Federal Register: August 7, 2009 (Volume 74, Number 151)
DOCID: fr07au09-18 FR Doc E9-18807
SECURITIES AND EXCHANGE COMMISSION
Veterans Affairs Department
CFR Citation: 17 CFR Part 275
RIN ID: RIN 3235-AK39
NOTICE: Part IV
DOCID: fr07au09-18
DOCUMENT ACTION: Proposed rule.
SUBJECT CATEGORY:
Political Contributions by Certain Investment Advisers
DATES: Comments should be received on or before October 6, 2009.
DOCUMENT SUMMARY:
The Securities and Exchange Commission is proposing for comment a new rule under the Investment Advisers Act of 1940 that would prohibit 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 would also prohibit 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. Additionally, the new rule would prevent 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 proposing rule amendments that would 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 would address ``pay to play'' practices by investment advisers.
SUMMARY:
Securities and Exchange Commission
SUPPLEMENTAL INFORMATION
The Commission is requesting public comment
on proposed rule 206(4)5 [17 CFR 275.206(4)5] and proposed amendments
to rules 2042 [17 CFR 275.2042] 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'').
I. Background and Introduction
II. Discussion
A. Rule 206(4)5: ``Pay to Play'' Restrictions
1. Advisers Subject to the Rule
2. Relationship with MSRB Rules; Alternative Approaches
3. Pay to Play Restrictions
(a) TwoYear ``Time Out'' for Contributors
(1) Prohibition on Compensation
(2) Officials of a Government Entity
(3) Contributions
(4) Covered Associates
(5) ``Look Back''
(6) Exception for De Minimis Contributions
(7) Exception for Certain Returned Contributions
(b) Ban on Using Third Parties To Solicit Government Business
(c) Restrictions on Soliciting and Coordinating Contributions and Payments
(d) Direct and Indirect Contributions or Solicitations
(e) Investment Pools
(1) Application of the Rule to Pooled Investment Vehicles (2) Covered Investment Pools
(3) Applying the Compensation Limit to Covered Investment Pools (f) Exemptions
B. Recordkeeping
C. Amendment to Cash Solicitation Rule
D. Transition Period
E. General Request for Comment
III. Cost/Benefit Analysis
A. Benefits
B. Costs
C. Request for Comment
IV. Paperwork Reduction Act
A. Rule 2042
B. Rule 206(4)3
C. Request for Comment
V. Initial Regulatory Flexibility Analysis
A. Reasons for Proposed Action
B. Objectives and Legal Basis
C. Small Entities Subject to Rule
D. Reporting, Recordkeeping, and Other Compliance Requirements
E. Duplicative, Overlapping, or Conflicting Federal Rules
F. Significant Alternatives
G. Solicitation of Comments
VI. Effects on Competition, Efficiency and Capital Formation VII. Consideration of Impact on the Economy
VIII. Statutory Authority
I. Background and Introduction
Investment advisers provide a wide variety of advisory services to
State and local governments.\1\ Advisers manage public monies that fund
pension plans and a number of other important public programs,
including transportation, children's programs, arts programs,
environmental reclamation, and financial aid for education. In
addition, advisers provide risk management,\2\ asset allocation,\3\
financial planning \4\ and cash management services; \5\ assist in investing proceeds from bond
[[Page 39841]]
offerings; \6\ help State and local governments find and evaluate other
advisers that manage public funds (``pension consultants''); \7\ and provide other types of services.\8\
\1\ 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, in Local
Government Finance, Concepts and Practices 376 (John E. Peterson and
Dennis R. Strachota, eds., 1st ed. 1991) (discussing the services investment advisers provide for public funds).
\2\ See Robert A. Fippinger, The Securities Law of Public Finance 669 (2d ed. 2004).
\3\ See, e.g., John H. Ilkiw, Investment Policies, Processes and
Problems in U.S. Public Sector Pension Plans: Some Observations and
Solutions from a Practitioner, in Public Pension Fund Management:
Governance, Accountability and Investment Policies (Alberto R.
Musalem and Robert J. Palacios, eds. 2004). See also Barry B. Burr,
The New $100 Billion Club, Pens. & Inv. (May 4, 1998), at 1.
\4\ See Cal. Ed. Code Sec. 22303.5 (2008) (requiring teachers'
retirement system to offer retirement planning services to
beneficiaries); CalSTRS Counseling and Workshops, available at
http://www.calstrs.com/Counseling%20and%20Workshops/index.aspx.
Other funds also offer financial planning services to their
beneficiaries. See, e.g., CalPERS Launches Online Education Classes, U.S. States News (Mar. 3, 2008).
\5\ See Government Finance Officers Association, An Introduction
to External Money Management for Public Cash Managers 5 (1991).
\6\ See In the Matter of O'Brien Partners, Inc., Investment
Advisers Act Release No. 1772 (Oct. 27, 1998) (settled enforcement
action in which financial advisor was deemed subject to the Advisers Act for rendering advice to municipal securities issuers
``concerning their investment of bond proceeds in securities,
including [nongovernment securities], and was compensated for that advice'').
\7\ In addition to assisting public funds in selecting
investment advisers, pension consultants may also provide advice to
State and local governments on such things as designing investment
objectives, or recommending specific securities or investments for
the fund. Pension consultants may be investment advisers subject to
the Advisers Act. See 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)] (``Release 1092'').
\8\ For example, public funds may retain advisers to perform
custodial services. See, e.g., Public Employee Retirement Systems, supra note 1, at 37677.
