SEC Adopts New Rules Limiting Political Contributions by Investment Advisors

Citing pay-to-play problems in the management of public funds by investment advisors, on June 30 the Securities and Exchange Commission passed new rules that prohibit pay-to-play practices. The SEC first considered these rules, modeled after the MSRB G-37 and G-38 rules, in 1999. While the rules generally go into effect 60 days after publication in the Federal Register, the effective dates for some of the rules are extended to provide time for compliance. The new rules prohibit investment advisers from receiving compensation for advisory services to a government client for two years if they or “covered associates” make political contributions to covered officials or candidates. Covered officials include 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 selection 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 selection of an investment adviser. “Covered Associates” include the adviser’s general partners, managing members, executive officers, and other individuals with a similar status or function. Employees of the adviser who solicit government entity clients for the investment adviser and the supervisors of any such employees are also covered associates. Additionally, any political action committee controlled by the investment adviser or any of the adviser’s covered associates is included in the definition of covered associates. This prohibition will first be triggered by contributions made six months after the effective date; thus, contributions prior to the November 2010 elections are not covered by the new rules. Investment advisors should, of course use this six-month transition period to identify their covered associates and to modify their compliance programs and corporate political activity policies to enable full compliance with the new requirements before they take affect. The new rules also:

• Prohibit an adviser from providing payment to any third party for a solicitation of advisory business from any government entity on behalf of such adviser unless the third-party is registered with the SEC or FINRA. This prohibition goes into effect one year after the effective date.
• Prohibit an adviser from soliciting or coordinating contributions (i.e. bundling) to officials or candidates or payments to political parties where the adviser is providing or seeking government business. This prohibition will first be triggered by contributions made six months after the effective date.
• Require a registered adviser to maintain records of the political contributions made by the adviser or covered executives and employees. The record retention rule goes into effect six months after the effective date.

The new rules contain a de minimis exception that would permit each covered associate who is an individual to make aggregate contributions of $350 or less, per election, to an elected official or candidate if the person making the contribution is entitled to vote for the official or candidate. The de minimis exception is $150 for contributors not entitled to vote for the official or candidate. The SEC may exempt advisers from the rule’s two-year ban where the adviser discovers contributions that trigger the ban only after they have been made or when imposition of the prohibitions is unnecessary to achieve the rule’s intended purpose. In determining whether to grant an exemption from the two-year compensation ban, the SEC must consider, inter alia, whether the exemption is necessary or appropriate in the public interest and consistent with the protection of investors and whether the investment adviser had no actual knowledge of the contribution prior to it being made and taken all steps to obtain a refund. Importantly, the SEC must also consider whether, before the contribution was made, the adviser adopted and implemented policies and procedures reasonably designed to prevent violations. In adopting these rules the SEC noted that several local jurisdictions have adopted their own regulations. For example, New York State Comptroller DiNapoli issued an Executive Order last year imposing similar restrictions. The DiNapoli order provides that its restrictions will remain in effect until the SEC adopts these final rules. On the other hand, New Jersey State Investment Council’s restrictions on political contributions have been in effect for more than five years and do not express an intent to sunset. The SEC has not indicated that its rules supersede existing or future local restrictions. Accordingly, in some jurisdictions, the SEC rules will co-exist with local restrictions, and compliance policies and practices will need to be devised to meet those multiple obligations. If you would like more information on this topic, please contact Laurence D. Laufer.