The following is a guest blog post by Jason Abel:
Last Friday, the Securities and Exchange Commission (SEC) announced a settlement involving Rule 206(4)-5, otherwise known as the “pay-to-play” rule for investment advisers. This settlement is the first of its kind, for the moment. However, it may mark the start of increased enforcement of pay-to-play rules. As 2014 is upon us and we move toward 2016, the weakening of traditional campaign finance laws through recent court decisions and FEC deadlocks may leave an opening for increased enforcement by the SEC and other regulators. Those entities covered by pay-to-play rules, and in particular investment advisers, should view this settlement as a shot across the bow, and make sure their compliance policies and procedures accurately reflect this evolving area of campaign finance law.
Rule 206(4)-5 became effective in 2011 and mandates a two-year ban on compensated investment advisory services for an investment adviser if the adviser or a “covered associate” makes a contribution (above a de minimis amount) to a “covered official.” If the investment adviser does not abide by this two-year ban, it is in violation of the rule. The Rule also prohibits solicitations for covered officials and any attempts to circumvent the contribution ban (i.e. through PACs that then contribute to covered officials). Intent is not a factor in determining whether a violation occurred (though it could be a mitigating factor in seeking an exemption). I have explained a bit more about the Rule here, including how to define both “covered associate” and “covered official.”
On Friday, the SEC settled its first case under the Rule, forcing TL Ventures to pay almost $300,000 for pay-to-play violations. Specifically, TL Ventures violated the pay-to-play rule by continuing to accept compensation for advisory services from the Pennsylvania State Employees’ Retirement System (SERS) and the Philadelphia Retirement Board after one of its covered associates made campaign contributions to a candidate for Mayor of Philadelphia and Tom Corbett, the Governor of Pennsylvania ($2,500 and $2,000, respectively), which exceeded de minimis threshold. These offices fall squarely within the Rule’s definition of “covered official.” As explained in footnote 6 of the Order, “If the governor of a state can appoint at least part of a state pension fund’s board, the governor is considered to be an official of the government entity.”
The SEC’s decision regarding TL Ventures can and should be viewed in the larger context of campaign finance law. In light of McCutcheon v. FEC, there has been an intense discussion over the definition of “corruption” and what level of corruption is needed to justify campaign finance regulations. Interestingly, on page two of the Order, the SEC stated that “Rule 206(4)-5 does not require a showing of quid pro quo or actual intent to influence an elected official or candidate.” While this is true given that Rule 206(4)-5 is a strict liability rule with de minimis exceptions, it may reignite the debate over corruption rationale in the pay-to-play area. Despite not needing to demonstrate quid pro quo corruption occurred in order prove a violation, the justification of pay-to-play rules appear to be to prevent such quid pro quo corruption. For instance, during the announcement of the drafting of a pay-to-play rule for municipal advisors, the Chair of the MSRB stated that “Extending these [pay-to-play] provisions to municipal advisors will help prevent quid pro quo political corruption, or the appearance of such corruption, in public contracting for both dealers and municipal advisors.”
To that end, pay-to-play rules are on the rise. In addition to G-37 and Rule 206(4)-5, the MSRB is working on its aforementioned rule for municipal advisors, the Commodity Futures Trading Commission already has a rule that governs the actions of swap dealers, and the SEC is poised to release its rule for security-based swap dealers. Eventually there will be a rule to govern the actions of placement agents. The SEC’s actions in the TL Ventures case demonstrate that it will not back down from enforcement of pay-to-play, and expect other regulators to follow suit. Even though the Federal Election Commission is deadlocked, the SEC and others could become increasingly active in the cycles ahead, especially as covered officials (e.g. Chris Christie) may run for higher office in 2016.