Expect the Inquisition: Dissent from Obra Capital Management, LLC

Sometimes heeding the advice of your high school civics teacher to get involved in the political process and support your preferred candidate carries unexpected costs imposed from unanticipated quarters. Today’s settlement with Obra Capital Management, LLC[1] is yet another reminder that when it comes to participation in the political process by means of contributions to preferred candidates, investment advisers, their associated persons, and anyone who might be looking for a job at an investment adviser always should expect the Commission’s inquisition.

In December 2019, “an individual”—for ease of reference, we shall call him Bob—contributed $7,150 to a Michigan government official. According to the Order Instituting Proceedings (“OIP”), “the office of the government official had the ability to influence the hiring of investment advisers” through appointments to the Michigan Investment Board. When Bob made this contribution, the Michigan Public Employees’ Retirement Fund, which was subject to the influence of the Michigan Investment Board, was approximately two years in on an investment in a private, closed-end fund advised by Obra Capital. The Michigan pension fund “was not able to increase or withdraw its investment from the [closed-end] Fund.” In July 2020—about three years after that investment and just more than six months after his political contribution—“Obra Capital hired [Bob] into a position in which [he] was a covered associate of Obra Capital.”[2] Then, “[b]etween September 2020 and May 2021, [Bob] solicited government entities for Obra Capital by attending and participating in meetings and presentations with government entities who were invested or solicited to invest in funds advised by Obra Capital.” According to the OIP, Bob’s participation in soliciting government entities triggered the two-year lookback provision, which captures not only contributions by persons who are covered associates at the time of the contribution, but also contributions by “a person who becomes a covered associate within two years after the contribution is made.”[3] With the two-year lookback triggered, Obra Capital ran afoul of the pay-to-play rule because it continued to receive investment advisory fees from the Michigan Public Employees’ Retirement Fund’s longstanding investment in the closed-end fund after Bob solicited government entities.

Especially notable is what the Order does not say. It states that Bob “solicited government entities.” It does not state that he solicited any Michigan government entities. Once Bob was a covered associate who solicited any government entity, his prior contribution to the covered Michigan government official meant that Obra Capital could not receive fees related to the Michigan pension fund’s investment in the closed-end fund. It does not matter that neither Bob’s past contribution nor his present solicitation had any nexus to the ongoing fees received by Obra Capital.

Also notable is the focus on mere solicitation of investments, which indicates that an actual investment decision is not required. Unsuccessful solicitation is enough to trigger a violation of the rule when paired with ongoing receipt of fees on longstanding investments. It does not matter that the investment decision pre-dated the contribution; receiving fees counts as “provid[ing] investment advisory services for compensation,” even though the relevant investment decision was made years earlier.

Advisers Act Section 206(4) provides the Commission broad authority to “define, and prescribe means reasonably designed” to prevent acts, practices, or courses of business that are fraudulent, deceptive, or manipulative.[4] Yet, as the Second Circuit noted years ago when construing a similar provision in the Securities Exchange Act of 1934, “the SEC’s rulemaking power under this broad grant of authority is not unlimited. The rule must still be reasonably related to the purposes of the enabling legislation.”[5] The Commission’s pay-to-play rule begins with the dubious assertion that it is “a means reasonably designed to prevent fraudulent, deceptive, or manipulative acts, practices, or courses of business.”[6] This assertion is in tension with the fact that, as interpreted and applied, the pay-to-play rule “does not require a showing of a quid pro quo or actual intent to influence and elected official or candidate.” The facts in this proceeding illustrate the tension. There is no rational connection between a contribution to a Michigan official and solicitation of government entities in other states. Similarly, there is no rational connection between the ongoing fees received in consequence of an investment decision made by a government entity potentially influenced by a government official in prior years and a contribution made to a different, second government official years later, especially when neither the subsequent government official nor her appointees can undo the previous decision.[7]

When we adopt and enforce rules that effectively chill a person’s right to engage in political activity,[8] we must be scrupulous in our articulation of a close nexus between the disfavored conduct and the fraudulent conduct prevented. Because today’s application of the pay-to-play rule’s sweeping prohibition captures conduct that lacks any reasonable probability of unduly influencing actual investment decisions—the fraudulent conduct we seek to prevent—I must dissent.