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[FR Doc. 2010-16559 Filed 07/13/2010 at 8:45 am; Publication Date: 07/14/2010]
8010-01P
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 275
Release No. IA-3043; File No. S7-18-09
RIN 3235-AK39
Political Contributions by Certain Investment Advisers
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
SUMMARY: The Securities and Exchange Commission is adopting a new rule under
the Investment Advisers Act of 1940 that prohibits an investment adviser from providing
advisory services for compensation to a government client for two years after the adviser
or certain of its executives or employees make a contribution to certain elected officials
or candidates. The new rule also prohibits an adviser from providing or agreeing to
provide, directly or indirectly, payment to any third party for a solicitation of advisory
business from any government entity on behalf of such adviser, unless such third parties
are registered broker-dealers or registered investment advisers, in each case themselves
subject to pay to play restrictions. Additionally, the new rule prevents an adviser from
soliciting from others, or coordinating, contributions to certain elected officials or
candidates or payments to political parties where the adviser is providing or seeking
government business. The Commission also is adopting rule amendments that require a
registered adviser to maintain certain records of the political contributions made by the
adviser or certain of its executives or employees. The new rule and rule amendments
address “pay to play” practices by investment advisers.
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DATES: Effective Date: [insert date 60 days after publication in Federal Register].
Compliance Dates: Investment advisers subject to rule 206(4)-5 must be in compliance
with the rule on March 14, 2011. Investment advisers may no longer use third parties to
solicit government business except in compliance with the rule on September 13, 2011.
Advisers to registered investment companies that are covered investment pools must
comply with the rule by September 13, 2011. Advisers subject to rule 204-2 must
comply with amended rule 204-2 on March 14, 2011. However, if they advise registered
investment companies that are covered investment pools, they have until September 13,
2011 to comply with the amended recordkeeping rule with respect to those registered
investment companies. See section III of this Release for further discussion of
compliance dates.
FOR FURTHER INFORMATION CONTACT: Melissa A. Roverts, Senior Counsel,
Matthew N. Goldin, Branch Chief, Daniel S. Kahl, Branch Chief, or Sarah A. Bessin,
Assistant Director, at (202) 551-6787 or IArules@sec.gov, Office of Investment Adviser
Regulation, Division of Investment Management, U.S. Securities and Exchange
Commission, 100 F Street, NE, Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is adopting rule 206(4)-5
[17 CFR 275.206(4)-5] and amendments to rules 204-2 [17 CFR 275.204-2] and 206(4)-3
[17 CFR 275.206(4)-3] under the Investment Advisers Act of 1940 [15 U.S.C. 80b]
(“Advisers Act” or “Act”).1
15 U.S.C. 80b. Unless otherwise noted, when we refer to the Advisers Act, or any
paragraph of the Advisers Act, we are referring to 15 U.S.C. 80b of the United States
Code, at which the Advisers Act is codified, and when we refer to rule 206(4)-5, rule
204-2, rule 204A-1, rule 206(4)-3, or any paragraph of these rules, we are referring to 17
CFR 275.206(4)-5, 17 CFR 275.204-2, 17 CFR 275.204A-1 and 17 CFR 275.206(4)-3,
respectively, of the Code of Federal Regulations, in which these rules are published.
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TABLE OF CONTENTS
I.
BACKGROUND
II.
DISCUSSION
A. First Amendment Considerations
B. Rule 206(4)-5
1. Advisers Subject to the Rule
2. Pay to Play Restrictions
(a) Two-Year “Time Out” for Contributions
(1) Prohibition on Compensation
(2) Officials of a Government Entity
(3) Contributions
(4) Covered Associates
(5) “Look Back”
(6) Exceptions for De Minimis Contributions
(7) Exception for Certain Returned Contributions
(b) Ban on Using Third Parties to Solicit Government Business
(1) Registered Broker-Dealers
(2) Registered Investment Advisers
(c) Restrictions on Soliciting and Coordinating Contributions and Payments
(d) Direct and Indirect Contributions or Solicitations
(e) Covered Investment Pools
(1) Definition of “Covered Investment Pool”
(2) Application of the Rule
(3) Subadvisory Arrangements
(f) Exemptions
D. Recordkeeping
E. Amendment to Cash Solicitation Rule
III.
EFFECTIVE AND COMPLIANCE DATES
A.
Two-Year Time Out and Prohibition on Soliciting or
Coordinating Contributions
B.
Prohibition on Using Third Parties to Solicit Government Business and Cash
Solicitation Rule Amendment
C. Recordkeeping
D. Registered Investment Companies
IV.
COST-BENEFIT ANALYSIS
A. Benefits
B. Costs
1. Compliance Costs Related to Rule 206(4)-5
2. Other Costs Related to Rule 206(4)-5
(a) Two-Year Time Out
(b) Third-Party Solicitor Ban
3. Costs Related to the Amendments to Rule 204-2
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V.
PAPERWORK REDUCTION ACT
A. Rule 204-2
B. Rule 206(4)-3
C. Rule 206(4)-7
D. Rule 0-4
VI.
FINAL REGULATORY FLEXIBILITY ANALYSIS
A. Need for the Rule
B. Significant Issues Raised by Public Comment
C. Small Entities Subject to Rule
D. Projected Reporting, Recordkeeping, and Other Compliance Requirements
E. Agency Action to Minimize Effect on Small Entities
VII.
EFFECTS ON COMPETITION, EFFICIENCY AND CAPITAL
FORMATION
VIII.
STATUTORY AUTHORITY
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I. BACKGROUND
Investment advisers provide a wide variety of advisory services to state and local
governments,2 including managing their public pension plans.3 These pension plans
have over $2.6 trillion of assets and represent one-third of all U.S. pension assets.4 They
are among the largest and most active institutional investors in the United States;5 the
management of these funds affects publicly held companies6 and the securities markets.7
But most significantly, their management affects taxpayers and the beneficiaries of these
2
See SOFIA ANASTOPOULOS, AN INTRODUCTION TO INVESTMENT ADVISERS FOR STATE
AND LOCAL GOVERNMENTS (2d ed. 2007); Werner Paul Zorn, Public Employee
Retirement Systems and Benefits, LOCAL GOVERNMENT FINANCE, CONCEPTS AND
PRACTICES 376 (John E. Peterson & Dennis R. Strachota eds., 1st ed. 1991) (discussing
the services investment advisers provide for public funds).
3
To simplify the discussion, we use the term “public pension plan” interchangeably with
“government client” and “government entity” in this Release. However, our rule applies
broadly to investment advisory activities for government clients, such as those mentioned
here in this Section of the Release, regardless of whether they are retirement funds. For a
discussion of how the proposed rule would apply with respect to investment programs or
plans sponsored or established by government entities, such as “qualified tuition plans”
authorized by section 529 of the Internal Revenue Code [26 U.S.C. 529] and retirement
plans authorized by section 403(b) or 457 of the Internal Revenue Code [26 U.S.C.
403(b) or 457], see section II.B.2(e) of this Release.
4
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, FLOW OF FUNDS ACCOUNTS
OF THE UNITED STATES, FLOWS AND OUTSTANDINGS, FOURTH QUARTER 2009 78
tbl.L.119 (Mar. 11, 2010). Since 2002, total financial assets of public pension funds
have grown by 28%. Id.
5
According to a recent survey, seven of the ten largest pension funds were sponsored by
state and municipal governments. The Top 200 Pension Funds/Sponsors, PENS. & INV.
(Sept. 30, 2008), available at
http://www.pionline.com/article/20090126/CHART/901209995.
6
See Stephen J. Choi & Jill E. Fisch, On Beyond CalPERS: Survey Evidence on the
Developing Role of Public Pension Funds in Corporate Governance, 61 VAND. L.
REV. 315 (2008) (“Collectively, public pension funds have the potential to be a powerful
shareholder force, and the example of CalPERS and its activities have spurred many to
advocate greater institutional activism.”).
7
Federal Reserve reports indicate that, of the $2.6 trillion in non-federal government plans,
$1.5 trillion is invested in corporate equities. BOARD OF GOVERNORS OF THE FEDERAL
RESERVE SYSTEM, supra note 4, at 78 tbl.L.119.
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funds, including the millions of present and future state and municipal retirees8 who rely
on the funds for their pensions and other benefits.9 Public pension plan assets are held,
administered and managed by government officials who often are responsible for
selecting investment advisers to manage the funds they oversee.
Elected officials who allow political contributions to play a role in the
management of these assets and who use these assets to reward contributors violate the
public trust. Moreover, they undermine the fairness of the process by which public
contracts are awarded. Similarly, investment advisers that seek to influence government
officials’ awards of advisory contracts by making or soliciting political contributions to
those officials compromise their fiduciary duties to the pension plans they advise and
defraud prospective clients. These practices, known as “pay to play,” distort the process
by which advisers are selected.10 They can harm pension plans that may subsequently
receive inferior advisory services and pay higher fees. Ultimately, these violations of
trust can harm the millions of retirees that rely on the plan or the taxpayers of the state
and municipal governments that must honor those obligations.11
8
See PAUL ZORN, 1997 SURVEY OF STATE AND LOCAL GOVERNMENT EMPLOYEE
RETIREMENT SYSTEMS 61 (1997) (hereinafter “1997 SURVEY”) (“[t]he investment of
plan assets is an issue of immense consequence to plan participants, taxpayers, and to the
economy as a whole” as a low rate of return will require additional funding from the
sponsoring government, which “can place an additional strain on the sponsoring
government and may require tax increases”).
9
The most current census data reports that public pension funds have 18.6 million
beneficiaries. 2007 Census of Governments, U.S. Bureau of Census, Number and
Membership of State and Local Government Employee-Retirement Systems by State:
2006-2007 (2007) (at Table 5), available at
http://www.census.gov/govs/retire/2007ret05.html.
10
Among other things, pay to play practices may manipulate the market for advisory
services by creating an uneven playing field among investment advisers. These practices
also may hurt smaller advisers that cannot afford the required contributions.
11
See1997 SURVEY, supra note 8.
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Pay to play practices are rarely explicit: participants do not typically let it be
publicly known that contributions or payments are made or accepted for the purpose of
influencing the selection of an adviser. As one court noted, “[w]hile the risk of
corruption is obvious and substantial, actors in this field are presumably shrewd enough
to structure their relations rather indirectly.”12 Pay to play practices may take a variety of
forms, including an adviser’s direct contributions to government officials, an adviser’s
solicitation of third parties to make contributions or payments to government officials or
political parties in the state or locality where the adviser seeks to provide services, or an
adviser’s payments to third parties to solicit (or as a condition of obtaining) government
business. As a result, the full extent of pay to play practice remains hidden and is often
hard to prove.
Public pension plans are particularly vulnerable to pay to play practices.
Management decisions over these investment pools, some of which are quite large, are
typically made by one or more trustees who are (or are appointed by) elected officials.
And the elected officials or appointed trustees that govern the funds are also often
involved, directly or indirectly, in selecting advisers to manage the public pension funds’
assets. These officials may have the sole authority to select advisers,13 may be members
of a governing board that selects advisers,14 or may appoint some or all of the board
members who make the selection.15
12 Blount v. SEC, 61 F.3d 938, 945 (D.C. Cir. 1995), cert. denied, 517 U.S. 1119 (1996).
13 See, e.g., 2 N.Y. COMP. CODES R. & REGS. TIT. 2 § 320.2 (2009) (placement of state and
local government retirement systems assets (valued at $109 billion as of March 2009) is
under the sole custodianship of the New York State Comptroller).
14 See, e.g., S.C. CODE ANN. §§ 9-1-20, 1-11-10 (2008) (board consists of all elected
officials); CAL. GOV’T CODE § 20090 (Deering 2008) (board consists of some elected
officials, some appointed members, and some representatives of interest groups chosen
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Numerous developments in recent years have led us to conclude that the selection
of advisers, whom we regulate under the Investment Advisers Act, has been influenced
by political contributions and that, as a result, the quality of management service
provided to public funds may be negatively affected. We have been particularly
concerned that these contributions have been funneled through “solicitors” and
“placement agents” that advisers engage (or believe they must engage) in order to secure
a client relationship with a public pension plan or an investment from one.16 As we will
discuss in more detail below, in such an arrangement the contribution may be made in the
form of a substantial fee for what may constitute no more than an introduction service by
a “well connected” individual who may use the proceeds of the fee to make (or reimburse
himself for having made) political contributions or provide some form of a “kickback” to
an official or his or her family or friends.17
by the members of those groups); MD. CODE ANN., STATE PERS. & PENS. § 21-104
(2008) (pension board consists of some elected officials, some appointed members, and
some representatives of interest groups chosen by the members of those groups).
15
See, e.g., ARIZ. REV. STAT. ANN. § 38-713 (2008) (governor appoints all nine members);
HAWAII REV. STAT. § 88-24 (2008) (governor appoints three of eight members); IDAHO
CODE ANN. § 59-1304 (2008) (governor appoints all five members).
16
For example, in one recent action we alleged that, in connection with a pay to play
scheme in New York State, investment advisers paid sham “placement agent” fees,
portions of which were funneled to public officials, as a means of obtaining public
pension fund investments in the funds those advisers managed and that participants, in
some instances, concealed the third-party solicitor’s role in transactions from the
investment management firms that paid fees to the solicitor by making misrepresentations
about the solicitor’s involvement and covertly using one of the solicitor’s legal entities as
an intermediary to funnel payments to the solicitor. SEC v. Henry Morris, et al.,
Litigation Release No. 20963 (Mar. 19, 2009).
17
See id. (along with the Commission’s complaint in the action, available by way of a
hyperlink from the litigation release). See also, e.g., In the Matter of Quadrangle Group
LLC, AGNY Investigation No. 2010-044 (Apr. 15, 2010) (finding that “private equity
firms and hedge funds frequently use placement agents, finders, lobbyists, and other
intermediaries . . . to obtain investments from public pension funds . . . , that these
placement agents are frequently politically connected individuals selling access to public
money. . .”); Complaint, Cal. v. Villalobos, et al., No. SC107850 (Cal. Super. Ct., W.
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The details of pay to play arrangements have been widely reported as a
consequence of the growing number of actions that we and state authorities have brought
involving investment advisers seeking to manage the considerable assets of the New
York State Common Retirement Fund.18 In addition, we have brought enforcement
actions against the former treasurer of the State of Connecticut and other parties in which
we alleged that the former treasurer awarded state pension fund investments to private
equity fund managers in exchange for payments, including political contributions,
funneled through the former treasurer’s friends and political associates.19 Criminal
Dist. of L.A. County, May 5, 2010), available at
http://ag.ca.gov/cms_attachments/press/pdfs/n1915_filed_complaint_for_civil_penalties.
pdf (alleging, inter alia, that a top executive and a board member at CalPERS accepted
various gifts from a former CalPERS board member, “known among private equity firms
as a person who attempts to exert pressure on CalPERS’ representatives,” who was acting
as a placement agent trying to secure investments from the California public pension
fund).
18
See SEC v. Henry Morris, et al., Litigation Release No. 21036 (May 12, 2009); In the
Matter of Quadrangle Group LLC, AGNY Investigation No. 2010-044 (Apr. 15, 2010);
In the Matter of GKM Newport Generation Capital Servs., LLC, AGNY Investigation
No. 2010-017 (Apr. 14, 2010); In the Matter of Kevin McCabe, AGNY Investigation No.
2009-152 (Apr. 14, 2010); In the Matter of Darius Anderson Platinum Advisors LLC,
AGNY Investigation No. 2009-153 (Apr. 14, 2010); In the Matter of Global Strategy
Group, AGNY Investigation No. 2009-161 (Apr. 14, 2010); In the Matter of Freeman
Spogli & Co., AGNY Investigation No. 2009-174 (Feb. 1, 2010); In the Matter of
Falconhead Capital, LLC, AGNY Investigation No. 2009-125 (Sept. 17, 2009); In the
Matter of HM Capital Partners I, LP, AGNY Investigation No. 2009-117 (Sept. 17,
2009); In the Matter of Ares Management LLC, AGNY Investigation No. 2009-173 (Feb.
17, 2010); In the Matter of Levine Leichtman Capital Partners, AGNY Investigation No.
2009-124 (Sept. 17, 2009); In the Matter of Access Capital Partners, AGNY
Investigation No. 09-135 (Sept. 17, 2009); In the Matter of The Markstone Group,
AGNY Investigation No. 10-012 (Feb. 28, 2010); In the Matter of Wetherly Capital
Group, LLC and DAV/Wetherly Financial, L.P., AGNY Investigation No. 2009-172
(Feb. 8, 2010) (in each case, banning the use of third-party placement agents pursuant to
a “Pension Reform Code of Conduct”).
19
See SEC v. Paul J. Silvester, et al., Litigation Release No. 16759 (Oct. 10, 2000);
Litigation Release No. 20027 (Mar. 2, 2007); Litigation Release No. 19583 (Mar. 1,
2006); Litigation Release No. 18461 (Nov. 17, 2003); Litigation Release No. 16834
(Dec. 19, 2000); SEC v. William A. DiBella et al., Litigation Release No. 20498 (Mar. 14,
2008) (2007 U.S. Dist. LEXIS 73850 (D. Conn., May 8, 2007), aff’d 587 F.3d 553 (2nd
Cir. 2009)). See also U.S. v. Ben F. Andrews, Litigation Release No. 19566 (Feb. 15,
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authorities have in recent years brought cases in New York,20 New Mexico,21 Illinois,22
Ohio,23 Connecticut,24 and Florida,25 charging defendants with the same or similar
conduct.
2006); In the Matter of Thayer Capital Partners, TC Equity Partners IV, L.L.C., TC
Management Partners IV, L.L.C., and Frederick V. Malek, Investment Advisers Act
Release No. 2276 (Aug. 12, 2004); In the Matter of Frederick W. McCarthy, Investment
Advisers Act Release No. 2218 (Mar. 5, 2004); In the Matter of Lisa A. Thiesfield,
Investment Advisers Act Release No. 2186 (Oct. 29, 2003).
20
See New York v. Henry “Hank” Morris and David Loglisci, Indictment No. 25/2009 (NY
Mar. 19, 2009) (alleging that the deputy comptroller and a “placement agent” engaged in
enterprise corruption and state securities fraud for selling access to management of public
funds in return for kickbacks and other payments for personal and political gain).
21
See U.S. v. Montoya, Criminal No. 05-2050 JP (D.N.M. Nov. 8, 2005) (the former
treasurer of New Mexico pleaded guilty); U.S. v. Kent Nelson, Criminal Information No.
05-2021 JP, (D.N.M. 2007) (defendant pleaded guilty to one count of mail fraud); U.S. v.
Vigil, 523 F. 3d 1258 (10th Cir. 2008) (affirming the conviction for attempted extortion
of the former treasurer of New Mexico for requiring that a friend be hired by an
investment manager at a high salary in return for the former treasurer’s willingness to
accept a proposal from the manager for government business).
22
See Jeff Coen, et al., State’s Ultimate Insider Indicted, CHI. TRIB., Oct. 31, 2008,
available at http://www.chicagotribune.com/news/local/chi-cellini-31oct31,0,6465036.
story (describing the thirteenth indictment in an Illinois pay to play
probe); Ellen Almer, Oct. 27, 2000, available at http://www.chicagobusiness.com/cgibin/
news.pl?id=775 (discussing the guilty plea of Miriam Santos, the former treasurer of
the City of Chicago, who told representatives of financial services firms seeking city
business that they were required to raise specified campaign contributions for her and
personally make up any shortfall in the amounts they raised). See also SEC v. Miriam
Santos, et al., Litigation Release No. 17839 (Nov. 14, 2002); Litigation Release No.
19269 (June 14, 2005) (355 F. Supp. 2d 917 (N.D. Ill. 2003)).
23
See Reginald Fields, Four More Convicted in Pension Case: Ex-Board Members
Took Gifts from Firm, CLEVELAND PLAIN DEALER, Sept. 20, 2006 (addressing pay to
play activities of members of the Ohio Teachers Retirement System).
24
See U.S. v. Joseph P. Ganim, 2007 U.S. App. LEXIS 29367 (2d Cir. 2007) (affirming the
district court’s decision to uphold an indictment of the former mayor of Bridgeport,
Connecticut, in connection with his conviction for, among other things, requiring
payment from an investment adviser in return for city business); U.S. v. Triumph Capital
Group, et al., No. 300CR217 JBA (D. Conn. 2000) (the former treasurer, along with
certain others, pleaded guilty—while others were ultimately convicted). One of the
defendants, who had been convicted at trial, recently won a new trial. U.S. v. Triumph
Capital Group, et al., 544 F.3d 149 (2d Cir. 2008).
25
United States v. Poirier, 321 F.3d 1024 (11th Cir.), cert. denied sub nom. deVegter v.
United States, 540 U.S. 874 (2003) (partner at Lazard Freres & Co., a municipal services
firm, was convicted for conspiracy and wire fraud for fraudulently paying $40,000
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Allegations of pay to play activity involving state and municipal pension plans in
other jurisdictions continue to be reported.26 In the course of this rulemaking we received
a letter from one public official detailing the role of pay to play arrangements in the
selection of public pension fund managers and the harms it can inflict on the affected
plans.27 In addition, other public officials wrote to express support for a Commission rule
to prohibit investment advisers from participating in pay to play arrangements.28
On August 3, 2009, we proposed a new antifraud rule under the Advisers Act
designed to prevent investment advisers from obtaining business from government
entities in return for political contributions or fund raising—i.e., from participating in pay
through an intermediary to Fulton County’s independent financial adviser to secure an
assurance that Lazard would be selected for the Fulton County underwriting contract).
26
See, e.g., Aaron Lester, et al., Cahill Taps Firms Tied to State Pension Investor,
BOSTON.COM, Mar. 21, 2010 (suggesting that an investment adviser may have bundled
out-of-state donations to the Massachusetts State Treasurer’s campaign in return for a
state pension fund investment management contract); Kevin McCoy, Do Campaign
Contributions Help Win Pension Fund Deals, USA TODAY, Aug. 28, 2009; Ted
Sherman, Pay to Play Alive and Well in New Jersey, NJ.COM, Nov. 28, 2009 (noting
more generally that pay to play continues to occur with government contracts of all kinds
in New Jersey); Imogen Rose-Smith and Ed Leefeldt, Pension Pay to Play Casts Shadow
Nationwide, INSTITUTIONAL INVESTOR, Oct. 1, 2009 (suggesting connections between a
private equity fund principal’s fundraising activities and pension investments in the
fund). See also sources cited supra note 17.
27
Comment Letter of Suzanne R. Weber, Erie County Controller (Oct. 6, 2009) (“Weber
Letter”) (“I have seen money managers awarded contracts with our fund which involved
payments to individuals who served as middlemen, creating needless expense for the
fund. These middlemen were political contributors to the campaigns of board members
who voted to contract for money management services with the companies who paid
them as middlemen.”). See also Comment Letter of David R. Pohndorf (Aug. 4, 2009)
(“Pohndorf Letter”) (noting that when the sole trustee of a major pension fund changed
several years ago, a firm managing some of the fund’s assets “began to receive
invitations to fundraising events for the new trustee with suggested donation amounts.”).
28
See, e.g., Comment Letter of New York State Comptroller Thomas P. DiNapoli (Oct. 2,
2009) (“DiNapoli Letter”); Comment Letter of New York City Mayor Michael R.
Bloomberg (Sept. 9, 2009) (“Bloomberg Letter”). See also Comment Letter of Kentucky
Retirement Systems Trustee Chris Tobe (Sept. 18, 2009) (“Tobe Letter”) (suggesting the
negative effects of pay to play activities on the Kentucky Retirement System’s
investment performance).
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to play practices.29 We modeled our proposed rule on those adopted by the Municipal
Securities Rulemaking Board, or MSRB, which since 1994 has prohibited municipal
securities dealers from participating in pay to play practices.30 We believe these rules
have significantly curbed pay to play practices in the municipal securities market.31
Along the lines of MSRB rule G-37,32 our proposed rule would have prohibited an
investment adviser from providing advisory services for compensation to a government
client for two years after the adviser or certain of its executives or employees make a
contribution to certain elected officials or candidates.33 It also would have prohibited an
adviser and certain of its executives and employees from soliciting from others, or
coordinating, contributions to certain elected officials or candidates or payments to
political parties where the adviser is providing or seeking government business.34 In
29
Political Contributions by Certain Investment Advisers, Investment Advisers Act Release
No. 2910 (Aug. 3, 2009) [74 FR 39840 (Aug. 7, 2009)] (the “Proposing Release”).
30
MSRB rule G-37 was approved by the Commission and adopted in 1994. See In the
Matter of Self-Regulatory Organizations; Order Approving Proposed Rule Change by the
Municipal Securities Rulemaking Board Relating to Political Contributions and
Prohibitions on Municipal Securities Business and Notice of Filing and Order Approving
on an Accelerated Basis Amendment No. 1 Relating to the Effective Date and
Contribution Date of the Proposed Rule, Exchange Act Release No. 33868 (Apr. 7, 1994)
[59 FR 17621 (Apr. 13, 1994)]. The MSRB’s pay to play rules include MSRB rules G37
and G-38. They are available on the MSRB’s Web site at
http://www.msrb.org/msrb1/rules/ruleg37.htm and
http://www.msrb.org/msrb1/rules/ruleg38.htm, respectively.
31
See Proposing Release, at n.23. See also infra note 101; Comment Letter of the
Municipal Securities Rulemaking Board (Oct. 23, 2009) (“MSRB Letter”); Comment
Letter of Common Cause (Oct. 6, 2009) (“Common Cause Letter”).
32
See MSRB rule G-37(b). Our proposal, like MSRB rule G-37, was designed to address
our concern that pay to play activities were “undermining the integrity” of the relevant
market, in particular the market for the provision of investment advisory services to
government entity clients. See Blount, 61 F.3d at 939 (referring to the MSRB’s concerns
that pay to play practices were “undermining the integrity of the $250 billion municipal
securities market” as its motivation for proposing MSRB rule G-37).
33
Proposed rule 206(4)-5(a)(1). See also MSRB rule G-37(b).
34
Proposed rule 206(4)-5(a)(2)(ii). See also MSRB rule G-37(c).
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addition, similar to MSRB rule G-38,35 our proposed rule would have prohibited the use
of third parties to solicit government business.36 We also proposed amendments to rule
204-2 under the Advisers Act that would have required registered advisers to maintain
certain records regarding political contributions and government clients. As discussed in
more detail below, our proposed rule departed in some respects from the MSRB rules to
reflect differences between advisers and broker-dealers and the scope of the statutory
authority we have sought to exercise.
We received some 250 comment letters on our proposal, many of which were
from advisers, third-party solicitors, placement agents, and their representatives.37 Public
pension plans and their officials were divided—some embraced the rule, including one
that stated that the rule is an important means to “increase transparency and public
confidence in the investment activities of all public pension funds,”38 while others were
critical, arguing, for example, that our proposal “may result in unintended hardships
being placed upon public pension funds.”39 We received no letters from plan
beneficiaries whom we sought to protect with the proposed rule,40 although two public
35
See MSRB rule G-38(a).
36
Proposed rule 206(4)-5(a)(2)(i).
37
Other commenters included pension plans and their officials, trade associations, law
firms, and public interest groups. Comments letters submitted in File No. S7-25-06 are
available on the Commission’s web site at: http://www.sec.gov/comments/s7-1809/
s71809.shtml.
38
Comment Letter of New York City Comptroller William C. Thompson, Jr. (Oct. 6, 2009)
(“Thompson Letter”).
39
Comment Letter of Executive Director and Secretary to the Board of Trustees of the State
Retirement and Pension System of Maryland R. Dean Kenderdine (Oct. 5, 2009).
40
We note, however, that subsequent to our proposal, AFSCME, which represents 1.6
million state and local employees and retirees, issued a report that strongly endorses
sanctions to prevent pay to play activities. AFSCME, ENHANCING PUBLIC RETIREE
PENSION PLAN SECURITY: BEST PRACTICE POLICIES FOR TRUSTEES AND PENSION
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interest groups supported it strongly. 41 Advisers, third-party solicitors and placement
agents, fund sponsors, and others whose business arrangements could be affected by the
rule generally supported our goal of eliminating advisers’ participation in pay to play
practices involving public plans.42 Nonetheless, most of them objected to our adoption
under the Advisers Act of a rule similar to MSRB rules G-37 and G-38.43 Most
particularly opposed the proposed prohibition on payments to third parties for soliciting
SYSTEMS (2010), available at http://www.afscme.org/docs/AFSCME-report-pensionbest-
practices.pdf.
41
See, e.g., Common Cause Letter; Comment Letter of Fund Democracy/Consumer
Federation of America (Oct. 6, 2009) (“Fund Democracy/Consumer Federation Letter”).
42
See, e.g., Comment Letter of the Investment Adviser Association (Oct. 5, 2009) (“IAA
Letter”) (noting “support [for] measures to combat pay to play activities, i.e., the practice
of investment advisers or their employees making political contributions intended to
influence the selection or retention of advisers by government entities. Pay to play
practices undermine the principle that advisers are selected on the basis of competence,
qualifications, expertise, and experience. The practice is unethical and undermines the
integrity of the public pension plan system and the process of selecting investment
advisers.”); Comment Letter of John R. Dempsey (Aug. 8, 2009) (“Dempsey Letter”)
(noting applause for efforts “to stop the ‘pay-to-play’ practice which only serves to
undermine public trust in investment advisors and regulators.”); Comment Letter of Barry
M. Gleicher (Sept. 7, 2009) (noting strong support for the proposal “with no
modifications. . . . The Rule is necessary to curb elaborated practices that would deprive
taxpayers and beneficiaries of cost effective and honest administration of pension
funds”); Tobe Letter.
43
See, e.g., IAA Letter (“We respectfully submit, however, that the structure of the MSRB
rules is not appropriately tailored to the investment advisory business. . . . We believe the
Commission should make significant changes to the Proposal, which would permit it to
accomplish its important goals.”); Comment Letter of Wesley Ogburn (Aug. 4, 2009)
(“Ogburn Letter”); Comment Letter of the Third Party Marketers Association (Aug. 27,
2009) (“3PM Letter”); Comment Letter of Preqin (Aug. 28, 2009) (“Preqin Letter I”)
(suggesting that institutional private equity investors polled favored a private equity
specific proposal rather than relying on the framework from the municipal securities
industry); Comment Letter of Dechert LLP (Oct. 22, 2009) (“Dechert Letter”); Comment
Letter of the Committee on Federal Regulation of Securities of the Section of Business
Law of the American Bar Association (Oct. 13, 2009) (“ABA Letter”); Comment Letter
of Fidelity Investments (Oct. 7, 2009) (“Fidelity Letter”); Comment Letter of Sutherland
Asbill & Brennan LLP (Oct. 6, 2009) (“Sutherland Letter”); Comment Letter of the
Investment Company Institute (Oct. 6, 2009) (“ICI Letter”); Comment Letter of the
Massachusetts Mutual Life Insurance Company (Oct. 6, 2009) (“MassMutual Letter”);
Comment Letter of Skadden, Arps, Slate, Meagher & Flom LLP (Oct. 6, 2009)
(“Skadden Letter”); Comment Letter of the Managed Funds Association (Oct. 6, 2009)
(“MFA Letter”).
--15--
or marketing to government entities modeled on MSRB rule G-38.44 Several urged that,
if we were to adopt a rule based on the approach taken in our proposal, we should
broaden exceptions and exemptions under the rule to accommodate certain business
arrangements.45 We respond to these comments below.46
II.
DISCUSSION
As discussed in more detail below, we have decided to adopt rule 206(4)-5, which
we have revised to reflect comments we received. For the reasons we discuss above and
in the Proposing Release, we believe rule 206(4)-5 is a proper exercise of our rulemaking
authority under the Advisers Act to prevent fraudulent and manipulative conduct.
The Commission regulates investment advisers under the Investment Advisers
Act of 1940. Section 206(1) of the Advisers Act prohibits an investment adviser from
employ[ing] any device, scheme or artifice to defraud any client or prospective client.”47
44
See, e.g., Comment Letter of Ounavarra Capital, LLC (Aug. 28, 2009) (“Ounavarra
Letter”) (noting that banning third-party marketers in the municipal securities industry
did not adversely affect most bankers’ ability to conduct basic marketing whereas
banning third-party marketers for small advisers could have a stronger impact on advisers
that have either no or very limited marketing capability of their own); Comment Letter of
MVision Private Equity Advisers USA LLC (Sept. 2, 2009) (“MVision Letter”) (arguing
that, whereas placement agents for municipal bond offerings are usually regulated
entities, the restrictions in the municipal securities arena were targeted at consultants who
offer only their contacts and influence with government officials and provided no
valuable services to the financial services industry or investors); Comment Letter of
Kalorama Capital (Sept. 8, 2009) (arguing that a better analogy, at least with respect to
the operation of third-party marketers, is to the licensed professional presenting an IPO to
a pension fund). For further discussion of these comments, see section II.B.2(b) of this
Release.
45
See, e.g., Comment Letter of the Committee on Investment Management Regulation and
the Committee on Private Investment Funds of the Association of the Bar of the City of
New York (Oct. 26, 2009) (“NY City Bar Letter”) (arguing that broker-dealer rules have
sufficient safeguards and that adopting the proposed pay to play rule will interfere with
traditional distribution arrangements); Dechert Letter; Sutherland Letter; MFA Letter.
46
Particular comments on the various aspects of our proposal are summarized in the
corresponding sub-sections of section II of this Release.
47
15 U.S.C. 80b-6(1).
--16--
Section 206(2) prohibits an investment adviser from engaging in “any transaction,
practice, or course of business which operates as a fraud or deceit upon any client or
prospective client.”48 The Supreme Court has construed section 206 as establishing a
federal fiduciary standard governing the conduct of advisers.49
We believe that pay to play is inconsistent with the high standards of ethical
conduct required of fiduciaries under the Advisers Act. We have authority under section
206(4) of the Act to adopt rules “reasonably designed to prevent, such acts, practices, and
courses of business as are fraudulent, deceptive or manipulative.”50 Congress gave us
this authority to prohibit “specific evils” that the broad antifraud provisions may be
incapable of covering.51 The provision thus permits the Commission to adopt
prophylactic rules that may prohibit acts that are not themselves fraudulent.52
48
15 U.S.C. 80b-6(2).
49
Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979); SEC v. Capital
Gains Research Bureau, Inc., 375 U.S. 180, 191-192 (1963).
50
15 U.S.C. 80b-6(4).
51 S. REP. NO. 1760, 86th Cong., 2d Sess. 4, 8 (1960). The Commission has used this
authority to adopt seven rules addressing abusive advertising practices, custodial
arrangements, the use of solicitors, required disclosures regarding advisers’ financial
conditions and disciplinary histories, proxy voting, compliance procedures and practices,
and deterring fraud with respect to pooled investment vehicles. 17 CFR 275.206(4)-1;
275.206(4)-2; 275.206(4)-3; 275.206(4)-4; 275.206(4)-6; 275.206(4)-7; and 275.206(4)
8.
52
Section 206(4) was added to the Advisers Act in Pub. L. No. 86-750, 74 Stat. 885, at sec.
9 (1960). See H.R. REP. NO. 2197, 86th Cong., 2d Sess., at 7-8 (1960) (“Because of the
general language of section 206 and the absence of express rulemaking power in that
section, there has always been a question as to the scope of the fraudulent and deceptive
activities which are prohibited and the extent to which the Commission is limited in this
area by common law concepts of fraud and deceit . . . [Section 206(4)] would empower
the Commission, by rules and regulations to define, and prescribe means reasonably
designed to prevent, acts, practices, and courses of business which are fraudulent,
deceptive, or manipulative. This is comparable to Section 15(c)(2) of the Securities
Exchange Act [15 U.S.C. 78o(c)(2)] which applies to brokers and dealers.”). See also S.
REP. NO. 1760, 86th Cong., 2d Sess., at 8 (1960) (“This [section 206(4) language] is
almost the identical wording of section 15(c)(2) of the Securities Exchange Act of 1934
in regard to brokers and dealers.”). The Supreme Court, in United States v. O’Hagan,
--17--
Investment advisers that seek to influence the award of advisory contracts by
public pension plans, by making political contributions to, or soliciting them for, those
officials who are in a position to influence the awards, compromise their fiduciary
obligations to the public pension plans they advise and defraud prospective clients.53 In
making such contributions, the adviser hopes to benefit from officials who “award the
contracts on the basis of benefit to their campaign chests rather than to the governmental
entity”54 or by retaining a contract that might otherwise not be renewed. If pay to play is
a factor in the selection or retention process, the public pension plan can be harmed in
interpreted nearly identical language in section 14(e) of the Securities Exchange Act [15
U.S.C. 78n(e)] as providing the Commission with authority to adopt rules that are
“definitional and prophylactic” and that may prohibit acts that are “not themselves
fraudulent ... if the prohibition is ‘reasonably designed to prevent ... acts and practices
[that] are fraudulent.’” United States v. O’Hagan, 521 U.S. 642, 667, 673 (1997). The
wording of the rulemaking authority in section 206(4) remains substantially similar to
that of section 14(e) and section 15(c)(2) of the Securities Exchange Act. See also
Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles, Investment
Advisers Act Release No. 2628 (Aug. 3, 2007) [72 FR 44756 (Aug. 9, 2007)] (stating, in
connection with the suggestion by commenters that section 206(4) provides us authority
only to adopt prophylactic rules that explicitly identify conduct that would be fraudulent
under a particular rule, “We believe our authority is broader. We do not believe that the
commenters’ suggested approach would be consistent with the purposes of the Advisers
Act or the protection of investors.”).
53
See Proposing Release, at section I; Political Contributions by Certain Investment
Advisers, Investment Advisers Act Release No. 1812 (Aug. 4, 1999) [64 FR 43556 (Aug.
10, 1999)] (“1999 Proposing Release”). As a fiduciary, an adviser has a duty to deal
fairly with clients and prospective clients, and must make full disclosure of any material
conflict or potential conflict. See, e.g., Capital Gains Research Bureau, 375 U.S. at 189,
191-92; Applicability of the Investment Advisers Act of 1940 to Financial Planners,
Pension Consultants, and Other Persons Who Provide Others with Investment Advice as
a Component of Other Financial Services, Investment Advisers Act Release No. 1092
(Oct. 8, 1987) [52 FR 38400 (Oct. 16, 1987)]. Most public pension plans establish
procedures for hiring investment advisers, the purpose of which is to obtain the best
possible management services. When an adviser makes political contributions for the
purpose of influencing the selection of the adviser to advise a public pension plan, the
adviser seeks to interfere with the merit-based selection process established by its
prospective clients—the public pension plan. The contribution creates a conflict of
interest between the adviser (whose interest is in being selected) and its prospective client
(whose interest is in obtaining the best possible management services).
54
See Blount, 61 F.3d at 944-45.
--18--
several ways. The most qualified adviser may not be selected or retained, potentially
leading to inferior management or performance. The pension plan may pay higher fees
because advisers must recoup the contributions, or because contract negotiations may not
occur on an arm’s-length basis. The absence of arm’s-length negotiations may enable
advisers to obtain greater ancillary benefits, such as “soft dollars,” from the advisory
relationship, which might be used for the benefit of the adviser, potentially at the expense
of the pension plan, thereby using the pension plan’s assets for the adviser’s own
55
purposes.
As we discuss above, pay to play practices are rarely explicit and often hard to
prove.56 In particular, when pay to play involves granting of government advisory
business in exchange for political contributions, it may be difficult to prove that an
adviser (or one of its executives or employees) made political contributions for the
purpose of obtaining the government business, or that it engaged a solicitor for his or her
political influence rather than substantive expertise.57 Pay to play practices by advisers to
public pension plans, which may generate significant contributions for elected officials
and yield lucrative management contracts for advisers, will not stop through voluntary
efforts. This is, in part, because these activities create a “collective action” problem in
55
Cf. In re Performance Analytics, et al., Investment Advisers Act Release No. 2036 (June
17, 2002) (settled enforcement action in which an investment consultant for a union
pension fund entered into a $100,000 brokerage arrangement with a soft dollar
component in which the investment consultant would continue to recommend the
investment adviser to the pension fund as long as the investment adviser sent its trades to
one particular broker-dealer).
56
Cf. Blount, 61 F.3d at 945 (“no smoking gun is needed where, as here, the conflict of
interest is apparent, the likelihood of stealth great, and the legislative purpose
prophylactic”).
57
See id. at 944 (“actors in this field are presumably shrewd enough to structure their
relations rather indirectly”).
--19--
two respects.58 First, government officials who participate may have an incentive to
continue to accept contributions to support their campaigns for fear of being
disadvantaged relative to their opponents. Second, advisers may have an incentive to
participate out of concern that they may be overlooked if they fail to make
contributions.59 Both the stealth in which these practices occur and the inability of
markets to properly address them argue strongly for the need for us to adopt the type of
prophylactic rule that section 206(4) of the Advisers Act authorizes.
A.
First Amendment Considerations
The Commission believes that rule 206(4)-5 is a necessary and appropriate
measure to prevent fraudulent acts and practices in the market for the provision of
investment advisory services to government entities by prohibiting investment advisers
from engaging in pay to play practices. We have examined a range of alternatives to our
proposal, carefully considered some 250 comments we received on the proposal and
made revisions to the proposed rule where we concluded it was appropriate. We believe
the rule represents a balanced response to the developments we discuss above regarding
pay to play activities occurring in the market for government investment advisory
services. The rule provides specific prohibitions to help ensure that adviser selection is
based on the merits, not on the amount of money given to a particular candidate for
58
Collective action problems exist, for example, where participants may prefer to abstain
from an unsavory practice (such as pay to play), but nonetheless participate out of
concern that, even if they abstain, their competitors will continue to engage in the
practice profitably and without adverse consequences. As a result, collective action
problems, such as those raised by pay to play practices, call for a regulatory response.
For further discussion, see infra note 459 and accompanying text.
59
In our view, the collective action problem we are trying to address is analogous to the one
noted in the case upholding MSRB rule G-37. See Blount, 61 F.3d at 945 (“Moreover,
there appears to be a collective action problem tending to make the misallocation of
resources persist”). For a discussion of concerns raised regarding our proposed rule that
are similar to those raised regarding MSRB rule G-37, see section II.A of this Release.
--20--
office, while respecting the rights of industry participants to participate in the political
process. The rule is not unique; Congress, for instance, has barred federal contractors
from making contributions to public officials.60
Before we address particular aspects of the rule, we would like to respond to
commenters’ assertions that the fact that the rule’s limitations on compensation are
triggered by political contributions represents an infringement on the First Amendment
guarantees of freedom of speech and association.61 These commenters acknowledge that
selection of an investment adviser by a government entity should not be a “pay back” for
political contributions, but argue that the rule impermissibly restricts the ability of
advisers and certain of their employees to demonstrate support for state and local
officials.
The Commission is sensitive to, and has carefully considered, these constitutional
concerns in adopting the rule. Though it is not a ban on political contributions or an
attempt to regulate state and local elections, we acknowledge that the two-year time out
provision may affect the propensity of investment advisers to make political
contributions. Although political contributions involve both speech and associational
rights protected by the First Amendment, a “limitation upon the amount that any one
person or group may contribute to a candidate or political committee entails only a
60
2 U.S.C. 441c.
61
See, e.g., Comment Letter of W. Hardy Callcott (Aug. 3, 2009) (“Callcott Letter I”);
Comment Letter of W. Hardy Callcott (Jan. 21, 2010) (“Callcott Letter II”); Comment
Letter of the National Association of Securities Professionals, Inc. (Oct. 6, 2009) (“NASP
Letter”); Comment Letter of Caplin & Drysdale, Chartered (Oct. 6, 2009) (“Caplin &
Drysdale Letter”); Comment Letter of the Securities Industry and Financial Markets
Association (Oct. 5, 2009) (“SIFMA Letter”); ABA Letter; Sutherland Letter; Comment
Letter of IM Compliance LLC (Oct. 6, 2009) (“IM Compliance Letter”); Comment Letter
of the American Bankers Association (Oct. 6, 2009) (“American Bankers Letter”).
--21--
marginal restriction upon the contributor's ability to engage in free communication.”62
Limitations on contributions are permissible if justified by a sufficiently important
government interest that is closely drawn to avoid unnecessary abridgment of protected
rights.63
Prevention of fraud is a sufficiently important government interest. 64 We believe
that payments to state officials as a quid pro quo for obtaining advisory business as well
as other forms of “pay to play” violate the antifraud provisions of section 206 of the
Advisers Act. As discussed in our Proposing Release, “pay to play” arrangements are
inconsistent with an adviser’s fiduciary obligations, distort the process by which
investment advisers are selected, can harm advisers’ public pension plan clients and the
beneficiaries of those plans, and can have detrimental effects on the market for
investment advisory services.65 The restrictions inherent in rule 206(4)-5 are in the
62
Buckley v. Valeo, 424 U.S. 1, 20 (1976). See also SpeechNow.org, et al. v. FEC, 599
F.3d 686 (D.C. Cir. 2010); McConnell v. FEC, 540 U.S. 93, 135-36 (2003).
63
Buckley, 424 U.S. at 25. See also FEC v. Wisconsin Right to Life, Inc., 551 U.S. 449
(2007); Republican Nat’l Comm. v. FEC, No. 08-1953, 2010 U.S. Dist. LEXIS 29163
(D.D.C. Mar. 26, 2010) (three judge panel). This standard is lower than the strict
scrutiny standard employed in reviewing such forms of expression as independent
expenditures. Under the higher level of scrutiny, a restriction must be narrowly tailored
to serve a compelling governmental interest. Blount, 61 F.3d at 943. See also Citizens
United v. FEC, 130 S. Ct. 876 (2010) (distinguishing restrictions on “independent
expenditures” from restrictions on “direct contributions” and leaving restrictions on direct
contributions untouched while striking down a restriction on independent expenditures as
unconstitutional). We note that in Blount, 61 F.3d at 949, the court upheld MSRB rule G37
even assuming that strict scrutiny applied. For the reasons stated by the court in that
decision, we believe that Rule 206(4)-5 would be upheld under a strict scrutiny standard
as well as under the standard the Supreme Court has applied to contribution restrictions.
64
Blount, 61 F.3d at 944.
65
See Proposing Release, at section I. The prohibitions on solicitation and coordination of
campaign contributions are justified by the same overriding purposes which support the
two-year time out provisions. The provisions are intended to prevent circumvention of
the time out provisions in cases where an investment adviser has or is seeking to establish
a business relationship with a government entity. Absent these restrictions, solicitation
and coordination of contributions could be used as effectively as political contributions to
--22--
nature of conflict of interest limitations which are particularly appropriate in cases of
government contracting and highly regulated industries.66 Pursuant to our authority
under section 206(4) of the Advisers Act, which we discuss above, we may adopt rules
that are reasonably designed to prevent such acts, practices and courses of business.
As detailed in the following pages, we have closely drawn rule 206(4)-5 to
accomplish its goal of preventing quid pro quo arrangements while avoiding unnecessary
burdens on the protected speech and associational rights of investment advisers and their
covered employees. The rule is therefore closely drawn in terms of the conduct it
prohibits, the persons who are subject to its restrictions, and the circumstances in which it
is triggered. The United States Court of Appeals for the District of Columbia Circuit
upheld the similarly designed MSRB rule G-37 in Blount v. SEC. 67 Indeed, the Blount
opinion has served as an important guidepost in helping us shape our rule.68
distort the adviser selection process. The solicitation and coordination restrictions relate
only to fundraising activities and would not prevent advisers and their covered employees
from expressing support for candidates in other ways, such as volunteering their time.