Most of the public funds managed by investment advisers fund State
and municipal pension plans.\9\ These pension plans have over $2.2
trillion of assets and represent onethird of all U.S. pension
assets.\10\ They are among the largest and most active institutional
investors in the United States.\11\ The management of these funds
significantly affects publicly held companies \12\ and the securities
markets.\13\ But most significantly, their management affects taxpayers
and the beneficiaries of these funds, including the millions of present
and future State and municipal retirees \14\ who rely on the funds for their pensions and other benefits.\15\
\9\ For this reason, in this Release, we use the term ``public
pension plan'' interchangeably with ``government client'' and
``government entity''; however, our proposed rule would apply
broadly to investment advisory activities for government clients,
such as those mentioned here in this Background and Introduction,
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 infra section II.A.3(e) of this Release.
\10\ Board of Governors of the Federal Reserve System, Flow of
Funds Accounts of the United States, Flows and Outstandings, First
Quarter 2009 (June 11, 2009) (at table L.119). Since 2002, total
financial assets of public pension funds have grown by 13% Id.
\11\ 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.
\12\ See Stephen J. Choi & Jill E. Fisch, On Beyond CalPERS:
Survey Evidence on the Developing Role of Public Pension Funds in
Corporate Governance, 61 Vanderbilt L.Rev. 315 (Mar. 2008) (noting,
``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.'').
\13\ Federal Reserve reports indicate that, of the $2.2 trillion
in nonFederal government plans, $1.1 trillion are invested in
corporate equities. Flow of Funds Accounts of the United States, supra note 10 (at table L.119).
\14\ See Paul Zorn, 1997 Survey of State and Local Government
Employee Retirement Systems 61 (1997) (``[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'').
\15\ 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 EmployeeRetirement Systems by State: 20062007 (2007)
(at Table 5), available at http://www.census.gov/govs/retire/ 2007ret05.html.
Public pension plan assets are held, administered and managed by elected officials who often are responsible for selecting investment advisers to manage the funds they oversee. Pay to play practices undermine the fairness of the selection process when advisers seeking to do business with the governments of States and municipalities make political contributions to elected officials or candidates, hoping to influence the selection process. In other cases, political contributions may be solicited from advisers, or it is simply understood that only contributors will be considered for selection. Contributions, in this circumstance, may not always guarantee an award of business to the contributor, but the failure to contribute will guarantee that another is selected. Hence the term ``pay to play.''
Elected officials who allow political contributions to play a role in the management of these assets violate the public trust by rewarding those who make political contributions. Similarly, investment advisers that seek to influence the award of advisory contracts by public entities, by making or soliciting political contributions to those officials who are in a position to influence the awards, compromise their fiduciary obligations. Pay to play practices can distort the process by which investment advisers are selected and can harm advisers' public pension plan clients, and the pension plan beneficiaries, which may receive inferior advisory services and pay higher fees because, for instance, advisers must recoup contributions, or because contract negotiations are not handled on an arm'slength basis. Pay to play practices also 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. We believe that advisers' participation in pay to play practices is inconsistent with the high standards of ethical conduct required of them under the Advisers Act.
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, in its decision upholding one of the rules
on which the proposed rule is modeled, ``[w]hile the risk of corruption
is obvious and substantial, actors in this field are presumably shrewd
enough to structure their relations rather indirectly.'' \16\ 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.
\16\ Blount v. SEC, 61 F.3d 938, 945 (DC Cir. 1995), cert. denied, 517 U.S. 1119 (1996).
The rule we are proposing today is modeled on rules G37 and G38
of the Municipal Securities Rulemaking Board (``MSRB''),\17\ which
address pay to play practices in the municipal securities markets.\18\
The Commission approved rule G37 in 1994, after concluding that pay to
play practices harm municipal securities markets.\19\ MSRB rule G37 [[Page 39842]]
prohibits a brokerdealer from engaging in municipal securities
business with a municipal issuer for two years after making a political
contribution to an elected official of the issuer who can influence the
selection of the brokerdealer.\20\ The rule also prohibits a broker
dealer from providing or seeking to provide underwriting services to a government if the firm or any of its ``municipal finance
professionals'' solicit contributions for a candidate or an elected
official of that government, or if they solicit payments to political
parties where the firm is providing or seeking to provide services to a
government client.\21\ MSRB rule G38 prohibits municipal securities
dealers from making payments to consultants for soliciting municipal
securities business.\22\ We believe that MSRB rules G37 and G38 have
been successful in addressing pay to play practices in the municipal securities market.\23\
\17\ 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'').
The Commission also proposed amendments in 1999 to rule 2042 [17
CFR 275.2042] under the Advisers Act, which would have required
advisers with government clients to keep certain records relating to
the 1999 proposed rule. See id., at section II.B. We are not re
proposing that rule or those rule amendments today; we are
withdrawing our 1999 proposal and proposing a new rule 206(4)5 as well as new amendments to rule 2042.
\18\ MSRB rule G37 and G38 are available on the MSRB's Web
site at http:// www.msrb.org/msrb1/rules/ruleg38.htm, respectively.
\19\ See In the Matter of SelfRegulatory 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)] (``MSRB Rule G37 Approval Order''), at sections V.A.1 and 2.
In approving MSRB rule G37, we concluded that pay to play practices
may harm the municipal markets by fostering a selection process that
excludes those firms that do not make contributions, causes less
qualified underwriters to be retained, and undermines equitable
practices in the municipal securities industry. Id. at section V.
