SEC Proposes Amendments to the Pay to Play Rule

Jan 3 2011 | 11:27am ET

By Cheri Hoff, Renée Dailey and Josephine Moon (Bracewell & Giuliani) -- On November 19, 2010, the Securities and Exchange Commission proposed new rules and amendments implementing certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Among other things, the new rules propose amendments to the "pay to play" rule under the Investment Adviser's Act of 1940. The SEC is seeking comments to the Proposed Rules for a period of 45 days after their publication in the Federal Register.

In the investment adviser context, pay to play refers to the practice of making contributions to the campaigns of elected officials with the intention of influencing the award of contracts for managing public pension plan assets. In June of 2010, the SEC adopted Rule 206(4)-5 of the Advisers Act to address the selection of advisers to manage assets of U.S. state and local government entities and to prohibit investment advisers from making direct political contributions and other activities that lead to pay to play arrangements. The rule generally prohibits (i) registered and certain unregistered advisers from providing advisory services for compensation to a government client for two years after the adviser or certain of its executives or employees makes political contributions to an elected official who is in a position to influence the selection of such adviser; (ii) paying third parties to solicit advisory business from any government entity unless the person is a "regulated person" subject to similar pay to play restrictions (i.e. regulated broker-dealers subject to such restrictions or registered investment advisers); and (iii) soliciting others, or coordinating contributions to elected officials or candidates or payments to political parties, where the adviser is providing or seeking government business.

Following the enactment of the Dodd-Frank Act, and in line with the general goal of the Dodd-Frank Act for greater transparency and regulation, the SEC proposed amendments to the existing pay to play rule affecting investment advisers. Specifically the Proposed Rules would (i) expand the scope of the rule to also apply to exempt reporting advisers and foreign private advisers and (ii) amend the definition of a "covered associate" of an investment adviser to clarify that it includes a legal entity (and not just a natural person) that is a general partner or managing member of an investment adviser. At the same time, the Proposed Rules would amend the provision prohibiting advisers from paying persons to solicit government entities unless such persons are "regulated persons" to permit an adviser to pay any "regulated municipal adviser" (a person registered under section 15B of the Securities Exchange Act of 1934 and subject to pay to play rules adopted by the Municipal Securities Rulemaking Board) to solicit government entities on its behalf.

The Proposed Rules seek to further abolish pay to play practices and promote the goal of greater protection to public pension plans and their beneficiaries, by significantly expanding the pool of investment advisers that are subject to the regulation. This heightened regulation will hopefully further level the playing field for advisers competing for government contracts, so that advisers can be judged on their performance rather than political or economic influence.

Cheri L. Hoff is a partner in Bracewell & Giuliani LLP's private investment funds practice; she is based in the New York office. Renée M. Dailey is a partner in the financial restructuring practice; she is based in the Connecticut office. Josephine Moon is an associate in the private investment funds practice; she is based in the New York office.


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