66
See In the Matter of Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the Municipal Securities Rulemaking Board Relating to Political
Contributions and Prohibitions on Municipal Securities Business and Notice of Filing
and Order Approving on an Accelerated Basis Amendment No. 1 Relating to the Effective
Date and Contribution Date of the Proposed Rule, Exchange Act Release No. 33868
(Apr. 7, 1994) [59 FR 17621 (Apr. 13, 1994)] (noting, in connection with the
Commission’s approval of MSRB rule G-37, that the restrictions inherent in that pay to
play rule “are in the nature of conflict of interest limitations which are particularly
appropriate in cases of government contracting and highly regulated industries.”).
67
61 F.3d at 947-48.
68
Notwithstanding the Blount decision, some commenters asserted that subsequent
Supreme Court jurisprudence, including Randall v. Sorrell, 548 U.S. 230 (2006), and
Citizens United, 130 S. Ct. 876 (decided following the closing of the comment period for
rule 206(4)-5), would result in the proposed rule being found unconstitutional because it
is not narrowly tailored to advance the Commission’s interests in addressing pay to play
by investment advisers. See, e.g., Callcott Letter I; Callcott Letter II; NASP Letter;
American Bankers Letter. We disagree. The cases cited by commenters are
distinguishable. Citizens United deals with certain independent expenditures (rather than
contributions to candidates), which are not implicated by our rule. Randall involved a
--23--
First, the rule is limited to contributions to officials of government entities who
can influence the hiring of an investment adviser in connection with money management
mandates.69 These restrictions are triggered only in situations where a business
relationship exists or will be established in the near future between the investment adviser
and a government entity.70
Second, the rule does not in any way impinge on a wide range of expressive
conduct in connection with elections. For example, the rule imposes no restrictions on
activities such as making independent expenditures to express support for candidates,
volunteering, making speeches, and other conduct.71
generally applicable state campaign finance law limiting overall contributions (and
expenditures), which the Court feared would disrupt the electoral process by limiting a
candidate’s ability to amass sufficient resources and mount a successful campaign.
Randall, 548 U.S. at 248-49. By contrast, our rule is not a general prohibition or
limitation, but rather is a focused effort to combat quid pro quo payments by investment
advisers seeking governmental business. Comparable restrictions targeted at a particular
industry have been upheld under Randall because the loss of contributions from such a
small segment of the electorate “would not significantly diminish the universe of funds
available to a candidate to a non-viable level.” Green Party of Conn. v. Garfield, 590 F.
Supp. 2d 288, 316 (D. Conn. 2008). See also Preston v. Leake, 629 F. Supp. 2d 517, 524
(E.D.N.C. 2009) (differentiating the “broad sweep of the Vermont statute” that “restricted
essentially any potential campaign contribution” from a statute that “only applies to
lobbyists”); In re Earle Asphalt Co., 950 A.2d 918, 927 (N.J. Super. Ct. App. Div. 2008),
aff’d 957 A.2d 1173 (N.J. 2008) (holding that a limitation on campaign contributions by
government contractors and their principals did not have the same capacity to prevent
candidates from amassing the resources necessary for effective campaigning as the
statute in Randall). One commenter expressly dismissed arguments that Randall would
have implications for the Commission’s proposed rule. Fund Democracy/Consumer
Federation Letter.
69
See section II.B.2(a)(2) of this Release (discussing the definition of “official” of a
government entity for purposes of rule 206(4)-5).
70
See section II.B.2(a)(1) of this Release (discussing the prohibition on compensation for
providing advisory services to the client during rule 206(4)-5’s two-year time out).
71
See Citizens United, 130 S. Ct. at 908-09 (noting that a government interest cannot be
sufficiently compelling to limit independent expenditures by corporate entities). See
also SpeechNow.org, 599 F.3d at 692 (spelling out the different standards of
constitutional review established by the Supreme Court for restrictions on independent
expenditures and direct contributions). Some commenters expressed concern, for
example, that rule 206(4)-5 may quell volunteer activities, deter employees of investment
--24--
Third, it does not prevent anyone from making a contribution to any candidate, as
covered employees may contribute $350 to candidates for whom they may vote, and $150
to other candidates. A limitation on the amount of a contribution involves little direct
restraint on political communication, because a person may still engage in the symbolic
expression of support evidenced by a contribution.72 Furthermore, the rule takes the form
of a restriction on providing compensated advisory business following the making of
contributions rather than a prohibition on making contributions in excess of the relevant
ceilings.73
Fourth, the rule only applies to investment advisers that are registered with us,74
or unregistered in reliance on section 203(b)(3) of the Advisers Act, that have (or that are
seeking) government clients.75 It applies only to the subset of the significantly broader
advisers from running for office, or chill charitable contributions. See, e.g., Caplin &
Drysdale Letter; NASP Letter. We have expressly clarified that volunteer activities and
charitable contributions generally would not trigger the rule’s time out provision and that
employees running for office would not be subject to the contribution limitation. See
infra notes 157 and 139, respectively.
72
Buckley, 424 U.S. at 21. See also section II.B.2(a)(6) of this Release (discussing the de
minimis exceptions to covered associates’ contributions triggering the two-year time out).
Some commenters raised constitutional concerns regarding the levels of the de minimis
exception in our proposal. See, e.g., Callcott Letter I; Callcott Letter II; Caplin &
Drysdale Letter; IM Compliance Letter; Sutherland Letter. As discussed below, we have
both raised the amount of the de minimis exception in line with inflation and added an
additional exception.
73
See section II.B.2(a)(1) of this Release (discussing the two-year time out on receiving
compensation for advisory services).
74
Unless indicated expressly otherwise, each time we refer to a “registered” investment
adviser in this Release, we mean an adviser registered with the Commission.
75
See section II.B.1 of this Release (discussing advisers covered by the rule). One
commenter raised constitutional concerns by arguing that the rule would apply beyond
the advisory business of an adviser that solicits government clients, no matter how
separate the other product or service offerings of the adviser are from the governmental
business. ABA Letter. But we believe we have made clear that the rule’s time out
provisions, which are designed to eliminate quid pro quo arrangements and ameliorate
market distortions, apply only with respect to the provision of advisory services to
--25--
set of advisers over which we have antifraud authority that we believe are most likely to
be engaged by government clients to manage public assets either directly or though
investment pools.76
Finally, the rule is not a restriction on contributions that is applicable to the public
and is not intended to eliminate corruption in the electoral process. Rather, it is focused
exclusively on conduct by professionals subject to fiduciary duties, seeking profitable
business from governmental entities. The rule is targeted at those employees of an
adviser whose contributions raise the greatest danger of quid pro quo exchanges,77 and it
covers only contributions to those governmental officials who would be the most likely
targets of pay to play arrangements because of their authority to influence the award of
advisory business.78
B.
Rule 206(4)-5
We are today adopting new rule 206(4)-5 under the Advisers Act that is designed
to protect public pension plans and other government investors from the consequences of
pay to play practices by deterring advisers’ participation in such practices.79 As we noted
government clients, which is consistent with our authority under the Advisers Act. See
section II.B.2(a)(1) of this Release.
76
See section II.B.1 of this Release.
77
See section II.B.2(a)(4) of this Release (discussing the definition of “covered associates,”
whose contributions could trigger the two-year time out).
78
See section II.B.2(a)(2) of this Release (discussing the definition of “official” of a
government entity for purposes of the rule 206(4)-(5)). Some commenters argued that the
defin
tion of “official” we included in our proposal was ambiguous. See, e.g., Caplin &
Drysdale Letter. In response, we have provided additional guidance. See section
II.B.2(a)(2) of this Release.
79
Rule 206(4)-5 is targeted to a concrete business relationship between contributors and
candidates’ governmental entities. It is not intended to restrict the voices of persons and
interest groups, reduce the overall scope of election campaigns, or equalize the relative
ability of all votes to affect electoral outcomes. Indeed, if investment advisers do not seek
government business from those to whom they and their covered associates make
--26--
in the Proposing Release, advisers and government officials might, in order to circumvent
our rule, attempt to structure their transactions in a manner intended to hide the true
purpose of a contribution or payment.80 Therefore, our pay to play restrictions are
intended to capture not only direct political contributions by advisers, but also other ways
that advisers may engage in pay to play arrangements. Rule 206(4)-5 prohibits several
principal avenues for pay to play activities.
First, the rule makes it unlawful for an adviser to receive compensation for
providing advisory services to a government entity for a two-year period after the adviser
or any of its covered associates makes a political contribution to a public official of a
government entity or candidate for such office who is or will be in a position to influence
the award of advisory business.81 Importantly, as we noted in the Proposing Release, rule
206(4)-5 would not ban or limit the amount of political contributions an adviser or its
covered associates could make; rather, it would impose a two-year time out on
conducting compensated advisory business with a government client after a contribution
contributions or for whom they solicit contributions, the rule’s limitations will not be
triggered. Rather, the rule is intended to prevent direct quid pro quo arrangements,
fraudulent and manipulative acts and practices, and improve the mechanism of a free and
open market for investment advisory services for government entity clients. With pay to
play activities, the conflict of interest is apparent, the likelihood of stealth in the
arrangements is great, and our regulatory purpose is prophylactic. See Blount, 61 F.3d at
945 (describing the court’s similar characterization of MSRB rule G-37).
80
Proposing Release, at section II.A.
81
Rule 206(4)-5(a)(1) makes it unlawful for any investment adviser covered by the rule to
provide investment advisory services for compensation to a government entity within two
years after a contribution to an official of the government entity is made by the
investment adviser or any covered associate, as defined in the rule, of the investment
adviser (including a person who becomes a covered associate within two years after the
contribution is made). As noted below, an “official” includes an incumbent, candidate or
successful candidate for elective office of a government entity if the office is directly or
indirectly responsible for, or can influence the outcome of, the hiring of an investment
adviser or has the authority to appoint any person who is directly or indirectly responsible
for or can influence the outcome of the hiring of an investment adviser. See section
II.B.2(a)(2) of this Release.
--27--
is made.82 This first prohibition is substantially similar to our proposal. However, as
discussed below, we have made certain modifications to some of the definitions of terms
in this prohibition.83
Second, the rule generally prohibits advisers from paying third parties to solicit
government entities for advisory business unless such third parties are registered broker-
dealers or registered investment advisers, in each case themselves subject to pay to play
restrictions.84 That is, an adviser is prohibited from providing or agreeing to provide,
directly or indirectly, payment to any person for solicitation of government advisory
business on behalf of such adviser unless that person is registered with us and subject to
pay to play restrictions either under our rule or the rules of a registered national securities
association.85 This represents a modification from our proposal, which included a flat
ban without an exception for any brokers or investment advisers.86 As discussed below,
82
Proposing Release, at section II.A.
83
See generally section II.B.2(a) of this Release.
84
Rule 206(4)-5(a)(2)(i) makes it unlawful for any investment adviser covered by the rule
and its covered associates (as defined in the rule) to provide or agree to provide, directly
or indirectly, payment to any person to solicit a government entity for investment
advisory services on behalf of such investment adviser unless such person is a regulated
person or is an executive officer, general partner, managing member (or, in each case, a
person with a similar status or function), or employee of the investment adviser.
“Regulated person” is defined in rule 206(4)-5(f)(9). See section II.B.2(b) of this Release
for a discussion of this definition.
85
See section II.B.2(b) of this Release. While our rule would apply to any registered
national securities association, the Financial Industry Regulatory Authority, or FINRA, is
currently the only registered national securities association under section 19(a) of the
Exchange Act [15 U.S.C. 78s(b)]. As such, for convenience, we will refer directly to
FINRA in this Release when describing the exception for certain broker-dealers from the
rule’s ban on advisers paying third parties to solicit government business on their behalf.
The Commission’s authority to consider rules proposed by a registered national securities
association is governed by section 19(b) of the Exchange Act [15 U.S.C. 78s(b)] (“No
proposed rule change shall take effect unless approved by the Commission or otherwise
permitted in accordance with the provisions of this subsection.”).
86
See Proposing Release, at section II.A.3(b).
--28--
commenters persuaded us that the objective of the rule in eliminating pay to play
activities of advisers could be preserved if the third parties they hire are themselves
registered investment advisers subject to Commission oversight or are broker-dealers
subject to pay to play restrictions imposed by a registered national securities association
that the Commission must approve.
Third, the rule makes it unlawful for an adviser itself or any of its covered
associates to solicit or to coordinate: (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.87
We are adopting this aspect of the rule as proposed.
Fourth, as it is not possible for us to anticipate all of the ways advisers and
government officials may structure pay to play arrangements to attempt to evade the
prohibitions of our rule, the rule includes a provision that makes it unlawful for an
adviser or any of its covered associates to do anything indirectly which, if done directly,
would result in a violation of the rule.88 This provision in the rule we are adopting today
is identical to our proposal.89
87
Rule 206(4)-5(a)(2)(ii) makes it unlawful for any investment adviser covered by the rule
and its covered associates to coordinate, or to solicit any person [including a political
action committee] to make, any: (A) contribution to an official of a government entity to
which the investment adviser is providing or seeking to provide investment advisory
services; or (B) payment 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. See section II.A.2.(c) of this Release.
88
Rule 206(4)-5(d) makes it unlawful for any investment adviser covered by the rule and its
covered associates to do anything indirectly which, if done directly, would result in a
violation of this section. See section II.B.2(d) of this Release.
89
See Proposing Release, at section II.A.3(d).
--29--
Finally, for purposes of our rule, an investment adviser to certain pooled
investment vehicles in which a government entity invests or is solicited to invest will be
treated as though the adviser were providing or seeking to provide investment advisory
services directly to the government entity.90 This provision is substantially similar to our
proposal, although we have made certain modifications described below.91
1.
Advisers Subject to the Rule
Rule 206(4)-5 applies to registered investment advisers and certain advisers
exempt from registration. In particular, it applies to any investment adviser registered (or
required to be registered) with the Commission, or unregistered in reliance on the
exemption available under section 203(b)(3) of the Advisers Act (15 U.S.C. 80b
3(b)(3)).92 The rule would not, however, apply to most small advisers that are registered
with state securities authorities instead of the Commission,93 or advisers that are
unregistered in reliance on exemptions other than section 203(b)(3) of the Advisers Act.94
90
Rule 206(4)-5(c) states that, for purposes of rule 206(4)-5, an investment adviser to a
covered investment pool in which a government entity invests or is solicited to invest,
shall be treated as though that investment adviser were providing or seeking to provide
investment advisory services directly to the government entity. See section II.B.2(e) of
this Release.
91
See section II.B.2(e) of this Release.
92
Rule 206(4)-5(a)(1) and (2). Section 203(b)(3) [15 U.S.C. 80b-3(b)(3)] exempts from
registration any investment adviser that is not holding itself out to the public as an
investment adviser and had fewer than 15 clients during the last 12 months. We are
including this category of exempt advisers within the scope of the rule in order to make
the rule applicable to the many advisers to private investment companies that are not
registered under the Advisers Act.
93
Advisers with less than $25 million of assets under management are prohibited from
registering with the Commission by section 203A of the Advisers Act [15 U.S.C. 80b3A].
94
The rule would also not apply to certain other advisers that are exempt from registration
with the Commission. See, e.g., section 203(b)(1) of the Advisers Act [15 U.S.C. 8b3(
b)(1)] (exempting from registration intrastate investment advisers). As explained in the
Proposing Release, we believe these advisers are unlikely to advise public pension plans.
--30--
We received limited comment on this aspect of the rule. One commenter
explicitly agreed with the scope of our proposed rule, noting that it would capture most, if
not all, advisers that provide discretionary management with respect to public pension
fund assets, regardless of whether they are registered.95 Other commenters recommended
that the rule apply more broadly to all advisers that may manage assets of government
entities.96 The primary effect of such an expansion of the rule would be to apply it to
smaller firms, the regulatory responsibility for which Congress has previously allocated
to the state securities authorities.97 It is our understanding that few of these firms manage
public pension plans or other public funds.98 Accordingly, we have decided to adopt this
provision as proposed.
See Proposing Release, at n.64 and accompanying text. The rule would also not apply to
persons who are excepted from the definition of investment adviser under section
202(a)(11) of the Advisers Act [15 U.S.C. 80b-2(a)(11)]. For a discussion, in particular,
of the exclusion of banks and bank holding companies which are not investment
companies from the Advisers Act’s definition of “investment adviser,” see infra note 274.
95
Comment Letter of the California Public Employees’ Retirement System (Oct. 6, 2009)
(“CalPERS Letter”) (“CalPERS agrees that the scope of the proposed rule would capture
most if not all external managers who have discretion over the investment of public
pension fund assets, including hedge fund managers, real estate managers, private equity
managers, traditional long-only managers, money managers, and others, regardless of
whether the managers are registered investment advisors. CalPERS supports application
of the rule to investment advisers, as defined in the proposed rule.”).
96
These suggestions included applying the rule to all registered (including SEC-registered
and state-registered) and unregistered advisers (see, e.g., 3PM Letter (arguing that
selective application of the rule could lead to convoluted organizational structures
designed to bypass its reach and that the proposal represents the kind of patchwork
regulation that will lead to the kind of inconsistency the Commission is seeking to
correct), and extending the rule to state-registered advisers (see, e.g., Comment Letter of
the Cornell Securities Law Clinic (Oct. 6, 2009) (“Cornell Law Letter”)).
97
Amendments to the Advisers Act in 1996 placed the regulatory responsibility for these
advisers in the hands of state regulators. See section 203A of the Advisers Act [15
U.S.C. 80b-3a] enacted as part of Title III of the National Securities Markets
Improvement Act of 1996, Pub. L. No. 104-290, 110 Stat. 3416 (1996) (codified in
scattered sections of the United States Code).
98
See Proposing Release, at n.64. We did not receive any comment challenging our
understanding.
--31--
2.
Pay to Play Restrictions
(a) Two-Year “Time Out” for Contributions
Rule 206(4)-5(a)(1) prohibits investment advisers from receiving compensation
for providing advice to a “government entity” within two years after a “contribution” to
an “official” of the government entity has been made by the investment adviser or by any
of its “covered associates.”99 The rule does not ban political contributions and does not
limit the amount of any political contribution. Instead, the rule imposes a ban—a “time
out”—on receiving compensation for conducting advisory business with a government
client for two years after certain contributions are made. 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 selection
process can be expected to dissipate.
Rule 206(4)-5(a)(1) is based largely on MSRB rule G-37 under which a broker-
dealer is prohibited from engaging in the municipal securities business for two years after
making a political contribution.100 As noted above and as explained in the Proposing
Release, we modeled the rule on the MSRB rules because we believe that they have
significantly curbed pay to play practices in the municipal securities market.101 We also
99
Rule 206(4)-5(a)(1).
100
Proposing Release, at section II.A.2.
101
See id. at n.23 (citing others, including the MSRB, who agree that the MSRB rules have
been effective: MSRB, MSRB Notice 2009-62, Amendments Filed to Rule G-37
Regarding Contributions to Bond Ballot Campaigns (Dec. 4, 2009), available at
http://msrb.org/msrb1/archive/2009/2009-62.asp (“Rule G-37, in effect since 1994, has
provided substantial benefits to the industry and the investing public by greatly reducing
the direct connection between political contributions given to issuer officials and the
awarding of municipal securities business to brokers, dealers and municipal securities
dealers (“dealers”), thereby effectively assisting with eliminating pay-to-play practices in
the new issue municipal securities market.”); MSRB, MSRB Notice 2009-35, Request for
Comment: Rule G-37 on Political Contributions and Prohibitions on Municipal
--32--
pointed out that our approach would minimize the compliance burdens on firms that
would be subject to both rule regimes. But we requested comment on our proposed
approach and whether alternative models might be appropriate.
Several commenters supporting the rule explicitly addressed the appropriateness
of the MSRB approach. One, for example, asserted that the proposed rule “appropriately
expands upon MSRB G-37 and G-38.”102 Another agreed that the MSRB rules “provide
an appropriate regulatory analogy for addressing [pay to play] issues.”103 Many other
commenters, however, sought to distinguish advisers and municipal securities dealers,
and asserted that, because of the differences between the two, MSRB rule G-37 is an
Securities Business – Bond Ballot Campaign Committee Contributions (June 22, 2009)
(“The MSRB believes the rule has provided substantial benefits to the industry and the
investing public by greatly reducing the direct connection between political contributions
given to issuer officials and the awarding of municipal securities business to dealers,
thereby effectively eliminating pay-to-play practices in the new issue municipal securities
market.” [footnote omitted]); MSRB, MSRB Notice 2003-32, Notice Concerning Indirect
Rule Violations: Rules G-37 and G-38 (Aug. 6, 2003) (“The impact of Rules G-37 and G38
has been very positive. The rules have altered the political contribution practices of
municipal securities dealers and opened discussion about the political contribution
practices of the entire municipal industry.”); Letter from Darrick L. Hills and Linda L.
Rittenhouse of the CFA Institute to Jill C. Finder, Asst. Gen. Counsel of the MSRB (Oct.
19, 2001), available at http://www.cfainstitute.org/Comment%20Letters/20011019.pdf
(stating, “We generally believe that the existing [MSRB] pay-to-play prohibitions have
been effective in stemming practices that compromise the integrity of the [municipal
securities] market by using political contributions to curry favor with politicians in
positions of influence.”); COMM. ON CAPITAL MKTS. REGULATION, INTERIM REPORT OF
THE COMMITTEE ON CAPITAL MARKETS REGULATION (Nov. 30, 2006), available at
http://www.capmktsreg.org/pdfs/11.30Committee_Interim_ReportREV2.pdf (stating,
upon describing MSRB Rule G-37 and the 2005 amendments to MSRB Rule G-38,
“Taken together, the MSRB’s rules have largely put an end to the old “pay to play”
practices in municipal underwriting.”)). See also Comment letter of Professors
Alexander W. Butler, Larry Fauver and Sandra Mortal (Sept. 30, 2009) (“Butler Letter”)
(citing Alexander W. Butler, Larry Fauver & Sandra Mortal, Corruption, Political
Integrity, and Municipal Finance, 22 R. OF FIN. STUD. 2673-705 (2009)).
102
Common Cause Letter.
103
Comment Letter of Credit Suisse Securities (USA) LLC (Sept. 14, 2009) (“Credit Suisse
Letter”).
--33--
inappropriate model on which to base an investment adviser pay to play rule.104 Some
argued that the long-term nature of advisory relationships is fundamentally different from
discrete municipal underwriting transactions, and consequently, the two-year time out is
more disruptive and severe for advisers and the governments that retain them than for
municipal securities dealers who are simply banned from obtaining “new” business as
opposed to terminating a long-term relationship.105 Some commenters asserted that the
relationships are different because advisers provide ongoing and continuous advice as a
fiduciary, rather than a one-time transaction such as an underwriting, and that advisory
services are typically subject to an open competitive bid process instead of through
negotiated transactions that are typical of municipal underwritings.106
We disagree that the differences between municipal securities underwriting and
money management are sufficient to warrant an alternative approach. Commenters are
correct that municipal securities underwriters provide episodic services rather than
ongoing services often provided by money managers. But underwriters seek to provide
104
See, e.g., IAA Letter; ICI Letter; SIFMA Letter; ABA Letter; Dechert Letter; Skadden
Letter; Comment Letter of Jones Day (Oct. 5, 2009) (“Jones Day Letter”); Comment
Letter of Simpson Thacher & Bartlett LLP on behalf of Park Hill Group LLC and its
affiliates (Sept. 21, 2009) (“Park Hill Letter”); Comment Letter of Monument Group, Inc.
(Sept. 18, 2009) (“Monument Group Letter”). One commenter suggested, in particular,
that the rule’s two-year time out provision is outside of our authority because it imposes
an “automatic penalty, subject only to discretionary post facto review.” Comment Letter
of Edwin C. Laurenson (Dec. 31, 2009). We disagree. The two-year time out is not a
penalty. Rather, it is a “cooling-off period” to dissipate any effects of a quid pro quo. A
violation of the provision would result from receiving, or continuing to receive, payment
after making the contribution, not from the making of the contribution itself.
105
See, e.g., IAA Letter; ABA Letter; Dechert Letter; Skadden Letter; Jones Day Letter;
Park Hill Letter; Monument Group Letter. But see Credit Suisse Letter (“G-37 and G-38
provide an appropriate regulatory analogy”); Butler Letter (“This practice [municipal
underwriting pay to play] was analogous to the type of pay to play currently under
consideration by the Commission”).
106
See, e.g., IAA Letter; ICI Letter; SIFMA Letter; ABA Letter; Dechert Letter; Skadden
Letter; Jones Day Letter; Park Hill Letter; Monument Group Letter.
--34--
repeated, if not ongoing, services, and the imposition of a two-year time out can have
considerable competitive consequences to a broker-dealer whose government client must
employ the services of a competitor whose services it may continue to employ after
MSRB rule G-37’s two-year time out has run its course. That advisers are in a fiduciary
relationship with their public pension plan clients argues for at least as significant
consequences for participation in pay to play practices that can harm these clients.
Our decision to adopt a rule based on the MSRB model is influenced primarily by
our judgment that the MSRB rules have significantly curbed pay to play practices in the
municipal securities market107 and that alternative approaches, including those suggested
by commenters, would fail to provide an adequate deterrent to pay to play activities. We
considered each of the principal suggestions offered by commenters.
Some commenters suggested requiring advisers to disclose their contributions to
state and local officials.108 Statutes requiring disclosure of political contributions are, in
part, designed to inform voters about a candidate’s financial supporters; an informed
electorate can then use the information to vote for or against a candidate.109 But voters’
possible reactions, if any, to such disclosure would not necessarily resolve the concerns
we are trying to address in this rulemaking. Our concern is protecting advisory clients
and investors whom we have the responsibility to protect under the Advisers Act—
107
See supra notes 31 and 101 and accompanying text.
108
See, e.g., SIFMA Letter; Preqin Letter I; Comment Letter of Triton Pacific Capital, LLC
(Sept. 1, 2009) (“Triton Pacific Letter”); Comment Letter of the State Association of
County Retirement Systems (Sept. 8, 2009); Comment Letter of CapLink Partners (Sept.
9, 2009) (“CapLink Letter”); Comment Letter of Parenteau Associates, LLC (Aug. 7,
2009) (“Parenteau Letter”).
109
See Buckley, 424 U.S. at 67 (1976) (noting that campaign financing disclosure
requirements “deter actual corruption and avoid the appearance of corruption by exposing
large contributions and expenditures to the light of publicity”).
--35--
namely, the public pension plans and their beneficiaries who are affected by pay to play
practices.110 Disclosure to a plan’s trustees might be insufficient where the trustee
(particularly a sole trustee) has received the contributions and is presumably well aware
of the conflicts involved. Moreover, and as we pointed out in the Proposing Release,
requiring advisers to disclose political contributions to beneficiaries would be unlikely to
protect them since most cannot act on the information by moving their pension assets to a
different plan or by reversing the plan trustees’ adviser hiring decisions.111 Not all
beneficiaries may be entitled to vote (or withhold their vote) for the official to whom a
contribution was made, and those that are may need to wait a substantial period of time
until a future election to exercise their vote. Further, as beneficiaries may constitute only
a small proportion of the electorate, they may not be able to influence an election;
therefore, reliance on the electoral process may be insufficient to protect government
plans and their beneficiaries from pay to play. In addition, even if the fact of a
contribution is disclosed (which is required in many states), the contribution’s true
purpose is unlikely to be disclosed.
Several commenters suggested that the Commission adopt a requirement that an
adviser include in its code of ethics112 a policy that prohibits contributions made for the
110
As discussed above, our purposes in this rulemaking are preventing fraud, protecting
investors and maintaining the integrity of the adviser selection process, not campaign
finance reform. See section I of this Release.
111
See Proposing Release, at section II.A.2. Some commenters made the same points. See,
e.g., NY City Bar Letter; Cornell Law Letter; 3PM Letter. See also Blount, 61 F.3d at
947 (explaining, in the context of the municipal securities industry, the potential
inadequacy of disclosure to address pay to play concerns, that “disclosure would not
likely cause market forces to erode ‘pay to play . . .’” because the “. . . purpose of
protecting the integrity of the market [would] . . . ‘be achieved less effectively.’”).
112
Registered investment advisers are required to have codes of ethics under the Advisers
Act. See Advisers Act rule 204A-1.
--36--
purpose of influencing the selection of the adviser.113 Several commenters
recommended, similarly, that we require advisers to adopt policies and procedures114
reasonably designed to prevent and detect contributions designed to influence the
selection of an adviser.115 Many of these commenters suggested that preclearance of
employee contributions could be required under an adviser’s code of ethics or compliance
policies and procedures.116 One commenter asserted that an advantage of this approach is
that it would allow an adviser to customize sanctions based on the severity of the
violation.117
We do not, however, believe that codes of ethics or compliance procedures alone
would be adequate to stop pay to play practices, particularly when the adviser or senior
officers of the adviser are involved either directly or indirectly. First, it is those senior
officers who, as noted below, have the greatest incentives to engage in pay to play and
therefore are most likely to make contributions, who would themselves ultimately be
responsible for enforcing their own compliance with the firm’s ethics code or compliance
procedures. Second, violations of codes of ethics or compliance procedures do not
themselves establish violations of the federal securities laws. Moreover, the comments
suggesting these alternatives would have us require the codes or procedures be designed
to prevent or detect contributions intended to influence the selection of the adviser by a
113
See, e.g., IAA Letter; ABA Letter; Comment letter of the National Society of Compliance
Professionals, Inc. (Oct. 6, 2009) (“NSCP Letter”); NY City Bar Letter; Fidelity Letter.
114
Registered investment advisers are required to adopt and implement policies and
procedures reasonably designed to prevent violation by the adviser or its supervised
persons of the Advisers Act and the rules the Commission has adopted thereunder. See
Advisers Act rule 206(4)-7.
115
See, e.g., ABA Letter; NY City Bar Letter; IAA Letter; ICI Letter; NSCP Letter.
116
See, e.g., IAA Letter; NY City Bar Letter; ABA Letter.
117
ABA Letter.
--37--
government entity. As discussed extensively above and in our Proposing Release, pay to
play is an area in which intent is often very difficult to prove, and is often hidden in the
guise of legitimate conduct.118 Political contributions are made ostensibly to support a
candidate; the burden on a regulator or prosecutor of proving a different intent presents
substantial challenges absent unusual evidence. Commenters would thus have us give the
adviser, which stands to benefit from the contribution, the discretion to determine
whether contributions were intended to influence its selection by the government entity.
We do not believe codes of ethics or policies and procedures alone, without a rule
providing for specific, prophylactic prohibitions, are adequate to address this type of
conduct.119
On balance, we believe that adopting a two-year time out for investment advisers
similar to the two-year time out applicable to broker-dealers underwriting municipal
securities is appropriate. Our years of experience with MSRB rule G-37 suggests that the
“strong medicine” provided by that rule has both significantly curbed participation in pay
to play and provides a reasonable cooling-off period to mitigate the effect of a political
contribution. We are sensitive about potential implications of the operation of the rule on
public pension funds, which could lose the services of an investment adviser subject to a
time out. While we have designed the rule to reduce its impact,120 investment advisers
are best positioned to protect these clients by developing and enforcing robust
118 See, e.g., Proposing Release, at n.16 and accompanying text.
119 We note that, under our rules, an adviser’s code of ethics must require compliance with
the rule we are today adopting (rule 204A-1(a)(2)) and the adviser must adopt policies
and procedures designed to prevent violation of the rule (rule 206(4)-7(a)).
120 See, e.g., section II.B.2(a)(6) of this Release (discussing the de minimis exceptions to the
two-year time out); section II.B.2(f) of this Release (discussing the rule’s exemptive
provision).
--38--
compliance programs designed to prevent contributions from triggering the two-year time
out.
(1) Prohibition on Compensation
As noted above, investment advisers subject to new rule 206(4)-5 are not
prohibited from providing advisory services to a government client, even after triggering
the two-year time out. Instead, an adviser is prohibited from receiving compensation for
providing advisory services to the government client during the time out.121 We have
taken this approach to enable an adviser to act consistently with its fiduciary obligations
so it will not have to abandon a government client after making a triggering contribution,
but rather may provide uncompensated advisory services for a reasonable period of time
to allow the government client to replace the adviser.122 We are adopting this element of
the rule as proposed.
One commenter supported the prohibition on compensation as the least disruptive
option to government clients,123 while others argued that the prohibition on compensation
121
Rule 206(4)-5(a)(1) makes it unlawful for investment advisers covered by the rule to
provide investment advisory services for compensation to a government entity within two
years after a triggering contribution. Under the rule, the two-year time out begins to run
once the contribution is made and not when the contribution is discovered either by our
examination staff or by the adviser. The adviser, therefore, should return all such
compensation promptly upon discovering the triggering contribution. For the application
of the rule to investments by government entities in pooled investment vehicles, see
section II.B.2(e) of this Release.
122
Proposing Release, at section II.A.3(a)(1). An investment adviser’s fiduciary duties may
require it to continue providing advisory services for a reasonable period of time under
these circumstances. For another instance in which an adviser’s fiduciary duties may
require its continued provision of services, see Temporary Exemption for Certain
Investment Advisers, Investment Advisers Act Release No. 1736 (July 22, 1998) [63 FR
40231, 40232 (July 28, 1998)] (describing an investment adviser’s fiduciary duties to an
investment company in the case of an assignment of the advisory contract).
123
Cornell Law Letter.
--39--
was unreasonable and, in some cases, difficult or near impossible to implement.124 A
coalition of commenters representing state and local governments asserted that, due to
restrictions on accepting uncompensated services under state and local law, it was
unlikely that government entities would accept uncompensated services even if an
adviser were willing or required to provide them.125 Commenters representing advisers
took the opposite view, expressing concern that they would be locked into providing
uncompensated services for extended periods of time as a result, and wanted the
Commission to provide guidelines as to what a reasonable amount of time is for a
government client to claim or move its assets.126 One asserted that it would be
unreasonable to require advisers to provide uncompensated services altogether.127
124
See, e.g., ICI Letter; Jones Day Letter. Some commenters argued for more flexibility in
sanctions (Skadden Letter; ABA Letter; Fidelity Letter; ICI Letter; MassMutual Letter;
Comment Letter of Wells Fargo Advisors (Oct. 6, 2009) (“Wells Fargo Letter”); IAA
Letter).
125
Comment Letter of the National Conference of State Legislatures, National Association
of Counties, National League of Cities, International City/County Management
Association, National Association of State Auditors, Comptrollers and Treasurers,
Government Finance Officers Association, National Association of State Retirement
Administrators, National Conference on Public Employee Retirement Systems, and
National Council on Teacher Retirement (Oct. 6, 2009) (“National Organizations
Letter”). With respect to direct advisory relationships, because restrictions on
governments receiving services without payment would be a function of particular state
or local laws, we believe government entities and their advisers are in the best position to
work out arrangements that are consistent with both state and local law and the
compensation prohibition of our rule. With respect to investments by government
entities in pooled investment vehicles, in particular, such restrictions could be avoided.
See section II.B.2(e)(2) of this Release (describing possible arrangements for continued
payment to investment pools even after a time out is triggered).
126
See, e.g., Comment Letter of Davis Polk & Wardwell LLP (Oct. 6, 2009) (“Davis Polk
Letter”) (recommending that three months would be reasonable); ICI Letter (suggesting
30 days). Other commenters raised concern regarding the potential harm of a time out to
government investors for whom identifying new managers may be a lengthy process.
See, e.g., NASP Letter. We believe, however, that, on balance, pension funds and their
beneficiaries are best served by the rule’s deterrent effect against engaging in pay to play
activities. An adviser’s fiduciary obligations to continue to provide services for a
reasonable amount of time, combined with the extended compliance dates described in
section III of this Release which should afford the ability of market participants to
--40--
Few of the commenters who opposed this provision appeared to favor its
elimination, which would require the adviser to immediately cease providing advisory
services upon making a triggering contribution.128 Rather, they appeared to oppose the
two-year time out more generally.129
We are not persuaded by their arguments. We believe the prohibition on
compensation is both appropriate and administrable. The incentives to engage in pay to
play may be significant, precisely because of the long-term nature of many advisory
relationships from which the adviser could benefit for several years. As a result, the
consequences of engaging in pay to play need to be commensurate with these incentives
for the prophylactic rule to have a meaningful deterrent effect.130 We acknowledge that
the rule will involve compliance costs and could adversely affect an adviser’s business.131
On the other hand, a political contribution would not affect the ability of an adviser to
provide compensated services to other clients, including other government clients.
organize themselves in a way to adapt to the rule’s requirements, should be sufficient to
minimize the impact on pension plans to the extent they need to prepare to transition to a
new money manager after a two-year time out is triggered.
127
Jones Day Letter. Other commenters argued that the specter of a two-year time out might
cause some firms to ban or require pre-clearance of all employees’ contributions. See,
e.g., Caplin & Drysdale Letter. Although the rule does not require this approach, as a
result of commenters’ assertions, we address this possibility in our cost-benefit analysis.
See section IV of this Release.
128
See, e.g., Davis Polk Letter; ICI Letter.
129
See, e.g., National Organizations Letter; ICI Letter; Jones Day Letter; Dechert Letter.
130
This deterrent effect is the basis for our view that the two-year time out should not apply
only to “new business” and that advisers should not be able to “negotiate” for lesser
consequences. See supra note 124 (pointing to commenters who called for more
flexibility regarding the two-year time out). As we point out above, our concerns extend
to contributions designed to enable advisers to retain contracts that might not otherwise
be renewed.
131
For a discussion of costs and other burdens that may be imposed by our rule, see
generally sections IV-V of this Release.
--41--
Moreover, the fiduciary obligations of an adviser would not require it to provide
uncompensated advice indefinitely—rather, the adviser may need to continue to provide
advice for only a reasonable period of time during which its client can seek to obtain
advisory services from others.132
Some commenters urged us to permit advisers to continue to receive
compensation during the two-year time out for services provided pursuant to an existing
management contract,133 without distinguishing whether the contract was acquired as a
result of political contributions. One commenter further suggested specifically that we
permit advisory services to continue to be provided by the adviser at cost during the time
out to remove the profit motive of pay to play.134 We are also not persuaded by their
suggestions. Allowing contracts acquired as a result of political contributions to continue
uninterrupted would eviscerate the rule. Were a “free pass” available for contracts
132
See supra note 122 and accompanying text. The amount of time a client might need in
good faith to find and engage a successor to the adviser would, in our view, be the
primary consideration of the length of a reasonable period, which may depend in part on
such matters as applicable law, the client’s customary process of finding and engaging
advisers and the types of assets managed by the adviser that is subject to the time out. In
some cases, a client may be able to quickly engage a “transition adviser” to manage its
assets until a permanent successor is found. See, e.g., Illinois State Board Sets
Transition Manager RFP, PENSIONS & INVESTMENTS, Feb. 8, 2010 available at
http://www.pionline.com/article/20100208/PRINTSUB/302089976. In other cases, the
client may be required by the law under which it operates to undertake a specified
process to obtain a new manager, such as a solicitation for proposals from potential
managers.
133
See, e.g., Dechert Letter; Fidelity Letter; ICI Letter; Jones Day Letter (in some instances,
pointing to the MSRB’s approach of not necessarily applying MSRB rule G-37’s two-
year time out when a contribution is made after a business contract is signed). See
MSRB, Interpretation on the Effect of a Ban on Municipal Securities Business under
Rule G-37 Arising During a Pre-Existing Engagement Related to Municipal Fund
Securities, MSRB Rule G-37 Interpretive Notice (April 2, 2002), available at
http://msrb.org/msrb1/archive/ContributionsNotice.htm). As we explain above, due to
the long-term nature of typical advisory contracts and our belief that the consequences of
giving a contribution need to be commensurate with the potential benefits obtained, we
are not taking this approach.
134
Dechert Letter.
--42--
merely because they were entered into prior to discovery of a contribution, advisers
would be strongly incentivized against “discovering” contributions.135 Because no new
business from a government client may even be available to the adviser until the two-year
period has run its course, advisers whose contributions succeeded in acquiring a
management contract for two years or more could escape any consequences under such
an exception.136 Further, in our judgment, the potential loss of profits will not operate as
an adequate deterrent. It is our understanding that being selected to manage public
pension plan assets has a reputational value that itself contributes to advisory profits by
attracting additional assets under management regardless of the profits derived directly
from the management of government client assets.137
135
An approach that applied the two-year time out only to new business would preclude the
adviser from receiving compensation only from additional contracts that might be
awarded by the government entity during the two-year period. In our judgment, the risk
of the potential loss of additional advisory contracts for a two-year period would provide
an inadequate deterrent to contributions designed to influence the award of such
additional advisory contracts.
136
We are concerned that limiting application of the rule to new business could invite abuse.
For example, pension officials seeking contributions after a contract has been awarded
could attempt to offer an adviser additional assets to manage under the existing contract
with the condition that the adviser subsequently make political contributions.
137
See, e.g., Kevin McCoy, Do Campaign Contributions Help Win Pension Fund Deals,
USA TODAY, Aug. 28, 2009, available at
http://www.usatoday.com/money/perfi/funds/2009-08-26-pension-fund-politicaldonations_
N.htm (referring to advisory firms winning management mandates from
pension funds, stating: “The awards generate lucrative fees and lend prestige that could
help lure new clients.”); Louise Story, Quadrangle Facing Questions Over Pension
Funds, N.Y. TIMES, Apr. 21, 2009, available at
http://www.nytimes.com/2009/04/22/business/22quadrangle.html (highlighting an
indirect benefit of a pension fund investment, stating: “the prestige associated with it
helped the firm lure other big investors.”).
--43--
(2)
Officials of a Government Entity
The rule’s two-year time out is triggered by a contribution to an “official” of a
“government entity.”138 An official includes an incumbent, candidate or successful
candidate for elective office of a government entity if the office is directly or indirectly
responsible for, or can influence the outcome of, the hiring of an investment adviser or
has authority to appoint any person who is directly or indirectly responsible for, or can
influence the outcome of, the hiring of an investment adviser.139 Government entities
include all state and local governments, their agencies and instrumentalities, and all
public pension plans and other collective government funds, including participant-
directed plans such as 403(b), 457, and 529 plans.140
The two-year time out is thus triggered by contributions, not only to elected
officials who have legal authority to hire the adviser, but also to elected officials (such as
persons with appointment authority) who can influence the hiring of the adviser. We
have not modified this approach from our proposal.141 As we noted in the Proposing
Release, a person appointed by an elected official is likely to be subject to that official’s
138
Rule 206(4)-5(a)(1) makes it unlawful for covered investment advisers to provide
investment advisory services for compensation to a government entity within two years
after a contribution to an official of the government entity is made by the investment
adviser or any of its covered associates.
139
Rule 206(4)-5(f)(6). For purposes of the rule, we would not interpret the definition of
“official” as covering an individual who is also a “covered associate” of the adviser.
Accordingly, under the rule, a covered associate who is an incumbent or candidate for
office is not limited to contributing the de minimis amount to his or her own campaign.
The MSRB takes a similar view with respect to its rule G-37. MSRB, Questions and
Answers Concerning Political Contributions and Prohibitions on Municipal Securities
Business: Rule G-37, MSRB rule G-37 Interpretive Notice, available at
http://www.msrb.org/Rules-and-Interpretations/MSRB-Rules/General/Rule-G37Frequently-
Asked-Questions.aspx (“MSRB Rule G-37 Q&A”), Question II.10 (May 24,
1994).
140
Rule 206(4)-5(f)(5).
141
See Proposing Release, at section II.A.3(a)(2).
--44--
influences and recommendations.142 It is the scope of authority of the particular office of
an official, not the influence actually exercised by the individual, that would determine
whether the individual has influence over the awarding of an investment advisory
contract under the definition.143 We are adopting these provisions as proposed.144
Some commenters asserted that the rule should be more specific as to which
public officials to whom a contribution is made would trigger application of the rule in
order to reduce uncertainty and compliance burdens.145 But state and municipal statutes
vary substantially with respect to whom they entrust with the management of public
142
Id.
143
As such, executive officers or legislators whose official position gives them the authority
to influence the hiring of an investment adviser generally would be “government
officials” under the rule. For example, a state may have a pension fund whose board of
directors, which has authority to hire an investment adviser, is constituted, at least in part,
by appointees of the governor and members of the state legislature. See, e.g., The
Commonwealth of Pennsylvania Public School Employees’ Retirement Board, Statement
of Organization, By-Laws and Other Procedures (rev. Jun. 11, 2009), art. II, sec. 2.1,
available at http://www.psers.state.pa.us/org/board/policies/201001_bylaws.pdf (noting
that the board shall be composed of, inter alia, two persons appointed by the
Pennsylvania State Governor, two Pennsylvania state senators and two members of the
Pennsylvania state house of representatives). In such circumstances, the governor and the
members of the state legislature serving on the board would be officials of the
government entity. Conversely, a public official who is tasked with performing an audit
of the selection process but has no influence over hiring outcomes would not be an
official of a government entity for purposes of the rule.
144
These definitions and their application are substantively the same as those in MSRB rule
G-37. See MSRB rule G-37(g)(ii) and (g)(vi).
145
See, e.g., IAA Letter; NSCP Letter; Comment Letter of T. Rowe Price Associates, Inc.
(Oct. 6, 2009) (“T. Rowe Letter”); MFA Letter; Davis Polk Letter. For a discussion of the
potential costs involved in identifying officials to whom contributions could trigger the
rule’s prohibitions, see section IV of this Release (presenting our cost-benefit analysis).
Another commenter suggested that advisers should be able to rely on certifications from
candidates and officials regarding whether their office would render them an “official”
for purposes of the rule—i.e., identifying the range, if any, of public investment vehicles
over which the relevant office directly or indirectly influences the selection of investment
advisers or appoints individuals who do). Caplin & Drysdale Letter. We are concerned
that such a safe harbor would undercut the purposes of the rule, not least because officials
will be incentivized to offer such certifications liberally (and will presumably sometimes
do so inappropriately) to encourage contributions.
--45--
funds, and any effort we make in a rule of general application to identify specific officials
who are in a position to influence the selection of an adviser would certainly be over-
inclusive in some circumstances and under-inclusive in others.146 Others urged that
triggering contributions should be limited to contributions to officials directly responsible
for the selection of advisers.147 Excluding from the application of the rule contributions
to those who are in a position to indirectly influence the selection of an investment
adviser could simply lead officials to re-structure their relationships to avoid application
of the rule to advisers that may contribute to those officials.
Two commenters argued that the rule should not cover contributions to candidates
for federal office,148 while another contended that it should.149 Under our rule, as
proposed, a candidate for federal office could be an “official” under the rule not because
of the office he or she is running for, but as a result of an office he or she currently
holds.150 So long as an official has influence over the hiring of investment advisers as a
function of his or her current office, contributions by an adviser could have the same
effect, regardless to which of the official’s campaigns the adviser contributes. For that
146
Like us, the MSRB does not specify which officials have the authority to influence the
granting of government business for purposes of its rule G-37. See MSRB, Campaign for
Federal Office, MSRB Rule G-37 Interpretive Notice (May 31, 1995), available at
http://msrb.org/msrb1/rules/interpg37.htm (“The Board does not make determinations
concerning whether a particular individual meets the definition of “official of an issuer.”).
147
See, e.g., IAA Letter; NASP Letter; NY City Bar Letter; Davis Polk Letter.
148
See, e.g., NSCP Letter; Dechert Letter.
149
Fund Democracy/Consumer Federation Letter.
150
As a result, if a state or municipal official were, for example, a candidate for the U.S.
Senate, House of Representatives, or presidency, an adviser’s contributions to that
official would be covered by the rule. MSRB rule G-37’s time out provision is also
triggered by contributions to state and local officials running for federal office. See
MSRB Rule G-37 Q&A, Questions IV.2-3.