\20\ MSRB rule G37(b). Shortly after MSRB rule G37 became
effective, a municipal securities dealer challenged it as an
infringement on the constitutional rights of municipal securities
professionals. A Federal appeals court upheld the constitutionality
of MSRB rule G37, finding that the rule is narrowly tailored to
serve a compelling government interest. See Blount, supra note 16.
\21\ MSRB rule G37(c). A ``municipal finance professional'' is
an associated person of a brokerdealer who is ``primarily engaged''
in municipal securities activities, who solicits municipal
securities business on behalf of a brokerdealer, who supervises
associated persons primarily engaged in municipal securities
activities ``up through and including'' the chief executive officer
of the firm (or person performing similar functions), or who is a
member of the firm's executive or management committee (or person performing similar functions). MSRB rule G37(g)(iv).
\22\ MSRB rule G38(a).
\23\ Others, including the MSRB, agree. See, e.g., MSRB Notice
200935, Request for Comment: Rule G37 on Political Contributions
and Prohibitions on Municipal Securities BusinessBond 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 paytoplay practices in the new issue
municipal securities market.'' [footnote omitted]); MSRB Notice
200332, Notice Concerning Indirect Rule Violations: Rules G37 and
G38 (Aug. 6, 2003) (``The impact of Rules G37 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, dated Oct. 19, 2001, available at http://www.cfainstitute.org/
centre/topics/comment/2001/01msrb_ruleg37.html (stating, ``We
generally believe that the existing [MSRB] paytoplay 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.''); Cmte. on Cap. Mkts. Reg., Interim Report of the Cmte.
on Cap. Mkts. Reg. (Nov. 30, 2006), available at http://
www.capmktsreg.org/pdfs/11.30Committee_Interim_ReportREV2.pdf
(stating, upon describing MSRB Rule G37 and the 2005 amendments to
MSRB Rule G38, ``Taken together, the MSRB's rules have largely put an end to the old ``pay to play'' practices in municipal
underwriting.'').
Following the adoption of MSRB rule G37, we were increasingly
concerned that the very success of the rule may have caused pay to play
practices to migrate to an area not covered by the MSRB rulesthe
management of public pension plans.\24\ 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 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,\25\ may be members of a governing
board that selects advisers,\26\ or may appoint some or all of the board members who make the selection.\27\
\24\ 1999 Proposing Release, supra note 17, at section I (``We
have become particularly concerned about the possibility that the
adoption of rule G37 has resulted in a shift of pay to play
practices to [the management of public pension funds] as political
contributions by brokerdealers are curtailed.''). See also Bill
Krueger, Money Managers Giving to Boyles, News & Observer (May 2,
1996), at A1 (noting that rule G37 ``dried up'' a contribution
source for a State treasurer, ``so now he is getting campaign
contributions from a group [investment advisers] that is not subject to [rule G37]''); Gerri Willis, Filling Carl's War Chest:
Comptroller Getting Thousands From State's Money Managers, Crain's
N.Y. Bus. (Sept. 16, 1996), at 1 (noting the observation of a
securities executive that ``[b]ecause of the SEC's crackdown on the
pay to play nature of the muni bond business, the game has shifted to asset management and brokerage'').
\25\ See, e.g., 2 NYCRR Sec. 320.2 (placement of State and
local government retirement systems assets (valued at $109 billion
as of Mar. 2009) is under the sole custodianship of the New York State Comptroller).
\26\ See, e.g., S.C. Code Ann. Sec. Sec. 9120, 11110 (2008)
(board consists of all elected officials); Cal. Gov't Code Sec.
20090 (Deering 2008) (board consists of some elected officials, some
appointed members, and some representatives of interest groups
chosen by the members of those groups); Md. Code Ann., State Pers. &
Pens. Sec. 21104 (2008) (pension board consists of some elected
officials, some appointed members, and some representatives of interest groups chosen by the members of those groups).
\27\ See, e.g., Ariz. Rev. Stat. Ann. Sec. 38713 (2008)
(governor appoints all nine members); Hawaii Rev. Stat. Sec. 8824
(2008) (governor appoints three of eight members); Idaho Code Sec. 591304 (2008) (governor appoints all five members).
In response to these concerns, in 1999 we proposed a rule under the
Advisers Act, modeled substantially on MSRB rule G37, that was
designed to prevent advisers from participating in pay to play
practices affecting the management of public pension plans.\28\ In
particular, the 1999 rule proposal would have prohibited an adviser
from receiving compensation for the provision of advisory services for
two years after the advisory firm or any of its partners, executive
officers or solicitors, directly or indirectly, made a contribution to
an elected official who (or a candidate for an elected office that) has
the ability to influence the selection of the adviser.\29\ Comments on
the proposal were mixed, and some commenters that objected asserted
that pay to play was not a problem in the management of public funds.\30\
\28\ See 1999 Proposing Release, supra note 17.
\29\ See id., at section II.A.1.
\30\ We received 59 comment letters on our 1999 proposal.
Commenters representing beneficiaries and public pension plans
expressed concern about pay to play practices and generally favored
our proposed rule. State government officials and investment
advisers generally opposed the rule. State government officials
generally argued that there was no demonstrated need for the
proposed rule and that State laws are adequate to address any
concerns. Most advisers submitting comments opposed the rule's
breadth and complained that the consequences of violating the rule
were too harsh; some denied the existence of the problem we sought
to address. Comment letters on our 1999 proposal and a summary of
comments prepared by our staff are available in our Public Reference Room in File No. S71999. Comment letters we received
electronically are also available at http://www.sec.gov/rules/ proposed/s71999.shtml.
