The Securities and Exchange Commission (the "SEC") has proposed Rule 206(4)-5 (SEC Rel. No. IA-2910 (8/3/09)) (the "Proposed Rule") under the Investment Advisers Act of 1940, as amended (the "Advisers Act"), designed to prevent "pay to play" practices by registered and nonregistered investment advisers compensating placement agents, finders and other intermediaries for procuring investment advisory business from government pension plans. The proposed rule arises out of the recent actions by Andrew Cuomo, attorney general of New York, and similar actions taken in other states, involving pay to play practices of private investment fund advisers. The proposed rule is largely modeled on Municipal Securities Rulemaking Board Rules G-37 and G-38, which prohibits member firm municipal securities brokers and dealers from engaging in pay to play practices.
Proposed Rule 206(4)-5 would prohibit an investment adviser (including investment advisers exempt from registration under Section 203(b)(3) of the Advisers Act) from providing or agreeing to provide, directly or indirectly, payment to any third party (other than certain "related parties" or officers, partners, managing members or employees of the investment adviser) for a solicitation of advisory business from any government entity on behalf of such investment adviser, regardless of whether the third party is itself a registered broker-dealer or the investment adviser and the solicitor are otherwise complying with Advisers Act Rule 206(4)-3 (Cash Payments for Client Solicitations). Under the Proposed Rule, an investment adviser to a "covered investment pool" ( i.e ., any investment company as defined in the Investment Company Act of 1940, as amended [the "Investment Company Act"], as well as any private investment company relying on the exceptions in Section 3(c)(1), 3(c)(7) or 3(c)(11 ) of the Investment Company Act), in which a government entity invests or is solicited to invest, would be treated as though that investment adviser were providing or seeking to provide investment advisory services directly to the government entity. The Proposed Rule includes a catch-all provision that would make it unlawful for an investment adviser or any of its covered associates to do anything indirectly which, if done directly, would result in a violation of the Proposed Rule.
More specifically, the Proposed Rule would:
• Make it unlawful for an investment adviser to receive compensation for providing advisory services to a government entity for a two-year period after the investment adviser or any of its covered associates makes a political contribution to a public official of a government entity that is in a position to influence the award of advisory business;
• Impose a two-year "time out" on an investment adviser conducting compensated advisory business with a government entity after a contribution is made, but would not ban or limit the amount of political contributions an investment adviser or its covered associates could make;
• Prohibit an investment adviser from paying any person who is not a related person of the investment adviser, such as a placement agent, finder or otherwise, to solicit a government entity for advisory business; and
• Make it unlawful for an investment adviser itself or through any of its covered associates to solicit or to coordinate contributions for an official of a government entity to which the investment adviser is seeking to provide investment advisory services, or 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.
The Proposed Rule would not apply to or prohibit political contributions by non-executives who are typically not involved in soliciting investors, such as an investment adviser's comptroller, human resources personnel and information technology personnel. Exemptive relief may be sought from the two-year "time out" in circumstances where contributions were discovered after the fact or where imposition of the prohibition is unnecessary to achieve the rule's intended purpose.
The SEC is soliciting comments on the Proposed Rule and has asked numerous questions including (i) whether the Proposed Rule should apply only to registered investment advisers or be expanded to cover state registered advisers, (ii) whether disclosures of political contributions to a pension plan trustee or requiring an investment adviser to adopt policies and procedures designed to prevent "pay to play" with an annual certification should be considered as an alternative to the Proposed Rule and (iii) whether other alternatives would have a greater impact than the Proposed Rule. Comments on the Proposed Rule are due by October 6, 2009. We will keep you apprised of further developments in this area.
Richard Ellenbogen is a Corporate Consultant in the New York office. He engages in a general corporate practice with particular emphasis on investment adviser and investment company laws and regulations and the organization, operations and regulatory compliance of investment advisers, private equity and hedge fund managers and broker-dealers.