--46--
reason, we are not persuaded that an incumbent state or local official should be excluded
from the definition solely because he or she is running for federal office.151
(3)
Contributions
The rule’s time out provisions are triggered by contributions made by an adviser
or any of its covered associates.152 A contribution is defined to include a 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.153 It also includes transition or inaugural expenses
incurred by a successful candidate for state or local office.154 The definition is the same
as we proposed and as the one used in MSRB rule G-37.155
151
Under certain circumstances, a state or municipal official running for federal office could
remove herself from being an “official” for purposes of rule 206(4)-5 by eliminating her
ability to influence the outcome of the hiring of an investment adviser. This might occur,
for example, if she were to: (i) formally withdraw from participation in or influencing
adviser hiring decisions; (ii) be leaving office, so that he or she could not participate in
subsequent decision-making; and (iii) have held direct influence over the adviser hiring
process (as opposed to, for example, having designated an appointee with such influence
who would remain in a position to influence such hiring).
152
Rule 206(4)-5(a)(1) makes it unlawful for covered investment advisers to provide
investment advisory services for compensation to a government entity within two years
after a contribution to an official of the government entity is made by the investment
adviser or any of its covered associates. As suggested above, we are concerned that
contributions may be used “as the cover for what is much like a bribe: a payment that
accrues to the private advantage of the official and is intended to induce him to exercise
his discretion in the donor’s favor, potentially at the expense of the polity he serves.”
Blount, 61 F.3d at 942 (describing the Commission’s approval of MSRB rule G-37 as
based on a wish to curtail this function).
153
Rule 206(4)-5(f)(1).
154
MSRB rule G-37 also covers payment of transition or inaugural expenses as contributions
for purposes of its time out provision. See MSRB Rule G-37 Q&A, Question II.6.
However, under neither rule does a contribution include the transition or inaugural
expenses of a successful candidate for federal office. Contributions to political parties
are not specifically covered by the definition and thus would not trigger the rule’s two-
year time out unless they are a means to do indirectly what the rule prohibits if done
directly (for example, the contributions are earmarked or known to be provided for the
benefit of a particular political official). We also note that “contributions” are not
intended to include independent “expenditures,” as that term is defined in 2 U.S.C. 431 &
--47--
We received requests that we clarify the application of the rule to some common
circumstances that may arise in the course of an adviser’s relationship with a government
client.156 We would not consider a donation of time by an individual to be a contribution,
provided the adviser has not solicited the individual’s efforts and the adviser’s resources,
such as office space and telephones, are not used.157 Similarly, we would not consider a
charitable donation made by an investment adviser to an organization that qualifies for an
exemption from federal taxation under the Internal Revenue Code,158 or its equivalent in
a foreign jurisdiction, at the request of an official of a government entity to be a
contribution for purposes of rule 206(4)-5.159
441b (the federal statutory provisions limiting contributions and expenditures by national
banks, corporations, or labor organizations invalidated by Citizens United v. Federal
Election Commission, 130 S. Ct. 876 (2010) (holding that corporate funding of
independent political broadcasts in candidate elections cannot be limited under the First
Amendment)). Indeed, it is our intent that, under the rule, advisers and their covered
associates “are not in any way restricted from engaging in the vast majority of political
activities, including making direct expenditures for the expression of their views, giving
speeches, soliciting votes, writing books, or appearing at fundraising events.” Blount, 61
F.3d at 948.
155
MSRB rule G-37(g)(i).
156
See, e.g., Caplin & Drysdale Letter; Callcott Letter I (volunteer activities); NASP Letter
(charitable contributions); Sutherland Letter; IAA Letter (entertainment expenses and
conference expenses). We address entertainment and conference expenses in section
II.B.2(c) of this Release (which discusses the prohibition on soliciting or coordinating
contributions from others).
157
See Proposing Release, at n.91. A covered associate’s donation of his or her time
generally would not be viewed as a contribution if such volunteering were to occur
during non-work hours, if the covered associate were using vacation time, or if the
adviser is not otherwise paying the employee's salary (e.g., an unpaid leave of absence).
But see rule 206(4)-5(d) (prohibiting an adviser from doing indirectly what the rule
would prohibit if done directly). The MSRB deals similarly with this issue. See MSRB
Rule G-37 Q&A, Question II.19.
158
Section 501(c)(3) of the Internal Revenue Code (26 U.S.C. 501(c)(3)) contains a list of
charitable organizations that are exempt from federal income taxation.
159
The MSRB deals similarly with this issue. See MSRB Rule G-37 Q&A, Question II.18.
But see rule 206(4)-5(d) (prohibiting an adviser from doing indirectly what the rule
would prohibit if done directly).
--48--
The few commenters that addressed the definition of “contribution” generally
urged us to adopt a narrower version. Some, for example, recommended that
contributions be expressly limited to political contributions and more explicitly exclude
expenditures not clearly made for the purpose of influencing an election.160 We are not
narrowing our definition. We are instead adopting our definition as proposed due to our
concern that “contributions” may also take the form of payment of election-related debts
and transition or inaugural expenses. Further, our definition of “contribution” already
requires that the payment be made for the purpose of influencing an election for a federal,
state or local office.161 We believe that the scope of our proposed definition is
appropriate in light of the conduct we are seeking to address.
Commenters were divided as to whether contributions to PACs or local political
parties should trigger the two-year time out.162 Such contributions were not explicitly
covered by the proposed rule and do not necessarily trigger the two-year time out in
MSRB rule G-37.163 In some cases, such contributions may effectively operate as a
160
See, e.g., National Organizations Letter; NASP Letter.
161
Rule 206(4)-5(f)(1).
162
See, e.g., CalPERS Letter; NSCP Letter (should not apply to contributions to PACs or
state or local parties, unless a particular candidate directly solicits contributions for those
entities); Comment Letter of James J. Reilly (Aug. 24, 2009) (“Reilly Letter”)
(contributions to political parties should be included because in state and local elections
contributions to political parties may effectively amount to contributions to an individual
candidate); SIFMA Letter.
163
See, e.g., MSRB, Payments to Non-Political Accounts of Political Organizations, MSRB
rule G-37 Interpretive Letter (Sept. 25, 2007), available at
http://msrb.org/msrb1/rules/interpg37.htm (explaining that not all payments to political
organizations that, in turn, make contributions to officials trigger Rule G-37’s time out).
With regard to solicitations from a PAC or a political party with no indication of how the
collected funds will be disbursed, advisers should inquire how any funds received from
the adviser or its covered associates would be used. For example, if the PAC or political
party is soliciting funds for the purpose of supporting a limited number of government
officials, then, depending upon the facts and circumstances, contributions to the PAC or
payments to the political party might well result in the same prohibition on compensation
--49--
funnel to the campaigns of the government officials.164 In other cases, however, they
may fund general party political activities or the campaigns of other candidates.165
Therefore, we have decided not to explicitly include all such contributions among those
that trigger the time out, although they may violate the provision of the rule, discussed
below, which prohibits an adviser or any of its covered persons from indirect actions that
would result in a violation of the rule if done directly.166
The MSRB rule G-37 definition of “contribution” has, in our view, proved to be
workable. The types of contributions relevant to money managers and elected officials
are unlikely to be different than those made to influence the awarding of municipal
securities business by broker-dealers. On balance, we believe that the MSRB’s definition
of “contribution,” which we mirrored in our proposal, achieves the goals of this
rulemaking. Therefore, we are adopting the definition as proposed.
(4) Covered Associates
Contributions made to influence the selection process are typically made not by
the firm itself, but by officers and employees of the firm who have a direct economic
stake in the business relationship with the government client.167 Accordingly, under the
for providing investment advisory services to a government entity as would a
contribution made directly to the official. Our approach is consistent with the MSRB’s.
See MSRB Rule G-37 Q&A, Question III.5.
164
See, e.g., Reilly Letter.
165
See, e.g., Caplin & Drysdale Letter (explaining that “leadership PACs,” for example, are
commonly established by officeholders to donate to other candidates and issues).
166
See section II.B.2(d) of this Release. For the MSRB’s approach to this issue, see MSRB
Rule G-37 Q&A, Question III.4. But see rule 206(4)-5(d) (noting that the rule’s
definition of “official” of a government entity includes any election committee for that
person).
167
Proposing Release, at section II.A.3(a)(4). Based on enforcement actions, we believe that
such persons are more likely to have an economic incentive to make contributions to
influence the advisory firm’s selection. See id.
--50--
rule, contributions by each of these persons, which the rule defines as “covered
associates,” trigger the two-year time out.168 A “covered associate” of an investment
adviser is defined as: (i) any general partner, managing member or executive officer, or
other individual with a similar status or functio
; (ii) any employee who solicits a
government entity for the investment adviser and any person who supervises, directly or
indirectly, such employee; and (iii) any political action committee controlled by the
investment adviser or by any of its covered associates.169
Owners. Contributions by sole proprietors are contributions by the adviser
itself.170 If the adviser is a partnership, the rule covers contributions by the adviser’s
general partners.171 If the adviser is a limited liability company, the rule covers
contributions made by managing members.172 A contribution by an owner that is a
limited partner or non-managing member (of a limited liability company) is not covered,
however, unless the limited partner or non-managing member is also an executive officer
or solicitor (or person who supervises a solicitor) covered by the rule, or unless the
contribution is an indirect contribution by the adviser, executive officer, solicitor, or
supervisor.173 Similarly, if the adviser is a corporation, shareholder contributions are not
covered unless the shareholder is also an executive officer or solicitor covered by the
168 Rule 206(4)-5(a)(1).
169 Rule 206(4)-5(f)(2).
170 We note, however, that a sole proprietor may, in a personal capacity, avail herself or
himself of the de minimis exceptions described in section II.B.2(a)(6) of this Release.
171 Rule 206(4)-5(f)(2)(i).
172 Id.
173 See rule 206(4)-5(a)(1), (d) and (f)(2)(i)-(ii).
--51--
rule, or unless the contribution is an indirect contribution by the adviser, executive
officer, solicitor, or supervisor.174
Executive Officers. Contributions by an executive officer of an investment
adviser trigger the two-year time out.175 Executive officers include: (i) the president; (ii)
any vice president in charge of a principal business unit, division or function (such as
sales, administration or finance); (iii) any other officer of the investment adviser who
performs a policy-making function; or (iv) any other person who performs similar policy-
making functions for the investment adviser.176 Whether a person is an executive officer
depends on his or her function, not title; for example, an officer who is the chief
executive of an advisory firm but whose title does not include “president” is nonetheless
an executive officer for purposes of the rule.
The definition reflects changes we have made from our proposal that are designed
to clarify the rule and to tailor it to apply to those officers of an investment adviser whose
position in the organization is more likely to incentivize them to obtain or retain clients
for the investment adviser (and, therefore, to engage in pay to play practices) while still
achieving our objectives. We have clarified that “other executive officers” under the
rule—i.e., those other than the president and vice presidents in charge of principal
business units or functions—include only those officers or other persons who perform a
policy-making function for the investment adviser.177 This limitation, which was
174
Id.
175
The definition of “covered associate” includes, among others, any executive officer or
other individual with a similar status or function. Rule 206(4)-5(f)(2)(i).
176
Rule 206(4)-5(f)(4).
177
Rule 206(4)-2(f)(4). This modification also aligns the definition more closely with the
definition of “executive officer” in our other rules. See, e.g., rule 205-3(d)(4) under the
Advisers Act [17 CFR 275.205-3(d)(4)] (defining executive officer for purposes of
--52--
recommended by commenters,178 excludes persons who enjoy certain titles as a formal
matter but do not engage in the kinds of activities that we believe should trigger the
prohibitions in the rule.179 We have also modified the definition to remove the limitation
that the officer, as part of his or her regular duties, performs or supervises any person
who performs advisory services for the adviser, or solicits or supervises any person who
solicits for the adviser. We agree with the commenter who asserted that “. . . all of the
adviser’s executive officers should be included because the nature of their status alone
determinations of who is a qualified client exempting an adviser from the prohibition on
entering into, performing, renewing or extending an investment advisory contract that
provides for compensation on the basis of a share of the capital gains upon, or the capital
appreciation of, the funds, or any portion of the funds, under the Advisers Act) and rule
3c-5(a)(3) [17 CFR 270.3c-5(a)(3)] under the Investment Company Act of 1940 [15
U.S.C. 80a] (“Investment Company Act”) (defining executive officer for purposes of
determinations of the number of beneficial owners of a company excluded from the
definition of “investment company” by section 3(c)(1) of the Investment Company Act,
and whether the outstanding securities of a company excluded from the definition of
“investment company” by section 3(c)(7) of the Investment Company Act are owned
exclusively by qualified purchasers, as defined in that Act). It also more closely aligns
the definition to the MSRB approach. See MSRB rule G-37(g)(v).
178
See, e.g., Sutherland Letter.
179
Several commenters urged us expressly to exclude from the definition the CEO, officers
and employees of a parent company. See, e.g., SIFMA Letter; ICI Letter; MFA Letter;
Skadden Letter. Depending on facts and circumstances, there may be instances in which
a supervisor of an adviser’s covered associate (who, for example, engages in solicitation
of government entity clients for the adviser) formally resides at a parent company, but
whose contributions should trigger the two-year time out because they raise the same
conflict of interest issues that we are concerned about, irrespective of that person’s
location or title. In other words, whether a person is a covered associate ultimately
depends on the activities of the individual and not his or her title. We recently considered
a similar issue in a report addressing whether MSRB rule G-37 could include
contributions by employees of parent companies as triggering that rule’s time out
provision, see Report of Investigation Pursuant to Section 21(a) of the Securities
Exchange Act of 1934: JP Morgan Securities, Inc., Exchange Act Release No. 61734
(Mar. 18, 2010), available at http://www.sec.gov/litigation/investreport/34-61734.htm
(“This Report serves to remind the financial community that placing an executive who
supervises the activities of a broker, dealer or municipal securities dealer outside of the
corporate governance structure of such broker, dealer or municipal securities dealer does
not prevent the application of MSRB Rule G-37 to that individual's conduct.”). The
MSRB also takes the view that it is an individual’s activities and not his or her title that
may render his or her contributions a trigger for that rule’s time out provision. See
MSRB Rule G-37 Q&A, Question IV.18.
--53--
creates a strong incentive to engage in pay to play practices.”180 Even if these senior
officers are not directly involved in advisory or solicitation activities, as part of senior
management, their success within the advisory firm is likely to be tied to the firm’s
success in obtaining clients.181
Employees who Solicit Government Clients. Contributions by any employee who
solicits a government entity for the adviser would trigger the two-year time out. 182 An
employee need not be primarily engaged in solicitation activities to be a “covered
associate” under the rule.183 We are also including persons who supervise employees
who solicit government entities because we believe these persons are strongly
incentivized to engage in pay to play activities to obtain government entity clients.184 We
180
See Fund Democracy Letter.
181
Commenters also suggested that our definition exclude vice presidents in charge of
business units, divisions or functions whose function is unrelated to investment advisory
or solicitation activities. See, e.g., IAA Letter. For the reasons described above, we do
not believe such an exclusion is appropriate.
182
We are not adopting the suggestion of several commenters that we treat third-party
solicitors the same way as employees. See, e.g., 3PM Letter; Triton Pacific Letter;
Comment Letter of Arrow Partners, Inc. Partner Ken Rogers (Sept. 2, 2009) (“Arrow
Letter”). We explained in the Proposing Release that we determined not to propose this
approach out of concern for the difficulties that advisers may have when monitoring the
activities of their third-party solicitors. See Proposing Release, at nn.135 and
accompanying text. Commenters did not persuade us that these concerns can reasonably
be expected to be overcome. Therefore, whereas contributions by covered associates of
the adviser trigger the two-year compensation time out, an adviser is prohibited from
hiring third parties to solicit government business on its behalf unless the third party is a
“regulated person.” See section II.B.2(b) of this Release. Our approach is similar to
MSRB’s rule G-38, which restricts third-party solicitation activities differently from the
two-year time out. See MSRB rule G-38.
183
The MSRB also takes the approach that an associated person need not be “primarily
engaged” in activities that would make his or her contributions trigger rule G-37’s time
out provision, particularly where he or she engages in soliciting business. See MSRB
Rule G-37 Q&A, Question IV.8.
184
Rule 206(4)-5(f)(2)(ii). The proposed rule would only have applied to senior officers
who supervise employee solicitors. See proposed rule 206(4)-5(f)(4)(ii). MSRB rule G37
also applies to supervisors of persons who solicit relevant business from government
entities. See MSRB Rule G-37 Q&A, Question IV.14.
--54--
have revised this aspect of the definition to include all supervisors of those solicitors that
solicit government entities because we believe the incentives to engage in pay to play
exist for all such supervisors, not just those that have a certain level of seniority.
Rule 206(4)-5 defines “solicit” to mean, with respect to investment advisory
services, to communicate, directly or indirectly, for the purpose of obtaining or retaining
a client for, or referring a client to, an investment adviser.185 Commenters asked us to
provide further guidance on what we mean by “solicit.”186 The determination of whether
a particular communication is a solicitation is dependent upon the specific facts and
circumstances relating to such communication. As a general proposition any
communication made under circumstances reasonably calculated to obtain or retain an
advisory client would be considered a solicitation unless the circumstances otherwise
indicate that the communication does not have the purpose of obtaining or retaining an
advisory client. For example, if a government official asks an employee of an advisory
firm whether the adviser has pension fund advisory capabilities, such employee generally
would not be viewed as having solicited advisory business if he or she provides a limited
affirmative response, together with either providing the government official with contact
information for a covered associate of the adviser or informing the government official
that advisory personnel who handle government advisory business will contact him or
her. 187
185 Rule 206(4)-5(f)(10)(i). We are adopting this definition as proposed.
186 See, e.g., Skadden Letter.
187 Similarly, if a government official is discussing governmental asset management issues
with an employee of an adviser, the employee generally would not be viewed as having
solicited business if he or she provides a limited communication to the government
official that such alternative may be appropriate, together with either providing the
government official with contact information for a covered associate or informing the
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Political Action Committees. A covered associate includes a political action
committee controlled by the investment adviser or by any of its covered associates.188
Under the rule, we would regard an adviser or its covered associate to have “control”
over a political action committee if the adviser or its covered associate has the ability to
direct or cause the direction of the governance or operations of the PAC.189
Two commenters asserted that we should narrow the definition of “covered
associate” with respect to political action committees.190 Specifically, they asserted that
the definition should only include PACs controlled by the adviser and not those
controlled by other covered associates, which could be a separate legal entity over which
government official that advisory personnel who handle asset management for
government clients will contact him or her. In these examples, however, if the adviser’s
employee receives compensation such as a finder’s or referral fee for such business or if
the employee engages in other activities that could be deemed a solicitation with respect
to such business, the employee generally would be viewed as having solicited the
advisory business. Our interpretation of what it means to “solicit” government business
is consistent with the MSRB’s. See MSRB, Interpretive Notice on the Definition of
Solicitation under Rules G-37 and G-38 (June 8, 2006), available at
http://msrb.org/msrb1/rules/notg38.htm.
188
Rule 206(4)-5(f)(2)(iii) (which we are adopting as proposed). One commenter suggested
that we define a “political action committee,” or PAC, as any organization required to
register as a political committee under federal, state or local law. Caplin & Drysdale
Letter. But we have not included this definition of PAC because we do not believe a
definition linked to the registration status of a political committee would serve our
purpose of deterring evasion of the rule as registration requirements vary among election
laws. We note, however, that we would construe the term PAC to include (but not
necessarily be limited to) those political committees generally referred to as PACs, such
as separate segregated funds or non-connected committees within the meaning of the
Federal Election Campaign Act, or any state or local law equivalent. See Federal
Election Commission, Quick Answers to PAC Questions, available at
http://www.fec.gov/ans/answers_pac.shtml#pac. Determination of whether an entity is a
PAC covered by our rule would not, in our view, turn on whether the PAC was, or was
required to be, registered under relevant law.
189
One commenter suggested a similar interpretation of “control.” Caplin & Drysdale
Letter. For the MSRB’s approach to this definition, see MSRB Rule G-37 Q&A,
Question IV.24.
190
SIFMA Letter; Sutherland Letter.
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the adviser may have little influence.191 We are not adopting this suggestion. As we
discussed in the Proposing Release, PACs are often used to make political
contributions.192 The recommended changes would permit an executive of the adviser or
another covered person of the adviser to use a PAC he or she controls to evade the rule.
Even where the adviser itself does not control such PACs directly, we are concerned
about their use to evade our rule where they are controlled by covered associates (whose
positions in the organization, as we note above, are more likely to incentivize them to
obtain or retain clients for the investment adviser).193
Other Persons. Several commenters urged that our definitions be broadened to
encompass other persons whose contributions should trigger the two-year time out.194
One urged that in some cases all employees should be covered associates because of the
likelihood they could directly benefit from engaging in pay to play.195 Another urged that
the definition of covered associate include affiliates of the adviser that solicit government
business on the adviser’s behalf, any director of the adviser, and any significant owner of
the adviser.196 These suggestions would expand the rule to a range of persons that could
191
Id.
192
Proposing Release, at n.101.
193
Advisers are responsible for supervising their supervised persons, including their covered
associates. We have the authority to seek sanctions where an investment adviser, or an
associated person, has failed reasonably to supervise, with a view to preventing violations
of the federal securities laws or rules, a person who is subject to the adviser’s (or its
associated person’s) supervision and who commits such violations. Sections 203(e)(6)
and 203(f) of the Advisers Act [15 U.S.C. 80b-3(e)(6) and (f)].
194
See, e.g., Fund Democracy/Consumer Federation Letter; DiNapoli Letter (suggesting the
rule also cover contributions from family members); Ounavarra Letter.
195
Ounavarra Letter.
196
Fund Democracy/Consumer Federation Letter.
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engage in pay to play activities.197 In our judgment, however, contributions from these
types of persons are less likely to involve pay to play unless the contributions were made
by these persons for the purpose of avoiding application of the rule, which could result in
the adviser’s violation of a separate provision of the rule.198 We do not believe that the
incremental benefits of capturing conduct of other individuals less likely to engage in pay
to play based on the record before us today outweigh the additional burden such an
expansion would impose.199 Thus, we are not expanding the definition as these
commenters have suggested.
Other commenters urged us to narrow our definition of “covered associate” to
include fewer persons.200 For example, one commenter recommended that the definition
of “covered associate” expressly exclude all “support personnel.”201 Another suggested
that we limit the definition to those who solicit government clients with a “major
purpose” of obtaining that government client.202 Expressly excluding all “support
personnel” is unnecessary because, in almost all cases, such persons would not be
197
See, e.g., supra note 179 (discussing why we have chosen not to limit the definition of
“executive officer” in other ways as suggested by some commenters).
198
See Rule 206(4)-5(d). We also note that the MSRB takes a similar approach. See, e.g.,
MSRB Rule G-37 Q&A, Question IV.9 (noting that the universe of those whose
contributions above the de minimis level per se trigger the two-year time out is limited
and does not include their consultants, lawyers or spouses). The MSRB also leaves
contributions by affiliates and personnel beyond those identified as triggering the two-
year time out to be addressed by a provision prohibiting municipal securities dealers from
doing indirectly what they are prohibited from doing directly under rule G-37. See
MSRB Rule G-37(d).
199
In this instance, as in others, we are sensitive to First Amendment concerns that further
expansion of the scope of covered associates could broaden the rule’s scope beyond what
is necessary to accomplish its purposes.
200
See, e.g., T. Rowe Price Letter; NSCP Letter; Skadden Letter.
201
T. Rowe Price Letter.
202
Skadden Letter.
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“covered associates,” as that term is defined in the rule. We have not limited the
definition to those who solicit government clients with a “major purpose” of obtaining
that government client because we believe that our rule’s definition of “solicit,” as
discussed above, adequately takes into account the purpose of the communication and
adding an additional element of intent may exclude employees who have an incentive to
engage in pay to play practices.
(5)
“Look Back”
The rule attributes to an adviser contributions made by a person within two years
(or, in some cases, six months) of becoming a covered associate of that adviser.203 In
other words, when an employee becomes a covered associate, the adviser must “look
back” in time to that employee’s contributions to determine whether the time out applies
to the adviser.204 If, for example, the contribution were made more than two years (or,
pursuant to the exception described below for non-solicitors, six months) prior to the
employee becoming a covered associate, the time out has run; if the contribution was
made less than two years (or six months) from the time the person becomes a covered
associate, the rule prohibits the adviser that hires or promotes the contributing covered
associate from receiving compensation for providing advisory services from the hiring or
203
Rule 206(4)-5(a)(1). The “look back” applies to any person who becomes a covered
associate, including a current employee who has been transferred or promoted to a
position covered by the rule. A person becomes a covered associate for purposes of the
rule’s look-back provision at the time he or she is hired or promoted to a position that
meets the definition of “covered associate” in rule 206(4)-5(f)(2). For a discussion of the
definition of “covered associate,” see section II.B.2(a)(4) of this Release.
204
Rule 206(4)-5(a)(1) (including among those covered associates whose contributions can
trigger the two-year time out a person who becomes a covered associate within two years
after the contribution is made); Rule 206(4)-5(b)(2) (excepting from the two-year look
back those contributions made by a natural person more than six months prior to
becoming a covered associate of the investment adviser unless such person, after
becoming a covered associate, solicits clients on behalf of the investment adviser).
--59--
promotion date until the two-year period has run.205 The look-back provision, which is
similar to that in MSRB rule G-37, is designed to prevent advisers from circumventing
the rule by influencing the selection process by hiring persons who have made political
contributions.206
We received many comments on our proposed look-back provision,207 which
would have applied the two-year look back with respect to all contributions of new
covered associates.208 One commenter asserted that such a provision is necessary to
prevent advisers from circumventing the prohibitions on pay to play.209 Most
commenters, however, argued that the rule should not contain a look-back provision or
should contain a shorter one because it could prevent advisers from hiring qualified
205
In no case would the prohibition imposed by the rule be longer than two years from the
date the covered associate makes a covered contribution. If, for example, a covered
associate becomes employed by an investment adviser (and engages in solicitation
activity for it) one year and six months after making a contribution, the new employer
would be subject to the proposed rule’s prohibition for the remaining six months of the
two-year period. We also note that the rule’s exemptive process may be available in
instances where an adviser believes application of the look-back provision would yield an
unintended result. Rule 206(4)-5(e). For a discussion of the rule’s exemptive provision,
see section II.B.2(f) of this Release.
206
Similarly, to prevent advisers from channeling contributions through departing
employees, advisers must “look forward” with respect to covered associates who cease to
qualify as covered associates or leave the firm. The covered associate’s employer at the
time of the contribution would be subject to the proposed rule’s prohibition for the entire
two-year period, regardless of whether the covered associate remains a covered associate
or remains employed by the adviser. Thus, dismissing a covered associate would not
relieve the adviser from the two-year time out. MSRB rule G-37 also includes a “lookforward
provision.” See MSRB Rule G-37 Q&A, Question IV.17 (“. . . any contributions
by [an] associated person [who leaves the dealer’s employ] (other than those that qualify
for the de minimis exception under Rule G-37(b)) will subject the dealer to the rule’s ban
on municipal securities business for two years from the date of the contribution”).
207
See, e.g., Fund Democracy/Consumer Federation Letter; ICI Letter; Davis Polk Letter;
NY City Bar Letter; Fidelity Letter; Wells Fargo Letter; MFA Letter; IAA Letter; NASP
Letter; American Bankers Letter; Comment Letter of Seward & Kissel LLP (Oct. 6.
2009) (“Seward & Kissel Letter”); Park Hill Letter; Dechert Letter; Skadden Letter.
208
See Proposing Release, at section II.A.3(a)(5).
209
Fund Democracy/Consumer Federation Letter.
--60--
individuals who have made unrelated political contributions,210 or it could be disruptive
to public pension plans seeking to hire qualified managers.211 While some urged that we
eliminate the look-back provision altogether,212 most asked us to shorten the period to
three to six months.213 Others suggested alternative approaches to the look back,
including adopting a higher contribution threshold to trigger the look-back provision214 or
permitting advisers to hire and promote persons to be covered associates who have made
prohibited contributions, but not permitting them to solicit government clients or
otherwise create firewalls between them and government clients.215
Upon consideration of the comments, we believe that applying the full two-year
look back to all new covered associates may be unnecessary to achieve the goals of the
rulemaking. We are adopting a suggestion offered by several commenters to shorten the
look-back period with respect to certain new covered associates whose contributions are
less likely to be involved in pay to play.216 Under an exception to the rule, the two-year
210
See, e.g., ICI Letter; Davis Polk Letter; NY City Bar Letter; Fidelity Letter; Wells Fargo
Letter; MFA Letter.
211
See, e.g., Comment Letter of Connecticut Treasurer Denise L. Nappier (Sept. 10, 2009)
(“CT Treasurer Letter”); CalPERS Letter.
212
See, e.g., IAA Letter; ICI Letter; Wells Fargo Letter; NASP Letter; American Bankers
Letter; MFA Letter; Seward & Kissel Letter.
213
See, e.g., ICI Letter (three-month look back); IAA Letter (six-month look back); Park
Hill Letter (six-month look back); Wells Fargo Letter (six-month look back); Davis Polk
Letter (six-month look back); Dechert Letter (six-month look back); MFA Letter (sixmonth
look back).
214
See, e.g., Wells Fargo Letter; NSCP Letter.
215
See, e.g., Comment Letter of Strategic Capital Partners (Oct. 1, 2009) (“Strategic Capital
Letter”); Comment Letter of B. Jack Miller (Oct. 3, 2009); Comment Letter of RP Realty
Partners, LLC Chief Financial Officer Jerry Gold (Oct. 2, 2009); SIFMA Letter.
216
See, e.g., MFA Letter; Fidelity Letter; Dechert Letter; Wells Fargo Letter; Skadden
Letter. The MSRB shortened the look-back period under MSRB rule G-37 to six months
for certain municipal finance professionals in response to similar industry concerns about
the impact on hiring. See MSRB, Amendments Filed to Rule G-37 Concerning the
--61--
time out is not triggered by a contribution made by a natural person more than six months
prior to becoming a covered associate, unless he or she, after becoming a covered
associate, solicits clients.217 As a result, the two-year look back applies only to covered
associates who solicit for the investment adviser.218
The potential link between obtaining advisory business and contributions made by
an individual prior to his or her becoming a covered associate that is uninvolved in
solicitation activities is likely more attenuated and therefore, in our judgment, should be
subject to a shorter look back. We have modeled this shortened look-back period219 on
the MSRB’s six-month look back for certain personnel, which it implemented as a result
of feedback it received from dealers that indicated the two-year look back was negatively
affecting in-firm transfers and promotions and “preclud[ing] them from hiring individuals
Exemption Process and the Definition of Municipal Finance Professional (Sept. 26,
2002), available at http://www.msrb.org/msrb1/archive/g%2D37902notice.htm.
217
Rule 206(4)-5(b)(2). An adviser is subject to the two-year time out regardless of whether
it is “aware” of the political contributions. Thus, statements by prospective employees
regarding whether they have made relevant contributions are insufficient to inoculate the
adviser, as some commenters urged (see, e.g., IAA Letter; ICI Letter; NSCP Letter;
Caplin & Drysdale Letter), to ensure that investment advisers are not encouraged to relax
their efforts to promote compliance with the rule’s prohibitions. Nonetheless, advisers
who advise or are considering advising any government entity should consider requiring
full disclosure of any relevant political contributions from covered associates or potential
covered associates to ensure compliance with rule 206(4)-5. Advisers are required to
request similar reports about securities holdings by Advisers Act rule 204A-1(b)(1)(ii)
[17 CFR 275.204A-1(b)(1)(ii)], which requires each of a firm’s “access persons” to
submit an initial “holdings report” of securities he or she beneficially owns at the time he
or she becomes an access person, even though the securities would likely have been
acquired in transactions prior to becoming an access person. For a discussion of an
adviser’s recordkeeping obligations with regard to records of contributions by a new
covered associate during that new covered associate’s look-back period, see infra note
428.
218
See rule 206(4)-5(f)(2) (defining covered associate of an investment adviser as: (i) any
general partner, managing member or executive officer, or other individual with a similar
status or function; (ii) any employee who solicits a government entity for the investment
adviser and any person who supervises, directly or indirectly, such employee).
219
See rule 206(4)-5(b)(2).
--62--
who had made contributions, even though the contributions (which may have been
relatively small) were made at a time when the individuals had no reason to be familiar
with Rule G-37.”220 This approach balances commenters’ concerns about the
implications for their hiring decisions with the need to protect against individuals
marketing to prospective investment adviser employers their connections to, or influence
over, government entities those advisers might be seeking as clients.221
(6)
Exceptions for De Minimis Contributions
Rule 206(4)-5 permits individuals to make aggregate contributions without
triggering the two-year time out of up to $350, per election, to an elected official or
candidate for whom the individual is entitled to vote,222 and up to $150, per election, to
220
MSRB, Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the
Municipal Securities Rulemaking Board Relating to Amendments to Rules G-37, on
Political Contributions and Prohibitions on Municipal Securities Business, G-8, on
Books and Records, Revisions to Form G-37/G-38 and the Withdrawal of Certain Rule
G-37 Questions and Answers, Exchange Act Release No. 47609 (April 1, 2003) [67 FR
17122 (Apr. 8, 2003)]. See also MSRB, Self-Regulatory Organizations; Order Granting
Approval of a Proposed Rule Change and Amendment No. 1 Thereto by the Municipal
Securities Rulemaking Board Relating to Amendments to Rules G-37, on Political
Contributions and Prohibitions on Municipal Securities Business, G-8, on Books and
Records, Revisions to Form G-37/G-38 and the Withdrawal of Certain Rule G-37
Questions and Answers, Exchange Act Release No. 47814 (May 8, 2003) [68 FR
25917 (May 14, 2003)] (Commission order approving amendments to MSRB rule G-37);
MSRB rule G-37(b)(iii).
221
We are not adopting the suggestion of commenters to exclude from the look-back
provision contributions made before a merger or acquisition by an adviser by not
attributing the contributions of the acquired adviser to the acquiring adviser. See, e.g.,
Dechert Letter; ICI Letter. We believe that an acquisition of another adviser could raise
identical concerns where the acquired adviser has made political contributions designed
to benefit the acquiring adviser. Rule 206(4)-5 is not intended to prevent mergers in the
investment advisory industry or, once a merger is consummated, to hinder the surviving
adviser’s government advisory business unless the merger was an attempt to circumvent
rule 206(4)-5. Thus, the adviser may wish to seek an exemption from the ban on
receiving compensation pursuant to rule 206(4)-5(a) from the Commission. The MSRB
takes the same approach to this issue. See MSRB Rule G-37 Q&A, Question II.16.
222
For purposes of rule 206(4)-5, a person would be “entitled to vote” for an official if the
person’s principal residence is in the locality in which the official seeks election. For
example, if a government official is a state governor running for re-election, any covered
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an elected official or candidate for whom the individual is not entitled to vote.223 These
de minimis exceptions are available only for contributions by individual covered
associates, not the investment adviser itself.224 Under both exceptions, primary and
general elections would be considered separate elections.225
We proposed a $250 de minimis exception for contributions to candidates for
whom a covered associate is entitled to vote,226 which reflects the current de minimis
exception in MSRB rule G-37.227 Many commenters urged us to increase the de minimis
amount (either to a larger number or by indexing it to inflation), arguing that a
associate of an adviser who resides in that state may make a de minimis contribution to
the official without causing a ban on that adviser being compensated for providing
advisory services for that government entity. In the example of a government official
running for President, any covered associate in the country can contribute the de minimis
amount to the official's Presidential campaign. The MSRB has issued a similar
interpretation of what it means to be “entitled to vote” for purposes of MSRB rule G-37.
See MSRB Reports, Vol. 16. No. 1 (January 1996) at 31-34.
223
See Rule 206(4)-5(b)(1) (excepting “de minimis” contributions to “officials” (see supra
note 139 and accompanying text) from the rule’s two-year time out provision).
224
Id. Under the rule, each covered associate, taken separately, would be subject to the de
minimis exceptions. In other words, the limit applies per covered associate and is not an
aggregate limit for all of an adviser’s covered associates. But see supra note 170
(pointing out that a sole proprietor may, in a personal capacity, avail herself or himself of
the de minimis exceptions even though his or her contributions are otherwise considered
contributions of the adviser itself).
225
Accordingly, a covered person of an investment adviser could, without triggering the
prohibitions of the rule, contribute up to the limit in both the primary election campaign
and the general election campaign of each official for whom the person making the
contribution would be entitled to vote. The MSRB takes the same approach of excepting
from rule G-37’s time out trigger contributions up to the rule’s de minimis amount for
each election (including a primary and general election). See MSRB Rule G-37 Q&A,
Question II.8. See also In the Matter of Pryor, McClendon, Counts & Co., Inc., et al.,
Exchange Act Release No. 48095 (June 26, 2003) (noting that contributions must be
limited to MSRB rule G-37’s de minimis amount before the primary, with the same de
minimis amount allowed after the primary for the general election).
226
See Proposing Release, at section II.A.3(a)(6).
227
See MSRB rule G-37(b)(i).
--64--
contribution as large as $1,000 would be unlikely to influence the award of an advisory
contract by a public pension plan.228
The $1,000 amount suggested by some commenters strikes us as a rather large
contribution that could influence the hiring decisions, depending upon the size of the
jurisdiction, the amount of campaign contributions to opposing candidates, and the
competitiveness of the primary or prospective election. Instead, we are taking the
suggestion of several commenters229 that we should increase the de minimis amount to
reflect the effects of inflation since the MSRB first established its $250 de minimis
amount in 1994.230 We may consider increasing the $350 amount in the future if, for
example, the value of it decreases materially as a result of further inflation.
Commenters also urged us to eliminate the condition that a covered associate
must be able to vote for the candidate.231 They asserted that persons can have a
legitimate interest in contributing to campaigns of people for whom they are unable to
228
See, e.g., SIFMA Letter; NASP Letter; Comment Letter of Philip K. Holl (Oct.5, 2009)
(“Holl Letter”); NSCP Letter; Caplin & Drysdale Letter; Cornell Law Letter; ICI Letter;
MFA Letter; Seward & Kissel Letter; Callcott Letter II; Comment Letter of the California
State Teachers’ Retirement System (Oct. 6, 2009) (adopted policies that limit
contributions to board members by those seeking investment relationships with the fund
to $1,000). Several commenters suggested our proposed de minimis limit could be
subject to a challenge on constitutional grounds. For a discussion of, and response to,
these comments, see supra note 72 and accompanying text.
229
See, e.g., Caplin & Drysdale Letter (recommending that we index the de minimis
threshold for inflation); Cornell Law Letter (recommending that we index the de minimis
threshold for inflation). See also Callcott Letter I.
230
We multiplied the $250 de minimis amount that we proposed (which was adopted by the
MSRB in 1994) by the annual consumer price index (a measure of inflation) change since
1994, as reported by the Bureau of Labor Statistics (available at
http://www.bls.gov/data/). The result was approximately $365 in 2009; we rounded it
down to $350 for administrative convenience.
231
See, e.g., T. Rowe Price Letter; Dechert Letter; MFA Letter; NASP Letter; Callcott Letter
I; Cornell Law Letter; IAA Letter.
--65--
vote.232 We acknowledge that persons can have such an interest, such as in large
metropolitan areas where a covered associate may work and live in different jurisdictions.
But commenters did not confine their recommendations to such circumstances and we
remain concerned that contributions by executives of advisers living in distant
jurisdictions may be less likely to be made for purely civic purposes. Accordingly, we
have added a de minimis exception for contributions of up to $150 to officials for whom a
covered associate is not entitled to vote, which is lower than the de minimis exception of
$350 for candidates for whom a covered associate is entitled to vote. We believe that
$150 is a reasonable amount for the additional de minimis exception we are adopting
because of the more remote interest a covered associate is likely to have in contributing
to a person for whom he or she is not entitled to vote.
(7)
Exception for Certain Returned Contributions
We are adopting, largely as proposed, an exception that will provide an adviser
with a limited ability to cure the consequences of an inadvertent political contribution to
an official for whom the covered associate making it is not entitled to vote.233 The
exception is available for contributions that, in the aggregate, do not exceed $350 to any
one official, per election.234 The adviser must have discovered the contribution which
resulted in the prohibition within four months of the date of such contribution235 and,
232
See, e.g., T. Rowe Price Letter; Dechert Letter; MFA Letter; NASP Letter; Callcott Letter
I; Cornell Law Letter.
233
Rule 206(4)-5(b)(3).
234
Rule 206(4)-5(b)(3)(i). We note that a contribution would not trigger the two-year ban at
all to the extent it falls within the de minimis exception described in rule 206(4)-5(b)(1).
See section II.B.2(a)(6) of this Release for a discussion of this exception.
235
Id.
--66--
within 60 days after learning of the triggering contribution, the contributor must obtain
the return of the contribution.236
The scope of this exception is limited to the types of contributions that we believe
are less likely to raise pay to play concerns. The prompt return of the contribution
provides an indication that the contribution would not affect an official of a government
entity’s decision to award an advisory contract.237 The relatively small amount of the
contribution, in conjunction with the other conditions of the exception, suggests that it
was unlikely to be made for the purpose of influencing the award of an advisory contract.
Repeated triggering contributions suggest otherwise or that the adviser has not
implemented effective compliance controls. Therefore, the rule limits an adviser’s
reliance on the exception to no more than two or three per 12-month period (based on the
size of the adviser),238 and no more than once for each covered associate,239 regardless of
the time period.240
236
Rule 206(4)-5(b)(3)(i).
237
The 60-day limit is designed to give contributors sufficient time to seek its return, but still
require that they do so in a timely manner. Also, this provision is consistent with MSRB
rule G-37(j)(i). If the recipient will not return the contribution, the adviser would still
have available the opportunity to apply for an exemption under paragraph (e) of the rule.
Paragraph (e), which sets forth factors we would consider in determining whether to grant
an exemption, includes as a factor whether the adviser has taken all available steps to
cause the contributor involved in making the contribution which resulted in such
prohibition to obtain a return of the contribution.
238
Rule 206(4)-5(b)(3)(ii). The approach we have taken will generally create some
flexibility to accommodate a limited number of contributions by covered associates that
would otherwise trigger the two-year time out. In a modification from our proposal that
we believe is responsive to certain commenters’ concerns (see note 251 and
accompanying text below), “larger” advisers may avail themselves of three automatic
exceptions, instead of two, in any calendar year. Rule 206(4)-5(b)(3)(ii). In contrast, our
proposal would have permitted each adviser, regardless of its size, to rely on the
automatic exception twice each year. The rule identifies a “larger” adviser for these
purposes as any adviser who has reported in response to Item 5.A on its most recently
filed Form ADV, Part 1A [17 CFR 279.1] that it has more than 50 employees. Id.
Investment Adviser Registration Depository (IARD) data as of April 1, 2010 indicate that
--67--
Commenters who addressed it generally supported our inclusion of an automatic
exception provision,241 although several suggested modifications.242 Some urged us to
eliminate the requirement that the contributor succeed in obtaining the return of the
contribution.243 We are not making this change, which could undermine our goals in
adopting the rule if it led to contributors asking for the return of a contribution where
such requests were expected to be refused by the government official. We would have to
discern whether the contributor itself, who may (or whose employer may) be seeking to
influence government officials, has tried “hard enough” to get the contribution back.
Other commenters recommended an alternative exception for inadvertent
contributions that would not require that an otherwise-triggering contribution be
approximately 10 percent of registered advisers have more than 50 employees (and would
therefore be limited to three “automatic” exceptions per calendar year instead of two). In
particular, the data indicate that there are 11,607 registered investment advisers. Of
those, 1,072 advisers (9.2% of the total) have indicated in their responses to Item 5.A of
Part 1A of Form ADV that they have more than 50 employees. We chose the 50
employee cut-off because the number of employees is independently reported on Form
ADV (and therefore cross-verifiable)—each adviser filing Form ADV must check a box
indicating an approximation of the number of employees it has, choosing among 1-5, 610,
11-50, 51-250, 251-500, 501-1,000, or more than 1,000—and because we believe that
inadvertent violations of the rule are more likely at advisers with greater numbers of
employees. We think that the twice per year limit is appropriate for small advisers and
the three times per year limit is appropriate for larger advisers. We do not believe it is
appropriate for there to be greater variation in the number of times advisers may rely on
the exception than that based either on their size or on other characteristics. We are
seeking to encourage robust monitoring and compliance.
239
Rule 206(4)-5(b)(3)(iii). Once a covered associate has been made aware of an
“inadvertent” violation, a justification for a second violation would be more questionable.
240
Although we have included different allowances for larger and smaller advisers (based on
the number of employees they report on Form ADV), our approach otherwise generally
tracks MSRB rule G-37’s “automatic exemption” provision. See MSRB rule G-37(j).
241
See, e.g., T. Rowe Price Letter; NSCP Letter; CT Treasurer Letter; Skadden Letter; ICI
Letter; IAA Letter.
242
See, e.g., NY City Bar Letter; Dechert Letter; IAA Letter.
243
See, e.g., T. Rowe Price Letter; NSCP Letter; CT Treasurer Letter.
--68--
returned.244 They contended that such an exception should be available to advisers with
policies and procedures in place to prevent pay to play that include sanctions for
employees violating the policies.245 Such an approach excludes any objective indication
that the contribution was inadvertent. As noted above, policies and procedures are
required to ensure compliance with our rule. But policies and procedures alone, without
critical objective criteria, such as obtaining a return of the contribution, are insufficient in
our view to justify an exception to our prophylactic rule.
Some commenters urged us to modify or eliminate the requirement that the
contribution be discovered by the adviser within four months.246 We believe, however,
that four months is the appropriate timeframe. We believe advisers should have a
reasonable amount of time to discover contributions made by covered associates if, for
example, their covered associates disclose their contributions to the adviser on a quarterly
basis.247 The absence of such a time limitation would encourage advisers not to seek to
244
See, e.g., IAA Letter (suggesting that we require, as a condition for such an exception,
that “such contribution resulted in an inadvertent violation, meaning violations that are
not reasonably known or condoned by the investment adviser and where the contributor
lacked intent to influence the award of the advisory contract or violate the rule in making
the contribution, as evidenced by the facts and circumstances surrounding such
contribution”).
245
See, e,g., IAA Letter; Dechert Letter; NY City Bar Letter.
246
See, e.g., T. Rowe Price Letter (arguing that, if an adviser has in place procedures to
require covered associates to report all contributions no less frequently than quarterly,
and an associate fails to report a contribution in violation of the procedures, the discovery
of a prohibited contribution outside this four-month window should not preclude the use
of this exception.). But see Fund Democracy/Consumer Federation Letter (urging us to
consider shortening the time in which a contribution must be discovered for the exception
to be available to one month).
247
Quarterly compliance reporting is familiar to advisory personnel. See, e.g., rule 204A-1
under the Advisers Act (requiring that, under an adviser’s code of ethics, personnel report
personal securities trading activity at least quarterly). We do not believe the exception
should be available where it takes longer for advisers to discover contributions made by
covered associates because they might enjoy the benefits of a contribution’s potential
--69--
discover such contributions if they believed they could simply rely on the exception any
time a contribution happened to come to light.
A number of commenters suggested the exception be allowed for all contributions
regardless of dollar amount, while a few recommended raising the dollar amount to
$1,000.248 As we noted above, we view the limitation on the amount of such a
contribution, in conjunction with the other conditions of the exception, important to the
rule because it is more likely that the contribution was, in fact, inadvertent. We have
modified this “automatic” exception from our proposal by raising the limit on
contributions eligible for the exception to $350, the same amount we have adopted as a
de minimis threshold for contributions to an official for whom a covered associate is
entitled to vote.249 In addition, at the suggestion of commenters who argued that our
proposed limitation on the annual use of such exception failed to take into consideration
the different size of advisers, 250 we have modified our proposal to permit use of the
exception three times in any year by an adviser that has reported on its Form ADV
influence for too long a period of time. The condition that the contribution be discovered
within four months is consistent with the MSRB’s approach. See MSRB rule G-37(j)(i).
248
See, e.g., SIFMA Letter; NASP Letter; Holl Letter; NSCP Letter; ICI Letter; MFA Letter.
