The U.S. Securities and Exchange Commission (“SEC”) issued Rule 206(4)-5 with the intent of curtailing “pay-to-play” political campaign contribution practices by investment advisers. Enacted in 2010, Rule 206(4)-5 attempts to limit the influence of political campaign contributions on the awarding of investment advisory business by governmental entities. This guide explores the rule’s key provisions and best practices for compliance.
Which Firms Are Covered by Rule 206(4)-5?
This SEC rule specifically covers the following investment adviser which provide advisory services to governmental entities:
- Investment advisers registered with the SEC;
- Investment advisers exempt from registering with but required to report to the SEC (“ERAs”); and
- Investment advisers relying on the foreign adviser exemption.
Important Exclusions: Rule 206(4)-5 does not cover investment advisers registered only with a state securities regulator; however, many states have additional requirements for political campaign contributions.
Who Is a Covered Associate?
A covered associate under Rule 206(4)-5 includes the following individuals of a covered investment adviser:
- General Partners, Managing Members, and Executive Officers – This refers to key individuals with authority within the covered investment adviser, such as those in policy-making or oversight roles;
- Employees Who Solicit Governmental Business – Any employee who actively solicits investment advisory business from government entities on behalf of the covered investment adviser; and
- Supervisors of Soliciting Employees – Individuals who directly or indirectly supervise employees involved in soliciting government business; and
- Controlled Political Action Committees (PACs) – Any PAC controlled by the covered investment adviser or by individuals identified above.
These individuals are subject to restrictions on political contributions to prevent conflicts of interest and ensure compliance with “pay-to-play” rules.
Who Is an Official of a Governmental Client?
For purposes of this rule, official includes any individual (or their election committee) who, at the time of a political contribution, is either an incumbent, candidate, or successful candidate for an elective office within a government entity. This definition applies if the official’s position:
(a) Directly or indirectly influences the hiring of an investment adviser by a government entity, or
(b) Has the authority to appoint someone who can influence the hiring of an investment adviser by a government entity.
Key Provisions of Rule 206(4)-5
- Two-Year Time-Out: Covered investment advisers cannot receive compensation for providing advisory services to a governmental client for two years if a prohibited political contribution has been made by the firm or its “covered associates” to an official of the governmental client.
- Look-Back Period: Campaign contributions made up to two years before an individual becomes a covered associate may trigger the two-year time-out. This means pre-hire contributions can still impact a covered investment adviser’s eligibility for advisory compensation.
- De Minimis Exception: Covered associates who are eligible voters for a candidate may contribute up to $350 per election, while those who are not eligible voters may contribute only up to $150.
- Return of Contribution Exception: The rule provides a one-time exception where a prohibited contribution can be returned. This exception is limited to contributions identified within four months of the date made, provided it does not exceed $350. Advisers with fewer than 50 employees may use this exception twice per year; those with more than 50 employees, three times.
- Third-Party Solicitation: Advisers may not make payments to any third-party solicitor unless the solicitor is a “regulated person”.
Best Practices for Compliance
If an investment adviser is covered under the Rule 206(4)-5 (or will be covered under the rule once it starts providing advisory services to a government entity), the following are examples of best practices which should be considered by the investment adviser’s chief compliance officer.
- Pre-Hire Screening: Ensure potential hires have not made contributions to government officials within the past two years if they will become covered associates.
- Establish Robust Policies: Develop and document policies addressing political contributions and interactions with governmental clients. Regularly update these policies to reflect any regulatory changes.
- Regular Training: Conduct mandatory training sessions for all employees on Rule 206(4)-5 requirements, focusing on political contributions and government entity clients.
- Ongoing Surveillance and Monitoring: Continuously monitor contributions by covered associates and implement a reporting process for contributions made. Regular audits can help detect any potential rule violations early.
- Timely Corrective Response: If a prohibited contribution is discovered, act quickly to seek its return, if eligible, within the rule’s four-month limit.
- Annual Reviews: Conduct annual reviews of your compliance policies and confirm if additional state-specific pay-to-play restrictions apply. Document all reviews and compliance efforts, maintaining a record of all political contributions made by covered associates.
(Please understand that this is not a comprehensive listing or analysis of all policies or practices which should be implemented in a particular circumstance.)
IAR CE
To fully understand and effectively comply with SEC Rule 206(4)-5, investment adviser representatives should consider expanding their knowledge and practical skills regarding political campaign contributions and the nuances and applications of Rule 206(4)-5. By enrolling in the investment adviser representative continuing education course, Investment Advisers and Campaign Donations, offered through RIA Compliance Consultants at our continuing education website, https://ce4advisers.com/, representatives can gain access to training on best practices, regulatory requirements, and an enforcement action that illustrates compliance challenges. This course offers valuable guidance to ensure adherence to pay-to-play regulations, equipping investment adviser representatives with tools to better safeguard their investment adviser firms against costly penalties and reputational risks.
Conclusion
SEC Rule 206(4)-5 is crucial in preventing conflicts of interest arising from political campaign contributions by investment advisers. Adopting comprehensive policies, conducting regular training, and maintaining rigorous monitoring procedures are essential for ensuring compliance and mitigating risks associated with pay-to-play practices.
Previous Posts
New SEC Pay-to-Play Rules Require Certain Solicitors to Register as Investment Advisers (06/15/2011)
SEC Unanimously Agrees to Ban Pay-to-Play Practices by Investment Advisers (07/04/2010)
Related Resources
Political Contributions – Reporting Form
Disclosures
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.
NASAA does not endorse any particular provider of IAR CE courses. The content of any course offered by RIA Compliance Consultants, Inc. through CE4Advisers.com and any views expressed therein are our own and do not necessarily reflect the views of NASAA or any of its member jurisdictions.
Posted by Bryan Hill
Labels: Continuing Education, Investment Adviser Rep Continuing Education, Political Contributions, SEC
