Pay-to-Play Compliance Reminders for Advisors at Election Time

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This is the time of year when I tend to throw things at my television, yell at my car radio and redirect most of the mail I receive directly to the trash (sorry – the recycling bin for you greenies). The reason is simple: it’s election season, and the amount of political bilge spewing through assorted media pipelines reaches toxic levels. Yet rather than assume the role of election Grinch, I found it a better use of time to undertake a refresher of advisor pay to play rules.

The landmines surrounding Rule 206(4)-5 of the Investment Advisers Act (aka, the “Pay to Play” rule) are even more susceptible to detonation during election season, when individuals are more likely to make contributions to certain candidates for public office.

Though the rule has been effective for just over four years, the SEC announced its first enforcement action for Pay to Play violations in June of this year. In it, the SEC highlighted that violation of the rule “does not require a showing of quid pro quo or actual intent to influence an elected official or candidate.” In other words, innocent or unintentional violation is enough to constitute a fraudulent, deceptive or manipulative act, practice, or course of business under the Investment Advisers Act. But let’s take a step back to refresh on the rule itself.

The SEC describes the Pay to Play rule as “a prophylactic rule designed to address pay-to-play abuses involving campaign contributions made by advisers or their covered associates to government officials who are in a position to influence the selection of advisers to manage government client assets, including public pension assets.”

In essence, advisors are prohibited from “providing advisory services for compensation to a government client (or to an investment vehicle in which a government entity invests), for two years after the adviser or certain of its executives or employees make a campaign contribution to certain elected officials or candidates.” This is known as the two-year “time out.”

A careful reading of the rule reveals important conditional language: application is limited to “covered” associates of an advisor, “certain” elected officials or candidates, and contributions over de minimis dollar thresholds. All caveats are defined fully in the rule itself, but here are the essential definitions:

  • “Covered associate” includes (1) executive officers, general partners, and managing members; (2) employees/supervisors that solicit government entities; and (3) any political action committee controlled by the advisor
  • “Government entity” includes any state or political subdivision of a state (encompassing (1) any agency, authority, instrumentality, political subdivision thereof; (2) any officer, agent, or employee thereof; and (3) any plan, program, or pool of assets sponsored or established thereby
  • The de minimis threshold is $350 per election to a candidate for whom the covered associate can vote and $150 per election to a candidate for whom the covered associate cannot vote.

Some leeway is granted for contributions made by newly-hired covered associates (but be sure to “look back” for contributions made within six months of hire) and certain returned contributions. On the other hand, advisors should note that the rule does encompass an advisor’s solicitors.

Practically speaking, an advisor should first review its client roster to determine if any current or potential clients are government entities (if this is found to be the case, certain recordkeeping rules are triggered under Rule 204-2). Next, it should identify and make special note of individuals that would be considered covered associates.

On an ongoing basis, advisors should consider the appropriate mix of contribution pre-clearance requirements, attestations, certifications, and contribution limits by employees to ensure none of the Pay to Play nuances are tripped up. Understandably, this has the potential to ruffle employees’ feathers and raises legitimate Constitutional concerns, but the rule is what it is.

Two helpful websites to check for employee political contributions and

Mixing politics with business can be a recipe for volatility and frustration, but unfortunately that is the pot the SEC decided to stir. Regardless of whether one agrees with the Pay to Play rule or not, this year’s enforcement action proves the SEC takes it seriously and will prosecute violations, willful or not.

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This article originally appeared on October 30, 2014 in ThinkAdvisor.