Since then, it has become increasingly clear that pay to play is a
significant problem in the management of public funds by investment
advisers. In recent years, we and criminal authorities have brought a
number of actions charging investment advisers with participating in
pay to play schemes. We recently brought a civil action in Federal
court charging former New York State officials, as well as a
``placement agent,'' with engaging in a fraudulent scheme to extract
kickbacks from investment advisers seeking to manage assets of the New
York State Common Retirement Fund.\31\ Investment advisers allegedly
paid sham ``placement agent'' fees, portions of which were funneled to
public officials, as a means of obtaining public pension fund investments in the
[[Page 39843]]
funds those advisers managed.\32\ Another settled administrative action
involved an investment adviser who allegedly paid kickbacks in return
for investment advisory business awarded by the New Mexico State
treasurer's office.\33\ In addition, we brought two separate cases
against the former treasurer of the State of Connecticut and various
other parties in which we alleged that the former treasurer awarded
State pension fund investments to private equity fund managers in
exchange for fees paid to the former treasurer's friends and political
associates.\34\ Criminal authorities have in recent years also brought
cases in New York,\35\ New Mexico,\36\ Illinois,\37\ Ohio,\38\
Connecticut,\39\ and Florida,\40\ charging defendants with the same or
similar conduct. In addition, there are a growing number of reports
about pay to play activities involving investment advisers in other
jurisdictions.\41\ These cases involving investment advisers, as well
as others involving brokerdealers, may reflect more widespread
involvement by securities professionals in pay to play activities.\42\
\31\ See SEC v. Henry Morris, et al., Litigation Release No. 21036 (May 12, 2009).
\32\ See id.
\33\ See In the Matter of Kent D. Nelson, Investment Advisers
Act Release No. 2765 (Aug. 1, 2008); Initial Decision Release No.
371 (Feb. 24, 2009); Investment Advisers Act Release No. 2868 (Apr.
17, 2009) (in which investment adviser was barred from association with any broker, dealer or investment adviser).
\34\ 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). See also U.S. v. Ben F. Andrews, Litigation Release No.
19566 (Feb. 15, 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).
\35\ 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).
\36\ See U.S. v. Montoya, Criminal No. 052050 JP (D.N.M. Nov.
8, 2005) (the former treasurer of New Mexico pleaded guilty); U.S.
v. Kent Nelson, Criminal Information No. 052021 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's
successor 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).
\37\ See Jeff Coen et al., State's Ultimate Insider Indicted,
Chicago Tribune (Oct. 31, 2008) (describing the thirteenth indictment in an Illinois pay to play probe).
\38\ See Reginald Fields, Four More Convicted in Pension Case:
ExBoard Members Took Gifts from Firm, Cleveland Plain Dealer (Sept.
20, 2006) (addressing pay to play activities of members of the Ohio Teachers Retirement System).
\39\ 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.
filed Oct. 10, 2000) (the former treasurer, along with certain
others, pleaded guiltywhile others were ultimately convicted).
\40\ See 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 found liable for conspiracy and wire fraud for fraudulently paying $40,000 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).
\41\ See, e.g., David Zahniser, California; Private Finances,
Public Role Intersect; Former Pension Board Member Had Consulted for
a Firm that Sought Work with the Panel on Which He Served, Los
Angeles Times (May 9, 2009) (discussing alleged pay to play
activities relating to a former member of the Los Angeles Fire and
Police Pensions Board); Rick Rothacker & David Ingram, Moore Defends
Pension System, Charlotte Observer (Feb. 25, 2007) (discussing
alleged pay to play activities involving North Carolina's State
treasurer); Len Boselovic, Pensions, Politics and Consultants Make
for Unsavory Bedfellows, Pittsburgh PostGazzette (Aug. 13, 2006)
and Jeffrey Cohan, Fund Managers `Pay to Play': Six Firms Managing
County's Pension Investments Gave to Board Members' Campaigns,
Pittsburgh PostGazzette (Feb. 22, 2001) (discussing alleged pay to
play activities relating to the Allegheny County Retirement Board); Mary Williams Walsh, Political Money Said to Sway Pension
Investments, N.Y. Times (Feb. 10, 2004) (regarding a 2002 audit by
thennew controller of Luzerne County, Pennsylvania alleging pay to
play activities among various parties involved with county pension funds).
\42\ For example, we recently brought a case against the mayor
of Birmingham, Alabama, and other defendants, alleging that while
the mayor served as president of the County Commission of Jefferson
County, Alabama, he accepted undisclosed cash and benefits through a
lobbyist as a conduit from the chairman of a Montgomery, Alabama
based brokerdealer, in return for awarding municipal bond business
and swap transactions to the brokerdealer. See SEC v. Larry P.
Langford et al., Litigation Release No. 20545 (Apr. 30, 2008).
Several years earlier, we brought an enforcement action against the
former treasurer of the City of Chicago, to whom two registered
representatives were alleged to have made secret cash payments to
obtain a share of the city's lucrative securities investments. See
SEC v. Miriam Santos et al., Litigation Release No. 17839 (Nov. 14,
2002); Litigation Release No. 19269 (June 14, 2005). We also brought
enforcement actions against the registered representatives allegedly
involved in the scheme. See SEC v. Miriam Santos, Peter J. Burns,
and Michael F. Hollendoner, Litigation Release Nos. 19270 and 19271
(June 14, 2005). In addition, we brought a case against a broker
dealer, two of its officers and a city official for participating in
a scheme to defraud the City of Atlanta in connection with the
purchase and sale of certain securities while providing substantial,
undisclosed monetary benefits to the city's investment officer who
was authorized to select a brokerdealer for the transactions. See
In the Matter of Pryor, McClendon, Counts & Co., Inc. et al.,
Securities Act Release No. 7673 (Apr. 29, 1999); Securities Act
Release No. 8062 (Feb. 6, 2002); Exchange Act Release No. 48095
(June 26, 2003); Securities Act Release No. 8245 (June 26, 2003); Securities Act Release No. 8246 (June 26, 2003).
