SEC Proposes to Rescind Investment Adviser "Pay-to-Play" Rule

The Securities and Exchange Commission announced yesterday a proposal to rescind Rule 206(4)-5 under the Investment Advisers Act of 1940, the Commission’s “pay-to-play” rule that has governed political contributions by investment advisers and their covered associates since 2010.  The proposal would also eliminate the Rule’s specific recordkeeping requirements.  If adopted, the proposed rescission would end one of the most restrictive contribution regimes in the country and shift responsibility for policing pay-to-play risk to each adviser’s own compliance program, backed by the Advisers Act's antifraud provisions.  The Rule remains in effect unless and until the Commission adopts a final rescission.  Caplin & Drysdale is prepared to help advisers, placement agents, political committees, advocacy organizations, and public officials evaluate what the proposal means for their existing policies and their plans to participate in the political process. 

The Proposal

Rule 206(4)-5 currently bars an adviser from receiving compensation for advisory services to a state or local government entity for two years after the adviser or one of its covered associates makes a contribution to an “official” who is directly or indirectly able to influence the selection of the adviser.  The Rule also prohibits advisers from soliciting certain political contributions and requires advisers to keep records of covered associates, government clients, and contributions.

The Commission’s stated rationale for the proposed rescission is that the Rule has, in its view, produced the following significant unintended consequences:

• The two-year compensation ban is triggered automatically by contributions as small as $150 over the de minimis threshold, creating a de facto strict liability standard in which minor “foot faults” carry severe consequences.
• Advisers have been deterred from hiring or promoting qualified personnel because of prior contributions with little or no connection to pay-to-play concerns.
• Public pension plans have lost, or been unable to hire, the advisers they preferred.
• The definitions of “official” and “covered associate” are difficult to apply and have been read more broadly than intended.
• Most significantly for the Commission, many advisers have responded by prohibiting all political contributions by their employees at the state and local level, which is a result the Commission describes as burdening core political speech protected by the First Amendment. In an accompanying statement, SEC Chairman Atkins framed the proposal as a reminder that “the SEC is not the nation's elections regulator,” faulted the Rule for penalizing small and impulsive donations to candidates of both parties, and said that no one should have to choose between political speech rights and a job in the advisory industry.

Notably, the SEC’s announcement reaffirmed that quid pro quo contributions to secure government advisory business violate the antifraud provisions of Section 206 of the Advisers Act, mentioned that the Commission brought pay-to-play enforcement actions before 2010, and suggested that the Commission would continue to do so after the potential rescission.

What Would Remain

The Commission’s release stated that a registered adviser would still be required to maintain policies and procedures reasonably designed to prevent pay-to-play practices.  An adviser could keep the policies it built around Rule 206(4)-5, or it could replace them with policies tailored to the size of its business-development team, its existing and prospective government relationships, and the potential for contributions to be routed through consultants, family members, or affiliated entities.  Existing adviser recordkeeping obligations covering compliance policies, annual reviews, codes of ethics, and government client agreements would continue to apply.

Practical Implications

State and local laws are unaffected.  Rescission of the federal Rule 206(4)-5 would not affect the many state and municipal pay-to-play statutes, contribution restrictions, and placement-agent rules that apply to advisers seeking public business.  The Commission repeatedly identified these state and local laws as part of the framework that justifies the Rule’s rescission.  

Other federal pay-to-play rules stay in place for now.  MSRB Rule G-37, FINRA Rule 2030, and Exchange Act Rule 15Fh-6 would continue to govern municipal advisors, broker-dealers, and security-based swap dealers.  Firms that are dually registered or that rely on broker-dealer or municipal advisor affiliates to solicit government clients would remain subject to those rules, including their third-party solicitation restrictions.

Rescission is not the only possible outcome.  The Commission solicited public comment on whether it should modify the Rule rather than rescind it by, for example, raising the de minimis threshold to $3,500, shortening the two-year timeout and lookback periods, eliminating the “indirect” concept from the “official” and “covered associate” definitions, or expanding the exemptive process.  

What’s Next

Comments on the proposal (File No. S7-2026-31) are due 60 days after publication in the Federal Register.  Until the Commission acts on a final rule, advisers should continue to comply fully with Rule 206(4)-5 and its recordkeeping requirements.

If you have questions concerning this Alert or if you need more information, please contact a member of Caplin & Drysdale’s Political Law Group.