249
Rule 206(4)-5(3)(i)(B). No automatic exception is available for any contributions to an
official for whom the covered associate is entitled to vote that exceed the de minimis
$350 amount. As explained above, we believe that $350 is the appropriate de minimis
threshold for contributions to officials for whom a covered associate is entitled to vote
and $150 is the appropriate de minimis threshold for contributions to officials for whom a
covered associate it not entitled to vote. See section II.B(6) of this Release. Because
these thresholds are different, we anticipate that covered associates could mistakenly
make contributions up to the higher threshold under the mistaken belief that they are
entitled to vote for an official when in fact they are not entitled to do so. So long as those
contributions are returned and the other conditions of the exception are met, we believe
they should be eligible for the automatic exception.
250
See, e.g., Skadden Letter; T. Rowe Price Letter; NSCP Letter; ICI Letter; IAA Letter.
--70--
registration statement that it had more than 50 employees who perform investment
advisory functions.251
The exception is intended to provide advisers with the ability to undo certain
mistakes. Because it operates automatically,252 we believe it should be subject to
conditions that are objective and limited in order to capture only those contributions that
are unlikely to raise pay to play concerns.253
(b)
Ban on Using Third Parties to Solicit Government
Business
Rule 206(4)-5 makes it unlawful for any investment adviser subject to the rule or
any of the adviser’s covered associates to provide or agree to provide, directly or
indirectly, payment254 to any person to solicit255 government clients for investment
251
See supra note 238.
252
The exception is “automatic” in the sense that an adviser relying on it may do so without
notifying the Commission or its staff. However, we note that the recordkeeping
obligations for registered advisers mandate specifically that an adviser maintain records
regarding contributions with respect to which the adviser has invoked this exception.
Rule 204-2(a)(18)(ii)(D). See also section II.D of this Release.
253
As discussed below in section II.B.2(f) of this Release, in other circumstances, advisers
can apply to the Commission for an exemption from the rule’s two-year time out. See
rule 206(4)-5(e).
254
The term “payment” is defined in rule 206(4)-5(5)(f) as any gift, subscription, loan,
advance, or deposit of money or anything of value. Depending on the specific facts and
circumstances, payment can include quid pro quo arrangements whereby a non-affiliated
person solicits advisory business for the adviser in exchange for being hired by the
adviser to provide other unrelated services. This approach is consistent with the MSRB’s
with regard to MSRB rule G-38’s third-party solicitor ban. See MSRB, Interpretive
Notice on the Definition of Solicitation under Rules G-37 and G-38 (June 8, 2006),
available at http://msrb.org/msrb1/rules/notg38.htm. But see infra note 257 (discussing
the provision of professional services by third parties).
255
For the definition of what it means to “solicit” a client or prospective client to provide
investment advisory services, which we are adopting as proposed, see text accompanying
note 185. This definition is consistent with the definition the MSRB employs for similar
purposes in rule G-38, the MSRB’s rule that restricts third-party solicitation activity.
MSRB rule G-38(b)(i).
--71--
advisory services on its behalf.256 The prohibition is limited to third-party solicitors.
Thus, the prohibition does not apply to any of the adviser’s employees, general partners,
managing members, or executive officers.257 Contributions by these persons, however,
may trigger the two-year time out. As discussed in more detail below, the prohibition
also does not apply to certain “regulated persons” that themselves are subject to
prohibitions against engaging in pay to play practices.258
We proposed to prohibit advisers from paying third parties in order to prevent
advisers from circumventing the rule.259 We observed in the Proposing Release that
solicitors or “placement agents” have played a central role in actions that we and other
authorities have brought involving pay to play schemes;260 in several instances, advisers
allegedly made significant payments to placement agents and other intermediaries in
order to influence the award of advisory contracts.261 We noted that government
authorities in New York and other jurisdictions have prohibited or are considering
256
Rule 206(4)-5(a)(2)(i). See also Proposing Release, at section II.A.3(b).
257
Rule 206(4)-5(a)(2)(i). We note that, so long as non-affiliated persons providing legal,
accounting, or other professional services in connection with specific investment
advisory business are not being paid directly or indirectly by an investment adviser for
communicating with a government entity (or its representatives) for the purpose of
obtaining or retaining investment advisory business for the adviser—i.e., they are paid
solely for their provision of legal, accounting, or other professional services with respect
to the business—they would not become subject to the ban on payments by advisers to
third-party solicitors. This approach is similar to the MSRB’s with regard to MSRB rule
G-38’s third-party solicitor ban. See MSRB, Interpretive Notice on the Definition of
Solicitation under Rules G-37 and G-38 (June 8, 2006), available at
http://msrb.org/msrb1/rules/notg38.htm.
258
This exception, which is responsive to commenters’ concerns, is a modification of our
proposal. As discussed below, we also eliminated an exception in our proposal that
would have applied to “related persons” of the adviser and, if such “related person” were
a company, an employee of the “related person.” See Proposing Release, at section
II.A.3(b).
259
See Proposing Release, at section II.A.3(b).
260
Id. at sections I and II.A.3(b).
261
Id. at section II.A.3(b).
--72--
limiting or prohibiting the use of consultants, solicitors, or placement agents by
investment advisers to solicit government business.262 We considered the MSRB’s
experience with solicitors, which ultimately led it to ban municipal securities dealers
from hiring consultants to solicit government clients after concluding that less restrictive
approaches were ineffective to prevent circumvention of MSRB rule G-37.263 We
recalled comment letters we received in 1999 from advisers asserting that they should not
262
Id. Since our proposal, a few state and local governments have undertaken actions to
prohibit or regulate pay to play practices involving placement agents in response to
concerns about to pay to play activities in their jurisdictions. For example, New York
City Comptroller John C. Liu announced reforms relating to how the New York City
pension funds make investments (including prohibitions on gifts and campaign
contributions, strict rules on employees of the Office of New York City Comptroller,
employees and trustees of the New York City pension systems, fund managers, and
placement agents, and an expansion of the ban on private equity placement agents to
include placement agents to other types of funds while providing an exclusion for
legitimate placement agents who provide value-added services). See Office of the New
York City Comptroller, Comptroller Liu Announces Major Reforms to Pension Fund
Investments, Press Release, Feb. 18, 2010, available at
http://www.comptroller.nyc.gov/press/2010_releases/pr10-02-022.shtm. A bill was
introduced in California that would treat placement agents soliciting government entity
clients as lobbyists and therefore restrict them from charging contingency fees. See
Assem. B. 1743, 2009-10 Leg., Reg. Sess. (Cal. 2010), available at
http://info.sen.ca.gov/pub/09-10/bill/asm/ab_17011750/
ab_1743_bill_20100208_introduced.html. See also Cal. Gov’t. Code §86205(f)
(Deering 2010). Another law was passed in California on an emergency basis imposing
new disclosure obligations and prohibitions regarding placement agents. See Assem. B.
1854, 2009-10 Leg., Reg. Sess. (Cal. 2010) available at http://info.sen.ca.gov/pub/0910/
statute/ch_0301-0350/ch_301_st_2009_ab_1584. See also CalPERS, CalPERS
Releases Placement Agent Disclosures, Press Release, Jan. 14, 2010, available at
http://www.calpers.ca.gov/index.jsp?bc=/about/press/pr-2010/jan/agent-disclosures.xml.
(discussing recent actions by CalPERS to make public more than 600 placement agent
disclosures from the fund’s external managers).
263
See Proposing Release, at n.130 and accompanying text. See also MSRB Letter (“Due to
concerns regarding questionable practices by some consultants and a determination by
the MSRB that it would be in the public interest to make the process of soliciting
municipal securities business fully subject to the MSRB rules of fair practice and
professionalism, the MSRB rescinded its original rule in 2005 and adopted new Rule G38,
on solicitation of municipal securities business, to prohibit dealers from using paid
third-party consultants to obtain municipal securities business on their behalf.”).
--73--
be held accountable for the political contributions of their third-party solicitors whom,
they asserted, advisers lacked the ability to control.264
The record before us raised deeply troubling concerns about advisers’ use of
third-party solicitors to engage in pay to play activities.265 We were concerned that a rule
that failed to address the use of these solicitors would be ineffective were advisers simply
to begin using solicitors and placement agents that have made political contributions or
payments funded in part or in whole by the fees they receive from advisers.266 Therefore,
we proposed to prohibit advisers from engaging third parties to solicit government clients
on their behalf.267 In doing so, we requested comments on alternative approaches we
264
In 1999, the Commission proposed a similar rule, which also would have been codified as
rule 206(4)-5 under the Advisers Act, had it been adopted. See Political Contributions by
Certain Investment Advisers, Investment Advisers Act Release No. 1812 (Aug. 4, 1999)
[64 FR 43556 (Aug. 10, 1999)] (“1999 Proposing Release”). Comments on that proposal
received electronically (comment file S7-19-99) are available at
http://www.sec.gov/rules/proposed/s71999.shtml. Among the commenters on the 1999
Proposing Release who argued that advisers should not be held accountable for the
political contributions of their third-party solicitors are: Comment Letter of Davis Polk
(Nov. 1, 1999); Comment Letter of Legg Mason (Nov. 1, 1999); Comment Letter of
MSDW (Nov. 1, 1999). At least one commenter on our 2009 proposal, although
opposing the proposed third-party solicitor ban, took the same view. See MFA Letter
(“We strongly agree with the SEC’s comment in the Release that “covered associates”
should not include employees of entities unaffiliated with an investment adviser, such as
the employees of a third-party placement agent. An investment adviser would not have
the authority or capability to monitor and restrict political contributions made by
individuals not employed by the adviser.”).
265
See Proposing Release, at section I; section I of this Release. Moreover, “no smoking
gun is needed where, as here, the conflict of interest is apparent, the likelihood of stealth
great, and the legislative purpose prophylactic.” Blount, 61 F.3d at 945.
266
See Proposing Release, at section II.A.3(b). Some commenters have supported this
approach. See, e.g., Fund Democracy/Consumer Federation Letter (“Permitting advisers
to circumvent pay-to-play restrictions by hiring solicitors would eviscerate the heart of
the direct prohibition against advisers’ bribing politicians in return for money
management contracts.”). We also noted commenters’ concerns regarding the difficulties
advisers face in monitoring the activities of their third-party solicitors. See Proposing
Release, at section II.A.3(b).
267
See Proposing Release, at section II.A.3(b).
--74--
could take.268 We wanted to know whether there might be a more effective means to
accomplish our objectives, or means that would be less restrictive.
We received a large number of comments on this question. We received letters
from the New York S
ate Comptroller and New York City Comptroller that expressed
strong support for the ban on using third parties to solicit government plans.269 One
commenter supporting the ban pointed out the key role that placement agents have played
in pay to play practices.270 It expressed concern that adopting the rule without the ban
would exacerbate the problem by placing more pressure on advisers to pay “wellconnected”
placement agents for access since the advisers will be limited in their
contributions.271 Another commenter expressed the view that “the most egregious
violations of the public trust in this area have come from placement agents and those
seeking finder’s fees. The outright ban on their use to deter pay-to-play schemes is
entirely appropriate.”272
Most commenters, including many representing advisers, broker-dealers,
placement agents and solicitors, and some government officials, however, strongly
opposed the ban. Many asserted that solicitors, consultants and placement agents provide
valuable services both for advisers seeking clients and for the public pension plans that
268
See id.
269
DiNapoli Letter; Thompson Letter (as indicated in note 262 above, NYC Comptroller Liu
recently announced his office’s approach to third-party solicitors).
270
Fund Democracy/Consumer Federation Letter.
271
Id.
272
Common Cause Letter. See also Cornell Law Letter (generally supporting the
prohibition on using third-party solicitors “given that third-party solicitors have played a
central role in each of the enforcement actions against investment advisors that the
Commission has brought in the past several years involving pay-to-play schemes.”).
--75--
employ them and that banning their use would have several deleterious effects.273
Several claimed that the rule would favor banks because banks are excluded from the
definition of “investment adviser” under the Advisers Act and therefore are not subject to
the Commission’s rules, including rule 206(4)-5.274 Others claimed the rule would favor
larger investment advisers (which have internal marketing departments) over smaller
firms.275 Other commenters asserted the ban would harm smaller pension funds that do
273
See, e.g., Comment Letter of Senator Christopher J. Dodd (Feb. 2, 2010) (“Dodd Letter”);
NY City Bar Letter; Dechert Letter; ABA Letter; Comment Letter of Teacher Retirement
System of Texas (Oct. 12, 2009); Comment Letter of Bryant Law (Oct. 9, 2009) (“Bryant
Law Letter”); Comment Letter of Probitas Partners (Oct. 6, 2009) (“Probitas Letter”);
Comment Letter of Larry Simon (Oct. 6, 2009) (“Simon Letter”); Comment Letter of
MarketCounsel, LLC (Oct. 6, 2009); ICI Letter; Comment Letter of Colorado Public
Employees’ Retirement Association (Oct. 6, 2009); Skadden Letter.
274
See Advisers Act section 202(a)(11)(A) [15 U.S.C. 80b-2(a)(11)(A)] (excepting from the
definition of “investment adviser,” and therefore from regulation under the Advisers Act,
“a bank, or any bank holding company as defined in the Bank Holding Company Act of
1956, which is not an investment company . . . .”). We discuss possible competitive
effects of our rule’s inapplicability to banks in section VI of this Release. We believe
that the concerns the rule is designed to address, as discussed throughout this Release,
warrant its adoption, notwithstanding these potential competitive effects.
275
See, e.g., SIFMA Letter; IAA Letter; MFA Letter; Comment Letter of National
Conference on Public Employee Retirement Systems (Oct. 6, 2009) (“NCPERS Letter”);
Comment Letter of European Private Equity & Venture Capital Association (Sept. 9,
2009) (“EVCA Letter”); Seward & Kissel Letter; Comment Letter of Sadis & Goldberg
LLP (Oct. 2, 2009) (“Sadis & Goldberg Letter”); Comment Letter of State of Wisconsin
Investment Board (Aug. 31, 2009) (“WI Board Letter”); Comment Letter of the
Executive Director of Georgia Firefighters’ Pension Fund, James R. Meynard, (Sept. 3,
2009) (“GA Firefighters Letter”); Comment Letter of Minnesota State Board of
Investment (Sept. 8, 2009) (“MN Board Letter”); Comment Letter of Illinois Public
Pension Fund Association (Sept. 29, 2009) (“IL Fund Association Letter”); Comment
Letter of Melvyn Aaronson, Sandra March and Mona Romain, Trustees of the Teachers’
Retirement System of the City of New York (Oct. 1, 2009) (“NYC Teachers Letter”);
Comment Letter of the Texas Association of Public Employee Retirement Systems (Oct.
6, 2009) (“TX Public Retirement Letter”); Comment Letter of the Pennsylvania Public
School Employees’ Retirement Board (Oct. 6, 2009) (“PA Public School Retirement
Letter”); Comment Letter of the California State Association of County Retirement
Systems (Sept. 8, 2009) (“CA Assoc. of County Retirement Letter”); Caplin & Drysdale
Letter; Comment Letter of Paul Ehrmann (Aug. 10, 2009) (“Ehrmann Letter”); Comment
Letter of Joseph Finn (Aug. 10, 2009) (“Finn Letter”); Comment Letter of the Managing
Partner of The Savanna Real Estate Fund I, LLP, Nicholas Bienstock (Aug. 11, 2009)
(“Savanna Letter”); Comment Letter of Atlantic-Pacific Capital, Inc. (Aug. 12, 2009)
(“Atlantic-Pacific Letter”); Comment Letter of Tricia Peterson (Aug. 14, 2009)
--76--
not have the resources to conduct a search for advisers on their own, and harm advisers
that rely on the services that placement agents provide.276 A number of commenters
argued that the prohibition would reduce competition by reducing the number of advisers
competing for government business,277 and limit the universe of investment opportunities
presented to public pension funds.278
Many of these commenters conceded that there is a problem with placement
agents and other intermediaries, but asserted it is caused by a few bad actors, for which
an entire industry should not be penalized.279 A common theme among many
(“Peterson Letter”); Comment Letter of Devon Self Storage Holdings (US) LLC (Aug.
21, 2009) (“Devon Letter”); Comment Letter of Thomas Capital Group, Inc. (Aug. 24,
2009) (“Thomas Letter”); Comment Letter of Stephen R. Myers (Aug. 26, 2009) (“Myers
Letter”); Comment Letter of Chaldon Associates LLC (Aug. 26, 2009) (“Chaldon
Letter”); Comment Letter of The Meridian Group (Aug. 26, 2009) (“Meridian Letter”);
Comment Letter of Benedetto, Gartland & Company, Inc. (Sept. 30, 2009) (“Benedetto
Letter”); Comment Letter of the Partners of CSP Securities, LP and Capstone Partners,
LP (Sept. 17, 2009) (“Capstone Letter”); Comment Letter of Presidio Partners LLC
Managing Partner Alan R. Braxton (Sept. 21, 2009) (“Braxton Letter”); Comment Letter
of Littlejohn & Co., LLC (Sept. 14, 2009) (“Littlejohn Letter”); Comment Letter of Alta
Communications (Sept. 18, 2009) (“Alta Letter”); Comment Letter of Charles River
Realty Investors LLC (Sept. 23, 2009) (“Charles River Letter”); Comment Letter of W.
Allen Reed (Sept. 19, 2009) (“Reed Letter”); Comment Letter of Glovista Investments
LLC (Sept. 23, 2009) (“Glovista Letter”); Comment Letter of The Blackstone Group
(Sept. 14, 2009) (“Blackstone Letter”); Park Hill Letter. Two commenters noted that the
ban would result in less transparency as these services go “in-house.” CalPERS Letter;
Bryant Law Letter. Others commented on the effects on minority and women-owned
firms. See, e.g., NYC Teachers Letter, Myers Letter; GA Firefighters Letter; MN Board
Letter; Blackstone Letter.
276
See, e.g., Dodd Letter; NY City Bar Letter; Dechert Letter; ABA Letter; Probitas Letter;
Seward & Kissel Letter; MFA Letter.
277
See, e.g., Seward & Kissel Letter; Meridian Letter; NY City Bar Letter; Probitas Letter;
Simon Letter; MFA Letter.
278
See, e.g., SIFMA Letter; IAA Letter; Strategic Capital Letter; Alta Letter; Benedetto
Letter; Comment Letter of Jim Glantz (Sept. 24, 2009) (“Glantz Letter”); Comment
Letter of Venera Kurmanaliyeva (Sept. 15, 2009) (“Kurmanaliyeva Letter”); Park Hill
Letter.
279
See, e.g., Comment Letters of Brady Pyeatt (Aug. 4, 2009) & (Oct. 6, 2009); Comment
Letter of Andrew Wang (Aug. 10, 2009); Comment Letter of Monomoy Capital
Management, LLC (Aug. 25, 2009) (“Monomoy Letter”); Comment Letter of Ted Carroll
--77--
commenters was that the rule failed to distinguish “illegitimate” consultants and
placement agents from the “legitimate” ones who provide an important service.280
We believe that many of the comments overstate the likely consequences of
adoption of the rule. First, the rule will not prevent public pension plans from hiring their
own consultants—i.e., using their own resources—to assist them in their search for an
investment adviser.281 These consultants would have access to information about smaller
advisers whose services may be appropriate for the plan. Many public pension plans
already make—or are required to make—specific accommodations for so-called
“emerging money managers” that otherwise may have difficulty getting noticed by public
pension plans.282 Second, these commenters failed to consider the potentially significant
(Aug. 4, 2009); Comment Letter of James C. George (Sept. 10, 2009) (“George Letter”);
Comment Letter of Ariane Capital Partners LLC (Sept. 17, 2009); Blackstone Letter;
Comment Letter of Nancy Fossland (Sept. 16, 2009); Comment Letter of Steven A.
Friedmann (Sept. 14, 2009); Comment Letter of Keith P. Harney (Sept. 15, 2009);
Comment Letter of Robert F. Muhlhauser III (Sept. 14, 2009); Comment Letter of XT
Capital Partners, LLC (Sept. 30, 2009); CapLink Letter.
280
See, e.g., Bryant Law Letter; Comment Letter of Hedgeforce (Oct. 6, 2009) (“Hedgeforce
Letter”).
281
See Fund Democracy/Consumer Federation Letter (“The proposed ban would “deny
access” to nothing. There is nothing [in the proposed rule] preventing pension funds from
retaining their own consultants whose sole responsibility is to the pension fund and its
beneficiaries.”).
282
See, e.g., Randy Diamond, CalPERS CIO Joe Dear says Emerging Managers Don’t Need
Placement Agents, PENSIONS & INVESTMENTS, Feb. 24, 2010, available at
http://www.pionline.com/article/20100224/REG/100229965; Michael Marois, CalPERS,
Blackstone Clash over Placement Agent ‘Jackpot’ Fees, BLOOMBERG (Apr. 7, 2010),
available at
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=acPNrTn1q7pw (quoting
CalPERS CIO Joe Dear, “There’s clear evidence in past practice that it’s possible to
develop an investment relationship with us by making a normal approach, without the
assistance of a contingent-paid placement agent.”); Ohio Pub. Employees Ret. Sys.,
Ohio-Qualified and Minority Manager Policy (May 2006), available at
https://www.opers.org/pdf/investments/policies/Ohio-Qualified-Minority-ManagerPolicy.
pdf; Teachers’ Ret. Sys. of the State of Ill., Fiscal Year 2009 Annual Report on the
use of Women, Minority and Disabled-Owned (W/MBE) Investment Advisors and
Broker/Dealers (Aug. 31, 2009), available at
--78--
costs of hiring consultants and placement agents,283 which already may make them
unavailable to smaller advisers. Eliminating the cost of pay to play may, in fact, provide
greater access to pension plans by those advisers which are unable to afford the costs of
direct or indirect political contributions or placement agent fees.284 We expect that
prohibiting pay to play may reduce the costs to plans and their beneficiaries of inferior
asset management services arising from adviser selection based on political contributions
rather than investment considerations.285 Finally, commenters failed to identify any
http://trs.illinois.gov/subsections/investments/minorityrpt.pdf; Md. State Ret. and Pension
Sys., Terra Maria: The Maryland Developing Manager Program, available at
http://www.sra.state.md.us/Agency/Investment/Downloads/TerraMariaDevelopingManag
erProgram-Description.pdf; Thurman V. White, Jr., Progress Inv. Mgmt. Co., Successful
Emerging Manager Strategies for the 21st Century, 3 (2008), available at
http://www.progressinvestment.com/content/files/successful_emerging_manager_strategi
es.pdf (containing a “representative list of known U.S. Pension Plans that have
committed assets to emerging manager strategies”).
283
One commenter made a similar point: “The proposed ban would simply replace the
indirect cost of placement agents incurred by pension plan sponsors with the direct cost
of hiring their own placement agents—without the conflict of interest and potential for
abuse that relying on advisers’ placement agents creates. It is not the cost of independent
advice that the Commission has not accounted for in its proposal, but the cost of conflicts
that critics have failed to acknowledge in their analysis.” Fund Democracy/Consumer
Federation Letter.
284
At least one commenter agreed. See Butler Letter (“[W]e find some evidence that the pay
to play practices by underwriters [before rule G-37 was adopted] distorted not only the
fees, but which firms were allocated business. The current proposal mentions that pay to
play practices may create an uneven playing field among investment advisers by hurting
smaller advisers that cannot afford to make political contributions. We find evidence that
is consistent with this view [in our research on pay to play by municipal underwriters].
During the pay to play era, municipal bonds were underwritten by investment banks with
larger underwriting market shares compared to afterward. One interpretation of this result
is that smaller underwriters were passed over in favor of larger underwriters (who
presumably had deeper pockets for political contributions).”). As we indicated in the
Proposing Release, pay to play practices may hurt smaller advisers that cannot afford the
required contributions. Curtailing pay to play arrangements enables advisory firms,
particularly smaller advisory firms, to compete on merit, rather than their ability or
willingness to make contributions. See Proposing Release, at sections I and IV.
285
See Tobe Letter (describing an under-performing money manager that was fired after the
commenter, a pension official, began to inquire into how it was selected); Weber Letter
(“I have seen money managers awarded contracts with our fund which involved
payments to individuals who served as middlemen, creating needless expense for the
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meaningful way in which our rule might distinguish “legitimate” from “illegitimate”
solicitors or placement agents. Even solicitors and placement agents that engage in pay
to play may appear to operate “legitimately.”286
Some commenters suggested alternatives to our proposed ban to address our
concern that pay to play activities are often carried out through or with the assistance of
third parties.287 Several commenters, for example, suggested that we instead require
greater disclosure by advisers of payments to solicitors.288 Such an approach could be
fund. These middlemen were political contributors to the campaigns of board members
who voted to contract for money management services with the companies who paid
them as middlemen.”).
286
See Blount, 61 F.3d at 944 (“actors in this field are presumably shrewd enough to
structure their relations rather indirectly”).
287
We note that, in addition to the alternatives discussed below, some commenters called for
approaches outside the scope of our authority, such as an outright ban on all political
contributions by third-party solicitors, the imposition of criminal penalties, or
modification of the structure of pension boards. See, e.g., Monomoy Letter (arguing that
the Commission or the appropriate criminal authority should mandate jail time for public
officials and intermediaries where the official gets a benefit from a public fund
investment in a particular fund, that all managers of intermediaries who receive fees in
such transactions should be banned from the financial services industry for life, and that
all members of the general partner (manager) of the fund in which the investment is made
be banned from the financial services industry for life); NCPERS Letter (arguing that the
most effective method of eliminating pay to play is by having multiple trustees on public
pension boards); Thomas Letter (suggesting that stronger internal control procedures,
segregation of duties and dispersed or committee approval of granting pension business
could help prevent pay to play activities, each of which historically has involved a
complicit senior public plan fund official); Comment Letter of the Massachusetts Pension
Reserves Investment Management Board (Aug. 26, 2009) (“PRIM Board Letter”); Preqin
Letter I (acknowledging that it is outside the remit of the Commission, but arguing that
there should be better oversight of public pension funds, and investment committees
should consist of a minimum number of members in order to prevent a sole official being
responsible for the investment-decision process); Triton Pacific Letter (arguing that the
Commission should adopt regulation of pension officials who are often responsible for
initiating pay to play arrangements).
288
Several commenters urged us to require advisers to disclose to clients their payments to
third-party solicitors and placement agents. See, e.g., ABA Letter; 3PM Letter; ICI
Letter; NY City Bar Letter; Comment Letter of Forum Capital Securities, LLC (Oct. 5,
2009) (“Forum Letter”); Jones Day Letter; CapLink Letter. Some asserted that existing
disclosure requirements, such as those included in the Commission’s investment adviser
cash solicitation rule, are sufficient to address pay to play. See, e.g., Comment Letter of
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helpful to give plan fiduciaries information necessary for them to satisfy their legal
obligations and uncover abuses,289 but it would not be useful when plan fiduciaries
themselves are participants in the pay to play activities.290 In addition, as one commenter
pointed out, the MSRB had already sought unsuccessfully to address the problem of
placement agents and consultants engaging in pay to play activities on their principals’
behalf through mandating greater disclosure.291
Steven Rubenstein (Aug. 17, 2009) (“Rubenstein Letter”) (noting that Advisers Act rule
206(4)-3 [17 CFR 275.206(4)-3], the “cash solicitation rule,” is adequate as is, but “just
needs to be followed”); Thomas Letter (supporting “enforcement of existing disclosure
rules”); Chaldon Letter (arguing that, in the scandals that have recently occurred, if the
fee sharing arrangements had been disclosed to pension fund boards, no law or regulation
would have been violated, and that third-party marketers should adhere to current law
instead of banning a legitimate business practice); Comment Letter of Ray Wirta (Sept. 4,
2009) (arguing that all that is necessary is that penalties should be heightened,
enforcement stepped up and results highly publicized); Arrow Letter (arguing that
enforcement of the Advisers Act and FINRA requirements have ensured lawful and
ethical business practices for decades); 3PM Letter (arguing that the rule’s scope could be
extended to include various additional disclosures). But we do not believe, for the
reasons described above, that enforcement of existing obligations alone is sufficient to
deter pay to play activities.
289
Some public pension plans have adopted policies requiring advisers they hire to disclose
information about placement agents, including their political connections. See, e.g., Cal.
Pub. Employees Ret. Sys., CalPERS Adopts Placement Agent Policy – Requires
Disclosure of Agents, Fees, Press Release (May 11, 2009), available at
http://www.calpers.ca.gov/index.jsp?bc=/about/press/pr-2009/may/adopts-placementagent-
policy.xml.
290
For examples of cases in which plan fiduciaries themselves have allegedly participated in
pay to play activities involving placement agents, see New York v. Henry “Hank” Morris
and David Loglisci, Indictment No. 25/2009 (NY Mar. 19, 2009) (a public official was
alleged to be a beneficiary of the pay to play activities); SEC v. Paul J. Silvester, et al.,
Litigation Release No. 16759, Civil Action No. 3:00-CV-19411 DJS (D. Conn. 2000)
(former Connecticut State Treasurer was alleged to be a beneficiary of a pay to play
scheme in which an investment adviser to a private equity fund had paid third-party
solicitors to obtain public pension fund investments in the fund). See also Proposing
Release, at n.49 (discussing additional reasons why we believe a disclosure approach
would not effectively address our concerns regarding pay to play activities).
291
Cornell Law Letter (“For example, after concluding that required disclosure was neither
adequate to prevent circumvention nor consistently being made, the [MSRB] amended its
own rules on pay-to-play practices in the municipal securities markets to impose a
complete ban on the use of third-party consultants to solicit government clients.”
(citations omitted)). See also 3PM Letter (acknowledging that, although increased
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Other commenters recommended that we rely on voluntary industry codes of
conduct.292 But we believe, in light of the growing body of evidence of advisers’ use of
third-party solicitors to engage in pay to play activities we describe above, that voluntary
actions are insufficient to deter pay to play, which may yield lucrative management
contracts.293 As we discuss above, pay to play involves a “collective action” problem
that is unlikely to be resolved by voluntary actions.294 Elected officials who accept
contributions from state contractors may believe they have an advantage over their
opponents who foreswear the contributions, and firms that do not “pay” may fear that
they will lose government business to those that do.295
transparency by all parties involved in the investment process who might have the ability
to exert influence, including advisers, third-party marketers, public officials or other
trustees, etc., is necessary to minimize the adverse effects of pay to play, the issue will
not be completely solved by disclosure).
292
See, e.g., MVision Letter (arguing that self-regulatory initiatives such as the EVCA’s
Code of Conduct for Placement Agents are working and that many public pension plans’
own anti-pay to play policies have been successful); EVCA Letter (describing its Code of
Conduct that prohibits pay to play and is supported by various stakeholders and arguing
that it, along with strong punishment of wrongdoers, should restore confidence in the
process). Another commenter suggested a code of conduct enforceable by regulators.
Comment Letter of Charlie Eaton on behalf of a Coalition of Professional Institutional
Placement Agents (Sept. 9, 2009) (proposing an industry Code of Conduct that could be
enforced by FINRA and the Commission, which should ban firms that do not adhere
from doing business with all potential investors, public and private). In our view, the rule
we are adopting today not only essentially serves this purpose, but more appropriately
reflects prohibitions we, instead of others, have determined appropriately address our
concerns.
293
See Proposing Release, at sections I and II.A.3(b). See also section I of this Release.
294
See supra note 58 and accompanying text.
295
See Blount, 61 F.3d at 945-46 (describing the parallel dynamics applicable in municipal
underwriting, “As beneficiaries of the practice, politicians vying for state or local office
may be reluctant to stop it legislatively; some, of course, may seek to exploit their rivals’
cozy relation with bond dealers as a campaign issue, but if they refuse to enter into
similar relations, their campaigns will be financially handicapped. Bond dealers are in a
still worse position to initiate reform: individual firms that decline to pay will have less
chance to play, and may even be the object of explicit boycott if they do.”).
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Other commenters recommended that we amend our rules to require that advisers
amend their codes of ethics to monitor contributions by third-party solicitors.296 But
advisers using third-party solicitors to circumvent pay to play restrictions are well aware
of these payments, and are unlikely to be deterred by a monitoring requirement. In
addition, adviser codes of ethics are unlikely to be a sufficient means to induce third-
party solicitors to be transparent about their own pay to play activities.
Instead of suggesting alternative approaches, other commenters urged us to apply
the rule more narrowly by exempting from the ban solicitors that are registered broker-
dealers or associated persons of broker-dealers.297 Some were concerned that the rule
would interfere with traditional distribution arrangements of mutual funds and private
funds, which are usually distributed by registered broker-dealers that may be
compensated by the adviser in some form.298 Many argued that registration as a broker-
dealer generally differentiates placement agents that provide “legitimate” services from
296
See, e.g., ABA Letter; 3PM Letter; ICI Letter; NY City Bar Letter; Forum Letter; Jones
Day Letter.
297
See, e.g., Davis Polk Letter; Comment Letter of UBS Securities LLC (Oct. 2, 2009)
(“UBS Letter”).
298
See, e.g., SIFMA Letter; NY City Bar Letter; Monomoy Letter; IAA Letter. Mutual fund
distribution fees are typically paid by the fund pursuant to a 12b-1 plan, and therefore
generally would not constitute payment by the fund’s adviser. As a result, such payments
would not be prohibited by rule 206(4)-5 by its terms. Where an adviser pays for the
fund’s distribution out of its “legitimate profits,” however, the rule would generally be
implicated. For a discussion of a mutual fund adviser’s ability to use “legitimate profits”
for fund distribution, see Bearing of Distribution Expenses by Mutual Funds, Investment
Company Act Release No. 11414 (Oct. 28, 1980) [45 FR 73898 (Nov. 7, 1980)]
(explaining, in the context of the prohibition on the indirect use of fund assets for
distribution, unless pursuant to a 12b-1 plan, “[h]owever, under the rule there is no
indirect use of fund assets if an adviser makes distribution related payments out of its
own resources . . . . Profits which are legitimate or not excessive are simply those which
are derived from an advisory contract which does not result in a breach of fiduciary duty
under section 36 of the [Investment Company] Act.”). For private funds, third parties are
often compensated by the adviser or its affiliated general partner and, therefore, those
payments are subject to the rule. Structuring such a payment to come from the private
fund for the purpose of evading the rule would violate the rule. See Rule 206(4)-5(d).
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those that merely offer political influence.299 Others expressed concern that some broker-
dealer firms that rely on placement agent business could be harmed.300 We recognize that
services that commenters have identified as beneficial would typically require broker-
dealer registration. But registration under the Exchange Act does not preclude a broker-
dealer from participating in pay to play practices—MSRB rules G-37 and G-38 do not
apply, for example, to broker-dealers soliciting investments on behalf of investment
companies or private funds.301 Thus, amending our rule to limit third parties soliciting
governments to broker-dealers registered under the Exchange Act would not achieve the
prophylactic purpose of this rulemaking. We believe that our approach is appropriate in
light of the concerns we are seeking to address.302
Several commenters proposed that we achieve our goals by permitting advisers to
engage solicitors and placement agents that are registered broker-dealers and subject to
rules similar to those adopted by the MSRB.303 One asserted that such rules would be “a
299
See, e.g., Bryant Law Letter; Hedgeforce Letter; Comment Letter of Girard Miller (Aug.
8, 2009); Comment Letter of Frank Schmitz (Aug. 11, 2009) (“Schmitz Letter”);
Atlantic-Pacific Letter; Rubenstein Letter; Thomas Letter; Monomoy Letter; MVision
Letter; Comment Letter of Lime Rock Management (Sept. 28, 2009); Benedetto Letter;
Strategic Capital Letter; Comment Letter of Portfolio Advisors, LLC (Oct. 2, 2009)
(“Portfolio Advisors Letter”); UBS Letter; Comment Letter of Brian Fitzgibbon (Oct. 5,
2009); Comment Letter of GenNx360 Capital Partners, L.P. (Oct. 5, 2009).
300
Comment Letter of the National Association of Independent Broker-Dealers (Oct. 5,
2009).
301
At least one commenter suggested that there are “inherent” safeguards in the broker-
dealer regulatory regime sufficient to protect against pay to play practices. See, e.g.,
ABA Letter. But the broker-dealer regulatory regime does not specifically address pay to
play activities, as demonstrated by the MSRB’s adoption of rules G-37 and G-38.
302
We acknowledge that there are costs associated with our rule. For further analysis of
these, along with the benefits, see sections I and IV of this Release.
303
Skadden Letter (“The Commission and FINRA could directly impose and enforce
restrictions on such broker-dealers.”); Davis Polk Letter (“Registered broker-dealers that
provide legitimate placement agent services could be required by the Commission to
comply with “pay-to-play” restrictions”); Credit Suisse Letter (preclude an investment
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logical extension of the already-existing regulatory scheme governing broker-dealers.”304
Another agreed, arguing that such rules would be consistent with the approach the MSRB
took when it adopted MSRB rule G-38, the effect of which was to sweep “all solicitors of
municipal business (underwriting, sales and advisory) into the broker-dealer registration
regime” where they would be subject to oversight of a registered broker-dealer and are
required to conform their municipal securities activities to applicable MSRB rules,
including MSRB rule G-37.305 Others suggested we could similarly achieve our goals by
adviser from using a placement agent that is not subject to pay to play restrictions
analogous to rule G-37); Comment Letter of the President of M Advisory Group J. Daniel
Vogelzang (Sept. 18, 2009) (“M Advisory Letter”) (treat “[a]ll placement agents,
investment advisers and consultants . . . exactly the same regarding prohibited political
contributions; i.e., a two-year ban on doing business with any governmental agency to
which a prohibited political contribution is made.”). See also Comment Letter of Hudson
Capital Management (NY), L.P. (Oct. 5, 2009) (suggesting Commission take measures to
properly license and regulate third-party solicitors); SIFMA Letter (“The pay-to-play and
political activity of registered placement agents involved in soliciting government
investment could . . . be directly regulated under the Exchange Act.”). We believe our
rule, as adopted, which allows advisers to pay certain regulated third parties to solicit
government clients on their behalf, addresses these concerns. See infra notes 312-26 and
accompanying text.
304
Davis Polk Letter.
305
SIFMA Letter (“Although Rule G-38(a) specifically prohibits a municipal dealer from
paying a fee to a nonaffiliated person for solicitation of municipal securities business, the
policies underlying Rule G-38 were to bring solicitors within the purview of the federal
securities laws — not to exclude the involvement of registered broker-dealers, including
those registered broker-dealers not affiliated with advisers and private funds.”). See also
Monument Group Letter (“We believe that MSRB Rule G-38 is not analogous to the
proposed rule. Rule G-38 permits a broker-dealer that is unaffiliated with an issuer to
market that issuer’s securities to a public pension plan or any other investor. Proposed
Rule 206(4)-5(a)(2)(i) prevents this and seeks to entirely disintermediate the process
between the issuer of a security and the ultimate investor.”); Credit Suisse Letter (“[W]e
strongly believe that a more complete analogy to the MSRB Pay-to-Play Rules would not
preclude regulated broker-dealers from performing placement agent services in the
context of municipal investors, as the Proposed Rule would do. Notably, the MSRB Pay-
to-Play Rules do not preclude SEC-registered broker-dealers from acting as placement
agents to municipal issuers. Instead, the MSRB Pay-to-Play Rules subject such placement
agents to “pay-to-play” restrictions and requirements and preclude them from retaining
unregulated third-party finders and solicitors.”).
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permitting advisers to engage as solicitors registered investment advisers that are
themselves subject to pay to play restrictions under an Advisers Act rule.306
We are persuaded by these comments and have decided to revise the proposed
rule to permit advisers to make payments to certain “regulated persons” to solicit
government clients on their behalf.307 As described in more detail below, “regulated
persons” include certain broker-dealers and registered investment advisers that are
themselves subject to prohibitions against participating in pay to play practices and are
subject to our oversight and, in the case of broker-dealers, the oversight of a registered
national securities association, such as FINRA.308 As one commenter observed, “the
Commission would have the direct authority to determine these restrictions as well as the
oversight, control and enforcement of penalties over any violations. The restrictions
could be tailored to operate with the same underlying purpose and effect on [solicitors] as
the “pay-to-play” restrictions imposed on investment advisers.”309 We believe that the
application of such rules would provide an effective deterrent to these solicitors or
placement agents from participating in pay to play arrangements because political
contributions or payments would subject solicitors to similar consequences, as discussed
306
See, e.g., IAA Letter.
307
See Rule 206(4)-5(a)(2)(i).
308
Rule 206(4)-5(f)(9). See supra note 85 (noting that, in this Release, we will refer directly
to FINRA, currently the only registered national securities association). As noted below,
under the definition of “regulated persons” as it applies to brokers, the Commission must
find, by order, that a registered national securities association’s pay to play rule
applicable to such brokers imposes substantially equivalent or more stringent restrictions
on them than rule 206(4)-5 imposes on investment advisers and that such rule is
consistent with the objectives of rule 206(4)-5. Rule 206(4)-5(f)(9)(ii)(B).
309
Davis Polk Letter.
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below.310 Because rule 206(4)-5 prohibits an adviser from compensating a registered
adviser solicitor for solicitation activities if that adviser solicitor does not meet the
definition of “regulated person,” the adviser that hired the solicitor must immediately
cease compensating a solicitor that no longer meets these conditions.311
In light of our decision to permit advisers to make payments to certain “regulated
persons,” described below, to solicit government clients on their behalf, we no longer
believe that our proposed exception from the prohibition on advisers paying third-party
solicitors for payments to related persons and employees of related person companies of
the adviser is necessary.312 We had proposed the exception to enable advisers to
compensate these persons for government entity solicitation activities because we
recognized there may be efficiencies in allowing advisers to rely on these particular types
310
Another group of commenters argued that third-party solicitors should be treated as
covered associates—that is, their contributions should trigger the two-year ban for
advisers that hire them. See, e.g., ABA Letter; 3PM Letter; ICI Letter; NY City Bar
Letter; Forum Letter; Jones Day Letter. In explaining our rejection of this approach in
the Proposing Release, we noted that this approach—which we included our 1999 pay to
play proposal—was criticized by commenters at that time. See Proposing Release, at
section II.A.3(b). They primarily argued that it was unfair to impute the activities of third
parties to advisers, especially given what they perceived as the harsh consequences
caused by a triggering contribution—i.e., a two-year time out imposed on the adviser.
See id. They further argued that an approach in which contributions by third-party
solicitors triggered a two-year time out for an adviser would create over-burdensome
compliance challenges because the adviser could not meaningfully control the
contribution activities of such third parties. See id. We continue to be sympathetic to
these concerns and believe that an approach in which a contribution by a third party
triggered a two-year time out for the adviser that hires the third party as a solicitor could
lead to unfair consequences. See, e.g., Capstone Letter; Monument Group Letter; Park
Hill Letter. For example, if a solicitor gives a triggering contribution in order to assist
one client, we are concerned about the harsh result that such a contribution could have on
all of the solicitor’s other clients seeking business with the same prospective government
entity client.
311
It would be a violation of the rule for an adviser to compensate a third party for
solicitation of government entity clients at any time that third party did not meet the
definition of “regulated person,” regardless of whether the “regulated person” failed to
meet the definition at the time it was hired or subsequently.
312
See Proposing Release, at section II.A.3(b).
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of persons to assist them in seeking clients. We requested comment regarding whether
the exception would undermine the rule’s efficacy by allowing advisers to compensate
certain employees of related person companies whose contributions would not have
triggered the two-year time out. Although we did not receive comment specifically
addressing our concern,313 we believe the approach we are adopting that allows advisers
to pay “regulated persons” to solicit government entities on their behalf will still allow
advisers to use employees of certain related companies—i.e., of those related companies
that qualify as “regulated persons”—as solicitors.314
(1) Registered Broker-Dealers
Registered national securities association rules of similar scope and consequence
as the rule we are today adopting could sufficiently satisfy the concerns that led us to
propose to prohibit advisers from paying brokers to solicit potential government clients.
Advisers could not easily use placement agents covered by such rules to circumvent rule
206(4)-5. Under this approach, placement agents would be deterred from engaging in
pay to play directly on account of the registered national securities association’s rules.
313
One commenter asked that we clarify the proposed exception for related parties
(Sutherland Letter) and another recommended a case-by-case determination of whether
independent contractors may be eligible for the exception, due to concern for life
insurance agents who may not technically have qualified as “employees” for purposes of
the exception (Skadden Letter). As noted, however, we have eliminated this exception in
favor of allowing advisers to pay “regulated persons,” affiliated or not, to solicit
government clients on their behalf.
314
We acknowledge that some advisers may have to bear certain additional costs of hiring
outside parties as a result of our elimination of our proposal’s “related person” exception,
which would have allowed advisers to compensate related persons that are not registered
broker-dealers or advisers for solicitation activities. For a discussion of costs relating to
the rule, see section IV of this Release. But, we also note that the rule, as adopted, does
not favor an adviser with affiliates (which our proposal would have allowed an adviser to
use to solicit on its behalf) over another adviser without affiliates. Instead, our rule, as
adopted, allows an adviser to pay a “regulated person” affiliated or not, to solicit on its
behalf.
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There would be no need for the Commission to prove in an enforcement action that a
contribution by a placement agent amounted to an indirect contribution by the investment
adviser because the placement agent itself could be charged with violating the registered
national securities association’s rules. Therefore, as adopted, rule 206(4)-5 allows an
adviser to compensate “regulated persons,” which includes registered brokers subject to a
registered national securities association’s rules, for soliciting government clients on its
behalf.315 An adviser may engage a registered broker to solicit government clients on its
behalf so long as the broker continues to meet the definition of “regulated person”
throughout its engagement as a solicitor by the adviser.
For a broker-dealer to be a “regulated person” under rule 206(4)-5, the broker-
dealer must be registered with the Commission and be a member of a registered national
securities association that has a rule: (i) that prohibits members from engaging in
distribution or solicitation activities if certain political contributions have been made; and
(ii) that the Commission finds both to impose substantially equivalent or more stringent
restrictions on broker-dealers than rule 206(4)-5 imposes on investment advisers and to
Rule 206(4)-5(a)(2)(i) (which prohibits advisers and their covered associates from
providing or agreeing to provide, directly or indirectly, payment to any third party other
than a regulated person to solicit a government entity for investment advisory services on
behalf of such investment adviser). Rule 206(4)-5 defines a “regulated person” to include
a “broker,” as defined in section 3(a)(4) of the Securities Exchange Act of 1934 [15
U.S.C. 78c(a)(4)] or a “dealer,” as defined in section 3(a)(5) of that Act [15 U.S.C.
78c(a)(5)], that is registered with the Commission, and is a member of a registered
national securities association registered under section 15A of that Act [15 U.S.C. 78o-3],
provided that (A) the rules of the association prohibit members from engaging in
distribution or solicitation activities if certain political contributions have been made; and
(B) the Commission finds that such rules impose substantially equivalent or more
stringent restrictions on broker-dealers than [rule 206(4)-5] imposes on investment
advisers and that such rules are consistent with the objectives of [rule 206(4)-5]. The
rule’s definition of “regulated person” also includes certain investment advisers. See
infra text accompanying note 323.
--89--
be consistent with the objectives of rule 206(4)-5.316 We have included the requirement
that a broker-dealer, in order to qualify as a regulated person, be subject to a pay to play
rule of a registered national securities association of which it is a member so that brokers
seeking to act as placement agents for investment advisers are, in turn, adequately
deterred from engaging in pay to play activities on behalf of those advisers by such a
rule.
FINRA has informed us that it is preparing rules for consideration that would
prohibit its members from soliciting advisory business from a government entity on
behalf of an adviser unless they comply with requirements prohibiting pay to play
activities.317 FINRA has said its rule would impose regulatory requirements on member
brokers318 “as rigorous and as expansive” as would be imposed on investment advisers by
rule 206(4)-5, and that in developing its proposal it intends to “draw closely upon all the
substantive and technical elements of the SEC’s proposal as well as our regulatory
expertise in examining and enforcing the MSRB rules upon which the SEC’s proposal is
316
Rule 206(4)-5(f)(9)(ii).