Recognizing the harm pay to play practices cause in the management
of public funds, several States, counties, localities, and even
individual public pension funds, have undertaken to prohibit or
regulate these practices in recent years.\43\ And, most recently, in
response to pay to play scandals that have emerged in their
jurisdictions, public officials with oversight of public pension funds
have written to us expressing support for a Commission rule to prohibit
investment advisers from participating in pay to play practices,
including prohibiting the use by advisers of placement agents (or other
types of consultants) to help secure government business.\44\
\43\ For an example of a State statutory restriction on pay to
play activities, see Ill. Pub. Act 0950971 (2008). For an example
of a restriction pursuant to a State constitutional amendment, see
Colo. Const. amend. LIV (2008). For an example of a county
restriction, see Resolution No. 08397 (May 8, 2008) Special Pay to Play Restrictions for Professional Service Contracts and
Extraordinary Unspecifiable Service Contracts, Monmouth County, NJ.
For an example of a city restriction, see Ordinance 3663 (July 2,
2007), Prohibition of Redevelopment with Certain Contributors,
Township of Franklin, NJ. For an example of a particular local
government agency restriction, see Cal. Pub. Util. Code Sec.
130051.20 (2008), Contributions to Authority Members, Los Angeles
County Metropolitan Transportation Authority. For an example of a
particular public pension fund restriction, see Prohibitions on
Campaign Contributions, California State Teachers' Retirement System, 5 CCR Sec. 24010 (2009).
\44\ See, e.g., Letter from New York City Comptroller William C.
Thompson, Jr., to Securities and Exchange Commission Chairman Mary
L. Schapiro, dated May 12, 2009, available at http://
www.comptroller.nyc.gov/press/pdfs/051309_SECletter.pdf, at 2;
Letter from New York State Comptroller Thomas P. DiNapoli to
Securities and Exchange Commission Chairman Mary L. Schapiro, dated
May 7, 2009, available at http://www.osc.state.ny.us/press/releases/ may09/sec050709.pdf, at 12.
These developments indicate that investment advisers may be playing
an increasing role in pay to play activities. We therefore believe it
is time for us to act with respect to investment advisers who may engage in such activities.\45\
\45\ Another reason we believe it is important for us to act is
because pay to play practices are characterized by what the Blount
court called a ``collective action problem [that tends] to make the
misallocation of resources persist.'' Blount, supra note 16 at 945
46. Elected officials that accept contributions from State
contractors may believe they have an advantage over their opponents
that forswear the contributions, and firms that do not ``pay'' may
fear they will lose government business to those that do. See id.
See generally Mancur Olson, The Logic of Collective Action; Public
Goods and the Theory of Groups 44 (17th ed. 1998) (group members
that seek to maximize their individual personal welfare will not act
to advance common objectives absent coercion or other incentive).
See also Paul Jacobs, Donations to Pension Officials Scrutinized;
Politics: Connell, Fong Say They Are not Influenced by Contributions
from Firms Doing Business with State Systems, L.A. Times, Aug. 21,
1997, at A41 (fund contractor quoted as saying, ``[i]f you don't
contribute, you're subject to the concern that others might make contributions'').
[[Page 39844]]
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.'' \46\ Section 206(2) prohibits advisers
from engaging in ``any transaction, practice or course of business
which operates as a fraud or deceit on any client or prospective
client.'' \47\ The Supreme Court has construed section 206 as
establishing a Federal fiduciary standard governing the conduct of advisers.\48\
\46\ 15 U.S.C. 80b6(1).
\47\ 15 U.S.C. 80b6(2).
\48\ Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11,
17 (1979); SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191192 (1963).
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.\49\ In making such contributions, the adviser
hopes to benefit from officials that ``award the contracts on the basis
of benefit to their campaign chests rather than to the governmental
entity.'' \50\ If pay to play is a factor in the selection process, the
public pension plan can be harmed in several ways. The most qualified
adviser may not be selected, potentially leading to inferior
management, diminished returns or greater losses. The pension plan may
pay higher fees because advisers must recoup the contributions, or
because contract negotiations may not occur on an arm'slength basis.
The absence of arm'slength negotiations may enable advisers to 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 for the adviser's own purposes.\51\
\49\ See 1999 Proposing Release, supra note 17, at 3. 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, 191192; Release 1092, supra note 7. 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 meritbased selection process established by its prospective
clientsthe 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). Even if the conflict was
acknowledged and disclosed by the adviser, disclosure may not be
effective in protecting the plan from harm. Disclosure to the
trustee or board of trustees may be futile in protecting the plan
since the trustees may be similarly conflicted, having accepted the
contribution. Disclosure to beneficiaries may also be inadequate as
they may be unable to act on the disclosurebeneficiaries generally cannot fire the adviser or find another pension plan.
\50\ See Blount, supra note 16, at 94445.
\51\ 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 brokerdealer).
