New SEC rules regarding political contributions by certain investment advisers – dubbed the pay to play rules – become operative on March 14, 2011. These rules generally prohibit registered and certain unregistered advisers from engaging in various political contribution practices with a quid-pro-quo element.
This article summarizes the scope of these new rules and the investment advisers subject to them and suggests some practical considerations for fund managers affected by the rules.
Scope of the pay to play rules
The pay to play rules set out in Rule 206(4)-5 under the Investment Advisers Act of 1940 have three main components:
Two-year “time out” for contributions. An investment adviser may not provide advisory services for compensation, either directly or indirectly through its associates or pooled vehicles, for two years, if the adviser or certain of its executives or employees make a political “contribution” to an incumbent, candidate, or successful candidate for elective office of a “government entity” and the office is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser. A “contribution” includes any gift, subscription, loan, advance, deposit of money or anything of value made for the purpose of influencing an election for a federal, state or local office, including any payments for debts incurred in such an election and including any transition or inaugural expenses incurred by a successful candidate for state or local office. A “government entity” includes all state and local governments, their agencies and instrumentalities, and all public pension plans and other collective government funds. Certain de minimis contributions are permitted in limited circumstances.
Similar to rules currently applicable to municipal securities broker-dealers, the two-year time out is intended to discourage advisers from participating in pay to play practices by requiring a “cooling-off period” during which the effects of a political contribution on the process for selecting an adviser can be expected to dissipate.
Restrictions on soliciting and coordinating contributions and payment. Investment advisors and certain executives and employees may not solicit or coordinate campaign contributions from others for an elected official who is in a position to influence the selection of the adviser. The new rules also prohibit solicitation and coordination of payments to political parties in the state or locality where the adviser is seeking business. These restrictions are intended to prevent advisers from circumventing the rule’s prohibition on direct contributions to certain elected officials by “bundling” a large number of small employee contributions to influence an election, or making contributions (or payments) indirectly through a state or local political party.
Ban on third-party solicitations. An investment adviser and its associates may not pay a third party, such as a solicitor or placement agent, to solicit a government client on behalf of the investment adviser, unless that third party is an SEC-registered investment adviser or broker-dealer subject to similar pay to play restrictions. This provision is mainly intended to avoid circumvention of the pay to play rules through the use of third-party solicitors.
While the new pay to play rules became effective September 13, 2010, they have delayed dates on which they become operative. Fund managers must be in compliance with the new rules by March 14, 2011 in most cases. With respect to the ban on payments to third parties, compliance is required by September 13, 2011.
Who is subject to the pay to play rules?
The pay to play rules are intentionally broad and apply to both registered and unregistered investment advisers.
As previously adopted, Rule 206(4)-5 applies to investment advisers that are either registered with the SEC or unregistered in reliance on the "private adviser" exemption for advisers with 15 or fewer clients set forth in Section 203(b)(3) of the Investment Advisers Act of 1940. As discussed previously in The Venture Alley, the Dodd-Frank Act eliminated the “private adviser” exemption, replacing it with new exemptions for advisers to venture capital funds, foreign private advisers and funds with less than $150 million in assets under management. Given that the new pay to play rules require compliance by March 14, 2011 but the Dodd-Frank Act repeal of the private adviser exemption does not become effective until July 21, 2011, advisers currently relying on the private adviser exemption will be subject to the pay to play rules on March 14.
In rules proposed pursuant to the Dodd-Frank Act, the SEC has proposed revising Rule 206(4)-5 to provide that the pay to play rules apply to exempt reporting advisers (including advisers to venture capital funds and funds with less than $150 million in assets under management) and to foreign private advisers. The SEC is proposing this change to ensure that the intentionally broad scope of the pay to play rules is not inadvertently narrowed by the new Dodd-Frank Act.
Considerations for fund managers
Fund managers should be planning now for compliance with the new pay to play rules. Among other things, fund managers should review their historical practices and institute policies, procedures and training to ensure compliance with the new rules. Should you have any questions regarding implementation of the new rules, please feel free to contact your DLA Piper lawyer or Andrew Ledbetter.