317
See Letter from Richard G. Ketchum, Chairman & Chief Executive Officer, FINRA, to
Andrew J. Donohue, Director, Division of Investment Management, U.S. Securities and
Exchange Commission (Mar. 15, 2010), available at http://www.sec.gov/comments/s718-
09/s71809-252.pdf (“Ketchum Letter”) (“[w]e believe that a regulatory scheme
targeting improper pay to play practices by broker-dealers acting on behalf of investment
advisers is . . . a viable solution to a ban on certain private placement agents serving a
legitimate function”). See also Letter from Andrew J. Donohue, Director, Division of
Investment Management, U.S. Securities and Exchange Commission, to Richard G.
Ketchum, Chairman & Chief Executive Officer, FINRA (Dec. 18, 2009), available at
http://www.sec.gov/comments/s7-18-09/s71809-252.pdf.
318
As used in this Section, “broker” means a “broker” or “dealer,” as each term is defined in
section 3(a) of the Securities Exchange Act of 1934 [15 U.S.C. 78c(a)].
--90--
based.”319 The rules, including any recordkeeping requirements, would be enforced by
FINRA, which has substantial experience enforcing MSRB rules G-37 and G-38.320
For the Commission to adopt a rule prohibiting advisers from using placement
agents until FINRA adopts a rule could impose substantial hardships on a significant
number of advisers and solicitors that wrote to us. It could also disrupt pension funds’
investment opportunities. Therefore, as we discuss in more detail below, we are delaying
application of the prohibition on compensating third-party solicitors for one year from the
effective date of this rule, in part to give FINRA time to propose such a rule.321
(2)
Registered Investment Advisers
We are also permitting advisers covered by the rule to pay solicitors for
government clients that are registered investment advisers subject to similar
limitations.322 Under the rule, a “regulated person” includes (in addition to a registered
broker subject to the conditions described above), an investment adviser that is registered
with the Commission under the Advisers Act, provided that the solicitor and its covered
associates have not, within two years of soliciting a government entity: (i) made a
contribution to an official of that government entity (other than a de minimis contribution,
as permitted by the rule); or (ii) coordinated, or solicited any person (including a PAC) to
319
Ketchum Letter.
320
See MSRB, About the MSRB: Enforcement of Board Rules, available at
http://msrb.org/msrb1/whatsnew/default.asp (“Responsibility for examination and
enforcement of Board rules is delegated to the Financial Industry Regulatory Authority
for all securities firms, and to the Federal Deposit Insurance Corporation, the Federal
Reserve Board, the Comptroller of the Currency, and the Office of Thrift Supervision for
banks.”).
321
For a discussion of transition issues, see section III of this Release.
322
Rule 206(4)-5(a)(2)(i) (which prohibits advisers and their covered associates from
providing or agreeing to provide, directly or indirectly, payment to any third party other
than a regulated person to solicit a government entity for investment advisory services on
behalf of such investment adviser).
--91--
make, any contribution to an official of a government entity to which the investment
adviser that hired the solicitor is providing or seeking to provide investment advisory
services, or payment to a political party of a state or locality where the investment adviser
that hired the solicitor is providing or seeking to provide investment advisory services to
a government entity.323
We received comments urging us to permit advisers to compensate registered
investment advisers for soliciting government officials, subject to rules or rule
amendments the Commission could adopt under the Advisers Act.324 We believe such an
allowance is appropriate for similar reasons to those for permitting advisers to
compensate broker-dealers subject to pay to play rules we have determined meet our
objectives under rule 206(4)-5. We have direct oversight authority over investment
advisers registered with us. Accordingly, we believe it is appropriate to allow them to act
as third-party solicitors for other advisers. Therefore, the rule, as adopted, limits the
advisers that another adviser may pay to solicit government entities on its behalf to those
advisers that are registered with the Commission325 and that have neither made the types
of political contributions that would trigger the two-year time out nor otherwise engaged
323
Rule 206(4)-5(f)(9)(i).
324
See, e.g., IAA Letter.
325
We are not including within the definition of “regulated person” investment advisers
registered solely with state securities authorities as some commenters suggested. See id.
We do not have regulatory authority over those advisers as we do over advisers who are
registered with us (and as we do over FINRA in connection with its oversight of brokers
and dealers and enforcement of its own rules). In fact, such advisers are subject neither
to our oversight nor to the recordkeeping rules we are adopting today.
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in activities (e.g., bundling of contributions) that the adviser could not engage in under
the rule.326
Advisers compensating other advisers that qualify as “regulated persons” for
soliciting government entities must adopt policies and procedures reasonably designed to
prevent a violation of the rule.327 Such policies and procedures should include, among
other things, a careful vetting of candidates and ongoing review of “regulated person”
investment advisers acting as solicitors currently being used. Such review would need to
determine whether the adviser (and its covered persons) acting as a solicitor has made
political contributions or otherwise engaged in conduct that would disqualify it from the
definition of “regulated person” and thereby preclude the hiring adviser from paying it
for the solicitation activity.
326
Importantly, a person that is registered under the Exchange Act as a broker-dealer and
under the Advisers Act as an investment adviser could potentially be a “regulated person”
under the rule if it met the conditions for either prong of the definition. Such a regulated
person should follow the rules that apply to the services it is performing, rather than
complying with both investment adviser and broker-dealer pay to play requirements. The
Exchange Act generally requires brokers and dealers to register with the Commission and
become members of at least one self-regulatory organization. Exchange Act sections
15(a), 15(b)(8) [15 U.S.C. 78o(a), (b)(8)]. Section 3(a)(4)(A) of the Exchange Act
generally defines a “broker” as any person engaged in the business of effecting
transactions in securities for the account of others [15 U.S.C. 78c(a)(4)(A)]. See, e.g.,
Definition of Terms in and Specific Exemptions for Banks, Savings Associations, and
Savings Banks Under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of
1934, Exchange Act Release No. 44291, at n.124 (May 11, 2001) [66 FR 27759 (May 18,
2001)] (“Solicitation is one of the most relevant factors in determining whether a person
is effecting transactions.”); Strengthening the Commission’s Requirements Regarding
Auditor Independence, Exchange Act Release No. 47265, at n.82 (Jan. 28, 2003) [68 FR
6006 (Feb. 5, 2003)] (noting that a person may be “engaged in the business,” among
other ways, by receiving compensation tied to the successful completion of a securities
transaction). See also Persons Deemed Not to Be Brokers, Exchange Act Release No.
22172, at sec. II.A (Jun. 27, 1985) [50 FR 27940 (Jul. 9, 1985)] (noting that attorneys,
accountants, insurance brokers, financial service organizations and financial consultants
are engaged in the business of effecting transactions in securities for the account of others
if they are retained by an issuer specifically for the purpose of selling securities to the
public and receive transaction based-compensation for their services).
327
See Advisers Act rule 206(4)-7 [17 CFR 275.206(4)-7] (requiring advisers to adopt and
implement compliance policies and procedures).
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(c)
Restrictions on Soliciting and Coordinating
Contributions and Payments
Rule 206(4)-5 prohibits advisers and covered persons from coordinating or
soliciting328 any person or PAC to make (i) any contribution329 to an official of a
government entity to which the adviser is providing or seeking to provide investment
advisory services,330 or (ii) any payment331 to a political party of a state or locality where
328
Rule 206(4)-5(f)(10)(ii) (defining “solicit,” with respect to a contribution or payment, as
communicating, directly or indirectly, for the purpose of obtaining or arranging a
contribution or payment.). Some commenters requested that we provide guidance
regarding when an adviser would be deemed to be soliciting contributions for purposes of
the rule. See, e.g., Caplin & Drysdale Letter. An adviser that consents to the use of its
name on fundraising literature for a candidate would be soliciting contributions for that
candidate. Similarly, an adviser that sponsors a meeting or conference which features a
government official as an attendee or guest speaker and which involves fundraising for
the government official would be soliciting contributions for that government official.
Whether a particular activity involves a solicitation or coordination of a contribution or
payment for purposes of the rule will depend on the facts and circumstances, thus we
have not attempted to draw a bright line. The MSRB takes a similar approach. See
MSRB, Solicitation of Contributions, MSRB Interpretive Letter (May 21, 1999),
available at http://msrb.org/msrb1/rules/interpg37.htm (determination of whether activity
constitutes “soliciting” under rule G-37 is a facts and circumstances analysis). See also
supra note 255.
329
In the case of the fundraising meeting or conference described as an example in note 328,
expenses incurred by the adviser for hosting the event would be a contribution by the
adviser, thereby triggering the two-year ban on the adviser receiving compensation for
providing advisory services to the government entity over which that official has
influence. See section II.B.2(a) of this Release. Such expenses may include, but are not
limited to, the cost of the facility, the cost of refreshments, any expenses paid for
administrative staff, and the payment or reimbursement of any of the government
official’s expenses for the event. The de minimis exception under rule 206(4)-5(b)(1)
would not be available with respect to these expenses because they would have been
incurred by the firm, not by a natural person. See MSRB, Supervision When Sponsoring
Meetings and Conferences Involving Issuer Officials, MSRB Rule G-37 Interpretive
Notice (Mar. 26, 2007), available at http://www.msrb.org/msrb1/rules/notg37.htm (rather
than addressing meetings and conferences in its rules directly, the MSRB applies a facts
and circumstances test on a case-by-case basis).
330
Rule 206(4)-5(a)(2)(ii). An investment adviser would be seeking to provide advisory
services to a government entity when it responds to a request for proposal, communicates
with a government entity regarding that entity’s formal selection process for investment
advisers, or engages in some other solicitation of investment advisory business of the
government entity. A violation of paragraph (a)(2)(ii) of the rule would not trigger a two-
year ban on the provision of investment advisory services for compensation, but would be
a violation of the rule.
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the investment adviser is providing or seeking to provide investment advisory services to
a government entity.332 These restrictions are intended to prevent advisers from
circumventing the rule’s prohibition on direct contributions to certain elected officials
such as 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.333
We received only a few comments on this provision. One supporter of our
proposal asserted that it “would close an important gap in which contributions might be
made indirectly to government officials for the purpose of influencing their choice of
investment advisers.”334 Most commenters that addressed the provision focused on the
prohibition relating to contributions and payments to state and local political parties
where the adviser is providing, or seeking to provide, advisory services. One state
official suggested that this prohibition would unfairly affect states with strict limitations
331
A payment is defined as any gift, subscription, loan, advance, or deposit of money or
anything of value. Rule 206(4)-5(f)(7). This definition is similar to the definition of
“contribution,” but broader, in the sense that it does not include limitations on the
purposes for which such money is given (e.g., it does not have to be made for the purpose
of influencing an election). We are including the broader term “payments,” as opposed to
“contributions,” here to deter an adviser from circumventing the rule’s prohibitions by
coordinating indirect contributions to government officials by making payments to
political parties.
332
Rule 206(4)-5(a)(2)(ii). This provision prohibits, for example, an adviser from soliciting
a payment to the political party of a state if the adviser is providing or seeking to provide
advisory services to the state, but would not preclude that adviser from soliciting a
payment to a local political party (as long as the adviser is not also providing or seeking
to provide advisory services to a government entity in that locality). In these
circumstances, the rule would, however, prohibit an adviser from soliciting the payment
to a local political party as a means to indirectly make payments to the state party. See
rule 206(4)-5(d).
333
We note that this provision is not limited to the bundling of employee contributions.
Another example of conduct that would be prohibited by this section would be an adviser
or its covered associates soliciting contributions from professional service providers.
334
Cornell Law Letter.
--95--
on individual contributions to candidates as they are now more reliant on party money for
campaigns.335 Another state official, however, explained the importance of the provision
by pointing out that it is often difficult or impossible to differentiate between individuals
seeking an office and the political party, which often merely passes contributions it
receives on to the candidate, and may direct successful candidates to place pension
business with contributors.336
We are adopting this provision, as proposed. These restrictions on soliciting and
coordinating contributions and payments close what would otherwise be a potential gap
in the rule as advisers could circumvent its limitations on direct contributions through
soliciting and coordinating others to make contributions to influence an election or a
government official’s investment adviser selection process.337 We disagree that this
335
CT Treasurer Letter. In upholding restrictions targeted at a particular industry, courts
have found that the loss of contributions from a small segment of the electorate “would
not significantly diminish the universe of funds available to a candidate to a non-viable
level.” Green Party of Conn. v. Garfield, 590 F. Supp. 2d 288, 316 (D. Conn. 2008); see
also Preston v. Leake, 629 F. Supp. 2d 517, 524 (E.D.N.C. 2009) (differentiating the
“broad sweep of the Vermont statute” that “restricted essentially any potential campaign
contribution” from a statute that “only applies to lobbyists”); In re Earle Asphalt Co., 950
A.2d 918, 927 (N.J. Super. Ct. App. Div. 2008), aff’d 957 A.2d 1173 (N.J. 2008)
(holding that a limitation on campaign contributions by government contractors and their
principals did not have the same capacity to prevent candidates from amassing the
resources necessary for effective campaigning as the statute in Randall). See supra note
68.
336
Reilly Letter.
337
We note that a direct contribution to a political party by an adviser or its covered
associates would not violate the rule, unless the contribution was a means for the adviser
to do indirectly what the rule would prohibit if done directly (for example, if the
contribution was earmarked or known to be provided for the benefit of a particular
government official). See section II.B.2(d) of this Release. The MSRB amended rule G37
in 2005 to expand its prohibition on soliciting others to make, and on coordinating,
payments to state and local political parties to close what the MSRB identified as a gap in
which contributions were being made indirectly to officials through payments to political
parties for the purposes of influencing their choice of municipal securities dealers. The
MSRB had not previously been able to deter this misconduct, despite issuing informal
guidance in both 1996 and 2003. See Rule G-37: Request for Comments on Draft
Amendments to Rule G-37(c), Relating to Prohibiting Solicitation and Coordination of
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prohibition would unfairly affect candidates in states that limit individual contributions,
because the rule is non-discriminatory and would affect contributions (and payments) to
all candidates equally that were being bundled or made through a gatekeeper for the
benefit of an investment adviser seeking or doing business with the state or local
government.
(d)
Direct and Indirect Contributions or Solicitations
Rule 206(4)-5(d) prohibits acts done indirectly, which, if done directly, would
violate the rule.338 As a result, an adviser and its covered associates could not funnel
payments through third parties, including, for example, consultants, attorneys, family
members, friends or companies affiliated with the adviser as a means to circumvent the
rule.339 We emphasize, however, that contributions by these other persons would not
Payments to Political Parties, and Draft Question and Answer Guidance Concerning
Indirect Rule Violations, MSRB Notice 2005-11 (Feb. 15, 2005), available at
http://www.msrb.org/msrb1/archive/2005/2005-11.asp (“Both the 1996 Q&A guidance
and the 2003 Notice were intended to alert dealers and [m
nicipal finance professionals]
to the realities of political fundraising and guide them toward developing procedures that
would lead to compliance with both the letter and the spirit of the rule. The MSRB
continues to be concerned, however, that dealer, [municipal finance professional], and
affiliated persons’ payments to political parties, including “housekeeping”, “conference”
or “overhead” type accounts, and PACs give rise to at least the appearance that dealers
may be circumventing the intent of Rule G-37.”); Self-Regulatory Organizations;
Municipal Securities Rulemaking Board; Order Approving Proposed Rule Change
Concerning Solicitation and Coordination of Payments to Political Parties and Question
and Answer Guidance on Supervisory Procedures Related to Rule G-37(d) on Indirect
Violations, Exchange Act Release No. 52496 (Sept. 22, 2005) (SEC order approving
change to MSRB G-37 to prohibit soliciting or coordinating payments to political
parties).
338
Paragraph (d) of the rule is substantially similar to section 208(d) of the Advisers Act [15
U.S.C. 80b-8(d)], which states, “It shall be unlawful for any person indirectly, or through
or by any other person, to do any act or thing which it would be unlawful for such person
to do directly under the provisions of this title or any rule or regulation thereunder.”
MSRB rule G-37 contains a similar provision. See MSRB rule G-37(d).
339
This provision would also cover, for example, situations in which contributions by an
adviser are made, directed or funded through a third party with an expectation that, as a
result of the contributions, another contribution is likely to be made by a third party to an
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otherwise trigger the rule’s two-year time out.340 We received no comments on this
aspect of the proposed rule and are adopting it as proposed.
(e)
Covered Investment Pools
Rule 206(4)-5 includes a provision that applies each of the prohibitions of rule
206(4)-5 to an investment adviser that manages assets of a government entity through a
hedge fund or other type of pooled investment vehicle (“covered investment pool”).341
For example, a political contribution to a government official that would, under the rule,
trigger the two-year time out from providing advice for compensation to the government
entity would also trigger a two-year time out from the receipt of compensation for the
management of those assets through a covered investment pool. This provision extends
the protection of the rule to public pension plans that increasingly access the services of
“official of the government entity,” for the benefit of the adviser. Contributions made
through gatekeepers thus would be considered to be made “indirectly” for purposes of the
rule. In approving MSRB rule G-37, the Commission stated: “[rule G-37(d)] is intended
to prevent dealers from funneling funds or payments through other persons or entities to
circumvent the [rule]'s requirements. For example, a dealer would violate the [rule] if it
does business with an issuer after contributions were made to an issuer official from or by
associated persons, family members of associated persons, consultants, lobbyists,
attorneys, other dealer affiliates, their employees or PACs, or other persons or entities as
a means to circumvent the rule. A dealer also would violate the rule by doing business
with an issuer after providing money to any person or entity when the dealer knows that
the money will be given to an official of an issuer who could not receive the contribution
directly from the dealer without triggering the rule's prohibition on business.” Self-
Regulatory Organizations; Order Approving Proposed Rule Change by the Municipal
Securities Rulemaking Board Relating to Political Contributions and Prohibitions on
Municipal Securities Business and Notice of Filing and Order Approving on an
Accelerated Basis Amendment No. 1 Relating to the Effective Date and Contribution
Date of the Proposed Rule, Exchange Act Release No. 33868 (Apr. 7, 1994) [59 FR
17621 (Apr. 13, 1994)].
340
Like MSRB rule G-37(d), rule 206(4)-5(d) requires a showing of intent to circumvent the
rule in order for such persons to trigger the time out. See Blount, 61 F.3d at 948 (“In
short, according to the SEC, the rule restricts such gifts and contributions only when they
are intended as end-runs around the direct contribution limitations.”).
341
See rule 206(4)-5(c). We discuss the types of pooled investment vehicles that are
“covered investment pools” below at section II.B.2.(e)(1) of this release.
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investment advisers through hedge funds and other types of pooled investment vehicles
they sponsor or advise.
This provision will generally affect two common types of arrangements in which
a government official is in a position to influence investment of funds in pooled
investment vehicles. The first is the investment of public funds in a hedge fund or other
type of pooled investment vehicle. The other is the selection of a pooled investment
vehicle sponsored or advised by an investment adviser as a funding vehicle or investment
option in a government-sponsored plan, such as a “529 plan.”342
An adviser that makes political contributions to steer assets to a pooled
investment vehicle it manages facilitates fraud by implementing a government official’s
quid pro quo scheme.343 Public pension plan beneficiaries are harmed when a
government official violates the public trust, for example, by failing to disclose that the
government official has directed the investment of the plan’s assets in a pooled
investment vehicle not because of the vehicle’s financial merits but rather because the
official has received a political contribution.344 By engaging in such conduct, the adviser
engages in a scheme to defraud the beneficiaries of the government plan or program.345
Additionally, an investment adviser to a pooled investment vehicle that is an investment
option in a government plan or program may prepare information about the pooled
342
We note that if an adviser is selected by a government entity to advise a government-
sponsored plan (regardless of whether the plan selects one of the pools the adviser offers
or manages as an option available under its plan), the prohibitions of the rule directly
apply. See rule 206(4)-5(a)(1) and (a)(2).
343
SEC v. DiBella, 587 F.3d 553, 568 (2d Cir. 2009).
344
Id. at 566.
345
See id. at 568–69; section 206(4) of the Advisers Act. See also Exchange Act rule 10b-5
[17 CFR 240.10b-5].
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investment vehicle that may be used by plan officials to evaluate the vehicle and by
pension plan beneficiaries to decide whether to allocate assets to the vehicle. Such an
adviser engages in or facilitates an act, practice, or course of business which is
fraudulent, deceptive, or manipulative when the adviser does not disclose that it made a
contribution for the purpose of inducing an investment by the government officials and
that the government officials sponsoring the plan chose the vehicle as an investment
option for beneficiaries not solely on the basis of its merits, but rather as the consequence
of improper quid pro quo payments.346 The rule also operates to prevent an adviser from
engaging in pay to play practices indirectly through an investment pool that it would not
be permitted to do if it directly managed (or sought to directly manage) the assets of a
government entity.347
Although a few commenters asserted that the rule or parts of it should not apply to
pooled investment vehicles,348 none made a persuasive argument that the problems the
rule is designed to address are not present in the management of public pension plan and
other public monies invested in pooled investment vehicles. As we discussed in the
Proposing Release,349 when a decision to invest public funds in a pooled investment
vehicle is based on campaign contributions, the public pension plan may make inferior
346
See, e.g., Oran v. Stafford, 226 F.3d 275, 285-86 (3d Cir. 2000) (“a duty to disclose may
arise when there is . . . an inaccurate, incomplete or misleading prior disclosure”); Glazer
v. Formica Corp., 964 F.2d 149, 157 (2d Cir. 1992) (“when a corporation does make a
disclosure—whether it be voluntary or required—there is a duty to make it complete and
accurate”) (quoting Roeder v. Alpha Industries, Inc., 814 F.2d 22, 26 (1st Cir. 1987). See
also Exchange Act Rule 10b-5(b).
347
See rule 206(4)-5(d). See also section 208(d) of the Act.
348
See, e.g., Comment Letter of Abbott Capital Management, LLC (Oct. 6, 2009) (“Abbott
Letter”); ICI Letter; NY City Bar Letter; SIFMA Letter; Skadden Letter; Sutherland
Letter.
349
See Proposing Release, at section II.A.3.(e)(2).
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investment choices and may pay higher fees. And such pension plans may invest in
pooled investment vehicles that pay substantially higher advisory fees and assume
significantly greater risks than other investment alternatives.350
We find nothing in the structure of pooled investment vehicles or the variety of
investment strategies they employ that suggests a reason for treating advisers to pooled
investment vehicles differently from advisers to separately managed advisory accounts,
except, as we discuss below, registered investment companies to which we apply a more
limited version of the rule. That an investment in a pooled investment vehicle may not
involve a direct advisory relationship with a government sponsored plan does not change
the nature of the fraud or the harm that may be inflicted as a consequence of the adviser’s
pay to play activity.
Indeed, many of our recent enforcement cases alleged political contributions or
kickbacks designed to induce public officials to invest public pension plan assets in
pooled investment vehicles.351 We are concerned that our failure to apply the rule to
350
See, e.g., Nanette Burns, Can Retirees Afford This Much Risk? BUSINESS WEEK (Sept.
17, 2007), available at
http://www.businessweek.com/magazine/content/07_38/b4050048.htm (asserting that
public pension plan assets are increasingly being invested in higher risk alternative
investments, including hedge funds); Hannah M. Terhune, Accounts Training, MONEY
SCIENCE (Dec. 11, 2006), available at
http://www.moneyscience.com/Hedge_Fund_Tutorials/Hedge_Fund_Management_and_
Performance_Fees.html (noting an “enormous difference in rewards for the managers of
hedge funds versus those of mutual funds” because hedge fund managers are entitled to
performance fees).
351
See, e.g., SEC v. Paul J. Silvester, et al., Litigation Release No. 16759, Civil Action No.
3:00-CV-19411 DJS (D. Conn.) (Oct. 10, 2000) (action in which investment adviser
allegedly paid third-party solicitors who kicked back a portion of the money to the former
Connecticut State Treasurer in order to obtain public pension fund investments in a hedge
fund managed by the adviser); SEC v. William A. DiBella, et al., Litigation Release No.
20498, Civil Action No. 3:04 CV 1342 (EBB) (D. Conn.) (Mar. 14, 2008) (consultant
was found to have aided and abetted the former Connecticut State Treasurer in a pay to
play scheme involving an investment adviser to a private equity fund who had paid third-
party solicitors to obtain public pension fund investments in the fund). There are
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advisers who manage assets through these vehicles would ignore an area where there has
been considerable growth, both in the amount of public assets invested in such pooled
investment vehicles and allegations of pay to play activity involving public pension
plans.352 We believe a failure to apply the rule in this area could, in some cases, even
encourage the use of covered investment pools as a means of avoiding application of the
rule.
Nonetheless, as described in more detail below, we have made several changes
from the proposal to more narrowly tailor the applicability of the rule to pooled
investment vehicles in order to achieve our regulatory purpose while reducing
examples of pay to play activity in the context of pooled investment vehicles in other
jurisdictions as well. See, e.g., supra note 18 (listing various actions relating to the recent
pay to play allegations surrounding the New York Common Retirement Fund). See also
Guilty Plea in Fraud Case Tied to New York Pension, ASSOCIATED PRESS (Dec. 4,
2009), available at http://www.nytimes.com/2009/12/04/nyregion/04pension.html
(describing the guilty plea of an adviser to a venture capital fund to charges that he
helped his company land a lucrative deal with New York’s public pension fund by giving
nearly $1 million worth of illegal gifts to state officials).
See, e.g., Investment Company Institute, 529 Plan Program Statistics, Mar. 2009 (Feb. 5,
2010), available at http://www.ici.org/research/stats/529s/529s_03-09 (indicating that
529 plan assets have increased from $8.6 billion in 2000 to $100.3 billion in the first
quarter of 2009, and that 529 plan accounts have increased from 1.3 million in 2000 to
11.2 million in the first quarter of 2009); Investment Company Institute, The U.S.
Retirement Market, 2008, 18 RESEARCH FUNDAMENTALS, No. 5 (June 2009), available
at http://www.ici.org/pdf/fm-v18n5.pdf (indicating that 403(b) plan and 457 plan assets
have increased from $627 billion in 2000 to $712 billion in the fourth quarter of 2008);
SEI, Collective Investment Trusts: The New Wave in Retirement Investing (May 2008),
available at
https://longjump.com/networking/RepositoryPublicDocDownload?id=80031025axe1395
09557&docname=SEI%20CIT%20White%20Paper%205.08.pdf&cid=80031025&encod
e=application/pdf (citing Morningstar data indicating that collective investment trust
assets nearly tripled from 2004 to 2007 and grew by more than 150 percent between 2005
and 2007 alone). See also Michael Marois, CalPERS, Blackstone Clash over Placement
Agent ‘Jackpot’ Fees, BLOOMBERG (Apr. 7, 2010), available at
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=acPNrTn1q7pw (noting
that placement agents working for private equity, hedge funds, venture capital and real
estate firms typically earn the equivalent of 0.5 percent to 3 percent of the money they
place under the management of their client, quoting California State Treasurer Bill
Lockyer, a member of the CalPERS board, “[t]he contingency fees are too much of a
jackpot for the placement agents . . . [they] invite corrupt practices”).
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compliance burdens that commenters brought to our attention. In addition, we have made
certain clarifying changes to the rule, as described below.
(1)
Definition of “Covered Investment Pool”
Under the rule, a “covered investment pool”353 includes: (i) any investment
company registered under the Investment Company Act of 1940 that is an investment
option of a plan or program of a government entity; or (ii) any company that would be an
investment company under section 3(a) of that Act but for the exclusion provided from
that definition by section 3(c)(1), section 3(c)(7) or section 3(c)(11) of that Act.354
Accordingly, it includes such unregistered pooled investment vehicles as hedge funds,
private equity funds, venture capital funds and collective investment trusts.355 It also
353
Rule 206(4)-5(f)(3).
354
15 U.S.C. 80a-3(c)(1), (7) or (11). We note that a bank maintaining a collective
investment trust would not be subject to the rule if the bank falls within the exclusion
from the definition of “investment adviser” in section 202(a)(11)(A) of the Advisers Act
[15 U.S.C. 80b-2(a)(11)(A)]. A non-bank adviser that provides advisory services with
respect to a collective investment trust in which a government entity invests, however,
would be subject to the rule’s prohibitions with respect to all of its government entity
clients, including the collective investment trust in which a government entity invests,
unless another exemption is available.
355
One commenter questioned the Commission’s authority to apply the rule in the context of
covered investment pools in light of the opinion of the Court of Appeals for the District
of Columbia Circuit in Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006). Sutherland
Letter. That case created some uncertainty regarding the application of sections 206(1)
and 206(2) of the Advisers Act in certain cases where investors in a pool are defrauded
by an investment adviser to that pool. See Prohibition of Fraud by Advisers to Certain
Pooled Investment Vehicles, Investment Advisers Act Release No. 2628 (Aug. 3, 2007)
[72 FR 44756 (Aug. 9, 2007)], (adopting rule 206(4)-8 [17 CFR 275.206(4)-8]). In
addressing the scope of the exemption from registration in section 203(b)(3) of the
Advisers Act and the meaning of ‘‘client’’ as used in that section, the Court of Appeals
expressed the view that, for purposes of sections 206(1) and (2), the ‘‘client’’ of an
investment adviser managing a pool is the pool itself, not an investor in the pool. In its
opinion, the Court of Appeals distinguished sections 206(1) and (2) from section 206(4)
of the Advisers Act, which applies to persons other than clients. Id. at n.6. See also
United States v. Elliott, 62 F.3d 1304, 1311 (11th Cir. 1995). Section 206(4) permits us
to adopt rules proscribing fraudulent conduct that is potentially harmful to investors in
pooled investment vehicles. We are adopting rule 206(4)-5 under this authority.
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includes registered pooled investment vehicles, such as mutual funds, but only if those
registered pools are an investment option of a participant-directed plan or program of a
government entity.356 These plans or programs may include college savings plans like
“529 plans”357 and retirement plans like “403(b) plans”358 and “457 plans”359 that
typically allow participants to select among pre-established investment “options,” or
particular investment pools (often invested in registered investment companies or funds
of funds, such as target date funds), that a government official has directly or indirectly
selected to include as investment choices for participants.360
356
Rule 206(4)-5(f)(8).
357
A 529 plan is a “qualified tuition plan” established under section 529 of the Internal
Revenue Code of 1986 [26 U.S.C. 529]. States generally establish 529 plans as state
trusts which are considered instrumentalities of states for federal securities law purposes.
As a result, the plans themselves are generally not regulated under the federal securities
laws and many of the protections of the federal securities laws do not apply to investors
in them. See section 2(b) of the Investment Company Act [15 U.S.C. 80a-2(b) and
section 202(b) of the Advisers Act [15 U.S.C. 80b-2(b) (exempting state-owned entities
from those statutes). However, the federal securities laws do generally apply to, and the
Commission does generally regulate, the brokers, dealers, and municipal securities
dealers that effect transactions in interests in 529 plans. See generally sections 15(a)(1)
and 15B of the Exchange Act [15 U.S.C. 78a-15(a)(1) and 15B]. A bank effecting
transactions in 529 plan interests may be exempt from the definition of “broker” or
“municipal securities dealer” under the Exchange Act if it can rely on an exception from
the definition of broker in the Exchange Act. In addition, state sponsors of 529 plans
may hire third-party investment advisers either to manage 529 plan assets on their behalf
or to act as investment consultants to the agency responsible for managing plan assets.
These investment advisers, unless they qualify for a specific exemption from registration
under the Advisers Act, are generally required to be registered with the Commission as
investment advisers and would therefore be subject to our rule.
358
A 403(b) plan is a tax-deferred employee benefit retirement plan established under
section 403(b) of the Internal Revenue Code of 1986 [26 U.S.C. 403(b)].
359
A 457 plan is a tax-deferred employee benefit retirement plan established under section
457 of the Internal Revenue Code of 1986 [26 U.S.C. 457].
360
We would consider a registered investment company to be an investment option of a plan
or program of a government entity where the participant selects a model fund or portfolio
(such as an age-based investment option of a 529 plan) and the government entity selects
the specific underlying registered investment company or companies in which the
portfolio’s assets are invested.
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We proposed to include in the definition of “covered investment pool” the types
of pooled investment vehicles that are likely to be used as funding vehicles for, or
investments of, government-sponsored savings and retirement plans. We explained that
we included registered investment companies because of the significant growth in
government-sponsored savings plans in recent years, which increasingly use these funds
as investment options,361 and the increased competition among advisers for selection of
their fund as an investment option for these plans.362 We were concerned that advisers to
pooled investment vehicles, including registered investment companies, may make
political contributions to influence the decision by government officials to include their
funds as options in such plans.
We recognized in our proposal, however, that an adviser to a registered
investment company might have difficulty in identifying when or if a government
investor was a fund shareholder for purposes of preventing the adviser (or its covered
associates) from making contributions that would trigger a two-year time out.363
Therefore, we proposed to only include publicly offered registered investment companies
361
See supra note 352 and accompanying text.
362
See, e.g., Charles Paikert, TIAA-CREF Stages Comeback in College Savings
Plans, CRAIN’S NEW YORK BUS., Apr. 23, 2007 (depicting TIAA-CREF’s struggle to
remain a major player in managing State 529 plans because of increasing competition
from the industry’s heavyweights); Beth Healy, Investment Giants Battle for Share of
Exploding College-Savings Market, BOSTON GLOBE, Oct. 29, 2000, at F1 (describing the
increasing competition between investment firms for state 529 plans and increasing
competition to market their plans nationally). See also AnnaMaria Andriotis, 529 Plan
Fees are Dropping, SMARTMONEY, Dec. 16, 2009, available at
http://www.smartmoney.com/personal-finance/college-planning/529-plan-fees-aredropping-
but-for-how-long/?hpadref=1 (“Costs on these plans are falling for a few
reasons, and the biggest one has little to do with the state of the economy: the nature of
their contracts creates competition. When a contract for a state 529 plan expires, program
managers compete against each other and may lower their fees to try to secure the new
contract.”).
363
See Proposing Release, at nn. 185-87 and accompanying text.
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in the definition of covered investment pool for purposes of the two-year time out
provision to the extent they were investments or investment options of a plan or program
of a government entity.364
Several commenters asserted that an adviser to a publicly offered investment
company would have similar difficulties in identifying government investors in registered
investment companies for purposes of complying with other provisions of the rule.365
One opposed application of the rule to registered investment companies “even if the
[company] is not included in a plan or program of a government entity,”366 although
several generally urged us to exclude registered investment companies from the rule
altogether.367 Another commenter urged us to apply the rule’s recordkeeping
requirements (discussed below) prospectively and after a period of time that would be
adequate to enable funds to redesign their processes and systems to capture information
about whether an investor is a “government entity,” which would be necessary to comply
364
See proposed rule 206(4)-5(f)(3) (“Covered investment pool means any investment
company, as defined in section 3(a) of the Investment Company Act of 1940 (15 U.S.C.
80a-3(a)) . . . except that for purposes of paragraph (a)(1) of this section, an investment
company registered under the Investment Company Act of 1940 (15 U.S.C. 80a), the
shares of which are registered under the Securities Act of 1933 (15 U.S.C. 77a), shall be a
covered investment pool only if it is an investment or an investment option of a plan or
program of a government entity.”).
365
See Davis Polk Letter; Fidelity Letter; ICI Letter; NSCP Letter; Comment Letter of
Standard & Poor’s Investment Advisory Services LLC and Standard & Poor’s Securities
Evaluations, Inc. (Oct. 5, 2009) (“S&P Letter”); SIFMA Letter; T. Rowe Price Letter.
366
T. Rowe Price Letter.
367
Fidelity Letter; ICI Letter; NSCP Letter; SIFMA Letter. We disagree that registered
investment companies should be excluded from our rule. Pay to play activity is
fraudulent, regardless of whether it occurs in the context of a pooled investment vehicle
or a separately managed account. One commenter asserted that the existence of a
regulatory regime applicable to investment companies precludes the need for pay to play
prohibitions with respect to these pools. See ICI Letter. However, existing laws and
regulations applicable to investment companies do not specifically address pay to play
practices.
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with the rule and our proposed amendment to the Act’s recordkeeping rule.368 Some
noted that identifying government investors would be particularly challenging when
shares were held through an intermediary.369
We continue to believe for the reasons discussed above370 and in the Proposing
Release, that advisers to registered investment companies should be subject to the rule.
In response to comments, we have modified our proposal to include a registered
investment company in the definition of covered investment pool, for purposes of all
three of the rule’s pay to play prohibitions, but only if it is an investment option of a plan
or program of a government entity.371 We believe this approach strikes the right balance
between applying the rule in those contexts, discussed in the Proposing Release,372 in
which advisers to registered investment companies may be more likely to engage in pay
to play conduct, while recognizing the compliance challenges relating to identifying
government investors in registered investment companies373 that may result from a
368
ICI Letter. See also section II.D of this Release.
369
See T. Rowe Price Letter; ICI Letter, Fidelity Letter.
370
See supra notes 361-362 and accompanying text.
371
Rule 206(4)-5(f)(3).
372
Proposing Release, at nn.185-87 and accompanying text. See also supra notes 352 and
362 and accompanying text (describing the growth in government-sponsored savings
plans in recent years and the increased competition for an adviser’s fund to be selected as
an investment option of such a plan).
373
Identifying government investors in other types of covered investment pools does not
generally present similar compliance challenges. See, e.g., rule 2(a)(51) under the
Investment Company Act [17 CFR 270.2(a)(51)] (defining “qualified purchaser,” as that
term is used in section 3(c)(7) of that Act); Rule 501(a) of Regulation D under the
Securities Act of 1933 (“Securities Act”) [17 CFR 230.501(a)] (defining “accredited
investor” for purposes of limited offerings without registration under the Securities Act of
1933); and Advisers Act rule 205-3 (creating an exception from the prohibition against an
adviser receiving performance-based compensation from clients that are not “qualified
clients,” and which is relied on by many advisers to funds that are exempt from
Investment Company Act registration under section 3(c)(1) of that Act).
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broader application of the rule. When an adviser’s investment company is an investment
option in a participant-directed government plan or program, we believe it is reasonable
to expect the adviser will know (or can reasonably be expected to acquire information
about) the identity of the government plan.374 We recognize that when shares are held
through an intermediary, an adviser may have to take additional steps to identify a
government entity.375 Therefore, we have provided advisers to registered investment
companies with additional time to modify current systems and processes.376
We have also made several minor changes from our proposal intended to clarify
and simplify application of the rule. First, at the suggestion of commenters,377 we are
clarifying that an adviser to a registered investment company is only subject to the rule—
i.e., the investment company is only considered a covered investment pool—if the
investment company is an investment option of a plan or program of a government entity
that is participant-directed.378 This change reflects our intent, as demonstrated by the
374
With respect to a 529 plan, for example, an adviser would know that its investment
company is an investment option of the plan and will know the identity of the
government entity investor because a 529 plan can only be established by a state, which
generally establishes a trust to serve as the direct investor in the investment company,
while plan participants invest in various options offered by the 529 trust. The rule does
not require an adviser to identify plan participants, only the government plan or program.
See rule 206(4)-5(f)(5)(iii) (defining a “government entity” to include a plan or program
of a government entity. The definition does not include the participants in those plans or
programs).
375
For example, while 403(b) plans and 457 plans are generally associated with retirement
plans for government employees, they are not used exclusively for this purpose. For
instance, certain non-profit or tax-exempt entities can establish these types of plans. We
also understand that it is not uncommon for contributions of 403(b) and 457 plans to be
commingled into an omnibus position that is forwarded to the fund, making it more
challenging for an adviser to distinguish government entity investors from others.
376
See section III.D of this Release. We received several letters addressing this concern.
ICI Letter; T. Rowe Price Letter; Fidelity Letter.
377
See, e.g., ICI Letter; Davis Polk Letter; SIFMA Letter.
378
Rule 206(4)-5(f)(8).
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examples we give in the definition (i.e., 529 plans, 403(b) plans, and 457 plans) that the
definition is intended to encompass those covered investment pools that have been preselected
by the government sponsoring or establishing the plan or program as part of a
limited menu of investment options from which participants in the plan or program may
allocate their account. We have also added, as additional examples to the definition of
“government entity,” a defined benefit plan and a state general fund to better distinguish
these pools of assets from a plan or program of a government entity.379 We have also
made minor organizational changes within the definition of government entity from our
proposal to make clear that such pools are not “plans or programs of a government
entity.”
Finally, we have simplified the definition of “covered investment pool” as it
applies to registered investment companies. The definition as adopted includes
investment companies registered under the Investment Company Act that are an option of
a plan or program of a government entity, regardless of whether, as proposed, their shares
are registered under the Securities Act of 1933 (“1933 Act”). As discussed above, under
the rule as adopted an adviser to a registered investment company is only subject to the
rule if the company is an investment option of a plan or program. As a result, we believe
it is unnecessary to distinguish between registered investment companies based on
whether their shares are registered under the 1933 Act, although we understand that those
shares will typically be registered where the fund is an option in a plan or program of a
government entity.
Rule 206(4)-5(f)(5).
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(2) Application of the Rule
Under rule 206(4)-5 (and as proposed) an investment adviser is subject to the two-
year time out if it manages a covered investment pool in which the assets of a
government entity are invested.380 The rule does not require a government entity’s
withdrawal of its investment or cancellation of any commitment it has made. Indeed, the
rule prohibits advisers not from providing advice subsequent to a triggering political
contribution, but rather from receiving compensation for providing advice. If a
government entity is an investor in a covered investment pool at the time a contribution
triggering a two-year “time out” is made, the adviser must forgo any compensation
related to the assets invested or committed by that government entity.381
Application of the two-year time out may present different issues for covered
investment pools than for separately managed accounts due to various structural and legal
differences. Having made a contribution triggering the two-year time out, the adviser
may have multiple options available to comply with the rule in light of its fiduciary
obligations and the disclosure it has made to investors. For instance, in the case of a
private pool, the adviser could seek to cause the pool to redeem the investment of the
380 Rule 206(4)-5(c).
381 As we noted above and in the Proposing Release, the phrase “for compensation” includes
both profits and the recouping of costs, so an adviser is not permitted to continue to
manage assets at cost after a disqualifying contribution is made. Proposing Release, at
n.191. See also supra note 137 and accompanying text. As we discussed above in
section II.B.2(a)(1) of this Release, we are not persuaded by commenters who suggested
permitting the adviser to be compensated at cost following payment of a triggering
contribution or payment. See, e.g., Dechert Letter; NY City Bar Letter. In our judgment,
the potential loss of profits from the government client alone may be insufficient to deter
pay to play activities. However, costs specifically attributable to the covered investment
pool and not normally incurred in connection with a separately managed account, such as
costs attributable to an annual audit of the pool’s assets and delivery of its audited
financial statements, would not be considered compensation to the adviser for these
purposes.
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government entity.382 Such redemptions may be relatively simple matters in the case of,
for example, a highly liquid private pool.383 Commenters pointed out to us that, for some
private pools, such as venture capital and private equity funds, a government entity’s
withdrawal of its capital or cancellation of its commitment may have adverse
implications for other investors in the fund.384 In such cases, the adviser could instead
comply with the rule by waiving or rebating the portion of its fees or any performance
allocation or carried interest attributable to assets of the government client.385
For registered investment companies, the options for restricting compensation
involving government investors are more limited, due to both Investment Company Act
382
To the extent the adviser may seek to cause the private pool to redeem the investment of
a government entity investor under these circumstances, it should consider disclosing this
as an investment risk in a private placement memorandum, prospectus or other disclosure
document to current and prospective investors in such a fund. See, e.g., Rule 502 of
Regulation D under the Securities Act [17 CFR 230.502] (addressing disclosure
obligations for non-accredited investors who purchase securities in a limited offering
pursuant to rules 505 or 506 of Regulation D under the Securities Act [17 CFR 230.505
or 17 CFR 230.506].
383
We understand that other types of pooled investment vehicles, including private equity
and venture capital funds, already have special withdrawal and transfer provisions related
to the regulatory and tax considerations applicable to certain types of investors, such as
those regulated by the Employee Retirement Income Security Act of 1974 (“ERISA”) [29
U.S.C. 18]. See generally JAMES M. SCHELL, PRIVATE EQUITY FUNDS – BUSINESS
STRUCTURE AND OPERATIONS (Law Journal Press 2000) (2010).
384
See Abbott Letter; ICI Letter; NY City Bar Letter.
385
As we noted in the Proposing Release, some commenters to our 1999 Proposal asserted
that a performance fee waiver raises various calculation issues. See Proposing Release, at
n.192. An adviser making a disqualifying contribution could comply with rule 206(4)-5
by waiving a performance fee or carried interest determined on the same basis as the fee
or carried interest is normally calculated—e.g., on a mark-to-market basis. For
arrangements like those typically found in private equity and venture capital funds where
the fee or carry is calculated based on realized gains and losses and mark-to-market
calculations are not feasible, advisers could use a straight-line method of calculation
which assumes that the realized gains and losses were earned over the life of the
investment.
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provisions and potential tax consequences.386 In our proposal, we suggested one
approach that would meet the requirements of the rule—an adviser of a registered
investment company could waive its advisory fee for the fund as a whole in an amount
approximately equal to fees attributable to the government entity.387 One commenter
agreed with our approach,388 while another commenter suggested we could, alternatively,
permit the government entity to continue to pay its portion of the advisory fee, but require
the adviser to rebate that portion of the fee to the fund as a whole.389 We believe either
approach would meet the requirements of the rule we are adopting today.
(3) Subadvisory Arrangements
A number of commenters urged that we exclude from the rule subadvisers to
covered investment pools because, being in a subordinate role to the adviser, they may
have no involvement in the adviser’s solicitation activities including no ability to identify
government entities being solicited, and therefore should not be held accountable for the
adviser’s actions.390 None of these commenters, however, indicated that a subadviser
could not obtain from the adviser the information necessary to comply with the rule.
Additionally, no commenter provided us with a basis to distinguish advisers from
subadvisers that would be adequate to avoid undermining the prophylactic nature of our
386
See Proposing Release, at n.193 and accompanying text. See, e.g., rule 18f-3 under the
Investment Company Act [17 CFR 270.18f-3]. Moreover, other regulatory
considerations, such as those under ERISA, may impact these arrangements with respect
to collective investment trusts.
387
This may also be done at the class level or series level for private funds organized as
corporations.
388
ICI Letter.
389
NY City Bar Letter.
390
See, e.g., IAA Letter; S&P Letter; Skadden Letter; Davis Polk Letter.
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rule. “Subadviser” is not defined under the Act,391 and significant variation exists in
subadvisory relationships.392 There is no readily available way to draw meaningful
distinctions between advisers and subadvisers by, for example, looking at who controls
marketing and solicitation activities,393 who has an advisory contract directly with the
government client,394 or other factors. In addition, subadvisers generally have the same
economic incentives as advisers to obtain new business and increase assets under
management. We are concerned that under the approaches suggested by commenters, an
adviser that sought to avoid compliance with the prophylactic provisions of our rule and
engage in pay to play could organize itself to operate as a subadviser in such an
arrangement. We therefore believe it is not appropriate to exclude subadvisers from the
rule.
391
“Subadviser” also is not defined under the Investment Company Act, which requires that
both advisory and subadvisory contracts (“which contract, whether with such registered
company or with an investment adviser of such registered company . . .”) be approved by
a vote of a majority of the outstanding voting securities of the registered investment
company. See section 15(a) of the Investment Company Act [15 U.S.C. 80a-15(a)].
392
See, e.g., Investment Company Institute, Board Oversight of Subadvisers (Jan. 2010),
available at http://www.ici.org/pdf/idc_10_subadvisers.pdf (providing guidance to
mutual fund boards of directors with respect to overseeing subadvisory arrangements and
recognizing that “there is no one ‘correct’ approach to effective subadvisory oversight by
fund boards” because there are a wide variety of potential subadvisory arrangements).
