SEC Settles Charges with 10 Investment Advisory Firms for Violating Pay-to-Play Rules

On January 17, 2017, the Securities and Exchange Commission (“SEC”) issued ten Orders Instituting Administrative and Cease-and-Desist Proceedings (“Orders”) against ten investment advisory firms.  In each of its Orders, the SEC alleges that each investment advisory firm gave money to campaigns for politicians who, if elected, would have the power to determine the choice of investment advisers to oversee government assets, and subsequently gave investment advisory services to public pension funds.  According to the SEC, these actions constituted violations of the Investment Advisers Act of 1940 (“Advisers Act”).

Rule 206(4)-5(a)(1), commonly known as the Pay-to-Play Rule, provides that investment advisers who are registered with the SEC, foreign private advisers, and exempt reporting advisers are not permitted to provide “investment advisory services for compensation to a government entity within two years after a contribution to an official of a government entity made by the investment adviser or any covered associate of the investment adviser.”  This rule applies regardless of whether the investment adviser or covered person intended to sway the official.  According to the SEC’s Orders, five of the investment advisory firms were SEC-registered investment advisers, while the remaining five were exempt reporting advisers.  Thus, all ten of the investment advisory firms were subject to the provisions of Rule 206(4)-5(a)(1).

Each of the SEC’s Orders alleges that a covered associate of each investment advisory firm contributed money to various candidates for public office, such as state governors and treasurers, city mayors, and the Manhattan Borough President.  According to the SEC, individuals who hold these offices all have the power to determine the choice of investment advisers to oversee government assets.  As a result, when the covered associates made the contributions to the candidates, the two-year time frame during which the firms could not give investment advisory services to the government entities began.

The SEC’s Orders claim that the investment advisory firms’ violation of Rule 206(4)-5(a)(1) stemmed from their giving investment advice to public pension plans less than two years after the covered associates made the contributions.  Rule 206(4)-5 covers advisers “to a covered investment pool in which a government entity invests or is solicited to invest as though the adviser were providing or seeking to provide investment advisory services directly to the government entity.”  As stated in the SEC’s Orders, a pension fund is an example of such an investment pool because it fits the definition of an investment company under section 3(a) of the Investment Company Act of 1940 (“Investment Company Act”), except that it is excluded from that definition under section 3(c)(7).

The SEC’s Orders allege that the ten investment advisory firms provided services to public pension funds for compensation.  The Orders also allege that the firms provided these services during a two-year time frame where they were prohibited from doing so because of their covered associates’ campaign contributions.  This resulted in the firms’ violation of Rule 206(4)-5.  In response, the SEC imposed monetary penalties against all ten firms.  The fines vary in size from $35,000 to $100,000.

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