These FAQs are part of a series of frequently asked questions that address four primary areas of interest to investment advisers:
- Compliance Program Components;
- Daily Operations;
- Client Protection; and
- Registration and Disclosure
Q1: What is pay-to-play?
A1: In general, pay-to-play refers to various arrangements by which investment advisers may seek to influence the award of advisory business by making or soliciting political contributions to the government officials charged with awarding such business.
Q2: What is the purposes of the pay-to-play rule?
A2: According to former SEC Chairman Mary L. Shapiro, “The selection of investment advisers to manage public plans should be based on the best interests of the plans and their beneficiaries, not kickbacks and favors.” Chairman Shapiro also stated that the Rule “will help level the playing field, allowing advisers of all sizes to compete for government contracts based on investment skill and quality of service.”
Q3: What investment advisers are subject to the pay-to-paly rule?
A3: The pay-to-play rule applies only to investment advisers registered with the SEC. It does not apply to state-registered investment advisers.
Q4: Who is considered a covered associate?
A4: A covered associate is (i) any general partner, managing member or executive officer, or other individual with a similar status or function; (ii) any employee who solicits a government entity for the investment adviser and any person who supervises, directly or indirectly, such employee; (iii) any political action committee controlled by the investment adviser or by any person described in (i) or (i) above.
Q5: Who is considered an official?
A5: An official is defined as any person who was, at the time of the contribution, an incumbent, candidate, or successful candidate for elective office of a government entity, if the office: (i) is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser by a government entity; or (ii) has authority to appoint any person who is directly or indirectly responsible for, or can influence the hiring of, an investment adviser by a government entity.
Q6: What is considered a government entity?
A6: Government entity is defined as any state or political subdivision of a state, including: (i) any agency, authority, or instrumentality of the state or political subdivision; (ii) a pool of assets sponsored by the state or political subdivision or any agency, authority, or instrumentality, including but not limited to a defined benefit plan, as defined by section 414(j) of the Internal Revenue Code, or a state general fund; (iii) a plan or program of a government entity; or (iv) officers, agents, or employees of the state or political subdivision or any agency, authority, or instrumentality acting in an official capacity.
Q7: Who is considered an executive officer?
A7: Executive officer of an investment adviser means: (i) the president; (ii) any vice president in charge of a principal business unit, division, or function; (iii) any other officer of the investment adviser who performs a policy-making function; or (iv) any other person who performs similar policy-making functions for the investment adviser
Q8: What is a covered investment pool?
A8: A covered investment pool is an investment company registered under the Investment Company Act of 1940 that is an investment option of a plan or program of a government entity; or any company that would be an investment company under section 3(a) of the Investment Company Act of 1940, but for the exclusion provided from that definition by either section 3(c)(1), section 3(c)(7), or section 3(c)(11) of that Act.
Q9: Who is considered a regulated person?
A9: A regulated person includes the following:
- An SEC-registered broker-dealer that is also a member of a national securities association (the definition of which, currently, only includes the Financial Industry Regulatory Authority, “FINRA”), subject to the rules of the association (i) prohibiting its members from engaging in distribution or solicitation activities if certain contributions have been made and (ii) which rules the SEC has found to be “substantially equivalent or more stringent” then those restrictions contained within Advisers Act Rule 206(4)-5; and
- An SEC-registered adviser that has not, and whose covered associates have not, within two years of soliciting a government entity, made a contribution to an official of that entity, other than a de minimis contribution, or coordinated or solicited any political contribution.
Q9: What are the elements of the pay-to-play rule?
A9: The rule consists of three primary elements:
- A two-year prohibition on an adviser’s providing compensated investment advisory services to a government entity after a contribution has been made by the adviser or one of its covered associates;
- A prohibition on the use of third-party solicitors who are not themselves regulated persons subject to pay-to-play restrictions on political contributions; and
- A prohibition on bundling and other efforts by advisers to solicit political contributions to certain officials of a government entity to which the adviser is seeking to provide services
Q10: What happens if an investment adviser makes a triggering contribution?
A10: In accordance with its fiduciary duties to its government clients, an adviser that makes a triggering contribution may be obligated to continue to provide uncompensated advisory services for a reasonable period of time during the time-out to allow the government client to obtain replacement services.
Q11: Are there any exceptions to the two-year time out period?
A11: The pay-to-play rule contains certain de minimis exceptions to the two-year time out period. Covered associates, but not the investment adviser itself, are allowed to make contributions of up to $350 per election to an elected official or candidate for whom the individual is entitled to vote (when the covered associate’s principal residence is in the locality in which the official seeks election); and contributions of up to $150 per election for an elected official or candidate for whom the individual is not entitled to vote.
Q12: What happens if an inadvertent contribution is made in violation of the pay-to-play rule?
A12: An investment adviser can automatically cure a contribution that does not exceed $350 per official, per election if the adviser (i) discovers the contribution within four months of the date of the contribution and (ii) facilitates the return of the triggering contribution within sixty days of learning about it.
Q13: Are there any limitations on the use of the inadvertent contribution cure?
A13: Investment advisers have a limited number of opportunities to make use of this cure provision within a given time period. Investment advisers that have reported more than fifty employees in response to Item 5.A. on their most recent Form ADV Part 1 can use this cure three times in a 12-month period, while smaller advisers can only use it two times within the same period.
Q14: What is the pay-to-play rule’s “catch-all” provision?
A14: The catch-all provision prohibits an investment adviser or a covered associate from doing indirectly what it may not do directly in accordance with the rule.
Q15: What is an example of the type of activity the catch-all provision is intended to prohibit?
A15: An investment adviser funneling its contributions through another party, such as a lawyer, spouse or family member.
Q16: What are the record keeping requirements under the pay-to-play rule?
A16: Advisers Act Rule 204-2 requires investment advisers to keep copies of the following material pertaining to political contributions:
- A list or other record of the names, titles and business and residence addresses of all covered associates of the investment adviser (Note: An investment adviser is only required to make and keep current these records if it provides investment advisory services to a government entity or a government entity is an investor in any covered investment pool to which the investment adviser provides investment advisory services).
- A list or other record of all government entities to which the investment adviser provides or has provided investment advisory services, or which are or were investors in any covered investment pool to which the investment adviser provides or has provided investment advisory services, as applicable, in the past five years, but not prior to September 13, 2010.
- All direct or indirect contributions made by the investment adviser or any of its covered associates to an official of a government entity, or direct or indirect payments to a political party of a State or political subdivision thereof, or to a political action committee (Note: An investment adviser is only required to make and keep current these records if it provides investment advisory services to a government entity or a government entity is an investor in any covered investment pool to which the investment adviser provides investment advisory services).
- The name and business address of each regulated person to whom the investment adviser provides or agrees to provide, directly or indirectly, payment to solicit a government entity for investment advisory services on its behalf, in accordance with §275.206(4)–5(a)(2).
- Records relating to the contributions and payments referred to in paragraph (a)(18)(i)(C) of this section must be listed in chronological order and indicate:
- The name and title of each contributor;
- The name and title (including any city/county/State or other political subdivision) of each recipient of a contribution or payment;
- The amount and date of each contribution or payment; and
- Whether any such contribution was the subject of the exception for certain returned contributions pursuant to §275.206(4)–5(b)(2).