The U.S. Securities and Exchange Commission (“SEC”) recently entered into an Order Instituting Administrative and Cease-and-Desist Proceedings against an investment adviser firm for an alleged violation of Rule 206(4)-5 under the Investment Advisers Act of 1940 as amended. This rule, commonly known as the “pay-to-play” rule, is designed to prevent investment advisers from making political contributions to government officials or candidates in exchange for business from government entities.
Overview of Rule 206(4)-5 Requirements
Rule 206(4)-5 restricts investment advisers from providing advisory services for compensation to a government entity within two years after the investment adviser or certain of its covered associates make a political contribution to an official of that entity. The rule applies to investment advisers registered with the SEC, exempt reporting advisers, and foreign private advisers.
A crucial component of this rule is the definition of a “covered associate,” which includes the following: (i) any general partners, managing members, or executives of the investment adviser; (ii) any employees who solicit government entities on behalf of the investment adviser and any employee who supervises directly or indirectly such employee; and (iii) a political action committee controlled by the investment adviser or any person described in sub-sections (i) or (ii).
The rule does include a de minimis exception, which allows covered associates to contribute up to $350 per election to an official or a candidate for whom they are eligible to vote and up to $150 per election for an official or a candidate for whom they are not eligible to vote. Contributions under these limits do not trigger the two-year “time-out” period.
When a new employee joins an investment adviser, their prior political contributions may trigger the two-year ban if they are now soliciting government entities. Under the exception for new covered associates, this prohibition does “… not apply to an investment adviser as a result of a contribution made by a natural person more than six months prior to becoming a covered associate of the investment adviser unless such person, after becoming a covered associate, solicits clients on behalf of the investment adviser.” See Rule 206(4)-5(b)(2).
SEC’s Allegations Against Investment Adviser
According to the SEC’s order, the investment adviser firm allegedly violated Rule 206(4)-5 by providing advisory services for compensation to a government entity within two years of a newly hired employee who made a political contribution (in the amount $7,150) to an official of that government entity.
Return of Donation Exception
In footnote five of the order, the SEC discusses the firm’s attempt to qualify for the return of donation exception. This exception allows for the return of a campaign donation to negate the two-year time-out period, provided the donation is $350 or less and that the investment adviser discovers the donation within four months of the contribution and returns the donation within 60 days of discovery. However, as asserted by the SEC, the firm’s return of the donation did not meet the criteria necessary to fall under this exception.
Penalties Imposed
As a result of these alleged violations, the SEC imposed significant penalties on the investment adviser firm. The firm was censured and was ordered to pay a civil monetary penalty of $95,000. Additionally, the firm is required to cease and desist from committing or causing any further violations of Section 206(4) of Investment Advisers Act and Rule 206(4)-5.
Upcoming Webinar
This proceeding underscores the importance of thorough compliance procedures, especially when hiring new employees who may solicit government entities. Investment advisers must carefully monitor political contributions and ensure they meet all requirements of Rule 206(4)-5 to avoid similar enforcement actions.
For more insights into Rule 206(4)-5 and its implications for your firm, we invite you to attend our complimentary webinar on Wednesday, August 28, at 12:00 p.m. U.S. Central. You can register for the event at https://riacompliance.wistia.com/live/events/yudpyn048t .
Related Resources
Political Contributions – Reporting Form
Disclaimer
This post is a brief summary which is general in nature and offered only for educational purposes. RIA Compliance Consultants, Inc. has not verified the accuracy of the securities regulator’s order and is not offering any opinion whether the allegations made by the securities regulator are accurate. It should not be considered as a comprehensive review or analysis of this development. There are certain requirements and exceptions outlined in the rule which are not covered in this post. This communication is not intended to constitute compliance consulting advice or apply to any particular investment adviser firm’s specific situation without further analysis. This post is not a safe harbor or a legal opinion. The reader should study the actual rule and enforcement action in detail and consult with his or her compliance professionals. This information in this post may become out of date.
Posted by Bryan Hill
Labels: Political Contributions
