SECURITIES AND EXCHANGE COMMISSION 

17 CFR Part 275 

Release No. IA-3043; File No. S7-18-09 

RIN 3235-AK39 

Political Contributions by Certain Investment Advisers 

AGENCY: Securities and Exchange Commission. 

ACTION: Final rule. 

SUMMARY: The Securities and Exchange Commission is adopting a new rule under 

the Investment Advisers Act of 1940 that prohibits an investment adviser from providing 

advisory services for compensation to a government client for two years after the adviser 

or certain of its executives or employees make a contribution to certain elected officials 

or candidates. The new rule also prohibits an adviser from providing or agreeing to 

provide, directly or indirectly, payment to any third party for a solicitation of advisory 

business from any government entity on behalf of such adviser, unless such third parties 

are registered broker-dealers or registered investment advisers, in each case themselves 

subject to pay to play restrictions. Additionally, the new rule prevents an adviser from 

soliciting from others, or coordinating, contributions to certain elected officials or 

candidates or payments to political parties where the adviser is providing or seeking 

government business. The Commission also is adopting rule amendments that require a 

registered adviser to maintain certain records of the political contributions made by the 

adviser or certain of its executives or employees. The new rule and rule amendments 

address “pay to play” practices by investment advisers. 

DATES: Effective Date: September 13, 2010. 
 

 

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Compliance Dates: Investment advisers subject to rule 206(4)-5 must be in compliance 

with the rule on March 14, 2011. Investment advisers may no longer use third parties to 

solicit government business except in compliance with the rule on September 13, 2011. 

Advisers to registered investment companies that are covered investment pools must 

comply with the rule by September 13, 2011. Advisers subject to rule 204-2 must 

comply with amended rule 204-2 on March 14, 2011. However, if they advise registered 

investment companies that are covered investment pools, they have until September 13, 

2011 to comply with the amended recordkeeping rule with respect to those registered 

investment companies. See section III of this Release for further discussion of 

compliance dates. 

FOR FURTHER INFORMATION CONTACT: Melissa A. Roverts, Senior Counsel, 

Matthew N. Goldin, Branch Chief, Daniel S. Kahl, Branch Chief, or Sarah A. Bessin, 

Assistant Director, at (202) 551-6787 or IArules@sec.gov, Office of Investment Adviser 

Regulation, Division of Investment Management, U.S. Securities and Exchange 

Commission, 100 F Street, NE, Washington, DC 20549-8549. 

SUPPLEMENTARY INFORMATION: The Commission is adopting rule 206(4)-5 

[17 CFR 275.206(4)-5] and amendments to rules 204-2 [17 CFR 275.204-2] and 206(4)-3 

[17 CFR 275.206(4)-3] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] 

(“Advisers Act” or “Act”).1 

15 U.S.C. 80b. Unless otherwise noted, when we refer to the Advisers Act, or any 

paragraph of the Advisers Act, we are referring to 15 U.S.C. 80b of the United States 

Code, at which the Advisers Act is codified, and when we refer to rule 206(4)-5, rule 

204-2, rule 204A-1, rule 206(4)-3, or any paragraph of these rules, we are referring to 17 

CFR 275.206(4)-5, 17 CFR 275.204-2, 17 CFR 275.204A-1 and 17 CFR 275.206(4)-3, 

respectively, of the Code of Federal Regulations, in which these rules are published. 

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TABLE OF CONTENTS 

I. BACKGROUND ................................................................................................... 5
 

II. DISCUSSION ...................................................................................................... 15
 

A. First Amendment Considerations ......................................................................... 19 

B. Rule 206(4)-5........................................................................................................ 25 

1. Advisers Subject to the Rule............................................................................. 29 

2. Pay to Play Restrictions .................................................................................... 31 

(a) Two-Year “Time Out” for Contributions ................................................... 31 

(1) Prohibition on Compensation.................................................................. 38 

(2) Officials of a Government Entity............................................................ 43 

(3) Contributions........................................................................................... 46 

(4) Covered Associates ................................................................................. 49 

(5) “Look Back”............................................................................................ 58 

(6) Exceptions for De Minimis Contributions .............................................. 62 

(7) Exception for Certain Returned Contributions........................................ 65 

(b) Ban on Using Third Parties to Solicit Government Business..................... 70 

(1) Registered Broker-Dealers ...................................................................... 87 

(2) Registered Investment Advisers.............................................................. 90 

(c) Restrictions on Soliciting and Coordinating Contributions and Payments. 93 

(d) Direct and Indirect Contributions or Solicitations...................................... 96 

(e) Covered Investment Pools .......................................................................... 97 

(1) Definition of “Covered Investment Pool”............................................. 102 

(2) Application of the Rule ......................................................................... 109 

(3) Subadvisory Arrangements ................................................................... 111 

(f) Exemptions ............................................................................................... 114 

D. Recordkeeping .................................................................................................... 116 

E. Amendment to Cash Solicitation Rule................................................................ 121 

III.	 EFFECTIVE AND COMPLIANCE DATES................................................. 122
 

A. Two-Year Time Out and Prohibition on Soliciting or 

Coordinating Contributions ............................................................................ 122 

B. Prohibition on Using Third Parties to Solicit Government Business and Cash 

Solicitation Rule Amendment......................................................................... 123 

C. Recordkeeping .................................................................................................... 125 

D. Registered Investment Companies...................................................................... 125 

IV.	 COST-BENEFIT ANALYSIS.......................................................................... 127
 

A. Benefits ............................................................................................................... 130 

B. Costs.................................................................................................................... 136
 

1. Compliance Costs Related to Rule 206(4)-5 .................................................. 136 

2. Other Costs Related to Rule 206(4)-5............................................................. 148 

(a) Two-Year Time Out.................................................................................. 148 

(b) Third-Party Solicitor Ban.......................................................................... 154 

3. Costs Related to the Amendments to Rule 204-2........................................... 159 
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V. PAPERWORK REDUCTION ACT ............................................................... 162
 

A. Rule 204-2........................................................................................................... 162 

B. Rule 206(4)-3...................................................................................................... 171 

C. Rule 206(4)-7...................................................................................................... 174 

D. Rule 0-4............................................................................................................... 176 

VI. FINAL REGULATORY FLEXIBILITY ANALYSIS.................................. 176
 

A. Need for the Rule ................................................................................................ 179 

B. Significant Issues Raised by Public Comment ................................................... 180 

C. Small Entities Subject to Rule ............................................................................ 181 

D. Projected Reporting, Recordkeeping, and Other Compliance Requirements..... 183 

E. Agency Action to Minimize Effect on Small Entities ........................................ 184 

VII.	 EFFECTS ON COMPETITION, EFFICIENCY AND CAPITAL 

FORMATION ................................................................................................... 188
 

VIII.	 STATUTORY AUTHORITY.......................................................................... 191
 
 

 

 

 

 

 

 

 

 

 

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I. BACKGROUND 

Investment advisers provide a wide variety of advisory services to state and local 

governments,2 including managing their public pension plans.3 These pension plans 

have over $2.6 trillion of assets and represent one-third of all U.S. pension assets.4 They 

are among the largest and most active institutional investors in the United States;5 the 

management of these funds affects publicly held companies6

 and the securities markets.7 

But most significantly, their management affects taxpayers and the beneficiaries of these 

2 See SOFIA ANASTOPOULOS, AN INTRODUCTION TO INVESTMENT ADVISERS FOR STATE 

AND LOCAL GOVERNMENTS (2d ed. 2007); Werner Paul Zorn, Public Employee 

Retirement Systems and Benefits, LOCAL GOVERNMENT FINANCE, CONCEPTS AND 

PRACTICES 376 (John E. Peterson & Dennis R. Strachota eds., 1st ed. 1991) (discussing 

the services investment advisers provide for public funds). 

3	 To simplify the discussion, we use the term “public pension plan” interchangeably with 

“government client” and “government entity” in this Release. However, our rule applies 

broadly to investment advisory activities for government clients, such as those mentioned 

here in this Section of the Release, regardless of whether they are retirement funds. For a 

discussion of how the proposed rule would apply with respect to investment programs or 

plans sponsored or established by government entities, such as “qualified tuition plans” 

authorized by section 529 of the Internal Revenue Code [26 U.S.C. 529] and retirement 

plans authorized by section 403(b) or 457 of the Internal Revenue Code [26 U.S.C. 

403(b) or 457], see section II.B.2(e) of this Release. 

4	 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, FLOW OF FUNDS ACCOUNTS 

OF THE UNITED STATES, FLOWS AND OUTSTANDINGS, FOURTH QUARTER 2009 78 

tbl.L.119 (Mar. 11, 2010). Since 2002, total financial assets of public pension funds 

have grown by 28%. Id. 

5	 According to a recent survey, seven of the ten largest pension funds were sponsored by 

state and municipal governments. The Top 200 Pension Funds/Sponsors, PENS. & INV. 

(Sept. 30, 2008), available at 

http://www.pionline.com/article/20090126/CHART/901209995. 

6	 See Stephen J. Choi & Jill E. Fisch, On Beyond CalPERS: Survey Evidence on the 

Developing Role of Public Pension Funds in Corporate Governance, 61 VAND. L. 

REV. 315 (2008) (“Collectively, public pension funds have the potential to be a powerful 

shareholder force, and the example of CalPERS and its activities have spurred many to 

advocate greater institutional activism.”). 

7	 Federal Reserve reports indicate that, of the $2.6 trillion in non-federal government plans, 

$1.5 trillion is invested in corporate equities. BOARD OF GOVERNORS OF THE FEDERAL 

RESERVE SYSTEM, supra note 4, at 78 tbl.L.119. 
 

 

 

 

 

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funds, including the millions of present and future state and municipal retirees8 who rely 

on the funds for their pensions and other benefits.9 Public pension plan assets are held, 

administered and managed by government officials who often are responsible for 

selecting investment advisers to manage the funds they oversee. 

Elected officials who allow political contributions to play a role in the 

management of these assets and who use these assets to reward contributors violate the 

public trust. Moreover, they undermine the fairness of the process by which public 

contracts are awarded. Similarly, investment advisers that seek to influence government 

officials’ awards of advisory contracts by making or soliciting political contributions to 

those officials compromise their fiduciary duties to the pension plans they advise and 

defraud prospective clients. These practices, known as “pay to play,” distort the process 

by which advisers are selected.10 They can harm pension plans that may subsequently 

receive inferior advisory services and pay higher fees. Ultimately, these violations of 

trust can harm the millions of retirees that rely on the plan or the taxpayers of the state 

and municipal governments that must honor those obligations.11 

8 See PAUL ZORN, 1997 SURVEY OF STATE AND LOCAL GOVERNMENT EMPLOYEE 

RETIREMENT SYSTEMS 61 (1997) (hereinafter “1997 SURVEY”) (“[t]he investment of 

plan assets is an issue of immense consequence to plan participants, taxpayers, and to the 

economy as a whole” as a low rate of return will require additional funding from the 

sponsoring government, which “can place an additional strain on the sponsoring 

government and may require tax increases”). 

9	 The most current census data reports that public pension funds have 18.6 million 

beneficiaries. 2007 Census of Governments, U.S. Bureau of Census, Number and 

Membership of State and Local Government Employee-Retirement Systems by State: 

2006-2007 (2007) (at Table 5), available at 

http://www.census.gov/govs/retire/2007ret05.html. 

10	 Among other things, pay to play practices may manipulate the market for advisory 

services by creating an uneven playing field among investment advisers. These practices 

also may hurt smaller advisers that cannot afford the required contributions. 

11	 See1997 SURVEY, supra note 8. 
 

 

 

 

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Pay to play practices are rarely explicit: participants do not typically let it be 

publicly known that contributions or payments are made or accepted for the purpose of 

influencing the selection of an adviser. As one court noted, “[w]hile the risk of 

corruption is obvious and substantial, actors in this field are presumably shrewd enough 

to structure their relations rather indirectly.”12 Pay to play practices may take a variety of 

forms, including an adviser’s direct contributions to government officials, an adviser’s 

solicitation of third parties to make contributions or payments to government officials or 

political parties in the state or locality where the adviser seeks to provide services, or an 

adviser’s payments to third parties to solicit (or as a condition of obtaining) government 

business. As a result, the full extent of pay to play practice remains hidden and is often 

hard to prove. 

Public pension plans are particularly vulnerable to pay to play practices. 

Management decisions over these investment pools, some of which are quite large, are 

typically made by one or more trustees who are (or are appointed by) elected officials. 

And the elected officials or appointed trustees that govern the funds are also often 

involved, directly or indirectly, in selecting advisers to manage the public pension funds’ 

assets. These officials may have the sole authority to select advisers,13 may be members 

of a governing board that selects advisers,14 or may appoint some or all of the board 

members who make the selection.15 

12 Blount v. SEC, 61 F.3d 938, 945 (D.C. Cir. 1995), cert. denied, 517 U.S. 1119 (1996). 

13 See, e.g., 2 N.Y. COMP. CODES R. & REGS. TIT. 2 § 320.2 (2009) (placement of state and 

local government retirement systems assets (valued at $109 billion as of March 2009) is 

under the sole custodianship of the New York State Comptroller). 

14 See, e.g., S.C. CODE ANN. §§ 9-1-20, 1-11-10 (2008) (board consists of all elected 

officials); CAL. GOV’T CODE § 20090 (Deering 2008) (board consists of some elected 

officials, some appointed members, and some representatives of interest groups chosen 
 

 

 

 

 

 

 

 

 

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Numerous developments in recent years have led us to conclude that the selection 

of advisers, whom we regulate under the Investment Advisers Act, has been influenced 

by political contributions and that, as a result, the quality of management service 

provided to public funds may be negatively affected. We have been particularly 

concerned that these contributions have been funneled through “solicitors” and 

“placement agents” that advisers engage (or believe they must engage) in order to secure 

a client relationship with a public pension plan or an investment from one.16 As we will 

discuss in more detail below, in such an arrangement the contribution may be made in the 

form of a substantial fee for what may constitute no more than an introduction service by 

a “well connected” individual who may use the proceeds of the fee to make (or reimburse 

himself for having made) political contributions or provide some form of a “kickback” to 

an official or his or her family or friends.17 

by the members of those groups); MD. CODE ANN., STATE PERS. & PENS. § 21-104 

(2008) (pension board consists of some elected officials, some appointed members, and 

some representatives of interest groups chosen by the members of those groups). 

15	 See, e.g., ARIZ. REV. STAT. ANN. § 38-713 (2008) (governor appoints all nine members); 

HAWAII REV. STAT. § 88-24 (2008) (governor appoints three of eight members); IDAHO 

CODE ANN. § 59-1304 (2008) (governor appoints all five members). 

16	 For example, in one recent action we alleged that, in connection with a pay to play 

scheme in New York State, investment advisers paid sham “placement agent” fees, 

portions of which were funneled to public officials, as a means of obtaining public 

pension fund investments in the funds those advisers managed and that participants, in 

some instances, concealed the third-party solicitor’s role in transactions from the 

investment management firms that paid fees to the solicitor by making misrepresentations 

about the solicitor’s involvement and covertly using one of the solicitor’s legal entities as 

an intermediary to funnel payments to the solicitor. SEC v. Henry Morris, et al., 

Litigation Release No. 20963 (Mar. 19, 2009). 

17	 See id. (along with the Commission’s complaint in the action, available by way of a 

hyperlink from the litigation release). See also, e.g., In the Matter of Quadrangle Group 

LLC, AGNY Investigation No. 2010-044 (Apr. 15, 2010) (finding that “private equity 

firms and hedge funds frequently use placement agents, finders, lobbyists, and other 

intermediaries . . . to obtain investments from public pension funds . . . , that these 

placement agents are frequently politically connected individuals selling access to public 

money. . .”); Complaint, Cal. v. Villalobos, et al., No. SC107850 (Cal. Super. Ct., W. 
 

 

 

 

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The details of pay to play arrangements have been widely reported as a 

consequence of the growing number of actions that we and state authorities have brought 

involving investment advisers seeking to manage the considerable assets of the New 

York State Common Retirement Fund.18 In addition, we have brought enforcement 

actions against the former treasurer of the State of Connecticut and other parties in which 

we alleged that the former treasurer awarded state pension fund investments to private 

equity fund managers in exchange for payments, including political contributions, 

funneled through the former treasurer’s friends and political associates.19 Criminal 

Dist. of L.A. County, May 5, 2010), available at 

http://ag.ca.gov/cms_attachments/press/pdfs/n1915_filed_complaint_for_civil_penalties. 

pdf (alleging, inter alia, that a top executive and a board member at CalPERS accepted 

various gifts from a former CalPERS board member, “known among private equity firms 

as a person who attempts to exert pressure on CalPERS’ representatives,” who was acting 

as a placement agent trying to secure investments from the California public pension 

fund). 

18	 See SEC v. Henry Morris, et al., Litigation Release No. 21036 (May 12, 2009); In the 

Matter of Quadrangle Group LLC, AGNY Investigation No. 2010-044 (Apr. 15, 2010); 

In the Matter of GKM Newport Generation Capital Servs., LLC, AGNY Investigation 

No. 2010-017 (Apr. 14, 2010); In the Matter of Kevin McCabe, AGNY Investigation No. 

2009-152 (Apr. 14, 2010); In the Matter of Darius Anderson Platinum Advisors LLC, 

AGNY Investigation No. 2009-153 (Apr. 14, 2010); In the Matter of Global Strategy 

Group, AGNY Investigation No. 2009-161 (Apr. 14, 2010); In the Matter of Freeman 

Spogli & Co., AGNY Investigation No. 2009-174 (Feb. 1, 2010); In the Matter of 

Falconhead Capital, LLC, AGNY Investigation No. 2009-125 (Sept. 17, 2009); In the 

Matter of HM Capital Partners I, LP, AGNY Investigation No. 2009-117 (Sept. 17, 

2009); In the Matter of Ares Management LLC, AGNY Investigation No. 2009-173 (Feb. 

17, 2010); In the Matter of Levine Leichtman Capital Partners, AGNY Investigation No. 

2009-124 (Sept. 17, 2009); In the Matter of Access Capital Partners, AGNY 

Investigation No. 09-135 (Sept. 17, 2009); In the Matter of The Markstone Group, 

AGNY Investigation No. 10-012 (Feb. 28, 2010); In the Matter of Wetherly Capital 

Group, LLC and DAV/Wetherly Financial, L.P., AGNY Investigation No. 2009-172 

(Feb. 8, 2010) (in each case, banning the use of third-party placement agents pursuant to 

a “Pension Reform Code of Conduct”). 

19	 See SEC v. Paul J. Silvester, et al., Litigation Release No. 16759 (Oct. 10, 2000); 

Litigation Release No. 20027 (Mar. 2, 2007); Litigation Release No. 19583 (Mar. 1, 

2006); Litigation Release No. 18461 (Nov. 17, 2003); Litigation Release No. 16834 

(Dec. 19, 2000); SEC v. William A. DiBella et al., Litigation Release No. 20498 (Mar. 14, 

2008) (2007 U.S. Dist. LEXIS 73850 (D. Conn., May 8, 2007), aff’d 587 F.3d 553 (2nd 

Cir. 2009)). See also U.S. v. Ben F. Andrews, Litigation Release No. 19566 (Feb. 15, 
 

 

 

 

 

 

 

 

 

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authorities have in recent years brought cases in New York,20 New Mexico,21 Illinois,22 

Ohio,23 Connecticut,24 and Florida,25 charging defendants with the same or similar 

conduct. 

2006); In the Matter of Thayer Capital Partners, TC Equity Partners IV, L.L.C., TC 

Management Partners IV, L.L.C., and Frederick V. Malek, Investment Advisers Act 

Release No. 2276 (Aug. 12, 2004); In the Matter of Frederick W. McCarthy, Investment 

Advisers Act Release No. 2218 (Mar. 5, 2004); In the Matter of Lisa A. Thiesfield, 

Investment Advisers Act Release No. 2186 (Oct. 29, 2003). 

20	 See New York v. Henry “Hank” Morris and David Loglisci, Indictment No. 25/2009 (NY 

Mar. 19, 2009) (alleging that the deputy comptroller and a “placement agent” engaged in 

enterprise corruption and state securities fraud for selling access to management of public 

funds in return for kickbacks and other payments for personal and political gain). 

21	 See U.S. v. Montoya, Criminal No. 05-2050 JP (D.N.M. Nov. 8, 2005) (the former 

treasurer of New Mexico pleaded guilty); U.S. v. Kent Nelson, Criminal Information No. 

05-2021 JP, (D.N.M. 2007) (defendant pleaded guilty to one count of mail fraud); U.S. v. 

Vigil, 523 F. 3d 1258 (10th Cir. 2008) (affirming the conviction for attempted extortion 

of the former treasurer of New Mexico for requiring that a friend be hired by an 

investment manager at a high salary in return for the former treasurer’s willingness to 

accept a proposal from the manager for government business). 

22	 See Jeff Coen, et al., State’s Ultimate Insider Indicted, CHI. TRIB., Oct. 31, 2008, 

available at http://www.chicagotribune.com/news/local/chi-cellini-31­

oct31,0,6465036.story (describing the thirteenth indictment in an Illinois pay to play 

probe); Ellen Almer, Oct. 27, 2000, available at http://www.chicagobusiness.com/cgibin/news.pl?id=775 (discussing the guilty plea of Miriam Santos, the former treasurer of 

the City of Chicago, who told representatives of financial services firms seeking city 

business that they were required to raise specified campaign contributions for her and 

personally make up any shortfall in the amounts they raised). See also SEC v. Miriam 

Santos, et al., Litigation Release No. 17839 (Nov. 14, 2002); Litigation Release No. 

19269 (June 14, 2005) (355 F. Supp. 2d 917 (N.D. Ill. 2003)). 

23	 See Reginald Fields, Four More Convicted in Pension Case: Ex-Board Members 

Took Gifts from Firm, CLEVELAND PLAIN DEALER, Sept. 20, 2006 (addressing pay to 

play activities of members of the Ohio Teachers Retirement System). 

24	 See U.S. v. Joseph P. Ganim, 2007 U.S. App. LEXIS 29367 (2d Cir. 2007) (affirming the 

district court’s decision to uphold an indictment of the former mayor of Bridgeport, 

Connecticut, in connection with his conviction for, among other things, requiring 

payment from an investment adviser in return for city business); U.S. v. Triumph Capital 

Group, et al., No. 300CR217 JBA (D. Conn. 2000) (the former treasurer, along with 

certain others, pleaded guilty—while others were ultimately convicted). One of the 

defendants, who had been convicted at trial, recently won a new trial. U.S. v. Triumph 

Capital Group, et al., 544 F.3d 149 (2d Cir. 2008). 

25	 United States v. Poirier, 321 F.3d 1024 (11th Cir.), cert. denied sub nom. deVegter v. 

United States, 540 U.S. 874 (2003) (partner at Lazard Freres & Co., a municipal services 

firm, was convicted for conspiracy and wire fraud for fraudulently paying $40,000 
 

 

 

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Allegations of pay to play activity involving state and municipal pension plans in 

other jurisdictions continue to be reported.26 In the course of this rulemaking we received 

a letter from one public official detailing the role of pay to play arrangements in the 

selection of public pension fund managers and the harms it can inflict on the affected 

plans.27 In addition, other public officials wrote to express support for a Commission rule 

to prohibit investment advisers from participating in pay to play arrangements.28 

On August 3, 2009, we proposed a new antifraud rule under the Advisers Act 

designed to prevent investment advisers from obtaining business from government 

entities in return for political contributions or fund raising—i.e., from participating in pay 

through an intermediary to Fulton County’s independent financial adviser to secure an 

assurance that Lazard would be selected for the Fulton County underwriting contract). 

26	 See, e.g., Aaron Lester, et al., Cahill Taps Firms Tied to State Pension Investor, 

BOSTON.COM, Mar. 21, 2010 (suggesting that an investment adviser may have bundled 

out-of-state donations to the Massachusetts State Treasurer’s campaign in return for a 

state pension fund investment management contract); Kevin McCoy, Do Campaign 

Contributions Help Win Pension Fund Deals, USA TODAY, Aug. 28, 2009; Ted 

Sherman, Pay to Play Alive and Well in New Jersey, NJ.COM, Nov. 28, 2009 (noting 

more generally that pay to play continues to occur with government contracts of all kinds 

in New Jersey); Imogen Rose-Smith and Ed Leefeldt, Pension Pay to Play Casts Shadow 

Nationwide, INSTITUTIONAL INVESTOR, Oct. 1, 2009 (suggesting connections between a 

private equity fund principal’s fundraising activities and pension investments in the 

fund). See also sources cited supra note 17. 

27	 Comment Letter of Suzanne R. Weber, Erie County Controller (Oct. 6, 2009) (“Weber 

Letter”) (“I have seen money managers awarded contracts with our fund which involved 

payments to individuals who served as middlemen, creating needless expense for the 

fund. These middlemen were political contributors to the campaigns of board members 

who voted to contract for money management services with the companies who paid 

them as middlemen.”). See also Comment Letter of David R. Pohndorf (Aug. 4, 2009) 

(“Pohndorf Letter”) (noting that when the sole trustee of a major pension fund changed 

several years ago, a firm managing some of the fund’s assets “began to receive 

invitations to fundraising events for the new trustee with suggested donation amounts.”). 

28	 See, e.g., Comment Letter of New York State Comptroller Thomas P. DiNapoli (Oct. 2, 

2009) (“DiNapoli Letter”); Comment Letter of New York City Mayor Michael R. 

Bloomberg (Sept. 9, 2009) (“Bloomberg Letter”). See also Comment Letter of Kentucky 

Retirement Systems Trustee Chris Tobe (Sept. 18, 2009) (“Tobe Letter”) (suggesting the 

negative effects of pay to play activities on the Kentucky Retirement System’s 

investment performance). 
 

 

 

 

 

 

 

 

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to play practices.29 We modeled our proposed rule on those adopted by the Municipal 

Securities Rulemaking Board, or MSRB, which since 1994 has prohibited municipal 

securities dealers from participating in pay to play practices.30 We believe these rules 

have significantly curbed pay to play practices in the municipal securities market.31 

Along the lines of MSRB rule G-37,32 our proposed rule would have prohibited an 

investment adviser from providing advisory services for compensation to a government 

client for two years after the adviser or certain of its executives or employees make a 

contribution to certain elected officials or candidates.33 It also would have prohibited an 

adviser and certain of its executives and employees from soliciting from others, or 

coordinating, contributions to certain elected officials or candidates or payments to 

political parties where the adviser is providing or seeking government business.34 In 

29	 Political Contributions by Certain Investment Advisers, Investment Advisers Act Release 

No. 2910 (Aug. 3, 2009) [74 FR 39840 (Aug. 7, 2009)] (the “Proposing Release”). 

30	 MSRB rule G-37 was approved by the Commission and adopted in 1994. See In the 

Matter of Self-Regulatory Organizations; Order Approving Proposed Rule Change by the 

Municipal Securities Rulemaking Board Relating to Political Contributions and 

Prohibitions on Municipal Securities Business and Notice of Filing and Order Approving 

on an Accelerated Basis Amendment No. 1 Relating to the Effective Date and 

Contribution Date of the Proposed Rule, Exchange Act Release No. 33868 (Apr. 7, 1994) 

[59 FR 17621 (Apr. 13, 1994)]. The MSRB’s pay to play rules include MSRB rules G37 and G-38. They are available on the MSRB’s Web site at 

http://www.msrb.org/msrb1/rules/ruleg37.htm and 

http://www.msrb.org/msrb1/rules/ruleg38.htm, respectively. 

31	 See Proposing Release, at n.23. See also infra note 101; Comment Letter of the 

Municipal Securities Rulemaking Board (Oct. 23, 2009) (“MSRB Letter”); Comment 

Letter of Common Cause (Oct. 6, 2009) (“Common Cause Letter”). 

32	 See MSRB rule G-37(b). Our proposal, like MSRB rule G-37, was designed to address 

our concern that pay to play activities were “undermining the integrity” of the relevant 

market, in particular the market for the provision of investment advisory services to 

government entity clients. See Blount, 61 F.3d at 939 (referring to the MSRB’s concerns 

that pay to play practices were “undermining the integrity of the $250 billion municipal 

securities market” as its motivation for proposing MSRB rule G-37). 

33	 Proposed rule 206(4)-5(a)(1). See also MSRB rule G-37(b). 

34	 Proposed rule 206(4)-5(a)(2)(ii). See also MSRB rule G-37(c). 
 

 

 

 

 

 

 

 

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addition, similar to MSRB rule G-38,35 our proposed rule would have prohibited the use 

of third parties to solicit government business.36 We also proposed amendments to rule 

204-2 under the Advisers Act that would have required registered advisers to maintain 

certain records regarding political contributions and government clients. As discussed in 

more detail below, our proposed rule departed in some respects from the MSRB rules to 

reflect differences between advisers and broker-dealers and the scope of the statutory 

authority we have sought to exercise. 

We received some 250 comment letters on our proposal, many of which were 

from advisers, third-party solicitors, placement agents, and their representatives.37 Public 

pension plans and their officials were divided—some embraced the rule, including one 

that stated that the rule is an important means to “increase transparency and public 

confidence in the investment activities of all public pension funds,”38 while others were 

critical, arguing, for example, that our proposal “may result in unintended hardships 

being placed upon public pension funds.”39 We received no letters from plan 

beneficiaries whom we sought to protect with the proposed rule,40 although two public 

35	 See MSRB rule G-38(a). 

36	 Proposed rule 206(4)-5(a)(2)(i). 

37	 Other commenters included pension plans and their officials, trade associations, law 

firms, and public interest groups. Comments letters submitted in File No. S7-25-06 are 

available on the Commission’s web site at: http://www.sec.gov/comments/s7-18­

09/s71809.shtml. 

38	 Comment Letter of New York City Comptroller William C. Thompson, Jr. (Oct. 6, 2009) 

(“Thompson Letter”). 

39	 Comment Letter of Executive Director and Secretary to the Board of Trustees of the State 

Retirement and Pension System of Maryland R. Dean Kenderdine (Oct. 5, 2009). 

40	 We note, however, that subsequent to our proposal, AFSCME, which represents 1.6 

million state and local employees and retirees, issued a report that strongly endorses 

sanctions to prevent pay to play activities. AFSCME, ENHANCING PUBLIC RETIREE 

PENSION PLAN SECURITY: BEST PRACTICE POLICIES FOR TRUSTEES AND PENSION 
 

 

 

 

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interest groups supported it strongly. 41 Advisers, third-party solicitors and placement 

agents, fund sponsors, and others whose business arrangements could be affected by the 

rule generally supported our goal of eliminating advisers’ participation in pay to play 

practices involving public plans.42 Nonetheless, most of them objected to our adoption 

under the Advisers Act of a rule similar to MSRB rules G-37 and G-38.43 Most 

particularly opposed the proposed prohibition on payments to third parties for soliciting 

SYSTEMS (2010), available at http://www.afscme.org/docs/AFSCME-report-pensionbest-practices.pdf. 

41	 See, e.g., Common Cause Letter; Comment Letter of Fund Democracy/Consumer 

Federation of America (Oct. 6, 2009) (“Fund Democracy/Consumer Federation Letter”). 

42	 See, e.g., Comment Letter of the Investment Adviser Association (Oct. 5, 2009) (“IAA 

Letter”) (noting “support [for] measures to combat pay to play activities, i.e., the practice 

of investment advisers or their employees making political contributions intended to 

influence the selection or retention of advisers by government entities. Pay to play 

practices undermine the principle that advisers are selected on the basis of competence, 

qualifications, expertise, and experience. The practice is unethical and undermines the 

integrity of the public pension plan system and the process of selecting investment 

advisers.”); Comment Letter of John R. Dempsey (Aug. 8, 2009) (“Dempsey Letter”) 

(noting applause for efforts “to stop the ‘pay-to-play’ practice which only serves to 

undermine public trust in investment advisors and regulators.”); Comment Letter of Barry 

M. Gleicher (Sept. 7, 2009) (noting strong support for the proposal “with no 

modifications. . . . The Rule is necessary to curb elaborated practices that would deprive 

taxpayers and beneficiaries of cost effective and honest administration of pension 

funds”); Tobe Letter. 

43	 See, e.g., IAA Letter (“We respectfully submit, however, that the structure of the MSRB 

rules is not appropriately tailored to the investment advisory business. . . . We believe the 

Commission should make significant changes to the Proposal, which would permit it to 

accomplish its important goals.”); Comment Letter of Wesley Ogburn (Aug. 4, 2009) 

(“Ogburn Letter”); Comment Letter of the Third Party Marketers Association (Aug. 27, 

2009) (“3PM Letter”); Comment Letter of Preqin (Aug. 28, 2009) (“Preqin Letter I”) 

(suggesting that institutional private equity investors polled favored a private equity 

specific proposal rather than relying on the framework from the municipal securities 

industry); Comment Letter of Dechert LLP (Oct. 22, 2009) (“Dechert Letter”); Comment 

Letter of the Committee on Federal Regulation of Securities of the Section of Business 

Law of the American Bar Association (Oct. 13, 2009) (“ABA Letter”); Comment Letter 

of Fidelity Investments (Oct. 7, 2009) (“Fidelity Letter”); Comment Letter of Sutherland 

Asbill & Brennan LLP (Oct. 6, 2009) (“Sutherland Letter”); Comment Letter of the 

Investment Company Institute (Oct. 6, 2009) (“ICI Letter”); Comment Letter of the 

Massachusetts Mutual Life Insurance Company (Oct. 6, 2009) (“MassMutual Letter”); 

Comment Letter of Skadden, Arps, Slate, Meagher & Flom LLP (Oct. 6, 2009) 

(“Skadden Letter”); Comment Letter of the Managed Funds Association (Oct. 6, 2009) 

(“MFA Letter”). 
 

 

 

 

 

 

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or marketing to government entities modeled on MSRB rule G-38.44 Several urged that, 

if we were to adopt a rule based on the approach taken in our proposal, we should 

broaden exceptions and exemptions under the rule to accommodate certain business 

arrangements.45 We respond to these comments below.46 

II. DISCUSSION 

As discussed in more detail below, we have decided to adopt rule 206(4)-5, which 

we have revised to reflect comments we received. For the reasons we discuss above and 

in the Proposing Release, we believe rule 206(4)-5 is a proper exercise of our rulemaking 

authority under the Advisers Act to prevent fraudulent and manipulative conduct. 

The Commission regulates investment advisers under the Investment Advisers 

Act of 1940. Section 206(1) of the Advisers Act prohibits an investment adviser from 

employ[ing] any device, scheme or artifice to defraud any client or prospective client.”47 

44	 See, e.g., Comment Letter of Ounavarra Capital, LLC (Aug. 28, 2009) (“Ounavarra 

Letter”) (noting that banning third-party marketers in the municipal securities industry 

did not adversely affect most bankers’ ability to conduct basic marketing whereas 

banning third-party marketers for small advisers could have a stronger impact on advisers 

that have either no or very limited marketing capability of their own); Comment Letter of 

MVision Private Equity Advisers USA LLC (Sept. 2, 2009) (“MVision Letter”) (arguing 

that, whereas placement agents for municipal bond offerings are usually regulated 

entities, the restrictions in the municipal securities arena were targeted at consultants who 

offer only their contacts and influence with government officials and provided no 

valuable services to the financial services industry or investors); Comment Letter of 

Kalorama Capital (Sept. 8, 2009) (arguing that a better analogy, at least with respect to 

the operation of third-party marketers, is to the licensed professional presenting an IPO to 

a pension fund). For further discussion of these comments, see section II.B.2(b) of this 

Release. 

45	 See, e.g., Comment Letter of the Committee on Investment Management Regulation and 

the Committee on Private Investment Funds of the Association of the Bar of the City of 

New York (Oct. 26, 2009) (“NY City Bar Letter”) (arguing that broker-dealer rules have 

sufficient safeguards and that adopting the proposed pay to play rule will interfere with 

traditional distribution arrangements); Dechert Letter; Sutherland Letter; MFA Letter. 

46	 Particular comments on the various aspects of our proposal are summarized in the 

corresponding sub-sections of section II of this Release. 

