Adviser Settles SEC Charges for "Pay-to-Play" Violations
Commentary by Steven Lofchie
An investment adviser settled SEC charges for violating the "pay-to-play rule" which prohibits campaign contributions by investment advisers to government officials "who are in a position to influence the hiring of investment advisers to manage government client assets."
According to the Order, an individual made a $7,150 campaign contribution to a Michigan government official whose office had influence over hiring advisers to a state public pension. The SEC found that six months after the contribution, an investment adviser hired the individual as a "covered associate" at the firm. The SEC said that the individual then solicited government entities for investment advisory services. The SEC found that the individual's contribution triggered the two-year "lookback" provision under the pay-to-play rule, which prohibits investment advisers from providing compensated advisory services to government entities within two years of a covered associate's political contribution. Notwithstanding the prohibition, the firm continued to provide advisory services and collect fees from the Michigan Public Employees' Retirement Fund. The SEC noted that the contribution did not directly involve any Michigan government entity, yet the firm's ongoing receipt of fees from the Michigan pension fund after the individual's solicitation activities constituted a violation. The SEC stated that even unsuccessful solicitations could trigger the rule's prohibitions if paired with ongoing compensation from government entities.
The SEC found that the firm violated Section 206(4) of the Advisers Act ("Prohibited transactions by investment advisers") and Rule 206(4)-5 ("Political contributions by certain investment advisers").
To settle the charges, the firm agreed to (i) cease and desist from future violations; (ii) a censure; and (iii) pay a civil money penalty of $95,000.
In a dissenting statement, SEC Commissioner Hester M. Peirce expressed concern over the broad application of the pay-to-play rule. Ms. Peirce described the settlement as a warning that investment advisers and their associated persons must "expect the Commission's inquisition" when participating in the political process, even when their contributions have no direct connection to the advisory services in question. Ms. Peirce argued that the rule's application in this case lacked a "rational connection" to the prevention of fraudulent conduct and that the SEC's broad interpretation effectively chills political activity. Ms. Peirce argued that the rule's enforcement should be tied to preventing actual fraudulent conduct, not applied in ways that capture "conduct that lacks any reasonable probability of unduly influencing actual investment decisions."
Commentary
As Commissioner Peirce states in her dissent, this enforcement action seems divorced from the underlying policy of the relevant rule. The advisory firm had been awarded the relevant business years before either the individual was hired or the contribution was made. The contribution was made before the individual was hired and subsequently was returned (but the return was legally ineffective as it did not meet the conditions of the rule).
If the injustice of the application of the rule in this context can not be corrected, perhaps the case can serve as a reason to revisit the rule.
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An investment adviser settled SEC charges for violating the Advisers Act "pay-to-play" rule. SEC Commissioner Hester M. Peirce dissented from the Commission's Order.
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