Federal Register: July 14, 2010 (Volume 75, Number 134)
DOCID: fr14jy10-12 FR Doc 2010-16559
SECURITIES AND EXCHANGE COMMISSION
U.S. Citizenship and Immigration Services
CFR Citation: 17 CFR Part 275
RIN ID: RIN 3235-AK39
NOTICE: Part IV
DOCID: fr14jy10-12
DOCUMENT ACTION: Final rule.
SUBJECT CATEGORY:
Political Contributions by Certain Investment Advisers
DATES: Effective Date: September 13, 2010.
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 2042 must comply with amended rule 2042 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.
DOCUMENT 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 brokerdealers 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.
SUMMARY:
Securities and Exchange Commission
SUPPLEMENTAL INFORMATION
The Commission is adopting rule 206(4)-5 [17
CFR 275.206(4)5] and 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'').\1\
\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 2042,
rule 204A1, rule 206(4)3, or any paragraph of these rules, we are
referring to 17 CFR 275.206(4)5, 17 CFR 275.2042, 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.
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) TwoYear ``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 BrokerDealers
(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. TwoYear 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. CostBenefit Analysis
A. Benefits
B. Costs
1. Compliance Costs Related to Rule 206(4)5
2. Other Costs Related to Rule 206(4)5
(a) TwoYear Time Out
(b) ThirdParty Solicitor Ban
3. Costs Related to the Amendments to Rule 2042
V. Paperwork Reduction Act
A. Rule 2042
B. Rule 206(4)3
C. Rule 206(4)7
D. Rule 04
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
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 onethird 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
[[Page 41019]]
publicly held companies \6\ and the securities markets.\7\ But most
significantly, their management affects taxpayers and the beneficiaries
of these funds, including the millions of present and future State and
municipal retirees \8\ 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.
\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 nonFederal 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.
\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 EmployeeRetirement Systems by State: 20062007 (2007)
(at Table 5), available at http://www.census.gov/govs/retire/ 2007ret05.html.
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\ \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\ See 1997 Survey, supra note 8.
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.
\12\ Blount v. SEC, 61 F.3d 938, 945 (D.C. Cir. 1995), cert. denied, 517 U.S. 1119 (1996).
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\
\13\ See, e.g., 2 N.Y. Comp. Codes R. & Regs. tit. 2 Sec. 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. 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).
\15\ 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 Ann. Sec. 591304 (2008) (governor appoints all five members).
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\
\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 thirdparty
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. 2010044 (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. 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).
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
[[Page 41020]]
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 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.
\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. 2010044 (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. 2009152 (Apr. 14, 2010); In the Matter of Darius
Anderson Platinum Advisors LLC, AGNY Investigation No. 2009153
(Apr. 14, 2010); In the Matter of Global Strategy Group, AGNY
Investigation No. 2009161 (Apr. 14, 2010); In the Matter of Freeman
Spogli & Co., AGNY Investigation No. 2009174 (Feb. 1, 2010); In the
Matter of Falconhead Capital, LLC, AGNY Investigation No. 2009125
(Sept. 17, 2009); In the Matter of HM Capital Partners I, LP, AGNY
Investigation No. 2009117 (Sept. 17, 2009); In the Matter of Ares
Management LLC, AGNY Investigation No. 2009173 (Feb. 17, 2010); In
the Matter of Levine Leichtman Capital Partners, AGNY Investigation
No. 2009124 (Sept. 17, 2009); In the Matter of Access Capital
Partners, AGNY Investigation No. 09135 (Sept. 17, 2009); In the
Matter of The Markstone Group, AGNY Investigation No. 10012 (Feb.
28, 2010); In the Matter of Wetherly Capital Group, LLC and DAV/
Wetherly Financial, L.P., AGNY Investigation No. 2009172 (Feb. 8,
2010) (in each case, banning the use of thirdparty 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,
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. 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 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/chicellini31
oct31,0,6465036.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:
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).
\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 guiltywhile 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 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).
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\
\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 outofState 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 RoseSmith 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).
