SEC cracks down on pay-to-play

Private fund managers need to ensure all employees are aware of pay-to-play regulation, and be careful who they hire, as the Securities and Exchange Commission homes in on its enforcement.

The pay-to-play rule prevents anyone who has made political donations in the last two years from working for a company that benefits from US public money. Private fund firms, which often manage capital on behalf of US public pension funds, fall into this category.

The agency recently settled 10 enforcement actions against advisory firms that allegedly breached the rule. Private equity firm Lime Rock Partners and venture capital-focused firms Adams Capital Management and NGN Capital were among those charged.

The SEC has taken a hard line in enforcing this rule, bringing action against individuals who have exceeded the threshold by as little as $50, according to law firm Robinson & Cole.

The regulation imposes a two-year ban on providing paid advisory services to a government investor if a “covered associate” – anyone involved in fundraising – has made political contributions to any candidate with direct or indirect influence over how the public pension invests its money.

The ban on compensation does not apply for political contributions below certain threshold amounts. Contributions up to $350 to a candidate for which an associate is entitled to vote, and $150 to a candidate for which an associate is not entitled to vote are acceptable.

If an investment advisor’s partners or associates give money to a politician or candidate, there’s a two-year “timeout” period before the firm can manage money for a pension fund over which that politician has influence, even if the contribution was made before the advisor was hired by the firm. GPs will therefore need to review candidates’ political donations before hiring them.

Pay attention

There are nuances to which private fund advisors should pay close attention or risk falling foul of the regulation, lawyers advise.

While the SEC has said contributions by a covered associate’s family members are not explicitly prohibited, advisors are also prohibited from indirect actions.

“Advisors should remind personnel that any political contributions from financial accounts held jointly by an employee and his or her spouse, partner or other family member could be viewed by the SEC staff as contributions in whole or in part, by the employee,” law firm Proskauer says.

Contributions to a political party, political action committee or other committee or organization could also trigger a two-year ban on receiving compensation if it is a means to do indirectly what the rule prohibits. Covered associates cannot co-ordinate or solicit any person or PAC to make any payment to a political party of a state or locality where the investment advisor is providing, or seeking to provide, investment advisory services to a government entity.

A government official’s “indirect influence” can also trigger disqualification. Under the rule, executive or legislative officers who hold a position with influence over the hiring of an investment advisor are considered government officials.

“While a determination of indirect responsibility or influence is a highly facts and circumstances-driven analysis, advisers generally should consider viewing a state government hierarchy as a pyramid, and the higher the official in the pyramid, the more likely that official will be viewed by the SEC as holding at least indirect influence over the administration of the state government entity plan in question,” the law firm adds.

A number of additional pay-to-play restrictions at the state, municipality and plan level exist, which fund managers should be aware of.

“These prohibitions may be either specific or general in nature and may apply to employees, independent contractors or other individuals or entities, including placement agents, solicitors and other marketers acting on behalf of an investment adviser beyond covered associates,” Proskauer says.