We believe that play 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.'' \52\ Congress
gave us this authority to prohibit ``specific evils'' that the broad
antifraud provisions may be incapable of covering.\53\ The provision
thus permits the Commission to adopt prophylactic rules that may
prohibit acts that are not themselves fraudulent.\54\ As noted above,
pay to play practices are rarely explicit and often hard to prove,
which makes a prophylactic rule particularly appropriate.\55\ We are
today proposing new rule 206(4)5 under the Advisers Act designed to eliminate adviser participation in pay to play practices.
\52\ 15 U.S.C. 80b6(4).
\53\ 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 the adviser's financial
condition and disciplinary history, 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.
\54\ Section 206(4) was added to the Advisers Act in Public Law
86750, 74 Stat. 885 (1960) at sec. 9. See H.R. Rep. No. 2197, 86th
Cong., 2d Sess. (1960) at 78 (``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. (1960) at 8 (``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,
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, at 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.'').
\55\ Cf. Blount, supra note 16 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'').
II. Discussion
A. Rule 206(4)5: ``Pay To Play'' Restrictions
The rule we are proposing today is designed to protect public
pension plans from the consequences of pay to play practices by
preventing advisers' participation in such practices. As a result,
advisers and government officials may attempt to structure their
transactions in a manner intended to hide the true purpose of a
contribution or a payment. For that reason, our proposed pay to play
restrictions would 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 would accomplish this through three
measures. First, the rule would make it unlawful for an adviser to
receive compensation for providing advisory services to a government
entity for a twoyear period after the adviser or any of its covered
associates makes a political contribution to a public official of a
government entity that is in a position to influence the award of advisory business.\56\
[[Page 39845]]
Proposed rule 206(4)5 would not, therefore, ban or limit the amount of
political contributions an adviser or its covered associates could
make; rather, it would impose a twoyear ``time out'' on conducting
compensated advisory business with a government client after a
contribution is made. This aspect of the proposed rule is modeled on MSRB rule G37 and is consistent with our 1999 proposal.
\56\ Proposed rule 206(4)5(a)(1) states: ``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. 80b6(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. 80b3(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).''
Second, the rule would prohibit advisers from paying third parties
to solicit government entities for advisory business.\57\ That is, an
adviser would be prohibited from providing or agreeing to provide,
directly or indirectly, payment to any person who is not a related
person of the adviser for solicitation of government advisory business
on behalf of such adviser. This aspect of our proposed rule is modeled
on MSRB rule G38.\58\ Third, the rule would also make it unlawful for
an adviser itself or through any of its covered associates to solicit
or to coordinate contributions for an official of a government entity
to which the investment adviser is seeking to provide investment
advisory services, or 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. MSRB rule
G37 contains a similar prohibition, as did our 1999 proposal.\59\ \57\ Proposed rule 206(4)5(a)(2)(i).
\58\ MSRB rule G38 was amended in 2005 to prohibit municipal
securities dealers from paying thirdparty solicitors to solicit
municipal securities business. In the Matter of SelfRegulatory
Organizations; Municipal Securities Rulemaking Board; Order
Approving Proposed Rule Change and Notice of Filing and Order
Granting Accelerated Approval to Amendment No. 1 to the Proposed
Rule Change Relating to Solicitation of Municipal Securities
Business under MSRB Rule G38, Exchange Act Release No. 52278 (Aug.
17, 2005) [70 FR 49342 (Aug. 23, 2005)]. Our 1999 proposal did not include an analogous prohibition.
\59\ See MSRB rule G37(c); 1999 Proposing Release, supra note 17, at section II.A.2.
We recognize that we cannot anticipate all of the ways advisers and government officials may structure pay to play arrangements to attempt to evade the prohibitions of our proposed rule. For that reason, we are also proposing to include a provision that would make 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 proposed rule. Finally, for purposes of the proposed rule, an investment adviser to certain pooled investment vehicles in which a government entity invests or is solicited to invest would be treated as though the adviser were providing or seeking to provide investment advisory services directly to the government entity.
Although today's proposal is similar to the one we made in 1999, we are proposing a few critical changes in response to intervening developments that we highlight in the discussion below. We have made these changes to conform our proposal to measures undertaken in recent years to curtail pay to play activities by the MSRB and various State and local authorities and to deter circumvention of the restrictions through the use of thirdparty placement agents or through an adviser obtaining government clients indirectly by soliciting investment in funds it manages.
1. Advisers Subject to the Rule
Proposed rule 206(4)5 would apply 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. 80b3(b)(3)].\60\ 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.\61\ The rule would not apply, however, to most small advisers that
are registered with the State securities authorities,\62\ and certain
other advisers that are exempt from registration with us.\63\ We
believe that the rule would apply to most advisers to public pension
plans.\64\ We request comment on the scope of the proposed rule. Should
we apply the rule to Stateregistered advisers? Should we limit the
rule only to advisers registered (or required to be registered) with
us? Should we apply the rule to advisers that are exempt from
registration in reliance on Advisers Act section 203(b)(3)? We request
comment on whether we should extend the scope of the rule to apply to
advisers exempt from registering with us pursuant to any or all of the
other categories under Advisers Act section 203(b). For example, should
we include advisers exempt from registration pursuant to any or all of
Advisers Act sections 203(b)(1) (intrastate advisers), 203(b)(2)
(advisers with only insurance company clients), 203(b)(4) (investments
advisers that are charitable organizations), 203(b)(5) (advisers that
are plans described in section 414(e) of the Internal Revenue Code of
1986 or certain persons associated with such plans), or 203(b)(6)
(certain commodity trading advisors)? \65\ To the extent that they are
able to have government clients at all, are any of these advisers likely to engage in pay to play?