47	 15 U.S.C. 80b-6(1). 
 

 

 

 

 

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Section 206(2) prohibits an investment adviser from engaging in “any transaction, 

practice, or course of business which operates as a fraud or deceit upon any client or 

prospective client.”48 The Supreme Court has construed section 206 as establishing a 

federal fiduciary standard governing the conduct of advisers.49 

We believe that pay to play is inconsistent with the high standards of ethical 

conduct required of fiduciaries under the Advisers Act. We have authority under section 

206(4) of the Act to adopt rules “reasonably designed to prevent, such acts, practices, and 

courses of business as are fraudulent, deceptive or manipulative.”50 Congress gave us 

this authority to prohibit “specific evils” that the broad antifraud provisions may be 

incapable of covering.51 The provision thus permits the Commission to adopt 

prophylactic rules that may prohibit acts that are not themselves fraudulent.52 

48	 15 U.S.C. 80b-6(2). 

49	 Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979); SEC v. Capital 

Gains Research Bureau, Inc., 375 U.S. 180, 191-192 (1963). 

50	 15 U.S.C. 80b-6(4). 

51 S. REP. NO. 1760, 86th Cong., 2d Sess. 4, 8 (1960). The Commission has used this 

authority to adopt seven rules addressing abusive advertising practices, custodial 

arrangements, the use of solicitors, required disclosures regarding advisers’ financial 

conditions and disciplinary histories, proxy voting, compliance procedures and practices, 

and deterring fraud with respect to pooled investment vehicles. 17 CFR 275.206(4)-1; 

275.206(4)-2; 275.206(4)-3; 275.206(4)-4; 275.206(4)-6; 275.206(4)-7; and 275.206(4)­

8. 

52	 Section 206(4) was added to the Advisers Act in Pub. L. No. 86-750, 74 Stat. 885, at sec. 

9 (1960). See H.R. REP. NO. 2197, 86th Cong., 2d Sess., at 7-8 (1960) (“Because of the 

general language of section 206 and the absence of express rulemaking power in that 

section, there has always been a question as to the scope of the fraudulent and deceptive 

activities which are prohibited and the extent to which the Commission is limited in this 

area by common law concepts of fraud and deceit . . . [Section 206(4)] would empower 

the Commission, by rules and regulations to define, and prescribe means reasonably 

designed to prevent, acts, practices, and courses of business which are fraudulent, 

deceptive, or manipulative. This is comparable to Section 15(c)(2) of the Securities 

Exchange Act [15 U.S.C. 78o(c)(2)] which applies to brokers and dealers.”). See also S. 

REP. NO. 1760, 86th Cong., 2d Sess., at 8 (1960) (“This [section 206(4) language] is 

almost the identical wording of section 15(c)(2) of the Securities Exchange Act of 1934 

in regard to brokers and dealers.”). The Supreme Court, in United States v. O’Hagan, 
 

 

 

 

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Investment advisers that seek to influence the award of advisory contracts by 

public pension plans, by making political contributions to, or soliciting them for, those 

officials who are in a position to influence the awards, compromise their fiduciary 

obligations to the public pension plans they advise and defraud prospective clients.53 In 

making such contributions, the adviser hopes to benefit from officials who “award the 

contracts on the basis of benefit to their campaign chests rather than to the governmental 

entity”54 or by retaining a contract that might otherwise not be renewed. If pay to play is 

a factor in the selection or retention process, the public pension plan can be harmed in 

interpreted nearly identical language in section 14(e) of the Securities Exchange Act [15 

U.S.C. 78n(e)] as providing the Commission with authority to adopt rules that are 

“definitional and prophylactic” and that may prohibit acts that are “not themselves 

fraudulent ... if the prohibition is ‘reasonably designed to prevent ... acts and practices 

[that] are fraudulent.’” United States v. O’Hagan, 521 U.S. 642, 667, 673 (1997). The 

wording of the rulemaking authority in section 206(4) remains substantially similar to 

that of section 14(e) and section 15(c)(2) of the Securities Exchange Act. See also 

Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles, Investment 

Advisers Act Release No. 2628 (Aug. 3, 2007) [72 FR 44756 (Aug. 9, 2007)] (stating, in 

connection with the suggestion by commenters that section 206(4) provides us authority 

only to adopt prophylactic rules that explicitly identify conduct that would be fraudulent 

under a particular rule, “We believe our authority is broader. We do not believe that the 

commenters’ suggested approach would be consistent with the purposes of the Advisers 

Act or the protection of investors.”). 

53	 See Proposing Release, at section I; Political Contributions by Certain Investment 

Advisers, Investment Advisers Act Release No. 1812 (Aug. 4, 1999) [64 FR 43556 (Aug. 

10, 1999)] (“1999 Proposing Release”). As a fiduciary, an adviser has a duty to deal 

fairly with clients and prospective clients, and must make full disclosure of any material 

conflict or potential conflict. See, e.g., Capital Gains Research Bureau, 375 U.S. at 189, 

191-92; Applicability of the Investment Advisers Act of 1940 to Financial Planners, 

Pension Consultants, and Other Persons Who Provide Others with Investment Advice as 

a Component of Other Financial Services, Investment Advisers Act Release No. 1092 

(Oct. 8, 1987) [52 FR 38400 (Oct. 16, 1987)]. Most public pension plans establish 

procedures for hiring investment advisers, the purpose of which is to obtain the best 

possible management services. When an adviser makes political contributions for the 

purpose of influencing the selection of the adviser to advise a public pension plan, the 

adviser seeks to interfere with the merit-based selection process established by its 

prospective clients—the public pension plan. The contribution creates a conflict of 

interest between the adviser (whose interest is in being selected) and its prospective client 

(whose interest is in obtaining the best possible management services). 

54	 See Blount, 61 F.3d at 944-45. 
 

 

 

 

 

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several ways. The most qualified adviser may not be selected or retained, potentially 

leading to inferior management or performance. The pension plan may pay higher fees 

because advisers must recoup the contributions, or because contract negotiations may not 

occur on an arm’s-length basis. The absence of arm’s-length negotiations may enable 

advisers to obtain greater ancillary benefits, such as “soft dollars,” from the advisory 

relationship, which might be used for the benefit of the adviser, potentially at the expense 

of the pension plan, thereby using the pension plan’s assets for the adviser’s own 

55 purposes.

As we discuss above, pay to play practices are rarely explicit and often hard to 

prove.56 In particular, when pay to play involves granting of government advisory 

business in exchange for political contributions, it may be difficult to prove that an 

adviser (or one of its executives or employees) made political contributions for the 

purpose of obtaining the government business, or that it engaged a solicitor for his or her 

political influence rather than substantive expertise.57 Pay to play practices by advisers to 

public pension plans, which may generate significant contributions for elected officials 

and yield lucrative management contracts for advisers, will not stop through voluntary 

efforts. This is, in part, because these activities create a “collective action” problem in 

55	 Cf. In re Performance Analytics, et al., Investment Advisers Act Release No. 2036 (June 

17, 2002) (settled enforcement action in which an investment consultant for a union 

pension fund entered into a $100,000 brokerage arrangement with a soft dollar 

component in which the investment consultant would continue to recommend the 

investment adviser to the pension fund as long as the investment adviser sent its trades to 

one particular broker-dealer). 

56	 Cf. Blount, 61 F.3d at 945 (“no smoking gun is needed where, as here, the conflict of 

interest is apparent, the likelihood of stealth great, and the legislative purpose 

prophylactic”). 

57	 See id. at 944 (“actors in this field are presumably shrewd enough to structure their 

relations rather indirectly”). 
 

 

 

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two respects.58 First, government officials who participate may have an incentive to 

continue to accept contributions to support their campaigns for fear of being 

disadvantaged relative to their opponents. Second, advisers may have an incentive to 

participate out of concern that they may be overlooked if they fail to make 

contributions.59 Both the stealth in which these practices occur and the inability of 

markets to properly address them argue strongly for the need for us to adopt the type of 

prophylactic rule that section 206(4) of the Advisers Act authorizes. 

A. First Amendment Considerations 

The Commission believes that rule 206(4)-5 is a necessary and appropriate 

measure to prevent fraudulent acts and practices in the market for the provision of 

investment advisory services to government entities by prohibiting investment advisers 

from engaging in pay to play practices. We have examined a range of alternatives to our 

proposal, carefully considered some 250 comments we received on the proposal and 

made revisions to the proposed rule where we concluded it was appropriate. We believe 

the rule represents a balanced response to the developments we discuss above regarding 

pay to play activities occurring in the market for government investment advisory 

services. The rule provides specific prohibitions to help ensure that adviser selection is 

based on the merits, not on the amount of money given to a particular candidate for 

58	 Collective action problems exist, for example, where participants may prefer to abstain 

from an unsavory practice (such as pay to play), but nonetheless participate out of 

concern that, even if they abstain, their competitors will continue to engage in the 

practice profitably and without adverse consequences. As a result, collective action 

problems, such as those raised by pay to play practices, call for a regulatory response. 

For further discussion, see infra note 459 and accompanying text. 

59	 In our view, the collective action problem we are trying to address is analogous to the one 

noted in the case upholding MSRB rule G-37. See Blount, 61 F.3d at 945 (“Moreover, 

there appears to be a collective action problem tending to make the misallocation of 

resources persist”). For a discussion of concerns raised regarding our proposed rule that 

are similar to those raised regarding MSRB rule G-37, see section II.A of this Release. 
 

 

 

 

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office, while respecting the rights of industry participants to participate in the political 

process. The rule is not unique; Congress, for instance, has barred federal contractors 

from making contributions to public officials.60 

Before we address particular aspects of the rule, we would like to respond to 

commenters’ assertions that the fact that the rule’s limitations on compensation are 

triggered by political contributions represents an infringement on the First Amendment 

guarantees of freedom of speech and association.61 These commenters acknowledge that 

selection of an investment adviser by a government entity should not be a “pay back” for 

political contributions, but argue that the rule impermissibly restricts the ability of 

advisers and certain of their employees to demonstrate support for state and local 

officials. 

The Commission is sensitive to, and has carefully considered, these constitutional 

concerns in adopting the rule. Though it is not a ban on political contributions or an 

attempt to regulate state and local elections, we acknowledge that the two-year time out 

provision may affect the propensity of investment advisers to make political 

contributions. Although political contributions involve both speech and associational 

rights protected by the First Amendment, a “limitation upon the amount that any one 

person or group may contribute to a candidate or political committee entails only a 

60	 2 U.S.C. 441c. 

61	 See, e.g., Comment Letter of W. Hardy Callcott (Aug. 3, 2009) (“Callcott Letter I”); 

Comment Letter of W. Hardy Callcott (Jan. 21, 2010) (“Callcott Letter II”); Comment 

Letter of the National Association of Securities Professionals, Inc. (Oct. 6, 2009) (“NASP 

Letter”); Comment Letter of Caplin & Drysdale, Chartered (Oct. 6, 2009) (“Caplin & 

Drysdale Letter”); Comment Letter of the Securities Industry and Financial Markets 

Association (Oct. 5, 2009) (“SIFMA Letter”); ABA Letter; Sutherland Letter; Comment 

Letter of IM Compliance LLC (Oct. 6, 2009) (“IM Compliance Letter”); Comment Letter 

of the American Bankers Association (Oct. 6, 2009) (“American Bankers Letter”). 
 

 

 

 

 

 

 

--21--

marginal restriction upon the contributor's ability to engage in free communication.”62 

Limitations on contributions are permissible if justified by a sufficiently important 

government interest that is closely drawn to avoid unnecessary abridgment of protected 

rights.63 

Prevention of fraud is a sufficiently important government interest. 64 We believe 

that payments to state officials as a quid pro quo for obtaining advisory business as well 

as other forms of “pay to play” violate the antifraud provisions of section 206 of the 

Advisers Act. As discussed in our Proposing Release, “pay to play” arrangements are 

inconsistent with an adviser’s fiduciary obligations, distort the process by which 

investment advisers are selected, can harm advisers’ public pension plan clients and the 

beneficiaries of those plans, and can have detrimental effects on the market for 

investment advisory services.65 The restrictions inherent in rule 206(4)-5 are in the 

62	 Buckley v. Valeo, 424 U.S. 1, 20 (1976). See also SpeechNow.org, et al. v. FEC, 599 

F.3d 686 (D.C. Cir. 2010); McConnell v. FEC, 540 U.S. 93, 135-36 (2003). 

63	 Buckley, 424 U.S. at 25. See also FEC v. Wisconsin Right to Life, Inc., 551 U.S. 449 

(2007); Republican Nat’l Comm. v. FEC, No. 08-1953, 2010 U.S. Dist. LEXIS 29163 

(D.D.C. Mar. 26, 2010) (three judge panel). This standard is lower than the strict 

scrutiny standard employed in reviewing such forms of expression as independent 

expenditures. Under the higher level of scrutiny, a restriction must be narrowly tailored 

to serve a compelling governmental interest. Blount, 61 F.3d at 943. See also Citizens 

United v. FEC, 130 S. Ct. 876 (2010) (distinguishing restrictions on “independent 

expenditures” from restrictions on “direct contributions” and leaving restrictions on direct 

contributions untouched while striking down a restriction on independent expenditures as 

unconstitutional). We note that in Blount, 61 F.3d at 949, the court upheld MSRB rule G37 even assuming that strict scrutiny applied. For the reasons stated by the court in that 

decision, we believe that Rule 206(4)-5 would be upheld under a strict scrutiny standard 

as well as under the standard the Supreme Court has applied to contribution restrictions. 

64	 Blount, 61 F.3d at 944. 

65	 See Proposing Release, at section I. The prohibitions on solicitation and coordination of 

campaign contributions are justified by the same overriding purposes which support the 

two-year time out provisions. The provisions are intended to prevent circumvention of 

the time out provisions in cases where an investment adviser has or is seeking to establish 

a business relationship with a government entity. Absent these restrictions, solicitation 

and coordination of contributions could be used as effectively as political contributions to 
 

 

 

 

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nature of conflict of interest limitations which are particularly appropriate in cases of 

government contracting and highly regulated industries.66 Pursuant to our authority 

under section 206(4) of the Advisers Act, which we discuss above, we may adopt rules 

that are reasonably designed to prevent such acts, practices and courses of business. 

As detailed in the following pages, we have closely drawn rule 206(4)-5 to 

accomplish its goal of preventing quid pro quo arrangements while avoiding unnecessary 

burdens on the protected speech and associational rights of investment advisers and their 

covered employees. The rule is therefore closely drawn in terms of the conduct it 

prohibits, the persons who are subject to its restrictions, and the circumstances in which it 

is triggered. The United States Court of Appeals for the District of Columbia Circuit 

upheld the similarly designed MSRB rule G-37 in Blount v. SEC. 67 Indeed, the Blount 

opinion has served as an important guidepost in helping us shape our rule.68 

distort the adviser selection process. The solicitation and coordination restrictions relate 

only to fundraising activities and would not prevent advisers and their covered employees 

from expressing support for candidates in other ways, such as volunteering their time. 

66	 See In the Matter of Self-Regulatory Organizations; Order Approving Proposed Rule 

Change by the Municipal Securities Rulemaking Board Relating to Political 

Contributions and Prohibitions on Municipal Securities Business and Notice of Filing 

and Order Approving on an Accelerated Basis Amendment No. 1 Relating to the Effective 

Date and Contribution Date of the Proposed Rule, Exchange Act Release No. 33868 

(Apr. 7, 1994) [59 FR 17621 (Apr. 13, 1994)] (noting, in connection with the 

Commission’s approval of MSRB rule G-37, that the restrictions inherent in that pay to 

play rule “are in the nature of conflict of interest limitations which are particularly 

appropriate in cases of government contracting and highly regulated industries.”). 

67	 61 F.3d at 947-48. 

68	 Notwithstanding the Blount decision, some commenters asserted that subsequent 

Supreme Court jurisprudence, including Randall v. Sorrell, 548 U.S. 230 (2006), and 

Citizens United, 130 S. Ct. 876 (decided following the closing of the comment period for 

rule 206(4)-5), would result in the proposed rule being found unconstitutional because it 

is not narrowly tailored to advance the Commission’s interests in addressing pay to play 

by investment advisers. See, e.g., Callcott Letter I; Callcott Letter II; NASP Letter; 

American Bankers Letter. We disagree. The cases cited by commenters are 

distinguishable. Citizens United deals with certain independent expenditures (rather than 

contributions to candidates), which are not implicated by our rule. Randall involved a 
 

 

 

 

 

 

 

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First, the rule is limited to contributions to officials of government entities who 

can influence the hiring of an investment adviser in connection with money management 

mandates.69 These restrictions are triggered only in situations where a business 

relationship exists or will be established in the near future between the investment adviser 

and a government entity.70 

Second, the rule does not in any way impinge on a wide range of expressive 

conduct in connection with elections. For example, the rule imposes no restrictions on 

activities such as making independent expenditures to express support for candidates, 

volunteering, making speeches, and other conduct.71 

generally applicable state campaign finance law limiting overall contributions (and 

expenditures), which the Court feared would disrupt the electoral process by limiting a 

candidate’s ability to amass sufficient resources and mount a successful campaign. 

Randall, 548 U.S. at 248-49. By contrast, our rule is not a general prohibition or 

limitation, but rather is a focused effort to combat quid pro quo payments by investment 

advisers seeking governmental business. Comparable restrictions targeted at a particular 

industry have been upheld under Randall because the loss of contributions from such a 

small segment of the electorate “would not significantly diminish the universe of funds 

available to a candidate to a non-viable level.” Green Party of Conn. v. Garfield, 590 F. 

Supp. 2d 288, 316 (D. Conn. 2008). See also Preston v. Leake, 629 F. Supp. 2d 517, 524 

(E.D.N.C. 2009) (differentiating the “broad sweep of the Vermont statute” that “restricted 

essentially any potential campaign contribution” from a statute that “only applies to 

lobbyists”); In re Earle Asphalt Co., 950 A.2d 918, 927 (N.J. Super. Ct. App. Div. 2008), 

aff’d 957 A.2d 1173 (N.J. 2008) (holding that a limitation on campaign contributions by 

government contractors and their principals did not have the same capacity to prevent 

candidates from amassing the resources necessary for effective campaigning as the 

statute in Randall). One commenter expressly dismissed arguments that Randall would 

have implications for the Commission’s proposed rule. Fund Democracy/Consumer 

Federation Letter. 

69	 See section II.B.2(a)(2) of this Release (discussing the definition of “official” of a 

government entity for purposes of rule 206(4)-5). 

70	 See section II.B.2(a)(1) of this Release (discussing the prohibition on compensation for 

providing advisory services to the client during rule 206(4)-5’s two-year time out). 

71	 See Citizens United, 130 S. Ct. at 908-09 (noting that a government interest cannot be 

sufficiently compelling to limit independent expenditures by corporate entities). See 

also SpeechNow.org, 599 F.3d at 692 (spelling out the different standards of 

constitutional review established by the Supreme Court for restrictions on independent 

expenditures and direct contributions). Some commenters expressed concern, for 

example, that rule 206(4)-5 may quell volunteer activities, deter employees of investment 
 

 

 

 

 

 

 

 

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Third, it does not prevent anyone from making a contribution to any candidate, as 

covered employees may contribute $350 to candidates for whom they may vote, and $150 

to other candidates. A limitation on the amount of a contribution involves little direct 

restraint on political communication, because a person may still engage in the symbolic 

expression of support evidenced by a contribution.72 Furthermore, the rule takes the form 

of a restriction on providing compensated advisory business following the making of 

contributions rather than a prohibition on making contributions in excess of the relevant 

ceilings.73 

Fourth, the rule only applies to investment advisers that are registered with us,74 

or unregistered in reliance on section 203(b)(3) of the Advisers Act, that have (or that are 

seeking) government clients.75 It applies only to the subset of the significantly broader 

advisers from running for office, or chill charitable contributions. See, e.g., Caplin & 

Drysdale Letter; NASP Letter. We have expressly clarified that volunteer activities and 

charitable contributions generally would not trigger the rule’s time out provision and that 

employees running for office would not be subject to the contribution limitation. See 

infra notes 157 and 139, respectively. 

72	 Buckley, 424 U.S. at 21. See also section II.B.2(a)(6) of this Release (discussing the de 

minimis exceptions to covered associates’ contributions triggering the two-year time out). 

Some commenters raised constitutional concerns regarding the levels of the de minimis 

exception in our proposal. See, e.g., Callcott Letter I; Callcott Letter II; Caplin & 

Drysdale Letter; IM Compliance Letter; Sutherland Letter. As discussed below, we have 

both raised the amount of the de minimis exception in line with inflation and added an 

additional exception. 

73	 See section II.B.2(a)(1) of this Release (discussing the two-year time out on receiving 

compensation for advisory services). 

74	 Unless indicated expressly otherwise, each time we refer to a “registered” investment 

adviser in this Release, we mean an adviser registered with the Commission. 

75	 See section II.B.1 of this Release (discussing advisers covered by the rule). One 

commenter raised constitutional concerns by arguing that the rule would apply beyond 

the advisory business of an adviser that solicits government clients, no matter how 

separate the other product or service offerings of the adviser are from the governmental 

business. ABA Letter. But we believe we have made clear that the rule’s time out 

provisions, which are designed to eliminate quid pro quo arrangements and ameliorate 

market distortions, apply only with respect to the provision of advisory services to 
 

 

 

 

 

 

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set of advisers over which we have antifraud authority that we believe are most likely to 

be engaged by government clients to manage public assets either directly or though 

investment pools.76 

Finally, the rule is not a restriction on contributions that is applicable to the public 

and is not intended to eliminate corruption in the electoral process. Rather, it is focused 

exclusively on conduct by professionals subject to fiduciary duties, seeking profitable 

business from governmental entities. The rule is targeted at those employees of an 

adviser whose contributions raise the greatest danger of quid pro quo exchanges,77 and it 

covers only contributions to those governmental officials who would be the most likely 

targets of pay to play arrangements because of their authority to influence the award of 

advisory business.78 

B. Rule 206(4)-5 

We are today adopting new rule 206(4)-5 under the Advisers Act that is designed 

to protect public pension plans and other government investors from the consequences of 

pay to play practices by deterring advisers’ participation in such practices.79 As we noted 

government clients, which is consistent with our authority under the Advisers Act. See 

section II.B.2(a)(1) of this Release. 

76	 See section II.B.1 of this Release. 

77	 See section II.B.2(a)(4) of this Release (discussing the definition of “covered associates,” 

whose contributions could trigger the two-year time out). 

78	 See section II.B.2(a)(2) of this Release (discussing the definition of “official” of a 

government entity for purposes of the rule 206(4)-(5)). Some commenters argued that the 

definition of “official” we included in our proposal was ambiguous. See, e.g., Caplin & 

Drysdale Letter. In response, we have provided additional guidance. See section 

II.B.2(a)(2) of this Release. 

79	 Rule 206(4)-5 is targeted to a concrete business relationship between contributors and 

candidates’ governmental entities. It is not intended to restrict the voices of persons and 

interest groups, reduce the overall scope of election campaigns, or equalize the relative 

ability of all votes to affect electoral outcomes. Indeed, if investment advisers do not seek 

government business from those to whom they and their covered associates make 
 

 

 

--26--

in the Proposing Release, advisers and government officials might, in order to circumvent 

our rule, attempt to structure their transactions in a manner intended to hide the true 

purpose of a contribution or payment.80 Therefore, our pay to play restrictions are 

intended to capture not only direct political contributions by advisers, but also other ways 

that advisers may engage in pay to play arrangements. Rule 206(4)-5 prohibits several 

principal avenues for pay to play activities. 

First, the rule makes it unlawful for an adviser to receive compensation for 

providing advisory services to a government entity for a two-year period after the adviser 

or any of its covered associates makes a political contribution to a public official of a 

government entity or candidate for such office who is or will be in a position to influence 

the award of advisory business.81 Importantly, as we noted in the Proposing Release, rule 

206(4)-5 would not ban or limit the amount of political contributions an adviser or its 

covered associates could make; rather, it would impose a two-year time out on 

conducting compensated advisory business with a government client after a contribution 

contributions or for whom they solicit contributions, the rule’s limitations will not be 

triggered. Rather, the rule is intended to prevent direct quid pro quo arrangements, 

fraudulent and manipulative acts and practices, and improve the mechanism of a free and 

open market for investment advisory services for government entity clients. With pay to 

play activities, the conflict of interest is apparent, the likelihood of stealth in the 

arrangements is great, and our regulatory purpose is prophylactic. See Blount, 61 F.3d at 

945 (describing the court’s similar characterization of MSRB rule G-37). 

80	 Proposing Release, at section II.A. 

81	 Rule 206(4)-5(a)(1) makes it unlawful for any investment adviser covered by the rule to 

provide investment advisory services for compensation to a government entity within two 

years after a contribution to an official of the government entity is made by the 

investment adviser or any covered associate, as defined in the rule, of the investment 

adviser (including a person who becomes a covered associate within two years after the 

contribution is made). As noted below, an “official” includes an incumbent, candidate or 

successful candidate for elective office of a government entity if the office is directly or 

indirectly responsible for, or can influence the outcome of, the hiring of an investment 

adviser or has the authority to appoint any person who is directly or indirectly responsible 

for or can influence the outcome of the hiring of an investment adviser. See section 

II.B.2(a)(2) of this Release. 
 

 

 

 

 

 

 

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is made.82 This first prohibition is substantially similar to our proposal. However, as 

discussed below, we have made certain modifications to some of the definitions of terms 

in this prohibition.83 

Second, the rule generally prohibits advisers from paying third parties to solicit 

government entities for advisory business unless such third parties are registered brokerdealers or registered investment advisers, in each case themselves subject to pay to play 

restrictions.84 That is, an adviser is prohibited from providing or agreeing to provide, 

directly or indirectly, payment to any person for solicitation of government advisory 

business on behalf of such adviser unless that person is registered with us and subject to 

pay to play restrictions either under our rule or the rules of a registered national securities 

association.85 This represents a modification from our proposal, which included a flat 

ban without an exception for any brokers or investment advisers.86 As discussed below, 

82	 Proposing Release, at section II.A. 

83	 See generally section II.B.2(a) of this Release. 

84	 Rule 206(4)-5(a)(2)(i) makes it unlawful for any investment adviser covered by the rule 

and its covered associates (as defined in the rule) to provide or agree to provide, directly 

or indirectly, payment to any person to solicit a government entity for investment 

advisory services on behalf of such investment adviser unless such person is a regulated 

person or is an executive officer, general partner, managing member (or, in each case, a 

person with a similar status or function), or employee of the investment adviser. 

“Regulated person” is defined in rule 206(4)-5(f)(9). See section II.B.2(b) of this Release 

for a discussion of this definition. 

85	 See section II.B.2(b) of this Release. While our rule would apply to any registered 

national securities association, the Financial Industry Regulatory Authority, or FINRA, is 

currently the only registered national securities association under section 19(a) of the 

Exchange Act [15 U.S.C. 78s(b)]. As such, for convenience, we will refer directly to 

FINRA in this Release when describing the exception for certain broker-dealers from the 

rule’s ban on advisers paying third parties to solicit government business on their behalf. 

The Commission’s authority to consider rules proposed by a registered national securities 

association is governed by section 19(b) of the Exchange Act [15 U.S.C. 78s(b)] (“No 

proposed rule change shall take effect unless approved by the Commission or otherwise 

permitted in accordance with the provisions of this subsection.”). 

86	 See Proposing Release, at section II.A.3(b). 
 

 

 

 

 

 

 

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commenters persuaded us that the objective of the rule in eliminating pay to play 

activities of advisers could be preserved if the third parties they hire are themselves 

registered investment advisers subject to Commission oversight or are broker-dealers 

subject to pay to play restrictions imposed by a registered national securities association 

that the Commission must approve. 

Third, the rule makes it unlawful for an adviser itself 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 investment advisory services; 

or (ii) payments to a political party of a state or locality where the investment adviser is 

providing or seeking to provide investment advisory services to a government entity.87 

We are adopting this aspect of the rule as proposed. 

Fourth, as it is not possible for us to anticipate all of the ways advisers and 

government officials may structure pay to play arrangements to attempt to evade the 

prohibitions of our rule, the rule includes a provision that makes it unlawful for an 

adviser or any of its covered associates to do anything indirectly which, if done directly, 

would result in a violation of the rule.88 This provision in the rule we are adopting today 

is identical to our proposal.89 

87	 Rule 206(4)-5(a)(2)(ii) makes it unlawful for any investment adviser covered by the rule 

and its covered associates to coordinate, or to solicit any person [including a political 

action committee] to make, any: (A) contribution to an official of a government entity to 

which the investment adviser is providing or seeking to provide investment advisory 

services; or (B) payment to a political party of a state or locality where the investment 

adviser is providing or seeking to provide investment advisory services to a government 

entity. See section II.A.2.(c) of this Release. 

88	 Rule 206(4)-5(d) makes it unlawful for any investment adviser covered by the rule and its 

covered associates to do anything indirectly which, if done directly, would result in a 

violation of this section. See section II.B.2(d) of this Release. 

89	 See Proposing Release, at section II.A.3(d). 
 

 

 

 

 

 

 

 

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Finally, for purposes of our rule, an investment adviser to certain pooled 

investment vehicles in which a government entity invests or is solicited to invest will be 

treated as though the adviser were providing or seeking to provide investment advisory 

services directly to the government entity.90 This provision is substantially similar to our 

proposal, although we have made certain modifications described below.91 

1. Advisers Subject to the Rule 

Rule 206(4)-5 applies to registered investment advisers and certain advisers 

exempt from registration. In particular, it applies to any investment adviser registered (or 

required to be registered) with the Commission, or unregistered in reliance on the 

exemption available under section 203(b)(3) of the Advisers Act (15 U.S.C. 80b3(b)(3)).92 The rule would not, however, apply to most small advisers that are registered 

with state securities authorities instead of the Commission,93 or advisers that are 

unregistered in reliance on exemptions other than section 203(b)(3) of the Advisers Act.94 

90	 Rule 206(4)-5(c) states that, for purposes of rule 206(4)-5, an investment adviser to a 

covered investment pool in which a government entity invests or is solicited to invest, 

shall be treated as though that investment adviser were providing or seeking to provide 

investment advisory services directly to the government entity. See section II.B.2(e) of 

this Release. 

91	 See section II.B.2(e) of this Release. 

92	 Rule 206(4)-5(a)(1) and (2). Section 203(b)(3) [15 U.S.C. 80b-3(b)(3)] exempts from 

registration any investment adviser that is not holding itself out to the public as an 

investment adviser and had fewer than 15 clients during the last 12 months. We are 

including this category of exempt advisers within the scope of the rule in order to make 

the rule applicable to the many advisers to private investment companies that are not 

registered under the Advisers Act. 

93	 Advisers with less than $25 million of assets under management are prohibited from 

registering with the Commission by section 203A of the Advisers Act [15 U.S.C. 80b3A]. 

94	 The rule would also not apply to certain other advisers that are exempt from registration 

with the Commission. See, e.g., section 203(b)(1) of the Advisers Act [15 U.S.C. 8b3(b)(1)] (exempting from registration intrastate investment advisers). As explained in the 

Proposing Release, we believe these advisers are unlikely to advise public pension plans. 
 

 

 

 

 

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We received limited comment on this aspect of the rule. One commenter 

explicitly agreed with the scope of our proposed rule, noting that it would capture most, if 

not all, advisers that provide discretionary management with respect to public pension 

fund assets, regardless of whether they are registered.95 Other commenters recommended 

that the rule apply more broadly to all advisers that may manage assets of government 

entities.96 The primary effect of such an expansion of the rule would be to apply it to 

smaller firms, the regulatory responsibility for which Congress has previously allocated 

to the state securities authorities.97 It is our understanding that few of these firms manage 

public pension plans or other public funds.98 Accordingly, we have decided to adopt this 

provision as proposed. 

See Proposing Release, at n.64 and accompanying text. The rule would also not apply to 

persons who are excepted from the definition of investment adviser under section 

202(a)(11) of the Advisers Act [15 U.S.C. 80b-2(a)(11)]. For a discussion, in particular, 

of the exclusion of banks and bank holding companies which are not investment 

companies from the Advisers Act’s definition of “investment adviser,” see infra note 274. 

95	 Comment Letter of the California Public Employees’ Retirement System (Oct. 6, 2009) 

(“CalPERS Letter”) (“CalPERS agrees that the scope of the proposed rule would capture 

most if not all external managers who have discretion over the investment of public 

pension fund assets, including hedge fund managers, real estate managers, private equity 

managers, traditional long-only managers, money managers, and others, regardless of 

whether the managers are registered investment advisors. CalPERS supports application 

of the rule to investment advisers, as defined in the proposed rule.”). 

96	 These suggestions included applying the rule to all registered (including SEC-registered 

and state-registered) and unregistered advisers (see, e.g., 3PM Letter (arguing that 

selective application of the rule could lead to convoluted organizational structures 

designed to bypass its reach and that the proposal represents the kind of patchwork 

regulation that will lead to the kind of inconsistency the Commission is seeking to 

correct), and extending the rule to state-registered advisers (see, e.g., Comment Letter of 

the Cornell Securities Law Clinic (Oct. 6, 2009) (“Cornell Law Letter”)). 

97	 Amendments to the Advisers Act in 1996 placed the regulatory responsibility for these 

advisers in the hands of state regulators. See section 203A of the Advisers Act [15 

U.S.C. 80b-3a] enacted as part of Title III of the National Securities Markets 

Improvement Act of 1996, Pub. L. No. 104-290, 110 Stat. 3416 (1996) (codified in 

scattered sections of the United States Code). 

98	 See Proposing Release, at n.64. We did not receive any comment challenging our 

understanding. 
 

 

 

 

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2. Pay to Play Restrictions 

(a) Two-Year “Time Out” for Contributions 

Rule 206(4)-5(a)(1) prohibits investment advisers from receiving compensation 

for providing advice to a “government entity” within two years after a “contribution” to 

an “official” of the government entity has been made by the investment adviser or by any 

of its “covered associates.”99 The rule does not ban political contributions and does not 

limit the amount of any political contribution. Instead, the rule imposes a ban—a “time 

out”—on receiving compensation for conducting advisory business with a government 

client for two years after certain contributions are made. The two-year time out is 

intended to discourage advisers from participating in pay to play practices by requiring a 

“cooling-off period” during which the effects of a political contribution on the selection 

process can be expected to dissipate. 

Rule 206(4)-5(a)(1) is based largely on MSRB rule G-37 under which a brokerdealer is prohibited from engaging in the municipal securities business for two years after 

making a political contribution.100 As noted above and as explained in the Proposing 

Release, we modeled the rule on the MSRB rules because we believe that they have 

significantly curbed pay to play practices in the municipal securities market.101 We also 

99	 Rule 206(4)-5(a)(1). 

100	 Proposing Release, at section II.A.2. 

101	 See id. at n.23 (citing others, including the MSRB, who agree that the MSRB rules have 

been effective: MSRB, MSRB Notice 2009-62, Amendments Filed to Rule G-37 

Regarding Contributions to Bond Ballot Campaigns (Dec. 4, 2009), available at 

http://msrb.org/msrb1/archive/2009/2009-62.asp (“Rule G-37, in effect since 1994, has 

provided substantial benefits to the industry and the investing public by greatly reducing 

the direct connection between political contributions given to issuer officials and the 

awarding of municipal securities business to brokers, dealers and municipal securities 

dealers (“dealers”), thereby effectively assisting with eliminating pay-to-play practices in 

the new issue municipal securities market.”); MSRB, MSRB Notice 2009-35, Request for 

Comment: Rule G-37 on Political Contributions and Prohibitions on Municipal 
 

 

 

 

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pointed out that our approach would minimize the compliance burdens on firms that 

would be subject to both rule regimes. But we requested comment on our proposed 

approach and whether alternative models might be appropriate. 

