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SEC Commissioner Says It’s “Past Time” To Reform Overly “Blunt” Pay-to-Play Rule


The U.S. Securities and Exchange Commission (“SEC”) last week announced settlements with four investment advisory firms regarding alleged violations of the SEC’s pay-to-play rule, illustrating that federal regulators continue to aggressively pursue such cases.   The rule at issue, Rule 206(4)-5 (“the Rule”), prohibits investment advisors from, among other things, receiving compensation from certain government entities for two years after a person affiliated with the investment advisor makes a covered campaign contribution to an official of the government entity.  While the involved firms did not admit or deny the allegations in the settlement orders, an examination of the cases is instructive in assessing the current landscape of SEC pay-to-play rule enforcement.  Together, the four settlements are noteworthy in two major respects: (1) the circumstances of the underlying contributions that highlight the wide-reaching application of Rule 206(4)-5; and (2) the fact that one of the SEC Commissioners issued a sharp dissent that expressed deep concern about the breadth of the Rule.

The settlements involved covered associates at four different firms making contributions to four different recipients: an unsuccessful candidate for Mayor of New York City; the incumbent Governor of Hawaii ; an unsuccessful candidate for Governor of Massachusetts; and to a then-candidate for Governor of California.  In two cases, the firms managed public pension money and, in the other two, the firms managed state university endowments, an often overlooked category of government entity investors. 

While the SEC Rule is intended to prevent fraud, it seems highly unlikely that any of the contributions at issue in these four cases could have influenced state investment decisions: 

  • All four investment advisory firms had preexisting business relationships with the relevant government entities before the prohibited contributions were made and no new business was solicited after the contributions. 
  • One of the donors was not even a covered associate at the time of the contribution.
  • Only one of the four prohibited recipients was an incumbent officeholder at the time of the contribution. 
  • Two of the four recipients failed to win election to the offices they sought. 
  • Two of the cases involved situations where the donor either received a refund or requested a refund. 
  • The contribution amounts were a drop in the bucket in proportion to the tens of millions of dollars raised in these elections – three cases involved a single $1,000 contribution and the fourth involved a contribution of $1,000 and another $400. 

Despite these factors, the SEC still censured all four investment advisors and levied civil penalties ranging between $45,000 and $95,000.    

In a stinging dissent which appears to be the first of its kind, SEC Commissioner Hester M. Peirce highlighted some of these facts and called the Rule an “exceedingly blunt instrument” and a “poorly conceived means to pursue laudable ends.” Commissioner Peirce urged the SEC to revisit the Rule and consider revisions.  “The Rule,” she argued, “agnostic to evidence of actual, harmful pay-to-play schemes, dissuades political contributions that have nothing to do with obtaining advisory business from government client.”  Commissioner Peirce’s call for a wholesale reconsideration of the Rule as it stands today counts as a rare public criticism of the far-reaching and constitutionally-debated Rule from within the SEC.  For now, however, these four settlement orders illustrate that the majority of Commissioners are disposed to continue to take a rigorous approach to pay-to-play rule enforcement.

As we have noted, by matching up public campaign finance reports with public lists of state contractors, the SEC can easily identify potential violations.  This, of course, underscores the need for hedge funds, private equity funds, and other investment advisers to ensure they have adopted, and follow, pay-to-play compliance policies.


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