SEC to Propose Rules on Investment Adviser Pay-to-Play

Article

Corporate & Finance Alert

August 4, 2009

The Securities and Exchange Commission (the “SEC”), at its open meeting on July 22, 2009, voted unanimously to propose rules banning pay-to-play practices by investment advisers to governmental defined benefit pension plans. The rules will also apply to managers of mutual funds offered as investment options in governmental defined contribution plans established under Sections 401(k), 403(b), and 457 of the Internal Revenue Code, and in Section 529 college investment plans. The rules are largely based on Municipal Securities Rulemaking Board Rule G-37, which bans pay-to-play practices by municipal finance dealers, their high level executives, and the professionals who perform municipal finance services. Pay-to-play refers to the practice of investment advisers and managers making campaign contributions to candidates and officeholders, who then award contracts based on the contributions, rather than on an investment adviser’s or manager’s skill and track record.

The SEC will publish its proposal in the Federal Register, and members of the public will have sixty days to submit comments.

Under the proposed rules, an investment adviser or manager who makes a campaign contribution to an elected official in a position to influence the selection of the adviser or manager will be barred from providing investment services for compensation for two years. The prohibition on campaign contributions will apply to the investment advisory or management firm, its political action committees, its high level executives, and its professionals who perform the investment services. The campaign contributions subject to the prohibition are contributions to political incumbents and the candidates for elective office who can influence the selection of an investment adviser or manager.

There is a de minimis exception that permits a covered executive or professional to make contributions of up to $250 per election per candidate if the contributor is entitled to vote for the candidate.

The proposed rule also contains a ban on solicitation of contributions. The rule prohibits the investment advisory or management firm, its high level executives, and its investment professionals from coordinating or soliciting another person or political action committee to make a contribution to an incumbent or candidate, or to make a payment to a political party of the state or locality in which the adviser or manager is seeking to provide services.

The proposed rule also prohibits the investment advisory or management firm, its high level executives, and its investment professionals from paying a third-party, such as a solicitor or placement agent, to solicit a government client.

Finally, the proposed rule will prohibit practices aimed at skirting the ban on pay-to-play practices. These practices include directing or funding contributions through third-parties, such as spouses, lawyers, and companies affiliated with the firm. The SEC will also consider the potential for circumvention through making charitable contributions in lieu of political contributions.

It is important to note that the New Jersey State Investment Council adopted regulations in 2005 banning pay-to-play practices by investment management firms that provide services to State Pension and Annuity Fund clients. The regulations, like the proposed SEC rule, are largely based on Municipal Securities Rulemaking Board Rule G-37. Since the SEC rule will extend beyond State Pension and Annuity Fund clients, its reach will be broader than the State Investment Council regulations.

Should you have any questions regarding your own situation, please contact Steven H. Sholk of our Corporate Department.