Compliance on the Charles: Boston Regional Summit

June 14- | The Harvard Club of Boston

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The SEC’s Crackdown on Pay to Play Suggests They are not Playing


In general, “pay to play” refers to investment advisers that make or solicit political contributions to government officials in an attempt to influence those officials charged with awarding advisory business.

The SEC has commented that pay to play practices potentially result in higher fees paid to advisers for possibly inferior advisory services provided to government entities.  This is because of an attempt by the adviser to recoup political contributions or because contracts have not been negotiated at arms-length. Pay to play could also effectively block the most suitable adviser for a mandate from consideration if the adviser is a smaller adviser that either cannot afford to make, or refuses to make, political contributions.

In 2010, the SEC enacted rule 206(4)-5, a rule largely modeled on the Municipal Securities Rulemaking Board’s existing pay to play rules G-37 and G-38.  In 2015, the SEC amended the rule to prohibit investment advisers and their covered associates from providing, or agreeing to provide, payment, directly or indirectly, to any third party to solicit a government entity for investment advisory services if the third party is subject to the pay to play rule.

Recent Sweep

On Jan. 17, 2017, the U.S. Securities and Exchange Commission announced 10 separate settlements with investment advisory firms relating to violations of SEC Rule 206(4)-5, the SEC’s pay to play rule for investment advisers and exempt reporting advisers (https://www.sec.gov/news/pressrelease/2017-15.html).

The 10 cases involved penalties ranging from $35,000 to $100,000.  Although some people may not find the fines exorbitant, the firms involved are banned from receiving compensation from affected public sector investors for two years, making the opportunity and reputation cost of the violations significantly higher than the fines alone.

Pershing Square is just one example of the 10 firms that were fined. A review of the facts and circumstances regarding the employee’s conduct demonstrates that the SEC is sending the regulated community a message.

Pershing Square’s application for exemption from Rule 206(4)-5’s penalty provisions (https://www.sec.gov/rules/ia/2016/803-00233-application.pdf) include the following facts that they perceived to be mitigating factors:

  • A former analyst made a single $500 contribution to a candidate for Governor of Massachusetts in excess of the $150 limit.
  • The analyst failed to pre-clear the contribution and, as a result, it was made without the apparent knowledge of the Firm’s Chief Compliance Officer.
  • The analyst made the contribution for personal reasons (at the request of a family friend) more than two years after the initial investment was made.
  • The analyst never spoke with the state fund or its representatives.
  • The analyst was not an executive officer or an equivalent and, given his job description, may not have been considered a “covered associate”.
  • The candidate did not receive sufficient votes to get on the ballot and the contribution was returned.

Pay to Play Rule Summary

Rule 206(4)-5 prohibits, among other things, investment advisers:

  1. from providing advisory services for compensation to a government entity for two years after the adviser or certain of its executives or employees (covered associates) makes a contribution to certain candidates or elected officials;
  2. from providing or agreeing to provide, directly or indirectly, payment to any third party for a solicitation of advisory business from any government entity on behalf of such adviser, unless such third parties are registered broker-dealers or registered investment advisers, subject to pay to play restrictions; and
  3. from soliciting from others, or coordinating, contributions to certain candidates or elected officials, or from making payments to political parties where the adviser is providing or seeking government business.

Rule 206(4)-5 provides certain exceptions including:

  1. De minimis exception for a covered associate who:
    1. is entitled to vote for the candidate or official at the time of the contributions and whose contributions, in the aggregate, do not exceed $350 to any one official, per election
    2. is not entitled to vote for the candidate or official at the time of the contributions and whose contributions, in the aggregate, do not exceed $150 to any one official, per election;
  2. Newly covered associates when a contribution is made 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; and
  3. Certain returned contributions.


It can be argued that Pershing Square’s application for exemption was not unreasonable, as the violation was unintended and had no obvious influence on the investor’s decision. However, the Commission is making it clear that they have zero tolerance, even in apparently benign circumstances. One can speculate that there is more to come, given this recent enforcement activity.  As then-head of the SEC’s Enforcement Division, Andrew Ceresney, noted in 2016 when discussing the unit’s work, there will be “continued activity” in public finance enforcement.

Monique Schulman