\60\ Proposed rule 206(4)5(a)(1) and (2). Section 203(b)(3) [15
U.S.C. 80b3(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. \61\ See discussion infra section II.A.3(e).
\62\ Section 203A of the Advisers Act [15 U.S.C. 80b3A]
prohibits investment advisers with less than $25 million in assets
under management from registering with the Commission; although we
do not propose to include them within the coverage of this rule,
they remain subject to the Act's general antifraud authority. See,
e.g., Rules Implementing Amendments to the Investment Advisers Act
of 1940, Investment Advisers Act Release No. 1633, n.154 and
accompanying text (May 15, 1997) [62 FR 28112 (May 22, 1997)]
(``Both the Commission and the States will be able to continue
bringing antifraud actions against investment advisers regardless of
whether the investment adviser is registered with the State or the
SEC.''). See also S. Rep. No. 293, 104th Cong., 2d Sess. 34 (1996) (``1996 Senate Report'') at 4.
\63\ See, e.g, exemption for intrastate investment advisers under section 203(b)(1) [15 U.S.C. 80b3(b)(1)].
\64\ With the exception of the exemption from registration
provided for by section 203(b)(3) [15 U.S.C. 80b3(b)(3)], advisers
that are exempt from SEC registration are unlikely to have State or
municipal government clients as providing advisory services to them
would result in the adviser no longer being eligible for the
exemption, e.g., section 203(b)(2) [15 U.S.C. 80b3(b)(2)] and
section 203(b)(4) [15 U.S.C. 80b3(b)(4)]. Moreover, based on a
review of a sampling of requests for proposals from State and
municipal governments for investment advisory services, a common
requirement is that the adviser be registered with the SEC or a
State. See, e.g., Request for Information Vermont Pension Investment
CommitteeVermont Manager Program RFI (Feb. 27, 2009) (stating that
eligible investment advisers must be SECregistered with at least
$100 million in assets under management), available at: http:// www.vermonttreasurer.gov/documents/rfp/20090316_
VPICVermontManagerProgram.pdf. It also is our understanding from
discussions with representatives of the State securities regulators
that a very small percentage of Stateregistered advisers have State or municipal government clients.
\65\ Our 1999 proposed rule would have applied to all investment
advisers not prohibited from registering with the Commission. See 1999 Proposing Release, supra note 17.
We note that proposed rule 206(4)5 would regulate the activities
of investment advisersbusiness organizations over which we have clear
regulatory authority under the Advisers Act. The rule would have no
effect on State laws, codes of ethics or other rules governing the
activities of State and municipal officials or employees of [[Page 39846]]
public pension plans over whom we have no regulatory jurisdiction.\66\ \66\ A number of commenters in 1999, including those
representing State and local officials, argued that the rule would
be an intrusion on State sovereignty. We disagree. We have a
responsibility to regulate the activities of investment advisers.
Our objectives in the proposed rule do not relate to campaign
finance, but rather to prohibiting fraudulent activity by investment
advisers. We believe our proposed rule is appropriately tailored to those ends.
2. Relationship With MSRB Rules; Alternative Approaches
As discussed above, we modeled proposed rule 206(4)5 on MSRB rules
G37 and G38, which we believe have successfully addressed pay to play
in the municipal bond market. This approach should minimize the
compliance burdens on firms that would be subject to both rule regimes
because firms that are already subject to MSRB rules would already have
developed policies and systems for compliance that could be adapted to
meet investment adviser requirements. Certain provisions of our
proposed rule, however, are somewhat different in ways that reflect the
different statutory framework under which the rule would be adopted and
the differences between municipal underwriting and asset management.
Comment is requested on whether we should use rules G37 and G38 as
the models for proposed rule 206(4)5.\67\ If not, are there
alternative models that would be more appropriate? Are there
significant differences in governments' selection process for municipal
underwriters and investment advisers that we have not addressed but
that should be reflected in the rule? Would our approach adequately
protect public pension plans, their sponsors and participants against the adverse effects of pay to play practices?
\67\ For instance, in 1999, we requested comment on our use of
MSRB rule G37 as a model, and several commenters responded that,
because of distinctions between the investment adviser profession
and the municipal securities industry, we should not follow the
approach of MSRB rule G37. Some commenters asserted that, unlike
municipal underwriters, advisers' business relationships with State
and municipal clients are ongoing and longterm and thus the two
year ban is much more harsh a consequence. While municipal
underwritings themselves tend to be episodic, underwriting
relationships are often longstanding. As a result, the rules' time outs may have similar effects.
We understand many advisers have established restrictions on pay to
play practices in their codes of ethics and compliance policies.
Instead of, or in addition to, adopting a new rule to address pay to
play practices, should we amend our code of ethics rule \68\ or our
compliance rule \69\ to require all registered advisers to adopt
policies and procedures designed to prevent them from engaging in pay
to play practices? \70\ Should we instead, or also, require an
executive officer of each adviser to certify annually that the adviser
or its covered associates did not participate in pay to play? Should
some other employee of the adviser, such as the chief compliance officer, make the certification?
\68\ Rule 204A1 under the Advisers Act [17 CFR 275.204A1].
\69\ Rule 206(4)7 under the Advisers Act [17 CFR 275.206(4)7].
\70\ Some commenters in 1999 suggested that the better approach
would be to require advisers to adopt codes of ethics designed to
prevent pay to play practices. The Investment Counsel Association of
America (subsequently renamed the Investment Advisers Association)
submitted to the comment file relating to our 1999 proposal ``Best
Practice PaytoPlay Guidelines for Adviser Codes of Ethics,''
advocating such an approach as an alternative to our 1999 proposal.