Several commenters supporting the rule explicitly addressed the appropriateness 

of the MSRB approach. One, for example, asserted that the proposed rule “appropriately 

expands upon MSRB G-37 and G-38.”102 Another agreed that the MSRB rules “provide 

an appropriate regulatory analogy for addressing [pay to play] issues.”103 Many other 

commenters, however, sought to distinguish advisers and municipal securities dealers, 

and asserted that, because of the differences between the two, MSRB rule G-37 is an 

Securities Business – Bond Ballot Campaign Committee Contributions (June 22, 2009) 

(“The MSRB believes the rule has provided substantial benefits to the industry and the 

investing public by greatly reducing the direct connection between political contributions 

given to issuer officials and the awarding of municipal securities business to dealers, 

thereby effectively eliminating pay-to-play practices in the new issue municipal securities 

market.” [footnote omitted]); MSRB, MSRB Notice 2003-32, Notice Concerning Indirect 

Rule Violations: Rules G-37 and G-38 (Aug. 6, 2003) (“The impact of Rules G-37 and G38 has been very positive. The rules have altered the political contribution practices of 

municipal securities dealers and opened discussion about the political contribution 

practices of the entire municipal industry.”); Letter from Darrick L. Hills and Linda L. 

Rittenhouse of the CFA Institute to Jill C. Finder, Asst. Gen. Counsel of the MSRB (Oct. 

19, 2001), available at http://www.cfainstitute.org/Comment%20Letters/20011019.pdf 

(stating, “We generally believe that the existing [MSRB] pay-to-play prohibitions have 

been effective in stemming practices that compromise the integrity of the [municipal 

securities] market by using political contributions to curry favor with politicians in 

positions of influence.”); COMM. ON CAPITAL MKTS. REGULATION, INTERIM REPORT OF 

THE COMMITTEE ON CAPITAL MARKETS REGULATION (Nov. 30, 2006), available at 

http://www.capmktsreg.org/pdfs/11.30Committee_Interim_ReportREV2.pdf (stating, 

upon describing MSRB Rule G-37 and the 2005 amendments to MSRB Rule G-38, 

“Taken together, the MSRB’s rules have largely put an end to the old “pay to play” 

practices in municipal underwriting.”)). See also Comment letter of Professors 

Alexander W. Butler, Larry Fauver and Sandra Mortal (Sept. 30, 2009) (“Butler Letter”) 

(citing Alexander W. Butler, Larry Fauver & Sandra Mortal, Corruption, Political 

Integrity, and Municipal Finance, 22 R. OF FIN. STUD. 2673-705 (2009)). 

102	 Common Cause Letter. 

103	 Comment Letter of Credit Suisse Securities (USA) LLC (Sept. 14, 2009) (“Credit Suisse 

Letter”). 
 

 

 

 

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inappropriate model on which to base an investment adviser pay to play rule.104 Some 

argued that the long-term nature of advisory relationships is fundamentally different from 

discrete municipal underwriting transactions, and consequently, the two-year time out is 

more disruptive and severe for advisers and the governments that retain them than for 

municipal securities dealers who are simply banned from obtaining “new” business as 

opposed to terminating a long-term relationship.105 Some commenters asserted that the 

relationships are different because advisers provide ongoing and continuous advice as a 

fiduciary, rather than a one-time transaction such as an underwriting, and that advisory 

services are typically subject to an open competitive bid process instead of through 

negotiated transactions that are typical of municipal underwritings.106 

We disagree that the differences between municipal securities underwriting and 

money management are sufficient to warrant an alternative approach. Commenters are 

correct that municipal securities underwriters provide episodic services rather than 

ongoing services often provided by money managers. But underwriters seek to provide 

104	 See, e.g., IAA Letter; ICI Letter; SIFMA Letter; ABA Letter; Dechert Letter; Skadden 

Letter; Comment Letter of Jones Day (Oct. 5, 2009) (“Jones Day Letter”); Comment 

Letter of Simpson Thacher & Bartlett LLP on behalf of Park Hill Group LLC and its 

affiliates (Sept. 21, 2009) (“Park Hill Letter”); Comment Letter of Monument Group, Inc. 

(Sept. 18, 2009) (“Monument Group Letter”). One commenter suggested, in particular, 

that the rule’s two-year time out provision is outside of our authority because it imposes 

an “automatic penalty, subject only to discretionary post facto review.” Comment Letter 

of Edwin C. Laurenson (Dec. 31, 2009). We disagree. The two-year time out is not a 

penalty. Rather, it is a “cooling-off period” to dissipate any effects of a quid pro quo. A 

violation of the provision would result from receiving, or continuing to receive, payment 

after making the contribution, not from the making of the contribution itself. 

105	 See, e.g., IAA Letter; ABA Letter; Dechert Letter; Skadden Letter; Jones Day Letter; 

Park Hill Letter; Monument Group Letter. But see Credit Suisse Letter (“G-37 and G-38 

provide an appropriate regulatory analogy”); Butler Letter (“This practice [municipal 

underwriting pay to play] was analogous to the type of pay to play currently under 

consideration by the Commission”). 

106	 See, e.g., IAA Letter; ICI Letter; SIFMA Letter; ABA Letter; Dechert Letter; Skadden 

Letter; Jones Day Letter; Park Hill Letter; Monument Group Letter. 
 

 

 

 

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repeated, if not ongoing, services, and the imposition of a two-year time out can have 

considerable competitive consequences to a broker-dealer whose government client must 

employ the services of a competitor whose services it may continue to employ after 

MSRB rule G-37’s two-year time out has run its course. That advisers are in a fiduciary 

relationship with their public pension plan clients argues for at least as significant 

consequences for participation in pay to play practices that can harm these clients. 

Our decision to adopt a rule based on the MSRB model is influenced primarily by 

our judgment that the MSRB rules have significantly curbed pay to play practices in the 

municipal securities market107 and that alternative approaches, including those suggested 

by commenters, would fail to provide an adequate deterrent to pay to play activities. We 

considered each of the principal suggestions offered by commenters. 

Some commenters suggested requiring advisers to disclose their contributions to 

state and local officials.108 Statutes requiring disclosure of political contributions are, in 

part, designed to inform voters about a candidate’s financial supporters; an informed 

electorate can then use the information to vote for or against a candidate.109 But voters’ 

possible reactions, if any, to such disclosure would not necessarily resolve the concerns 

we are trying to address in this rulemaking. Our concern is protecting advisory clients 

and investors whom we have the responsibility to protect under the Advisers Act— 

107	 See supra notes 31 and 101 and accompanying text. 

108	 See, e.g., SIFMA Letter; Preqin Letter I; Comment Letter of Triton Pacific Capital, LLC 

(Sept. 1, 2009) (“Triton Pacific Letter”); Comment Letter of the State Association of 

County Retirement Systems (Sept. 8, 2009); Comment Letter of CapLink Partners (Sept. 

9, 2009) (“CapLink Letter”); Comment Letter of Parenteau Associates, LLC (Aug. 7, 

2009) (“Parenteau Letter”). 

109	 See Buckley, 424 U.S. at 67 (1976) (noting that campaign financing disclosure 

requirements “deter actual corruption and avoid the appearance of corruption by exposing 

large contributions and expenditures to the light of publicity”). 
 

 

 

 

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namely, the public pension plans and their beneficiaries who are affected by pay to play 

practices.110 Disclosure to a plan’s trustees might be insufficient where the trustee 

(particularly a sole trustee) has received the contributions and is presumably well aware 

of the conflicts involved. Moreover, and as we pointed out in the Proposing Release, 

requiring advisers to disclose political contributions to beneficiaries would be unlikely to 

protect them since most cannot act on the information by moving their pension assets to a 

different plan or by reversing the plan trustees’ adviser hiring decisions.111 Not all 

beneficiaries may be entitled to vote (or withhold their vote) for the official to whom a 

contribution was made, and those that are may need to wait a substantial period of time 

until a future election to exercise their vote. Further, as beneficiaries may constitute only 

a small proportion of the electorate, they may not be able to influence an election; 

therefore, reliance on the electoral process may be insufficient to protect government 

plans and their beneficiaries from pay to play. In addition, even if the fact of a 

contribution is disclosed (which is required in many states), the contribution’s true 

purpose is unlikely to be disclosed. 

Several commenters suggested that the Commission adopt a requirement that an 

adviser include in its code of ethics112 a policy that prohibits contributions made for the 

110	 As discussed above, our purposes in this rulemaking are preventing fraud, protecting 

investors and maintaining the integrity of the adviser selection process, not campaign 

finance reform. See section I of this Release. 

111	 See Proposing Release, at section II.A.2. Some commenters made the same points. See, 

e.g., NY City Bar Letter; Cornell Law Letter; 3PM Letter. See also Blount, 61 F.3d at 

947 (explaining, in the context of the municipal securities industry, the potential 

inadequacy of disclosure to address pay to play concerns, that “disclosure would not 

likely cause market forces to erode ‘pay to play . . .’” because the “. . . purpose of 

protecting the integrity of the market [would] . . . ‘be achieved less effectively.’”). 

112	 Registered investment advisers are required to have codes of ethics under the Advisers 

Act. See Advisers Act rule 204A-1. 
 

 

 

 

 

 

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purpose of influencing the selection of the adviser.113 Several commenters 

recommended, similarly, that we require advisers to adopt policies and procedures114 

reasonably designed to prevent and detect contributions designed to influence the 

selection of an adviser.115 Many of these commenters suggested that preclearance of 

employee contributions could be required under an adviser’s code of ethics or compliance 

policies and procedures.116 One commenter asserted that an advantage of this approach is 

that it would allow an adviser to customize sanctions based on the severity of the 

violation.117 

We do not, however, believe that codes of ethics or compliance procedures alone 

would be adequate to stop pay to play practices, particularly when the adviser or senior 

officers of the adviser are involved either directly or indirectly. First, it is those senior 

officers who, as noted below, have the greatest incentives to engage in pay to play and 

therefore are most likely to make contributions, who would themselves ultimately be 

responsible for enforcing their own compliance with the firm’s ethics code or compliance 

procedures. Second, violations of codes of ethics or compliance procedures do not 

themselves establish violations of the federal securities laws. Moreover, the comments 

suggesting these alternatives would have us require the codes or procedures be designed 

to prevent or detect contributions intended to influence the selection of the adviser by a 

113	 See, e.g., IAA Letter; ABA Letter; Comment letter of the National Society of Compliance 

Professionals, Inc. (Oct. 6, 2009) (“NSCP Letter”); NY City Bar Letter; Fidelity Letter. 

114	 Registered investment advisers are required to adopt and implement policies and 

procedures reasonably designed to prevent violation by the adviser or its supervised 

persons of the Advisers Act and the rules the Commission has adopted thereunder. See 

Advisers Act rule 206(4)-7. 

115	 See, e.g., ABA Letter; NY City Bar Letter; IAA Letter; ICI Letter; NSCP Letter. 

116	 See, e.g., IAA Letter; NY City Bar Letter; ABA Letter. 

117	 ABA Letter. 
 

 

 

 

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government entity. As discussed extensively above and in our Proposing Release, pay to 

play is an area in which intent is often very difficult to prove, and is often hidden in the 

guise of legitimate conduct.118 Political contributions are made ostensibly to support a 

candidate; the burden on a regulator or prosecutor of proving a different intent presents 

substantial challenges absent unusual evidence. Commenters would thus have us give the 

adviser, which stands to benefit from the contribution, the discretion to determine 

whether contributions were intended to influence its selection by the government entity. 

We do not believe codes of ethics or policies and procedures alone, without a rule 

providing for specific, prophylactic prohibitions, are adequate to address this type of 

conduct.119 

On balance, we believe that adopting a two-year time out for investment advisers 

similar to the two-year time out applicable to broker-dealers underwriting municipal 

securities is appropriate. Our years of experience with MSRB rule G-37 suggests that the 

“strong medicine” provided by that rule has both significantly curbed participation in pay 

to play and provides a reasonable cooling-off period to mitigate the effect of a political 

contribution. We are sensitive about potential implications of the operation of the rule on 

public pension funds, which could lose the services of an investment adviser subject to a 

time out. While we have designed the rule to reduce its impact,120 investment advisers 

are best positioned to protect these clients by developing and enforcing robust 

118 See, e.g., Proposing Release, at n.16 and accompanying text. 

119 We note that, under our rules, an adviser’s code of ethics must require compliance with 

the rule we are today adopting (rule 204A-1(a)(2)) and the adviser must adopt policies 

and procedures designed to prevent violation of the rule (rule 206(4)-7(a)). 

120 See, e.g., section II.B.2(a)(6) of this Release (discussing the de minimis exceptions to the 

two-year time out); section II.B.2(f) of this Release (discussing the rule’s exemptive 

provision). 
 

 

 

 

 

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compliance programs designed to prevent contributions from triggering the two-year time 

out. 

(1) Prohibition on Compensation 

As noted above, investment advisers subject to new rule 206(4)-5 are not 

prohibited from providing advisory services to a government client, even after triggering 

the two-year time out. Instead, an adviser is prohibited from receiving compensation for 

providing advisory services to the government client during the time out.121 We have 

taken this approach to enable an adviser to act consistently with its fiduciary obligations 

so it will not have to abandon a government client after making a triggering contribution, 

but rather may provide uncompensated advisory services for a reasonable period of time 

to allow the government client to replace the adviser.122 We are adopting this element of 

the rule as proposed. 

One commenter supported the prohibition on compensation as the least disruptive 

option to government clients,123 while others argued that the prohibition on compensation 

121	 Rule 206(4)-5(a)(1) makes it unlawful for investment advisers covered by the rule to 

provide investment advisory services for compensation to a government entity within two 

years after a triggering contribution. Under the rule, the two-year time out begins to run 

once the contribution is made and not when the contribution is discovered either by our 

examination staff or by the adviser. The adviser, therefore, should return all such 

compensation promptly upon discovering the triggering contribution. For the application 

of the rule to investments by government entities in pooled investment vehicles, see 

section II.B.2(e) of this Release. 

122	 Proposing Release, at section II.A.3(a)(1). An investment adviser’s fiduciary duties may 

require it to continue providing advisory services for a reasonable period of time under 

these circumstances. For another instance in which an adviser’s fiduciary duties may 

require its continued provision of services, see Temporary Exemption for Certain 

Investment Advisers, Investment Advisers Act Release No. 1736 (July 22, 1998) [63 FR 

40231, 40232 (July 28, 1998)] (describing an investment adviser’s fiduciary duties to an 

investment company in the case of an assignment of the advisory contract). 

123	 Cornell Law Letter. 
 

 

 

 

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was unreasonable and, in some cases, difficult or near impossible to implement.124 A 

coalition of commenters representing state and local governments asserted that, due to 

restrictions on accepting uncompensated services under state and local law, it was 

unlikely that government entities would accept uncompensated services even if an 

adviser were willing or required to provide them.125 Commenters representing advisers 

took the opposite view, expressing concern that they would be locked into providing 

uncompensated services for extended periods of time as a result, and wanted the 

Commission to provide guidelines as to what a reasonable amount of time is for a 

government client to claim or move its assets.126 One asserted that it would be 

unreasonable to require advisers to provide uncompensated services altogether.127 

124	 See, e.g., ICI Letter; Jones Day Letter. Some commenters argued for more flexibility in 

sanctions (Skadden Letter; ABA Letter; Fidelity Letter; ICI Letter; MassMutual Letter; 

Comment Letter of Wells Fargo Advisors (Oct. 6, 2009) (“Wells Fargo Letter”); IAA 

Letter). 

125	 Comment Letter of the National Conference of State Legislatures, National Association 

of Counties, National League of Cities, International City/County Management 

Association, National Association of State Auditors, Comptrollers and Treasurers, 

Government Finance Officers Association, National Association of State Retirement 

Administrators, National Conference on Public Employee Retirement Systems, and 

National Council on Teacher Retirement (Oct. 6, 2009) (“National Organizations 

Letter”). With respect to direct advisory relationships, because restrictions on 

governments receiving services without payment would be a function of particular state 

or local laws, we believe government entities and their advisers are in the best position to 

work out arrangements that are consistent with both state and local law and the 

compensation prohibition of our rule. With respect to investments by government 

entities in pooled investment vehicles, in particular, such restrictions could be avoided. 

See section II.B.2(e)(2) of this Release (describing possible arrangements for continued 

payment to investment pools even after a time out is triggered). 

126	 See, e.g., Comment Letter of Davis Polk & Wardwell LLP (Oct. 6, 2009) (“Davis Polk 

Letter”) (recommending that three months would be reasonable); ICI Letter (suggesting 

30 days). Other commenters raised concern regarding the potential harm of a time out to 

government investors for whom identifying new managers may be a lengthy process. 

See, e.g., NASP Letter. We believe, however, that, on balance, pension funds and their 

beneficiaries are best served by the rule’s deterrent effect against engaging in pay to play 

activities. An adviser’s fiduciary obligations to continue to provide services for a 

reasonable amount of time, combined with the extended compliance dates described in 

section III of this Release which should afford the ability of market participants to 
 

 

 

 

 

 

 

 

--40--

Few of the commenters who opposed this provision appeared to favor its 

elimination, which would require the adviser to immediately cease providing advisory 

services upon making a triggering contribution.128 Rather, they appeared to oppose the 

two-year time out more generally.129 

We are not persuaded by their arguments. We believe the prohibition on 

compensation is both appropriate and administrable. The incentives to engage in pay to 

play may be significant, precisely because of the long-term nature of many advisory 

relationships from which the adviser could benefit for several years. As a result, the 

consequences of engaging in pay to play need to be commensurate with these incentives 

for the prophylactic rule to have a meaningful deterrent effect.130 We acknowledge that 

the rule will involve compliance costs and could adversely affect an adviser’s business.131 

On the other hand, a political contribution would not affect the ability of an adviser to 

provide compensated services to other clients, including other government clients. 

organize themselves in a way to adapt to the rule’s requirements, should be sufficient to 

minimize the impact on pension plans to the extent they need to prepare to transition to a 

new money manager after a two-year time out is triggered. 

127	 Jones Day Letter. Other commenters argued that the specter of a two-year time out might 

cause some firms to ban or require pre-clearance of all employees’ contributions. See, 

e.g., Caplin & Drysdale Letter. Although the rule does not require this approach, as a 

result of commenters’ assertions, we address this possibility in our cost-benefit analysis. 

See section IV of this Release. 

128	 See, e.g., Davis Polk Letter; ICI Letter. 

129	 See, e.g., National Organizations Letter; ICI Letter; Jones Day Letter; Dechert Letter. 

130	 This deterrent effect is the basis for our view that the two-year time out should not apply 

only to “new business” and that advisers should not be able to “negotiate” for lesser 

consequences. See supra note 124 (pointing to commenters who called for more 

flexibility regarding the two-year time out). As we point out above, our concerns extend 

to contributions designed to enable advisers to retain contracts that might not otherwise 

be renewed. 

131	 For a discussion of costs and other burdens that may be imposed by our rule, see 

generally sections IV-V of this Release. 
 

 

 

 

 

--41--

Moreover, the fiduciary obligations of an adviser would not require it to provide 

uncompensated advice indefinitely—rather, the adviser may need to continue to provide 

advice for only a reasonable period of time during which its client can seek to obtain 

advisory services from others.132 

Some commenters urged us to permit advisers to continue to receive 

compensation during the two-year time out for services provided pursuant to an existing 

management contract,133 without distinguishing whether the contract was acquired as a 

result of political contributions. One commenter further suggested specifically that we 

permit advisory services to continue to be provided by the adviser at cost during the time 

out to remove the profit motive of pay to play.134 We are also not persuaded by their 

suggestions. Allowing contracts acquired as a result of political contributions to continue 

uninterrupted would eviscerate the rule. Were a “free pass” available for contracts 

132	 See supra note 122 and accompanying text. The amount of time a client might need in 

good faith to find and engage a successor to the adviser would, in our view, be the 

primary consideration of the length of a reasonable period, which may depend in part on 

such matters as applicable law, the client’s customary process of finding and engaging 

advisers and the types of assets managed by the adviser that is subject to the time out. In 

some cases, a client may be able to quickly engage a “transition adviser” to manage its 

assets until a permanent successor is found. See, e.g., Illinois State Board Sets 

Transition Manager RFP, PENSIONS & INVESTMENTS, Feb. 8, 2010 available at 

http://www.pionline.com/article/20100208/PRINTSUB/302089976. In other cases, the 

client may be required by the law under which it operates to undertake a specified 

process to obtain a new manager, such as a solicitation for proposals from potential 

managers. 

133	 See, e.g., Dechert Letter; Fidelity Letter; ICI Letter; Jones Day Letter (in some instances, 

pointing to the MSRB’s approach of not necessarily applying MSRB rule G-37’s twoyear time out when a contribution is made after a business contract is signed). See 

MSRB, Interpretation on the Effect of a Ban on Municipal Securities Business under 

Rule G-37 Arising During a Pre-Existing Engagement Related to Municipal Fund 

Securities, MSRB Rule G-37 Interpretive Notice (April 2, 2002), available at 

http://msrb.org/msrb1/archive/ContributionsNotice.htm). As we explain above, due to 

the long-term nature of typical advisory contracts and our belief that the consequences of 

giving a contribution need to be commensurate with the potential benefits obtained, we 

are not taking this approach. 

134	 Dechert Letter. 
 

 

 

 

 

--42--

merely because they were entered into prior to discovery of a contribution, advisers 

would be strongly incentivized against “discovering” contributions.135 Because no new 

business from a government client may even be available to the adviser until the two-year 

period has run its course, advisers whose contributions succeeded in acquiring a 

management contract for two years or more could escape any consequences under such 

an exception.136 Further, in our judgment, the potential loss of profits will not operate as 

an adequate deterrent. It is our understanding that being selected to manage public 

pension plan assets has a reputational value that itself contributes to advisory profits by 

attracting additional assets under management regardless of the profits derived directly 

from the management of government client assets.137 

135	 An approach that applied the two-year time out only to new business would preclude the 

adviser from receiving compensation only from additional contracts that might be 

awarded by the government entity during the two-year period. In our judgment, the risk 

of the potential loss of additional advisory contracts for a two-year period would provide 

an inadequate deterrent to contributions designed to influence the award of such 

additional advisory contracts. 

136	 We are concerned that limiting application of the rule to new business could invite abuse. 

For example, pension officials seeking contributions after a contract has been awarded 

could attempt to offer an adviser additional assets to manage under the existing contract 

with the condition that the adviser subsequently make political contributions. 

137	 See, e.g., Kevin McCoy, Do Campaign Contributions Help Win Pension Fund Deals, 

USA TODAY, Aug. 28, 2009, available at 

http://www.usatoday.com/money/perfi/funds/2009-08-26-pension-fund-politicaldonations_N.htm (referring to advisory firms winning management mandates from 

pension funds, stating: “The awards generate lucrative fees and lend prestige that could 

help lure new clients.”); Louise Story, Quadrangle Facing Questions Over Pension 

Funds, N.Y. TIMES, Apr. 21, 2009, available at 

http://www.nytimes.com/2009/04/22/business/22quadrangle.html (highlighting an 

indirect benefit of a pension fund investment, stating: “the prestige associated with it 

helped the firm lure other big investors.”). 
 

 

 

 

 

 

 

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(2) Officials of a Government Entity 

The rule’s two-year time out is triggered by a contribution to an “official” of a 

“government entity.”138 An official includes an incumbent, candidate or successful 

candidate for elective office of a government entity if the office is directly or indirectly 

responsible for, or can influence the outcome of, the hiring of an investment adviser or 

has authority to appoint any person who is directly or indirectly responsible for, or can 

influence the outcome of, the hiring of an investment adviser.139 Government entities 

include all state and local governments, their agencies and instrumentalities, and all 

public pension plans and other collective government funds, including participantdirected plans such as 403(b), 457, and 529 plans.140 

The two-year time out is thus triggered by contributions, not only to elected 

officials who have legal authority to hire the adviser, but also to elected officials (such as 

persons with appointment authority) who can influence the hiring of the adviser. We 

have not modified this approach from our proposal.141 As we noted in the Proposing 

Release, a person appointed by an elected official is likely to be subject to that official’s 

138	 Rule 206(4)-5(a)(1) makes it unlawful for covered investment advisers to provide 

investment advisory services for compensation to a government entity within two years 

after a contribution to an official of the government entity is made by the investment 

adviser or any of its covered associates. 

139	 Rule 206(4)-5(f)(6). For purposes of the rule, we would not interpret the definition of 

“official” as covering an individual who is also a “covered associate” of the adviser. 

Accordingly, under the rule, a covered associate who is an incumbent or candidate for 

office is not limited to contributing the de minimis amount to his or her own campaign. 

The MSRB takes a similar view with respect to its rule G-37. MSRB, Questions and 

Answers Concerning Political Contributions and Prohibitions on Municipal Securities 

Business: Rule G-37, MSRB rule G-37 Interpretive Notice, available at 

http://www.msrb.org/Rules-and-Interpretations/MSRB-Rules/General/Rule-G37­

Frequently-Asked-Questions.aspx (“MSRB Rule G-37 Q&A”), Question II.10 (May 24, 

1994). 

140	 Rule 206(4)-5(f)(5). 

141	 See Proposing Release, at section II.A.3(a)(2). 
 

 

 

 

 

 

--44--

influences and recommendations.142 It is the scope of authority of the particular office of 

an official, not the influence actually exercised by the individual, that would determine 

whether the individual has influence over the awarding of an investment advisory 

contract under the definition.143 We are adopting these provisions as proposed.144 

Some commenters asserted that the rule should be more specific as to which 

public officials to whom a contribution is made would trigger application of the rule in 

order to reduce uncertainty and compliance burdens.145 But state and municipal statutes 

vary substantially with respect to whom they entrust with the management of public 

142	 Id. 

143	 As such, executive officers or legislators whose official position gives them the authority 

to influence the hiring of an investment adviser generally would be “government 

officials” under the rule. For example, a state may have a pension fund whose board of 

directors, which has authority to hire an investment adviser, is constituted, at least in part, 

by appointees of the governor and members of the state legislature. See, e.g., The 

Commonwealth of Pennsylvania Public School Employees’ Retirement Board, Statement 

of Organization, By-Laws and Other Procedures (rev. Jun. 11, 2009), art. II, sec. 2.1, 

available at http://www.psers.state.pa.us/org/board/policies/201001_bylaws.pdf (noting 

that the board shall be composed of, inter alia, two persons appointed by the 

Pennsylvania State Governor, two Pennsylvania state senators and two members of the 

Pennsylvania state house of representatives). In such circumstances, the governor and the 

members of the state legislature serving on the board would be officials of the 

government entity. Conversely, a public official who is tasked with performing an audit 

of the selection process but has no influence over hiring outcomes would not be an 

official of a government entity for purposes of the rule. 

144	 These definitions and their application are substantively the same as those in MSRB rule 

G-37. See MSRB rule G-37(g)(ii) and (g)(vi). 

145	 See, e.g., IAA Letter; NSCP Letter; Comment Letter of T. Rowe Price Associates, Inc. 

(Oct. 6, 2009) (“T. Rowe Letter”); MFA Letter; Davis Polk Letter. For a discussion of the 

potential costs involved in identifying officials to whom contributions could trigger the 

rule’s prohibitions, see section IV of this Release (presenting our cost-benefit analysis). 

Another commenter suggested that advisers should be able to rely on certifications from 

candidates and officials regarding whether their office would render them an “official” 

for purposes of the rule—i.e., identifying the range, if any, of public investment vehicles 

over which the relevant office directly or indirectly influences the selection of investment 

advisers or appoints individuals who do). Caplin & Drysdale Letter. We are concerned 

that such a safe harbor would undercut the purposes of the rule, not least because officials 

will be incentivized to offer such certifications liberally (and will presumably sometimes 

do so inappropriately) to encourage contributions. 
 

 

 

 

 

 

 

--45--

funds, and any effort we make in a rule of general application to identify specific officials 

who are in a position to influence the selection of an adviser would certainly be overinclusive in some circumstances and under-inclusive in others.146 Others urged that 

triggering contributions should be limited to contributions to officials directly responsible 

for the selection of advisers.147 Excluding from the application of the rule contributions 

to those who are in a position to indirectly influence the selection of an investment 

adviser could simply lead officials to re-structure their relationships to avoid application 

of the rule to advisers that may contribute to those officials. 

Two commenters argued that the rule should not cover contributions to candidates 

for federal office,148 while another contended that it should.149 Under our rule, as 

proposed, a candidate for federal office could be an “official” under the rule not because 

of the office he or she is running for, but as a result of an office he or she currently 

holds.150 So long as an official has influence over the hiring of investment advisers as a 

function of his or her current office, contributions by an adviser could have the same 

effect, regardless to which of the official’s campaigns the adviser contributes. For that 

146	 Like us, the MSRB does not specify which officials have the authority to influence the 

granting of government business for purposes of its rule G-37. See MSRB, Campaign for 

Federal Office, MSRB Rule G-37 Interpretive Notice (May 31, 1995), available at 

http://msrb.org/msrb1/rules/interpg37.htm (“The Board does not make determinations 

concerning whether a particular individual meets the definition of “official of an issuer.”). 

147	 See, e.g., IAA Letter; NASP Letter; NY City Bar Letter; Davis Polk Letter. 

148	 See, e.g., NSCP Letter; Dechert Letter. 

149	 Fund Democracy/Consumer Federation Letter. 

150	 As a result, if a state or municipal official were, for example, a candidate for the U.S. 

Senate, House of Representatives, or presidency, an adviser’s contributions to that 

official would be covered by the rule. MSRB rule G-37’s time out provision is also 

triggered by contributions to state and local officials running for federal office. See 

MSRB Rule G-37 Q&A, Questions IV.2-3. 
 

 

 

 

 

 

 

 

--46--

reason, we are not persuaded that an incumbent state or local official should be excluded 

from the definition solely because he or she is running for federal office.151 

(3) Contributions 

The rule’s time out provisions are triggered by contributions made by an adviser 

or any of its covered associates.152 A contribution is defined to include a gift, 

subscription, loan, advance, deposit of money, or anything of value made for the purpose 

of influencing an election for a federal, state or local office, including any payments for 

debts incurred in such an election.153 It also includes transition or inaugural expenses 

incurred by a successful candidate for state or local office.154 The definition is the same 

as we proposed and as the one used in MSRB rule G-37.155 

151	 Under certain circumstances, a state or municipal official running for federal office could 

remove herself from being an “official” for purposes of rule 206(4)-5 by eliminating her 

ability to influence the outcome of the hiring of an investment adviser. This might occur, 

for example, if she were to: (i) formally withdraw from participation in or influencing 

adviser hiring decisions; (ii) be leaving office, so that he or she could not participate in 

subsequent decision-making; and (iii) have held direct influence over the adviser hiring 

process (as opposed to, for example, having designated an appointee with such influence 

who would remain in a position to influence such hiring). 

152	 Rule 206(4)-5(a)(1) makes it unlawful for covered investment advisers to provide 

investment advisory services for compensation to a government entity within two years 

after a contribution to an official of the government entity is made by the investment 

adviser or any of its covered associates. As suggested above, we are concerned that 

contributions may be used “as the cover for what is much like a bribe: a payment that 

accrues to the private advantage of the official and is intended to induce him to exercise 

his discretion in the donor’s favor, potentially at the expense of the polity he serves.” 

Blount, 61 F.3d at 942 (describing the Commission’s approval of MSRB rule G-37 as 

based on a wish to curtail this function). 

153	 Rule 206(4)-5(f)(1). 

154	 MSRB rule G-37 also covers payment of transition or inaugural expenses as contributions 

for purposes of its time out provision. See MSRB Rule G-37 Q&A, Question II.6. 

However, under neither rule does a contribution include the transition or inaugural 

expenses of a successful candidate for federal office. Contributions to political parties 

are not specifically covered by the definition and thus would not trigger the rule’s twoyear time out unless they are a means to do indirectly what the rule prohibits if done 

directly (for example, the contributions are earmarked or known to be provided for the 

benefit of a particular political official). We also note that “contributions” are not 

intended to include independent “expenditures,” as that term is defined in 2 U.S.C. 431 & 
 

 

 

 

 

 

 

 

 

--47--

We received requests that we clarify the application of the rule to some common 

circumstances that may arise in the course of an adviser’s relationship with a government 

client.156 We would not consider a donation of time by an individual to be a contribution, 

provided the adviser has not solicited the individual’s efforts and the adviser’s resources, 

such as office space and telephones, are not used.157 Similarly, we would not consider a 

charitable donation made by an investment adviser to an organization that qualifies for an 

exemption from federal taxation under the Internal Revenue Code,158 or its equivalent in 

a foreign jurisdiction, at the request of an official of a government entity to be a 

contribution for purposes of rule 206(4)-5.159 

441b (the federal statutory provisions limiting contributions and expenditures by national 

banks, corporations, or labor organizations invalidated by Citizens United v. Federal 

Election Commission, 130 S. Ct. 876 (2010) (holding that corporate funding of 

independent political broadcasts in candidate elections cannot be limited under the First 

Amendment)). Indeed, it is our intent that, under the rule, advisers and their covered 

associates “are not in any way restricted from engaging in the vast majority of political 

activities, including making direct expenditures for the expression of their views, giving 

speeches, soliciting votes, writing books, or appearing at fundraising events.” Blount, 61 

F.3d at 948. 

155	 MSRB rule G-37(g)(i). 

156	 See, e.g., Caplin & Drysdale Letter; Callcott Letter I (volunteer activities); NASP Letter 

(charitable contributions); Sutherland Letter; IAA Letter (entertainment expenses and 

conference expenses). We address entertainment and conference expenses in section 

II.B.2(c) of this Release (which discusses the prohibition on soliciting or coordinating 

contributions from others). 

157	 See Proposing Release, at n.91. A covered associate’s donation of his or her time 

generally would not be viewed as a contribution if such volunteering were to occur 

during non-work hours, if the covered associate were using vacation time, or if the 

adviser is not otherwise paying the employee's salary (e.g., an unpaid leave of absence). 

But see rule 206(4)-5(d) (prohibiting an adviser from doing indirectly what the rule 

would prohibit if done directly). The MSRB deals similarly with this issue. See MSRB 

Rule G-37 Q&A, Question II.19. 

158	 Section 501(c)(3) of the Internal Revenue Code (26 U.S.C. 501(c)(3)) contains a list of 

charitable organizations that are exempt from federal income taxation. 

159	 The MSRB deals similarly with this issue. See MSRB Rule G-37 Q&A, Question II.18. 

But see rule 206(4)-5(d) (prohibiting an adviser from doing indirectly what the rule 

would prohibit if done directly). 
 

 

 

 

 

--48--

The few commenters that addressed the definition of “contribution” generally 

urged us to adopt a narrower version. Some, for example, recommended that 

contributions be expressly limited to political contributions and more explicitly exclude 

expenditures not clearly made for the purpose of influencing an election.160 We are not 

narrowing our definition. We are instead adopting our definition as proposed due to our 

concern that “contributions” may also take the form of payment of election-related debts 

and transition or inaugural expenses. Further, our definition of “contribution” already 

requires that the payment be made for the purpose of influencing an election for a federal, 

state or local office.161 We believe that the scope of our proposed definition is 

appropriate in light of the conduct we are seeking to address. 

Commenters were divided as to whether contributions to PACs or local political 

parties should trigger the two-year time out.162 Such contributions were not explicitly 

covered by the proposed rule and do not necessarily trigger the two-year time out in 

MSRB rule G-37.163 In some cases, such contributions may effectively operate as a 

160	 See, e.g., National Organizations Letter; NASP Letter. 

161	 Rule 206(4)-5(f)(1). 

162	 See, e.g., CalPERS Letter; NSCP Letter (should not apply to contributions to PACs or 

state or local parties, unless a particular candidate directly solicits contributions for those 

entities); Comment Letter of James J. Reilly (Aug. 24, 2009) (“Reilly Letter”) 

(contributions to political parties should be included because in state and local elections 

contributions to political parties may effectively amount to contributions to an individual 

candidate); SIFMA Letter. 

163	 See, e.g., MSRB, Payments to Non-Political Accounts of Political Organizations, MSRB 

rule G-37 Interpretive Letter (Sept. 25, 2007), available at 

http://msrb.org/msrb1/rules/interpg37.htm (explaining that not all payments to political 

organizations that, in turn, make contributions to officials trigger Rule G-37’s time out). 

