Client Alert: Important Aspects of SEC Pay-to-Play Rules Took Effect on March 14, 2011; Rule Amendments Also Proposed


Important aspects of the Securities and Exchange Commission’s (“SEC”) “pay-to-play” rules, including rules significantly restricting political contributions by investment advisers, took effect on March 14, 2011.  In addition, the public comment period has recently expired for three additional amendments to Rule 206(4)-5 proposed by the SEC.

Upcoming Compliance Date for SEC Pay-to-Play Rules

As we have discussed in prior client alerts, Rule 206(4)-5 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”), significantly restricts political contributions by registered investment advisers as well as others who manage investments on behalf of state, city or other municipal authorities. Examples of covered investment advisers—whether they are registered or not—include (i) management companies of investment funds that have state authorities as investors, (ii) a manager of a development joint venture with a state investment authority as an investor where the manager takes a promoted interest or management fee from the venture or (iii) anyone else who takes a fee or promoted interest for managing state, city or other municipal investment funds.

Rule 206(4)-5, among other things, makes it unlawful for any covered investment adviser to receive compensation for providing investment advisory services to a state, city or other municipal government entity for a two-year period after the adviser or any of its “covered associates” makes a political contribution to a state or local public official or a candidate for such an office who is or will be in a position to influence the award of the government authority’s investment advisory business. An adviser’s “covered associates” include (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 and (iii) any political action committee controlled by the investment adviser or by any of its covered associates. The rule also makes it unlawful for an investment adviser or any of its covered associates to solicit or to coordinate (i) contributions to an official of a government entity to which the investment adviser is seeking to provide advisory services or (ii) payments to a political party of a state or locality where the investment adviser is providing or seeking to provide advisory services to a government entity. The rule does not apply to contributions made prior to March 14, 201 Violations of the rule could result in bans on doing business with the government authority, the forfeiture of fees for providing the services or other civil penalties provided for under the Advisers Act.

Under Rule 204-2, registered investment advisers that have government authority clients, or that provide advisory services to covered investment pools in which a government authority invests, are required to make and keep certain records of contributions made by the investment adviser and its covered associates to government officials (including candidates) in order to enable the SEC to examine for compliance with Rule 206(4)- However, investment advisers that pay regulated persons to solicit government entities for advisory services on their behalf will not be required to make and keep a list of those persons until September 13, 2011. 

SEC Proposed Amendments to Pay-to-Play Rules

The public comment period has recently expired for three additional amendments to Rule 206(4)-5 proposed by the SEC on November 19, 2010, which amendments were determined to be necessary as a result of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) in July 201 These amendments, if approved by the SEC in their current form, will (i) extend the reach of the exemption under Rule 206(4)-5 to exempt reporting advisers and foreign private advisers,[1] (ii) permit an investment adviser to pay any “regulated municipal advisor”[2] to solicit government entities on its behalf[3] and (iii) amend the definition of “covered associate” of an investment adviser to clarify that legal entities, not just natural persons, are included within the definition.

To see our prior client alerts on “pay-to-play” rules, click here for a link to our July 2 Client Alert and click here for a link to our July 16 Client Alert. If you have any questions about the status or details of the SEC pay-to-play rules, please contact:

This Client Alert has been prepared by Klehr Harrison Harvey Branzburg LLP (the “Firm”) 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 or the opinion of the Firm, and you should not rely on any information in this Client Alert for any specific situation. Rather, you should consult with us or other legal counsel with respect to particular circumstances addressed in this Client Alert before taking any action. Receipt of this summary does not create an attorney-client relationship between you and the Firm.

[1]  In its current form, Rule 206(4)-5 applies to investment advisers that are either registered with the SEC or not required to register in reliance on the exemption under Section 203(b)(3) of the Advisers Act. However, the “private adviser exemption” in Section 203(b)(3) of the Advisers Act was repealed by the Dodd-Frank Act (resulting in many unregistered investment advisers needing to register under the Advisers Act and becoming subject to Rule 206(4)-5). In addition, the Dodd-Frank Act added a new exemption for “foreign private advisers” in Section 203(b)(3) of the Advisers Act. As a result, and in order to preserve the original intent of the rule, the SEC has proposed extending the rule to apply to “exempt reporting advisers” as well as “foreign private advisers”. “Exempt reporting advisers” are investment advisers exempt from registration under (i) Section 203(l) of the Advisers Act (providing for an exemption to advisers that advise solely one or more “venture capital funds” (as defined by the SEC)) or (ii) Section 203(m) of the Advisers Act (providing for an exemption to advisers that act solely as advisers to private funds (as defined in the Dodd-Frank Act) and have assets under management in the United States of less than $150 million). 

[2] A “regulated municipal adviser” is defined under the Dodd-Frank Act as a third-party solicitor (including registered investment advisers and broker-dealers) that seeks business on behalf of an investment adviser from a municipal entity (including a pension fund person) that is registered under Section 15B of the Securities Exchange Act of 1934 and subject to the pay-to-play rules adopted by the Municipal Securities Rulemaking Board (“MSRB”). 

[3]  Rule 206(4)-5 currently prohibits investment advisers from paying “solicitors” or “placement agents” to solicit government entities unless such persons are “regulated persons” (registered investment advisers or broker-dealers subject to rules of a registered national securities association that restricts its members from engaging in pay-to-play activities (for example, the Financial Industry Regulatory Authority (“FINRA”))). However, the Dodd-Frank Act created a new category of person known as a “municipal advisor” subject to the rules of the MSRB. The SEC suggests that replacing references in Rule 206(4)-5 to FINRA’s pay-to-play rules with references to MSRB pay-to-play rules (which are expected to be at least as stringent, if not more so, than those promulgated by FINRA) would be more consistent with the overall objectives of Rule 206(4)-5.