393
See, e.g., Davis Polk Letter (suggesting that we limit the application of the prohibitions to
a subadviser to a covered investment pool that has the ability to control the soliciting,
marketing or acceptance of government clients); S&P Letter (suggesting that we limit the
application of the prohibitions to a subadviser to a covered investment pool that: (1) has
the ability to control the soliciting, marketing or acceptance of government clients; and
(2) is not a related person of the investment adviser or distributor or other investment
pool).
394
See, e.g., IAA Letter; Skadden Letter. See also sections 2(a)(20) and 15(a) of the
Investment Company Act (treating a subadviser as an adviser to a registered investment
company even in the absence of a direct contractual relationship with the investment
company).
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We are, however, providing some guidance that may assist advisers in
subadvisory and fund of funds arrangements in complying with the rule.395 First, by the
terms of the rule, if an adviser or subadviser makes a contribution that triggers the two-
year time out from receiving compensation, the subadviser or adviser, as applicable, that
did not make the triggering contribution could continue to receive compensation from the
government entity,396 unless the arrangement were a means to do indirectly what the
adviser or subadviser could not do directly under the rule.397 Second, advisers to
underlying funds in a fund of funds arrangement are not required to look through the
investing fund to determine whether a government entity is an investor in the investing
fund unless the investment were made in that manner as a means for the adviser to do
indirectly what it could not do directly under the rule.398
395
See, e.g., IAA Letter (requesting clarification as to how the rule would apply when an
adviser becomes subject to the compensation ban after hiring a subadviser or vice versa).
See also Fidelity Letter; MFA Letter; SIFMA Letter (each expressing concern about how
the rule would apply in the fund of funds context).
396
We understand that, under some advisory arrangements, the government entity has a
contract only with the adviser and not the subadviser. Under those circumstances, it
would be consistent with the rule for an adviser that has triggered the two-year time out
to pass through to the subadviser that portion of the fee to which the subadviser is
entitled, as long as the adviser retains no compensation from the government entity and
the subadviser (and its own covered associates) has not triggered a time out as well.
397
See Rule 206(4)-5(d). For instance, an adviser that hires an affiliated subadviser to
manage a covered investment pool in which a government entity invests so that the
adviser could make contributions to that government entity would be doing indirectly
what it would be prohibited from doing directly under the rule. A subadviser would be
providing “investment advisory services for compensation to a government entity”
regardless of whether the subadviser is paid directly by the government entity or by the
adviser.
398
See rule 206(4)-5(d).
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(f) Exemptions
An adviser may apply to the Commission for an order exempting it from the two-
year compensation ban.399 Under this provision, which we are adopting as proposed, we
can exempt advisers from the rule’s time out requirement where the adviser discovers
contributions that trigger the compensation ban only after they have been made, and
when imposition of the prohibition is unnecessary to achieve the rule’s intended purpose.
This provision will provide advisers with an additional avenue by which to seek to cure
the consequences of an inadvertent violation by the adviser that falls outside the limits of
the rule’s de minimis exception and exception for returned contributions,400 such as when
a disgruntled employee makes a greater than $350 contribution as he or she exits the firm.
In determining whether to grant an exemption, we will take into account the varying facts
and circumstances that each application presents. Among other factors, we will consider:
(i) whether the exemption is necessary or appropriate in the public interest and consistent
with the protection of investors and the purposes fairly intended by the policy and
provisions of the Advisers Act; (ii) whether the investment adviser, (A) before the
contribution resulting in the prohibition was made, adopted and implemented policies and
procedures reasonably designed to prevent violations of rule 206(4)-5; (B) prior to or at
the time the contribution which resulted in such prohibition was made, had no actual
knowledge of the contribution; and (C) after learning of the contribution, (1) has taken all
available steps to cause the contributor involved in making the contribution which
399
Rules 0-4, 0-5, and 0-6 under the Advisers Act [17 CFR 275.0-4, 0-5, and 0-6] provide
procedures for filing applications under the Act, including applications under the rule
206(4)-5.
400
See sections II.B.2(a)(6) and (7) of this Release, describing exceptions to the two-year
time out prohibition of the rule.
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resulted in such prohibition to obtain a return of the contribution; and (2) has taken such
other remedial or preventive measures as may be appropriate under the circumstances;
(iii) whether, at the time of the contribution, the contributor was a covered associate or
otherwise an employee of the investment adviser, or was seeking such employment; (iv)
the timing and amount of the contribution which resulted in the prohibition; (v) the nature
of the election (e.g., federal, state or local); and (vi) the contributor’s apparent intent or
motive in making the contribution which resulted in the prohibition, as evidenced by the
facts and circumstances surrounding such contribution.401 We intend to apply these
factors with sufficient flexibility to avoid consequences disproportionate to the violation,
while effecting the policies underlying the rule.
We received limited comment on this provision. A few commenters suggested
that the operation of the rule should toll until a decision is made about an applicant’s
request.402 We are concerned that such an approach could encourage frivolous
applications and encourage applicants to delay the disposition of their applications. As
we explained in the Proposing Release, an adviser seeking an exemption could place into
an escrow account any advisory fees earned between the date of the contribution
triggering the prohibition and the date on which we determine whether to grant an
exemption.403 Some commenters recommended the rule build in a specified length of
401
See Rule 206(4)-5(e). These factors are similar to those considered by FINRA and the
appropriate bank regulators in determining whether to grant an exemption under MSRB
rule G-37(i).
402
ICI Letter; Skadden Letter.
403
See Proposing Release, at n.199. The escrow account would be payable to the adviser if
the Commission grants the exemption. If the Commission does not grant the exemption,
the fees contained in the account would be returned to the government entity client. In
contrast, MSRB rule G-37, on which rule 206(4)-5 is based, does not permit a municipal
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time for the Commission to respond to requests for relief.404 We recognize that
applications for an exemptive order will be time-sensitive and will consider such
applications expeditiously. We note that the escrow arrangements discussed above may
lessen the hardship on advisers.
D.
Recordkeeping
We are adopting amendments to rule 204-2 to require registered investment
advisers that have government clients, or that provide investment advisory services to a
covered investment pool in which a government entity investor invests, to make and keep
certain records that will allow us to examine for compliance with new rule 206(4)-5.405
The rule amendments reflect several changes from our proposal, which are discussed
below. These requirements are similar to the MSRB recordkeeping requirements for
brokers, dealers and municipal securities dealers.406
Amended rule 204-2 requires registered advisers that provide investment advisory
services to a government entity, or to a covered investment pool in which a government
securities dealer to continue to engage in municipal securities business with an issuer
while an application is pending. See MSRB Rule G-37 Q&A, Question V.1.
404
IAA Letter; ICI Letter; NASP Letter (each suggesting all applications be granted if they
are not acted upon in 30 days); Skadden Letter (suggesting a 45-day deadline).
405
Rule 204-2(a)(18) and (h)(1). An adviser is required to make and keep these records only
if it provides investment advisory services to a government entity or if a government
entity is an investor in any covered investment pool to which the investment adviser
provides investment advisory services. Advisers that solicit government clients on behalf
of other advisers are also subject to the amended recordkeeping requirements. Advisers
that are exempt from Commission registration under section 203(b)(3) of the Advisers
Act, however, are not subject to the recordkeeping requirements under amended 204-2
unless they do register with us, although as discussed earlier, supra note 92 and
accompanying text, they are subject to rule 206(4)-5. Advisers keeping substantially the
same records under rules adopted by the MSRB are not required to keep duplicate
records. Rule 204-2(h)(1).
406
MSRB rule G-8(a)(xvi). The MSRB also requires certain records to be made and kept in
accordance with disclosure requirements that our rule does not contain.
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entity is an investor, to make and keep records of contributions made by the adviser and
covered associates to government officials (including candidates), and of payments to
state or local political parties and PACs.407 The adviser’s records of contributions and
payments must be listed in chronological order identifying each contributor and recipient,
the amounts and dates of each contribution or payment and whether a contribution was
subject to rule 206(4)-5’s exception for certain returned contributions.408 The rule also
requires an adviser that has government clients to make and keep a list of its covered
associates,409 and the government entities to which the adviser has provided advisory
services in the past five years.410 Similarly, advisers to covered investment pools must
make and keep a list of government entities that invest, or have invested in the past five
years, in a covered investment pool, including any government entity that selects a
covered investment pool to be an option of a plan or program of a government entity,
such as a 529, 457 or 403(b) plan.411 An investment adviser, regardless of whether it
currently has a government client, must also keep a list of the names and business
addresses of each regulated person to whom the adviser provides or agrees to provide,
407
Contributions and payments by PACs controlled by the adviser or a covered associate
would also have to be recorded as these PACs are “covered associates” under the rule.
Rule 206(4)-5(f)(2)(iii). See section II.B.2(a)(4) of this Release.
408
Rule 204-2(a)(18)(ii).
409
The adviser must record the name, title(s), and business and residence addresses of each
covered associate. Rule 204-2(a)(18)(i)(A).
410
Advisers do not have to maintain a record of government entities that were clients before
the effective date. For additional information regarding the implementation of rule
206(4)-5, see section III of this Release.
411
Amended rule 204-2 does not require an adviser to a covered investment pool that is an
option of a government plan or program to make and keep records of participants in the
plan or program, but only the government entity. See supra note 374. Consistent with
changes we have made to the definition of covered investment pool, we note that an
adviser’s recordkeeping obligations with respect to a registered investment company
apply only if such an investment company is an option of a plan or program of a
government entity. See section II.B.2(e) of this Release.
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directly or indirectly, payment to solicit a government entity on its behalf.412 The
amended rule reflects several changes from our proposal, which we describe below.
First, in response to comments,413 we have limited the rule to provide that only
records of contributions,414 not payments,415 to government officials and candidates are
required to be kept under the rule.416 We have made this change because, unlike
contributions, which are one type of payment, all payments do not trigger the two-year
time out. As a result of this change, the recordkeeping obligations better reflect the
activities of an adviser or a covered associate that could result in the adviser being subject
to the two-year time out. Commenters also argued that we should not require, as
proposed, advisers to maintain records of payments to PACs.417 Although those
payments do not trigger application of the two-year time out, payments to PACs can be a
means for an adviser or covered associate to funnel contributions to a government official
without directly contributing. We are, therefore, adopting the amendment to require
advisers to keep records of payments to PACs as these records will allow our staff to
identify situations that might suggest an intent to circumvent the rule.418
412
Rule 204-2(a)(18)(i)(D).
413
Fidelity Letter; IAA Letter; SIFMA Letter.
414
See supra note 153 and accompanying text (defining “contribution”)
415
See supra note 331 (defining “payment”).
416
Rule 204-2(a)(18)(i)(C).
417
See, e.g., IAA Letter; SIFMA Letter.
418
Accordingly, as part of a strong compliance program, an adviser or covered associate that
receives a general solicitation to make a contribution to a PAC should consider inquiring
about how the collected funds would be used to determine whether the PAC is closely
associated with a government official to whom a direct contribution would subject the
adviser to the two-year time out. See section II.B.2(d) of this Release and rule 206(4)5(
d). The MSRB takes a similar approach regarding whether a payment to a PAC is an
indirect contribution to a government official. See MSRB Rule G-37 Q&A, Questions
III.4 and III.5.
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Second, an investment adviser to a registered investment company must maintain
records identifying government entity investors only if the investments are made as part
of a plan or program of a government entity or provide participants in the plan or
program with the option of investing in the fund.419 This change would narrow the
records required to those necessary to support the rule as modified from our proposal, and
we believe addresses commenters’ concerns regarding the ability of advisers to registered
investment companies to identify government entity investors.420 As discussed above, we
believe it is reasonable to expect advisers to know the identity of the government entity
when a registered fund they advise is part of a plan or program. In addition, as
commenters suggested, we are providing a substantial transition period for advisers to
registered investment companies that should allow these advisers to make the necessary
changes to account documents and systems to allow them to identify government entities
that provide one or more of the investment companies they advise as an investment
option.421
Third, the amended rule requires an adviser to maintain a list of only those
government entities to which it provides, or has provided in the past five years,
419
Rule 204-2(a)(18)(i)(B). Amended rule 204-2 does not require an adviser to a covered
investment pool that is an option of a government plan or program to make and keep
records of participants in the plan or program, but only the government entity. For a
discussion of the application of the rule to a covered investment pool that is an option of
a government plan or program, see supra note 371 and accompanying text. Consistent
with changes we have made to the definition of covered investment pool, we note that an
adviser’s recordkeeping obligations with respect to a registered investment company
apply only if such an investment company is an option of a plan or program of a
government entity. See section II.B.2(e) of this Release.
420
Advisers to covered investment pools that are relying on Investment Company Act
exclusions in sections 3(c)(1), 3(c)(7) and 3(c)(11) must identify government entity
investors regardless of whether they are an investment option of a plan or program of a
government entity. Rule 204-2(a)(18)(i)(B).
421
See section III of this Release.
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investment advisory services.422 We are not requiring, as proposed, a list of government
entities the adviser solicited for advisory business.423 Some commenters expressed
concerns about the potential scope of this requirement and noted that solicitation does not
trigger rule 206(4)-5’s two-year time out, rather it is providing advice for compensation
that does so.424 In light of these concerns, and the record before us today, we are not
requiring advisers to maintain lists of government entities solicited that do not become
clients.
Fourth, as discussed above, rule 206(4)-5 permits an adviser to use certain third
parties to solicit on its behalf. We are, therefore, requiring that advisers that provide or
agree to provide, directly or indirectly, payment to advisers or broker-dealers registered
with the Commission that act as regulated persons under rule 206(4)-5 to maintain a list
of the names and business addresses of each such regulated person.425 These records will
enable the Commission’s staff to review and compare the regulated person’s records to
those of the adviser that hired the regulated person.
Finally, the amendments require advisers to make and keep records of their
covered associates, and their own and their covered associates’ contributions, only if they
provide advisory services to a government client.426 Commenters had expressed concerns
that requiring advisers with no government business to make and keep these records
422 See rule 204-2(a)(18)(i)(B).
423 See proposed rule 204-2(a)(18)(i)(B).
424 Dechert Letter; SIFMA Letter; Skadden Letter.
425 Rule 204-2(a)(18)(i)(D). If an adviser does not specify which types of clients the
regulated person should solicit on its behalf (e.g., that it should only solicit government
entities), the adviser could satisfy this requirement by maintaining a list of all of its
regulated person solicitors. Supra note 412.
426 Rule 204-2(a)(18)(iii).
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could be unnecessarily intrusive to employees and burdensome on advisers.427 In light
of those concerns, and the record before us today, we are not requiring advisers with no
government business to make and keep these records.428 As a consequence, an adviser
with no government clients would not have to require employees to report their political
contributions.
E.
Amendment to Cash Solicitation Rule
We are adopting, as proposed, a technical amendment to rule 206(4)-3 under the
Advisers Act, the “cash solicitation rule.” That rule makes it unlawful, except under
specified circumstances and subject to certain conditions, for an investment adviser to
make a cash payment to a person who directly or indirectly solicits any client for, or
refers any client to, an investment adviser.429
Paragraph (iii) of the cash solicitation rule contains general restrictions on third-
party solicitors that cover solicitation activities directed at any client, regardless of
whether it is a government entity client. New paragraph (e) to rule 206(4)-3 alerts
427
IAA Letter; Dechert Letter; SIFMA Letter.
428
Although advisers that do not have government entity clients are not required to maintain
records under the amendments, the look-back requirements of rule 206(4)-5 continue to
apply. As a result, an adviser that has not maintained records of the firm’s and its
covered associates’ contributions would have to determine whether any contributions by
the adviser, its covered associates, and any former covered associates would subject the
firm to the two-year time out prior to accepting compensation from a new government
entity client. The same applies to newly-formed advisers. The records an adviser
develops during this determination process, would fall under the adviser’s obligation to
maintain records of all direct or indirect contributions made by the investment adviser or
its covered associates to an official of a government entity, or payments to a political
party of a state or political subdivision thereof, or to a political action committee. Rule
204-2(a)(18)(i)(C).
429
17 CFR 275.206(4)-3.
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advisers and others that special prohibitions apply to solicitation activities involving
government entity clients under rule 206(4)-5.430
III.
EFFECTIVE AND COMPLIANCE DATES
Rule 206(4)-5 and the amendments to rules 204
2 and 206(4)-3 are effective on
[insert date 60 days after publication in Federal Register]. Investment advisers subject to
rule 206(4)-5 must be in compliance with the rule on March 14, 2011. Investment
advisers may no longer use third parties to solicit government business except in
compliance with the rule on September 13, 2011.431 Advisers to registered investment
companies that are covered investment pools must comply with the rule by September 13,
2011.432 Advisers subject to rule 204-2 must comply with amended rule 204-2 on March
14, 2011. However, if they advise registered investment companies that are covered
investment pools, they have until September 13, 2011 to comply with the amended
recordkeeping rule with respect to those registered investment companies.
A.
Two-Year Time Out and Prohibition on Soliciting or Coordinating
Contributions
We are providing advisers with a six month transition period to give them time to
identify their covered associates and current government entity clients and to modify their
compliance programs to address new compliance obligations under the rule.433
Accordingly, rule 206(4)-5’s prohibition on providing advisory services for compensation
430
Rule 206(4)-3(e). We received no comments on this proposed amendment.
431
Rule 206(4)-5(a)(2).
432
Rule 206(4)-5(f)(3).
433
Section III.D of this Release addresses when advisers to “covered investment pools” that
are registered investment companies must comply with the rule; section III.E of this
Release addresses transition considerations specific to certain other pooled investment
vehicles.
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within two years of a contribution will not apply to, and the rule’s prohibition on
soliciting or coordinating contributions will not be triggered by contributions made
before March 14, 2011.434 We believe that the length of the transition period should
address commenters’ concerns that advisers have sufficient time to implement policies
and procedures regarding contributions to avoid violations of the rule and that the rule not
affect the 2010 elections for which some advisory personnel may already have committed
to make political contributions.435
B.
Prohibition on Using Third Parties to Solicit Government Business
and Cash Solicitation Rule Amendment
Advisers must comply with the new rule’s prohibition on making payments to
third parties to solicit government entities for investment advisory services on September
13, 2011.436 Before this compliance date, advisers are not prohibited by the rule from
making payments to third-party solicitors regardless of whether they are registered as
broker-dealers or investment advisers.437
We have provided an extended transition period to provide advisers and third-
party solicitors with sufficient time to conform their business practices to the new rule,
434
Likewise, these prohibitions do not apply to contributions made before March 14, 2011 by
new covered associates to which the look back applies. See section II.B.2(a)(5) of this
Release for a discussion of the rule’s look-back provision. For example, if an individual
who becomes a covered associate of an adviser on or after March 14, 2011 made a
contribution before March 14, 2011, that new covered associate’s contribution would not
trigger the two-year time out for the adviser. On the other hand, if an individual who
later becomes a covered associate made the contribution on or after March 14, 2011, the
contribution would trigger the two-year time out for the adviser if it were made less than,
as applicable, six months or two years before the individual became a covered associate.
435
Commenters recommended that we provide advisers with six months to one year as a
transition for rule 206(4)-5. See Davis Polk Letter; MFA Letter; ICI Letter; IAA Letter;
NASP Letter; Skadden Letter.
436
Rule 206(4)-5(a)(2).
437
We note, however, that the antifraud provisions of the federal securities laws continue to
apply during the transition period.
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and to revise their compliance policies and procedures to prevent violation of the new
rule. In addition, the transition period will provide an opportunity for a registered
national securities association to propose a rule that would meet the requirements of rule
206(4)-5(f)(9)(ii)(B) and for the Commission to consider such a rule. If, after one year, a
registered national securities association has not adopted such rules, advisers would be
prohibited from making payments to broker-dealers for distribution or solicitation
activities with respect to government entities, but would be permitted to make payments
to registered investment advisers that meet the definition of “regulated person” under the
rule.438 We understand from our staff, however, that FINRA plans to act within the
timeframe; if they do not, we will consider whether we should take further action.
Finally, the compliance date for the technical amendment to the cash solicitation
rule, rule 206(4)-3, which is intended to alert advisers that rule 206(4)-5 is applicable to
solicitations of a government entity, is one year from the effective date, as the
amendment to the cash solicitation rule need only be operative when rule 206(4)-5’s
third-party solicitor provisions are in effect.
C. Recordkeeping
As discussed above, the amendments to rule 204-2 apply only to investment
advisers with clients who are government entities. Such advisers must comply with the
amended rule on March 14, 2011 except as noted below. By March 14, 2011, these
advisers must begin to maintain records of all persons who are covered associates under
the rule and keep records of political contributions they make on and after that date.
Advisers must also make and keep a record of all government entities that they provide
See rule 206(4)-5(f)(9)(i).
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advisory services to on and after March 14, 2011. Advisers are not, however, required to
look back for the five years prior to the effective date to identify former government
clients. Advisers that pay regulated persons to solicit government entities for advisory
services on their behalf must make and keep a list of those persons beginning on and after
September 13, 2011.439
D.
Registered Investment Companies
Advisers to registered investment companies that are “covered investment pools”
under the rule440 must comply with rule 205(4)-5 with respect to those covered pools
September 13, 2011. During the transition period, contributions by the adviser or its
employees to government entity clients that have selected an adviser’s registered
investment company as an investment option of a plan or program will not trigger the
prohibitions of rule 206(4)-5.441
We have provided for an extended compliance date to respond to concerns
expressed by commenters that an adviser to a registered investment company may require
additional time to identify government entities that have selected that registered
investment company as an investment option when shares of the fund are held through
omnibus arrangements such that the identity of the fund investor is not readily available
439
Rule 204-2(a)(18)(i)(D).
440
A registered investment company is only a covered investment pool if it is an investment
option of a plan or program of a government entity, such as a 529 plan, 403(b) plan or
457 plan. See rule 206(4)-5(f)(3).
441
Advisers to covered investment pools other than registered investment companies—i.e.,
companies that would be investment companies under section 3(a) of the Investment
Company Act but for the exclusion provided from that definition by either section
3(c)(1), section 3(c)(7) or section 3(c)(11)—are subject to the six-month transition
period. We believe advisers to these types of funds, because the interests in them are
typically held in the name of the investor, should be able to identify government entities
without significant difficulty.
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to the adviser.442 The changes we have made to the proposed rule that limit the
application of the two-year time out with respect to registered investment companies to
those that are options in a plan or program of a government entity,443 together with this
extended compliance date should provide advisers to registered investment companies
sufficient time to put into place those system enhancements or business arrangements,
such as those with intermediaries, that may be necessary to identify those government
plans or programs in which the funds serve as investment options.444
As noted above, we are providing for an extended compliance date for advisers
that manage registered investment companies that are covered investment pools under the
rule, which we are applying, for the same reasons, to recordkeeping obligations that arise
as a result of those covered investment pools. Thus, advisers to these covered investment
pools must make and keep a record of all government entity investors on and after [insert
date 60 days plus one year after publication in Federal Register].445
IV.
COST-BENEFIT ANALYSIS
We are sensitive to the costs and benefits imposed by our rules, and understand
that there will be costs associated with compliance with rule 206(4)-5 and the
442
See ICI Letter; T. Rowe Price Letter.
443
See section II.B.2(a) of this Release.
444
A few commenters recommended that the rule apply only to new government investors in
registered investment companies after the effective date of the rule. See ICI Letter; T.
Rowe Price Letter. We do not believe this would be appropriate because pay to play can
be just as troubling in the context of an adviser renewing an advisory contract (or
including a registered investment company as an investment option in a plan or program)
as one that is endeavoring to obtain business for the first time.
445
Amended rule 204-2 does not require an adviser to a covered investment pool that is an
option of a government plan or program to make and keep records of participants in the
plan or program, but only the government entity. See supra note 411.
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amendments to rule 204-2.446 We recognize that the rule and amendments will place
burdens on advisers that provide or seek to provide advisory services to government
entities, and that advisers may in turn choose to limit the ability of certain persons
associated with an adviser to make contributions to candidates for certain offices and to
solicit contributions for certain candidates and payments to political parties. We believe
there are practical, cost-effective means to comply with the rule without an adviser
imposing a blanket ban on political contributions by its covered associates. We have
closely drawn the rule, and modified it based on comments received, to achieve our goal
of addressing adviser participation in pay to play practices, while seeking to limit the
burdens imposed by the rule.
The rule and rule amendments are designed to address pay to play practices by
investment advisers that provide advisory services to government entity clients and to
certain covered investment pools in which a government entity invests. The rule
prohibits an investment adviser from providing advisory services for compensation to a
government client for two years after the adviser or certain of its executives or employees
make a contribution to certain elected officials or candidates. The rule also prohibits an
adviser from providing or agreeing to provide, directly or indirectly, payment to any third
party that is not a “regulated person” for a solicitation of advisory business from any
government entity, or for a solicitation of a government entity to invest in certain covered
investment pools, on behalf of such adviser. Additionally, the rule prevents an adviser
As proposed, we are also making a conforming technical amendment to rule 206(4)-3 to
address potential areas of conflict with proposed rule 206(4)-5. We do not believe that
this technical amendment affects the costs associated with the rulemaking. It will benefit
advisers because it provides clarity about the application of our rules when they
potentially overlap.
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from coordinating or soliciting from others contributions to certain elected officials or
candidates or payments to certain political parties. The rule applies both to advisers
registered with us (or required to be registered) and those that are unregistered in reliance
on the exemption available under section 203(b)(3) of the Advisers Act (15 U.S.C. 80b3(
b)(3)). Our amendment to rule 204-2 requires a registered adviser to maintain certain
records of the political contributions made by the adviser or certain of its executives or
employees, as well as records of the regulated persons the adviser pays or agrees to pay
to solicit government entities on the adviser’s behalf.
In the Proposing Release, we requested comment on the effects of the proposed
rule and rule amendments on pension plan beneficiaries, participants in government plans
or programs, investors in pooled investment vehicles, investment advisers, the advisory
profession as a whole, government entities, third party solicitors, and political action
committees.447 We requested that commenters provide analysis and empirical data to
support their views on the costs and benefits associated with the proposal. For example,
we requested comment on the costs of establishing compliance procedures to comply
with the proposed rule, both on an initial and ongoing basis and on the costs of using
compliance procedures of an affiliated broker-dealer that the broker-dealer established as
a result of MSRB rules G-37 and G-38. In addition, we requested data regarding our
assumptions about the number of unregistered advisers that would be subject to the
proposed rule, and the number of covered associates of these exempt advisers. Finally, in
the context of the objectives of this rulemaking, we sought comments that address
whether these rules will promote efficiency, competition and capital formation, and what
Proposing Release, at section III.C.
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effect the rule would have on the market for investment advisory services and third-party
solicitation services.
We received approximately 250 comment letters on the proposal. Almost all of
the commenters agreed that pay to play is a serious issue that should be addressed. One
commenter stated that “the benefits derived from the application of pay to play
limitations to public sector advisory services will far outweigh any temporary
dislocations that may occur as private and public sector professionals make the necessary
adjustments to their activities to transition to the Commission's new standards.”448 Many,
however, expressed concern about costs,449 particularly those related to the proposed ban
on payments to third parties. Some suggested that the Commission underestimated the
costs of compliance with the rule and rule amendments.450 As discussed below, many of
the commenters that did comment specifically on the costs and benefits of the proposal
did not provide empirical data to support their views.
448
MSRB Letter. See also Thompson Letter; Common Cause Letter; Fund
Democracy/Consumer Federation Letter (each identifying benefits of the rule).
449
See, e.g., Davis Polk Letter (generally commenting that any benefits of the proposed rule
were outweighed by its likely costs). See also ICI Letter; Monument Group Letter.
450
See, e.g., SIFMA Letter (“While SIFMA believes that addressing practices that
potentially undermine the merit-based selection of investment advisers is an important
and laudable effort, the SEC appears to have underestimated the compliance costs the
Proposed Rule will impose on covered parties.”); ICI Letter ([I]n relying on the estimates
for compliance with the MSRB rules, the Commission significantly underestimates the
compliance and recordkeeping burdens associated with the proposed rule.”); Davis Polk
Letter (“We believe that the Commission may have substantially underestimated the
number of investment advisers that will be affected by the Proposed Rule and its costs
and market effects in concluding that many of the aspects of the Rule would impose only
minimal additional costs and burdens on investors and investment advisers.”). The
commenters who addressed our estimates, however, did so in general terms and did not
provide specific suggestions as to how they should be modified. See the discussion
below regarding changes from the proposed rule that we believe mitigate some of the
costs.
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A. Benefits
As we discuss extensively throughout this Release, we expect that rule 206(4)-5
will yield several important direct and indirect benefits. Overall, the rule is intended to
address pay to play relationships that interfere with the legitimate process by which
advisers are chosen based on the merits rather than on their contributions to political
officials. The potential for fraud to invade the various, intertwined relationships created
by pay to play arrangements is without question. We believe that rule 206(4)-5 will
reduce the occurrence of fraudulent conduct resulting from pay to play and thus will
achieve its goals of protecting public pension plans, beneficiaries, and other investors
from the resulting harms. One commenter who agreed with us commended the proposed
rule as a “strong start in controlling corruption, balancing the rights of the advisors and
their executives with the very real detriment to the public which the numerous cases of
pay-to-play involving public pension funds and other public entities have caused.”451
Addressing pay to play practices will help protect public pension plans and
investments of the public in government-sponsored savings and retirement plans and
programs by addressing situations in which a more qualified adviser may not be selected,
potentially leading to inferior management, diminished returns or greater losses. One
commenter who agreed, observed, “[w]hen lucrative investment contracts are awarded to
those who pay to play, public pension funds may end up receiving substandard services
and higher fees, resulting in lower earnings.”452 One public official commenter detailed
the role of pay to play arrangements in the selection of public pension fund managers and
451 Common Cause Letter.
452 Bloomberg Letter.
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the harm it can inflict on the affected plans,453 while other officials wrote to us explicitly
expressing support for a Commission rule.454 By addressing pay to play practices, we
will help level the playing field so that the advisers selected to manage retirement funds
and other investments for the public are more likely to be selected based on the quality of
their advisory services. These benefits, although difficult to quantify, could result in
substantial savings and better performance for the public pension plans, their
beneficiaries, and participants.455 Two commenters noted that the rule would promote the
interests of plan beneficiaries.456
By leveling the playing field among advisers competing for state and local
government business, the rule will help minimize or eliminate manipulation of the market
for advisory services provided to state and local governments.457 For example, direct
453
Weber Letter (“I have seen money managers awarded contracts with our fund which
involved payments to individuals who served as middlemen, creating needless expense
for the fund. These middlemen were political contributors to the campaigns of board
members who voted to contract for money management services with the companies who
paid them as middlemen.”). See also Pohndorf Letter (noting that when the sole trustee
of a major pension fund changed several years ago, a firm managing some of the fund’s
assets “began to receive invitations to fundraising events for the new trustee with
suggested donation amounts”); Tobe Letter (suggesting the negative effects of pay to play
activities on the Kentucky Retirement System’s investment performance).
454
See, e.g., DiNapoli Letter; Bloomberg Letter.
455
According to the most recently available US census data, as of 2008, there are 2,550 state
and local government employee retirement systems. http://www.census.gov/govs/retire/.
See also Fund Democracy/Consumer Federation Letter (“These practices adversely affect
the economic interests of millions of America’s public servants.”).
456
Comment Letter of John C. Emmel (Sept. 18, 2009) (“one more step to foster a level
playing field for investors . . . where advisors’ priorities trump those of the investing
public”); Comment Letter of George E. Kozel (Aug. 31, 2009) (“Kozel Letter”) (“Their
interests lie in obtaining the highest fees not in producing benefits for the
pensioners . . . .”).
457
See DiNapoli Letter (advocating for a “level playing field for investors and investment
advisers that protects the integrity of the decision-making process [for hiring an
investment adviser]”); Bloomberg Letter (“Pay to play practices clearly undermine the
open competitive process by which government contracts are to be awarded.”).
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political contributions or payments made to third-party solicitors as part of pay to play
practices create artificial barriers to competition for firms that cannot, or will not, make
those contributions or payments.458 They also increase costs for firms that may feel they
have no alternative but to pay to play. The rule addresses a collective action problem
created by this dynamic analogous to the one identified in the Blount opinion.459 One
commenter emphasized the importance of restoring public confidence in the investment
activities of all public pension funds.460 Indeed, at its core, the rulemaking addresses
practices that undermine the integrity of the market for advisory services, as underscored
by another commenter.461
Allocative efficiency is enhanced when government clients award advisory
business to advisers that compete based on price, performance and service and not the
influence of pay to play, which in turn enables advisory firms, particularly smaller
advisory firms, to compete on merit, rather than their ability or willingness to make
458
See supra note 453.
459
See Blount, 61 F.3d at 945-46 (discussing the harms of pay to play: “Moreover, there
appears to be a collective action problem tending to make the misallocation of resources
persist.”). See also text accompanying notes 291-294 of this release. Collective action
problems are a class of market failures calling for a regulatory response, and exist, for
example, where participants may prefer to abstain from an unsavory practice (such as pay
to play), but nonetheless participate out of concern that, even if they abstain, their
competitors will continue to engage in the practice profitably and without adverse
consequences.
460
Thompson Letter. See also Bloomberg Letter.
461
Common Cause Letter (“Pay-to-play has not only the potential to compromise an
investment adviser’s ethical and legal duties under the Investment Advisers Act of 1940,
but in several high profile cases across the nation, has already done so, negatively
impacting the public perception of government decision making and, in some cases,
costing the taxpayer millions of dollars and placing billions of dollars in pension funds at
risk.”). See also Dempsey Letter (noting applause for efforts “to stop the ‘pay-to-play’
practice which only serves to undermine public trust in investment advisors and
regulators”).
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contributions.462 In addition, taking into account the effects of analogous practices in the
underwriting of municipal securities prior to MSRB rule G-37,463 we believe a merit-
based competitive process may result in the allocation of public pension monies to
different advisers who may well deliver better investment performance and lower
advisory fees than those advisers whose selection was influenced by pay to play.
As adopted, the rule contains a prohibition against advisers directly or indirectly
compensating a third party to solicit government entities on its behalf, unless the third-
party solicitor is a “regulated person” subject to pay to play restrictions. This exception
enables advisers and pension plans (and their beneficiaries) to continue to benefit from
the services of third-party solicitors, such as the placement of interests in private funds,
while at the same time benefitting from a Commission rule that prohibits pay to play
practices.464
Our rule may also benefit pension plans by preventing harms that can result when
an adviser is not negotiating at arm’s length with a government official. For example, as
a result of pay to play, an adviser may obtain greater ancillary benefits, such as “soft
dollars,” from the advisory relationship, which may be directed for the benefit of the
adviser, potentially at the expense of the pension plan, thereby using a pension plan asset
462
See Comment Letter of Budge Collins (Sept. 30, 2009) (the rule would “level the playing
field for the rest of us who have never made contributions to elected officials who sit on
investment management committees”).
463
One commenter cited a study containing evidence that before rule G-37 was adopted,
underwriters’ pay to play practices distorted underwriting fees as well as which firms
were hired by government issuers. See Butler Letter.
464
Commenters, both on the Proposing Release and our 1999 proposal, argued that treating
third-party solicitors as covered associates would create significant compliance
challenges because these solicitors were not controlled by advisers. See supra note 264
and accompanying text.
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for the adviser’s own purposes.465 Additionally, taxpayers may benefit from our rule
because they might otherwise bear the financial burden of bailing out a government
pension fund that has ended up with a shortfall due to poor performance or excessive fees
that might result from pay to play.466
In addition to the general benefits of addressing pay to play practices by
investment advisers noted above, we believe the specific provisions of the rule, including
the two-year time out, the ban on using third parties to solicit government business, and
the restrictions on soliciting and coordinating contributions and payments will likely
result in similar benefits to those that have resulted from MSRB rules G-37 and G-38, on
which our rule is closely modeled. The MSRB rules have prohibited municipal securities
dealers from participating in pay to play practices since 1994.467 As we have stated
previously, we believe these rules have significantly curbed pay to play practices in the
municipal securities market, and are likely to be similarly effective in deterring pay to
play activities by investment advisers.468
Applying the rule to government entity investments in certain pooled investment
vehicles or where a pooled investment vehicle is an investment option in a government
465
See supra note 55 and accompanying text.
466
See Kozel Letter (supporting the Commission’s proposal and asserting that the persons
who engage in pay to play practices know that any shortfalls would be covered by
taxpayers); Bloomberg Letter (“Because the City is legally obligated to make up any
short fall in the pension system assets to ensure full payment of pension benefits, pay to
play practices can potentially harm all New Yorkers.”). See also Common Cause Letter;
1997 SURVEY, supra note 8 (“[t]he investment of plan assets is an issue of immense
consequence to plan participants, taxpayers, and to the economy as a whole” as a low rate
of return will require additional funding from the sponsoring government, which “can
place an additional strain on the sponsoring government and may require tax increases”).
467
MSRB rule G-37 was approved by the Commission and adopted by the MSRB in 1994.
See supra note 66.
468
See supra notes 101–107 and accompanying text.
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sponsored plan or program will extend the same benefits regardless of whether an adviser
subject to the rule is providing advice directly to the government entity or is managing
assets for the government entity indirectly through a pooled investment vehicle. By
addressing distortions in the process by which investment decisions are made regarding
public investments, we are providing important protections to public pension plans and
their beneficiaries, as well as participants in other important plans or programs sponsored
by government entities. Other investors in a pooled investment vehicle also will be better
protected from, among other things, the effects of fraud that may result from an adviser’s
participation in pay to play activities, such as higher advisory fees.
Finally, the amendments to rule 204-2 will benefit the public plans and their
beneficiaries and participants in state plans or programs as well as investment advisers
that keep the required records. The public pension plans, beneficiaries, and participants
will benefit from these amendments because the records required to be kept will provide
Commission staff with information to review an adviser’s compliance with rule 206(4)-5
and thereby may promote improved compliance. Advisers will benefit from the
amendments to the recordkeeping rule as these records will assist the Commission in
enforcing the rule against, for example, a competitor whose pay to play activities, if not
uncovered, could adversely affect the competitive position of a compliant adviser.
B. Costs
We acknowledge that the rule and rule amendments will impose costs on advisers
that provide or seek to provide advisory services to government clients directly, or
indirectly through pooled investment vehicles. We discuss these costs below, along with
a number of modifications we have made to the proposed rule and proposed amendments
that will reduce costs.
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1.
Compliance Costs Related to Rule 206(4)-5
Rule 206(4)-5 requires an adviser with government clients to incur costs to
monitor contributions made by the adviser and its covered associates and to establish
procedures to comply with the rule. The initial and ongoing compliance costs imposed
by the rule will vary significantly among firms, depending on a number of factors. Our
estimated compliance costs, discussed below, take into account different ways a firm
might comply with the rule. These factors include the number of covered associates of
the adviser, the degree to which compliance procedures are automated (including policies
and procedures that could require pre-clearance), the extent to which an adviser has a preexisting
policy under its code of ethics or compliance program,469 and whether the
adviser is affiliated with a broker-dealer firm that is subject to MSRB rules G-37 and G
38. A smaller adviser, for example, will likely have a small number of covered
associates, and thus expend less resources to comply with the rule and rule amendments
than a larger adviser.
Although a larger adviser is likely to spend more resources to comply with the
rule, based on staff observations, a larger adviser is more likely to have an affiliated
broker-dealer that is required to comply with MSRB rules G-37 and G-38.470 As we
469
One commenter stated that many investment advisers already have pay to play policies
and procedures in place within the framework of their codes of ethics. See IAA Letter
(advocating for regulation that would address pay to play practices through an adviser’s
code of ethics, as an alternative to the approach taken in proposed rule 206(4)-5).
470
According to registration information available from Investment Adviser Registration
Depository (“IARD”) as of April 1, 2010, there are 1,332 SEC-registered investment
advisers (or 11.48% of the total 11,607 registered advisers) that indicate in Item 5.D.(9)
of Form ADV that they have state or municipal government clients. Of those 1,332
advisers, 113 (or 85.0%) of the largest 10% have one or more affiliated broker-dealers or
are, themselves, also registered as a broker-dealer. 204 of the largest 20% (or 76.7%)
have one or more affiliated broker-dealers or are, themselves, also registered as a broker-
dealer. Conversely, only 40 (or 30.1%) of the smallest 10% have one or more affiliated
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learned from a broker-dealer with an investment adviser affiliate that commented on our
1999 proposal, “the more the Rule mirrors G-37, the more firms can borrow from or
build upon compliance procedures already in place. . . .”471 Accordingly, we believe
some advisers with broker-dealer affiliates may spend fewer resources to comply with the
rule and rule amendments. We recognize, as some commenters pointed out, that MSRB
rules G-37 and G-38 compliance systems may not be easily extensible in all cases, and
we acknowledge that the range of efficiencies created in these circumstances will vary.472
A prominent concern of these commenters related to a proposed recordkeeping
amendment which would have required advisers to keep records of solicitations—
something that is not required under MSRB recordkeeping rule G-8. As previously
discussed, we are not adopting that proposed amendment, which may address the concern
noted by commenters.
We anticipate that advisory firms subject to rule 206(4)-5 will develop
compliance procedures to monitor the political contributions made by the adviser and its
broker-dealers or are, themselves, also registered as a broker-dealer; and only 67 of the
smallest 20% (or 25.2%) have one or more affiliated broker-dealers or are, themselves,
also registered as a broker-dealer. With respect to broker-dealer affiliates, however, we
note that our IARD data does not indicate whether the affiliated broker-dealer is a
municipal securities dealer subject to MSRB rules G-37 and G-38. Also, as one
commenter asserted, private fund managers may be among the larger advisers, based on
assets under management, but they are unlikely to have an affiliated broker-dealer that
has already adopted similar procedures to comply with MSRB rules G-37 and G-38
because most private fund managers are not involved in municipal underwriting. MFA
Letter. We acknowledge that a private fund manager generally would be less likely to
have an affiliated broker-dealer from which it can borrow or build upon compliance
procedures; however, we also expect that a private fund manager would use less
resources than other large registered advisers to comply with the rule because a private
fund manager is not subject to rule 206(4)-7, the Advisers Act compliance rule, and
would likely have fewer employees and covered associates than a larger organization.
471
Comment Letter of US Bancorp Piper Jaffray Inc. (now, “Piper Jaffray & Co.”) (Nov. 15,
1999).
472
SIFMA Letter. See also ICI Letter.
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covered associates.473 We estimate that the costs imposed by the rule will be higher
initially, as firms establish and implement procedures and systems to comply with the
rule and rule amendments. We expect that compliance expenses would then decline to a
relatively constant amount in future years, and annual expenses are likely to be lower for
small advisers as the systems and processes should be less complex than for a large
adviser.
We estimate that approximately 1,697 investment advisers registered with the
Commission may be affected by the rule and rule amendments.474 Of the 1,697 advisers,
473
Investment advisers registered with the Commission are required to adopt and implement
policies and procedures reasonably designed to prevent violation by the adviser or its
supervised persons of the Advisers Act and the rules the Commission has adopted
thereunder. See rule 206(4)-7.
474
This estimate is based on registration information from IARD as of April 1, 2010,
applying the same methodology as in the Proposing Release. As previously noted,
according to responses to Item 5.D(9) of Part 1 of Form ADV, 1,332 advisers have clients
that are state or municipal government entities, which represents 11.48% of all advisers
registered with us. 10,275 advisers have not responded that they have clients that are state
or municipal government entities. Of those, however, responses to Item 5.D(6) of Part 1
of Form ADV indicate that 2,486 advisers have some clients that are other pooled
investment vehicles. Estimating that the same percentage of these advisers advise pools
with government entity investors as advisers that have direct government entity clients—
i.e.,11.48%. 285 of these advisers would be subject to the rule (2,486 x 11.48 % = 285).
Out of the 10,275 that have not responded that they have clients that are state or
municipal government entities, after backing out the 2,486 which have clients that are
other pooled investment vehicles, responses to Item 5.D(4) of Part 1 of Form ADV
indicate that 699 advisers have some clients that are registered investment companies.
Estimating that roughly the same percentage of these advisers advise pools with
government entity investors as advisers that have direct government entity clients—
i.e.,11.48%. 80 of these advisers would be subject to the rule (699 x 11.48% = 80).
Although we limited the application of rule 206(4)-5 with respect to registered
investment companies to those that are investment options of a plan or program of a
government entity, we continue to estimate that 80 advisers would have to comply with
the recordkeeping provisions because of the difficulty in further delineating this
estimated number. Therefore, we estimate that the total number of advisers subject to the
rule would be: 1,332 advisers with state or municipal clients + 285 advisers with other
pooled investment vehicle clients + 80 advisers with registered investment company
clients = 1,697 advisers subject to rule. We expect certain additional advisers may incur
compliance costs associated with rule 206(4)-5. We anticipate some advisers may be
subject to the rule because they solicit government entities on behalf of other investment
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we estimate that approximately 1,271 advisers have fewer than five covered associates
that would be subject to the rule (each, a “smaller firm”); approximately 304 advisers
have between five and 15 covered associates (each, a “medium firm”); and approximately
122 advisers have more than 15 covered associates that would be subject to the
prohibitions of the rule (each, a “larger firm”).475
One commenter disagreed with us basing our cost estimates on an assumption that
most registered advisers would have fewer than five covered associates because the
commenter expects most advisers to require all or most of their employees to receive
approval prior to making any political contributions in order to avoid inadvertently
triggering the rule.476 Although the rule does not require this approach and the changes
we have made to the rule (e.g., modified definition of covered associate) should help
address the concerns of this commenter that led to the assertion, we recognize that some
advisers may voluntarily restrict all of their employees’ political contributions in such a
manner. This type of pre-screening process could be perceived by the individuals subject
to them as costs imposed on their ability to express their support for certain candidates
for elected office and government officials. We also received a comment that our
advisers. Additionally, some advisers that do not currently have government clients may
seek to obtain them in the future. In doing so, they likely would conduct due diligence to
confirm they would not be prohibited from receiving compensation for providing
investment advisory services to the government client.
475
This estimate is based on registration information from IARD as of April 1, 2010. These
estimates are based on IARD data, specifically the responses to Item 5.B.(1) of Form
ADV, that 997 (or 74.9%) of the 1,332 registered investment advisers that have
government clients have fewer than five employees who perform investment advisory
functions, 239 (or 17.9%) have five to 15 such employees, and 96 (or 7.2%) have more
than 15 such employees. We then applied those percentages to the 1,697 advisers we
believe will be subject to the proposed rule for a total of 1,271 smaller, 304 medium and
122 larger firms.
476
See MFA Letter.
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estimates should take into account turnover of personnel.477 Our cost estimate assumes a
certain level of turnover; although these categories are based on an adviser’s number of
covered associates, we have not calculated per-covered associate costs associated with
this rulemaking. The categories of smaller, medium and larger advisers are based on an
estimated number of covered associates, but are not intended to represent a static
population of covered associates within each category. For instance, in estimating the
ongoing burdens on advisers to comply with the rule, we implicitly incorporated a greater
degree of turnover at larger advisers in estimating that they would incur 1,000 hours
annually as compared to the estimated 10 hours for a small adviser.
Advisers that are unregistered in reliance on the exemption available under
section 203(b)(3) of the Advisers Act [15 U.S.C. 80b-3(b)(3)] would be subject to rule
206(4)-5.478 Based on our review of registration information on IARD and outside
sources and reports, we estimate that there are approximately 2,000 advisers that are
unregistered in reliance on section 203(b)(3).479 Applying the same principles we used
with respect to registered investment advisers, we estimate that 230 of those advisers
manage pooled investment vehicles in which government client assets are invested and
would therefore be subject to the rule.480 For purposes of this analysis, it is assumed that
each unregistered advisory firm that would be subject to the rule would either be a
477
ICI Letter.