With regard to solicitations from a PAC or a political party with no indication of how the 

collected funds will be disbursed, advisers should inquire how any funds received from 

the adviser or its covered associates would be used. For example, if the PAC or political 

party is soliciting funds for the purpose of supporting a limited number of government 

officials, then, depending upon the facts and circumstances, contributions to the PAC or 

payments to the political party might well result in the same prohibition on compensation 
 

 

 

 

 

 

 

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funnel to the campaigns of the government officials.164 In other cases, however, they 

may fund general party political activities or the campaigns of other candidates.165 

Therefore, we have decided not to explicitly include all such contributions among those 

that trigger the time out, although they may violate the provision of the rule, discussed 

below, which prohibits an adviser or any of its covered persons from indirect actions that 

would result in a violation of the rule if done directly.166 

The MSRB rule G-37 definition of “contribution” has, in our view, proved to be 

workable. The types of contributions relevant to money managers and elected officials 

are unlikely to be different than those made to influence the awarding of municipal 

securities business by broker-dealers. On balance, we believe that the MSRB’s definition 

of “contribution,” which we mirrored in our proposal, achieves the goals of this 

rulemaking. Therefore, we are adopting the definition as proposed. 

(4) Covered Associates 

Contributions made to influence the selection process are typically made not by 

the firm itself, but by officers and employees of the firm who have a direct economic 

stake in the business relationship with the government client.167 Accordingly, under the 

for providing investment advisory services to a government entity as would a 

contribution made directly to the official. Our approach is consistent with the MSRB’s. 

See MSRB Rule G-37 Q&A, Question III.5. 

164	 See, e.g., Reilly Letter. 

165	 See, e.g., Caplin & Drysdale Letter (explaining that “leadership PACs,” for example, are 

commonly established by officeholders to donate to other candidates and issues). 

166	 See section II.B.2(d) of this Release. For the MSRB’s approach to this issue, see MSRB 

Rule G-37 Q&A, Question III.4. But see rule 206(4)-5(d) (noting that the rule’s 

definition of “official” of a government entity includes any election committee for that 

person). 

167	 Proposing Release, at section II.A.3(a)(4). Based on enforcement actions, we believe that 

such persons are more likely to have an economic incentive to make contributions to 

influence the advisory firm’s selection. See id. 
 

 

 

 

 

 

 

 

--50--

rule, contributions by each of these persons, which the rule defines as “covered 

associates,” trigger the two-year time out.168 A “covered associate” of an investment 

adviser is defined as: (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.169 

Owners. Contributions by sole proprietors are contributions by the adviser 

itself.170 If the adviser is a partnership, the rule covers contributions by the adviser’s 

general partners.171 If the adviser is a limited liability company, the rule covers 

contributions made by managing members.172 A contribution by an owner that is a 

limited partner or non-managing member (of a limited liability company) is not covered, 

however, unless the limited partner or non-managing member is also an executive officer 

or solicitor (or person who supervises a solicitor) covered by the rule, or unless the 

contribution is an indirect contribution by the adviser, executive officer, solicitor, or 

supervisor.173 Similarly, if the adviser is a corporation, shareholder contributions are not 

covered unless the shareholder is also an executive officer or solicitor covered by the 

168 Rule 206(4)-5(a)(1). 

169 Rule 206(4)-5(f)(2). 

170 We note, however, that a sole proprietor may, in a personal capacity, avail herself or 

himself of the de minimis exceptions described in section II.B.2(a)(6) of this Release. 

171 Rule 206(4)-5(f)(2)(i). 

172 Id. 

173 See rule 206(4)-5(a)(1), (d) and (f)(2)(i)-(ii). 
 

 

 

 

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rule, or unless the contribution is an indirect contribution by the adviser, executive 

officer, solicitor, or supervisor.174 

Executive Officers. Contributions by an executive officer of an investment 

adviser trigger the two-year time out.175 Executive officers include: (i) the president; (ii) 

any vice president in charge of a principal business unit, division or function (such as 

sales, administration or finance); (iii) any other officer of the investment adviser who 

performs a policy-making function; or (iv) any other person who performs similar policymaking functions for the investment adviser.176 Whether a person is an executive officer 

depends on his or her function, not title; for example, an officer who is the chief 

executive of an advisory firm but whose title does not include “president” is nonetheless 

an executive officer for purposes of the rule. 

The definition reflects changes we have made from our proposal that are designed 

to clarify the rule and to tailor it to apply to those officers of an investment adviser whose 

position in the organization is more likely to incentivize them to obtain or retain clients 

for the investment adviser (and, therefore, to engage in pay to play practices) while still 

achieving our objectives. We have clarified that “other executive officers” under the 

rule—i.e., those other than the president and vice presidents in charge of principal 

business units or functions—include only those officers or other persons who perform a 

policy-making function for the investment adviser.177 This limitation, which was 

174	 Id. 

175	 The definition of “covered associate” includes, among others, any executive officer or 

other individual with a similar status or function. Rule 206(4)-5(f)(2)(i). 

176	 Rule 206(4)-5(f)(4). 

177	 Rule 206(4)-2(f)(4). This modification also aligns the definition more closely with the 

definition of “executive officer” in our other rules. See, e.g., rule 205-3(d)(4) under the 

Advisers Act [17 CFR 275.205-3(d)(4)] (defining executive officer for purposes of 
 

 

 

 

--52--

recommended by commenters,178 excludes persons who enjoy certain titles as a formal 

matter but do not engage in the kinds of activities that we believe should trigger the 

prohibitions in the rule.179 We have also modified the definition to remove the limitation 

that the officer, as part of his or her regular duties, performs or supervises any person 

who performs advisory services for the adviser, or solicits or supervises any person who 

solicits for the adviser. We agree with the commenter who asserted that “. . . all of the 

adviser’s executive officers should be included because the nature of their status alone 

determinations of who is a qualified client exempting an adviser from the prohibition on 

entering into, performing, renewing or extending an investment advisory contract that 

provides for compensation on the basis of a share of the capital gains upon, or the capital 

appreciation of, the funds, or any portion of the funds, under the Advisers Act) and rule 

3c-5(a)(3) [17 CFR 270.3c-5(a)(3)] under the Investment Company Act of 1940 [15 

U.S.C. 80a] (“Investment Company Act”) (defining executive officer for purposes of 

determinations of the number of beneficial owners of a company excluded from the 

definition of “investment company” by section 3(c)(1) of the Investment Company Act, 

and whether the outstanding securities of a company excluded from the definition of 

“investment company” by section 3(c)(7) of the Investment Company Act are owned 

exclusively by qualified purchasers, as defined in that Act). It also more closely aligns 

the definition to the MSRB approach. See MSRB rule G-37(g)(v). 

178	 See, e.g., Sutherland Letter. 

179	 Several commenters urged us expressly to exclude from the definition the CEO, officers 

and employees of a parent company. See, e.g., SIFMA Letter; ICI Letter; MFA Letter; 

Skadden Letter. Depending on facts and circumstances, there may be instances in which 

a supervisor of an adviser’s covered associate (who, for example, engages in solicitation 

of government entity clients for the adviser) formally resides at a parent company, but 

whose contributions should trigger the two-year time out because they raise the same 

conflict of interest issues that we are concerned about, irrespective of that person’s 

location or title. In other words, whether a person is a covered associate ultimately 

depends on the activities of the individual and not his or her title. We recently considered 

a similar issue in a report addressing whether MSRB rule G-37 could include 

contributions by employees of parent companies as triggering that rule’s time out 

provision, see Report of Investigation Pursuant to Section 21(a) of the Securities 

Exchange Act of 1934: JP Morgan Securities, Inc., Exchange Act Release No. 61734 

(Mar. 18, 2010), available at http://www.sec.gov/litigation/investreport/34-61734.htm 

(“This Report serves to remind the financial community that placing an executive who 

supervises the activities of a broker, dealer or municipal securities dealer outside of the 

corporate governance structure of such broker, dealer or municipal securities dealer does 

not prevent the application of MSRB Rule G-37 to that individual's conduct.”). The 

MSRB also takes the view that it is an individual’s activities and not his or her title that 

may render his or her contributions a trigger for that rule’s time out provision. See 

MSRB Rule G-37 Q&A, Question IV.18. 
 

 

 

 

 

 

 

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creates a strong incentive to engage in pay to play practices.”180 Even if these senior 

officers are not directly involved in advisory or solicitation activities, as part of senior 

management, their success within the advisory firm is likely to be tied to the firm’s 

success in obtaining clients.181 

Employees who Solicit Government Clients. Contributions by any employee who 

solicits a government entity for the adviser would trigger the two-year time out. 182 An 

employee need not be primarily engaged in solicitation activities to be a “covered 

associate” under the rule.183 We are also including persons who supervise employees 

who solicit government entities because we believe these persons are strongly 

incentivized to engage in pay to play activities to obtain government entity clients.184 We 

180	 See Fund Democracy Letter. 

181	 Commenters also suggested that our definition exclude vice presidents in charge of 

business units, divisions or functions whose function is unrelated to investment advisory 

or solicitation activities. See, e.g., IAA Letter. For the reasons described above, we do 

not believe such an exclusion is appropriate. 

182	 We are not adopting the suggestion of several commenters that we treat third-party 

solicitors the same way as employees. See, e.g., 3PM Letter; Triton Pacific Letter; 

Comment Letter of Arrow Partners, Inc. Partner Ken Rogers (Sept. 2, 2009) (“Arrow 

Letter”). We explained in the Proposing Release that we determined not to propose this 

approach out of concern for the difficulties that advisers may have when monitoring the 

activities of their third-party solicitors. See Proposing Release, at nn.135 and 

accompanying text. Commenters did not persuade us that these concerns can reasonably 

be expected to be overcome. Therefore, whereas contributions by covered associates of 

the adviser trigger the two-year compensation time out, an adviser is prohibited from 

hiring third parties to solicit government business on its behalf unless the third party is a 

“regulated person.” See section II.B.2(b) of this Release. Our approach is similar to 

MSRB’s rule G-38, which restricts third-party solicitation activities differently from the 

two-year time out. See MSRB rule G-38. 

183	 The MSRB also takes the approach that an associated person need not be “primarily 

engaged” in activities that would make his or her contributions trigger rule G-37’s time 

out provision, particularly where he or she engages in soliciting business. See MSRB 

Rule G-37 Q&A, Question IV.8. 

184	 Rule 206(4)-5(f)(2)(ii). The proposed rule would only have applied to senior officers 

who supervise employee solicitors. See proposed rule 206(4)-5(f)(4)(ii). MSRB rule G37 also applies to supervisors of persons who solicit relevant business from government 

entities. See MSRB Rule G-37 Q&A, Question IV.14. 
 

 

 

 

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have revised this aspect of the definition to include all supervisors of those solicitors that 

solicit government entities because we believe the incentives to engage in pay to play 

exist for all such supervisors, not just those that have a certain level of seniority. 

Rule 206(4)-5 defines “solicit” to mean, with respect to investment advisory 

services, to communicate, directly or indirectly, for the purpose of obtaining or retaining 

a client for, or referring a client to, an investment adviser.185 Commenters asked us to 

provide further guidance on what we mean by “solicit.”186 The determination of whether 

a particular communication is a solicitation is dependent upon the specific facts and 

circumstances relating to such communication. As a general proposition any 

communication made under circumstances reasonably calculated to obtain or retain an 

advisory client would be considered a solicitation unless the circumstances otherwise 

indicate that the communication does not have the purpose of obtaining or retaining an 

advisory client. For example, if a government official asks an employee of an advisory 

firm whether the adviser has pension fund advisory capabilities, such employee generally 

would not be viewed as having solicited advisory business if he or she provides a limited 

affirmative response, together with either providing the government official with contact 

information for a covered associate of the adviser or informing the government official 

that advisory personnel who handle government advisory business will contact him or 

her. 187 

185 Rule 206(4)-5(f)(10)(i). We are adopting this definition as proposed. 

186 See, e.g., Skadden Letter. 

187 Similarly, if a government official is discussing governmental asset management issues 

with an employee of an adviser, the employee generally would not be viewed as having 

solicited business if he or she provides a limited communication to the government 

official that such alternative may be appropriate, together with either providing the 

government official with contact information for a covered associate or informing the 
 

 

 

 

 

 

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Political Action Committees. A covered associate includes a political action 

committee controlled by the investment adviser or by any of its covered associates.188 

Under the rule, we would regard an adviser or its covered associate to have “control” 

over a political action committee if the adviser or its covered associate has the ability to 

direct or cause the direction of the governance or operations of the PAC.189 

Two commenters asserted that we should narrow the definition of “covered 

associate” with respect to political action committees.190 Specifically, they asserted that 

the definition should only include PACs controlled by the adviser and not those 

controlled by other covered associates, which could be a separate legal entity over which 

government official that advisory personnel who handle asset management for 

government clients will contact him or her. In these examples, however, if the adviser’s 

employee receives compensation such as a finder’s or referral fee for such business or if 

the employee engages in other activities that could be deemed a solicitation with respect 

to such business, the employee generally would be viewed as having solicited the 

advisory business. Our interpretation of what it means to “solicit” government business 

is consistent with the MSRB’s. See MSRB, Interpretive Notice on the Definition of 

Solicitation under Rules G-37 and G-38 (June 8, 2006), available at 

http://msrb.org/msrb1/rules/notg38.htm. 

188	 Rule 206(4)-5(f)(2)(iii) (which we are adopting as proposed). One commenter suggested 

that we define a “political action committee,” or PAC, as any organization required to 

register as a political committee under federal, state or local law. Caplin & Drysdale 

Letter. But we have not included this definition of PAC because we do not believe a 

definition linked to the registration status of a political committee would serve our 

purpose of deterring evasion of the rule as registration requirements vary among election 

laws. We note, however, that we would construe the term PAC to include (but not 

necessarily be limited to) those political committees generally referred to as PACs, such 

as separate segregated funds or non-connected committees within the meaning of the 

Federal Election Campaign Act, or any state or local law equivalent. See Federal 

Election Commission, Quick Answers to PAC Questions, available at 

http://www.fec.gov/ans/answers_pac.shtml#pac. Determination of whether an entity is a 

PAC covered by our rule would not, in our view, turn on whether the PAC was, or was 

required to be, registered under relevant law. 

189	 One commenter suggested a similar interpretation of “control.” Caplin & Drysdale 

Letter. For the MSRB’s approach to this definition, see MSRB Rule G-37 Q&A, 

Question IV.24. 

190	 SIFMA Letter; Sutherland Letter. 
 

 

 

 

 

 

 

 

 

 

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the adviser may have little influence.191 We are not adopting this suggestion. As we 

discussed in the Proposing Release, PACs are often used to make political 

contributions.192 The recommended changes would permit an executive of the adviser or 

another covered person of the adviser to use a PAC he or she controls to evade the rule. 

Even where the adviser itself does not control such PACs directly, we are concerned 

about their use to evade our rule where they are controlled by covered associates (whose 

positions in the organization, as we note above, are more likely to incentivize them to 

obtain or retain clients for the investment adviser).193 

Other Persons. Several commenters urged that our definitions be broadened to 

encompass other persons whose contributions should trigger the two-year time out.194 

One urged that in some cases all employees should be covered associates because of the 

likelihood they could directly benefit from engaging in pay to play.195 Another urged that 

the definition of covered associate include affiliates of the adviser that solicit government 

business on the adviser’s behalf, any director of the adviser, and any significant owner of 

the adviser.196 These suggestions would expand the rule to a range of persons that could 

191	 Id. 

192	 Proposing Release, at n.101. 

193	 Advisers are responsible for supervising their supervised persons, including their covered 

associates. We have the authority to seek sanctions where an investment adviser, or an 

associated person, has failed reasonably to supervise, with a view to preventing violations 

of the federal securities laws or rules, a person who is subject to the adviser’s (or its 

associated person’s) supervision and who commits such violations. Sections 203(e)(6) 

and 203(f) of the Advisers Act [15 U.S.C. 80b-3(e)(6) and (f)]. 

194	 See, e.g., Fund Democracy/Consumer Federation Letter; DiNapoli Letter (suggesting the 

rule also cover contributions from family members); Ounavarra Letter. 

195	 Ounavarra Letter. 

196	 Fund Democracy/Consumer Federation Letter. 
 

 

 

 

 

 

 

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engage in pay to play activities.197 In our judgment, however, contributions from these 

types of persons are less likely to involve pay to play unless the contributions were made 

by these persons for the purpose of avoiding application of the rule, which could result in 

the adviser’s violation of a separate provision of the rule.198 We do not believe that the 

incremental benefits of capturing conduct of other individuals less likely to engage in pay 

to play based on the record before us today outweigh the additional burden such an 

expansion would impose.199 Thus, we are not expanding the definition as these 

commenters have suggested. 

Other commenters urged us to narrow our definition of “covered associate” to 

include fewer persons.200 For example, one commenter recommended that the definition 

of “covered associate” expressly exclude all “support personnel.”201 Another suggested 

that we limit the definition to those who solicit government clients with a “major 

purpose” of obtaining that government client.202 Expressly excluding all “support 

personnel” is unnecessary because, in almost all cases, such persons would not be 

197	 See, e.g., supra note 179 (discussing why we have chosen not to limit the definition of 

“executive officer” in other ways as suggested by some commenters). 

198	 See Rule 206(4)-5(d). We also note that the MSRB takes a similar approach. See, e.g., 

MSRB Rule G-37 Q&A, Question IV.9 (noting that the universe of those whose 

contributions above the de minimis level per se trigger the two-year time out is limited 

and does not include their consultants, lawyers or spouses). The MSRB also leaves 

contributions by affiliates and personnel beyond those identified as triggering the twoyear time out to be addressed by a provision prohibiting municipal securities dealers from 

doing indirectly what they are prohibited from doing directly under rule G-37. See 

MSRB Rule G-37(d). 

199	 In this instance, as in others, we are sensitive to First Amendment concerns that further 

expansion of the scope of covered associates could broaden the rule’s scope beyond what 

is necessary to accomplish its purposes. 

200	 See, e.g., T. Rowe Price Letter; NSCP Letter; Skadden Letter. 

201	 T. Rowe Price Letter. 

202	 Skadden Letter. 
 

 

 

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“covered associates,” as that term is defined in the rule. We have not limited the 

definition to those who solicit government clients with a “major purpose” of obtaining 

that government client because we believe that our rule’s definition of “solicit,” as 

discussed above, adequately takes into account the purpose of the communication and 

adding an additional element of intent may exclude employees who have an incentive to 

engage in pay to play practices. 

(5) “Look Back” 

The rule attributes to an adviser contributions made by a person within two years 

(or, in some cases, six months) of becoming a covered associate of that adviser.203 In 

other words, when an employee becomes a covered associate, the adviser must “look 

back” in time to that employee’s contributions to determine whether the time out applies 

to the adviser.204 If, for example, the contribution were made more than two years (or, 

pursuant to the exception described below for non-solicitors, six months) prior to the 

employee becoming a covered associate, the time out has run; if the contribution was 

made less than two years (or six months) from the time the person becomes a covered 

associate, the rule prohibits the adviser that hires or promotes the contributing covered 

associate from receiving compensation for providing advisory services from the hiring or 

203	 Rule 206(4)-5(a)(1). The “look back” applies to any person who becomes a covered 

associate, including a current employee who has been transferred or promoted to a 

position covered by the rule. A person becomes a covered associate for purposes of the 

rule’s look-back provision at the time he or she is hired or promoted to a position that 

meets the definition of “covered associate” in rule 206(4)-5(f)(2). For a discussion of the 

definition of “covered associate,” see section II.B.2(a)(4) of this Release. 

204	 Rule 206(4)-5(a)(1) (including among those covered associates whose contributions can 

trigger the two-year time out a person who becomes a covered associate within two years 

after the contribution is made); Rule 206(4)-5(b)(2) (excepting from the two-year look 

back those contributions made by a natural person more than six months prior to 

becoming a covered associate of the investment adviser unless such person, after 

becoming a covered associate, solicits clients on behalf of the investment adviser). 
 

 

 

 

 

 

 

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promotion date until the two-year period has run.205 The look-back provision, which is 

similar to that in MSRB rule G-37, is designed to prevent advisers from circumventing 

the rule by influencing the selection process by hiring persons who have made political 

contributions.206 

We received many comments on our proposed look-back provision,207 which 

would have applied the two-year look back with respect to all contributions of new 

covered associates.208 One commenter asserted that such a provision is necessary to 

prevent advisers from circumventing the prohibitions on pay to play.209 Most 

commenters, however, argued that the rule should not contain a look-back provision or 

should contain a shorter one because it could prevent advisers from hiring qualified 

205	 In no case would the prohibition imposed by the rule be longer than two years from the 

date the covered associate makes a covered contribution. If, for example, a covered 

associate becomes employed by an investment adviser (and engages in solicitation 

activity for it) one year and six months after making a contribution, the new employer 

would be subject to the proposed rule’s prohibition for the remaining six months of the 

two-year period. We also note that the rule’s exemptive process may be available in 

instances where an adviser believes application of the look-back provision would yield an 

unintended result. Rule 206(4)-5(e). For a discussion of the rule’s exemptive provision, 

see section II.B.2(f) of this Release. 

206	 Similarly, to prevent advisers from channeling contributions through departing 

employees, advisers must “look forward” with respect to covered associates who cease to 

qualify as covered associates or leave the firm. The covered associate’s employer at the 

time of the contribution would be subject to the proposed rule’s prohibition for the entire 

two-year period, regardless of whether the covered associate remains a covered associate 

or remains employed by the adviser. Thus, dismissing a covered associate would not 

relieve the adviser from the two-year time out. MSRB rule G-37 also includes a “lookforward provision.” See MSRB Rule G-37 Q&A, Question IV.17 (“. . . any contributions 

by [an] associated person [who leaves the dealer’s employ] (other than those that qualify 

for the de minimis exception under Rule G-37(b)) will subject the dealer to the rule’s ban 

on municipal securities business for two years from the date of the contribution”). 

207	 See, e.g., Fund Democracy/Consumer Federation Letter; ICI Letter; Davis Polk Letter; 

NY City Bar Letter; Fidelity Letter; Wells Fargo Letter; MFA Letter; IAA Letter; NASP 

Letter; American Bankers Letter; Comment Letter of Seward & Kissel LLP (Oct. 6. 

2009) (“Seward & Kissel Letter”); Park Hill Letter; Dechert Letter; Skadden Letter. 

208	 See Proposing Release, at section II.A.3(a)(5). 

209	 Fund Democracy/Consumer Federation Letter. 
 

 

 

 

 

 

 

 

 

 

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individuals who have made unrelated political contributions,210 or it could be disruptive 

to public pension plans seeking to hire qualified managers.211 While some urged that we 

eliminate the look-back provision altogether,212 most asked us to shorten the period to 

three to six months.213 Others suggested alternative approaches to the look back, 

including adopting a higher contribution threshold to trigger the look-back provision214 or 

permitting advisers to hire and promote persons to be covered associates who have made 

prohibited contributions, but not permitting them to solicit government clients or 

otherwise create firewalls between them and government clients.215 

Upon consideration of the comments, we believe that applying the full two-year 

look back to all new covered associates may be unnecessary to achieve the goals of the 

rulemaking. We are adopting a suggestion offered by several commenters to shorten the 

look-back period with respect to certain new covered associates whose contributions are 

less likely to be involved in pay to play.216 Under an exception to the rule, the two-year 

210	 See, e.g., ICI Letter; Davis Polk Letter; NY City Bar Letter; Fidelity Letter; Wells Fargo 

Letter; MFA Letter. 

211	 See, e.g., Comment Letter of Connecticut Treasurer Denise L. Nappier (Sept. 10, 2009) 

(“CT Treasurer Letter”); CalPERS Letter. 

212	 See, e.g., IAA Letter; ICI Letter; Wells Fargo Letter; NASP Letter; American Bankers 

Letter; MFA Letter; Seward & Kissel Letter. 

213	 See, e.g., ICI Letter (three-month look back); IAA Letter (six-month look back); Park 

Hill Letter (six-month look back); Wells Fargo Letter (six-month look back); Davis Polk 

Letter (six-month look back); Dechert Letter (six-month look back); MFA Letter (sixmonth look back). 

214	 See, e.g., Wells Fargo Letter; NSCP Letter. 

215	 See, e.g., Comment Letter of Strategic Capital Partners (Oct. 1, 2009) (“Strategic Capital 

Letter”); Comment Letter of B. Jack Miller (Oct. 3, 2009); Comment Letter of RP Realty 

Partners, LLC Chief Financial Officer Jerry Gold (Oct. 2, 2009); SIFMA Letter. 

216	 See, e.g., MFA Letter; Fidelity Letter; Dechert Letter; Wells Fargo Letter; Skadden 

Letter. The MSRB shortened the look-back period under MSRB rule G-37 to six months 

for certain municipal finance professionals in response to similar industry concerns about 

the impact on hiring. See MSRB, Amendments Filed to Rule G-37 Concerning the 
 

 

 

 

 

 

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time out is not triggered by a contribution made by a natural person more than six months 

prior to becoming a covered associate, unless he or she, after becoming a covered 

associate, solicits clients.217 As a result, the two-year look back applies only to covered 

associates who solicit for the investment adviser.218 

The potential link between obtaining advisory business and contributions made by 

an individual prior to his or her becoming a covered associate that is uninvolved in 

solicitation activities is likely more attenuated and therefore, in our judgment, should be 

subject to a shorter look back. We have modeled this shortened look-back period219 on 

the MSRB’s six-month look back for certain personnel, which it implemented as a result 

of feedback it received from dealers that indicated the two-year look back was negatively 

affecting in-firm transfers and promotions and “preclud[ing] them from hiring individuals 

Exemption Process and the Definition of Municipal Finance Professional (Sept. 26, 

2002), available at http://www.msrb.org/msrb1/archive/g%2D37902notice.htm. 

217	 Rule 206(4)-5(b)(2). An adviser is subject to the two-year time out regardless of whether 

it is “aware” of the political contributions. Thus, statements by prospective employees 

regarding whether they have made relevant contributions are insufficient to inoculate the 

adviser, as some commenters urged (see, e.g., IAA Letter; ICI Letter; NSCP Letter; 

Caplin & Drysdale Letter), to ensure that investment advisers are not encouraged to relax 

their efforts to promote compliance with the rule’s prohibitions. Nonetheless, advisers 

who advise or are considering advising any government entity should consider requiring 

full disclosure of any relevant political contributions from covered associates or potential 

covered associates to ensure compliance with rule 206(4)-5. Advisers are required to 

request similar reports about securities holdings by Advisers Act rule 204A-1(b)(1)(ii) 

[17 CFR 275.204A-1(b)(1)(ii)], which requires each of a firm’s “access persons” to 

submit an initial “holdings report” of securities he or she beneficially owns at the time he 

or she becomes an access person, even though the securities would likely have been 

acquired in transactions prior to becoming an access person. For a discussion of an 

adviser’s recordkeeping obligations with regard to records of contributions by a new 

covered associate during that new covered associate’s look-back period, see infra note 

428. 

218	 See rule 206(4)-5(f)(2) (defining covered associate of an investment adviser as: (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). 

219	 See rule 206(4)-5(b)(2). 
 

 

 

 

 

 

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who had made contributions, even though the contributions (which may have been 

relatively small) were made at a time when the individuals had no reason to be familiar 

with Rule G-37.”220 This approach balances commenters’ concerns about the 

implications for their hiring decisions with the need to protect against individuals 

marketing to prospective investment adviser employers their connections to, or influence 

over, government entities those advisers might be seeking as clients.221 

(6) Exceptions for De Minimis Contributions 

Rule 206(4)-5 permits individuals to make aggregate contributions without 

triggering the two-year time out of up to $350, per election, to an elected official or 

candidate for whom the individual is entitled to vote,222 and up to $150, per election, to 

220	 MSRB, Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the 

Municipal Securities Rulemaking Board Relating to Amendments to Rules G-37, on 

Political Contributions and Prohibitions on Municipal Securities Business, G-8, on 

Books and Records, Revisions to Form G-37/G-38 and the Withdrawal of Certain Rule 

G-37 Questions and Answers, Exchange Act Release No. 47609 (April 1, 2003) [67 FR 

17122 (Apr. 8, 2003)]. See also MSRB, Self-Regulatory Organizations; Order Granting 

Approval of a Proposed Rule Change and Amendment No. 1 Thereto by the Municipal 

Securities Rulemaking Board Relating to Amendments to Rules G-37, on Political 

Contributions and Prohibitions on Municipal Securities Business, G-8, on Books and 

Records, Revisions to Form G-37/G-38 and the Withdrawal of Certain Rule G-37 

Questions and Answers, Exchange Act Release No. 47814 (May 8, 2003) [68 FR 

25917 (May 14, 2003)] (Commission order approving amendments to MSRB rule G-37); 

MSRB rule G-37(b)(iii). 

221	 We are not adopting the suggestion of commenters to exclude from the look-back 

provision contributions made before a merger or acquisition by an adviser by not 

attributing the contributions of the acquired adviser to the acquiring adviser. See, e.g., 

Dechert Letter; ICI Letter. We believe that an acquisition of another adviser could raise 

identical concerns where the acquired adviser has made political contributions designed 

to benefit the acquiring adviser. Rule 206(4)-5 is not intended to prevent mergers in the 

investment advisory industry or, once a merger is consummated, to hinder the surviving 

adviser’s government advisory business unless the merger was an attempt to circumvent 

rule 206(4)-5. Thus, the adviser may wish to seek an exemption from the ban on 

receiving compensation pursuant to rule 206(4)-5(a) from the Commission. The MSRB 

takes the same approach to this issue. See MSRB Rule G-37 Q&A, Question II.16. 

222	 For purposes of rule 206(4)-5, a person would be “entitled to vote” for an official if the 

person’s principal residence is in the locality in which the official seeks election. For 

example, if a government official is a state governor running for re-election, any covered 
 

 

 

 

 

 

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an elected official or candidate for whom the individual is not entitled to vote.223 These 

de minimis exceptions are available only for contributions by individual covered 

associates, not the investment adviser itself.224 Under both exceptions, primary and 

general elections would be considered separate elections.225 

We proposed a $250 de minimis exception for contributions to candidates for 

whom a covered associate is entitled to vote,226 which reflects the current de minimis 

exception in MSRB rule G-37.227 Many commenters urged us to increase the de minimis 

amount (either to a larger number or by indexing it to inflation), arguing that a 

associate of an adviser who resides in that state may make a de minimis contribution to 

the official without causing a ban on that adviser being compensated for providing 

advisory services for that government entity. In the example of a government official 

running for President, any covered associate in the country can contribute the de minimis 

amount to the official's Presidential campaign. The MSRB has issued a similar 

interpretation of what it means to be “entitled to vote” for purposes of MSRB rule G-37. 

See MSRB Reports, Vol. 16. No. 1 (January 1996) at 31-34. 

223	 See Rule 206(4)-5(b)(1) (excepting “de minimis” contributions to “officials” (see supra 

note 139 and accompanying text) from the rule’s two-year time out provision). 

224	 Id. Under the rule, each covered associate, taken separately, would be subject to the de 

minimis exceptions. In other words, the limit applies per covered associate and is not an 

aggregate limit for all of an adviser’s covered associates. But see supra note 170 

(pointing out that a sole proprietor may, in a personal capacity, avail herself or himself of 

the de minimis exceptions even though his or her contributions are otherwise considered 

contributions of the adviser itself). 

225	 Accordingly, a covered person of an investment adviser could, without triggering the 

prohibitions of the rule, contribute up to the limit in both the primary election campaign 

and the general election campaign of each official for whom the person making the 

contribution would be entitled to vote. The MSRB takes the same approach of excepting 

from rule G-37’s time out trigger contributions up to the rule’s de minimis amount for 

each election (including a primary and general election). See MSRB Rule G-37 Q&A, 

Question II.8. See also In the Matter of Pryor, McClendon, Counts & Co., Inc., et al., 

Exchange Act Release No. 48095 (June 26, 2003) (noting that contributions must be 

limited to MSRB rule G-37’s de minimis amount before the primary, with the same de 

minimis amount allowed after the primary for the general election). 

226	 See Proposing Release, at section II.A.3(a)(6). 

227	 See MSRB rule G-37(b)(i). 
 

 

 

 

 

 

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contribution as large as $1,000 would be unlikely to influence the award of an advisory 

contract by a public pension plan.228 

The $1,000 amount suggested by some commenters strikes us as a rather large 

contribution that could influence the hiring decisions, depending upon the size of the 

jurisdiction, the amount of campaign contributions to opposing candidates, and the 

competitiveness of the primary or prospective election. Instead, we are taking the 

suggestion of several commenters229 that we should increase the de minimis amount to 

reflect the effects of inflation since the MSRB first established its $250 de minimis 

amount in 1994.230 We may consider increasing the $350 amount in the future if, for 

example, the value of it decreases materially as a result of further inflation. 

Commenters also urged us to eliminate the condition that a covered associate 

must be able to vote for the candidate.231 They asserted that persons can have a 

legitimate interest in contributing to campaigns of people for whom they are unable to 

228	 See, e.g., SIFMA Letter; NASP Letter; Comment Letter of Philip K. Holl (Oct.5, 2009) 

(“Holl Letter”); NSCP Letter; Caplin & Drysdale Letter; Cornell Law Letter; ICI Letter; 

MFA Letter; Seward & Kissel Letter; Callcott Letter II; Comment Letter of the California 

State Teachers’ Retirement System (Oct. 6, 2009) (adopted policies that limit 

contributions to board members by those seeking investment relationships with the fund 

to $1,000). Several commenters suggested our proposed de minimis limit could be 

subject to a challenge on constitutional grounds. For a discussion of, and response to, 

these comments, see supra note 72 and accompanying text. 

229	 See, e.g., Caplin & Drysdale Letter (recommending that we index the de minimis 

threshold for inflation); Cornell Law Letter (recommending that we index the de minimis 

threshold for inflation). See also Callcott Letter I. 

230	 We multiplied the $250 de minimis amount that we proposed (which was adopted by the 

MSRB in 1994) by the annual consumer price index (a measure of inflation) change since 

1994, as reported by the Bureau of Labor Statistics (available at 

http://www.bls.gov/data/). The result was approximately $365 in 2009; we rounded it 

down to $350 for administrative convenience. 

231	 See, e.g., T. Rowe Price Letter; Dechert Letter; MFA Letter; NASP Letter; Callcott Letter 

I; Cornell Law Letter; IAA Letter. 
 

 

 

 

 

 

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vote.232 We acknowledge that persons can have such an interest, such as in large 

metropolitan areas where a covered associate may work and live in different jurisdictions. 

But commenters did not confine their recommendations to such circumstances and we 

remain concerned that contributions by executives of advisers living in distant 

jurisdictions may be less likely to be made for purely civic purposes. Accordingly, we 

have added a de minimis exception for contributions of up to $150 to officials for whom a 

covered associate is not entitled to vote, which is lower than the de minimis exception of 

$350 for candidates for whom a covered associate is entitled to vote. We believe that 

$150 is a reasonable amount for the additional de minimis exception we are adopting 

because of the more remote interest a covered associate is likely to have in contributing 

to a person for whom he or she is not entitled to vote. 

(7) Exception for Certain Returned Contributions 

We are adopting, largely as proposed, an exception that will provide an adviser 

with a limited ability to cure the consequences of an inadvertent political contribution to 

an official for whom the covered associate making it is not entitled to vote.233 The 

exception is available for contributions that, in the aggregate, do not exceed $350 to any 

one official, per election.234 The adviser must have discovered the contribution which 

resulted in the prohibition within four months of the date of such contribution235 and, 

232	 See, e.g., T. Rowe Price Letter; Dechert Letter; MFA Letter; NASP Letter; Callcott Letter 

I; Cornell Law Letter. 

233	 Rule 206(4)-5(b)(3). 

234	 Rule 206(4)-5(b)(3)(i). We note that a contribution would not trigger the two-year ban at 

all to the extent it falls within the de minimis exception described in rule 206(4)-5(b)(1). 

See section II.B.2(a)(6) of this Release for a discussion of this exception. 