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 raisingi.e., from participating in pay 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\
\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 G37 was approved by the Commission and adopted
in 1994. 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)]. 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'').
[[Page 41021]]
Along the lines of MSRB rule G37,\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 addition,
similar to MSRB rule G38,\35\ our proposed rule would have prohibited
the use of third parties to solicit government business.\36\ We also
proposed amendments to rule 2042 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 brokerdealers and
the scope of the statutory authority we have sought to exercise.
\32\ See MSRB rule G37(b). Our proposal, like MSRB rule G37,
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 G37).
\33\ Proposed rule 206(4)5(a)(1). See also MSRB rule G37(b).
\34\ Proposed rule 206(4)5(a)(2)(ii). See also MSRB rule G 37(c).
\35\ See MSRB rule G38(a).
\36\ Proposed rule 206(4)5(a)(2)(i).
We received some 250 comment letters on our proposal, many of which
were from advisers, thirdparty solicitors, placement agents, and their
representatives.\37\ Public pension plans and their officials were
dividedsome 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 interest groups supported it strongly.\41\ Advisers, thirdparty
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 G37 and G38.\43\ Most particularly opposed the proposed
prohibition on payments to third parties for soliciting or marketing to
government entities modeled on MSRB rule G38.\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\
\37\ Other commenters included pension plans and their
officials, trade associations, law firms, and public interest groups. Comments letters submitted in File No. S72506 are
available on the Commission's Web site at: http://www.sec.gov/ comments/s71809/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 Systems
(2010), available at http://www.afscme.org/docs/AFSCMEreport pensionbestpractices.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 `paytoplay' 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'').
\44\ See, e.g., Comment Letter of Ounavarra Capital, LLC (Aug.
28, 2009) (``Ounavarra Letter'') (noting that banning thirdparty
marketers in the municipal securities industry did not adversely
affect most bankers' ability to conduct basic marketing whereas
banning thirdparty 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 brokerdealer 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 subsections of section II of this Release.
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
[[Page 41022]]
or prospective client.'' \47\ 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\
\47\ 15 U.S.C. 80b6(1).
\48\ 15 U.S.C. 80b6(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, 191192 (1963).
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\
\50\ 15 U.S.C. 80b6(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 Public Law
86750, 74 Stat. 885, at sec. 9 (1960). See H.R. Rep. No. 2197, 86th
Cong., 2d Sess., at 78 (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,
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.'').
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 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'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 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 purposes.\55\
\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, 19192;
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 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).
\54\ See Blount, 61 F.3d at 94445.
\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 brokerdealer).
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 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 [[Page 41023]]
prophylactic rule that section 206(4) of the Advisers Act authorizes.
\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'').
\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 G37. 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 G37, see section II.A of this Release.
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 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\
\60\ 2 U.S.C. 441c.
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. \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'').
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 twoyear 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 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\
\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, 13536 (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.
081953, 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.
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 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.
\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 twoyear
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 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 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)] (noting, in connection with the Commission's approval of MSRB
rule G37, 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.'').
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 G37 in Blount v. SEC.\67\ Indeed, the Blount
opinion has served as an important guidepost in helping us shape our rule.\68\
\67\ 61 F.3d at 94748.
\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 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 24849. 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 nonviable
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.
[[Page 41024]]
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\
\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 twoyear time out).
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\
\71\ See Citizens United, 130 S. Ct. at 90809 (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
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.
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\
\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 twoyear 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
twoyear time out on receiving compensation for advisory services).
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 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\
\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
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.
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\
\77\ See section II.B.2(a)(4) of this Release (discussing the
definition of ``covered associates,'' whose contributions could trigger the twoyear 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 definition 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.
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 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.
\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
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 G37).
\80\ Proposing Release, at section II.A.
First, the rule makes 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 or candidate for such office who is or will be in a position to influence the award of advisory business.\81\
[[Page 41025]]
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 twoyear
time out on conducting compensated advisory business with a government
client after a contribution 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\
\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
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) 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.