Client Alert: The SEC and States Propose Restrictions To Address "Pay-To-Play" Scandals


Headline “pay-to-play” scandals over the past year have caused the Securities and Exchange Commission (“SEC”) and a number of states to propose and, in some cases enact, laws and regulations that significantly limit the manner in which investment funds may seek investments from state authorities if the funds’ sponsors, executives and employees make political contributions to certain officeholders and candidates for certain political offices.

A. Federal / SEC Regulation

On August 3, 2009, the SEC proposed new Rule 206(4)-5 under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) to prohibit investment advisers, including fund general partners, management companies and their personnel, from making political contributions to government officials for the purpose of influencing decisions related to asset management and the investment of state funds, such as investments by state pension authorities in private investment funds. Under the proposal, an investment adviser and certain of its affiliates would not be permitted to be compensated by a state authority, including taking fees or a carried interest on the a state authority investment, for a two-year period if they have made contributions to a government official who is in a position to influence an award of the state authority’s business. The proposed rule also prohibits the use of third parties to solicit an investment from a state authority and requires investment advisers to keep detailed records of political contributions by covered persons.   The SEC comment period for proposed Rule 206(4)-5 ended on October 6, 2009 with no specific timetable for the adoption of a final rule. However, based on various statements by SEC personnel, it is clear that addressing pay-to-play practices is a priority for the SEC.

B. State Laws and Regulations

Several states have proposed or enacted legislation that regulates various aspects of pay-to-play conduct, primarily with regard to the use by investment funds of politically-connected intermediaries to solicit pension fund investments. Recent activity at the state-level includes:

On September 18, 2009, the Pennsylvania Municipal Pension Plan Funding Standard and Recovery Act was amended to prohibit persons from receiving fees for services provided to municipal pension systems if they make political contributions to officeholders who are in a position to influence decisions to retain service providers for the pension system. The amendments will take effect on December 17, 2009, but will not apply retroactively to political contributions made prior to that date. Under the amendments, if a person or an affiliated entity has, within the past two years, made a contribution to a municipal official or candidate for municipal office, that person or affiliated entity may not enter into a professional services contract with, including taking a fee or carried interest on an investment by, that municipality’s pension system. Executives and employees of a contractor or prospective contractor may not solicit a contribution to any municipal official or candidate for municipal office in the municipality where the municipal pension system is organized or to the political party or political action committee of that official or candidate. A person or an affiliated entity that enters into a professional services contract may not have a direct financial, commercial or business relationship with any official of the municipal pension system or the municipality that controls the municipal pension system, unless the pension system consents in writing to the relationship following full disclosure.
The amendment also requires the municipal pension systems to set standards for contracts, bans the retention for certain purposes of persons formerly working for the pensions systems by persons entering into contracts with the pension system for one year, and requires disclosure of certain political contributions and of fees paid to placement agents for procuring municipal pension system investments.
New York

On October 8, 2009, legislation was proposed in New York that would ban the use of placement agents in soliciting investments by state pension systems, and prohibit persons who make political contributions to certain officeholders from doing business with state pension systems for two years. The legislation is a codification of Attorney General Cuomo’s “Public Pension Fund Reform Code of Conduct,” a non-legislative “code of reform” that seven private equity firms have adopted over the last year in lieu of facing prosecution by the Attorney General on corruption charges.

On October 11, 2009, legislation was enacted that regulates the use of placement agents by asset managers who solicit investments from state or local public pension and retirement funds. The California statute establishes a disclosure-based regime that requires potential placement agents, prior to soliciting a potential state or local public pension or retirement system investment, to disclose campaign contributions and gifts to public pension board members during the prior two-year period and to disclose any subsequent gifts and campaign contributions to such board members for as long as the placement agent is being paid to solicit investments. In addition, each state and local public pension system must develop and implement policies requiring disclosure of payments by external asset managers to placement agents, as well as certain additional information regarding the placement agent, by June 30, 2010. A state or local public pension or retirement system may not enter into an agreement with any asset manager that does not agree in writing to comply with their policy. Placement agents or external managers that violate these policies will be barred from soliciting new investments from that state or local retirement system for five years from the time of the violation.

Other States

In addition to Pennsylvania, New York and California, other states previously enacted “pay-to-play” legislation that requires disclosure of certain political contributions and/or restricts doing business with state authorities if political contributions have been made under certain circumstances. It is important to inquire about these rules before you make a political contribution to an officeholder or candidate in a state where you or your organization expects to do business with state authorities or solicit investments from them.
Contact Information

We will continue to monitor the legislative and regulatory proposals to further regulate pay-to-play activities and communicate pertinent information to you. If you have any questions about the status or details of “pay-to-play” laws and regulations, please contact:
Keith W. Kaplan, Esq.
(215) 569-4143
Jon M. Katona, Esq.
(215) 569-4222
This Client Alert is prepared for the general information of our clients and other interested persons.  This Client Alert is not, and is not intended to be, comprehensive in nature.  Due to the general nature of its content, this Client Alert is not and should not be regarded as legal advice.

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