235	 Id. 
 

 

 

 

 

 

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within 60 days after learning of the triggering contribution, the contributor must obtain 

the return of the contribution.236 

The scope of this exception is limited to the types of contributions that we believe 

are less likely to raise pay to play concerns. The prompt return of the contribution 

provides an indication that the contribution would not affect an official of a government 

entity’s decision to award an advisory contract.237 The relatively small amount of the 

contribution, in conjunction with the other conditions of the exception, suggests that it 

was unlikely to be made for the purpose of influencing the award of an advisory contract. 

Repeated triggering contributions suggest otherwise or that the adviser has not 

implemented effective compliance controls. Therefore, the rule limits an adviser’s 

reliance on the exception to no more than two or three per 12-month period (based on the 

size of the adviser),238 and no more than once for each covered associate,239 regardless of 

the time period.240 

236	 Rule 206(4)-5(b)(3)(i). 

237	 The 60-day limit is designed to give contributors sufficient time to seek its return, but still 

require that they do so in a timely manner. Also, this provision is consistent with MSRB 

rule G-37(j)(i). If the recipient will not return the contribution, the adviser would still 

have available the opportunity to apply for an exemption under paragraph (e) of the rule. 

Paragraph (e), which sets forth factors we would consider in determining whether to grant 

an exemption, includes as a factor whether the adviser has taken all available steps to 

cause the contributor involved in making the contribution which resulted in such 

prohibition to obtain a return of the contribution. 

238	 Rule 206(4)-5(b)(3)(ii). The approach we have taken will generally create some 

flexibility to accommodate a limited number of contributions by covered associates that 

would otherwise trigger the two-year time out. In a modification from our proposal that 

we believe is responsive to certain commenters’ concerns (see note 251 and 

accompanying text below), “larger” advisers may avail themselves of three automatic 

exceptions, instead of two, in any calendar year. Rule 206(4)-5(b)(3)(ii). In contrast, our 

proposal would have permitted each adviser, regardless of its size, to rely on the 

automatic exception twice each year. The rule identifies a “larger” adviser for these 

purposes as any adviser who has reported in response to Item 5.A on its most recently 

filed Form ADV, Part 1A [17 CFR 279.1] that it has more than 50 employees. Id. 

Investment Adviser Registration Depository (IARD) data as of April 1, 2010 indicate that 
 

 

 

 

 

 

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Commenters who addressed it generally supported our inclusion of an automatic 

exception provision,241 although several suggested modifications.242 Some urged us to 

eliminate the requirement that the contributor succeed in obtaining the return of the 

contribution.243 We are not making this change, which could undermine our goals in 

adopting the rule if it led to contributors asking for the return of a contribution where 

such requests were expected to be refused by the government official. We would have to 

discern whether the contributor itself, who may (or whose employer may) be seeking to 

influence government officials, has tried “hard enough” to get the contribution back. 

Other commenters recommended an alternative exception for inadvertent 

contributions that would not require that an otherwise-triggering contribution be 

approximately 10 percent of registered advisers have more than 50 employees (and would 

therefore be limited to three “automatic” exceptions per calendar year instead of two). In 

particular, the data indicate that there are 11,607 registered investment advisers. Of 

those, 1,072 advisers (9.2% of the total) have indicated in their responses to Item 5.A of 

Part 1A of Form ADV that they have more than 50 employees. We chose the 50 

employee cut-off because the number of employees is independently reported on Form 

ADV (and therefore cross-verifiable)—each adviser filing Form ADV must check a box 

indicating an approximation of the number of employees it has, choosing among 1-5, 6­

10, 11-50, 51-250, 251-500, 501-1,000, or more than 1,000—and because we believe that 

inadvertent violations of the rule are more likely at advisers with greater numbers of 

employees. We think that the twice per year limit is appropriate for small advisers and 

the three times per year limit is appropriate for larger advisers. We do not believe it is 

appropriate for there to be greater variation in the number of times advisers may rely on 

the exception than that based either on their size or on other characteristics. We are 

seeking to encourage robust monitoring and compliance. 

239	 Rule 206(4)-5(b)(3)(iii). Once a covered associate has been made aware of an 

“inadvertent” violation, a justification for a second violation would be more questionable. 

240	 Although we have included different allowances for larger and smaller advisers (based on 

the number of employees they report on Form ADV), our approach otherwise generally 

tracks MSRB rule G-37’s “automatic exemption” provision. See MSRB rule G-37(j). 

241	 See, e.g., T. Rowe Price Letter; NSCP Letter; CT Treasurer Letter; Skadden Letter; ICI 

Letter; IAA Letter. 

242	 See, e.g., NY City Bar Letter; Dechert Letter; IAA Letter. 

243	 See, e.g., T. Rowe Price Letter; NSCP Letter; CT Treasurer Letter. 
 

 

 

 

 

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returned.244 They contended that such an exception should be available to advisers with 

policies and procedures in place to prevent pay to play that include sanctions for 

employees violating the policies.245 Such an approach excludes any objective indication 

that the contribution was inadvertent. As noted above, policies and procedures are 

required to ensure compliance with our rule. But policies and procedures alone, without 

critical objective criteria, such as obtaining a return of the contribution, are insufficient in 

our view to justify an exception to our prophylactic rule. 

Some commenters urged us to modify or eliminate the requirement that the 

contribution be discovered by the adviser within four months.246 We believe, however, 

that four months is the appropriate timeframe. We believe advisers should have a 

reasonable amount of time to discover contributions made by covered associates if, for 

example, their covered associates disclose their contributions to the adviser on a quarterly 

basis.247 The absence of such a time limitation would encourage advisers not to seek to 

244	 See, e.g., IAA Letter (suggesting that we require, as a condition for such an exception, 

that “such contribution resulted in an inadvertent violation, meaning violations that are 

not reasonably known or condoned by the investment adviser and where the contributor 

lacked intent to influence the award of the advisory contract or violate the rule in making 

the contribution, as evidenced by the facts and circumstances surrounding such 

contribution”). 

245	 See, e,g., IAA Letter; Dechert Letter; NY City Bar Letter. 

246	 See, e.g., T. Rowe Price Letter (arguing that, if an adviser has in place procedures to 

require covered associates to report all contributions no less frequently than quarterly, 

and an associate fails to report a contribution in violation of the procedures, the discovery 

of a prohibited contribution outside this four-month window should not preclude the use 

of this exception.). But see Fund Democracy/Consumer Federation Letter (urging us to 

consider shortening the time in which a contribution must be discovered for the exception 

to be available to one month). 

247	 Quarterly compliance reporting is familiar to advisory personnel. See, e.g., rule 204A-1 

under the Advisers Act (requiring that, under an adviser’s code of ethics, personnel report 

personal securities trading activity at least quarterly). We do not believe the exception 

should be available where it takes longer for advisers to discover contributions made by 

covered associates because they might enjoy the benefits of a contribution’s potential 
 

 

 

 

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discover such contributions if they believed they could simply rely on the exception any 

time a contribution happened to come to light. 

A number of commenters suggested the exception be allowed for all contributions 

regardless of dollar amount, while a few recommended raising the dollar amount to 

$1,000.248 As we noted above, we view the limitation on the amount of such a 

contribution, in conjunction with the other conditions of the exception, important to the 

rule because it is more likely that the contribution was, in fact, inadvertent. We have 

modified this “automatic” exception from our proposal by raising the limit on 

contributions eligible for the exception to $350, the same amount we have adopted as a 

de minimis threshold for contributions to an official for whom a covered associate is 

entitled to vote.249 In addition, at the suggestion of commenters who argued that our 

proposed limitation on the annual use of such exception failed to take into consideration 

the different size of advisers, 250 we have modified our proposal to permit use of the 

exception three times in any year by an adviser that has reported on its Form ADV 

influence for too long a period of time. The condition that the contribution be discovered 

within four months is consistent with the MSRB’s approach. See MSRB rule G-37(j)(i). 

248	 See, e.g., SIFMA Letter; NASP Letter; Holl Letter; NSCP Letter; ICI Letter; MFA Letter. 

249	 Rule 206(4)-5(3)(i)(B). No automatic exception is available for any contributions to an 

official for whom the covered associate is entitled to vote that exceed the de minimis 

$350 amount. As explained above, we believe that $350 is the appropriate de minimis 

threshold for contributions to officials for whom a covered associate is entitled to vote 

and $150 is the appropriate de minimis threshold for contributions to officials for whom a 

covered associate it not entitled to vote. See section II.B(6) of this Release. Because 

these thresholds are different, we anticipate that covered associates could mistakenly 

make contributions up to the higher threshold under the mistaken belief that they are 

entitled to vote for an official when in fact they are not entitled to do so. So long as those 

contributions are returned and the other conditions of the exception are met, we believe 

they should be eligible for the automatic exception. 

250	 See, e.g., Skadden Letter; T. Rowe Price Letter; NSCP Letter; ICI Letter; IAA Letter. 
 

 

 

 

 

 

 

 

 

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registration statement that it had more than 50 employees who perform investment 

advisory functions.251 

The exception is intended to provide advisers with the ability to undo certain 

mistakes. Because it operates automatically,252 we believe it should be subject to 

conditions that are objective and limited in order to capture only those contributions that 

are unlikely to raise pay to play concerns.253 

(b) Ban on Using Third Parties to Solicit Government 

Business 

Rule 206(4)-5 makes it unlawful for any investment adviser subject to the rule or 

any of the adviser’s covered associates to provide or agree to provide, directly or 

indirectly, payment254 to any person to solicit255 government clients for investment 

251	 See supra note 238. 

252	 The exception is “automatic” in the sense that an adviser relying on it may do so without 

notifying the Commission or its staff. However, we note that the recordkeeping 

obligations for registered advisers mandate specifically that an adviser maintain records 

regarding contributions with respect to which the adviser has invoked this exception. 

Rule 204-2(a)(18)(ii)(D). See also section II.D of this Release. 

253	 As discussed below in section II.B.2(f) of this Release, in other circumstances, advisers 

can apply to the Commission for an exemption from the rule’s two-year time out. See 

rule 206(4)-5(e). 

254	 The term “payment” is defined in rule 206(4)-5(5)(f) as any gift, subscription, loan, 

advance, or deposit of money or anything of value. Depending on the specific facts and 

circumstances, payment can include quid pro quo arrangements whereby a non-affiliated 

person solicits advisory business for the adviser in exchange for being hired by the 

adviser to provide other unrelated services. This approach is consistent with the MSRB’s 

with regard to MSRB rule G-38’s third-party solicitor ban. See MSRB, Interpretive 

Notice on the Definition of Solicitation under Rules G-37 and G-38 (June 8, 2006), 

available at http://msrb.org/msrb1/rules/notg38.htm. But see infra note 257 (discussing 

the provision of professional services by third parties). 

255	 For the definition of what it means to “solicit” a client or prospective client to provide 

investment advisory services, which we are adopting as proposed, see text accompanying 

note 185. This definition is consistent with the definition the MSRB employs for similar 

purposes in rule G-38, the MSRB’s rule that restricts third-party solicitation activity. 

MSRB rule G-38(b)(i). 
 

 

 

 

 

 

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advisory services on its behalf.256 The prohibition is limited to third-party solicitors. 

Thus, the prohibition does not apply to any of the adviser’s employees, general partners, 

managing members, or executive officers.257 Contributions by these persons, however, 

may trigger the two-year time out. As discussed in more detail below, the prohibition 

also does not apply to certain “regulated persons” that themselves are subject to 

prohibitions against engaging in pay to play practices.258

 We proposed to prohibit advisers from paying third parties in order to prevent 

advisers from circumventing the rule.259 We observed in the Proposing Release that 

solicitors or “placement agents” have played a central role in actions that we and other 

authorities have brought involving pay to play schemes;260 in several instances, advisers 

allegedly made significant payments to placement agents and other intermediaries in 

order to influence the award of advisory contracts.261 We noted that government 

authorities in New York and other jurisdictions have prohibited or are considering 

256	 Rule 206(4)-5(a)(2)(i). See also Proposing Release, at section II.A.3(b). 

257	 Rule 206(4)-5(a)(2)(i). We note that, so long as non-affiliated persons providing legal, 

accounting, or other professional services in connection with specific investment 

advisory business are not being paid directly or indirectly by an investment adviser for 

communicating with a government entity (or its representatives) for the purpose of 

obtaining or retaining investment advisory business for the adviser—i.e., they are paid 

solely for their provision of legal, accounting, or other professional services with respect 

to the business—they would not become subject to the ban on payments by advisers to 

third-party solicitors. This approach is similar to the MSRB’s with regard to MSRB rule 

G-38’s third-party solicitor ban. See MSRB, Interpretive Notice on the Definition of 

Solicitation under Rules G-37 and G-38 (June 8, 2006), available at 

http://msrb.org/msrb1/rules/notg38.htm. 

258	 This exception, which is responsive to commenters’ concerns, is a modification of our 

proposal. As discussed below, we also eliminated an exception in our proposal that 

would have applied to “related persons” of the adviser and, if such “related person” were 

a company, an employee of the “related person.” See Proposing Release, at section 

II.A.3(b). 

259	 See Proposing Release, at section II.A.3(b). 

260	 Id. at sections I and II.A.3(b). 

261	 Id. at section II.A.3(b). 
 

 

 

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limiting or prohibiting the use of consultants, solicitors, or placement agents by 

investment advisers to solicit government business.262 We considered the MSRB’s 

experience with solicitors, which ultimately led it to ban municipal securities dealers 

from hiring consultants to solicit government clients after concluding that less restrictive 

approaches were ineffective to prevent circumvention of MSRB rule G-37.263 We 

recalled comment letters we received in 1999 from advisers asserting that they should not 

262	 Id. Since our proposal, a few state and local governments have undertaken actions to 

prohibit or regulate pay to play practices involving placement agents in response to 

concerns about to pay to play activities in their jurisdictions. For example, New York 

City Comptroller John C. Liu announced reforms relating to how the New York City 

pension funds make investments (including prohibitions on gifts and campaign 

contributions, strict rules on employees of the Office of New York City Comptroller, 

employees and trustees of the New York City pension systems, fund managers, and 

placement agents, and an expansion of the ban on private equity placement agents to 

include placement agents to other types of funds while providing an exclusion for 

legitimate placement agents who provide value-added services). See Office of the New 

York City Comptroller, Comptroller Liu Announces Major Reforms to Pension Fund 

Investments, Press Release, Feb. 18, 2010, available at 

http://www.comptroller.nyc.gov/press/2010_releases/pr10-02-022.shtm. A bill was 

introduced in California that would treat placement agents soliciting government entity 

clients as lobbyists and therefore restrict them from charging contingency fees. See 

Assem. B. 1743, 2009-10 Leg., Reg. Sess. (Cal. 2010), available at 

http://info.sen.ca.gov/pub/09-10/bill/asm/ab_1701­

1750/ab_1743_bill_20100208_introduced.html. See also Cal. Gov’t. Code §86205(f) 

(Deering 2010). Another law was passed in California on an emergency basis imposing 

new disclosure obligations and prohibitions regarding placement agents. See Assem. B. 

1854, 2009-10 Leg., Reg. Sess. (Cal. 2010) available at http://info.sen.ca.gov/pub/09­

10/statute/ch_0301-0350/ch_301_st_2009_ab_1584. See also CalPERS, CalPERS 

Releases Placement Agent Disclosures, Press Release, Jan. 14, 2010, available at 

http://www.calpers.ca.gov/index.jsp?bc=/about/press/pr-2010/jan/agent-disclosures.xml. 

(discussing recent actions by CalPERS to make public more than 600 placement agent 

disclosures from the fund’s external managers). 

263	 See Proposing Release, at n.130 and accompanying text. See also MSRB Letter (“Due to 

concerns regarding questionable practices by some consultants and a determination by 

the MSRB that it would be in the public interest to make the process of soliciting 

municipal securities business fully subject to the MSRB rules of fair practice and 

professionalism, the MSRB rescinded its original rule in 2005 and adopted new Rule G38, on solicitation of municipal securities business, to prohibit dealers from using paid 

third-party consultants to obtain municipal securities business on their behalf.”). 
 

 

 

 

 

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be held accountable for the political contributions of their third-party solicitors whom, 

they asserted, advisers lacked the ability to control.264 

The record before us raised deeply troubling concerns about advisers’ use of 

third-party solicitors to engage in pay to play activities.265 We were concerned that a rule 

that failed to address the use of these solicitors would be ineffective were advisers simply 

to begin using solicitors and placement agents that have made political contributions or 

payments funded in part or in whole by the fees they receive from advisers.266 Therefore, 

we proposed to prohibit advisers from engaging third parties to solicit government clients 

on their behalf.267 In doing so, we requested comments on alternative approaches we 

264	 In 1999, the Commission proposed a similar rule, which also would have been codified as 

rule 206(4)-5 under the Advisers Act, had it been adopted. See Political Contributions by 

Certain Investment Advisers, Investment Advisers Act Release No. 1812 (Aug. 4, 1999) 

[64 FR 43556 (Aug. 10, 1999)] (“1999 Proposing Release”). Comments on that proposal 

received electronically (comment file S7-19-99) are available at 

http://www.sec.gov/rules/proposed/s71999.shtml. Among the commenters on the 1999 

Proposing Release who argued that advisers should not be held accountable for the 

political contributions of their third-party solicitors are: Comment Letter of Davis Polk 

(Nov. 1, 1999); Comment Letter of Legg Mason (Nov. 1, 1999); Comment Letter of 

MSDW (Nov. 1, 1999). At least one commenter on our 2009 proposal, although 

opposing the proposed third-party solicitor ban, took the same view. See MFA Letter 

(“We strongly agree with the SEC’s comment in the Release that “covered associates” 

should not include employees of entities unaffiliated with an investment adviser, such as 

the employees of a third-party placement agent. An investment adviser would not have 

the authority or capability to monitor and restrict political contributions made by 

individuals not employed by the adviser.”). 

265	 See Proposing Release, at section I; section I of this Release. Moreover, “no smoking 

gun is needed where, as here, the conflict of interest is apparent, the likelihood of stealth 

great, and the legislative purpose prophylactic.” Blount, 61 F.3d at 945. 

266	 See Proposing Release, at section II.A.3(b). Some commenters have supported this 

approach. See, e.g., Fund Democracy/Consumer Federation Letter (“Permitting advisers 

to circumvent pay-to-play restrictions by hiring solicitors would eviscerate the heart of 

the direct prohibition against advisers’ bribing politicians in return for money 

management contracts.”). We also noted commenters’ concerns regarding the difficulties 

advisers face in monitoring the activities of their third-party solicitors. See Proposing 

Release, at section II.A.3(b). 

267	 See Proposing Release, at section II.A.3(b). 
 

 

 

 

 

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could take.268 We wanted to know whether there might be a more effective means to 

accomplish our objectives, or means that would be less restrictive. 

We received a large number of comments on this question. We received letters 

from the New York State Comptroller and New York City Comptroller that expressed 

strong support for the ban on using third parties to solicit government plans.269 One 

commenter supporting the ban pointed out the key role that placement agents have played 

in pay to play practices.270 It expressed concern that adopting the rule without the ban 

would exacerbate the problem by placing more pressure on advisers to pay “wellconnected” placement agents for access since the advisers will be limited in their 

contributions.271 Another commenter expressed the view that “the most egregious 

violations of the public trust in this area have come from placement agents and those 

seeking finder’s fees. The outright ban on their use to deter pay-to-play schemes is 

entirely appropriate.”272 

Most commenters, including many representing advisers, broker-dealers, 

placement agents and solicitors, and some government officials, however, strongly 

opposed the ban. Many asserted that solicitors, consultants and placement agents provide 

valuable services both for advisers seeking clients and for the public pension plans that 

268	 See id. 

269	 DiNapoli Letter; Thompson Letter (as indicated in note 262 above, NYC Comptroller Liu 

recently announced his office’s approach to third-party solicitors). 

270	 Fund Democracy/Consumer Federation Letter. 

271	 Id. 

272	 Common Cause Letter. See also Cornell Law Letter (generally supporting the 

prohibition on using third-party solicitors “given that third-party solicitors have played a 

central role in each of the enforcement actions against investment advisors that the 

Commission has brought in the past several years involving pay-to-play schemes.”). 
 

 

 

 

 

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employ them and that banning their use would have several deleterious effects.273 

Several claimed that the rule would favor banks because banks are excluded from the 

definition of “investment adviser” under the Advisers Act and therefore are not subject to 

the Commission’s rules, including rule 206(4)-5.274 Others claimed the rule would favor 

larger investment advisers (which have internal marketing departments) over smaller 

firms.275 Other commenters asserted the ban would harm smaller pension funds that do 

273	 See, e.g., Comment Letter of Senator Christopher J. Dodd (Feb. 2, 2010) (“Dodd Letter”); 

NY City Bar Letter; Dechert Letter; ABA Letter; Comment Letter of Teacher Retirement 

System of Texas (Oct. 12, 2009); Comment Letter of Bryant Law (Oct. 9, 2009) (“Bryant 

Law Letter”); Comment Letter of Probitas Partners (Oct. 6, 2009) (“Probitas Letter”); 

Comment Letter of Larry Simon (Oct. 6, 2009) (“Simon Letter”); Comment Letter of 

MarketCounsel, LLC (Oct. 6, 2009); ICI Letter; Comment Letter of Colorado Public 

Employees’ Retirement Association (Oct. 6, 2009); Skadden Letter. 

274	 See Advisers Act section 202(a)(11)(A) [15 U.S.C. 80b-2(a)(11)(A)] (excepting from the 

definition of “investment adviser,” and therefore from regulation under the Advisers Act, 

“a bank, or any bank holding company as defined in the Bank Holding Company Act of 

1956, which is not an investment company . . . .”). We discuss possible competitive 

effects of our rule’s inapplicability to banks in section VI of this Release. We believe 

that the concerns the rule is designed to address, as discussed throughout this Release, 

warrant its adoption, notwithstanding these potential competitive effects. 

275	 See, e.g., SIFMA Letter; IAA Letter; MFA Letter; Comment Letter of National 

Conference on Public Employee Retirement Systems (Oct. 6, 2009) (“NCPERS Letter”); 

Comment Letter of European Private Equity & Venture Capital Association (Sept. 9, 

2009) (“EVCA Letter”); Seward & Kissel Letter; Comment Letter of Sadis & Goldberg 

LLP (Oct. 2, 2009) (“Sadis & Goldberg Letter”); Comment Letter of State of Wisconsin 

Investment Board (Aug. 31, 2009) (“WI Board Letter”); Comment Letter of the 

Executive Director of Georgia Firefighters’ Pension Fund, James R. Meynard, (Sept. 3, 

2009) (“GA Firefighters Letter”); Comment Letter of Minnesota State Board of 

Investment (Sept. 8, 2009) (“MN Board Letter”); Comment Letter of Illinois Public 

Pension Fund Association (Sept. 29, 2009) (“IL Fund Association Letter”); Comment 

Letter of Melvyn Aaronson, Sandra March and Mona Romain, Trustees of the Teachers’ 

Retirement System of the City of New York (Oct. 1, 2009) (“NYC Teachers Letter”); 

Comment Letter of the Texas Association of Public Employee Retirement Systems (Oct. 

6, 2009) (“TX Public Retirement Letter”); Comment Letter of the Pennsylvania Public 

School Employees’ Retirement Board (Oct. 6, 2009) (“PA Public School Retirement 

Letter”); Comment Letter of the California State Association of County Retirement 

Systems (Sept. 8, 2009) (“CA Assoc. of County Retirement Letter”); Caplin & Drysdale 

Letter; Comment Letter of Paul Ehrmann (Aug. 10, 2009) (“Ehrmann Letter”); Comment 

Letter of Joseph Finn (Aug. 10, 2009) (“Finn Letter”); Comment Letter of the Managing 

Partner of The Savanna Real Estate Fund I, LLP, Nicholas Bienstock (Aug. 11, 2009) 

(“Savanna Letter”); Comment Letter of Atlantic-Pacific Capital, Inc. (Aug. 12, 2009) 

(“Atlantic-Pacific Letter”); Comment Letter of Tricia Peterson (Aug. 14, 2009) 
 

 

 

 

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not have the resources to conduct a search for advisers on their own, and harm advisers 

that rely on the services that placement agents provide.276 A number of commenters 

argued that the prohibition would reduce competition by reducing the number of advisers 

competing for government business,277 and limit the universe of investment opportunities 

presented to public pension funds.278 

Many of these commenters conceded that there is a problem with placement 

agents and other intermediaries, but asserted it is caused by a few bad actors, for which 

an entire industry should not be penalized.279 A common theme among many 

(“Peterson Letter”); Comment Letter of Devon Self Storage Holdings (US) LLC (Aug. 

21, 2009) (“Devon Letter”); Comment Letter of Thomas Capital Group, Inc. (Aug. 24, 

2009) (“Thomas Letter”); Comment Letter of Stephen R. Myers (Aug. 26, 2009) (“Myers 

Letter”); Comment Letter of Chaldon Associates LLC (Aug. 26, 2009) (“Chaldon 

Letter”); Comment Letter of The Meridian Group (Aug. 26, 2009) (“Meridian Letter”); 

Comment Letter of Benedetto, Gartland & Company, Inc. (Sept. 30, 2009) (“Benedetto 

Letter”); Comment Letter of the Partners of CSP Securities, LP and Capstone Partners, 

LP (Sept. 17, 2009) (“Capstone Letter”); Comment Letter of Presidio Partners LLC 

Managing Partner Alan R. Braxton (Sept. 21, 2009) (“Braxton Letter”); Comment Letter 

of Littlejohn & Co., LLC (Sept. 14, 2009) (“Littlejohn Letter”); Comment Letter of Alta 

Communications (Sept. 18, 2009) (“Alta Letter”); Comment Letter of Charles River 

Realty Investors LLC (Sept. 23, 2009) (“Charles River Letter”); Comment Letter of W. 

Allen Reed (Sept. 19, 2009) (“Reed Letter”); Comment Letter of Glovista Investments 

LLC (Sept. 23, 2009) (“Glovista Letter”); Comment Letter of The Blackstone Group 

(Sept. 14, 2009) (“Blackstone Letter”); Park Hill Letter. Two commenters noted that the 

ban would result in less transparency as these services go “in-house.” CalPERS Letter; 

Bryant Law Letter. Others commented on the effects on minority and women-owned 

firms. See, e.g., NYC Teachers Letter, Myers Letter; GA Firefighters Letter; MN Board 

Letter; Blackstone Letter. 

276	 See, e.g., Dodd Letter; NY City Bar Letter; Dechert Letter; ABA Letter; Probitas Letter; 

Seward & Kissel Letter; MFA Letter. 

277	 See, e.g., Seward & Kissel Letter; Meridian Letter; NY City Bar Letter; Probitas Letter; 

Simon Letter; MFA Letter. 

278	 See, e.g., SIFMA Letter; IAA Letter; Strategic Capital Letter; Alta Letter; Benedetto 

Letter; Comment Letter of Jim Glantz (Sept. 24, 2009) (“Glantz Letter”); Comment 

Letter of Venera Kurmanaliyeva (Sept. 15, 2009) (“Kurmanaliyeva Letter”); Park Hill 

Letter. 

279	 See, e.g., Comment Letters of Brady Pyeatt (Aug. 4, 2009) & (Oct. 6, 2009); Comment 

Letter of Andrew Wang (Aug. 10, 2009); Comment Letter of Monomoy Capital 

Management, LLC (Aug. 25, 2009) (“Monomoy Letter”); Comment Letter of Ted Carroll 
 

 

 

 

 

 

 

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commenters was that the rule failed to distinguish “illegitimate” consultants and 

placement agents from the “legitimate” ones who provide an important service.280 

We believe that many of the comments overstate the likely consequences of 

adoption of the rule. First, the rule will not prevent public pension plans from hiring their 

own consultants—i.e., using their own resources—to assist them in their search for an 

investment adviser.281 These consultants would have access to information about smaller 

advisers whose services may be appropriate for the plan. Many public pension plans 

already make—or are required to make—specific accommodations for so-called 

“emerging money managers” that otherwise may have difficulty getting noticed by public 

pension plans.282 Second, these commenters failed to consider the potentially significant 

(Aug. 4, 2009); Comment Letter of James C. George (Sept. 10, 2009) (“George Letter”); 

Comment Letter of Ariane Capital Partners LLC (Sept. 17, 2009); Blackstone Letter; 

Comment Letter of Nancy Fossland (Sept. 16, 2009); Comment Letter of Steven A. 

Friedmann (Sept. 14, 2009); Comment Letter of Keith P. Harney (Sept. 15, 2009); 

Comment Letter of Robert F. Muhlhauser III (Sept. 14, 2009); Comment Letter of XT 

Capital Partners, LLC (Sept. 30, 2009); CapLink Letter. 

280	 See, e.g., Bryant Law Letter; Comment Letter of Hedgeforce (Oct. 6, 2009) (“Hedgeforce 

Letter”). 

281	 See Fund Democracy/Consumer Federation Letter (“The proposed ban would “deny 

access” to nothing. There is nothing [in the proposed rule] preventing pension funds from 

retaining their own consultants whose sole responsibility is to the pension fund and its 

beneficiaries.”). 

282	 See, e.g., Randy Diamond, CalPERS CIO Joe Dear says Emerging Managers Don’t Need 

Placement Agents, PENSIONS & INVESTMENTS, Feb. 24, 2010, available at 

http://www.pionline.com/article/20100224/REG/100229965; Michael Marois, CalPERS, 

Blackstone Clash over Placement Agent ‘Jackpot’ Fees, BLOOMBERG (Apr. 7, 2010), 

available at 

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=acPNrTn1q7pw (quoting 

CalPERS CIO Joe Dear, “There’s clear evidence in past practice that it’s possible to 

develop an investment relationship with us by making a normal approach, without the 

assistance of a contingent-paid placement agent.”); Ohio Pub. Employees Ret. Sys., 

Ohio-Qualified and Minority Manager Policy (May 2006), available at 

https://www.opers.org/pdf/investments/policies/Ohio-Qualified-Minority-ManagerPolicy.pdf; Teachers’ Ret. Sys. of the State of Ill., Fiscal Year 2009 Annual Report on the 

use of Women, Minority and Disabled-Owned (W/MBE) Investment Advisors and 

Broker/Dealers (Aug. 31, 2009), available at 
 

 

 

 

 

 

--78--

costs of hiring consultants and placement agents,283 which already may make them 

unavailable to smaller advisers. Eliminating the cost of pay to play may, in fact, provide 

greater access to pension plans by those advisers which are unable to afford the costs of 

direct or indirect political contributions or placement agent fees.284 We expect that 

prohibiting pay to play may reduce the costs to plans and their beneficiaries of inferior 

asset management services arising from adviser selection based on political contributions 

rather than investment considerations.285 Finally, commenters failed to identify any 

http://trs.illinois.gov/subsections/investments/minorityrpt.pdf; Md. State Ret. and Pension 

Sys., Terra Maria: The Maryland Developing Manager Program, available at 

http://www.sra.state.md.us/Agency/Investment/Downloads/TerraMariaDevelopingManag 

erProgram-Description.pdf; Thurman V. White, Jr., Progress Inv. Mgmt. Co., Successful 

Emerging Manager Strategies for the 21st Century, 3 (2008), available at 

http://www.progressinvestment.com/content/files/successful_emerging_manager_strategi 

es.pdf (containing a “representative list of known U.S. Pension Plans that have 

committed assets to emerging manager strategies”). 

283	 One commenter made a similar point: “The proposed ban would simply replace the 

indirect cost of placement agents incurred by pension plan sponsors with the direct cost 

of hiring their own placement agents—without the conflict of interest and potential for 

abuse that relying on advisers’ placement agents creates. It is not the cost of independent 

advice that the Commission has not accounted for in its proposal, but the cost of conflicts 

that critics have failed to acknowledge in their analysis.” Fund Democracy/Consumer 

Federation Letter. 

284	 At least one commenter agreed. See Butler Letter (“[W]e find some evidence that the pay 

to play practices by underwriters [before rule G-37 was adopted] distorted not only the 

fees, but which firms were allocated business. The current proposal mentions that pay to 

play practices may create an uneven playing field among investment advisers by hurting 

smaller advisers that cannot afford to make political contributions. We find evidence that 

is consistent with this view [in our research on pay to play by municipal underwriters]. 

During the pay to play era, municipal bonds were underwritten by investment banks with 

larger underwriting market shares compared to afterward. One interpretation of this result 

is that smaller underwriters were passed over in favor of larger underwriters (who 

presumably had deeper pockets for political contributions).”). As we indicated in the 

Proposing Release, pay to play practices may hurt smaller advisers that cannot afford the 

required contributions. Curtailing pay to play arrangements enables advisory firms, 

particularly smaller advisory firms, to compete on merit, rather than their ability or 

willingness to make contributions. See Proposing Release, at sections I and IV. 

285	 See Tobe Letter (describing an under-performing money manager that was fired after the 

commenter, a pension official, began to inquire into how it was selected); Weber Letter 

(“I have seen money managers awarded contracts with our fund which involved 

payments to individuals who served as middlemen, creating needless expense for the 
 

 

 

 

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meaningful way in which our rule might distinguish “legitimate” from “illegitimate” 

solicitors or placement agents. Even solicitors and placement agents that engage in pay 

to play may appear to operate “legitimately.”286 

Some commenters suggested alternatives to our proposed ban to address our 

concern that pay to play activities are often carried out through or with the assistance of 

third parties.287 Several commenters, for example, suggested that we instead require 

greater disclosure by advisers of payments to solicitors.288 Such an approach could be 

fund. These middlemen were political contributors to the campaigns of board members 

who voted to contract for money management services with the companies who paid 

them as middlemen.”). 

286	 See Blount, 61 F.3d at 944 (“actors in this field are presumably shrewd enough to 

structure their relations rather indirectly”). 

287	 We note that, in addition to the alternatives discussed below, some commenters called for 

approaches outside the scope of our authority, such as an outright ban on all political 

contributions by third-party solicitors, the imposition of criminal penalties, or 

modification of the structure of pension boards. See, e.g., Monomoy Letter (arguing that 

the Commission or the appropriate criminal authority should mandate jail time for public 

officials and intermediaries where the official gets a benefit from a public fund 

investment in a particular fund, that all managers of intermediaries who receive fees in 

such transactions should be banned from the financial services industry for life, and that 

all members of the general partner (manager) of the fund in which the investment is made 

be banned from the financial services industry for life); NCPERS Letter (arguing that the 

most effective method of eliminating pay to play is by having multiple trustees on public 

pension boards); Thomas Letter (suggesting that stronger internal control procedures, 

segregation of duties and dispersed or committee approval of granting pension business 

could help prevent pay to play activities, each of which historically has involved a 

complicit senior public plan fund official); Comment Letter of the Massachusetts Pension 

Reserves Investment Management Board (Aug. 26, 2009) (“PRIM Board Letter”); Preqin 

Letter I (acknowledging that it is outside the remit of the Commission, but arguing that 

there should be better oversight of public pension funds, and investment committees 

should consist of a minimum number of members in order to prevent a sole official being 

responsible for the investment-decision process); Triton Pacific Letter (arguing that the 

Commission should adopt regulation of pension officials who are often responsible for 

initiating pay to play arrangements). 

288	 Several commenters urged us to require advisers to disclose to clients their payments to 

third-party solicitors and placement agents. See, e.g., ABA Letter; 3PM Letter; ICI 

Letter; NY City Bar Letter; Comment Letter of Forum Capital Securities, LLC (Oct. 5, 

2009) (“Forum Letter”); Jones Day Letter; CapLink Letter. Some asserted that existing 

disclosure requirements, such as those included in the Commission’s investment adviser 

cash solicitation rule, are sufficient to address pay to play. See, e.g., Comment Letter of 
 

 

 

 

 

 

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helpful to give plan fiduciaries information necessary for them to satisfy their legal 

obligations and uncover abuses,289 but it would not be useful when plan fiduciaries 

themselves are participants in the pay to play activities.290 In addition, as one commenter 

pointed out, the MSRB had already sought unsuccessfully to address the problem of 

placement agents and consultants engaging in pay to play activities on their principals’ 

behalf through mandating greater disclosure.291 

Steven Rubenstein (Aug. 17, 2009) (“Rubenstein Letter”) (noting that Advisers Act rule 

206(4)-3 [17 CFR 275.206(4)-3], the “cash solicitation rule,” is adequate as is, but “just 

needs to be followed”); Thomas Letter (supporting “enforcement of existing disclosure 

rules”); Chaldon Letter (arguing that, in the scandals that have recently occurred, if the 

fee sharing arrangements had been disclosed to pension fund boards, no law or regulation 

would have been violated, and that third-party marketers should adhere to current law 

instead of banning a legitimate business practice); Comment Letter of Ray Wirta (Sept. 4, 

2009) (arguing that all that is necessary is that penalties should be heightened, 

enforcement stepped up and results highly publicized); Arrow Letter (arguing that 

enforcement of the Advisers Act and FINRA requirements have ensured lawful and 

ethical business practices for decades); 3PM Letter (arguing that the rule’s scope could be 

extended to include various additional disclosures). But we do not believe, for the 

reasons described above, that enforcement of existing obligations alone is sufficient to 

deter pay to play activities. 

