Overview:

Investment advisers that seek to manage public money need to consider the SEC’s “pay to play” rule, which restricts election-related contributions by the firms or their “covered associates” to elected state government officials, including those running for federal office. As the current governor of Minnesota, Vice Presidential candidate Tim Walz is an incumbent in an elective office of a state government. The Harris/Walz campaign is raising money to win a federal election, so a contribution of “anything of value” is subject to the pay to play rule.

Background:

In an effort to “combat pay to play arrangements in which advisers are chosen based on their campaign contributions to political officials rather than on merit,” the SEC adopted the Investment Advisers Act “pay to play” rule in 2010. (The CFTC, MSRB and FINRA have similar rules for certain registrants.) The SEC rule makes it unlawful for investment advisory firms “to provide investment advice for compensation” to state government entities for two years, if the firm or its covered associates have made more than de minimis contributions to campaigns of certain state government officials, including those running for federal office. Because the rule does not prohibit firms from performing advisory services without compensation, its effect can be especially harsh where an investment advisory agreement obligates the advisory firm to continue providing services for a fixed period.

Specifics:

The rule has two prohibitions: a contribution prohibition and a solicitation prohibition. First, under the contribution prohibition, it is unlawful for a registered investment adviser “to provide investment advisory services for compensation” to a government entity within two years of a contribution by the firm or a “covered associate” to an official of that government entity. Second, under the solicitation prohibition, it is unlawful for a registered firm or covered associate to make or solicit either payments to third parties or campaign contributions to government officials, when the firm is providing or seeking to provide advisory services to the government entity.

The rule’s scope is seen in several important definitions:

• “Covered associate” of a firm includes its principal owners, executive officers (those with “policy-making function[s]”), any employee who solicits business from a government entity, and any supervisor of a soliciting employee. The rule sweeps in new hires as well: anyone “who becomes a covered associate” within two years after making a contribution.
• “Government entity” includes any state or political subdivision of a state.
• “Official” includes any incumbent or candidate for elective office of a government entity who can directly or indirectly influence the hiring of an investment adviser by the government entity.
• “Contribution” means “any gift, subscription, loan, advance or deposit of money or anything of value” for the purpose of (among other things) influencing any election to federal, state, or local office.

The contribution prohibition has three exceptions:

• De minimis. The contribution prohibition does not apply to donations by covered associates (but not the firm) of $350 or less to any one official per election, if the contributor is entitled to vote for the official, and $150 or less if the contributor is not entitled to vote for the official. (In a national election, this would include anyone eligible under their state’s laws.)
• Certain new covered associates. The firm does not have to count contributions made by newly hired covered associates who do not solicit clients if the contributions were made more than six months before the person was hired.
• Retroactively fixing violations. If a firm would have violated the contribution prohibition because of a covered associate’s contribution, the rule’s prohibitions will not apply if the contribution in question involved no more than $350, is discovered within four months, and is returned with 60 days of discovery. However, the number of such exceptions is limited with respect to each firm and covered associate.

(NSEU 24-10)