Securities and Exchange Commission Offers Curbs on Pay-to-Play

WASHINGTON - The Securities and Exchange Commission yesterday released its proposed pay-to-play restrictions for investment advisers and has set an Oct. 6 deadline for public comments, including on whether the curbs should be expanded to include contributions to charities and other institutions closely affiliated with elected officials.

The SEC formally released the 114 pages of proposed rules and rule changes, which are modeled on Municipal Securities Rulemaking Board rules, about two weeks after the five-member commission met and unanimously voted to propose them.

The proposal comes amid several ongoing probes of alleged pay-to-play practices, including in New York, where Attorney General Andrew Cuomo and the SEC are investigating a massive scheme involving that state's largest pension fund. The investigations there have led to enforcement actions against individuals and firms in New York and has spread to other states.

The proposals are revised from a plan floated by the SEC in 1999 that never went anywhere, in part because of congressional opposition. They would restrict investment advisers in the $2.2 trillion industry from providing advisory services for compensation to a government for two years if the adviser or any of its key employees make a contribution to elected officials or candidates who can influence the hiring of advisers to manage public funds.

The proposed rules, however, would allow for contributions of up to $250 to officials the adviser can vote for. This mirrors the $250 safe harbor provision for "municipal finance professionals" in the MSRB's Rule G-37, which is aimed at preventing dealers from engaging in pay-to-play practices.

The SEC proposal also would restrict advisers from soliciting or coordinating either contributions for a government official, or payments to a political party of the state or locality where they are seeking to provide advisory services, a provision that also mirrors G-37.

As with the MSRB's Rule G-38, which bans the use of outside consultants to solicit muni business, the SEC proposals would ban investment advisers from hiring third parties or placement agents to solicit government clients on their behalf.

The SEC proposals also would prohibit advisers from engaging in pay-to-play conduct indirectly, such as by directing or funding contributions through spouses or lawyers, a provision modeled on G-37.

Finally, they would impose significant new record-keeping requirements on advisers. They include that they keep: the names of all employees covered by the proposals; the names of all government entities for which the adviser or any of its associates is providing, or seeking to provide, investment advisory services; all government entities to which the adviser has provided investment advisory services; and all direct or indirect contributions or payments made by the adviser or its covered employees to an official of a government entity, a political party of a state or its political subdivision, or political action committee.

Though largely modeled on MSRB rules, the proposed rules could ultimately go beyond those restrictions.

For instance, the SEC is asking for comment on whether the rule's prohibitions should be expanded to "apply expressly" in cases where an adviser gives a contribution "to others closely associated with the official - such as an official's political action committee, his or her inauguration or transition committee, a local or state political party that provides assistance to such official, or a foundation or other charitable institutions associated with such official."

In a footnote, the SEC said it is asking if these types of contributions should be specifically prohibited because the proposed provision against indirect violations of the rule might be so vague as to be ineffective.

After last month's open meeting, for example, SEC staff told reporters that they are concerned about reports that municipal dealers may be skirting G-37's restrictions on political contributions to issuer officials by making contributions to the officials' favored charities.

The SEC asked for comments on several specific questions, including whether advisory firms need additional time to develop procedures to comply with the proposed rules before they are implemented and, if so, how long a transition period would be necessary.

Besides the exemption for certain $250 contributions to issuer officials, the SEC is proposing and seeking comment on another proposed exemption that would save an adviser from the two-year "time out" from pay if it triggered the ban inadvertently.

This exemption would be granted only if the individual is from an advisory firm with existing policies and procedures and accidentally makes a contribution that does not exceed $250 to a candidate for which they are not eligible to vote. The contribution would need to be discovered within four months of the date it was made and returned within 60 days of its being discovered. Advisers would not be eligible for the exception more than twice per 12-month period.

Meanwhile, the SEC's proposal estimates that about 1,764 advisory firms registered with the commission may be affected by the proposal. It also estimates that the proposal would impose annual, ongoing compliance expenses of about $2,580 for smaller firms, $104,625 for medium-sized firms, and $209,250 for larger firms.

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