SEC Proposes Rescission of Investment Adviser Pay-to-Play Rule

The proposed rescission would eliminate the rule in its entirety, including its prohibition on certain political contributions, its two-year compensation ban, and its restrictions on the use of certain third-party placement agents to solicit state and local government investors. All other requirements of the Advisers Act and its associated rules, including prohibitions on fraud, fiduciary duty requirements, the compliance rule (Rule 206(4)-7), and the code of ethics rule (Rule 204A-1), would continue to apply.

The Current Pay-to-Play Framework

Rule 206(4)-5 was adopted in 2010 to deter pay-to-play practices in the investment advisory industry. Key features of the rule include the following.

• A two-year ban on compensation for advisory services to a state or local government entity after the adviser, or any of its “covered associates,” makes a political contribution to an official or candidate in a position to influence the adviser’s selection.

• Restrictions on third-party solicitors who are not “regulated persons,” prohibitions on soliciting or coordinating certain contributions, and detailed recordkeeping requirements under Rule 204-2(a)(18).

• Application to registered advisers, exempt reporting advisers, and foreign private advisers, including where a government entity invests in a “covered investment pool” such as a public pension fund’s allocation to a private fund. 

• Limited de minimis exceptions of $350 per election for officials the covered associate can vote for, and $150 for all others — though contributions at or above these thresholds can trigger the full two-year ban regardless of intent. 

SEC Rationale for the Proposed Rescission

The SEC cited more than 15 years of administering the rule and identified the following concerns with its design and operation.

• The definitions of “covered associate” and “official” under Rule 206(4)-5(f) extend well beyond their intended scope, reaching individuals and political activity with no meaningful connection to the award of advisory contracts.

• The rule’s two-year compensation ban operates without regard to intent or materiality — contributions that are minor in amount or unintentional in nature can result in the same penalty as deliberate pay-to-play conduct. 

• The lookback provisions can effectively disqualify otherwise suitable candidates for employment or promotion based on prior contributions that bear no meaningful relationship to pay-to-play concerns. 

• The rule’s complexity has driven a number of advisory firms to prohibit employee political contributions altogether — a response that curtails political participation well in excess of what the regulatory framework demands. 

• Compliance costs may be disproportionate to the harm the rule prevents, particularly for advisers with lower pay-to-play risk profiles. 

The SEC took the position that the Advisers Act’s existing regulatory framework — including its antifraud provisions (Sections 206(1) and (2)), fiduciary duty requirements, the compliance rule, and the code of ethics rule — provides an adequate foundation for addressing pay-to-play risks without the need for a standalone prescriptive rule and emphasized that the SEC would retain its authority to pursue enforcement actions targeting pay-to-play conduct.

Public Comment Period and Open Questions

The Proposed Release poses 20 questions for public comment, including whether the SEC should instead:

• Amend specific provisions, such as raising the de minimis threshold (e.g., to $3,500), shortening the lookback periods, or narrowing the definitions of “official” and “covered associate.” 

• Adopt enhanced disclosure obligations (e.g., Form ADV disclosures) as an alternative transparency mechanism. 

The SEC also flagged a potential gap in its proposed approach: the compliance rule and the code of ethics rules do not extend to exempt reporting advisers or foreign private advisers, both of which are currently subject to the pay-to-play rule. The SEC sought comment on whether rescission would increase the risk of pay-to-play for these categories of advisers.

The SEC further asked whether rescission would affect the application of related pay-to-play regimes, including MSRB Rule G-37, FINRA Rule 2030, and Exchange Act Rule 15Fh-6, and what impact the rescission would have on dually registered investment advisers and broker-dealers.

Key Takeaways and Next Steps

The rule remains in full force and effect during the pendency of the rulemaking, and investment advisers should maintain their existing compliance programs governing political contributions until any final rescission takes effect. 

Even if the rescission is ultimately adopted, investment advisers should be aware of the following.

• Conduct that constitutes a pay-to-play practice would continue to violate the anti-fraud provisions of the Advisers Act (Sections 206(1) and (2)) and an adviser’s fiduciary duty, and would remain subject to the compliance rule, the code of ethics rule, and applicable federal, state, and local law.

• Investment advisers that provide or seek to provide advisory services to state or local government entities will need to assess their material pay-to-play risks and determine how to tailor their compliance policies and procedures and codes of ethics in the absence of the rule’s prescriptive requirements. The proposed release identifies several relevant factors, including applicable state and local pay-to-play laws, the nature and scope of the adviser’s government clients, and the adviser’s organizational structure and risk profile. 

• Advisers would continue to be subject to applicable state and local laws governing political contributions, federal anti-bribery statutes, any requirements imposed by government entity clients or investors as a condition of awarding investment management contracts, and parallel federal pay-to-play regimes, including MSRB Rule G-37, FINRA Rule 2030, and Exchange Act Rule 15Fh-6. 

• The rescission would eliminate the prohibition under Rule 206(4)-5(a)(2) on paying a third party that is not a “regulated person” to solicit government entities, but advisers may still face restrictions under MSRB Rule G-37, FINRA Rule 2030, Exchange Act Rule 15Fh-6, and state and local laws regulating the use of placement agents. 

Public comments to the proposed rule may be submitted now and are due by November 9.

ArentFox Schiff attorneys are available to answer your questions and assist with navigating these regulatory developments, including advising on the implications of the proposed rescission for your compliance programs, evaluating whether to submit public comments, and reviewing and updating pay-to-play policies and procedures. Please contact the authors of this alert or your ArentFox Schiff attorney contact for more information.