Friday, July 9, 2010

SEC Adopts New "Pay to Play" Rule

On June 30, 2010, the SEC unanimously approved new Rule 206(4)-5 (the "Rule") under the Investment Advisers Act of 1940, designed to restrict "pay to play" practices by investment advisers.

Pay to play is a practice in which an investment adviser seeks to influence a government official’s award of a potentially lucrative investment advisory contract by making or soliciting political contributions to that official. The motivation behind the Rule, as noted in the SEC press release, is the notion that "selection of investment advisers to manage public plans should be based on the best interests of the plans and their beneficiaries, not kickbacks and favors."

The Rule attempts to diminish pay to play practices through three important prohibitions:

  1. If an investment adviser makes a contribution to a government official or candidate who is or will be able to influence the selection of advisory work for a government entity, that investment adviser may not, within the following two-year period, receive compensation -- either directly or through a pooled fund -- for providing advisory services to that government entity.

  2. An investment adviser may not pay third parties to solicit advisory work from government entities unless the third parties are registered with the SEC as investment advisers or broker-dealers and are subject to similar pay to play restrictions.

  3. An investment adviser and certain executives or employees of an investment adviser may not solicit or coordinate either (i) contributions to an official of a government entity to which the investment adviser is seeking to provide investment advisory services; or (ii) payments to a political party of a state or locality where the investment adviser is providing or seeking to provide investment advisory services to a government entity.
The Rule also prohibits an investment adviser from doing anything indirectly which, if done directly, would violate the Rule. This prohibition attempts to prevent investment advisers and government officials from circumventing the explicit prohibitions of the Rule.

The Rule does contain an exception for de minimis contributions by executives or employees of the investment adviser. This exception allows, per election, contributions of up to $350 to an official or candidate for whom the individual can vote and up to $150 to an official or candidate for whom the individual cannot vote.

The Rule will be effective 60 days after publication in the Federal Register. Investment advisers generally will be required to comply with the Rule within six months of the effective date.