August 12, 2024
What Happened?
Under Rule 206(4)-5 of the Advisers Act (the “Pay to Play” Rule), registered investment advisers are prohibited from providing investment advisory services for compensation to a “government entity” within two years after a contribution to an official of the government entity is made by the investment adviser or any “covered associate.”
“Covered associate” includes general partners, managing members and executive officers, employees who solicit government entities for the adviser, and any political action committee controlled by the investment adviser.
“Government entities” mean any agency, authority or instrumentality of a state or political subdivision, and would include state pension plans, municipal plans, and public university endowments. Because the rule focuses on state and local officials, the rule is not typically an issue for contributions to federal candidates.
However, when a federal candidate holds a state office, such as Tim Walz who is both the Governor of Minnesota and candidate for Vice President, contributions to the Harris-Walz campaign are scoped into the rule. The same was true for the Trump-Pence campaign in 2016 when Mike Pence was both the Governor of Indianna and candidate for Vice President. Contributions to the Harris-Walz campaign are subject to the rule’s restrictions, while contributions prior to Walz joining the ticket (prior to August 6, 2024) would not be covered by the rule. With Walz joining the campaign, the SEC may turn more attention to compliance with the Pay to Play Rule.
Violating the rule has steep penalties. The rule was designed to prevent advisers from swaying state and local officials with financial incentives to secure contracts to manage public pension plans. Advisers that violate the rule face civil penalties, including the return of all compensation charged to the plan during the look-back period to the contribution. Additionally, advisers that violate the rule are subject to cease and desist orders and requirements to disclose violations in their regulatory filings.
If your firm does not solicit government pension plans and has no intention of pursuing those clients, then this rule does not pose a risk. You can consider reviewing this rule as an exercise in risk assessment. However, if your firm does solicit government plans or could do so in the future, then understanding the rule, its exceptions, and the way your compliance program handles political contributions is critical.
In-Kind Contributions and Volunteer Work – Contributions include money or anything of value, such as hosting a fundraiser or providing firm resources. Volunteer work is generally not covered as long as the firm did not solicit the volunteer activity, use firm resources, and the volunteer activity happened outside of paid working hours.
The De Minimis Exception – Contributions that do not exceed $350 in the aggregate to a campaign in which the contributor could vote, or that do not exceed $150 in the aggregate to campaigns in which the contributor is not permitted to vote. Since all U.S. citizens of voting age can vote in the Presidential election, the $350 limit would apply to contributions to the Harris-Walz campaign on or after August 6th.
New Hires and The Look Back Period – Advisers should monitor new hires and employees that become “covered associates” under the rule. Contributions by new hires that become covered associates within two years of the contribution can be covered by the rule. If the new covered associate solicits clients on behalf of the adviser, the contribution is prohibited by the rule. If the new covered associate does not solicit clients and made the contribution 6 months prior to becoming a covered associate, then the rule does not prohibit the contribution.
Correcting Errors – The rule does permit advisers to correct an improper contribution if it is $350 or less, is discovered within four months after the contribution was made, and the contribution is returned within 60 days after it is discovered. This exception is available so long as the firm has not already corrected two other contributions that violated the rule in the same calendar year, or the firm has more than 50 employees and has not already corrected three such violations. Alternatively, if this exception is unavailable, a firm can request an exception if the firm has implemented reasonable policies and procedures to comply with the rule, took reasonable steps to have the contribution returned, and has taken other remedial actions if appropriate.
What Does This Mean For Me?
An election year, especially one that has a state official on the ticket, is likely to heighten the SEC’s attention to the Pay to Play Rule. Review your policies and procedures on political contributions, make sure you are monitoring covered associates, and remind employees of your compliance requirements around political contributions. If you have any questions, or if you would like to speak with one of our regulatory experts, let us know.
