With the 2024 elections underway, it is important to remind investment advisers about the U.S. Securities and Exchange Commission ("SEC") "Pay-to-Play" Rule (the "Rule"). Compliance with this highly technical rule is essential, especially given the SEC's continued actions against advisers for noncompliance.
As recently as April 2024, the SEC settled charges against an investment adviser for violations of Rule 206(4) under the Investment Advisers Act of 1940, otherwise known as the Pay-to-Play Rule. In this instance, the adviser failed to disclose a $4,000 contribution made by a covered associate to a candidate seeking a position on the Minnesota State Board of Investment. The adviser agreed to pay a $60,000 penalty to settle the enforcement action.
This most recent enforcement action highlights the SEC's continued interest in bringing actions for violations of the Pay-to-Play Rule. Both registered investment advisers and exempt reporting advisers should review their compliance policies and procedures to ensure they are adequately designed to comply with the Rule.
Pay-to-Play Rule Explained
The Rule prohibits registered investment advisers and exempt reporting advisers from providing investment advisory services for compensation to a government entity for two years if the adviser or its covered associates make political contributions over a de minimis threshold to certain officials. The Rule defines officials as individuals who either hold or are seeking political office and who have the ability to directly or indirectly influence the hiring of investment advisers on behalf of a government entity.
Before making a contribution, it is important to understand which political offices have influence over the hiring and firing of investment advisers or are otherwise responsible for appointing individuals who have such influence as this will determine whether covered associates can make contributions to a specific candidate. Generally speaking, political contributions to candidates seeking federal office are not covered under the Rule. However, local and municipal political offices are covered by the Rule. Additionally, certain contributions to PACs or political parties can implicate the Rule.
There are several parts of the Rule that should be carefully reviewed:
Look Back and Look Forward: The Rule includes a “look-back” provision for both existing employees who become covered associates and new hires who are covered associates. It attributes to an investment adviser the political contributions made by an individual within two years of becoming a covered associate, regardless of their association at the time of the contribution. This period is reduced to six months for covered associates not involved in client solicitation. Advisers must also "look forward" to political contributions made by covered associates who were formerly employed by the adviser. The prohibition applies for the entire two-year period, even if the associate no longer works for the adviser or is no longer a covered associate.
Non-solicitation of Persons: The Rule prohibits coordinating or soliciting any person or Political Action Committee ("PAC") to contribute to an official of a government entity to whom the adviser is providing or seeking to provide investment advice or make payments to a political party of a state or locality where the investment adviser is providing or seeking to provide investment advisory services to a government entity.
Broad Definition of Contributions: The Rule is not limited to cash contributions. Providing an official with "any gift, subscription, loan, advance or deposit of money or anything of value" can trigger the Rule's two-year time-out period. The Rule, however, does not prohibit covered associates from volunteering their time to support an official or an official's political campaign as long as the covered associate is not involved with any fundraising activities.
Anti-Circumvention Provision: The Rule prohibits investment advisers and covered associates from doing anything indirectly, which, if done directly, would result in a violation of the Rule.
What Investment Advisers Can Do Now to Prepare
Compliance with the Pay-to-Play Rule requires investment advisers to adopt and maintain policies and procedures designed to prevent improper political contributions from being made. One of the most effective ways to accomplish this is for advisers to require pre-clearance of all political contributions made by covered associates regardless of the dollar amount of the contribution or its intended recipient. Given the complexity of the Rule, Petra Compliance suggests investment advisers require all employees to comply with the pre-clearance requirement.
Additionally, it is important for investment advisers to provide all employees with compliance training at least annually. Periodic trainings that cover the Rule and the adviser's policies and procedures on political contributions are an effective way to educate employees and prevent breaches. A brief training, especially during an election year, is extremely helpful, as employees may be considering how to support their candidate.
How Petra Can Help
Petra Funds Group’s compliance team has decades of experience managing SEC regulatory compliance programs for private fund advisers. The group’s expertise enables them to provide insight and guidance on a wide range of regulatory compliance services, from investment adviser registration to ongoing compliance support to performing SEC mock examinations. Learn more about Petra’s comprehensive compliance offering here and contact Jesse Brown with questions.
