SEC Proposes New Pay to Play Restrictions
October 22, 2009
Background The Securities and Exchange Commission (“SEC”) has reconsidered a rule it last considered in 1999 to curb political contributions by investment advisers seeking to manage the investment of state pension funds. The new proposal comes in the wake of continuing investigations by New York Attorney General Andrew Cuomo (“NYAG”) concerning investments by New York’s largest pension fund under former State Comptroller Alan Hevesi. These investigations have resulted in a “Public Pension Fund Reform Code of Conduct,” issued by the NYAG, which restricts campaign contributions by investment firms and related parties as a condition of maintaining eligibility to accept, manage or retain investments from or to provide investment management services to public pension funds. The Cuomo Code is national in scope; it is not limited to government pension funds in New York. The NYAG has made firm acceptance of this Code of Conduct a condition for resolving allegations. In its 1999 proposal, the SEC looked to Municipal Securities Rulemaking Board (“MSRB”) Rule G-37 as a model. In brief, G-37 bans broker-dealers and municipal finance professionals from engaging in the municipal securities business for two years after soliciting or making a contribution to an official of a governmental issuer. G-37 is distinctive as the product of a self-regulatory organization and not merely an imposition by an agency of government. In 1999, the SEC proposed but ultimately failed to adopt a similar rule to ban investment advisory firms from providing paid advisory services to a government entity for two years after the firm (or its partners, executive officers, or political action committee) made or solicited a contribution to an official of that government entity directly or indirectly responsible for the use of an investment adviser (including candidates for such office). As in G-37, contributions up to $250 per election made to officials for whom the contributor was entitled to vote would not trigger the ban. Measures Taken by New Jersey and Connecticut Since 1999 Since the 1999 SEC proposal, some states, notably New Jersey and Connecticut, have stepped into the breach by implementing pay to play restrictions on investment managers. The New Jersey rules, also modeled after G-37, are similar to the 1999 SEC proposal. Both (i) impose a two year ban on the award of business following a covered contribution; (ii) reach the making and solicitation of contributions, as well as “indirect” violations; and (iii) include a de minimis exception for certain contributions of $250 or less. The New Jersey rules have a broader reach. For example, the New Jersey ban extends beyond partners, executives, solicitors, and PACs to also cover contributions made or solicited by the investment management firm’s parent company, controlling persons or entities, various employees defined as “investment management professionals,” and third party solicitors. The New Jersey ban also covers a broader range of contribution recipients, including candidates for state and local office, and political parties, regardless whether the recipient has a role in choosing investment advisers for the state. New Jersey also requires extensive periodic reporting, a feature absent from the 1999 SEC proposal. Connecticut’s statute reaches an even broader group of contributors. These individuals, defined as principals of an investment services firm, include directors, individuals with an ownership interest, senior executives, employees with managerial or discretionary responsibilities with respect to investment services, and their spouses and dependent children. Investment services are broadly defined as investment legal, banking or advisory services, underwriting services, financial advisory services and brokerage firm services. Likewise following the G-37 structure, the Connecticut State Treasurer is barred from issuing any contract to any firm which provides investment services if a principal of that firm has made or solicited a contribution to a candidate for State Treasurer. The ban covers the full term of office as State Treasurer following the contribution and also the remainder of the prior term in the case of an incumbent Treasurer seeking reelection. There is no exception for small contributions. Proposed New Rule 206(4)-5: “Political Contributions by Certain Investment Advisers" As in its aborted 1999 proposal, the SEC models its current proposed rule: “Political Contributions by Certain Investment Advisers” on MSRB Rule G-37. In addition, the current proposed rule also incorporates MSRB Rule G-38. MSRB rule G-38 prohibits municipal securities dealers from paying third-party solicitors to solicit municipal securities business. As applied here, investment advisers would be prohibited from paying third parties to solicit government entities for advisory business. Thus, in addition to the ban proposed by the 1999 proposal the current proposal attempts to curtail “pay-to-play” practices engaged in by investment advisors through making it unlawful to use third party solicitors to obtain government clients. Additionally, the proposed rule would also prohibit the solicitation or coordination of contributions by advisers for “an official of a government entity to which the investment advisor is seeking to provide investment advisory services.” Accordingly, the three means by which the current proposed rule attempts to rein in investment advisors participation in “pay-to play” practices are:
- Making it unlawful for an investment adviser to be compensated for advisory services provided to a government entity within two years of making a political contribution to a public official “that is in a position to influence the award of advisory business.” Note that the prohibition is on the adviser receiving compensation for advisory services and not on making contributions or providing services after making contributions. This distinction is important because it was deliberately designed to avoid forcing advisors to abandon government entity clients;
- Prohibiting the use of third parties to solicit advisory business from government entities. Not included in the definition of third parties are “related persons.” Related persons are defined as “any person, directly or indirectly, controlling or controlled by the investment adviser, and any person that is under common control with the investment adviser;” and
- Prohibiting the solicitation or coordination of contributions for public officials of government entities that the adviser would like to furnish with advisory services.