289	 Some public pension plans have adopted policies requiring advisers they hire to disclose 

information about placement agents, including their political connections. See, e.g., Cal. 

Pub. Employees Ret. Sys., CalPERS Adopts Placement Agent Policy – Requires 

Disclosure of Agents, Fees, Press Release (May 11, 2009), available at 

http://www.calpers.ca.gov/index.jsp?bc=/about/press/pr-2009/may/adopts-placementagent-policy.xml. 

290	 For examples of cases in which plan fiduciaries themselves have allegedly participated in 

pay to play activities involving placement agents, see New York v. Henry “Hank” Morris 

and David Loglisci, Indictment No. 25/2009 (NY Mar. 19, 2009) (a public official was 

alleged to be a beneficiary of the pay to play activities); SEC v. Paul J. Silvester, et al., 

Litigation Release No. 16759, Civil Action No. 3:00-CV-19411 DJS (D. Conn. 2000) 

(former Connecticut State Treasurer was alleged to be a beneficiary of a pay to play 

scheme in which an investment adviser to a private equity fund had paid third-party 

solicitors to obtain public pension fund investments in the fund). See also Proposing 

Release, at n.49 (discussing additional reasons why we believe a disclosure approach 

would not effectively address our concerns regarding pay to play activities). 

291	 Cornell Law Letter (“For example, after concluding that required disclosure was neither 

adequate to prevent circumvention nor consistently being made, the [MSRB] amended its 

own rules on pay-to-play practices in the municipal securities markets to impose a 

complete ban on the use of third-party consultants to solicit government clients.” 

(citations omitted)). See also 3PM Letter (acknowledging that, although increased 
 

 

 

 

 

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Other commenters recommended that we rely on voluntary industry codes of 

conduct.292 But we believe, in light of the growing body of evidence of advisers’ use of 

third-party solicitors to engage in pay to play activities we describe above, that voluntary 

actions are insufficient to deter pay to play, which may yield lucrative management 

contracts.293 As we discuss above, pay to play involves a “collective action” problem 

that is unlikely to be resolved by voluntary actions.294 Elected officials who accept 

contributions from state contractors may believe they have an advantage over their 

opponents who foreswear the contributions, and firms that do not “pay” may fear that 

they will lose government business to those that do.295 

transparency by all parties involved in the investment process who might have the ability 

to exert influence, including advisers, third-party marketers, public officials or other 

trustees, etc., is necessary to minimize the adverse effects of pay to play, the issue will 

not be completely solved by disclosure). 

292	 See, e.g., MVision Letter (arguing that self-regulatory initiatives such as the EVCA’s 

Code of Conduct for Placement Agents are working and that many public pension plans’ 

own anti-pay to play policies have been successful); EVCA Letter (describing its Code of 

Conduct that prohibits pay to play and is supported by various stakeholders and arguing 

that it, along with strong punishment of wrongdoers, should restore confidence in the 

process). Another commenter suggested a code of conduct enforceable by regulators. 

Comment Letter of Charlie Eaton on behalf of a Coalition of Professional Institutional 

Placement Agents (Sept. 9, 2009) (proposing an industry Code of Conduct that could be 

enforced by FINRA and the Commission, which should ban firms that do not adhere 

from doing business with all potential investors, public and private). In our view, the rule 

we are adopting today not only essentially serves this purpose, but more appropriately 

reflects prohibitions we, instead of others, have determined appropriately address our 

concerns. 

293	 See Proposing Release, at sections I and II.A.3(b). See also section I of this Release. 

294	 See supra note 58 and accompanying text. 

295	 See Blount, 61 F.3d at 945-46 (describing the parallel dynamics applicable in municipal 

underwriting, “As beneficiaries of the practice, politicians vying for state or local office 

may be reluctant to stop it legislatively; some, of course, may seek to exploit their rivals’ 

cozy relation with bond dealers as a campaign issue, but if they refuse to enter into 

similar relations, their campaigns will be financially handicapped. Bond dealers are in a 

still worse position to initiate reform: individual firms that decline to pay will have less 

chance to play, and may even be the object of explicit boycott if they do.”). 
 

 

 

--82--

Other commenters recommended that we amend our rules to require that advisers 

amend their codes of ethics to monitor contributions by third-party solicitors.296 But 

advisers using third-party solicitors to circumvent pay to play restrictions are well aware 

of these payments, and are unlikely to be deterred by a monitoring requirement. In 

addition, adviser codes of ethics are unlikely to be a sufficient means to induce thirdparty solicitors to be transparent about their own pay to play activities. 

Instead of suggesting alternative approaches, other commenters urged us to apply 

the rule more narrowly by exempting from the ban solicitors that are registered brokerdealers or associated persons of broker-dealers.297 Some were concerned that the rule 

would interfere with traditional distribution arrangements of mutual funds and private 

funds, which are usually distributed by registered broker-dealers that may be 

compensated by the adviser in some form.298 Many argued that registration as a brokerdealer generally differentiates placement agents that provide “legitimate” services from 

296	 See, e.g., ABA Letter; 3PM Letter; ICI Letter; NY City Bar Letter; Forum Letter; Jones 

Day Letter. 

297	 See, e.g., Davis Polk Letter; Comment Letter of UBS Securities LLC (Oct. 2, 2009) 

(“UBS Letter”). 

298	 See, e.g., SIFMA Letter; NY City Bar Letter; Monomoy Letter; IAA Letter. Mutual fund 

distribution fees are typically paid by the fund pursuant to a 12b-1 plan, and therefore 

generally would not constitute payment by the fund’s adviser. As a result, such payments 

would not be prohibited by rule 206(4)-5 by its terms. Where an adviser pays for the 

fund’s distribution out of its “legitimate profits,” however, the rule would generally be 

implicated. For a discussion of a mutual fund adviser’s ability to use “legitimate profits” 

for fund distribution, see Bearing of Distribution Expenses by Mutual Funds, Investment 

Company Act Release No. 11414 (Oct. 28, 1980) [45 FR 73898 (Nov. 7, 1980)] 

(explaining, in the context of the prohibition on the indirect use of fund assets for 

distribution, unless pursuant to a 12b-1 plan, “[h]owever, under the rule there is no 

indirect use of fund assets if an adviser makes distribution related payments out of its 

own resources . . . . Profits which are legitimate or not excessive are simply those which 

are derived from an advisory contract which does not result in a breach of fiduciary duty 

under section 36 of the [Investment Company] Act.”). For private funds, third parties are 

often compensated by the adviser or its affiliated general partner and, therefore, those 

payments are subject to the rule. Structuring such a payment to come from the private 

fund for the purpose of evading the rule would violate the rule. See Rule 206(4)-5(d). 
 

 

 

 

 

 

 

 

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those that merely offer political influence.299 Others expressed concern that some brokerdealer firms that rely on placement agent business could be harmed.300 We recognize that 

services that commenters have identified as beneficial would typically require brokerdealer registration. But registration under the Exchange Act does not preclude a brokerdealer from participating in pay to play practices—MSRB rules G-37 and G-38 do not 

apply, for example, to broker-dealers soliciting investments on behalf of investment 

companies or private funds.301 Thus, amending our rule to limit third parties soliciting 

governments to broker-dealers registered under the Exchange Act would not achieve the 

prophylactic purpose of this rulemaking. We believe that our approach is appropriate in 

light of the concerns we are seeking to address.302 

Several commenters proposed that we achieve our goals by permitting advisers to 

engage solicitors and placement agents that are registered broker-dealers and subject to 

rules similar to those adopted by the MSRB.303 One asserted that such rules would be “a 

299	 See, e.g., Bryant Law Letter; Hedgeforce Letter; Comment Letter of Girard Miller (Aug. 

8, 2009); Comment Letter of Frank Schmitz (Aug. 11, 2009) (“Schmitz Letter”); 

Atlantic-Pacific Letter; Rubenstein Letter; Thomas Letter; Monomoy Letter; MVision 

Letter; Comment Letter of Lime Rock Management (Sept. 28, 2009); Benedetto Letter; 

Strategic Capital Letter; Comment Letter of Portfolio Advisors, LLC (Oct. 2, 2009) 

(“Portfolio Advisors Letter”); UBS Letter; Comment Letter of Brian Fitzgibbon (Oct. 5, 

2009); Comment Letter of GenNx360 Capital Partners, L.P. (Oct. 5, 2009). 

300	 Comment Letter of the National Association of Independent Broker-Dealers (Oct. 5, 

2009). 

301	 At least one commenter suggested that there are “inherent” safeguards in the brokerdealer regulatory regime sufficient to protect against pay to play practices. See, e.g., 

ABA Letter. But the broker-dealer regulatory regime does not specifically address pay to 

play activities, as demonstrated by the MSRB’s adoption of rules G-37 and G-38. 

302	 We acknowledge that there are costs associated with our rule. For further analysis of 

these, along with the benefits, see sections I and IV of this Release. 

303	 Skadden Letter (“The Commission and FINRA could directly impose and enforce 

restrictions on such broker-dealers.”); Davis Polk Letter (“Registered broker-dealers that 

provide legitimate placement agent services could be required by the Commission to 

comply with “pay-to-play” restrictions”); Credit Suisse Letter (preclude an investment 
 

 

 

 

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logical extension of the already-existing regulatory scheme governing broker-dealers.”304 

Another agreed, arguing that such rules would be consistent with the approach the MSRB 

took when it adopted MSRB rule G-38, the effect of which was to sweep “all solicitors of 

municipal business (underwriting, sales and advisory) into the broker-dealer registration 

regime” where they would be subject to oversight of a registered broker-dealer and are 

required to conform their municipal securities activities to applicable MSRB rules, 

including MSRB rule G-37.305 Others suggested we could similarly achieve our goals by 

adviser from using a placement agent that is not subject to pay to play restrictions 

analogous to rule G-37); Comment Letter of the President of M Advisory Group J. Daniel 

Vogelzang (Sept. 18, 2009) (“M Advisory Letter”) (treat “[a]ll placement agents, 

investment advisers and consultants . . . exactly the same regarding prohibited political 

contributions; i.e., a two-year ban on doing business with any governmental agency to 

which a prohibited political contribution is made.”). See also Comment Letter of Hudson 

Capital Management (NY), L.P. (Oct. 5, 2009) (suggesting Commission take measures to 

properly license and regulate third-party solicitors); SIFMA Letter (“The pay-to-play and 

political activity of registered placement agents involved in soliciting government 

investment could . . . be directly regulated under the Exchange Act.”). We believe our 

rule, as adopted, which allows advisers to pay certain regulated third parties to solicit 

government clients on their behalf, addresses these concerns. See infra notes 312-26 and 

accompanying text. 

304	 Davis Polk Letter. 

305	 SIFMA Letter (“Although Rule G-38(a) specifically prohibits a municipal dealer from 

paying a fee to a nonaffiliated person for solicitation of municipal securities business, the 

policies underlying Rule G-38 were to bring solicitors within the purview of the federal 

securities laws — not to exclude the involvement of registered broker-dealers, including 

those registered broker-dealers not affiliated with advisers and private funds.”). See also 

Monument Group Letter (“We believe that MSRB Rule G-38 is not analogous to the 

proposed rule. Rule G-38 permits a broker-dealer that is unaffiliated with an issuer to 

market that issuer’s securities to a public pension plan or any other investor. Proposed 

Rule 206(4)-5(a)(2)(i) prevents this and seeks to entirely disintermediate the process 

between the issuer of a security and the ultimate investor.”); Credit Suisse Letter (“[W]e 

strongly believe that a more complete analogy to the MSRB Pay-to-Play Rules would not 

preclude regulated broker-dealers from performing placement agent services in the 

context of municipal investors, as the Proposed Rule would do. Notably, the MSRB Payto-Play Rules do not preclude SEC-registered broker-dealers from acting as placement 

agents to municipal issuers. Instead, the MSRB Pay-to-Play Rules subject such placement 

agents to “pay-to-play” restrictions and requirements and preclude them from retaining 

unregulated third-party finders and solicitors.”). 
 

 

 

 

 

 

--85--

permitting advisers to engage as solicitors registered investment advisers that are 

themselves subject to pay to play restrictions under an Advisers Act rule.306 

We are persuaded by these comments and have decided to revise the proposed 

rule to permit advisers to make payments to certain “regulated persons” to solicit 

government clients on their behalf.307 As described in more detail below, “regulated 

persons” include certain broker-dealers and registered investment advisers that are 

themselves subject to prohibitions against participating in pay to play practices and are 

subject to our oversight and, in the case of broker-dealers, the oversight of a registered 

national securities association, such as FINRA.308 As one commenter observed, “the 

Commission would have the direct authority to determine these restrictions as well as the 

oversight, control and enforcement of penalties over any violations. The restrictions 

could be tailored to operate with the same underlying purpose and effect on [solicitors] as 

the “pay-to-play” restrictions imposed on investment advisers.”309 We believe that the 

application of such rules would provide an effective deterrent to these solicitors or 

placement agents from participating in pay to play arrangements because political 

contributions or payments would subject solicitors to similar consequences, as discussed 

306	 See, e.g., IAA Letter. 

307	 See Rule 206(4)-5(a)(2)(i). 

308	 Rule 206(4)-5(f)(9). See supra note 85 (noting that, in this Release, we will refer directly 

to FINRA, currently the only registered national securities association). As noted below, 

under the definition of “regulated persons” as it applies to brokers, the Commission must 

find, by order, that a registered national securities association’s pay to play rule 

applicable to such brokers imposes substantially equivalent or more stringent restrictions 

on them than rule 206(4)-5 imposes on investment advisers and that such rule is 

consistent with the objectives of rule 206(4)-5. Rule 206(4)-5(f)(9)(ii)(B). 

309	 Davis Polk Letter. 
 

 

 

 

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below.310 Because rule 206(4)-5 prohibits an adviser from compensating a registered 

adviser solicitor for solicitation activities if that adviser solicitor does not meet the 

definition of “regulated person,” the adviser that hired the solicitor must immediately 

cease compensating a solicitor that no longer meets these conditions.311 

In light of our decision to permit advisers to make payments to certain “regulated 

persons,” described below, to solicit government clients on their behalf, we no longer 

believe that our proposed exception from the prohibition on advisers paying third-party 

solicitors for payments to related persons and employees of related person companies of 

the adviser is necessary.312 We had proposed the exception to enable advisers to 

compensate these persons for government entity solicitation activities because we 

recognized there may be efficiencies in allowing advisers to rely on these particular types 

310	 Another group of commenters argued that third-party solicitors should be treated as 

covered associates—that is, their contributions should trigger the two-year ban for 

advisers that hire them. See, e.g., ABA Letter; 3PM Letter; ICI Letter; NY City Bar 

Letter; Forum Letter; Jones Day Letter. In explaining our rejection of this approach in 

the Proposing Release, we noted that this approach—which we included our 1999 pay to 

play proposal—was criticized by commenters at that time. See Proposing Release, at 

section II.A.3(b). They primarily argued that it was unfair to impute the activities of third 

parties to advisers, especially given what they perceived as the harsh consequences 

caused by a triggering contribution—i.e., a two-year time out imposed on the adviser. 

See id. They further argued that an approach in which contributions by third-party 

solicitors triggered a two-year time out for an adviser would create over-burdensome 

compliance challenges because the adviser could not meaningfully control the 

contribution activities of such third parties. See id. We continue to be sympathetic to 

these concerns and believe that an approach in which a contribution by a third party 

triggered a two-year time out for the adviser that hires the third party as a solicitor could 

lead to unfair consequences. See, e.g., Capstone Letter; Monument Group Letter; Park 

Hill Letter. For example, if a solicitor gives a triggering contribution in order to assist 

one client, we are concerned about the harsh result that such a contribution could have on 

all of the solicitor’s other clients seeking business with the same prospective government 

entity client. 

311	 It would be a violation of the rule for an adviser to compensate a third party for 

solicitation of government entity clients at any time that third party did not meet the 

definition of “regulated person,” regardless of whether the “regulated person” failed to 

meet the definition at the time it was hired or subsequently. 

312	 See Proposing Release, at section II.A.3(b). 
 

 

 

 

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of persons to assist them in seeking clients. We requested comment regarding whether 

the exception would undermine the rule’s efficacy by allowing advisers to compensate 

certain employees of related person companies whose contributions would not have 

triggered the two-year time out. Although we did not receive comment specifically 

addressing our concern,313 we believe the approach we are adopting that allows advisers 

to pay “regulated persons” to solicit government entities on their behalf will still allow 

advisers to use employees of certain related companies—i.e., of those related companies 

that qualify as “regulated persons”—as solicitors.314 

(1) Registered Broker-Dealers 

Registered national securities association rules of similar scope and consequence 

as the rule we are today adopting could sufficiently satisfy the concerns that led us to 

propose to prohibit advisers from paying brokers to solicit potential government clients. 

Advisers could not easily use placement agents covered by such rules to circumvent rule 

206(4)-5. Under this approach, placement agents would be deterred from engaging in 

pay to play directly on account of the registered national securities association’s rules. 

313	 One commenter asked that we clarify the proposed exception for related parties 

(Sutherland Letter) and another recommended a case-by-case determination of whether 

independent contractors may be eligible for the exception, due to concern for life 

insurance agents who may not technically have qualified as “employees” for purposes of 

the exception (Skadden Letter). As noted, however, we have eliminated this exception in 

favor of allowing advisers to pay “regulated persons,” affiliated or not, to solicit 

government clients on their behalf. 

314	 We acknowledge that some advisers may have to bear certain additional costs of hiring 

outside parties as a result of our elimination of our proposal’s “related person” exception, 

which would have allowed advisers to compensate related persons that are not registered 

broker-dealers or advisers for solicitation activities. For a discussion of costs relating to 

the rule, see section IV of this Release. But, we also note that the rule, as adopted, does 

not favor an adviser with affiliates (which our proposal would have allowed an adviser to 

use to solicit on its behalf) over another adviser without affiliates. Instead, our rule, as 

adopted, allows an adviser to pay a “regulated person” affiliated or not, to solicit on its 

behalf. 
 

 

 

315 

--88--

There would be no need for the Commission to prove in an enforcement action that a 

contribution by a placement agent amounted to an indirect contribution by the investment 

adviser because the placement agent itself could be charged with violating the registered 

national securities association’s rules. Therefore, as adopted, rule 206(4)-5 allows an 

adviser to compensate “regulated persons,” which includes registered brokers subject to a 

registered national securities association’s rules, for soliciting government clients on its 

behalf.315 An adviser may engage a registered broker to solicit government clients on its 

behalf so long as the broker continues to meet the definition of “regulated person” 

throughout its engagement as a solicitor by the adviser. 

For a broker-dealer to be a “regulated person” under rule 206(4)-5, the brokerdealer must be registered with the Commission and be a member of a registered national 

securities association that has a rule: (i) that prohibits members from engaging in 

distribution or solicitation activities if certain political contributions have been made; and 

(ii) that the Commission finds both to impose substantially equivalent or more stringent 

restrictions on broker-dealers than rule 206(4)-5 imposes on investment advisers and to 

Rule 206(4)-5(a)(2)(i) (which prohibits advisers and their covered associates from 

providing or agreeing to provide, directly or indirectly, payment to any third party other 

than a regulated person to solicit a government entity for investment advisory services on 

behalf of such investment adviser). Rule 206(4)-5 defines a “regulated person” to include 

a “broker,” as defined in section 3(a)(4) of the Securities Exchange Act of 1934 [15 

U.S.C. 78c(a)(4)] or a “dealer,” as defined in section 3(a)(5) of that Act [15 U.S.C. 

78c(a)(5)], that is registered with the Commission, and is a member of a registered 

national securities association registered under section 15A of that Act [15 U.S.C. 78o-3], 

provided that (A) the rules of the association prohibit members from engaging in 

distribution or solicitation activities if certain political contributions have been made; and 

(B) the Commission finds that such rules impose substantially equivalent or more 

stringent restrictions on broker-dealers than [rule 206(4)-5] imposes on investment 

advisers and that such rules are consistent with the objectives of [rule 206(4)-5]. The 

rule’s definition of “regulated person” also includes certain investment advisers. See 

infra text accompanying note 323. 
 

 

 

 

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be consistent with the objectives of rule 206(4)-5.316 We have included the requirement 

that a broker-dealer, in order to qualify as a regulated person, be subject to a pay to play 

rule of a registered national securities association of which it is a member so that brokers 

seeking to act as placement agents for investment advisers are, in turn, adequately 

deterred from engaging in pay to play activities on behalf of those advisers by such a 

rule. 

FINRA has informed us that it is preparing rules for consideration that would 

prohibit its members from soliciting advisory business from a government entity on 

behalf of an adviser unless they comply with requirements prohibiting pay to play 

activities.317 FINRA has said its rule would impose regulatory requirements on member 

brokers318 “as rigorous and as expansive” as would be imposed on investment advisers by 

rule 206(4)-5, and that in developing its proposal it intends to “draw closely upon all the 

substantive and technical elements of the SEC’s proposal as well as our regulatory 

expertise in examining and enforcing the MSRB rules upon which the SEC’s proposal is 

316	 Rule 206(4)-5(f)(9)(ii). 

317	 See Letter from Richard G. Ketchum, Chairman & Chief Executive Officer, FINRA, to 

Andrew J. Donohue, Director, Division of Investment Management, U.S. Securities and 

Exchange Commission (Mar. 15, 2010), available at http://www.sec.gov/comments/s7­

18-09/s71809-252.pdf (“Ketchum Letter”) (“[w]e believe that a regulatory scheme 

targeting improper pay to play practices by broker-dealers acting on behalf of investment 

advisers is . . . a viable solution to a ban on certain private placement agents serving a 

legitimate function”). See also Letter from Andrew J. Donohue, Director, Division of 

Investment Management, U.S. Securities and Exchange Commission, to Richard G. 

Ketchum, Chairman & Chief Executive Officer, FINRA (Dec. 18, 2009), available at 

http://www.sec.gov/comments/s7-18-09/s71809-252.pdf. 

318	 As used in this Section, “broker” means a “broker” or “dealer,” as each term is defined in 

section 3(a) of the Securities Exchange Act of 1934 [15 U.S.C. 78c(a)]. 
 

 

 

 

 

 

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based.”319 The rules, including any recordkeeping requirements, would be enforced by 

FINRA, which has substantial experience enforcing MSRB rules G-37 and G-38.320 

For the Commission to adopt a rule prohibiting advisers from using placement 

agents until FINRA adopts a rule could impose substantial hardships on a significant 

number of advisers and solicitors that wrote to us. It could also disrupt pension funds’ 

investment opportunities. Therefore, as we discuss in more detail below, we are delaying 

application of the prohibition on compensating third-party solicitors for one year from the 

effective date of this rule, in part to give FINRA time to propose such a rule.321 

(2) Registered Investment Advisers 

We are also permitting advisers covered by the rule to pay solicitors for 

government clients that are registered investment advisers subject to similar 

limitations.322 Under the rule, a “regulated person” includes (in addition to a registered 

broker subject to the conditions described above), an investment adviser that is registered 

with the Commission under the Advisers Act, provided that the solicitor and its covered 

associates have not, within two years of soliciting a government entity: (i) made a 

contribution to an official of that government entity (other than a de minimis contribution, 

as permitted by the rule); or (ii) coordinated, or solicited any person (including a PAC) to 

319	 Ketchum Letter. 

320	 See MSRB, About the MSRB: Enforcement of Board Rules, available at 

http://msrb.org/msrb1/whatsnew/default.asp (“Responsibility for examination and 

enforcement of Board rules is delegated to the Financial Industry Regulatory Authority 

for all securities firms, and to the Federal Deposit Insurance Corporation, the Federal 

Reserve Board, the Comptroller of the Currency, and the Office of Thrift Supervision for 

banks.”). 

321	 For a discussion of transition issues, see section III of this Release. 

322	 Rule 206(4)-5(a)(2)(i) (which prohibits advisers and their covered associates from 

providing or agreeing to provide, directly or indirectly, payment to any third party other 

than a regulated person to solicit a government entity for investment advisory services on 

behalf of such investment adviser). 
 

 

 

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make, any contribution to an official of a government entity to which the investment 

adviser that hired the solicitor is providing or seeking to provide investment advisory 

services, or payment to a political party of a state or locality where the investment adviser 

that hired the solicitor is providing or seeking to provide investment advisory services to 

a government entity.323 

We received comments urging us to permit advisers to compensate registered 

investment advisers for soliciting government officials, subject to rules or rule 

amendments the Commission could adopt under the Advisers Act.324 We believe such an 

allowance is appropriate for similar reasons to those for permitting advisers to 

compensate broker-dealers subject to pay to play rules we have determined meet our 

objectives under rule 206(4)-5. We have direct oversight authority over investment 

advisers registered with us. Accordingly, we believe it is appropriate to allow them to act 

as third-party solicitors for other advisers. Therefore, the rule, as adopted, limits the 

advisers that another adviser may pay to solicit government entities on its behalf to those 

advisers that are registered with the Commission325 and that have neither made the types 

of political contributions that would trigger the two-year time out nor otherwise engaged 

323	 Rule 206(4)-5(f)(9)(i). 

324	 See, e.g., IAA Letter. 

325	 We are not including within the definition of “regulated person” investment advisers 

registered solely with state securities authorities as some commenters suggested. See id. 

We do not have regulatory authority over those advisers as we do over advisers who are 

registered with us (and as we do over FINRA in connection with its oversight of brokers 

and dealers and enforcement of its own rules). In fact, such advisers are subject neither 

to our oversight nor to the recordkeeping rules we are adopting today. 
 

 

 

 

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in activities (e.g., bundling of contributions) that the adviser could not engage in under 

the rule.326 

Advisers compensating other advisers that qualify as “regulated persons” for 

soliciting government entities must adopt policies and procedures reasonably designed to 

prevent a violation of the rule.327 Such policies and procedures should include, among 

other things, a careful vetting of candidates and ongoing review of “regulated person” 

investment advisers acting as solicitors currently being used. Such review would need to 

determine whether the adviser (and its covered persons) acting as a solicitor has made 

political contributions or otherwise engaged in conduct that would disqualify it from the 

definition of “regulated person” and thereby preclude the hiring adviser from paying it 

for the solicitation activity. 

326	 Importantly, a person that is registered under the Exchange Act as a broker-dealer and 

under the Advisers Act as an investment adviser could potentially be a “regulated person” 

under the rule if it met the conditions for either prong of the definition. Such a regulated 

person should follow the rules that apply to the services it is performing, rather than 

complying with both investment adviser and broker-dealer pay to play requirements. The 

Exchange Act generally requires brokers and dealers to register with the Commission and 

become members of at least one self-regulatory organization. Exchange Act sections 

15(a), 15(b)(8) [15 U.S.C. 78o(a), (b)(8)]. Section 3(a)(4)(A) of the Exchange Act 

generally defines a “broker” as any person engaged in the business of effecting 

transactions in securities for the account of others [15 U.S.C. 78c(a)(4)(A)]. See, e.g., 

Definition of Terms in and Specific Exemptions for Banks, Savings Associations, and 

Savings Banks Under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 

1934, Exchange Act Release No. 44291, at n.124 (May 11, 2001) [66 FR 27759 (May 18, 

2001)] (“Solicitation is one of the most relevant factors in determining whether a person 

is effecting transactions.”); Strengthening the Commission’s Requirements Regarding 

Auditor Independence, Exchange Act Release No. 47265, at n.82 (Jan. 28, 2003) [68 FR 

6006 (Feb. 5, 2003)] (noting that a person may be “engaged in the business,” among 

other ways, by receiving compensation tied to the successful completion of a securities 

transaction). See also Persons Deemed Not to Be Brokers, Exchange Act Release No. 

22172, at sec. II.A (Jun. 27, 1985) [50 FR 27940 (Jul. 9, 1985)] (noting that attorneys, 

accountants, insurance brokers, financial service organizations and financial consultants 

are engaged in the business of effecting transactions in securities for the account of others 

if they are retained by an issuer specifically for the purpose of selling securities to the 

public and receive transaction based-compensation for their services). 

327	 See Advisers Act rule 206(4)-7 [17 CFR 275.206(4)-7] (requiring advisers to adopt and 

implement compliance policies and procedures). 
 

 

 

 

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(c) Restrictions on Soliciting and Coordinating 

Contributions and Payments 

Rule 206(4)-5 prohibits advisers and covered persons from coordinating or 

soliciting328 any person or PAC to make (i) any contribution329 to an official of a 

government entity to which the adviser is providing or seeking to provide investment 

advisory services,330 or (ii) any payment331 to a political party of a state or locality where 

328	 Rule 206(4)-5(f)(10)(ii) (defining “solicit,” with respect to a contribution or payment, as 

communicating, directly or indirectly, for the purpose of obtaining or arranging a 

contribution or payment.). Some commenters requested that we provide guidance 

regarding when an adviser would be deemed to be soliciting contributions for purposes of 

the rule. See, e.g., Caplin & Drysdale Letter. An adviser that consents to the use of its 

name on fundraising literature for a candidate would be soliciting contributions for that 

candidate. Similarly, an adviser that sponsors a meeting or conference which features a 

government official as an attendee or guest speaker and which involves fundraising for 

the government official would be soliciting contributions for that government official. 

Whether a particular activity involves a solicitation or coordination of a contribution or 

payment for purposes of the rule will depend on the facts and circumstances, thus we 

have not attempted to draw a bright line. The MSRB takes a similar approach. See 

MSRB, Solicitation of Contributions, MSRB Interpretive Letter (May 21, 1999), 

available at http://msrb.org/msrb1/rules/interpg37.htm (determination of whether activity 

constitutes “soliciting” under rule G-37 is a facts and circumstances analysis). See also 

supra note 255. 

329	 In the case of the fundraising meeting or conference described as an example in note 328, 

expenses incurred by the adviser for hosting the event would be a contribution by the 

adviser, thereby triggering the two-year ban on the adviser receiving compensation for 

providing advisory services to the government entity over which that official has 

influence. See section II.B.2(a) of this Release. Such expenses may include, but are not 

limited to, the cost of the facility, the cost of refreshments, any expenses paid for 

administrative staff, and the payment or reimbursement of any of the government 

official’s expenses for the event. The de minimis exception under rule 206(4)-5(b)(1) 

would not be available with respect to these expenses because they would have been 

incurred by the firm, not by a natural person. See MSRB, Supervision When Sponsoring 

Meetings and Conferences Involving Issuer Officials, MSRB Rule G-37 Interpretive 

Notice (Mar. 26, 2007), available at http://www.msrb.org/msrb1/rules/notg37.htm (rather 

than addressing meetings and conferences in its rules directly, the MSRB applies a facts 

and circumstances test on a case-by-case basis). 

330	 Rule 206(4)-5(a)(2)(ii). An investment adviser would be seeking to provide advisory 

services to a government entity when it responds to a request for proposal, communicates 

with a government entity regarding that entity’s formal selection process for investment 

advisers, or engages in some other solicitation of investment advisory business of the 

government entity. A violation of paragraph (a)(2)(ii) of the rule would not trigger a twoyear ban on the provision of investment advisory services for compensation, but would be 

a violation of the rule. 
 

 

 

 

 

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the investment adviser is providing or seeking to provide investment advisory services to 

a government entity.332 These restrictions are intended to prevent advisers from 

circumventing the rule’s prohibition on direct contributions to certain elected officials 

such as by “bundling” a large number of small employee contributions to influence an 

election, or making contributions (or payments) indirectly through a state or local 

political party.333 

We received only a few comments on this provision. One supporter of our 

proposal asserted that it “would close an important gap in which contributions might be 

made indirectly to government officials for the purpose of influencing their choice of 

investment advisers.”334 Most commenters that addressed the provision focused on the 

prohibition relating to contributions and payments to state and local political parties 

where the adviser is providing, or seeking to provide, advisory services. One state 

official suggested that this prohibition would unfairly affect states with strict limitations 

331	 A payment is defined as any gift, subscription, loan, advance, or deposit of money or 

anything of value. Rule 206(4)-5(f)(7). This definition is similar to the definition of 

“contribution,” but broader, in the sense that it does not include limitations on the 

purposes for which such money is given (e.g., it does not have to be made for the purpose 

of influencing an election). We are including the broader term “payments,” as opposed to 

“contributions,” here to deter an adviser from circumventing the rule’s prohibitions by 

coordinating indirect contributions to government officials by making payments to 

political parties. 

332	 Rule 206(4)-5(a)(2)(ii). This provision prohibits, for example, an adviser from soliciting 

a payment to the political party of a state if the adviser is providing or seeking to provide 

advisory services to the state, but would not preclude that adviser from soliciting a 

payment to a local political party (as long as the adviser is not also providing or seeking 

to provide advisory services to a government entity in that locality). In these 

circumstances, the rule would, however, prohibit an adviser from soliciting the payment 

to a local political party as a means to indirectly make payments to the state party. See 

rule 206(4)-5(d). 

333	 We note that this provision is not limited to the bundling of employee contributions. 

Another example of conduct that would be prohibited by this section would be an adviser 

or its covered associates soliciting contributions from professional service providers. 

334	 Cornell Law Letter. 
 

 

 

 

 

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on individual contributions to candidates as they are now more reliant on party money for 

campaigns.335 Another state official, however, explained the importance of the provision 

by pointing out that it is often difficult or impossible to differentiate between individuals 

seeking an office and the political party, which often merely passes contributions it 

receives on to the candidate, and may direct successful candidates to place pension 

business with contributors.336 

We are adopting this provision, as proposed. These restrictions on soliciting and 

coordinating contributions and payments close what would otherwise be a potential gap 

in the rule as advisers could circumvent its limitations on direct contributions through 

soliciting and coordinating others to make contributions to influence an election or a 

government official’s investment adviser selection process.337 We disagree that this 

335	 CT Treasurer Letter. In upholding restrictions targeted at a particular industry, courts 

have found that the loss of contributions from a small segment of the electorate “would 

not significantly diminish the universe of funds available to a candidate to a non-viable 

level.” Green Party of Conn. v. Garfield, 590 F. Supp. 2d 288, 316 (D. Conn. 2008); see 

also Preston v. Leake, 629 F. Supp. 2d 517, 524 (E.D.N.C. 2009) (differentiating the 

“broad sweep of the Vermont statute” that “restricted essentially any potential campaign 

contribution” from a statute that “only applies to lobbyists”); In re Earle Asphalt Co., 950 

A.2d 918, 927 (N.J. Super. Ct. App. Div. 2008), aff’d 957 A.2d 1173 (N.J. 2008) 

(holding that a limitation on campaign contributions by government contractors and their 

principals did not have the same capacity to prevent candidates from amassing the 

resources necessary for effective campaigning as the statute in Randall). See supra note 

68. 

