Advisers Act Rule 206(4)-5 (Political Contributions by Certain Investment Advisers)

A Small Entity Compliance Guide¹

Introduction

The Securities and Exchange Commission ("SEC" or "Commission") approved a new rule on June 30, 2010 to address so-called "pay to play" practices in which investment advisers make campaign contributions to elected officials in order to influence the award of contracts to manage public pension plan assets and other government investment accounts.

The rule is intended to combat pay to play arrangements in which advisers are chosen based on their campaign contributions to political officials rather than on merit. The potential for fraud to invade the various, intertwined relationships created by pay to play arrangements is without question, and the new rule is meant to reduce the occurrence of fraudulent conduct resulting from these practices and to protect public pension plans, beneficiaries, and other investors from the resulting harms. Pay to play practices often are not explicit, but have been widely reported.

Pay to play practices could, for example, lead a political official to choose an investment adviser with higher fees or inferior investment performance because the adviser contributed funds to the official's election campaign. Choosing an adviser with higher fees or weaker performance could harm retirees who rely on public pension plans. Moreover, advisers' participation in pay to play activities may diminish investor confidence, as pay to play practices are inconsistent with the high standards of ethical conduct required of investment advisers.

Importantly, the rule would not ban or limit the amount of political contributions an adviser or its covered associates could make; rather, it would impose a limited "time-out" on conducting advisory business for compensation with a government client after a contribution is made.

Advisers Act Rule 206(4)-5

The new rule, adopted under the Investment Advisers Act of 1940, applies to SEC-registered investment advisers and certain advisers exempt from registration with the SEC who provide investment advisory services, or are seeking to provide investment advisory services, to government entities. The rule subjects these advisers to several restrictions designed to curb pay to play activities. In particular, the rule prohibits:

• an investment adviser from providing advisory services for compensation to a government entity, either directly or through a pooled investment vehicle (specifically, a private fund or a registered investment company that is an investment option of a participant-directed plan or program of a government entity, including a college savings plan like a 529 plan and a retirement plan like a 403(b) or 457 plan), for two years after the adviser or certain of its executives or employees makes political contributions above specified thresholds to an elected official or candidate for political office if the office is directly or indirectly responsible for, or can influence that government entity's selection of the adviser;
   
• an investment adviser and certain of its executives and employees from paying or agreeing to pay a third-party placement agent or "finder" to solicit business from a government entity on the adviser's behalf unless the third party is a registered broker-dealer or SEC-registered investment adviser subject to pay to play restrictions; and
   
• an investment adviser and certain of its executives and employees from soliciting or coordinating contributions (i.e., "bundling") from others to a political official, candidate or political party in a state or locality where the adviser provides or is seeking to provide advisory services.

Rule 206(4)-5 includes a provision that makes it unlawful for an adviser or certain of its executives or employees to do anything indirectly which, if done directly, would result in a violation of the rule. The rule allows investment advisers subject to the rule to apply for an exemption. In addition, an SEC-registered investment adviser subject to the rule also will have to maintain certain records under a related amendment to the Investment Advisers Act recordkeeping rule that the Commission adopted along with the new rule.

Other Resources

The text of Rule 206(4)-5 can be accessed through the "Laws and Rules" section of the Division of Investment Management page of the SEC's website at http://www.sec.gov/divisions/investment.shtml

Contacting the SEC

The SEC's Division of Investment Management is happy to assist small investment advisers with questions regarding Rule 206(4)-5. The Division's Office of Investment Adviser Regulation answers questions submitted by e-mail and telephone. You can submit a question by e-mail to iarules@sec.gov and a staff member of the office will call you to discuss your question. In addition, you can contact the Office of Investment Adviser Regulation at (202) 551-6787. Questions on other investment management matters concerning small companies may be directed to the Division's Office of Chief Counsel by e-mail at IMOCC@sec.gov, or by telephone at (202) 551-6825.

Endnotes

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¹ This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a "small entity compliance guide" under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains rules adopted by the SEC, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.

http://www.sec.gov/rules/final/2010/ia-3043-secg.htm