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Paying for Playing: SEC Brings First Pay-to-Play Action against an Investment Adviser

Posted in Enforcement, Investment Adviser Regulation, SEC Enforcement

The SEC has brought the first action under the “pay-to-play” rule adopted under the Investment Advisers Act.  The SEC also found that two affiliated exempt reporting advisers were operationally integrated and as such should have registered as an investment adviser.

Pay-to-Play Violation.  Rule 206(4)-5 under the Investment Advisers Act provides that investment advisers (whether registered or unregistered) are prohibited from providing advisory services in exchange for compensation to a government client for two years after the adviser or certain officers or employees of the adviser make a campaign contribution to certain elected officials or candidates for office related to that government client.

The SEC charged a venture capital firm whose associate contributed to candidates in the Philadelphia mayoral campaign and the Pennsylvania gubernatorial campaign in 2011.  Both the mayor and governor appoint board members of public pension plans that had been investors in the firm’s venture capital funds since 2000, and the firm provided advisory services to the pension funds.

The SEC found that the firm continued to receive compensation for advisory services it provided to the public pension plans for two years after the associate made the campaign contributions, in violation of the pay-to-play rule.

It appears that the SEC is actively enforcing the “pay-to-play” rule under the Investment Advisers Act.  More interestingly, in this case the government clients in question first invested in the subject funds more than a decade before the associate made the campaign contributions, and at a time when the funds were winding down (but the adviser was still receiving fees).  In other words, it seems that the SEC is applying Rule 206(4)-5 even if the government client invested with an adviser prior to the time of the political contribution.  Investment advisers should ensure that they have robust internal procedures to monitor political contributions by employees and officers, including those made to preexisting government clients, and to act immediately when pay-to-play rules may be triggered.

Failure to Register/Integration.  The SEC’s second charge is also noteworthy.  The SEC found that the two affiliated advisers, who separately claimed to be exempt reporting advisers, were significantly operationally integrated and thus should have been integrated into a single investment adviser for purposes of determining whether they were required to register with the SEC.  Once integrated, the adviser did not qualify for either of the exemptions it previously relied on and the firm was charged with failing to register itself and its affiliate as investment advisers.

Investment advisers in similar situations that seek to claim exemptions from registration with the SEC should consult with counsel familiar with registration requirements of investment advisers and carefully review their relationships with affiliates to determine if they should be integrated for purposes of the SEC’s registration rules.

More details on this development can be found here.