336	 Reilly Letter. 

337	 We note that a direct contribution to a political party by an adviser or its covered 

associates would not violate the rule, unless the contribution was a means for the adviser 

to do indirectly what the rule would prohibit if done directly (for example, if the 

contribution was earmarked or known to be provided for the benefit of a particular 

government official). See section II.B.2(d) of this Release. The MSRB amended rule G37 in 2005 to expand its prohibition on soliciting others to make, and on coordinating, 

payments to state and local political parties to close what the MSRB identified as a gap in 

which contributions were being made indirectly to officials through payments to political 

parties for the purposes of influencing their choice of municipal securities dealers. The 

MSRB had not previously been able to deter this misconduct, despite issuing informal 

guidance in both 1996 and 2003. See Rule G-37: Request for Comments on Draft 

Amendments to Rule G-37(c), Relating to Prohibiting Solicitation and Coordination of 
 

 

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prohibition would unfairly affect candidates in states that limit individual contributions, 

because the rule is non-discriminatory and would affect contributions (and payments) to 

all candidates equally that were being bundled or made through a gatekeeper for the 

benefit of an investment adviser seeking or doing business with the state or local 

government. 

(d) Direct and Indirect Contributions or Solicitations 

Rule 206(4)-5(d) prohibits acts done indirectly, which, if done directly, would 

violate the rule.338 As a result, an adviser and its covered associates could not funnel 

payments through third parties, including, for example, consultants, attorneys, family 

members, friends or companies affiliated with the adviser as a means to circumvent the 

rule.339 We emphasize, however, that contributions by these other persons would not 

Payments to Political Parties, and Draft Question and Answer Guidance Concerning 

Indirect Rule Violations, MSRB Notice 2005-11 (Feb. 15, 2005), available at 

http://www.msrb.org/msrb1/archive/2005/2005-11.asp (“Both the 1996 Q&A guidance 

and the 2003 Notice were intended to alert dealers and [municipal finance professionals] 

to the realities of political fundraising and guide them toward developing procedures that 

would lead to compliance with both the letter and the spirit of the rule. The MSRB 

continues to be concerned, however, that dealer, [municipal finance professional], and 

affiliated persons’ payments to political parties, including “housekeeping”, “conference” 

or “overhead” type accounts, and PACs give rise to at least the appearance that dealers 

may be circumventing the intent of Rule G-37.”); Self-Regulatory Organizations; 

Municipal Securities Rulemaking Board; Order Approving Proposed Rule Change 

Concerning Solicitation and Coordination of Payments to Political Parties and Question 

and Answer Guidance on Supervisory Procedures Related to Rule G-37(d) on Indirect 

Violations, Exchange Act Release No. 52496 (Sept. 22, 2005) (SEC order approving 

change to MSRB G-37 to prohibit soliciting or coordinating payments to political 

parties). 

338	 Paragraph (d) of the rule is substantially similar to section 208(d) of the Advisers Act [15 

U.S.C. 80b-8(d)], which states, “It shall be unlawful for any person indirectly, or through 

or by any other person, to do any act or thing which it would be unlawful for such person 

to do directly under the provisions of this title or any rule or regulation thereunder.” 

MSRB rule G-37 contains a similar provision. See MSRB rule G-37(d). 

339	 This provision would also cover, for example, situations in which contributions by an 

adviser are made, directed or funded through a third party with an expectation that, as a 

result of the contributions, another contribution is likely to be made by a third party to an 
 

 

 

 

 

 

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otherwise trigger the rule’s two-year time out.340 We received no comments on this 

aspect of the proposed rule and are adopting it as proposed. 

(e) Covered Investment Pools 

Rule 206(4)-5 includes a provision that applies each of the prohibitions of rule 

206(4)-5 to an investment adviser that manages assets of a government entity through a 

hedge fund or other type of pooled investment vehicle (“covered investment pool”).341 

For example, a political contribution to a government official that would, under the rule, 

trigger the two-year time out from providing advice for compensation to the government 

entity would also trigger a two-year time out from the receipt of compensation for the 

management of those assets through a covered investment pool. This provision extends 

the protection of the rule to public pension plans that increasingly access the services of 

“official of the government entity,” for the benefit of the adviser. Contributions made 

through gatekeepers thus would be considered to be made “indirectly” for purposes of the 

rule. In approving MSRB rule G-37, the Commission stated: “[rule G-37(d)] is intended 

to prevent dealers from funneling funds or payments through other persons or entities to 

circumvent the [rule]'s requirements. For example, a dealer would violate the [rule] if it 

does business with an issuer after contributions were made to an issuer official from or by 

associated persons, family members of associated persons, consultants, lobbyists, 

attorneys, other dealer affiliates, their employees or PACs, or other persons or entities as 

a means to circumvent the rule. A dealer also would violate the rule by doing business 

with an issuer after providing money to any person or entity when the dealer knows that 

the money will be given to an official of an issuer who could not receive the contribution 

directly from the dealer without triggering the rule's prohibition on business.” SelfRegulatory Organizations; Order Approving Proposed Rule Change by the Municipal 

Securities Rulemaking Board Relating to Political Contributions and Prohibitions on 

Municipal Securities Business and Notice of Filing and Order Approving on an 

Accelerated Basis Amendment No. 1 Relating to the Effective Date and Contribution 

Date of the Proposed Rule, Exchange Act Release No. 33868 (Apr. 7, 1994) [59 FR 

17621 (Apr. 13, 1994)]. 

340	 Like MSRB rule G-37(d), rule 206(4)-5(d) requires a showing of intent to circumvent the 

rule in order for such persons to trigger the time out. See Blount, 61 F.3d at 948 (“In 

short, according to the SEC, the rule restricts such gifts and contributions only when they 

are intended as end-runs around the direct contribution limitations.”). 

341	 See rule 206(4)-5(c). We discuss the types of pooled investment vehicles that are 

“covered investment pools” below at section II.B.2.(e)(1) of this release. 
 

 

 

 

 

 

 

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investment advisers through hedge funds and other types of pooled investment vehicles 

they sponsor or advise. 

This provision will generally affect two common types of arrangements in which 

a government official is in a position to influence investment of funds in pooled 

investment vehicles. The first is the investment of public funds in a hedge fund or other 

type of pooled investment vehicle. The other is the selection of a pooled investment 

vehicle sponsored or advised by an investment adviser as a funding vehicle or investment 

option in a government-sponsored plan, such as a “529 plan.”342 

An adviser that makes political contributions to steer assets to a pooled 

investment vehicle it manages facilitates fraud by implementing a government official’s 

quid pro quo scheme.343 Public pension plan beneficiaries are harmed when a 

government official violates the public trust, for example, by failing to disclose that the 

government official has directed the investment of the plan’s assets in a pooled 

investment vehicle not because of the vehicle’s financial merits but rather because the 

official has received a political contribution.344 By engaging in such conduct, the adviser 

engages in a scheme to defraud the beneficiaries of the government plan or program.345 

Additionally, an investment adviser to a pooled investment vehicle that is an investment 

option in a government plan or program may prepare information about the pooled 

342	 We note that if an adviser is selected by a government entity to advise a governmentsponsored plan (regardless of whether the plan selects one of the pools the adviser offers 

or manages as an option available under its plan), the prohibitions of the rule directly 

apply. See rule 206(4)-5(a)(1) and (a)(2). 

343	 SEC v. DiBella, 587 F.3d 553, 568 (2d Cir. 2009). 

344	 Id. at 566. 

345	 See id. at 568–69; section 206(4) of the Advisers Act. See also Exchange Act rule 10b-5 

[17 CFR 240.10b-5]. 
 

 

 

 

 

 

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investment vehicle that may be used by plan officials to evaluate the vehicle and by 

pension plan beneficiaries to decide whether to allocate assets to the vehicle. Such an 

adviser engages in or facilitates an act, practice, or course of business which is 

fraudulent, deceptive, or manipulative when the adviser does not disclose that it made a 

contribution for the purpose of inducing an investment by the government officials and 

that the government officials sponsoring the plan chose the vehicle as an investment 

option for beneficiaries not solely on the basis of its merits, but rather as the consequence 

of improper quid pro quo payments.346 The rule also operates to prevent an adviser from 

engaging in pay to play practices indirectly through an investment pool that it would not 

be permitted to do if it directly managed (or sought to directly manage) the assets of a 

government entity.347 

Although a few commenters asserted that the rule or parts of it should not apply to 

pooled investment vehicles,348 none made a persuasive argument that the problems the 

rule is designed to address are not present in the management of public pension plan and 

other public monies invested in pooled investment vehicles. As we discussed in the 

Proposing Release,349 when a decision to invest public funds in a pooled investment 

vehicle is based on campaign contributions, the public pension plan may make inferior 

346	 See, e.g., Oran v. Stafford, 226 F.3d 275, 285-86 (3d Cir. 2000) (“a duty to disclose may 

arise when there is . . . an inaccurate, incomplete or misleading prior disclosure”); Glazer 

v. Formica Corp., 964 F.2d 149, 157 (2d Cir. 1992) (“when a corporation does make a 

disclosure—whether it be voluntary or required—there is a duty to make it complete and 

accurate”) (quoting Roeder v. Alpha Industries, Inc., 814 F.2d 22, 26 (1st Cir. 1987). See 

also Exchange Act Rule 10b-5(b). 

347	 See rule 206(4)-5(d). See also section 208(d) of the Act. 

348	 See, e.g., Comment Letter of Abbott Capital Management, LLC (Oct. 6, 2009) (“Abbott 

Letter”); ICI Letter; NY City Bar Letter; SIFMA Letter; Skadden Letter; Sutherland 

Letter. 

349	 See Proposing Release, at section II.A.3.(e)(2). 
 

 

 

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investment choices and may pay higher fees. And such pension plans may invest in 

pooled investment vehicles that pay substantially higher advisory fees and assume 

significantly greater risks than other investment alternatives.350 

We find nothing in the structure of pooled investment vehicles or the variety of 

investment strategies they employ that suggests a reason for treating advisers to pooled 

investment vehicles differently from advisers to separately managed advisory accounts, 

except, as we discuss below, registered investment companies to which we apply a more 

limited version of the rule. That an investment in a pooled investment vehicle may not 

involve a direct advisory relationship with a government sponsored plan does not change 

the nature of the fraud or the harm that may be inflicted as a consequence of the adviser’s 

pay to play activity. 

Indeed, many of our recent enforcement cases alleged political contributions or 

kickbacks designed to induce public officials to invest public pension plan assets in 

pooled investment vehicles.351 We are concerned that our failure to apply the rule to 

350	 See, e.g., Nanette Burns, Can Retirees Afford This Much Risk? BUSINESS WEEK (Sept. 

17, 2007), available at 

http://www.businessweek.com/magazine/content/07_38/b4050048.htm (asserting that 

public pension plan assets are increasingly being invested in higher risk alternative 

investments, including hedge funds); Hannah M. Terhune, Accounts Training, MONEY 

SCIENCE (Dec. 11, 2006), available at 

http://www.moneyscience.com/Hedge_Fund_Tutorials/Hedge_Fund_Management_and_ 

Performance_Fees.html (noting an “enormous difference in rewards for the managers of 

hedge funds versus those of mutual funds” because hedge fund managers are entitled to 

performance fees). 

351	 See, e.g., SEC v. Paul J. Silvester, et al., Litigation Release No. 16759, Civil Action No. 

3:00-CV-19411 DJS (D. Conn.) (Oct. 10, 2000) (action in which investment adviser 

allegedly paid third-party solicitors who kicked back a portion of the money to the former 

Connecticut State Treasurer in order to obtain public pension fund investments in a hedge 

fund managed by the adviser); SEC v. William A. DiBella, et al., Litigation Release No. 

20498, Civil Action No. 3:04 CV 1342 (EBB) (D. Conn.) (Mar. 14, 2008) (consultant 

was found to have aided and abetted the former Connecticut State Treasurer in a pay to 

play scheme involving an investment adviser to a private equity fund who had paid thirdparty solicitors to obtain public pension fund investments in the fund). There are 
 

 

 

352 

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advisers who manage assets through these vehicles would ignore an area where there has 

been considerable growth, both in the amount of public assets invested in such pooled 

investment vehicles and allegations of pay to play activity involving public pension 

plans.352 We believe a failure to apply the rule in this area could, in some cases, even 

encourage the use of covered investment pools as a means of avoiding application of the 

rule. 

Nonetheless, as described in more detail below, we have made several changes 

from the proposal to more narrowly tailor the applicability of the rule to pooled 

investment vehicles in order to achieve our regulatory purpose while reducing 

examples of pay to play activity in the context of pooled investment vehicles in other 

jurisdictions as well. See, e.g., supra note 18 (listing various actions relating to the recent 

pay to play allegations surrounding the New York Common Retirement Fund). See also 

Guilty Plea in Fraud Case Tied to New York Pension, ASSOCIATED PRESS (Dec. 4, 

2009), available at http://www.nytimes.com/2009/12/04/nyregion/04pension.html 

(describing the guilty plea of an adviser to a venture capital fund to charges that he 

helped his company land a lucrative deal with New York’s public pension fund by giving 

nearly $1 million worth of illegal gifts to state officials). 

See, e.g., Investment Company Institute, 529 Plan Program Statistics, Mar. 2009 (Feb. 5, 

2010), available at http://www.ici.org/research/stats/529s/529s_03-09 (indicating that 

529 plan assets have increased from $8.6 billion in 2000 to $100.3 billion in the first 

quarter of 2009, and that 529 plan accounts have increased from 1.3 million in 2000 to 

11.2 million in the first quarter of 2009); Investment Company Institute, The U.S. 

Retirement Market, 2008, 18 RESEARCH FUNDAMENTALS, No. 5 (June 2009), available 

at http://www.ici.org/pdf/fm-v18n5.pdf (indicating that 403(b) plan and 457 plan assets 

have increased from $627 billion in 2000 to $712 billion in the fourth quarter of 2008); 

SEI, Collective Investment Trusts: The New Wave in Retirement Investing (May 2008), 

available at 

https://longjump.com/networking/RepositoryPublicDocDownload?id=80031025axe1395 

09557&docname=SEI%20CIT%20White%20Paper%205.08.pdf&cid=80031025&encod 

e=application/pdf (citing Morningstar data indicating that collective investment trust 

assets nearly tripled from 2004 to 2007 and grew by more than 150 percent between 2005 

and 2007 alone). See also Michael Marois, CalPERS, Blackstone Clash over Placement 

Agent ‘Jackpot’ Fees, BLOOMBERG (Apr. 7, 2010), available at 

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=acPNrTn1q7pw (noting 

that placement agents working for private equity, hedge funds, venture capital and real 

estate firms typically earn the equivalent of 0.5 percent to 3 percent of the money they 

place under the management of their client, quoting California State Treasurer Bill 

Lockyer, a member of the CalPERS board, “[t]he contingency fees are too much of a 

jackpot for the placement agents . . . [they] invite corrupt practices”). 
 

 

 

 

 

 

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compliance burdens that commenters brought to our attention. In addition, we have made 

certain clarifying changes to the rule, as described below. 

(1) Definition of “Covered Investment Pool” 

Under the rule, a “covered investment pool”353 includes: (i) any investment 

company registered under the Investment Company Act of 1940 that is an investment 

option of a plan or program of a government entity; or (ii) any company that would be an 

investment company under section 3(a) of that Act but for the exclusion provided from 

that definition by section 3(c)(1), section 3(c)(7) or section 3(c)(11) of that Act.354 

Accordingly, it includes such unregistered pooled investment vehicles as hedge funds, 

private equity funds, venture capital funds and collective investment trusts.355 It also 

353	 Rule 206(4)-5(f)(3). 

354	 15 U.S.C. 80a-3(c)(1), (7) or (11). We note that a bank maintaining a collective 

investment trust would not be subject to the rule if the bank falls within the exclusion 

from the definition of “investment adviser” in section 202(a)(11)(A) of the Advisers Act 

[15 U.S.C. 80b-2(a)(11)(A)]. A non-bank adviser that provides advisory services with 

respect to a collective investment trust in which a government entity invests, however, 

would be subject to the rule’s prohibitions with respect to all of its government entity 

clients, including the collective investment trust in which a government entity invests, 

unless another exemption is available. 

355	 One commenter questioned the Commission’s authority to apply the rule in the context of 

covered investment pools in light of the opinion of the Court of Appeals for the District 

of Columbia Circuit in Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006). Sutherland 

Letter. That case created some uncertainty regarding the application of sections 206(1) 

and 206(2) of the Advisers Act in certain cases where investors in a pool are defrauded 

by an investment adviser to that pool. See Prohibition of Fraud by Advisers to Certain 

Pooled Investment Vehicles, Investment Advisers Act Release No. 2628 (Aug. 3, 2007) 

[72 FR 44756 (Aug. 9, 2007)], (adopting rule 206(4)-8 [17 CFR 275.206(4)-8]). In 

addressing the scope of the exemption from registration in section 203(b)(3) of the 

Advisers Act and the meaning of ‘‘client’’ as used in that section, the Court of Appeals 

expressed the view that, for purposes of sections 206(1) and (2), the ‘‘client’’ of an 

investment adviser managing a pool is the pool itself, not an investor in the pool. In its 

opinion, the Court of Appeals distinguished sections 206(1) and (2) from section 206(4) 

of the Advisers Act, which applies to persons other than clients. Id. at n.6. See also 

United States v. Elliott, 62 F.3d 1304, 1311 (11th Cir. 1995). Section 206(4) permits us 

to adopt rules proscribing fraudulent conduct that is potentially harmful to investors in 

pooled investment vehicles. We are adopting rule 206(4)-5 under this authority. 
 

 

 

 

 

 

 

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includes registered pooled investment vehicles, such as mutual funds, but only if those 

registered pools are an investment option of a participant-directed plan or program of a 

government entity.356 These plans or programs may include college savings plans like 

“529 plans”357 and retirement plans like “403(b) plans”358 and “457 plans”359 that 

typically allow participants to select among pre-established investment “options,” or 

particular investment pools (often invested in registered investment companies or funds 

of funds, such as target date funds), that a government official has directly or indirectly 

selected to include as investment choices for participants.360 

356	 Rule 206(4)-5(f)(8). 

357	 A 529 plan is a “qualified tuition plan” established under section 529 of the Internal 

Revenue Code of 1986 [26 U.S.C. 529]. States generally establish 529 plans as state 

trusts which are considered instrumentalities of states for federal securities law purposes. 

As a result, the plans themselves are generally not regulated under the federal securities 

laws and many of the protections of the federal securities laws do not apply to investors 

in them. See section 2(b) of the Investment Company Act [15 U.S.C. 80a-2(b) and 

section 202(b) of the Advisers Act [15 U.S.C. 80b-2(b) (exempting state-owned entities 

from those statutes). However, the federal securities laws do generally apply to, and the 

Commission does generally regulate, the brokers, dealers, and municipal securities 

dealers that effect transactions in interests in 529 plans. See generally sections 15(a)(1) 

and 15B of the Exchange Act [15 U.S.C. 78a-15(a)(1) and 15B]. A bank effecting 

transactions in 529 plan interests may be exempt from the definition of “broker” or 

“municipal securities dealer” under the Exchange Act if it can rely on an exception from 

the definition of broker in the Exchange Act. In addition, state sponsors of 529 plans 

may hire third-party investment advisers either to manage 529 plan assets on their behalf 

or to act as investment consultants to the agency responsible for managing plan assets. 

These investment advisers, unless they qualify for a specific exemption from registration 

under the Advisers Act, are generally required to be registered with the Commission as 

investment advisers and would therefore be subject to our rule. 

358	 A 403(b) plan is a tax-deferred employee benefit retirement plan established under 

section 403(b) of the Internal Revenue Code of 1986 [26 U.S.C. 403(b)]. 

359	 A 457 plan is a tax-deferred employee benefit retirement plan established under section 

457 of the Internal Revenue Code of 1986 [26 U.S.C. 457]. 

360	 We would consider a registered investment company to be an investment option of a plan 

or program of a government entity where the participant selects a model fund or portfolio 

(such as an age-based investment option of a 529 plan) and the government entity selects 

the specific underlying registered investment company or companies in which the 

portfolio’s assets are invested. 
 

 

 

 

 

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We proposed to include in the definition of “covered investment pool” the types 

of pooled investment vehicles that are likely to be used as funding vehicles for, or 

investments of, government-sponsored savings and retirement plans. We explained that 

we included registered investment companies because of the significant growth in 

government-sponsored savings plans in recent years, which increasingly use these funds 

as investment options,361 and the increased competition among advisers for selection of 

their fund as an investment option for these plans.362 We were concerned that advisers to 

pooled investment vehicles, including registered investment companies, may make 

political contributions to influence the decision by government officials to include their 

funds as options in such plans. 

We recognized in our proposal, however, that an adviser to a registered 

investment company might have difficulty in identifying when or if a government 

investor was a fund shareholder for purposes of preventing the adviser (or its covered 

associates) from making contributions that would trigger a two-year time out.363 

Therefore, we proposed to only include publicly offered registered investment companies 

361	 See supra note 352 and accompanying text. 

362	 See, e.g., Charles Paikert, TIAA-CREF Stages Comeback in College Savings 

Plans, CRAIN’S NEW YORK BUS., Apr. 23, 2007 (depicting TIAA-CREF’s struggle to 

remain a major player in managing State 529 plans because of increasing competition 

from the industry’s heavyweights); Beth Healy, Investment Giants Battle for Share of 

Exploding College-Savings Market, BOSTON GLOBE, Oct. 29, 2000, at F1 (describing the 

increasing competition between investment firms for state 529 plans and increasing 

competition to market their plans nationally). See also AnnaMaria Andriotis, 529 Plan 

Fees are Dropping, SMARTMONEY, Dec. 16, 2009, available at 

http://www.smartmoney.com/personal-finance/college-planning/529-plan-fees-aredropping-but-for-how-long/?hpadref=1 (“Costs on these plans are falling for a few 

reasons, and the biggest one has little to do with the state of the economy: the nature of 

their contracts creates competition. When a contract for a state 529 plan expires, program 

managers compete against each other and may lower their fees to try to secure the new 

contract.”). 

363	 See Proposing Release, at nn. 185-87 and accompanying text. 
 

 

 

 

 

 

 

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in the definition of covered investment pool for purposes of the two-year time out 

provision to the extent they were investments or investment options of a plan or program 

of a government entity.364 

Several commenters asserted that an adviser to a publicly offered investment 

company would have similar difficulties in identifying government investors in registered 

investment companies for purposes of complying with other provisions of the rule.365 

One opposed application of the rule to registered investment companies “even if the 

[company] is not included in a plan or program of a government entity,”366 although 

several generally urged us to exclude registered investment companies from the rule 

altogether.367 Another commenter urged us to apply the rule’s recordkeeping 

requirements (discussed below) prospectively and after a period of time that would be 

adequate to enable funds to redesign their processes and systems to capture information 

about whether an investor is a “government entity,” which would be necessary to comply 

364	 See proposed rule 206(4)-5(f)(3) (“Covered investment pool means any investment 

company, as defined in section 3(a) of the Investment Company Act of 1940 (15 U.S.C. 

80a-3(a)) . . . except that for purposes of paragraph (a)(1) of this section, an investment 

company registered under the Investment Company Act of 1940 (15 U.S.C. 80a), the 

shares of which are registered under the Securities Act of 1933 (15 U.S.C. 77a), shall be a 

covered investment pool only if it is an investment or an investment option of a plan or 

program of a government entity.”). 

365	 See Davis Polk Letter; Fidelity Letter; ICI Letter; NSCP Letter; Comment Letter of 

Standard & Poor’s Investment Advisory Services LLC and Standard & Poor’s Securities 

Evaluations, Inc. (Oct. 5, 2009) (“S&P Letter”); SIFMA Letter; T. Rowe Price Letter. 

366	 T. Rowe Price Letter. 

367	 Fidelity Letter; ICI Letter; NSCP Letter; SIFMA Letter. We disagree that registered 

investment companies should be excluded from our rule. Pay to play activity is 

fraudulent, regardless of whether it occurs in the context of a pooled investment vehicle 

or a separately managed account. One commenter asserted that the existence of a 

regulatory regime applicable to investment companies precludes the need for pay to play 

prohibitions with respect to these pools. See ICI Letter. However, existing laws and 

regulations applicable to investment companies do not specifically address pay to play 

practices. 
 

 

 

 

 

 

 

 

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with the rule and our proposed amendment to the Act’s recordkeeping rule.368 Some 

noted that identifying government investors would be particularly challenging when 

shares were held through an intermediary.369 

We continue to believe for the reasons discussed above370 and in the Proposing 

Release, that advisers to registered investment companies should be subject to the rule. 

In response to comments, we have modified our proposal to include a registered 

investment company in the definition of covered investment pool, for purposes of all 

three of the rule’s pay to play prohibitions, but only if it is an investment option of a plan 

or program of a government entity.371 We believe this approach strikes the right balance 

between applying the rule in those contexts, discussed in the Proposing Release,372 in 

which advisers to registered investment companies may be more likely to engage in pay 

to play conduct, while recognizing the compliance challenges relating to identifying 

government investors in registered investment companies373 that may result from a 

368	 ICI Letter. See also section II.D of this Release. 

369	 See T. Rowe Price Letter; ICI Letter, Fidelity Letter. 

370	 See supra notes 361-362 and accompanying text. 

371	 Rule 206(4)-5(f)(3). 

372	 Proposing Release, at nn.185-87 and accompanying text. See also supra notes 352 and 

362 and accompanying text (describing the growth in government-sponsored savings 

plans in recent years and the increased competition for an adviser’s fund to be selected as 

an investment option of such a plan). 

373	 Identifying government investors in other types of covered investment pools does not 

generally present similar compliance challenges. See, e.g., rule 2(a)(51) under the 

Investment Company Act [17 CFR 270.2(a)(51)] (defining “qualified purchaser,” as that 

term is used in section 3(c)(7) of that Act); Rule 501(a) of Regulation D under the 

Securities Act of 1933 (“Securities Act”) [17 CFR 230.501(a)] (defining “accredited 

investor” for purposes of limited offerings without registration under the Securities Act of 

1933); and Advisers Act rule 205-3 (creating an exception from the prohibition against an 

adviser receiving performance-based compensation from clients that are not “qualified 

clients,” and which is relied on by many advisers to funds that are exempt from 

Investment Company Act registration under section 3(c)(1) of that Act). 
 

 

 

 

 

 

 

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broader application of the rule. When an adviser’s investment company is an investment 

option in a participant-directed government plan or program, we believe it is reasonable 

to expect the adviser will know (or can reasonably be expected to acquire information 

about) the identity of the government plan.374 We recognize that when shares are held 

through an intermediary, an adviser may have to take additional steps to identify a 

government entity.375 Therefore, we have provided advisers to registered investment 

companies with additional time to modify current systems and processes.376 

We have also made several minor changes from our proposal intended to clarify 

and simplify application of the rule. First, at the suggestion of commenters,377 we are 

clarifying that an adviser to a registered investment company is only subject to the rule— 

i.e., the investment company is only considered a covered investment pool—if the 

investment company is an investment option of a plan or program of a government entity 

that is participant-directed.

378 This change reflects our intent, as demonstrated by the 

374	 With respect to a 529 plan, for example, an adviser would know that its investment 

company is an investment option of the plan and will know the identity of the 

government entity investor because a 529 plan can only be established by a state, which 

generally establishes a trust to serve as the direct investor in the investment company, 

while plan participants invest in various options offered by the 529 trust. The rule does 

not require an adviser to identify plan participants, only the government plan or program. 

See rule 206(4)-5(f)(5)(iii) (defining a “government entity” to include a plan or program 

of a government entity. The definition does not include the participants in those plans or 

programs). 

375	 For example, while 403(b) plans and 457 plans are generally associated with retirement 

plans for government employees, they are not used exclusively for this purpose. For 

instance, certain non-profit or tax-exempt entities can establish these types of plans. We 

also understand that it is not uncommon for contributions of 403(b) and 457 plans to be 

commingled into an omnibus position that is forwarded to the fund, making it more 

challenging for an adviser to distinguish government entity investors from others. 

376	 See section III.D of this Release. We received several letters addressing this concern. 

ICI Letter; T. Rowe Price Letter; Fidelity Letter. 

377	 See, e.g., ICI Letter; Davis Polk Letter; SIFMA Letter. 

378	 Rule 206(4)-5(f)(8). 
 

 

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examples we give in the definition (i.e., 529 plans, 403(b) plans, and 457 plans) that the 

definition is intended to encompass those covered investment pools that have been preselected by the government sponsoring or establishing the plan or program as part of a 

limited menu of investment options from which participants in the plan or program may 

allocate their account. We have also added, as additional examples to the definition of 

“government entity,” a defined benefit plan and a state general fund to better distinguish 

these pools of assets from a plan or program of a government entity.379 We have also 

made minor organizational changes within the definition of government entity from our 

proposal to make clear that such pools are not “plans or programs of a government 

entity.” 

Finally, we have simplified the definition of “covered investment pool” as it 

applies to registered investment companies. The definition as adopted includes 

investment companies registered under the Investment Company Act that are an option of 

a plan or program of a government entity, regardless of whether, as proposed, their shares 

are registered under the Securities Act of 1933 (“1933 Act”). As discussed above, under 

the rule as adopted an adviser to a registered investment company is only subject to the 

rule if the company is an investment option of a plan or program. As a result, we believe 

it is unnecessary to distinguish between registered investment companies based on 

whether their shares are registered under the 1933 Act, although we understand that those 

shares will typically be registered where the fund is an option in a plan or program of a 

government entity. 

Rule 206(4)-5(f)(5). 379 
 

 

 

 

 

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(2) Application of the Rule 

Under rule 206(4)-5 (and as proposed) an investment adviser is subject to the twoyear time out if it manages a covered investment pool in which the assets of a 

government entity are invested.380 The rule does not require a government entity’s 

withdrawal of its investment or cancellation of any commitment it has made. Indeed, the 

rule prohibits advisers not from providing advice subsequent to a triggering political 

contribution, but rather from receiving compensation for providing advice. If a 

government entity is an investor in a covered investment pool at the time a contribution 

triggering a two-year “time out” is made, the adviser must forgo any compensation 

related to the assets invested or committed by that government entity.381 

Application of the two-year time out may present different issues for covered 

investment pools than for separately managed accounts due to various structural and legal 

differences. Having made a contribution triggering the two-year time out, the adviser 

may have multiple options available to comply with the rule in light of its fiduciary 

obligations and the disclosure it has made to investors. For instance, in the case of a 

private pool, the adviser could seek to cause the pool to redeem the investment of the 

380 Rule 206(4)-5(c). 

381 As we noted above and in the Proposing Release, the phrase “for compensation” includes 

both profits and the recouping of costs, so an adviser is not permitted to continue to 

manage assets at cost after a disqualifying contribution is made. Proposing Release, at 

n.191. See also supra note 137 and accompanying text. As we discussed above in 

section II.B.2(a)(1) of this Release, we are not persuaded by commenters who suggested 

permitting the adviser to be compensated at cost following payment of a triggering 

contribution or payment. See, e.g., Dechert Letter; NY City Bar Letter. In our judgment, 

the potential loss of profits from the government client alone may be insufficient to deter 

pay to play activities. However, costs specifically attributable to the covered investment 

pool and not normally incurred in connection with a separately managed account, such as 

costs attributable to an annual audit of the pool’s assets and delivery of its audited 

financial statements, would not be considered compensation to the adviser for these 

purposes. 
 

 

 

 

 

 

 

 

 

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government entity.382 Such redemptions may be relatively simple matters in the case of, 

for example, a highly liquid private pool.383 Commenters pointed out to us that, for some 

private pools, such as venture capital and private equity funds, a government entity’s 

withdrawal of its capital or cancellation of its commitment may have adverse 

implications for other investors in the fund.384 In such cases, the adviser could instead 

comply with the rule by waiving or rebating the portion of its fees or any performance 

allocation or carried interest attributable to assets of the government client.385 

For registered investment companies, the options for restricting compensation 

involving government investors are more limited, due to both Investment Company Act 

382	 To the extent the adviser may seek to cause the private pool to redeem the investment of 

a government entity investor under these circumstances, it should consider disclosing this 

as an investment risk in a private placement memorandum, prospectus or other disclosure 

document to current and prospective investors in such a fund. See, e.g., Rule 502 of 

Regulation D under the Securities Act [17 CFR 230.502] (addressing disclosure 

obligations for non-accredited investors who purchase securities in a limited offering 

pursuant to rules 505 or 506 of Regulation D under the Securities Act [17 CFR 230.505 

or 17 CFR 230.506]. 

383	 We understand that other types of pooled investment vehicles, including private equity 

and venture capital funds, already have special withdrawal and transfer provisions related 

to the regulatory and tax considerations applicable to certain types of investors, such as 

those regulated by the Employee Retirement Income Security Act of 1974 (“ERISA”) [29 

U.S.C. 18]. See generally JAMES M. SCHELL, PRIVATE EQUITY FUNDS – BUSINESS 

STRUCTURE AND OPERATIONS (Law Journal Press 2000) (2010). 

384	 See Abbott Letter; ICI Letter; NY City Bar Letter. 

385	 As we noted in the Proposing Release, some commenters to our 1999 Proposal asserted 

that a performance fee waiver raises various calculation issues. See Proposing Release, at 

n.192. An adviser making a disqualifying contribution could comply with rule 206(4)-5 

by waiving a performance fee or carried interest determined on the same basis as the fee 

or carried interest is normally calculated—e.g., on a mark-to-market basis. For 

arrangements like those typically found in private equity and venture capital funds where 

the fee or carry is calculated based on realized gains and losses and mark-to-market 

calculations are not feasible, advisers could use a straight-line method of calculation 

which assumes that the realized gains and losses were earned over the life of the 

investment. 
 

 

 

 

 

 

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provisions and potential tax consequences.386 In our proposal, we suggested one 

approach that would meet the requirements of the rule—an adviser of a registered 

investment company could waive its advisory fee for the fund as a whole in an amount 

approximately equal to fees attributable to the government entity.387 One commenter 

agreed with our approach,388 while another commenter suggested we could, alternatively, 

permit the government entity to continue to pay its portion of the advisory fee, but require 

the adviser to rebate that portion of the fee to the fund as a whole.389 We believe either 

approach would meet the requirements of the rule we are adopting today. 

(3) Subadvisory Arrangements 

A number of commenters urged that we exclude from the rule subadvisers to 

covered investment pools because, being in a subordinate role to the adviser, they may 

have no involvement in the adviser’s solicitation activities including no ability to identify 

government entities being solicited, and therefore should not be held accountable for the 

adviser’s actions.390 None of these commenters, however, indicated that a subadviser 

could not obtain from the adviser the information necessary to comply with the rule. 

Additionally, no commenter provided us with a basis to distinguish advisers from 

subadvisers that would be adequate to avoid undermining the prophylactic nature of our 

386	 See Proposing Release, at n.193 and accompanying text. See, e.g., rule 18f-3 under the 

Investment Company Act [17 CFR 270.18f-3]. Moreover, other regulatory 

considerations, such as those under ERISA, may impact these arrangements with respect 

to collective investment trusts. 

387	 This may also be done at the class level or series level for private funds organized as 

corporations. 

388	 ICI Letter. 

389	 NY City Bar Letter. 

390	 See, e.g., IAA Letter; S&P Letter; Skadden Letter; Davis Polk Letter. 
 

 

 

 

 

 

 

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rule. “Subadviser” is not defined under the Act,391 and significant variation exists in 

subadvisory relationships.392 There is no readily available way to draw meaningful 

distinctions between advisers and subadvisers by, for example, looking at who controls 

marketing and solicitation activities,393 who has an advisory contract directly with the 

government client,394 or other factors. In addition, subadvisers generally have the same 

economic incentives as advisers to obtain new business and increase assets under 

management. We are concerned that under the approaches suggested by commenters, an 

adviser that sought to avoid compliance with the prophylactic provisions of our rule and 

engage in pay to play could organize itself to operate as a subadviser in such an 

arrangement. We therefore believe it is not appropriate to exclude subadvisers from the 

rule. 

391	 “Subadviser” also is not defined under the Investment Company Act, which requires that 

both advisory and subadvisory contracts (“which contract, whether with such registered 

company or with an investment adviser of such registered company . . .”) be approved by 

a vote of a majority of the outstanding voting securities of the registered investment 

company. See section 15(a) of the Investment Company Act [15 U.S.C. 80a-15(a)]. 

