Although some industry officials warn that the Securities and Exchange Commission's proposal to restrict investment advisers from pay-to-play practices would be draconian, an SEC official said yesterday that there does not seem to be an effective alternative.

Speaking at a luncheon hosted by the District of Columbia Bar, Sarah Bessin, assistant director in the SEC's division of investment management, said the hidden nature of pay-to-play contributions makes it difficult to crack down on them without strong regulations. Merely requiring improved disclosures of such contributions - which is one alternative floated by industry participants - probably would not be sufficient, Bessin said.

"The nature of pay-to-play is that people are trying to circumvent, people are trying to hide payments," she said, stressing she was speaking for herself, not the SEC.

Nonetheless, as part of the proposal, the commission will seek comment on whether there are less restrictive ways of limiting pay-to-play, she said.

Bessin's remarks came a week after the SEC proposed prohibiting investment advisers in the $2.3 trillion industry from providing advisory services for compensation to a government for two years if the adviser or any of its partners or executive officers make a contribution to certain elected officials or candidates who can influence the hiring of advisers to manage public funds, or contribute to a political party of the state or locality where the adviser is seeking to provide advisory services to the government.

The proposal, which stems in part from a massive pay-to-play scheme involving New York State's largest pension fund, also would ban investment advisers from hiring third parties or placement agents to solicit a government client on their behalf. In addition, it would prohibit an adviser from engaging in pay-to-play conduct indirectly, such as by directing or funding contributions through spouses or lawyers.

The proposal is revised from one the SEC floated in August 1999 under former chairman Arthur Levitt, modeled partly on limits already in place for municipal broker-dealers. Specifically, the Municipal Securities Rulemaking Board's G-37 bars a broker-dealer from engaging in negotiated muni securities business with an issuer for two years if it or its muni financial professionals make significant political contributions to issuer officials who can influence the award of bond business. In addition, since 2005 Rule G-38 has banned dealers from using third-party consultants to obtain muni securities business.

Karen Barr, general counsel for the Investment Adviser Association, who also spoke on the panel, said that extending muni-market restrictions to investment advisers would be too harsh and tantamount to the "death penalty" for many firms. Unlike the muni market, which is a transaction-based business, investment advisors must have an ongoing relationship with their clients, she argued.

"If you are banned from providing advice for compensation to [the California Public Employees' Retirement System], for example ... the Calpers business is going to go away and never come back," she said. "And that's a very harsh result in a long-term relationship business rather than a transaction-minded business."

As an alternative, Elizabeth Gray, a partner at Willkie, Farr & Gallagher LLP here, who also was on the panel, suggested that the SEC build on its cash solicitation rules for the advisers it regulates by requiring them to disclose more information about their compensation to placement agents and the work the agents are expected to complete in exchange for those payments. She also suggested advisers could be required to maintain better records of those disclosures.

Such changes, which could be modeled on additional disclosures sought by some state funds like Calpers, would not be as draconian as the SEC's proposal, yet they would give the commission more authority to bring cases, she said. Currently, the SEC must demonstrate fraud by proving that an adviser knew or was reckless in not knowing that a payment was illegitimate.

But Bessin was skeptical, saying that the disclosure approach did not work well in the municipal market. G-38 originally required dealers to disclose the names of the consultants they did business with and how much they were paid, but many dealers did not make those disclosures, prompting the board to overhaul the rule to ban all consultants, she said.

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