Four Investment Advisers Fined for Violating "Pay-to-Play" Rule
Commentary by Joanna Rosenberg
Four investment advisers settled charges for violating the SEC's "pay-to-play" rule by accepting compensation from "government entities" for advisory services during the rule's "time out" period after one or more covered associates of each adviser made campaign contributions. One of the advisers is a registered investment adviser and three of the advisers are not registered but report to the SEC as "exempt reporting advisers."
In separate orders, the SEC found that the advisers continued to accept compensation from their government entity clients - mostly state-funded universities or public pension plans - following campaign contributions by a covered associate to a government office that maintained an influence over selecting investment advisers for the applicable government entity. Although the respective government entities were either clients of, or had previously invested in funds managed by, the advisers prior to the contributions, the SEC's "pay-to-play" rule prohibits investment advisers from offering advisory services for compensation to government entities for two years after a covered associate of the adviser makes such a campaign contribution.
Settlements
The SEC found that in 2020 and 2021 two covered associates of StarVest contributed $1,000 and $400 to an unsuccessful candidate in New York City's mayoral race. Prior to the contributions, and during the two years after the contributions were made, two New York City public pension systems were invested in a closed-end fund ("StarVest Fund") advised by StarVest for compensation. In the Order, the SEC stated that the NYC mayor's office has influence over selecting advisers to the NYC public pension systems because the mayor appoints at least one member of their boards, which have influence over the selection of investments for the pension systems.
The SEC found the following that in 2021 a covered associate of Highland made a $1,000 campaign contribution to an unsuccessful candidate for governor of Massachusetts. Prior to the contribution, and during the two years after the contribution was made, a Massachusetts public pension plan was invested in a closed-end fund ("Highland Fund") advised by Highland for compensation. In the Order, the SEC stated that the office of Governor of Massachusetts holds a seat on, and has authority to appoint two additional members of the board of the pension plan, which has influence over the selection of investment advisers for the plan. Although the covered associate sought and obtained the return of the contribution, it did not meet the requirements for the returned contribution exception because the contribution exceeded the $350 limit and was not returned within 60 days.
The SEC found that in 2018 a covered associate of Canaan made a $1,000 contribution to the campaign of a candidate for the governor of California. Prior to the contribution, and during the two years after the contribution was made, the Regents of the University of California ("Regents") was invested in a closed-end fund ("Canaan Fund") advised by Canaan for compensation. In the Order, the SEC stated that the Office of Governor of California had the ability to influence the selection of investment advisers for Regents because the governor of California is on the board of Regents and appoints 18 other members of the board. Although the covered associate attempted to receive a return of the contribution, it did not meet the requirements for the returned contribution exception because the contribution exceeded the $350 limit and was not returned within 60 days.
The SEC found that in July 2018 an officer of the Bank of Hawaii made a $1,000 campaign contribution to the governor of Hawaii. In September 2018, the officer became a covered associate of AMG Hawaii. After 2007, and continuing beyond when the officer became a covered associate, AMG Hawaii provided investment advisory services for compensation to various investment accounts maintained by the University of Hawaii ("UHawaii"). In the Order, the SEC stated that the office of the Governor of Hawaii had the ability to influence the selection of investment advisers for UHawaii because the Governor of Hawaii appoints all 11 members of its board. This contribution triggered the look-back provision of the rule because it was made by the Bank of Hawaii officer less than six months before he became a covered associate of AMG Hawaii.
As a result, the SEC determined that the advisers violated IAA Section 206(4) ("Prohibited transactions by investment advisers") and IAA Rule 206(4)-5 ("Political contributions by certain investment advisers"). To settle the charges, the advisers agreed to (i) cease and desist, (ii) accept a censure and (iii) pay civil monetary penalties.
Commentary
These four cases illustrate the risk to investment advisers when any of their employees or new hires has made a political contribution. For example, in the case of AMG Hawaii, the contribution was of a small amount ($1,000), was made before the individual contributor worked for AMG Hawaii, and the relationship between the recipient of the contribution and the client entity was indirect and not obvious on its face. Firms, in particular those that provide advisory services for compensation to government entities, should review their policies and procedures around the "pay-to-play" rule to ensure that they are reasonably designed to prevent violations of the rule, and should provide training to employees and new hires regarding those policies and procedures and the prohibitions under the rule.