478
The amendments to rules 204-2 and 206(4)-3, however, only apply to advisers that are
registered, or required to be registered, with the Commission.
479
This number is based on our review of registration information on IARD as of April 1,
2010, IARD data from the peak of hedge fund adviser registration in 2005, and a
distillation of numerous third-party sources including news organizations and industry
trade groups.
480
11.48% of 2000 is 230. See supra note 474.
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smaller firm or a medium firm in terms of number of covered associates because it is
unlikely that an adviser that operates outside of public view and is limited to fewer than
15 clients481 would have a large number of advisory personnel that would be covered
associates. One commenter agreed that most of these unregistered advisers would be
small, although the commenter based its assessment on assets under management, not on
the adviser’s likely number of covered associates.482
Some commenters asserted that our estimated number of advisers subject to the
proposed rule was too low.483 One claimed that the number of advisory firms exempted
from registration in reliance on Section 203(b)(3) may be “over two times our estimate,”
but provided statistics about the number of unregistered pooled investment vehicles, not
the number of advisers to those pools.484 Other commenters did not provide empirical
data or suggest alternative formulas by which to recalculate our estimate. Additionally,
another seemed to misunderstand our estimates.485
As we stated in the Proposing Release,486 although the time needed to comply
with the rule will vary significantly from adviser to adviser, as discussed in detail below,
the Commission staff estimates that firms with government clients will spend between 8
hours and 250 hours to establish policies and procedures to comply with the rule.
481
See section 203(b)(3) of the Advisers Act [15 U.S.C. 80b-3(b)(3)] (advisers who rely on
this exception from registration must have fewer than 15 clients in a 12-month period) .
482
3PM Letter.
483
See Davis Polk Letter; MFA Letter; 3PM Letter.
484
3PM Letter. See also Davis Polk Letter (citing to 3PM Letter on this proposition).
485
Davis Polk Letter (suggesting that we failed to take into account the costs likely to be
borne by unregistered investment advisers). See supra notes 479 and 480 and
accompanying text; Proposing Release, nn.219-20 and accompanying text (providing an
estimate of the number of unregistered advisers we expect to be subject to this rule, and
that must develop compliance systems).
486
See Proposing Release, at section III.B.
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Commission staff further estimates that ongoing compliance with the rule will require
between 10 and 1,000 hours annually. In addition, advisory firms may incur one-time
costs to establish or enhance current systems to assist in their compliance with the rule.
These costs would vary widely among firms. Small advisers may not incur any system
costs if they determine a system is unnecessary due to the limited number of employees
they have or the limited number of government entity clients they have. Large firms
likely already have devoted significant resources into automating compliance and
reporting and the new rule could result in enhancements to these existing systems. We
believe such system costs could range from the tens of thousands of dollars for simple
reporting systems, to hundreds of thousands of dollars for complex systems used by the
large advisers.
Initial compliance procedures would likely be designed, and ongoing
administration of them performed, by compliance managers and compliance clerks. We
estimate that the hourly wage rate for compliance managers is $294, including benefits,
and for compliance clerks, $59 per hour, including benefits.487 To establish and
implement adequate compliance procedures, we estimate that the rule would impose
initial compliance costs of approximately $2,352 per smaller firm,488 approximately
487
Our hourly wage rate estimate for a compliance manager and compliance clerk is based
on data from the Securities Industry Financial Markets Association’s Management &
Professional Earnings in the Securities Industry 2009, modified by Commission staff to
account for an 1800-hour work-year and multiplied by 5.35 (in the case of compliance
managers) or 2.93 (in the case of compliance clerks) to account for bonuses, firm size,
employee benefits and overhead. The calculations discussed in this release are updated
from those included in the Proposing Release to incorporate data from the most recently
updated version of this publication.
488
The per firm cost estimate is based on our estimate that development of initial
compliance procedures for smaller firms would take 8 hours of compliance manager time
(at $294 per hour). Accordingly, the per firm cost estimate is $2,352 (8 x $294).
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$29,407 per medium firm,489 and approximately $58,813 per larger firm.490 It is
estimated that the rule would impose annual, ongoing compliance expenses of
approximately $2,940 per smaller firm,491 $117,625 per medium firm,492 and $235,250
per larger firm.493
In establishing these estimates, which are calculated in the same manner as those
we included in the Proposing Release, we took into consideration comments in 1999 that
suggested our cost estimates were too low.494 Our staff, in developing the estimates
contained in the Proposing Release, also engaged in conversations with industry
professionals regarding broker-dealer compliance with rules G-37 and G-38 and
489
With respect to our estimated range of 8-250 hours, we assume a medium firm would
take 125 hours to develop initial compliance procedures, and such a firm would likely
have support staff. We also anticipate that a compliance manager would do
approximately 75% of the work because he or she is responsible for implementing the
policy for the entire firm. Accordingly, the per firm cost estimate is based on our
estimate that development of initial compliance procedures for medium firms would take
93.75 hours of compliance manager time, at $294 per hour (or $27,563), and 31.25 hours
of clerical time, at $59 per hour (or $1,844), for a total estimated cost of $29,407.
490
With respect to our estimated range of 8-250 hours, we assume a larger firm would take
250 hours to develop initial compliance procedures, and such a firm would likely have
support staff. We also anticipate that a compliance manager would do approximately
75% of the work because he/she is responsible for implementing the policy for the entire
firm. Accordingly, the per firm cost estimate is based on our estimate that development
of initial compliance procedures for larger firms would take 187.50 hours of compliance
manager time, at $294 per hour (or $55,125), and 62.5 hours of clerical time, at $59 per
hour (or $3,688), for a total estimated cost of $58,813.
491
The per firm cost estimate is based on our estimate that ongoing compliance procedures
for smaller firms would take 10 hours of compliance manager time, at $294 per hour, for
a total estimated cost of $2,940 per year.
492
The per firm cost estimate is based on our estimate that ongoing compliance procedures
for medium firms would take 375 hours of compliance manager time, at $294 per hour
(or $110,250), and 125 hours of clerical time, at $59 per hour (or $7,375), for a total
estimated cost of $117,625 per year.
493
The per firm cost estimate is based on our estimate that ongoing compliance procedures
for larger firms would take 750 hours of compliance manager time, at $294 per hour (or
$220,500) and 250 hours of clerical time, at $59 per hour (or $14,750), for a total cost of
$235,250 per year.
494
See Proposing Release, at n.226 and accompanying text.
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representatives of investment advisers that have pay to play policies in place.495 We
significantly increased our cost estimates from the 1999 proposal as a result. Some
commenters on the proposed rule asserted that our projected costs are too low, but did not
provide empirical data or formulas for us to review.496 One commenter indicated that,
“as a practical matter, although there may be significant differences in the number of
hours dedicated to ongoing annual compliance between firms of different sizes, the
estimated number of hours needed to develop initial compliance procedures will be
similar for all firms, regardless of size. The initial effort of designing and implementing
new policies and procedures and educating personnel will require similar effort and
upfront fixed costs.”497 We disagree. Although there are some aspects of implementing a
compliance program that would be similar among all firms regardless of their number of
covered associates, we expect most costs will vary significantly among firms of different
sizes as they engage in such activities as developing and monitoring reporting
mechanisms to track covered associate contributions, revising their codes of ethics,
training their employees, and performing routine quality control tests.
In the Proposing Release, we estimated that 75% of larger advisory firms, 50% of
medium firms, and 25% of smaller firms that are subject to the rule may also engage
outside legal services to assist in drafting policies and procedures, based on staff
observations. In addition, we also estimated the cost associated with such an engagement
would include fees for approximately three hours of outside legal review for a smaller
firm, 10 hours for a medium firm, and 30 hours for a larger firm. One commenter
495 Id. at section III.B.
496 See, e.g., ICI Letter; MFA Letter; SIFMA Letter.
497 See Davis Polk Letter.
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suggested that we had underestimated both the percentage of advisers that would engage
outside counsel and the number of hours that outside counsel would spend lending their
assistance, but did not provide alternative estimates.498 Based on our staff’s experience
administering the compliance program rule, we continue to believe that our estimates for
the number of firms that will retain outside counsel for review of policies and procedures
are appropriate. Based on this comment, however, we have revisited the number of hours
we estimated outside counsel would spend reviewing policies and procedures and have
increased these estimates. We now estimate the cost associated with such an engagement
would include fees for approximately eight hours of outside legal review for a smaller
firm, 16 hours for a medium firm, and 40 hours for a larger firm, at a rate of $400 per
hour.499 Consequently, for a smaller firm we estimate a total of $3,200 in outside legal
fees for each of the estimated 318 advisers that would seek assistance, for a medium firm
we estimate a total of $6,400 for the estimated 152 advisers that would seek assistance,
and for each of the 92 larger firms we estimate a total of $16,000. Thus, we estimate that
approximately 562 investment advisers will incur these additional costs, for a total cost of
$3,462,400500 among advisers affected by the rule amendments.501
One commenter suggested that, due to the complexity of, and variation among,
state and local laws, it might be more difficult than we had accounted for in the proposal
498
Id.
499
In the Proposing Release we estimated the hourly cost of outside counsel to be $400
based on our consultation with advisers and law firms who regularly assist them in
compliance matters. We did not receive comment on this estimate and continue to
believe that it is an accurate estimate.
500
(318 x $3,200 = $1,017,600) + (152 x $6,400 = $972,800) + (92 x $16,000 = $1,472,000)
= $3,462,400.
501
One commenter asserted that a greater number of firms would seek assistance of counsel,
regardless of size, but did not provide data to support its assertion. Davis Polk Letter.
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for an adviser to determine with certainty who could be a covered official, and as a result,
a greater number of advisers would seek the help of outside counsel to make this
determination than we estimated.502 Although the commenter did not provide an estimate
of how many firms might seek such assistance, we believe that the additional guidance
we have provided in the discussion of officials will address this commenter’s concerns
and result in fewer consultations with outside counsel than anticipated. In addition, it is
our understanding from discussions with those involved in advising on compliance with
MSRB rules G-37 and G-38 that a small percentage of persons subject to the rule seek
legal assistance to make these determinations. Our rule uses substantially similar
definitions of “official” of a “government entity” to those used in the MSRB rules;
therefore we expect that the percentage of advisory firms that would retain legal counsel
to make these determinations would be similarly small. Moreover, we anticipate that the
advisers that are most likely to need assistance identifying officials of government
entities are larger advisers, whose businesses tend to be national in scope and whose
clients are located throughout the country. If all 122 of the larger advisory firms we
estimate are subject to the rule retain legal counsel at a rate of $400 per hour, for
approximately 20 hours per year, those advisers would incur an estimated total of
$976,000 in legal fees.503
In the Proposing Release, we estimated that approximately five advisers annually
would apply to the Commission for an exemption from the rule, based on staff
discussions with the FINRA staff responsible for reviewing exemptive applications
submitted under MSRB rule G-37, and that outside counsel would spend 16 hours
502 Caplin & Drysdale Letter. See also IAA Letter; MFA Letter.
503 $400 x 20 = $8,000, and $8,000 x 122 = $976,000.
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preparing and submitting an application. We received criticism that these approximations
were too low.504 Given that the advisory industry is much larger than the municipal
securities industry, and in light of the number of comment letters we received that
expressed concern about inadvertent violations of the rule that would not qualify for the
exception for returned contributions, our staff estimates that approximately seven
advisers annually would apply to the Commission for an exemption from the rule.
Although we may initially receive more than seven applications a year for an exemption,
over time, we expect the number of applications we receive will significantly decline to
an average of approximately seven annually. We continue to believe that a firm that
applies for an exemption will hire outside counsel to prepare an exemptive request, but
based on commenters concerns have raised the number of hours counsel will spend
preparing and submitting an application from 16 hours to 32 hours, at a rate of $400 per
hour.505 As a result, each application will cost approximately $12,800, and the total
estimated cost for seven applications annually will be $89,600.
2.
Other Costs Related to Rule 206(4)-5
The prohibitions of the rule may also impose other costs on advisers, covered
associates, third-party solicitors, and political officials.
(a)
Two-Year Time Out
An adviser that becomes subject to the prohibitions of the rule would no longer be
eligible to receive advisory fees from its government client. This would result in a direct
loss to the adviser of revenues and profits relating to that government client, although
504
See Davis Polk Letter; ICI Letter.
505
The hourly cost estimate of $400 is based on our consultation with advisers and law firms
who regularly assist them in compliance matters.
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another adviser that the government client subsequently chose to retain would see an
increase in revenues and profits. The two-year time out could also limit the number of
advisers able to provide services to potential government entity clients. An adviser that
triggers the two-year time out may be obligated to provide (uncompensated) advisory
services for a reasonable period of time until the government client finds a successor to
ensure its withdrawal did not harm the client, or the contractual arrangement between the
adviser and the government client might obligate the adviser to continue to perform under
the contract at no fee. An adviser that provides uncompensated advisory services to a
government client would, at a minimum, incur the direct cost of providing
uncompensated services, and may incur opportunity costs if the adviser is unable to
pursue other business opportunities for a period of time.
Advisers to government clients, as well as covered associates of the adviser, also
may be less likely to make contributions to government officials, including candidates,
potentially resulting in less funding for these officials. Under the rule, advisers and
covered associates will be subject to new limitations on the amounts and to whom they
can contribute without triggering the rule’s time out provision. In addition, these same
persons will be prohibited from soliciting others to contribute or from coordinating
contributions to government officials, including candidates, or payments to political
parties in certain circumstances. These limitations and prohibitions, including if a firm
chooses to adopt policies or procedures that are more restrictive than the rule, could be
perceived by the individuals subject to them as costs imposed on their ability to express
their support for certain candidates for elected office and government officials.506 In
One commenter suggested that the proposed rule would inhibit individuals who work for
an investment adviser from running for office because, if they were successful, it may
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addition to these costs, the rule’s impact on advisers’ and employees’ contributions will
introduce some inefficiency into the allocation of contributions to candidates and officials
as the rule impacts contributions regardless of whether they are being made for the
purpose of engaging in pay to play.
We have made several modifications to the rule from the proposal that will reduce
these costs or burdens. We are creating a new exception to the two-year time out for
contributions made by a natural person more than six months prior to becoming a covered
associate unless he or she, after becoming a covered associate, solicits clients on behalf of
the investment adviser.507 This modification will decrease the burdens on both
employees and employers in terms of tracking and limiting employee contributions prior
to becoming employed or promoted by an investment adviser. In terms of narrowing the
scope of “covered investment pools,” we included a registered investment company in
the definition of covered investment pool, for purposes of all three of the rule’s pay to
play prohibitions, only if it is an investment option of a plan or program of a government
entity.508 As noted above, we believe this approach strikes the right balance between
applying the rule in those contexts in which advisers to registered investment companies
are more likely to engage in pay to play conduct while recognizing the compliance
challenges and costs that may result from a broader application of the rule. We are also
broadening the exception to the rule’s time out provision in several respects that should
further decrease the compliance costs associated with the two-year time out and will
cost their former employer business. Caplin & Drysdale Letter. We have addressed this
comment by making it clear that an individual can contribute to his or her own campaign
without triggering the rule. See supra note 139.
507 Rule 206(4)-5(b)(2).
508 Rule 206(4)-5(f)(3) and (f)(8).
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lower any perceived costs on covered associates’ ability to express their support for
candidates. We are increasing the aggregate contribution amount eligible for the
exception for certain returned contributions from $250 to $350 to any one official per
election,509 and we are increasing the number of times an adviser is permitted to rely on
the returned contributions exception from two to three per calendar year for advisers with
more than 50 employees.510 Furthermore, we are making the same adjustment from $250
to $350 for contributions eligible for the de minimis exception,511 and we are adopting a
de minimis exception for contributions not exceeding $150 made by individuals who are
not entitled to vote for the candidate.512
Several commenters highlighted the costs of the two-year time out to the adviser
and government entity client, as well as pension fund beneficiaries, stating that the time
out could force termination of long-standing relationships and may result in a permanent
termination of the advisory relationship.513 We acknowledge that advisers subject to the
time out may lose a government client’s business beyond the two-year period and are
sensitive to the concerns of commenters regarding the operation of the rule on public
pension funds, including the burdens they may face in replacing managers and the
509
Rule 206(4)-5(b)(3).
510
Id.
511
Rule 206(4)-5(b)(1).
512
See id.
513
See, e.g., ICI Letter (“[E]xisting state and local government clients may be harmed by the
forced termination of a mutually beneficial business relationship, despite receiving free
services for a period of time, because the government client is subject to the costs
associated with selecting a new adviser, and plan beneficiaries are subject to the costs
associated with portfolio commissions and other restructuring costs. Consequently, our
members believe that the two-year ban will operate as a permanent ban because a
government entity will be unlikely to go through the process of identifying and hiring a
replacement adviser, and then return to the original adviser after the ban ends.”). See also
IAA Letter; NASP Letter; SIFMA Letter.
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possibility that some managers may no longer seek to manage public plan assets as a
result of the rule. We believe that these costs are necessary to accomplish our goal of
addressing pay to play and are justified by the benefits of rule 206(4)-5. As discussed
above, rule 206(4)-5 is modeled on the pay to play rules adopted by the MSRB, which
have significantly curbed pay to play practices in the municipal securities market. We
believe that adopting a two-year time out similar to the time out applicable under the
MSRB rules is appropriate, and that the fiduciary relationship advisers have with public
pension plans argues for a strong prophylactic rule. Finally, while we have designed the
rule to reduce its impact,514 investment advisers are best positioned to protect government
clients by developing and enforcing robust compliance programs designed to prevent
contributions from triggering the two-year time out.
Commenters also noted, particularly, the potential harm of the two-year time out
to government clients and to other investors in a fund that holds illiquid securities when a
government investor redeems its interests in the fund as a result of the fund adviser’s
triggering contribution.515 As we note above, however, our rule does not require an
adviser that has triggered the time out to redeem the interests of a government investor or
cancel its commitment. The adviser may have multiple options available from which to
select to comply with the rule in light of its fiduciary obligations and the disclosure it has
made to investors. The adviser could instead comply with the rule by waiving or rebating
514
See, e.g., section II.B.2(a)(6) of this Release (discussing the de minimis exceptions to the
two-year time out); section II.B.2(f) of this Release (discussing the rule’s exemptive
provision).
515
CT Treasurer Letter; NY City Bar Letter.
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the portion of its fees or any performance allocation or carried interest attributable to the
government client.516
Most of the comments we received about the costs of this aspect of the proposed
rule, however, focused on the costs of an inadvertent violation.517 We understand that
there will be costs, sometimes quite significant, as a result of inadvertent violations.
However, with these potential costs in mind, we have taken additional steps to decrease
the likelihood of inadvertent violations of the rule. First, as discussed above, we
shortened the look back with respect to most covered associates. We expect this new
exception will provide an additional mechanism for advisers to avoid the cost of a time
out as a result of an inadvertent violation and will largely address commenters’ concerns
about the screening burdens for new or promoted employees that this aspect of the
proposal would have imposed on advisers.518 Second, as discussed above, we are
increasing to $350 the amount eligible for an exception for certain returned contributions
from what we had proposed, we are increasing the number of times an adviser is
permitted to rely on the returned contributions exception, and we are also adopting an
additional de minimis exception for certain contributions not exceeding $150. Last, we
516
See supra note 385 and accompanying text.
517
See, e.g., IAA Letter (“We are concerned that the Commission has not considered the
significance of the sanctions imposed as a result of an adviser’s inadvertent violation of
the rule.”).
518
IAA Letter (“Under the Proposal, investment advisers would be required to screen for
and eliminate potential employment candidates based upon contributions made for a
period of up to twenty-four months before the person would begin employment with the
adviser. This requirement . . . would be extremely costly and burdensome to
implement.”); Wells Fargo Letter (“The “look back” provision is too draconian. . . . [A]
compliance system [will be] costly to develop and arduous to implement . . . [and] it
would also impose severe limitations on the career opportunities of those newly entering
the investment advisory world who are weighed down by political contributions that were
completely innocuous when made.”).
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note that an adviser’s implementation of a strong compliance program will reduce the
likelihood, and therefore costs, of inadvertent violations.
One commenter asserted that the proposed rule would put advisers at a
competitive disadvantage to other providers of advisory services to government plans that
would not be subject to it, such as banks and insurance companies.519 As we stated
earlier, we believe that the concerns that we are trying to address with the rule justify its
adoption, notwithstanding the potential competitive effects that advisers may face as a
result of the limits on our jurisdiction. We also do not view competition by means of
engaging in practices such as pay to play as an interest that we need to protect.
(b)
Third-Party Solicitor Ban
Under our proposal, advisers would have been prohibited from compensating any
third party to solicit government entities for advisory services, other than “related
persons.”520 As a result, advisers that rely on third-party solicitors to obtain government
clients would have had to bear the expense of hiring and training in-house staff in order
to continue their solicitation activities,521 a result that commenters said would be
519
NY City Bar Letter.
520
Proposed rule 206(4)-5(a)(2)(i)(a).
521
See, e.g., Comment Letter of Greenhill & Co., LLC (Oct. 2, 2009) (“The elimination of
placement agents would add a significant administrative and cost burden to fund sponsors
seeking investors.”). See also Alta Letter; Atlantic-Pacific Letter; Braxton Letter;
Benedetto Letter; CA Assoc. of County Retirement Letter; Capstone Letter; EVCA
Letter; GA Firefighters Letter; Glovista Letter; IL Fund Association Letter; MN Board
Letter; Myers Letter; NCPERS Letter; NYC Teachers Letter; PA Public School
Retirement Letter; Reed Letter; Myers Letter; TX Public Retirement Letter; WI Board
Letter; Credit Suisse Letter (“Moreover, by performing these functions, placement agents
enable investment advisers to focus on their core expertise, investment management, and
to avoid the necessity of developing the costly in-house resources necessary to raise
capital directly.”).
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particularly costly for small and new investment advisers.522 In addition, third-party
solicitors might also have experienced substantial negative consequences under the
proposed rule.523 We heard from many commenters on this issue, offering various
perspectives on how the costs would outweigh the benefits of the proposed prohibition.524
A few commenters asserted that this proposal would have a significant adverse effect on
efficient capital formation in that it would make it more difficult for private equity and
venture capital managers to obtain funding that they in turn can invest in portfolio
companies.525 As other commenters pointed out, this aspect of our proposed rule might
522
See, e.g., MFA Letter (“[M]anagers that engage placement agents, particularly small and
offshore managers, would lose the ability to market their services to government clients
or incur significantly higher costs to hire internal marketing personnel; and managers that
hire internal personnel could spend substantial amounts to register as a broker-dealer.”).
See also SIFMA Letter; IAA Letter; Seward & Kissel Letter; Sadis & Goldberg Letter;
WI Board Letter; GA Firefighters Letter; MN Board Letter; IL Fund Association Letter;
NYC Teachers Letter; TX Public Retirement Letter; PA Public School Retirement Letter;
Ehrmann Letter; Finn Letter; Savanna Letter; Atlantic-Pacific Letter; Peterson Letter;
Devon Letter; Chaldon Letter; Meridian Letter; Benedetto Letter; Capstone Letter;
Braxton Letter; Littlejohn Letter; Alta Letter; Charles River Letter; Reed Letter; Glovista
Letter; Blackstone Letter; Park Hill Letter.
523
Proposing Release, at 89. See also Thomas Letter (“The ban would very likely cripple
many legitimate placement agents – most of whom are currently regulated by the SEC
and FINRA – as the public pension plans are the largest source of capital for alternative
investments.”); Comment Letter of the Managing Partner of Bridge 1 Advisors, LLC
Robert G. McGroarty (Sept. 24, 2009) (“Bridge 1 Letter”); SIFMA Letter.
524
See, e.g., Davis Polk Letter (“While we strongly support the underlying purpose of the
Proposed Rule, we believe that this ban on all third-party solicitors is overly expansive
and the costs inflicted on both investment advisers and government clients from lack of
access to the valuable services provided by most third-party solicitors outweigh any
expected benefits to be gained from its adoption.”); Capstone Letter (suggesting that
many placement agent firms are small businesses helping investment managers that are,
themselves, minority- or women-owned small businesses, and that, together, they are
creating jobs and helping other businesses by efficiently directing capital); Monument
Letter (making a similar comment regarding the minority and female ownership of
placement agents); Glantz Letter; Comment Letter of Indian Harbor Partner Robert W.
Stone (Aug. 13, 2009) (“Indian Harbor Letter”); Kurmanaliyeva Letter; M Advisory
Letter (adding that the investment management industry as a whole will incur “dramatic
job losses”); Parenteau Letter.
525
Alta Letter; Benedetto Letter; Comment Letter of Berkshire Property Advisors, LLC
(Sept. 29, 2009) (“Berkshire Letter”); Bridge 1 Letter; Comment Letter of Hampshire
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also have placed a significant burden on public pension plans,526 particularly smaller
plans because third-party solicitors provide services that plans may value, including
serving as placement agent for alternative investments and serving a screening function
with respect to those investments presented to the pension plan.527
Real Estate Companies (Sept. 29, 2009); Comment Letter of Thomas J. Mizo on behalf of
HFF Securities L.P. (Sept. 24, 2009); M Advisory Letter; Monument Group Letter;
Comment Letter of Psilos Group Managers, LLC (Sept. 28, 2009).
526
See, e.g., Park Hill Letter (“The Commission has commented that if the Placement Agent
Ban is adopted, Public Pension Investors can seek to engage placement agents themselves
in order to continue to have access to their services in helping to find the best Fund
Sponsors. However, that would impose costs on Public Pension Investors that they do
not currently incur. Moreover, as the Commission has acknowledged in its cost-benefit
analysis, if the Placement Agent Ban were adopted, Fund Sponsors who do not have inhouse
marketing staffs would be disproportionately disadvantaged relative to larger firms
that have those internal resources in the competition for obtaining access to Public
Pension Investors and other institutional investors.”); Thomas Letter (“A ban on
placement agents would have significant unintended consequences for public pension
plans. . . . [For instance, the] incremental effort by investment staffs to perform due
diligence on promising but possibly ill-prepared investment managers will raise the cost
and lessen the overall pension fund portfolio performance.”); Comment Letter of Austin
F. Whitman (Sept. 21, 2009) (“Without access to placement agents, government pensions
would be significantly disadvantaged relative to their private sector peers, with limited
access (and benefit from) the services described above.”); ABA Letter. But see Fund
Democracy/Consumer Federation Letter (“The proposed ban would simply replace the
indirect cost of placement agents incurred by pension plan sponsors with the direct cost
of hiring their own placement agents – without the conflict of interest and potential for
abuse that relying on advisers’ placement agents creates.”).
527
See, e.g., Ogburn Letter; Schmitz Letter (highlighting the valuable “pre-vetting” function
of placement agents, especially in light of pension funds’ budgetary pressures and lean
staffs); Savanna Letter (discussing the “pre-screening” effect that reputable placement
agent client selection provides for pension professionals); Atlantic-Pacific Letter; Indian
Harbor Letter; Peterson Letter; Rubenstein Letter; Comment Letter of Réal Desrochers
(Aug. 20, 2009) (noting that from the perspective of a former pension fund investment
officer, “[t]he skill sets of certain placement agents streamlined what they brought to our
attention and made our internal process much more efficient.”); Devon Letter; Thomas
Letter; Myers Letter; PRIM Board Letter (“[T]he Commission should strongly resist the
politically expedient suggestion that an outright ban on the use of placement agents is
somehow good for plan sponsors; nothing could be further than the truth.”); Meridian
Letter; Comment Letter of Norman G. Benedict (Sept. 30, 2009) (indicating that, from
the perspective of a retired public pension chief investment officer, placement agents
provide an essential and invaluable service, particularly with providing access to private
equity fund investments, which often yielded higher returns than more traditional,
publicly traded securities); Berkshire Letter; Comment Letter of The British Private
Equity and Venture Capital Association (Sept. 18, 2009) (“BVCA Letter”) (“Placement
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Others argued, for similar reasons as those expressed above, that it would also
harm public pension plans to ban payments to third parties because it would decrease
competition by reducing the number of advisers competing for government business528
and limit the universe of investment opportunities presented to public pension funds.529
We believe our decision to modify the proposed rule to permit advisers to make
payments to certain “regulated persons” to solicit government clients on their behalf,530
as described in more detail above, should alleviate many of these concerns, including
those from private equity and venture capital managers on capital formation.531 In
particular, we believe the concerns expressed by private equity and venture capital
managers regarding the effects of the rule on capital formation have been substantially
agents are not just a crude middleman in the fundraising process”); CT Treasurer Letter;
Credit Suisse Letter (describing four key functions its placement agent group performs);
Portfolio Advisors Letter (noting that among the valuable services provided are: “(1)
helping new fund sponsors to become more established among the institutional investor
community; (ii) helping sponsors to complete RFPs, provide information and respond to
questions, which, in turn, gives the public pension plans and other investors a broader
pool of investment options; and (iii) serving as intermediaries in uniting capital with fund
sponsors who can put the money to work by investing in businesses and creating value”);
George Letter; Comment Letter of Rahul Mehta (Sept. 11, 2009); Touchstone Letter;
SIFMA Letter.
528
See, e.g., Seward & Kissel Letter; Meridian Letter; SIFMA Letter; Comment Letter of
Oakpoint Advisors (Aug. 26, 2009); Comment Letter of SeaCrest Investment
Management, LLC (Sept. 25, 2009).
529
See, e.g., Braxton Letter (stressing not only the increased costs that public pension funds
will likely face, but also the likely reduction in creative investment strategies and
opportunities available as a result of smaller and emerging funds being forced out of the
market); BVCA Letter; CT Treasurer Letter; SIFMA Letter; IAA Letter; Strategic Capital
Letter; Alta Letter; Benedetto Letter; Glantz Letter; Kurmanaliyeva Letter; Park Hill
Letter.
530
See Rule 206(4)-5(a)(2)(i).
531
Our decision not to adopt the “related person” exception contained in the proposed rule
does not diminish our belief. As we noted above, we believe our modification of the ban
to allow advisers to pay “regulated persons” to solicit government entities on their behalf
will still allow advisers to use employees of certain related companies—i.e., of those
related companies that qualify as “regulated persons”—as solicitors.
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addressed by the modification for payments to “regulated persons.” We expect advisers
that engage the services of regulated person solicitors will incur limited costs to initially
confirm and subsequently monitor the solicitor’s eligibility to be a “regulated person.”
Nevertheless, we expect this exception to the third-party solicitor ban will substantially
reduce the costs commenters associated with this aspect of the proposal.
We acknowledge, however, that the third-party solicitor ban will nonetheless have
a substantial negative impact on persons who provide third-party solicitation services that
are not regulated persons, including state-registered advisers.532 If their businesses
consist solely of soliciting government entities on behalf of investment advisers, the rule
could result in these persons instead being employed directly by regulated persons,
shifting the focus of their solicitation activities, seeking to change their business model to
shift their source of payment from investment advisers to pension plans, or going out of
business.533 In addition, we acknowledge that the third-party solicitor ban may adversely
affect both competition and allocative efficiency in the market for advisory services
where third-party solicitors that are not regulated persons participate. We have carefully
considered these effects. As discussed above, however, we do not have regulatory
authority to oversee the activities of state-registered advisers through examination and
our recordkeeping rules. Nor do we have authority over the states to oversee their
enforcement of their rules, as we do with FINRA. As a result, we have not included
state-registered advisers in the definition of regulated person.534
532 As we note above, state-registered advisers are subject neither to our oversight nor to the
recordkeeping rules we are adopting today.
533 See supra note 523.
534 See supra note 325 and accompanying text.
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In addition, some commenters suggested that the third-party prohibition could
have a negative impact on the efficient allocation of capital for government plans,
particularly small ones, and advisers that seek to manage these assets directly (not
through a covered investment pool).535 These small government plans may, as a result of
the rule’s ban on payments to third parties, have fewer managers to select from to the
extent that larger advisers choose not to participate in this market. In addition, both
government plans and advisers that seek these government clients may have to hire
internal staff, respectively, to identify potential advisers and potential government clients
to the extent these functions are not internalized. However, these commenters did not
discuss the potentially significant costs that exist today of hiring third-party solicitors,
and that eliminating the cost of pay to play may, in fact, provide greater access to pension
plans by those advisers that are currently unable to afford the costs of direct or indirect
political contributions or third-party solicitor fees.536 We expect that prohibiting pay to
play will reduce the costs to plans and their beneficiaries that may result when adviser
selection is based on political contributions rather than investment considerations.537
535
See, e.g., 3PM Letter; Bryant Law Letter.
536
At least one commenter agreed. See Butler Letter (“[W]e find some evidence that the pay
to play practices by underwriters [before rule G-37 was adopted] distorted not only the
fees, but which firms were allocated business. The current proposal mentions that pay to
play practices may create an uneven playing field among investment advisers by hurting
smaller advisers that cannot afford to make political contributions. We find evidence that
is consistent with this view [in our research on pay to play by municipal underwriters].
During the pay to play era, municipal bonds were underwritten by investment banks with
larger underwriting market shares compared to afterward. One interpretation of this result
is that smaller underwriters were passed over in favor of larger underwriters (who
presumably had deeper pockets for political contributions).”).
537
See supra notes 452 & 453 and accompanying text (describing commenters’ observations
about some of the pay to play costs to plans and their beneficiaries).
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3. Costs Related to the Amendments to Rule 204-2
The amendments to rule 204-2 require SEC-registered advisers with government
clients to maintain certain records of campaign contributions by certain advisory
personnel and records of the regulated persons the adviser pays or agrees to pay to solicit
government entities on its behalf.538 Records are a critical complement to rule 206(4)-5.
In particular, such records are necessary for examiners to inspect advisers for compliance
with the terms of the rule.
As described below, for purposes of the Paperwork Reduction Act of 1995
(“PRA”),539 we have estimated that Commission-registered advisers would incur
approximately 3,394 additional hours annually to comply with the amendments to rule
204-2.540 Based on this estimate, we anticipate that advisers would incur an aggregate
cost of approximately $200,246 per year for the total hours advisory personnel would
spend in complying with the recordkeeping requirements.541 In addition, we expect
advisory firms may incur one-time costs to establish or enhance current systems to assist
in their compliance with the amendments to rule 204-2. For purposes of the PRA, we
have estimated that some small and medium firms will incur start-up costs, on average, of
538
Unregistered advisers that would be subject to rule 206(4)-5 would not be subject to the
amendments to rule 204-2.
539
44 U.S.C. 3501.
540
See infra note 559 and accompanying text.
541
We expect that the function of recording and maintaining records of political
contributions would be performed by a compliance clerk at a cost of $59 per hour. See
supra note 487. Therefore, the total costs would be $200,246 (3,394 hours x $59
per/hour).
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$10,000, and larger firms will incur, on average, $100,000. As a result, the amendments
to rule 204-2 are estimated to increase the PRA non-labor cost burden by $20,080,000.542
We received a number of specific comments on this aspect of the proposal, many
of which included assertions about cost burdens associated with maintaining records
related to unsuccessful solicitations, and urged us to reconsider the benefits to be gained
from such a requirement in light of the costs.543 We were persuaded by these
commenters to eliminate provisions of the proposed amendments to the recordkeeping
rule that would have required advisers to maintain a list of government entities that the
adviser solicits.544 Instead, an adviser must only retain records of existing government
entity clients and investors as well as records of regulated persons that the adviser pays or
agrees to pay to solicit government entities on its behalf for a five-year period.
Additionally, we have narrowed the scope of the amended rule to apply only to advisers
with government entity clients; an adviser is only required to make and keep these
records if it provides investment advisory services to a government entity or a
government entity is an investor in any covered investment pool to which the investment
542
($10,000 x 788) + ($100,000 x 122) = $7,880,000 + $12,200,000 = $20,080,000.
543
MassMutual Letter (“[T]he requirement to maintain records of each governmental entity
being solicited would require a diverse financial services company like MassMutual to
undertake significant legacy software system modifications or build an entirely new
system to track each instance of a “solicitation,” which could include phone calls,
meetings, or responses to governmental requests. This system would then need to
aggregate data across multiple business lines, many with existing systems that may not
have the ability to share this data in a useful format. All of these are costly and time
consuming activities to meet a requirement that appears to add little value to the
Commission’s efforts to ensure compliance with the Proposed Rule.”). See also Davis
Polk Letter; Dechert Letter; Holl Letter; SIFMA Letter; Skadden Letter.
544
See proposed rule 204-2(a)(18)(i)(B).
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adviser provides investment advisory services.545 We have also limited the rule to
provide that only records of contributions, not payments, to government officials and
candidates are required to be kept under the rule. Additionally, because rule 206(4)-5
applies to an adviser to a registered investment company only if it is an investment option
of a participant-directed plan or program of a government entity,546 such investment
advisers will only have to identify government entities that provide plan or program
participants the option of investing in the fund, which addresses many commenters’
concerns about recordkeeping burdens that would have been imposed on advisers to
registered investment companies under the proposed rule.547
We anticipate that commenters’ general concerns that we may have
underestimated the burdens we presented in our proposal will be offset by what we
believe will be a reduction in burdens as a result of the various modifications from our
proposal described above. In addition, we have revised the rule to require advisers to
maintain a list of regulated persons that solicit on an adviser’s behalf, but expect advisers
to already have this information in the normal course of business, including in some
instances, to comply with existing requirements of rule 206(4)-3.
V. PAPERWORK REDUCTION ACT
A. Rule 204-2
The amendment to rule 204-2 contains a “collection of information” requirement
within the meaning of the PRA. In the Proposing Release, the Commission solicited
545 Rule 204-2(a)(18)(iii). See NASP Letter (“Many advisers do not have governmental
clients but will still have to collect the information or attestations which would increase
compliance costs while providing no public benefit at all.”)
546 See supra note 353 and accompanying text.
547 See, e.g., ICI Letter.
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comment on the proposed amendment to the collection of information requirement.548
The Commission also submitted the proposed amendment’s collection of information
requirement to the Office of Management and Budget (“OMB”) for review in accordance
with 44 U.S.C. 3507(d) and 5 CFR 1320.11 under control number 3235-0278. The title
for the collection of information is “Rule 204-2 under the Investment Advisers Act of
1940.” Rule 204-2 contains a currently approved collection of information number under
OMB control number 3235-0278. An agency may not sponsor, or conduct, and a person
is not required to respond to, a collection of information unless it displays a currently
valid OMB control number.
Section 204 of the Advisers Act provides that investment advisers registered or
required to be registered with the Commission must make and keep certain records for
prescribed periods, and make and disseminate certain reports. Rule 204-2 sets forth the
requirements for maintaining and preserving specified books and records. This collection
of information is mandatory. The collection of information under rule 204-2 is necessary
for the Commission staff to use in its examination and oversight program, and the
information generally is kept confidential.549 The respondents are investment advisers
registered or required to be registered with us.
Today’s amendments to rule 204-2 require every investment adviser registered or
required to be registered that provides advisory services to (or pays or agrees to pay
regulated persons to solicit) government entities to maintain certain records of
contributions made by the adviser or any of its covered associates and regarding
regulated persons the adviser pays or agrees to pay for soliciting government entities on
548 See Proposing Release, at section IV.
549 See section 210(b) of the Advisers Act [15 U.S.C. 80b-10(b)].
--163--
its behalf. The amendments require such an adviser to make and keep the following
records: (i) the names, titles, and business and residence addresses of all covered
associates of the investment adviser; (ii) all government entities to which the investment
adviser provides or has provided investment advisory services, or which are or were
investors in any covered investment pool to which the investment adviser provides or has
provided investment advisory services, as applicable, in the past five years, but not prior
to the effective date of the rule; (iii) all direct or indirect contributions made by the
investment adviser or any of its covered associates to an official of a government entity,
or payments to a political party of a state or political subdivision thereof, or to a political
action committee; and (iv) the name and business address of each regulated person to
whom the investment adviser provides or agrees to provide, directly or indirectly,
payment to solicit a government entity for investment advisory services on its behalf, in
accordance with rule 206(4)-5(a)(2)(i).
The adviser’s records of contributions and payments are required to be listed in
chronological order identifying each contributor and recipient, the amounts and dates of
each contribution or payment, and whether such contribution or payment was subject to
the exception for certain returned contributions pursuant to rule 206(4)-5(b)(2). An
investment adviser is only required to make and keep current the records referred to in (i)
and (iii) above if it provides investment advisory services to a government entity or a
government entity is an investor in any covered investment pool to which the adviser
provides investment advisory services. The records required by amended rule 204-2 are
required to be maintained in the same manner, and for the same period of time, as other
books and records under rule 204-2(a). This collection of information will be found at 17
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CFR 275.204-2. Advisers that are exempt from Commission registration under section
203(b)(3) of the Advisers Act are not subject to the recordkeeping requirements.
The amendments to rule 204-2 that we are adopting today differ from our
proposed amendments in several respects. We have tailored certain of the requirements
from our proposal. First, we have limited the rule to provide that only records of
contributions, not payments, to government officials, including candidates, are required to
be kept under the rule. Second, investment advisers to registered investment companies
only have to identify—and keep records regarding—government entities that invest in a
fund as part of a plan or program of a government entity, including any government
entity that selects the fund as an investment option for participants in the plan or
program.550 Third, we are not adopting provisions of the proposed amendments to the
recordkeeping rule that would have required advisers to maintain a list of all government
entities that they have solicited. In addition, we have revised the rule so that only those
advisers that have government entity clients must make and keep certain required
records, unlike the proposal, which would have required all registered advisers to
maintain records of contributions and covered associates. We are also adopting a
requirement that advisers maintain records of regulated persons they pay to solicit
government entities on their behalf, to reflect that rule 206(4)-5 permits advisers to
compensate these solicitors.
As noted above, we requested comment on the PRA analysis contained in the
Proposing Release. Although a few commenters expressed general concerns that the
Under our proposal, investment advisers to registered investment companies would have
had to identify and keep records regarding government entities that invest in the funds
regardless of whether they were part of a plan or program of a government entity. For a
discussion of this modification, see section II.B. of this Release.
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paperwork burdens associated with our proposed amendments to rule 204-2 might be
understated, commenters representing advisers to registered investment companies
suggested that the proposal significantly underestimated the burden attributed to these
covered investment pools.551 With respect to registered investment companies,
commenters noted that the proposed recordkeeping requirements required advisers to
identify government investors in registered investment companies regardless of whether
the fund was part of a plan or program of a government entity, and as a result the
proposed amendments to the recordkeeping rule would have been difficult to comply
with as fund shareholder records do not necessarily identify government investors.
As a result of these comments, we recognize that we may have underestimated the
recordkeeping burden for advisers to registered investment companies that would have
been subject to proposed rule 206(4)-5. However, we believe that our change to the
definition of “covered investment pool” from the proposal to only include those
registered investment companies that are an investment option of a plan or program of a
government entity addresses the recordkeeping concerns commenters expressed
regarding these covered investment pools and lowers recordkeeping burdens by limiting
the records relating to registered investment companies that an investment adviser must
keep under the rule.552 In addition, the other changes we highlight above—other than the
requirement to keep records regarding regulated persons—would lessen the
recordkeeping requirements relative to our proposal and thereby diminish our burden
estimates. We anticipate that commenters’ general concerns that we may have
551 See ICI Letter (“[I]n relying on the estimates for compliance with the MSRB rules, the
Commission significantly underestimates the compliance and recordkeeping burdens
associated with the proposed rule.”).
552 See Rule 204-2(a)(18)(i)(B).
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underestimated the burdens we presented in our proposal, as well as the burden
associated with the additional requirement to maintain a list of regulated persons that
solicit on an adviser’s behalf, will be offset by what we believe will be a reduction in
burdens as a result of the various modifications from proposed amendments to the
recordkeeping rule, as described above. Moreover, notwithstanding the fact that the
amendments we are adopting reduce advisers’ recordkeeping obligations relative to our
proposal, we are increasing our estimates to address the additional investment advisers
who have registered with us since our proposal was issued.
Prior to today’s amendments, the approved collection of information for rule 2042,
set to expire on March 31, 2011, was based on an average of 181.15 burden hours each
year, per Commission-registered adviser, for a total of 1,954,109 burden hours. In
addition, the currently-approved collection of information for Rule 204-2 includes a non-
labor cost estimate of $13,551,390. The total burden is based on an estimate of 10,787
registered advisers.
Commission records indicate that currently there are approximately 11,607
registered investment advisers subject to the collection of information imposed by rule
204-2.553 As a result of the increase in the number of advisers registered with the
Commission since the current total burden was approved, the total burden has increased
This figure is based on registration information from IARD as of April 1, 2010. The
figures we relied on in our Proposing Release were based on registration information
from IARD as of July 1, 2009. See Proposing Release, at section IV.
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by 148,543 hours.554 In addition, the total non-labor cost burden has increased to
$14,581,509 as a result of this increase in the number of registered advisers.555
In our Proposing Release, we estimated that approximately 1,764 Commission-
registered advisers provide, or seek to provide, advisory services to government clients
and to certain pooled investment vehicles in which government entities invest, and would
thus be affected by the rule amendments.556 One commenter argued that this estimate
was too low because it underestimates the number of investment advisers unregistered in
reliance on Section 203(b)(3) of the Advisers Act and estimated to be subject to the
Proposed Rule.557 Unregistered advisers are not subject to rule 204-2’s recordkeeping
requirements. As a result, they are not included in our estimates for purposes of this
analysis. We continue to believe our estimates are appropriate, although we have revised
this number for purposes of both our cost-benefit analysis above and our PRA analysis to
reflect both an increase in the number of registered advisers since the proposal and the
modification from our proposal to not require records of unsuccessful solicitations. We
now estimate that approximately 1,697 registered advisers provide advisory services to
554
11,607 – 10,787 = 820. 820 additional advisers x 181.15 hours = 148,543 hours.
555
We estimate that non-labor costs attributed to rule 204-2 will increase in the same
proportion as the increase in the estimated hour burden for the rule. (2,102,652 hours
/1,954,109 hours) x $13,551,390 currently approved non-labor cost estimate =
$14,581,509.
556
See Proposing Release, at section IV.
557
Davis Polk Letter (“The cost benefit analysis is based solely on an estimated 1,764
registered investment advisers and does not account for the costs and burdens of
compliance attributable to investment advisers exempt from registration. The estimated
number of investment advisers unregistered in reliance on section 203(b)(3) of the
Advisers Act (2,000) and estimated to be subject to the Proposed Rule (231), appears to
be low. In its comment letter, the Third Party Marketers Association notes that the
number of advisory firms exempted from registration may be ‘over two times the
estimate of the Commission. . . .’” (citations omitted)). The Davis Polk Letter does not
offer any of its own estimates for the number of unregistered advisers, and the 3PM
Letter references statistics regarding the number of funds, not the number of advisers.
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government clients and to certain pooled investment vehicles in which government
entities invest, and would thus be affected by the rule amendments.558
Under the amendments, each respondent is required to retain the records in the
same manner and for the same period of time as currently required under rule 204-2. The
amendments to rule 204-2 are estimated to increase the burden by approximately 2 hours
per Commission-registered adviser with government clients annually for a total increase
of 3,394 hours.559 The revised annual aggregate burden for all respondents to the
558
This estimate is based on registration information from IARD as of April 1, 2010,
applying the same methodology as in the Proposing Release. As previously noted,
according to responses to Item 5.D(9) of Part 1 of Form ADV, 1,332 advisers have clients
that are state or municipal government entities, which represents 11.48% of all advisers
registered with us. 10,275 advisers have not responded that they have clients that are state
or municipal government entities. Of those, however, responses to Item 5.D(6) of Part 1
of Form ADV indicate that 2,486 advisers have some clients that are other pooled
investment vehicles. Estimating that the same percentage of these advisers advise pools
with government entity investors as advisers that have direct government entity clients—
i.e.,11.48%. 285 of these advisers would be subject to the rule (2,486 x 11.48 % = 285).