See http://www.sec.gov/rules/proposed/s71999/tittswo2.htm. The ICAA
offered the following three alternative policies on political
contributions, and suggested that advisers should tailor these
policies to fit their respective circumstances: (1) A contribution
ban above a certain de minimis amount (either with respect to all
political contributions or ones that fall within certain specified
parameters); (2) a preclearance process for contributions; or (3) a
disclosure policy with respect to contributions. At that time, codes
of ethics were voluntary. However, in 2004, the Commission adopted a
requirement that advisers adopt and implement codes of ethics that
include a standard of conduct that reflects the adviser's fiduciary
obligations, although the code of ethics rule does not directly
address pay to play practices. See Advisers Act rule 204A1 [17 CFR
275.204A1]; Investment Adviser Codes of Ethics, Investment Advisers
Act Release No. 2256 (July 2, 2004) [69 FR 41696 (July 9, 2004)].
See also Investment Counsel Association of America, Report on Pay
toPlay and the Investment Advisory Profession (May 15, 2000),
available at http://www.investmentadviser.org/eweb/docs/
Publications_News/PublicDocs_UsefulWebsites/PubDoc/report
(condemning practices by which investment professionals try to gain
access to business through political contributions, and urging its
members to adopt codes of ethics designed to prevent pay to play).
In 1999, we considered proposing a different approach to address
pay to play, which would have required an adviser to disclose
information about its political contributions to officials of
government entities to which it provided or was seeking to provide
investment advisory services. We decided not to propose such an
approach at that time because we thought that disclosure would not be
effective to protect public pension plan clients.\71\ Disclosure to a
pension plan's trustees might be insufficient because, in some cases,
the trustees would have received the contributions. Disclosure to plan
beneficiaries also would likely be insufficient because they are
generally unable to act on the information by moving their pension
assets to a different plan or reversing adviser hiring decisions.
Moreover, disclosure requirements may not stop pay to play practices
and can be circumvented.\72\ Accordingly, we do not believe that
relying on disclosure is sufficient to address these problematic
practices.\73\ We request comment on whether we should, nonetheless,
consider this approach, as well as potential alternative approaches that may be more effective or less costly.
\71\ In response to our 1999 Proposal, some commenters suggested
requiring advisers to disclose publicly their contributions to State
and local officials. Statutes requiring disclosure of political
contributions are 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. But, as several
other commenters correctly pointed out, our goal is not campaign
finance reform, and how voters might react to such disclosure is
not, for us, the relevant concern. Our primary concern is the
protection of advisory clients and investors who are affected by pay
to play practices whom we have the responsibility to protect under the Advisers Act.
\72\ See infra note 158 and accompanying text regarding swap
arrangements that may be used to circumvent public disclosure.
\73\ MSRB rule G37, however, does establish a reporting and
disclosure system for brokerdealers subject to that rule. MSRB rule G37(e)(ii).
3. Pay To Play Restrictions
(a) TwoYear ``Time Out'' for Contributors
Proposed rule 206(4)5(a)(1) would prohibit investment advisers
from providing advice for compensation to a ``government entity'' \74\
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.'' \75\ We are proposing that the time out be
two years long because the duration needs to be sufficiently long to
have a deterrent effect. We recognize, however, that a longer ban could
be overly harsh.\76\ We note that MSRB rule G37 contains a twoyear
time out, which appears, based on the success of the MSRB rules, to have operated as an effective deterrent
[[Page 39847]]
in the municipal securities context.\77\ We request comment on whether two years is an appropriate length of time.\78\
\74\ ``Government entity'' is defined by the proposed rule as
``any State or political subdivision of a State, including any
agency, authority, or instrumentality of the State or political
subdivision, a plan, program, or pool of assets sponsored or
established by the State or political subdivision or any agency,
authority or instrumentality thereof; and officers, agents, or
employees of the State or political subdivision or any agency,
authority or instrumentality thereof, acting in their official capacity.'' Proposed rule 206(4)5(f)(5).
\75\ Proposed rule 206(4)5(a)(1).
\76\ We note that, notwithstanding the proposed duration of the rule's ``time out''two yearsthe reach of the time out is
relatively narrow in the sense that it only prohibits advisers from
receiving compensation for providing advice from the particular
government entities to whose officials triggering contributions have
been made. It does not limit the adviser from receiving compensation
from other government entities as to which triggering contributions have not been made.
\77\ See supra note 24. Several commenters in 1999 suggested
that, because advisers' business relationships with State and
municipal clients are ongoing and longterm, as compared to the
relationships between municipal underwriters and their clients, the
twoyear ban is much more harsh a consequence. As we note above,
while municipal underwritings themselves tend to be episodic,
underwriting relationships are often longstanding, which may result
in the rules' time outs having similar effects. See supra note 67.
\78\ Some commenters in 1999 objected to two years as being too
long a period of time (arguing, for example, that because changing
investment advisers can be so disruptive to a pension fund that such
a fund would be extremely unlikely to return to an adviser after a
``time out,'' thereby rendering the twoyear ban tantamount to a
permanent one), whereas others suggested that the period be longer
or that it track the remainder of the term of the government
official to whom the c
FOR FURTHER INFORMATION CONTACT
Melissa A. Roverts, Attorney-Adviser,
Matthew N. Goldin, Senior Counsel, Daniel S. Kahl, Branch Chief, or Sarah A. Bessin, Assistant Director, at (202) 5516787 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 205498549.