• SEC Adopts New Rule 206(4)-5 on "Pay to Play" Practices
  • July 15, 2010 | Author: Patrick R. Shane
  • Law Firm: Faegre & Benson LLP - Minneapolis Office
  • At an SEC open meeting on June 30, the commissioners unanimously approved a final rule proposal for "pay to play" practices related to government entity clients and investors. New Rule 206(4)-5 applies both to soliciting direct advisory clients and to obtaining investors for a private fund.

    The rule was originally proposed in August 2009 and received approximately 250 comments. As discussed at the open meeting, the final rule proposal contains three prohibitions:

    • A ban on an adviser receiving compensation for providing investment advisory services to a governmental entity for two years after a political contribution to an official of the government entity is made by the adviser or any of its "covered associates", subject to certain exceptions
    • A ban on an adviser or any of its "covered associates" soliciting or coordinating any person or PAC to make political contributions (sometimes referred to as "bundling") (i) to an official of a government entity to which the investment adviser is providing or seeking to provide investment advisory services and (ii) to a political party of a state or locality where the adviser is providing or seeking to provide advisory services to a government entity
    • A ban on an adviser retaining any third party to provide solicitation or placement agent services to government entities unless such third parties are regulated and subject to "pay to play" rules

    As defined in the original proposal, a "covered associate" of an investment adviser generally means any general partner, managing member or executive officer (also a defined term), or other individual with a similar status or function; any employee who solicits a government entity for the investment adviser; and any political action committee controlled by the investment adviser.

    The third prohibition is a substantial change from the original proposal to ban the use of solicitors and placement agents altogether, which received significant negative comment. As a practical matter, this is expected to result in such services being provided only by SEC registered investment advisers and registered broker-dealers. The final rule proposal as discussed has a one year transition period before effectiveness, which is intended in part to allow FINRA to adopt a similar rule governing broker-dealers. SEC staff indicated that it had already been working with FINRA on the issue and believed such a rule would be final before the effective date of Rule 206(4)-5. If not, the SEC will re-consider the total ban concept.

    Several changes to the original proposal were also discussed at the meeting.

    • The original de minimis exception contribution amount of $250 for elections in which a "covered associate" is entitled to vote was increased to $350
    • An additional de minimis exception contribution amount of $150 was added for elections in which a "covered associates" is not entitled to vote
    • The two-year lookback for "covered associates", which includes a person who becomes a "covered associate" within two years after a contribution is made (i.e., joins the adviser within two years of making the contribution), is apparently reduced to six months if the "covered associate" does not solicit clients
    • Certain recordkeeping requirements were changed, including clarifying that no records are required if the adviser does not have any governmental entity clients

    The text of the final rule proposal has not yet been posted to the SEC's website, and may result in some changes to or clarifications of the above summary. Once it is posted, a complete summary will be prepared.