Tuesday, August 4, 2009

SEC Publishes Proposed "Pay to Play" Rules

On August 3, 2009, the SEC published the text of its proposed rules to limit "pay to play" practices by investment advisers who seek to manage state and local government money and make political contributions to influence their selection. The proposed rules would apply to advisers registered under the Investment Advisers Act of 1940 (the "Act") as well as certain advisers of hedge funds and other private pools of capital who are exempt from registration by virtue of section 203(b)(3) of the Act. Section 203(b)(3) -- otherwise known as the "private adviser" exemption -- exempts from registration any investment adviser that is not holding itself out to the public as an investment adviser and had fewer than 15 clients during the last 12 months.

Two-Year "Time-Out" for Contributors
The proposed rules would make it unlawful for an investment adviser to receive compensation, either directly or through a fund, for providing advisory services to a "government entity" for two years after the adviser or any of its "covered associates" makes a political contribution to an "official" of the entity in a position to influence the selection of advisory business. The proposed rules contain a de minimis exception that would allow a covered associate to contribute up to $250 per election per candidate if the contributor is able to vote for the candidate.

Under the proposed rules, "government entities" would include all state and local governments, their agencies and instrumentalities, and all public pension plans and other collective government funds. "Covered associates" would include the adviser’s general partners, managing members, executive officers, or other individual with a similar status or function, as well as employees who solicit government entity clients for the adviser. 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 investment adviser or has authority to appoint any person who is directly or indirectly responsible for or can influence the outcome of the selection of an investment adviser.

The proposed rules would prohibit an adviser and its covered associates from coordinating or asking another person or political action committee to make a contribution to an official who can influence adviser selection or make a payment to a political party of the state or locality where the adviser is seeking to provide advisory services to the government entity.

The proposed rules would also prohibit an adviser and its covered associates from paying a third party to solicit advisory business from a government entity on behalf of the investment adviser. Additionally, the proposed rules would prohibit an adviser and its covered associates from engaging in any indirect "pay to play" conduct that would violate the rule if the adviser or covered associate did it directly, such as contributing to an official via a spouse, lawyer or company affiliated with the adviser or associate.

Record-Keeping Requirements
The proposed rules would require an adviser to make and keep the following records:

(i) the names, titles and business and residence addresses of all covered associates of the investment adviser;

(ii) all government entities for which the investment adviser or any of its covered associates is providing or seeking to provide investment advisory services, or which are investors or are solicited to invest in any covered investment pool to which the investment adviser provides investment advisory services, as applicable;

(iii) all government entities to which the investment adviser has provided investment advisory services, along with any related covered investment pools to which the investment adviser has provided investment advisory services and in which the government entity has invested, as applicable, in the past five years, but not prior to the effective date of the proposed rule; and

(iv) all direct or indirect contributions or payments made by the investment adviser or any of its covered associates to an official of a government entity, a political party of a state or political subdivision thereof, or a political action committee.

The SEC is soliciting comments on the proposed rules until October 6, 2009.

Link to SEC Release