, however, apply to de minimis ($250 or less) contributions by covered associates who are individuals and who were entitled to vote for the candidate or to de minimis contributions that are returned within six months of the contribution and meet certain other conditions.
Under the proposed rule, an investment adviser would be required to “look back” in time to determine whether it would be subject to any business restrictions under the proposed rule when employing or engaging a person who would be considered a covered associate. In addition, the two-year time out would continue in effect after the covered associate who made the triggering contribution left the advisory firm.
B. Ban on Paying Third Parties that Solicit Government Business
The proposed rule would prohibit an investment adviser from providing or agreeing to provide, directly or indirectly, payment to any third-party (e.g., finders, solicitors, placement agents and pension consultants) or third-party solicitation firms, for a solicitation of advisory business from any government entity on behalf of such adviser. The proposed rule would not, however, prohibit such payments to related persons of the adviser.
C. Application to Pooled Investment Vehicles
For purposes of the proposed rule, an investment adviser to pooled investment vehicles, including registered6 and unregistered investment companies (e.g., hedge funds, fund of funds, private equity funds and other entities that are typically excepted from the definition of investment company by section 3(c)(1), 3(c)(7) or 3(c)(11) of the Investment Company Act of 1940), in which a government entity invests or is solicited to invest would be treated as though the investment adviser were providing or seeking to provide investment advisory services directly to the government entity. The proposed rule would prohibit, for example, an investment adviser from receiving compensation with respect to a government entity’s investment in a private investment fund managed by the investment adviser if the investment adviser or any covered associate made a contribution to an official in a position to influence the investment decision.
D. Soliciting and Coordinating Contributions and Payments
The proposed rule would prohibit an investment adviser from coordinating, or soliciting others to make, contributions for an official (or a related political party) of a government entity to which the adviser is providing or seeking to provide investment advisory services. The proposed rule would also prohibit acts done indirectly, which, if done directly, would result in a violation of the rule. Thus, an adviser or its covered associates could not circumvent the rule by directing or funding contributions through third parties, including, for example, consultants, political action committees (“PACs”), attorneys, family members, friends or companies affiliated with the adviser.
E. Recordkeeping
The SEC also proposed amendments to Rule 204-2 that would require an investment adviser to keep detailed information regarding, among other things, (i) covered associates, (ii) government entity clients and potential clients, including those investing in or solicited to invest in a pooled investment vehicle managed by the investment adviser, and (iii) all direct and indirect contributions made by the investment adviser or any of its covered associates to an official, a political party of a State or political subdivision thereof or a PAC.
F. Exemptions
Under the proposed rule, an investment adviser may apply to the SEC for an order exempting it from the two-year compensation ban. An exemption would be granted based upon the facts and circumstances of the application, including whether the adviser had adopted and implemented policies and procedures reasonably designed to prevent violations of the rule and had no actual knowledge of the contribution resulting in application of the prohibition.
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Comments on the proposal must be submitted to the SEC on or before the date that is 60 days after publication of the proposing release in the Federal Register. If you have any questions or need more information, please contact an attorney in our Investment Management Group.
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1 Political Contributions by Certain Investment Advisers, Investment Advisers Act Release No. IA-2910 (August 3, 2009). Various states and cities have also adopted prohibitions against “pay to play” practices.
2 Unregistered investment advisers relying on section 203(b)(3) of the Investment Advisers Act of 1940 (“Advisers Act”) would be subject to the proposed rule. Section 203(b)(3) of the Advisers Act generally exempts from registration any investment adviser who, during the prior 12-month period, had fewer than 15 clients and does not hold itself out to the public nor acts as an investment adviser to an investment company registered under the Investment Company Act of 1940.
3 “Government entity” is defined by the proposed rule as “any State or political subdivision of a State, including any agency, authority, or instrumentality of the State or political subdivision, a plan, program, or pool of assets sponsored or established by the State or political subdivision or any agency, authority or instrumentality thereof; and officers, agents, or employees of the State or political subdivision or any agency, authority or instrumentality thereof, acting in their official capacity.”
4 “Covered associates” would include the adviser’s general partners, managing members, executive officers, or other individual with a similar status or function. For purposes of the proposed rule, an “executive officer” of an investment adviser means the president, any vice president in charge of a principal business unit, division or function (such as sales, administration or finance), or any other executive officer of the investment adviser who, in each case, in connection with his or her regular duties: (i) performs, or supervises any person who performs, investment advisory services for the investment adviser; (ii) solicits, or supervises any person who solicits, for the investment adviser, including with respect to investors for a covered investment pool; or (iii) supervises, directly or indirectly, any person described in (i) or (ii).
5 A “contribution” means any gift, subscription, loan, advance, deposit of money, or anything of value made for: (i) the purpose of influencing any election for federal, state or local office; (ii) payment of debt incurred in connection with any such election; or (iii) transition or inaugural expenses of the successful candidate for state or local office.
6 In the case of an adviser to a publicly-offered registered investment company, the two-year time out provision would apply only when the investment company is included in a plan or program of a government entity (e.g., a 529 plan).