Out of the 10,275 that have not responded that they have clients that are state or
municipal government entities, after backing out the 2,486 which have clients that are
other pooled investment vehicles, responses to Item 5.D(4) of Part 1 of Form ADV
indicate that 699 advisers have some clients that are registered investment companies.
Estimating that roughly the same percentage of these advisers advise pools with
government entity investors as advisers that have direct government entity clients—
i.e.,11.48%. 80 of these advisers would be subject to the rule (699 x 11.48% = 80).
Although we limited the application of rule 206(4)-5 with respect to registered
investment companies to those that are investment options of a plan or program of a
government entity, we continue to estimate that 80 advisers would have to comply with
the recordkeeping provisions because of the difficulty in further delineating this
estimated number. Therefore, we estimate that the total number of advisers subject to the
rule would be: 1,332 advisers with state or municipal clients + 285 advisers with other
pooled investment vehicle clients + 80 advisers with registered investment company
clients = 1,697 advisers subject to rule. We expect certain additional advisers may incur
compliance costs associated with rule 206(4)-5. We anticipate some advisers may be
subject to the rule because they solicit government entities on behalf of other investment
advisers. In the Proposing Release, our estimates included an estimated burden
attributable to advisers that do not currently have government clients but that may begin
to seek them. The revision to the recordkeeping rule that eliminated the requirement to
maintain records of government entities that an adviser solicits has eliminated the need
for this additional burden estimate.
559
2 x 1,697 = 3,394.
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recordkeeping requirements under rule 204-2 thus would be 2,106,046 hours.560 The
revised average burden per Commission-registered adviser would be 181.45 hours.561
Additionally, as we noted in the Proposing Release and reiterate above, we expect
advisory firms may incur one-time costs to establish or enhance current systems to assist
in their compliance with the amendments to rule 204-2. These costs would vary widely
among firms. Small advisers may not incur any system costs if they determine a system
is unnecessary due to the limited number of employees they have or the limited number
of government entity clients they have. Large firms likely already have devoted
significant resources into automating compliance and reporting and the new rule could
result in enhancements to these existing systems.
As a result of these one-time costs, we estimate that there will be an increase to
the total non-labor cost burden. We estimated above that the non-labor cost burden has
increased to $14,581,509 as a result of the increase in the number of registered advisers
since the collection was last approved.562 We believe the one-time costs could vary
substantially among smaller, medium, and larger firms as smaller and medium firms may
be able to use non-specialized software, such as a spreadsheet, or off-the-shelf
compliance software to keep track of the information required by the rule while larger
firms are more likely to have proprietary systems. Based on IARD data we estimate that
there are approximately 1,271 smaller firms, 304 medium firms, and 122 larger firms.563
560
1,954,109 (current approved burden) + 148,543 (burden for additional registrants) +
3,394 (burden for proposed amendments) = 2,106,046 hours.
561
2,106,046 (revised annual aggregate burden) divided by 11,607 (total number of
registrants) = 181.45.
562
See supra note 555.
563
This estimate is based on registration information from IARD as of April 1, 2010. These
estimates are based on IARD data, specifically the responses to Item 5.B.(1) of Form
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We estimate that one half of the smaller and medium firms will not incur these one-time
start up costs because they will use existing tools for compliance. We expect the other
half of smaller and medium firms will incur one-time start up costs on average of
$10,000, in the event they have a greater number of employees and government clients,
and larger firms, that likely have the most employees and government clients, will incur
one-time start up costs on average of $100,000. As a result, the amendments to rule 2042
are estimated to increase the non-labor cost burden by $20,080,000.564 Due to this
increase, we now estimate the revised total non-labor cost burden for rule 204-2 to be
$34,661,509.
B. Rule 206(4)-3
The amendment to rule 206(4)-3 contains a revised collection of information
requirement within the meaning of the PRA. In the Proposing Release, the Commission
published notice soliciting comment on the collection of information requirement.565 The
Commission submitted the revised collection of information requirement to OMB for
review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. Rule 206(4)-3
contains a currently approved collection of information under OMB control number
3235-0242. The title for the collection of information is “Rule 206(4)-3 – Cash
Payments for Client Solicitations.” As noted above, an agency may not sponsor, or
ADV, that 997 (or 74.9%) of the 1,332 registered investment advisers that have
government clients have fewer than five employees who perform investment advisory
functions, 239 (or 17.9%) have five to 15 such employees, and 96 (or 7.2%) have more
than 15 such employees. We then applied those percentages to the 1,697 advisers we
believe will be subject to the proposed rule for a total of 1,271 smaller, 304 medium and
122 larger firms.
564 [$10,000 x 788] + [$100,000 x 122] = $7,880,000 + $12,200,000 = $20,080,000.
565 See Proposing Release, at section IV.
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conduct, and a person is not required to respond to, a collection of information unless it
displays a currently valid OMB control number.
Section 206(4) of the Advisers Act provides that it shall be unlawful for any
investment adviser to engage in any act, practice, or course of business which is
fraudulent, deceptive, or manipulative. Rule 206(4)-3 generally prohibits investment
advisers from paying cash fees to solicitors for client referrals unless certain conditions
are met. The rule requires that an adviser pay all solicitors’ fees pursuant to a written
agreement that the adviser is required to retain. This collection of information is
mandatory. The Commission staff uses this collection of information in its examination
and oversight program, and the information generally is kept confidential.566
The Commission is adopting amendments to rule 206(4)-3 under the Advisers
Act. The amendments to rule 206(4)-3, which are identical to our proposed amendments,
require every investment adviser that relies on the rule and that provides or seeks to
provide advisory services to government entities to also abide by the limitations provided
in rule 206(4)-5. This collection of information is found at 17 CFR 275.206(4)-3.
Advisers that are exempt from Commission registration under section 203(b)(3) of the
Advisers Act would not be subject to rule 206(4)-3.
We requested comment on the PRA analysis contained in Proposing Release. We
received no comment on this portion of our analysis. In addition, we have not modified
our amendments to rule 206(4)-3 relative to our proposal.
The current approved collection of information for rule 206(4)-3, set to expire on
March 31, 2011, is based on an estimate that 20 percent of the 10,817 Commission-
Section 210(b) of the Advisers Act [15 U.S.C. 80b-10(b)].
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registered advisers (or 2,163 advisers) rely on the rule, at an average of 7.04 burden hours
each year, per respondent, for a total of 15,228 burden hours (7.04 x 2,163).
Commission records indicate that currently there are approximately 11,607
registered investment advisers,567 20 percent of which (or 2,321) are likely subject to the
collection of information imposed by rule 206(4)-3. As a result of the increase in the
number of advisers registered with the Commission since the current total burden was
approved, the total burden has increased by 1,112.32 hours (158 additional advisers568 x
7.04 hours). We estimate that approximately 20 percent of the Commission-registered
advisers that use rule 206(4)-3 (or 464 advisers)569 provide, or seek to provide, advisory
services to government clients.570 Under the amendments, each respondent would be
prohibited from certain solicitation activities, subject to the exception for “regulated
persons,” with respect to government clients, activities that otherwise would have been
covered by rule 206(4)-3.571 Thus, they would not need to enter into and retain the
written agreement required under rule 206(4)-3 with respect to those third parties they are
prohibited from paying to solicit government entities.
In the Proposing Release, we estimated a decrease to the burden due to the
prohibition on paying third party solicitors to be 20% of the annual burden. As a result of
567
This figure is based on registration information from IARD as of April 1, 2010. The
figures we relied on in our Proposing Release were based on registration information
from IARD as of July 1, 2009.
568
2,321 (20% of current registered investment advisers) – 2,163 (20% of registered
investment advisers when burden estimate was last approved by OMB) = 158.
569
2,321 x 20 percent = 464.
570
In light of the 11.48% of registered investment advisers that indicate they have state or
municipal government clients, we conservatively estimate that 20% of the advisers who
rely on rule 206(4)-3 are soliciting government entities to be advisory clients or to invest
in covered investment pools those advisers manage. See supra note 558.
571
Rule 206(4)-3(a).
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the revised ban on using third parties, we now estimate that the amendments to rule
206(4)-3 will only decrease the burden by 15 percent,572 or approximately 1.06 hour,573
per Commission-registered adviser that uses the rule and has or is seeking government
clients annually, for a total decrease of 491.84 hours.574 The revised annual aggregate
burden for all respondents to the recordkeeping requirements under rule 206(4)-3 thus
would be 15,848.48 hours.575 The revised average burden per Commission-registered
adviser would be 6.83 hours.576
C.
Rule 206(4)-7
As a result of the adoption of rule 206(4)-5, rule 206(4)-7 contains a revised
collection of information requirement within the meaning of the PRA. In the Proposing
Release, the Commission estimated that registered advisers would spend between 8 hours
and 250 hours to establish policies and procedures to comply with rule 206(4)-5.577 Rule
206(4)-7 contains a currently approved collection of information under OMB control
number 3235-0585. The title for the collection of information is “Investment Advisers
Act Rule 206(4)-7, Compliance procedures and practices.” As noted above, an agency
572
In our proposal, which would have banned the use of third-party solicitors altogether, we
estimated a 20 percent decrease in the burden under rule 206(4)-3. But, to account for the
regulated persons exception to the third-party solicitor ban in adopted rule 206(4)-5, we
have modified our estimate to only a 15 percent decrease. That is because our staff
estimates that one quarter (or 5 percent) of the proposal’s estimated burden reduction
relating to entering into and retaining the written agreement required under rule 206(4)-3
will be retained as investment advisers engage third parties that are regulated persons to
solicit on their behalf.
573
7.04 x 15 percent = 1.06.
574
464 x 1.06 = 491.84.
575
15,228 (current approved burden) + 1,112.32 (burden for additional registrants) - 491.84
(reduction in burden for amendments) = 15,848.48 hours.
576
15,848.48 (revised annual aggregate burden) divided by 2,321 (total number of
registrants who rely on rule) = 6.83.
577
See Proposing Release, at section III.B.
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may not sponsor, or conduct, and a person is not required to respond to, a collection of
information unless it displays a currently valid OMB control number.
Section 206(4) of the Advisers Act provides that it shall be unlawful for any
investment adviser to engage in any act, practice, or course of business which is
fraudulent, deceptive, or manipulative. Rule 206(4)-7, in part, requires registered
investment advisers to adopt and implement written policies and procedures reasonably
designed to prevent violation of the federal securities laws. This collection of
information is mandatory. The purpose of the information collection requirement is to
ensure that registered advisers maintain comprehensive, written internal compliance
programs. It also assists the Commission’s staff in its examination and oversight
program. Information obtained in our examination and oversight program generally is
kept confidential.578
As we previously noted, we expect that registered investment advisers subject to
rule 206(4)-5 will modify their compliance programs to address new obligations under
that rule. The current approved collection of information for rule 206(4)-7, set to expire
on March 31, 2011, is based on 10,817 registered advisers that were subject to the rule at
an average burden of 80 hours each year per respondent for a total of 865,360 burden
hours.
Commission records indicate that currently there are approximately 11,607
registered investment advisers.579 As a result of the increase in the number of advisers
registered with the Commission since the current total burden was approved, the total
burden has increased by 63,200 hours (790 x 80 hours). In addition, although the time
578 Section 210(b) of the Advisers Act [15 U.S.C. 80b-10(b)].
579 This figure is based on registration information from IARD as of April 1, 2010.
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needed to comply with rule 206(4)-5 will vary significantly from adviser to adviser, as
discussed in detail below, the Commission staff estimates that firms with government
clients will spend between 8 hours and 250 hours to implement policies and procedures to
comply with the rule, depending on the firm’s number of covered associates.580 Of the
1,697 registered advisers that we estimate may be affected by rule 206(4)-5,581 we
estimate that approximately 1,271 are smaller firms, 304 are medium firms, and 122 are
larger firms.582 We anticipate that smaller firms will spend 8 hours, medium firms will
spend 125 hours, and larger firms will spend 250 hours,583 for a total of 78,668 hours,584
to implement policies and procedures. Our estimates take into account our staff’s
observation that some registered advisers have established policies regarding political
contributions, which can be revised to reflect the new requirements. The revised annual
aggregate burden for all respondents to comply with rule 206(4)-7 thus would be
1,007,228 hours.585
D.
Rule 0-4
Rule 0-4 under the Advisers Act,586 entitled “General Requirements of Papers and
Applications,” prescribes general instructions for filing an application seeking exemptive
580
See section IV.B.1. of this Release (describing the cost estimates associated with
compliance with rule 206(4)-5).
581
See supra note 558. Advisers that are unregistered in reliance on the exemption available
under section 203(b)(3) of the Advisers Act [15 U.S.C. 80b-3(b)(3)] are not subject to
rule 206(4)-7 and, therefore, are not reflected in this burden estimates pursuant to the
PRA.
582 See supra note 475.
583 See supra notes 489-491.
584 (1,271 x 8 = 10,168) + (304 x 125 = 38,000) + (122 x 250 = 30,500) = 78,668.
585 865,360 (current approved burden) + 63,200 (burden for additional registrants) + 78,668
(burden attributable to rule 206(4)-5) = 1,007,228 hours.
586 17 CFR 275.0-4.
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relief with the Commission. The requirements of rule 0-4 are designed to provide the
Commission with the necessary information to assess whether granting the orders of
exemption are necessary and appropriate, in the public interest and consistent with the
protection of investors and the intended purposes of the Act. In light of the adoption of
rule 206(4)-5, which contains a provision for seeking an exemptive order from the
Commission, we are revising the collection of information requirement for rule 0-4. Rule
0-4 contains a currently approved collection of information under OMB control number
3235-0633. As noted above, an agency may not sponsor, or conduct, and a person is not
required to respond to, a collection of information unless it displays a currently valid
OMB control number.
The current approved collection of information contains an estimated total annual
hour burden of one hour for administrative purposes because most of the work of
preparing an application is performed by outside counsel and, therefore, imposes
minimal, if any, hourly burden on respondents. Because we expect that all, or
substantially all, of the work of preparing an application for an exemptive order under
rule 206(4)-5 will also be performed by outside counsel, we continue to believe that the
current estimate of one hour, in the unlikely event the adviser does perform an
administrative role, is sufficient. As a result, we are not increasing our estimated hourly
burden in connection with the adoption of rule 206(4)-5.
The current approved collection of information also contains an estimated total
annual cost burden of $355,000, which is attributed to outside counsel legal fees. In the
Proposing Release, we estimated that approximately five advisers annually would apply
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to the Commission for an exemption from rule 206(4)-5.587 We also estimated that an
advisory firm that applies for an exemption would hire outside counsel to prepare their
exemptive requests, and that counsel would spend 16 hours preparing an submitting an
application for review at a rate of $400 per hour, for a per application cost of $6,400 and
a total estimated cost for five applications annually of $32,000.
The Commission requested public comment on these estimates in the Proposing
Release, and we received comments indicating that our estimate of five exemptive
application submissions per year is too low.588 We did not receive comments on our cost
estimates. Given that the advisory industry is much larger than the municipal securities
industry, and in light of the number of comment letters we received that expressed
concern about inadvertent violations of the rule that would not qualify for the exception
for returned contributions, our staff estimates that approximately seven advisers annually
would apply to the Commission for an exemption from the rule. Although we may
initially receive more than seven applications a year for an exemption, over time, we
expect the number of applications we receive will significantly decline to an average of
approximately seven annually. We continue to believe that a firm that applies for an
exemption will hire outside counsel to prepare an exemptive request, but based on
commenters concerns have raised the number of hours counsel will spend preparing and
submitting an application from 16 hours to 32 hours, at a rate of $400 per hour.589 As a
result, each application will cost approximately $12,800, and the total estimated cost for
587 See Proposing Release, at Section III.B.
588 See Davis Polk Letter; ICI Letter.
589 The hourly cost estimate of $400 is based on our consultation with advisers and law firms
who regularly assist them in compliance matters.
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seven applications annually will be $89,600. The total estimated annual cost burden to
applicants of filing all applications has therefore increased to $444,600.590
VI. FINAL REGULATORY FLEXIBILITY ANALYSIS
The Commission has prepared the following Final Regulatory Flexibility Analysis
regarding rule 206(4)-5 and the amendments to rules 204-2 and 206(4)-3 in accordance
with section 3(a) of the Regulatory Flexibility Act.591 We prepared an Initial Regulatory
Flexibility Analysis (“IRFA”) in conjunction with the Proposing Release in August
2009.592 The Proposing Release included, and solicited comment, on the IRFA.
A. Need for the Rule
Inve
tment advisers that seek to influence the award of advisory contracts by
government entities, by making or soliciting political contributions to those officials who
are in a position to influence the awards, violate their fiduciary obligations. These
practices—known as “pay to play”—distort the process by which investment advisers are
selected and, as discussed in greater detail above, can harm advisers’ public pension plan
clients, and thereby beneficiaries of those plans, which may receive inferior advisory
services and pay higher fees.593 In addition, the most qualified adviser may not be
selected, potentially leading to inferior management, diminished returns, or greater losses
for the public pension plan. Pay to play is a significant problem in the management of
public funds by investment advisers. Moreover, we believe that advisers’ participation in
pay to play is inconsistent with the high standards of ethical conduct required of them
590 $355,000 + $89,600 = $444,600.
591 5 U.S.C. 604(b).
592 See Proposing Release, at section V.
593 See section I of this Release, for more information about the need for the Commission to
take action to prevent pay to play practices.
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under the Advisers Act. The rule and rule amendments we are adopting today are
designed to prevent fraud, deception, and manipulation by reducing or eliminating
adviser participation in pay to play practices.
Rule 206(4)-5, the “pay to play” rule, prohibits an investment adviser registered
(or required to be registered) with the Commission, or unregistered in reliance on the
exemption available under section 203(b)(3) of the Advisers Act, from providing
advisory services for compensation to a government client for two years after the adviser,
or any of its covered associates, makes a contribution to public officials (and candidates)
such as state treasurers, comptrollers, or other elected executives or administrators who
can influence the selection of the adviser.594 In addition, the rule we are adopting
prohibits an adviser and its covered associates from soliciting contributions for an elected
official or candidate or payments to a political party of a state or locality where the
adviser is providing or seeking to provide advisory services to a government entity,595
and from providing or agreeing to provide, directly or indirectly, payment to any third
party, other than a “regulated person,” engaged to solicit advisory business from any
government entity on behalf of the adviser.596 Further, the prohibitions in the rule also
apply to advisers to certain investment pools in which a government entity invests or that
are investment options of a plan or program of a government entity.597 The amendment
we are adopting to rule 204-2 is designed to provide Commission staff with records to
594 Rule 206(4)-5(a)(1).
595 Rule 206(4)-5(a)(2)(ii).
596 Rule 206(4)-5(a)(2)(i). “Regulated person” is defined in rule 206(4)-5(f)(9).
597 Rule 206(4)-5(c).
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review compliance with rule 206(4)-5, and the amendment to rule 206(4)-3 clarifies the
application of the cash solicitation rule as a result of the adoption of rule 206(4)-5.598
B. Significant Issues Raised by Public Comment
In the Proposing Release, we requested comment on the IRFA, in particular, on
the number of small entities, particularly small advisers, to which the rule and rule
amendments would apply and the effect on those entities, including whether the effects
would be economically significant; and how to quantify the number of small advisers,
including those that are unregistered, that would be subject to the proposed rule and rule
amendments. We received a number of comments related to the impact of our proposal
on small advisers. The commenters argued that the proposed rule, particularly the
provision that would have prohibited advisers from directly or indirectly compensating
any third party to solicit government business on its behalf, would be disproportionately
expensive for, and would impose an undue regulatory burden on, smaller firms.599
C. Small Entities Subject to Rule
Under Commission rules, for the purposes of the Advisers Act and the Regulatory
Flexibility Act, an investment adviser generally is a small entity if it: (i) has assets under
management having a total value of less than $25 million; (ii) did not have total assets of
$5 million or more on the last day of its most recent fiscal year; and (iii) does not control,
is not controlled by, and is not under common control with another investment adviser
that has assets under management of $25 million or more, or any person (other than a
natural person) that had $5 million or more on the last day of its most recent fiscal
598 For a more detailed discussion of the prohibitions contained in rule 206(4)-5, see section
II.B.2 of this Release. For a more detailed discussion of the amendments to rules 204-2
and 206(4)-3, see sections II.D and II.E, respectively, of this Release.
599 See supra note 522.
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600
year.
The Commission estimates that as of April 2010 there are approximately 708
small SEC-registered investment advisers.601 Of these 708 advisers, 61 indicate on Form
ADV that they have state or local government clients, and would, therefore, be affected
by the rule.602 The rule also applies to those advisers that are exempt from registration
with the Commission in reliance on section 203(b)(3) of the Advisers Act. As noted
above, based on our review of registration information on IARD and outside sources and
reports, we estimate that there are approximately 2,000 advisers that are unregistered in
reliance on section 203(b)(3).603 Applying the same principles we used with respect to
registered investment advisers, we estimate that 230 of those advisers manage pooled
investment vehicles in which government client assets are invested and would therefore
be subject to the rule.604 Based on the current number of registered advisers subject to
the rule that are small entities, we estimate that approximately 4 percent of unregistered
advisers,605 or nine, would be subject to the rule are small entities.606
600
17 CFR 275.0-7(a).
601
This estimate is based on registration information from IARD as of April 1, 2010. We
have estimated the number of small advisers by reference to advisers’ responses to Item
12.A, B and C of Part 1 of Form ADV.
602
This estimate is based on registration information from IARD as of April 1, 2010. We
have estimated the number of small advisers with state or local government clients by
reference to advisers’ responses to Item 5.D(9) of Part 1 of Form ADV.
603
This number is based on our review of registration information on IARD as of April 1,
2010, IARD data from the peak of hedge fund adviser registration in 2005, and a
distillation of numerous third-party sources including news organizations and industry
trade groups.
604
11.48% of 2000 is 230. See supra note 474.
605
61 registered small entities subject to the rule/1,697 registered advisers subject to the rule
= 3.6%.
606
230 x 4% = 9.2. Because these advisers are not registered with us, we do not have more
precise data about them, and we are not aware of any databases that compile information
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D.
Projected Reporting, Recordkeeping, and Other Compliance
Requirements
The rule imposes certain reporting, recordkeeping and compliance requirements
on advisers, including small advisers. The rule imposes a new compliance requirement
by: (i) prohibiting an adviser from providing investment advisory services for
compensation to government clients for two years after the adviser or any of its covered
associates makes a contribution to certain elected officials or candidates; (ii) prohibiting
an adviser from providing or agreeing to provide, directly or indirectly, payment to any
third party, other than a “regulated person,” engaged to solicit advisory business from any
government entity on behalf of the adviser; and (iii) prohibiting an adviser or any of its
covered associates from soliciting contributions for an elected official or candidate or
payments to a political party of a state or locality where the adviser is providing or
seeking to provide advisory services to a government entity.
The rule amendments impose new recordkeeping requirements by requiring an
adviser to maintain certain records about its covered associates, its advisory clients,
government entities invested in certain pooled investment vehicles managed by the
adviser, its solicitors, and its political contributions, as well as the political contributions
regarding how many advisers that are exempt from registration with the Commission in
reliance on section 203(b)(3) of the Advisers Act have state or local government clients,
and how many of these advisers would be small entities for purposes of this analysis. We
sought comments on this issue, but none of the comments we received provided any
estimates or empirical data. However, we address above commenters who generally
questioned our estimates. See supra notes 482-484 and accompanying text. We expect
certain additional advisers may incur compliance costs associated with rule 206(4)-5.
Some advisers may be subject to the rule because they solicit government entities on
behalf of other investment advisers.
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of its covered associates.607 An investment adviser that does not provide or seek to
provide advisory services to a government entity, or to a covered investment pool in
which a government entity invests, is not subject to rule 206(4)-5 and certain
recordkeeping requirements under amended rule 204-2.
As noted above, we believe that a limited number of small advisers608 will have to
comply with rule 206(4)-5 and the amendments to rules 204-2 and 206(4)-3. To the
extent small advisers tend to have fewer clients and fewer employees that would be
covered associates for purposes of the rule, the rule should impose lower costs on small
advisers as compared to large advisers because variable costs, such as the requirement to
make and keep records relating to contributions, should be lower due to the likelihood
that there would be fewer records to make and keep.609 Moreover, as discussed above,
the rule and amendments were modified from what we had proposed in several ways that
we expect will substantially minimize compliance burdens on small advisers.
E.
Agency Action to Minimize Effect on Small Entities
The Regulatory Flexibility Act directs the Commission to consider significant
alternatives that would accomplish the stated objective, while minimizing any significant
impact on small entities.610 In considering whether to adopt rule 206(4)-5 and the
607
See supra notes 559-564 and accompanying text (providing the revised estimated hour
burden and non-labor cost burden to comply with amended rule 204-2, for purposes of
the PRA).
608
See section VI.C of this Release.
609
However, as noted above, many larger advisers with broker-dealer affiliates may spend
fewer resources to comply with the proposed rule and rule amendments because they may
be able to rely on compliance procedures and systems that the broker-dealer already has
in place to comply with MSRB rules G-37 and G-38. See supra section IV.B.
610
As noted above, we considered two alternatives to certain aspects of proposed rule
206(4)-5: a disclosure obligation and a two-year time out for third-party solicitors. We
do not believe either alternative would accomplish our stated objective of curtailing pay
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amendments to rules 204-2 and 206(4)-3, the Commission considered the following
alternatives: (i) the establishment of differing compliance or reporting requirements or
timetables that take into account the resources available to small entities; (ii) the
clarification, consolidation, or simplification of compliance and reporting requirements
under the rule and rule amendments for such small entities; (iii) the use of performance
rather than design standards; and (iv) an exemption from coverage of the rule and rule
amendments, or any part thereof, for such small entities.
Regarding the first alternative, the Commission is not adopting different
compliance or reporting requirements for small advisers as it may be inappropriate to do
so under the circumstances. The proposal is designed to reduce or eliminate adviser
participation in pay to play, a practice that can distort the process by which investment
advisers are selected to manage public pension plans that can harm public pension plan
clients and cause advisers to violate their fiduciary obligations. To establish different
requirements for small advisers could diminish the protections the rule and rule
amendments would provide to public pension plan clients and their beneficiaries.
Regarding the second alternative, we considered whether further clarification,
consolidation, or simplification of the compliance requirements would be feasible or
necessary, and would reduce compliance requirements. As a result, we have simplified
the compliance requirements by limiting the recordkeeping obligations to better reflect
the activities of an adviser or a covered associate that could result in the adviser being
subject to the two-year time out, including not requiring advisers to maintain records of
unsuccessful solicitations of government entities and payments (as opposed to
to play activities and thereby address potential harms from those activities. See
Proposing Release, at section II.A.2, including nn.133 and 134 and accompanying text.
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contributions) by advisers or covered associates to government officials.611 Moreover,
we are amending rule 206(4)-3, the cash solicitation rule, to clarify that the requirements
of new rule 206(4)-5 apply to solicitation activities involving government clients.612
Regarding the third alternative, we considered using performance rather than
design standards with respect to pay to play practices of investment advisers to be neither
consistent with the objectives for this rulemaking nor sufficient to protect investors in
accordance with our statutory mandate of investor protection. Design standards, which
we have employed, provide a base line for advisory conduct as it relates to contributions
and other pay to play activities, which is consistent with a rule designed to prohibit pay to
play. The use of design standards also is important to ensure consistent application of the
rule among investment advisers to which the rule and rule amendments will apply.
Regarding the fourth alternative, exempting small entities could compromise the
overall effectiveness of the rule and related rule amendments. Banning pay to play
practices benefits clients of both small and large advisers, and it would be inconsistent to
specify different requirements for small advisers.
As discussed above, several commenters suggested alternative approaches to our
rule.613 Such alternatives include, for example: (i) that we require advisers to disclose
their contributions to state and local officials; (ii) that we require advisers to include in
their codes of ethics a policy that prohibits contributions made for the purpose of
influencing the selection of the adviser; (iii) that we require advisers to adopt policies and
611 See supra note 423 and accompanying text.
612 See section II.D. of this Release.
613 See generally section II.B.2(a) of this Release.
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procedures reasonably designed to prevent and detect contributions designed to influence
the selection of an adviser; (iv) that we mandate preclearance of employee contributions;
and (v) that we allow an adviser to customize sanctions based on the severity of the
violation.614 While it may be true that some of these approaches could diminish the
compliance burdens on advisers, including small advisers, as we explain above, we
considered these alternative approaches and do not believe they would appropriately
address the kind of conduct at which our rule is directed.615
We are sensitive to the burdens our rule amendments will have on small advisers.
We believe that the rule we are adopting today contains a number of modifications from
what we had proposed that will alleviate many of the commenters’ concerns regarding
small advisers. Most notably, as described above, we have created an exception to the
third-party solicitor ban for “regulated persons,” which will, for instance, allow advisers
to continue to use third party placement agents to sell interests in covered investment
pools they manage instead of incurring additional costs to hire internal marketing staff, a
result that could have disproportionally affected small advisers.616 Moreover, as
discussed above, we have modified the exceptions to the rule’s two-year time out
provisions in certain respects to reduce the likelihood of an inadvertent or minor violation
of the rule, including a shortened look back of six months for certain new covered
associates whose contributions are less likely to involve pay to play and a new de minimis
exception for contributions to officials for whom a covered associate is not entitled to
614 See id.
615 See id.
616 See section II.B.2(b) of this Release.
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vote.617 We have also limited certain recordkeeping requirements we had proposed in
order to achieve our goals in a way that balances the costs and benefits of the rule,
including not requiring records of unsuccessful solicitations or payments (that are not
contributions) by advisers or covered associates to government officials.618
VII.
EFFECTS ON COMPETITION, EFFICIENCY AND CAPITAL
FORMATION
We are adopting amendments to rule 204-2 pursuant to our authority under
sections 204 and 211. Section 204 requires the Commission, when engaging in
rulemaking pursuant to that authority, to consider whether the rule is “necessary or
appropriate in the public interest or for the protection of investors.”619 Section 202(c) of
the Advisers Act requires the Commission, when engaging in rulemaking that requires it
to consider or determine whether an action is necessary or appropriate in the public
interest, to consider, in addition to the protection of investors, whether the action will
promote efficiency, competition, and capital formation.620
In the Proposing Release, we solicited comment on whether, if adopted, the
proposed amendments to rule 204-2 would promote efficiency, competition and capital
formation. We further encouraged commenters to provide empirical data to support their
views on any burdens on efficiency, competition or capital formation that might result
from adoption of the proposed amendments. We did not receive any empirical data in
617
See sections II.B.2(a)(5) and (6) of this Release.
618
See sections II.D and III.B.3. of this Release.
619
15 U.S.C. 80b-4.
620
15 U.S.C. 80b-2(c). In contrast, we are adopting rule 206(4)-5 and amendments to rule
206(4)-3 pursuant to our authority set forth in sections 206(4) and 211. For a discussion
of the effects of these amendments on competition, efficiency and capital formation, see
sections IV, V, and VI of this Release.
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this regard concerning the proposed amendments. We received some general comments,
addressed below, asserting that the proposed amendments to require registered advisers to
maintain books and records relating to investment advisory services they provide to
government entities would have an adverse impact on competition.
We are amending rule 204-2 to require a registered adviser to make and keep a
list of its covered associates, the government entities to which the adviser directly or
indirectly provides advisory services, the “regulated person” solicitors the adviser retains,
and the contributions made by the firm and its covered associates, as applicable, to
government officials and candidates.621 The amendments are designed to provide our
examiners important information about the adviser and its covered associates’
contributions to government officials, the government entities to which the adviser
directly or indirectly provides advisory services, and the solicitors it retains. These
amendments may also benefit advisers as records required under the amended rule will
assist the Commission in enforcing the rule against, for example, an adviser whose pay to
play activities, if not uncovered, could adversely affect the competitive position of a
compliant adviser.
Although we believe that the amendments to the Advisers Act recordkeeping rule
will require advisers to incur both one-time costs to establish and enhance current
systems to assist in their compliance with the amendments and ongoing costs to maintain
records, these costs will be borne by all registered advisers that have government entity
clients or that pay regulated entities to solicit government clients on their behalf. As the
amendments to the recordkeeping rule do not disproportionally affect any particular
Rule 204-2(a)(18)(i).
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group of advisers with government entity clients and do not materially increase the
compliance burden on advisers under rule 204-2, we do not believe that they will affect
competition across registered investment advisers. Some commenters asserted that
certain asset managers that provide advice to government entities but are not subject to
the Advisers Act recordkeeping rule, such as banks and advisers that are exempt from
registration under the Act, may be at a competitive advantage to registered advisers that
must incur the costs of keeping records under the rule.622 While we acknowledge these
entities could potentially obtain a competitive advantage for this reason, we do not
believe the costs attributable to the amendments to rule 204-2 will have a significant
impact on registered advisers such that the advantage gained by asset managers not
subject to the Advisers Act recordkeeping rule will be substantial.623 Moreover, exempt
advisers or persons that do not meet the definition of investment adviser are not subject to
rule 204-2.624 Finally, we also note that banks may be subject to laws and rules that do
not apply to registered advisers.
We believe that the amendments to rule 204-2 may, to a limited extent, affect
efficiency and capital formation with respect to the allocation of public pension plan
assets. The amendments to rule 204-2 will allow our staff to examine for compliance
622
SIFMA Letter (“The books and records requirement under the Proposed Rule are under
inclusive. . . . As an initial matter, the books and records requirements apply only to
some of the advisers covered by the Proposed Rule – although the Proposed Rule applies
to a substantial number of entities who are exempt from registration under the Advisers
Act, the Proposed Rule’s additional books and records only modify the rules that apply to
registered investment advisers.”).
623
In addition, we note that advisers not subject to the amendments to rule 204-2 may
nonetheless maintain some of the required records as part of a strong compliance
program.
624
See section 204 of the Advisers Act, 15 U.S.C. 80b-4 (that provides the Commission
authority to prescribe recordkeeping for advisers, other than those specifically exempted
from registration).
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with rule 206(4)-5. Authority to examine records may improve registered investment
advisers’ compliance with rule 206(4)-5, which may reduce the adverse effects of
political contributions on the selection of investment advisers. While the amendments to
the rule will not affect the aggregate amount of pension fund assets available for
investment, limiting the effects of political contributions on the investment adviser
selection process should improve the mechanism by which capital is formed and
allocated to investment opportunities.
VIII. STATUTORY AUTHORITY
The Commission is adopting new rule 206(4)-5 and amending rule 206(4)-3 of the
Advisers Act pursuant to the authority set forth in sections 206(4) and 211(a) of the
Investment Advisers Act of 1940 [15 U.S.C. 80b-6(4), 80b-11(a)].
The Commission is amending rule 204-2 of the Advisers Act pursuant to the
authority set forth in sections 204 and 211(a) of the Advisers Act [15 U.S.C. 80b-4 and
80b-11(a)].
List of Subjects in 17 CFR Part 275
Reporting and recordkeeping requirements; Securities.
For the reasons set out in the preamble, Title 17 Chapter II of the Code of Federal
Regulations is amended as follows.
PART 275 -- RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF
1. The authority citation for Part 275 continues to read in part as follows:
Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(17), 80b-3, 80b-4, 80b-4a, 80b6(
4), 80b-6a, and 80b-11, unless otherwise noted.
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* * * * *
2. Section 275.204-2 is amended by adding paragraph (a)(18) and by
revising paragraph (h)(1) to read as follows:
§ 275.204-2 -- Books and records to be maintained by investment advisers.
(a)* * *
(18)(i) Books and records that pertain to § 275.206(4)-5 containing a list or other
record of:
(A) The names, titles and business and residence addresses of all covered
associates of the investment adviser;
(B) All government entities to which the investment adviser provides or has
provided investment advisory services, or which are or were investors in any covered
investment pool to which the investment adviser provides or has provided investment
advisory services, as applicable, in the past five years, but not prior to [insert date 60 days
after publication in Federal Register];
(C) All direct or indirect contributions made by the investment adviser or any of
its covered associates to an official of a government entity, or direct or indirect payments
to a political party of a state or political subdivision thereof, or to a political action
committee; and
(D) The name and business address of each regulated person to whom the
investment adviser provides or agrees to provide, directly or indirectly, payment to solicit
a government entity for investment advisory services on its behalf, in accordance with §
275.206(4)-5(a)(2).
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(ii) Records relating to the contributions and payments referred to in paragraph
(a)(18)(i)(C) of this section must be listed in chronological order and indicate:
(A) The name and title of each contributor;
(B) The name and title (including any city/county/state or other political
subdivision) of each recipient of a contribution or payment;
(C) The amount and date of each contribution or payment; and
(D) Whether any such contribution was the subject of the exception for certain
returned contributions pursuant to § 275.206(4)-5(b)(2).
(iii) An investment adviser is only required to make and keep current the records
referred to in paragraphs (a)(18)(i)(A) and (C) of this section if it provides investment
advisory services to a government entity or a government entity is an investor in any
covered investment pool to which the investment adviser provides investment advisory
services.
(iv) For purposes of this section, the terms “contribution,” “covered associate,”
“covered investment pool,” “government entity,” “official,” “payment,” “regulated
person,” and “solicit” have the same meanings as set forth in § 275.206(4)-5.
* * * * *
(h)(1) Any book or other record made, kept, maintained and preserved in
compliance with §§ 240.17a-3 and 240.17a-4 of this chapter under the Securities
Exchange Act of 1934, or with rules adopted by the Municipal Securities Rulemaking
Board, which is substantially the same as the book or other record required to be made,
kept, maintained and preserved under this section, shall be deemed to be made, kept,
maintained and preserved in compliance with this section.
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* * * * *
3. Section 275.206(4)-3 is amended by adding paragraph (e) and removing
the authority citation at the end of the section to read as follows:
§ 275.206(4)-3 Cash payments for client solicitations.
* * * * *
(e) Special rule for solicitation of government entity clients. Solicitation activities
involving a government entity, as defined in § 275.206(4)-5, shall be subject to the
additional limitations set forth in that section.
4. Section 275.206(4)-5 is added to read as follows:
§ 275.206(4)-5 Political contributions by certain investment advisers.
(a) Prohibitions. As a means reasonably designed to prevent fraudulent,
deceptive or manipulative acts, practices, or courses of business within the meaning of
section 206(4) of the Act (15 U.S.C. 80b-6(4)), it shall be unlawful:
(1) For any investment adviser registered (or required to be registered) with the
Commission, or unregistered in reliance on the exemption available under section
203(b)(3) of the Advisers Act (15 U.S.C. 80b-3(b)(3)) to provide investment advisory
services for compensation to a government entity within two years after a contribution to
an official of the government entity is made by the investment adviser or any covered
associate of the investment adviser (including a person who becomes a covered associate
within two years after the contribution is made); and
(2) For any investment adviser registered (or required to be registered) with the
Commission, or unregistered in reliance on the exemption available under section
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203(b)(3) of the Advisers Act (15 U.S.C. 80b-3(b)(3)) or any of the investment adviser’s
covered associates:
(i) To provide or agree to provide, directly or indirectly, payment to any person
to solicit a government entity for investment advisory services on behalf of such
investment adviser unless such person is a regulated person or is an executive officer,
general partner, managing member (or, in each case, a person with a similar status or
function), or employee of the investment adviser; and
(ii) To coordinate, or to solicit any person or political action committee to make,
any:
(A) Contribution to an official of a government entity to which the investment
adviser is providing or seeking to provide investment advisory services; or
(B) Payment 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.
(b) Exceptions.
(1) De minimis exception. Paragraph (a)(1) of this section does not apply to
contributions made by a covered associate, if a natural person, to officials for whom the
covered associate was entitled to vote at the time of the contributions and which in the
aggregate do not exceed $350 to any one official, per election, or to officials for whom
the covered associate was not entitled to vote at the time of the contributions and which
in the aggregate do not exceed $150 to any one official, per election.
(2) Exception for certain new covered associates. The prohibitions of paragraph
(a)(1) of this section shall not apply to an investment adviser as a result of a contribution
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made by a natural person more than six months prior to becoming a covered associate of
the investment adviser unless such person, after becoming a covered associate, solicits
clients on behalf of the investment adviser.
(3) Exception for certain returned contributions.
(i) An investment adviser that is prohibited from providing investment advisory
services for compensation pursuant to paragraph (a)(1) of this section as a result of a
contribution made by a covered associate of the investment adviser is excepted from such
prohibition, subject to paragraphs (b)(3)(ii) and (b)(3)(iii) of this section, upon
satisfaction of the following requirements:
(A) The investment adviser must have discovered the contribution which resulted
in the prohibition within four months of the date of such contribution;
(B) Such contribution must not have exceeded $350; and
(C) The contributor must obtain a return of the contribution within 60 calendar
days of the date of discovery of such contribution by the investment adviser.
(ii) In any calendar year, an investment adviser that has reported on its annual
updating amendment to Form ADV (17 CFR 279.1) that it has more than 50 employees is
entitled to no more than three exceptions pursuant to paragraph (b)(3)(i) of this section,
and an investment adviser that has reported on its annual updating amendment to Form
ADV that it has 50 or fewer employees is entitled to no more than two exceptions
pursuant to paragraph (b)(3)(i) of this section.
(iii) An investment adviser may not rely on the exception provided in paragraph
(b)(3)(i) of this section more than once with respect to contributions by the same covered
associate of the investment adviser regardless of the time period.
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(c) Prohibitions as applied to covered investment pools. For purposes of this
section, an investment adviser to a covered investment pool in which a government entity
invests or is solicited to invest shall be treated as though that investment adviser were
providing or seeking to provide investment advisory services directly to the government
entity.
(d) Further prohibition. As a means reasonably designed to prevent fraudulent,
deceptive or manipulative acts, practices, or courses of business within the meaning of
section 206(4) of Advisers Act (15 U.S.C. 80b-6(4)), it shall be unlawful for any
investment adviser registered (or required to be registered) with the Commission, or
unregistered in reliance on the exemption available under section 203(b)(3) of the
Advisers Act (15 U.S.C. 80b-3(b)(3)), or any of the investment adviser’s covered
associates to do anything indirectly which, if done directly, would result in a violation of
this section.
(e) Exemptions. The Commission, upon application, may conditionally or
unconditionally exempt an investment adviser from the prohibition under paragraph
(a)(1) of this section. In determining whether to grant an exemption, the Commission
will consider, among other factors:
(1) Whether the exemption is necessary or appropriate in the public interest and
consistent with the protection of investors and the purposes fairly intended by the policy
and provisions of the Advisers Act (15 U.S.C. 80b);
(2) Whether the investment adviser:
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(i) Before the contribution resulting in the prohibition was made, adopted and
implemented policies and procedures reasonably designed to prevent violations of this
section; and
(ii) Prior to or at the time the contribution which resulted in such prohibition was
made, had no actual knowledge of the contribution; and
(iii) After learning of the contribution:
(A) Has taken all available steps to cause the contributor involved in making the
contribution which resulted in such prohibition to obtain a return of the contribution; and
(B) Has taken such other remedial or preventive measures as may be appropriate
under the circumstances;
(3) Whether, at the time of the contribution, the contributor was a covered
associate or otherwise an employee of the investment adviser, or was seeking such
employment;
(4) The timing and amount of the contribution which resulted in the prohibition;
(5) The nature of the election (e.g, federal, state or local); and
(6) The contributor’s apparent intent or motive in making the contribution which
resulted in the prohibition, as evidenced by the facts and circumstances surrounding such
contribution.
(f) Definitions. For purposes of this section:
(1) Contribution means any gift, subscription, loan, advance, or deposit of money
or anything of value made for:
(i) The purpose of influencing any election for federal, state or local office;
(ii) Payment of debt incurred in connection with any such election; or
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(iii) Transition or inaugural expenses of the successful candidate for state or local
office.
(2) Covered associate of an investment adviser means:
(i) Any general partner, managing member or executive officer, or other
individual with a similar status or function;
(ii) Any employee who solicits a government entity for the investment adviser
and any person who supervises, directly or indirectly, such employee; and
(iii) Any political action committee controlled by the investment adviser or by
any person described in paragraphs (f)(2)(i) and (f)(2)(ii) of this section.
(3) Covered investment pool means:
(i) An investment company registered under the Investment Company Act of
1940 (15 U.S.C. 80a) that is an investment option of a plan or program of a government
entity; or
(ii) Any company that would be an investment company under section 3(a) of the
Investment Company Act of 1940 (15 U.S.C. 80a-3(a)), but for the exclusion provided
from that definition by either section 3(c)(1), section 3(c)(7) or section 3(c)(11) of that
Act (15 U.S.C. 80a-3(c)(1), (c)(7) or (c)(11)).
(4) Executive officer of an investment adviser means:
(i) The president;
(ii) Any vice president in charge of a principal business unit, division or function
(such as sales, administration or finance);
(iii) Any other officer of the investment adviser who performs a policy-making
function; or
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(iv) Any other person who performs similar policy-making functions for the
investment adviser.
(5) Government entity means any state or political subdivision of a state,
including:
(i) Any agency, authority, or instrumentality of the state or political subdivision;
(ii) A pool of assets sponsored or established by the state or political subdivision
or any agency, authority or instrumentality thereof, including, but not limited to a
“defined benefit plan” as defined in section 414(j) of the Internal Revenue Code (26
U.S.C. 414(j)), or a state general fund;
(iii) A plan or program of a government entity; and
(iv) Officers, agents, or employees of the state or political subdivision or any
agency, authority or instrumentality thereof, acting in their official capacity.
(6) Official means any person (including any election committee for the person)
who was, at the time of the contribution, an incumbent, candidate or successful candidate
for elective office of a government entity, if the office:
(i) Is directly or indirectly responsible for, or can influence the outcome of, the
hiring of an investment adviser by a government entity; or
(ii) Has authority to appoint any person who is directly or indirectly responsible
for, or can influence the outcome of, the hiring of an investment adviser by a government
entity.
(7) Payment means any gift, subscription, loan, advance, or deposit of money or
anything of value.
--200--
(8) Plan or program of a government entity means any participant-directed
investment program or plan sponsored or established by a state or political subdivision or
any agency, authority or instrumentality thereof, including, but not limited to, a “qualified
tuition plan” authorized by section 529 of the Internal Revenue Code (26 U.S.C. 529), a
retirement plan authorized by section 403(b) or 457 of the Internal Revenue Code (26
U.S.C. 403(b) or 457), or any similar program or plan.
(9) Regulated person means:
(i) An investment adviser registered with the Commission that has not, and whose
covered associates have not, within two years of soliciting a government entity:
(A) Made a contribution to an official of that government entity, other than as
described in paragraph (b)(1) of this section; and
(B) Coordinated or solicited any person or political action committee to make
any contribution or payment described in paragraphs (a)(2)(ii)(A) and (B) of this section;
or
(ii) A “broker,” as defined in section 3(a)(4) of the Securities Exchange Act of
1934 (15 U.S.C. 78c(a)(4)) or a “dealer,” as defined in section 3(a)(5) of that Act (15
U.S.C. 78c(a)(5)), that is registered with the Commission, and is a member of a national
securities association registered under section 15A of that Act (15 U.S.C. 78o-3),
provided that:
(A) The rules of the association prohibit members from engaging in distribution
or solicitation activities if certain political contributions have been made; and
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(B) The Commission, by order, finds that such rules impose substantially
equivalent or more stringent restrictions on broker-dealers than this section imposes on
investment advisers and that such rules are consistent with the objectives of this section.
(10) Solicit means:
(i) With respect to investment advisory services, to communicate, directly or
indirectly, for the purpose of obtaining or retaining a client for, or referring a client to, an
investment adviser; and
(ii) With respect to a contribution or payment, to communicate, directly or
indirectly, for the purpose of obtaining or arranging a contribution or payment.
By the Commission.
Elizabeth M. Murphy
Secretary
Dated: July 1, 2010