392	 See, e.g., Investment Company Institute, Board Oversight of Subadvisers (Jan. 2010), 

available at http://www.ici.org/pdf/idc_10_subadvisers.pdf (providing guidance to 

mutual fund boards of directors with respect to overseeing subadvisory arrangements and 

recognizing that “there is no one ‘correct’ approach to effective subadvisory oversight by 

fund boards” because there are a wide variety of potential subadvisory arrangements). 

393	 See, e.g., Davis Polk Letter (suggesting that we limit the application of the prohibitions to 

a subadviser to a covered investment pool that has the ability to control the soliciting, 

marketing or acceptance of government clients); S&P Letter (suggesting that we limit the 

application of the prohibitions to a subadviser to a covered investment pool that: (1) has 

the ability to control the soliciting, marketing or acceptance of government clients; and 

(2) is not a related person of the investment adviser or distributor or other investment 

pool). 

394	 See, e.g., IAA Letter; Skadden Letter. See also sections 2(a)(20) and 15(a) of the 

Investment Company Act (treating a subadviser as an adviser to a registered investment 

company even in the absence of a direct contractual relationship with the investment 

company). 
 

 

 

 

 

 

--113--

We are, however, providing some guidance that may assist advisers in 

subadvisory and fund of funds arrangements in complying with the rule.395 First, by the 

terms of the rule, if an adviser or subadviser makes a contribution that triggers the twoyear time out from receiving compensation, the subadviser or adviser, as applicable, that 

did not make the triggering contribution could continue to receive compensation from the 

government entity,396 unless the arrangement were a means to do indirectly what the 

adviser or subadviser could not do directly under the rule.397 Second, advisers to 

underlying funds in a fund of funds arrangement are not required to look through the 

investing fund to determine whether a government entity is an investor in the investing 

fund unless the investment were made in that manner as a means for the adviser to do 

indirectly what it could not do directly under the rule.398 

395	 See, e.g., IAA Letter (requesting clarification as to how the rule would apply when an 

adviser becomes subject to the compensation ban after hiring a subadviser or vice versa). 

See also Fidelity Letter; MFA Letter; SIFMA Letter (each expressing concern about how 

the rule would apply in the fund of funds context). 

396	 We understand that, under some advisory arrangements, the government entity has a 

contract only with the adviser and not the subadviser. Under those circumstances, it 

would be consistent with the rule for an adviser that has triggered the two-year time out 

to pass through to the subadviser that portion of the fee to which the subadviser is 

entitled, as long as the adviser retains no compensation from the government entity and 

the subadviser (and its own covered associates) has not triggered a time out as well. 

397	 See Rule 206(4)-5(d). For instance, an adviser that hires an affiliated subadviser to 

manage a covered investment pool in which a government entity invests so that the 

adviser could make contributions to that government entity would be doing indirectly 

what it would be prohibited from doing directly under the rule. A subadviser would be 

providing “investment advisory services for compensation to a government entity” 

regardless of whether the subadviser is paid directly by the government entity or by the 

adviser. 

398	 See rule 206(4)-5(d). 
 

 

 

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(f) Exemptions 

An adviser may apply to the Commission for an order exempting it from the twoyear compensation ban.399 Under this provision, which we are adopting as proposed, we 

can exempt advisers from the rule’s time out requirement where the adviser discovers 

contributions that trigger the compensation ban only after they have been made, and 

when imposition of the prohibition is unnecessary to achieve the rule’s intended purpose. 

This provision will provide advisers with an additional avenue by which to seek to cure 

the consequences of an inadvertent violation by the adviser that falls outside the limits of 

the rule’s de minimis exception and exception for returned contributions,400 such as when 

a disgruntled employee makes a greater than $350 contribution as he or she exits the firm. 

In determining whether to grant an exemption, we will take into account the varying facts 

and circumstances that each application presents. Among other factors, we will consider: 

(i) whether the exemption is necessary or appropriate in the public interest and consistent 

with the protection of investors and the purposes fairly intended by the policy and 

provisions of the Advisers Act; (ii) whether the investment adviser, (A) before the 

contribution resulting in the prohibition was made, adopted and implemented policies and 

procedures reasonably designed to prevent violations of rule 206(4)-5; (B) prior to or at 

the time the contribution which resulted in such prohibition was made, had no actual 

knowledge of the contribution; and (C) after learning of the contribution, (1) has taken all 

available steps to cause the contributor involved in making the contribution which 

399	 Rules 0-4, 0-5, and 0-6 under the Advisers Act [17 CFR 275.0-4, 0-5, and 0-6] provide 

procedures for filing applications under the Act, including applications under the rule 

206(4)-5. 

400	 See sections II.B.2(a)(6) and (7) of this Release, describing exceptions to the two-year 

time out prohibition of the rule. 
 

 

 

 

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resulted in such prohibition to obtain a return of the contribution; and (2) has taken such 

other remedial or preventive measures as may be appropriate under the circumstances; 

(iii) whether, at the time of the contribution, the contributor was a covered associate or 

otherwise an employee of the investment adviser, or was seeking such employment; (iv) 

the timing and amount of the contribution which resulted in the prohibition; (v) the nature 

of the election (e.g., federal, state or local); and (vi) the contributor’s apparent intent or 

motive in making the contribution which resulted in the prohibition, as evidenced by the 

facts and circumstances surrounding such contribution.401 We intend to apply these 

factors with sufficient flexibility to avoid consequences disproportionate to the violation, 

while effecting the policies underlying the rule. 

We received limited comment on this provision. A few commenters suggested 

that the operation of the rule should toll until a decision is made about an applicant’s 

request.402 We are concerned that such an approach could encourage frivolous 

applications and encourage applicants to delay the disposition of their applications. As 

we explained in the Proposing Release, an adviser seeking an exemption could place into 

an escrow account any advisory fees earned between the date of the contribution 

triggering the prohibition and the date on which we determine whether to grant an 

exemption.403 Some commenters recommended the rule build in a specified length of 

401	 See Rule 206(4)-5(e). These factors are similar to those considered by FINRA and the 

appropriate bank regulators in determining whether to grant an exemption under MSRB 

rule G-37(i). 

402	 ICI Letter; Skadden Letter. 

403	 See Proposing Release, at n.199. The escrow account would be payable to the adviser if 

the Commission grants the exemption. If the Commission does not grant the exemption, 

the fees contained in the account would be returned to the government entity client. In 

contrast, MSRB rule G-37, on which rule 206(4)-5 is based, does not permit a municipal 
 

 

 

 

 

 

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time for the Commission to respond to requests for relief.404 We recognize that 

applications for an exemptive order will be time-sensitive and will consider such 

applications expeditiously. We note that the escrow arrangements discussed above may 

lessen the hardship on advisers. 

D. Recordkeeping 

We are adopting amendments to rule 204-2 to require registered investment 

advisers that have government clients, or that provide investment advisory services to a 

covered investment pool in which a government entity investor invests, to make and keep 

certain records that will allow us to examine for compliance with new rule 206(4)-5.405 

The rule amendments reflect several changes from our proposal, which are discussed 

below. These requirements are similar to the MSRB recordkeeping requirements for 

brokers, dealers and municipal securities dealers.406 

Amended rule 204-2 requires registered advisers that provide investment advisory 

services to a government entity, or to a covered investment pool in which a government 

securities dealer to continue to engage in municipal securities business with an issuer 

while an application is pending. See MSRB Rule G-37 Q&A, Question V.1. 

404	 IAA Letter; ICI Letter; NASP Letter (each suggesting all applications be granted if they 

are not acted upon in 30 days); Skadden Letter (suggesting a 45-day deadline). 

405	 Rule 204-2(a)(18) and (h)(1). An adviser is required to make and keep these records only 

if it provides investment advisory services to a government entity or if a government 

entity is an investor in any covered investment pool to which the investment adviser 

provides investment advisory services. Advisers that solicit government clients on behalf 

of other advisers are also subject to the amended recordkeeping requirements. Advisers 

that are exempt from Commission registration under section 203(b)(3) of the Advisers 

Act, however, are not subject to the recordkeeping requirements under amended 204-2 

unless they do register with us, although as discussed earlier, supra note 92 and 

accompanying text, they are subject to rule 206(4)-5. Advisers keeping substantially the 

same records under rules adopted by the MSRB are not required to keep duplicate 

records. Rule 204-2(h)(1). 

406	 MSRB rule G-8(a)(xvi). The MSRB also requires certain records to be made and kept in 

accordance with disclosure requirements that our rule does not contain. 
 

 

 

 

 

 

 

 

 

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entity is an investor, to make and keep records of contributions made by the adviser and 

covered associates to government officials (including candidates), and of payments to 

state or local political parties and PACs.407 The adviser’s records of contributions and 

payments must be listed in chronological order identifying each contributor and recipient, 

the amounts and dates of each contribution or payment and whether a contribution was 

subject to rule 206(4)-5’s exception for certain returned contributions.408 The rule also 

requires an adviser that has government clients to make and keep a list of its covered 

associates,409 and the government entities to which the adviser has provided advisory 

services in the past five years.410 Similarly, advisers to covered investment pools must 

make and keep a list of government entities that invest, or have invested in the past five 

years, in a covered investment pool, including any government entity that selects a 

covered investment pool to be an option of a plan or program of a government entity, 

such as a 529, 457 or 403(b) plan.411 An investment adviser, regardless of whether it 

currently has a government client, must also keep a list of the names and business 

addresses of each regulated person to whom the adviser provides or agrees to provide, 

407	 Contributions and payments by PACs controlled by the adviser or a covered associate 

would also have to be recorded as these PACs are “covered associates” under the rule. 

Rule 206(4)-5(f)(2)(iii). See section II.B.2(a)(4) of this Release. 

408	 Rule 204-2(a)(18)(ii). 

409	 The adviser must record the name, title(s), and business and residence addresses of each 

covered associate. Rule 204-2(a)(18)(i)(A). 

410	 Advisers do not have to maintain a record of government entities that were clients before 

the effective date. For additional information regarding the implementation of rule 

206(4)-5, see section III of this Release. 

411	 Amended rule 204-2 does not require an adviser to a covered investment pool that is an 

option of a government plan or program to make and keep records of participants in the 

plan or program, but only the government entity. See supra note 374. Consistent with 

changes we have made to the definition of covered investment pool, we note that an 

adviser’s recordkeeping obligations with respect to a registered investment company 

apply only if such an investment company is an option of a plan or program of a 

government entity. See section II.B.2(e) of this Release. 
 

 

 

 

 

 

 

 

 

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directly or indirectly, payment to solicit a government entity on its behalf.412 The 

amended rule reflects several changes from our proposal, which we describe below. 

First, in response to comments,413 we have limited the rule to provide that only 

records of contributions,414 not payments,415 to government officials and candidates are 

required to be kept under the rule.416 We have made this change because, unlike 

contributions, which are one type of payment, all payments do not trigger the two-year 

time out. As a result of this change, the recordkeeping obligations better reflect the 

activities of an adviser or a covered associate that could result in the adviser being subject 

to the two-year time out. Commenters also argued that we should not require, as 

proposed, advisers to maintain records of payments to PACs.417 Although those 

payments do not trigger application of the two-year time out, payments to PACs can be a 

means for an adviser or covered associate to funnel contributions to a government official 

without directly contributing. We are, therefore, adopting the amendment to require 

advisers to keep records of payments to PACs as these records will allow our staff to 

identify situations that might suggest an intent to circumvent the rule.418 

412	 Rule 204-2(a)(18)(i)(D). 

413	 Fidelity Letter; IAA Letter; SIFMA Letter. 

414	 See supra note 153 and accompanying text (defining “contribution”) 

415	 See supra note 331 (defining “payment”). 

416	 Rule 204-2(a)(18)(i)(C). 

417	 See, e.g., IAA Letter; SIFMA Letter. 

418	 Accordingly, as part of a strong compliance program, an adviser or covered associate that 

receives a general solicitation to make a contribution to a PAC should consider inquiring 

about how the collected funds would be used to determine whether the PAC is closely 

associated with a government official to whom a direct contribution would subject the 

adviser to the two-year time out. See section II.B.2(d) of this Release and rule 206(4)­

5(d). The MSRB takes a similar approach regarding whether a payment to a PAC is an 

indirect contribution to a government official. See MSRB Rule G-37 Q&A, Questions 

III.4 and III.5. 
 

 

 

 

 

 

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Second, an investment adviser to a registered investment company must maintain 

records identifying government entity investors only if the investments are made as part 

of a plan or program of a government entity or provide participants in the plan or 

program with the option of investing in the fund.419 This change would narrow the 

records required to those necessary to support the rule as modified from our proposal, and 

we believe addresses commenters’ concerns regarding the ability of advisers to registered 

investment companies to identify government entity investors.420 As discussed above, we 

believe it is reasonable to expect advisers to know the identity of the government entity 

when a registered fund they advise is part of a plan or program. In addition, as 

commenters suggested, we are providing a substantial transition period for advisers to 

registered investment companies that should allow these advisers to make the necessary 

changes to account documents and systems to allow them to identify government entities 

that provide one or more of the investment companies they advise as an investment 

option.421 

Third, the amended rule requires an adviser to maintain a list of only those 

government entities to which it provides, or has provided in the past five years, 

419	 Rule 204-2(a)(18)(i)(B). Amended rule 204-2 does not require an adviser to a covered 

investment pool that is an option of a government plan or program to make and keep 

records of participants in the plan or program, but only the government entity. For a 

discussion of the application of the rule to a covered investment pool that is an option of 

a government plan or program, see supra note 371 and accompanying text. Consistent 

with changes we have made to the definition of covered investment pool, we note that an 

adviser’s recordkeeping obligations with respect to a registered investment company 

apply only if such an investment company is an option of a plan or program of a 

government entity. See section II.B.2(e) of this Release. 

420	 Advisers to covered investment pools that are relying on Investment Company Act 

exclusions in sections 3(c)(1), 3(c)(7) and 3(c)(11) must identify government entity 

investors regardless of whether they are an investment option of a plan or program of a 

government entity. Rule 204-2(a)(18)(i)(B). 

421	 See section III of this Release. 
 

 

 

 

 

 

 

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investment advisory services.422 We are not requiring, as proposed, a list of government 

entities the adviser solicited for advisory business.423 Some commenters expressed 

concerns about the potential scope of this requirement and noted that solicitation does not 

trigger rule 206(4)-5’s two-year time out, rather it is providing advice for compensation 

that does so.424 In light of these concerns, and the record before us today, we are not 

requiring advisers to maintain lists of government entities solicited that do not become 

clients. 

Fourth, as discussed above, rule 206(4)-5 permits an adviser to use certain third 

parties to solicit on its behalf. We are, therefore, requiring that advisers that provide or 

agree to provide, directly or indirectly, payment to advisers or broker-dealers registered 

with the Commission that act as regulated persons under rule 206(4)-5 to maintain a list 

of the names and business addresses of each such regulated person.425 These records will 

enable the Commission’s staff to review and compare the regulated person’s records to 

those of the adviser that hired the regulated person. 

Finally, the amendments require advisers to make and keep records of their 

covered associates, and their own and their covered associates’ contributions, only if they 

provide advisory services to a government client.426 Commenters had expressed concerns 

that requiring advisers with no government business to make and keep these records 

422 See rule 204-2(a)(18)(i)(B). 

423 See proposed rule 204-2(a)(18)(i)(B). 

424 Dechert Letter; SIFMA Letter; Skadden Letter. 

425 Rule 204-2(a)(18)(i)(D). If an adviser does not specify which types of clients the 

regulated person should solicit on its behalf (e.g., that it should only solicit government 

entities), the adviser could satisfy this requirement by maintaining a list of all of its 

regulated person solicitors. Supra note 412. 

426 Rule 204-2(a)(18)(iii). 
 

 

 

 

 

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could be unnecessarily intrusive to employees and burdensome on advisers.427 In light 

of those concerns, and the record before us today, we are not requiring advisers with no 

government business to make and keep these records.428 As a consequence, an adviser 

with no government clients would not have to require employees to report their political 

contributions. 

E. Amendment to Cash Solicitation Rule 

We are adopting, as proposed, a technical amendment to rule 206(4)-3 under the 

Advisers Act, the “cash solicitation rule.” That rule makes it unlawful, except under 

specified circumstances and subject to certain conditions, for an investment adviser to 

make a cash payment to a person who directly or indirectly solicits any client for, or 

refers any client to, an investment adviser.429 

Paragraph (iii) of the cash solicitation rule contains general restrictions on thirdparty solicitors that cover solicitation activities directed at any client, regardless of 

whether it is a government entity client. New paragraph (e) to rule 206(4)-3 alerts 

427	 IAA Letter; Dechert Letter; SIFMA Letter. 

428	 Although advisers that do not have government entity clients are not required to maintain 

records under the amendments, the look-back requirements of rule 206(4)-5 continue to 

apply. As a result, an adviser that has not maintained records of the firm’s and its 

covered associates’ contributions would have to determine whether any contributions by 

the adviser, its covered associates, and any former covered associates would subject the 

firm to the two-year time out prior to accepting compensation from a new government 

entity client. The same applies to newly-formed advisers. The records an adviser 

develops during this determination process, would fall under the adviser’s obligation to 

maintain records of all direct or indirect contributions made by the investment adviser or 

its covered associates to an official of a government entity, or payments to a political 

party of a state or political subdivision thereof, or to a political action committee. Rule 

204-2(a)(18)(i)(C). 

429	 17 CFR 275.206(4)-3. 
 

 

 

 

 

 

 

 

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advisers and others that special prohibitions apply to solicitation activities involving 

government entity clients under rule 206(4)-5.430 

III.	 EFFECTIVE AND COMPLIANCE DATES 

Rule 206(4)-5 and the amendments to rules 204-2 and 206(4)-3 are effective on 

September 13, 2010. Investment advisers subject to rule 206(4)-5 must be in compliance 

with the rule on March 14, 2011. Investment advisers may no longer use third parties to 

solicit government business except in compliance with the rule on September 13, 2011.431 

Advisers to registered investment companies that are covered investment pools must 

comply with the rule by September 13, 2011.432 Advisers subject to rule 204-2 must 

comply with amended rule 204-2 on March 14, 2011. However, if they advise registered 

investment companies that are covered investment pools, they have until September 13, 

2011 to comply with the amended recordkeeping rule with respect to those registered 

investment companies. 

A. Two-Year Time Out and Prohibition on Soliciting or Coordinating 

Contributions 

We are providing advisers with a six month transition period to give them time to 

identify their covered associates and current government entity clients and to modify their 

compliance programs to address new compliance obligations under the rule.433 

430	 Rule 206(4)-3(e). We received no comments on this proposed amendment. 

431	 Rule 206(4)-5(a)(2). 

432	 Rule 206(4)-5(f)(3). 

433	 Section III.D of this Release addresses when advisers to “covered investment pools” that 

are registered investment companies must comply with the rule; section III.E of this 

Release addresses transition considerations specific to certain other pooled investment 

vehicles. 
 

 

 

 

 

 

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Accordingly, rule 206(4)-5’s prohibition on providing advisory services for compensation 

within two years of a contribution will not apply to, and the rule’s prohibition on 

soliciting or coordinating contributions will not be triggered by contributions made 

before March 14, 2011.434 We believe that the length of the transition period should 

address commenters’ concerns that advisers have sufficient time to implement policies 

and procedures regarding contributions to avoid violations of the rule and that the rule not 

affect the 2010 elections for which some advisory personnel may already have committed 

to make political contributions.435 

B. Prohibition on Using Third Parties to Solicit Government Business 

and Cash Solicitation Rule Amendment 

Advisers must comply with the new rule’s prohibition on making payments to 

third parties to solicit government entities for investment advisory services on September 

13, 2011.436 Before this compliance date, advisers are not 

434	 Likewise, these prohibitions do not apply to contributions made before March 14, 2011 

by new covered associates to which the look back applies. See section II.B.2(a)(5) of this 

Release for a discussion of the rule’s look-back provision. For example, if an individual 

who becomes a covered associate of an adviser on or after March 14, 2011 made a 

contribution before March 14, 2011, that new covered associate’s contribution would not 

trigger the two-year time out for the adviser. On the other hand, if an individual who 

later becomes a covered associate made the contribution on or after March 14, 2011, the 

contribution would trigger the two-year time out for the adviser if it were made less than, 

as applicable, six months or two years before the individual became a covered associate. 

435	 Commenters recommended that we provide advisers with six months to one year as a 

transition for rule 206(4)-5. See Davis Polk Letter; MFA Letter; ICI Letter; IAA Letter; 

NASP Letter; Skadden Letter. 

436	 Rule 206(4)-5(a)(2). 
 

 

 

 

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prohibited by the rule from making payments to third-party solicitors regardless of 

whether they are registered as broker-dealers or investment advisers.437 

We have provided an extended transition period to provide advisers and thirdparty solicitors with sufficient time to conform their business practices to the new rule, 

and to revise their compliance policies and procedures to prevent violation of the new 

rule. In addition, the transition period will provide an opportunity for a registered 

national securities association to propose a rule that would meet the requirements of rule 

206(4)-5(f)(9)(ii)(B) and for the Commission to consider such a rule. If, after one year, a 

registered national securities association has not adopted such rules, advisers would be 

prohibited from making payments to broker-dealers for distribution or solicitation 

activities with respect to government entities, but would be permitted to make payments 

to registered investment advisers that meet the definition of “regulated person” under the 

rule.438 We understand from our staff, however, that FINRA plans to act within the 

timeframe; if they do not, we will consider whether we should take further action. 

Finally, the compliance date for the technical amendment to the cash solicitation 

rule, rule 206(4)-3, which is intended to alert advisers that rule 206(4)-5 is applicable to 

solicitations of a government entity, is one year from the effective date, as the 

amendment to the cash solicitation rule need only be operative when rule 206(4)-5’s 

third-party solicitor provisions are in effect. 

437	 We note, however, that the antifraud provisions of the federal securities laws continue to 

apply during the transition period. 

438	 See rule 206(4)-5(f)(9)(i). 
 

 

 

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C. Recordkeeping 

As discussed above, the amendments to rule 204-2 apply only to investment 

advisers with clients who are government entities. Such advisers must comply with the 

amended rule on March 14, 2011 except as noted below. By March 14, 2011, these 

advisers must begin to maintain records of all persons who are covered associates under 

the rule and keep records of political contributions they make on and after that date. 

Advisers must also make and keep a record of all government entities that they provide 

advisory services to on and after March 14, 2011. Advisers are not, however, required to 

look back for the five years prior to the effective date to identify former government 

clients. Advisers that pay regulated persons to solicit government entities for advisory 

services on their behalf must make and keep a list of those persons beginning on and after 

September 13, 2011.439 

D. Registered Investment Companies 

Advisers to registered investment companies that are “covered investment pools” 

under the rule440 must comply with rule 205(4)-5 with respect to those covered pools 

September 13, 2011. During the transition period, contributions by the adviser or its 

employees to government entity clients that have selected an adviser’s 

439	 Rule 204-2(a)(18)(i)(D). 

440	 A registered investment company is only a covered investment pool if it is an investment 

option of a plan or program of a government entity, such as a 529 plan, 403(b) plan or 

457 plan. See rule 206(4)-5(f)(3). 
 

 

 

 

 

 

 

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registered investment company as an investment option of a plan or program will not 

trigger the prohibitions of rule 206(4)-5.441 

We have provided for an extended compliance date to respond to concerns 

expressed by commenters that an adviser to a registered investment company may require 

additional time to identify government entities that have selected that registered 

investment company as an investment option when shares of the fund are held through 

omnibus arrangements such that the identity of the fund investor is not readily available 

to the adviser.442 The changes we have made to the proposed rule that limit the 

application of the two-year time out with respect to registered investment companies to 

those that are options in a plan or program of a government entity,443 together with this 

extended compliance date should provide advisers to registered investment companies 

sufficient time to put into place those system enhancements or business arrangements, 

such as those with intermediaries, that may be necessary to identify those government 

plans or programs in which the funds serve as investment options.444 

441	 Advisers to covered investment pools other than registered investment companies—i.e., 

companies that would be investment companies under section 3(a) of the Investment 

Company Act but for the exclusion provided from that definition by either section 

3(c)(1), section 3(c)(7) or section 3(c)(11)—are subject to the six-month transition 

period. We believe advisers to these types of funds, because the interests in them are 

typically held in the name of the investor, should be able to identify government entities 

without significant difficulty. 

442	 See ICI Letter; T. Rowe Price Letter. 

443	 See section II.B.2(a) of this Release. 

444	 A few commenters recommended that the rule apply only to new government investors in 

registered investment companies after the effective date of the rule. See ICI Letter; T. 

Rowe Price Letter. We do not believe this would be appropriate because pay to play can 

be just as troubling in the context of an adviser renewing an advisory contract (or 

including a registered investment company as an investment option in a plan or program) 

as one that is endeavoring to obtain business for the first time. 
 

 

 

 

 

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As noted above, we are providing for an extended compliance date for advisers 

that manage registered investment companies that are covered investment pools under the 

rule, which we are applying, for the same reasons, to recordkeeping obligations that arise 

as a result of those covered investment pools. Thus, advisers to these covered investment 

pools must make and keep a record of all government entity investors on and after 

September 13, 2011.445 

IV. COST-BENEFIT ANALYSIS 

We are sensitive to the costs and benefits imposed by our rules, and understand 

that there will be costs associated with compliance with rule 206(4)-5 and the 

amendments to rule 204-2.446 We recognize that the rule and amendments will place 

burdens on advisers that provide or seek to provide advisory services to government 

entities, and that advisers may in turn choose to limit the ability of certain persons 

associated with an adviser to make contributions to candidates for certain offices and to 

solicit contributions for certain candidates and payments to political parties. We believe 

there are practical, cost-effective means to comply with the rule without an adviser 

imposing a blanket ban on political contributions by its covered associates. We have 

closely drawn the rule, and modified it based on comments received, to achieve our goal 

of addressing adviser participation in pay to play practices, while seeking to limit the 

burdens imposed by the rule. 

445 Amended rule 204-2 does not require an adviser to a covered investment pool that is an 

option of a government plan or program to make and keep records of participants in the 

plan or program, but only the government entity. See supra note 411. 

446 As proposed, we are also making a conforming technical amendment to rule 206(4)-3 to 

address potential areas of conflict with proposed rule 206(4)-5. We do not believe that 

this technical amendment affects the costs associated with the rulemaking. It will benefit 

advisers because it provides clarity about the application of our rules when they 

potentially overlap. 
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The rule and rule amendments are designed to address pay to play practices by 

investment advisers that provide advisory services to government entity clients and to 

certain covered investment pools in which a government entity invests. The rule 

prohibits an investment adviser from providing advisory services for compensation to a 

government client for two years after the adviser or certain of its executives or employees 

make a contribution to certain elected officials or candidates. The rule also prohibits an 

adviser from providing or agreeing to provide, directly or indirectly, payment to any third 

party that is not a “regulated person” for a solicitation of advisory business from any 

government entity, or for a solicitation of a government entity to invest in certain covered 

investment pools, on behalf of such adviser. Additionally, the rule prevents an adviser 

from coordinating or soliciting from others contributions to certain elected officials or 

candidates or payments to certain political parties. The rule applies both to advisers 

registered with us (or required to be registered) and those that are unregistered in reliance 

on the exemption available under section 203(b)(3) of the Advisers Act (15 U.S.C. 80b3(b)(3)). Our amendment to rule 204-2 requires a registered adviser to maintain certain 

records of the political contributions made by the adviser or certain of its executives or 

employees, as well as records of the regulated persons the adviser pays or agrees to pay 

to solicit government entities on the adviser’s behalf. 

In the Proposing Release, we requested comment on the effects of the proposed 

rule and rule amendments on pension plan beneficiaries, participants in government plans 

or programs, investors in pooled investment vehicles, investment advisers, the advisory 

profession as a whole, government entities, third party solicitors, and political action 
 

 

 

 

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committees.447 We requested that commenters provide analysis and empirical data to 

support their views on the costs and benefits associated with the proposal. For example, 

we requested comment on the costs of establishing compliance procedures to comply 

with the proposed rule, both on an initial and ongoing basis and on the costs of using 

compliance procedures of an affiliated broker-dealer that the broker-dealer established as 

a result of MSRB rules G-37 and G-38. In addition, we requested data regarding our 

assumptions about the number of unregistered advisers that would be subject to the 

proposed rule, and the number of covered associates of these exempt advisers. Finally, in 

the context of the objectives of this rulemaking, we sought comments that address 

whether these rules will promote efficiency, competition and capital formation, and what 

effect the rule would have on the market for investment advisory services and third-party 

solicitation services. 

We received approximately 250 comment letters on the proposal. Almost all of 

the commenters agreed that pay to play is a serious issue that should be addressed. One 

commenter stated that “the benefits derived from the application of pay to play 

limitations to public sector advisory services will far outweigh any temporary 

dislocations that may occur as private and public sector professionals make the necessary 

adjustments to their activities to transition to the Commission's new standards.”448 Many, 

however, expressed concern about costs,449 particularly those related to the proposed ban 

on payments to third parties. Some suggested that the Commission underestimated the 

447	 Proposing Release, at section III.C. 

448	 MSRB Letter. See also Thompson Letter; Common Cause Letter; Fund 

Democracy/Consumer Federation Letter (each identifying benefits of the rule). 

449	 See, e.g., Davis Polk Letter (generally commenting that any benefits of the proposed rule 

were outweighed by its likely costs). See also ICI Letter; Monument Group Letter. 
 

 450 

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costs of compliance with the rule and rule amendments.450 As discussed below, many of 

the commenters that did comment specifically on the costs and benefits of the proposal 

did not provide empirical data to support their views. 

A. Benefits 

As we discuss extensively throughout this Release, we expect that rule 206(4)-5 

will yield several important direct and indirect benefits. Overall, the rule is intended to 

address pay to play relationships that interfere with the legitimate process by which 

advisers are chosen based on the merits rather than on their contributions to political 

officials. The potential for fraud to invade the various, intertwined relationships created 

by pay to play arrangements is without question. We believe that rule 206(4)-5 will 

reduce the occurrence of fraudulent conduct resulting from pay to play and thus will 

achieve its goals of protecting public pension plans, beneficiaries, and other investors 

from the resulting harms. One commenter who agreed with us commended the proposed 

rule as a “strong start in controlling corruption, balancing the rights of the advisors and 

See, e.g., SIFMA Letter (“While SIFMA believes that addressing practices that 

potentially undermine the merit-based selection of investment advisers is an important 

and laudable effort, the SEC appears to have underestimated the compliance costs the 

Proposed Rule will impose on covered parties.”); ICI Letter ([I]n relying on the estimates 

for compliance with the MSRB rules, the Commission significantly underestimates the 

compliance and recordkeeping burdens associated with the proposed rule.”); Davis Polk 

Letter (“We believe that the Commission may have substantially underestimated the 

number of investment advisers that will be affected by the Proposed Rule and its costs 

and market effects in concluding that many of the aspects of the Rule would impose only 

minimal additional costs and burdens on investors and investment advisers.”). The 

commenters who addressed our estimates, however, did so in general terms and did not 

provide specific suggestions as to how they should be modified. See the discussion 

below regarding changes from the proposed rule that we believe mitigate some of the 

costs. 
 

 

 

 

 

 

 

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their executives with the very real detriment to the public which the numerous cases of 

pay-to-play involving public pension funds and other public entities have caused.”451 

Addressing pay to play practices will help protect public pension plans and 

investments of the public in government-sponsored savings and retirement plans and 

programs by addressing situations in which a more qualified adviser may not be selected, 

potentially leading to inferior management, diminished returns or greater losses. One 

commenter who agreed, observed, “[w]hen lucrative investment contracts are awarded to 

those who pay to play, public pension funds may end up receiving substandard services 

and higher fees, resulting in lower earnings.”452 One public official commenter detailed 

the role of pay to play arrangements in the selection of public pension fund managers and 

the harm it can inflict on the affected plans,453 while other officials wrote to us explicitly 

expressing support for a Commission rule.454 By addressing pay to play practices, we 

will help level the playing field so that the advisers selected to manage retirement funds 

and other investments for the public are more likely to be selected based on the quality of 

their advisory services. These benefits, although difficult to quantify, could result in 

substantial savings and better performance for the public pension plans, their 

451	 Common Cause Letter. 

452	 Bloomberg Letter. 

453	 Weber Letter (“I have seen money managers awarded contracts with our fund which 

involved payments to individuals who served as middlemen, creating needless expense 

for the fund. These middlemen were political contributors to the campaigns of board 

members who voted to contract for money management services with the companies who 

paid them as middlemen.”). See also Pohndorf Letter (noting that when the sole trustee 

of a major pension fund changed several years ago, a firm managing some of the fund’s 

assets “began to receive invitations to fundraising events for the new trustee with 

suggested donation amounts”); Tobe Letter (suggesting the negative effects of pay to play 

activities on the Kentucky Retirement System’s investment performance). 

454	 See, e.g., DiNapoli Letter; Bloomberg Letter. 
 

 

 

 

 

 

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beneficiaries, and participants.455 Two commenters noted that the rule would promote the 

interests of plan beneficiaries.456 

By leveling the playing field among advisers competing for state and local 

government business, the rule will help minimize or eliminate manipulation of the market 

for advisory services provided to state and local governments.457 For example, direct 

political contributions or payments made to third-party solicitors as part of pay to play 

practices create artificial barriers to competition for firms that cannot, or will not, make 

those contributions or payments.458 They also increase costs for firms that may feel they 

have no alternative but to pay to play. The rule addresses a collective action problem 

created by this dynamic analogous to the one identified in the Blount opinion.459 One 

commenter emphasized the importance of restoring public confidence in the investment 

455	 According to the most recently available US census data, as of 2008, there are 2,550 state 

and local government employee retirement systems. http://www.census.gov/govs/retire/. 

See also Fund Democracy/Consumer Federation Letter (“These practices adversely affect 

the economic interests of millions of America’s public servants.”). 

456	 Comment Letter of John C. Emmel (Sept. 18, 2009) (“one more step to foster a level 

playing field for investors . . . where advisors’ priorities trump those of the investing 

public”); Comment Letter of George E. Kozel (Aug. 31, 2009) (“Kozel Letter”) (“Their 

interests lie in obtaining the highest fees not in producing benefits for the 

pensioners . . . .”). 

457	 See DiNapoli Letter (advocating for a “level playing field for investors and investment 

advisers that protects the integrity of the decision-making process [for hiring an 

investment adviser]”); Bloomberg Letter (“Pay to play practices clearly undermine the 

open competitive process by which government contracts are to be awarded.”). 

458	 See supra note 453. 

459	 See Blount, 61 F.3d at 945-46 (discussing the harms of pay to play: “Moreover, there 

appears to be a collective action problem tending to make the misallocation of resources 

persist.”). See also text accompanying notes 291-294 of this release. Collective action 

problems are a class of market failures calling for a regulatory response, and exist, for 

example, where participants may prefer to abstain from an unsavory practice (such as pay 

to play), but nonetheless participate out of concern that, even if they abstain, their 

competitors will continue to engage in the practice profitably and without adverse 

consequences. 
 

 

 

 

 

 

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activities of all public pension funds.460 Indeed, at its core, the rulemaking addresses 

practices that undermine the integrity of the market for advisory services, as underscored 

by another commenter.461 

Allocative efficiency is enhanced when government clients award advisory 

business to advisers that compete based on price, performance and service and not the 

influence of pay to play, which in turn enables advisory firms, particularly smaller 

advisory firms, to compete on merit, rather than their ability or willingness to make 

contributions.462 In addition, taking into account the effects of analogous practices in the 

underwriting of municipal securities prior to MSRB rule G-37,463 we believe a meritbased competitive process may result in the allocation of public pension monies to 

different advisers who may well deliver better investment performance and lower 

advisory fees than those advisers whose selection was influenced by pay to play. 

As adopted, the rule contains a prohibition against advisers directly or indirectly 

compensating a third party to solicit government entities on its behalf, unless the thirdparty solicitor is a “regulated person” subject to pay to play restrictions. This exception 

460	 Thompson Letter. See also Bloomberg Letter. 

461	 Common Cause Letter (“Pay-to-play has not only the potential to compromise an 

investment adviser’s ethical and legal duties under the Investment Advisers Act of 1940, 

but in several high profile cases across the nation, has already done so, negatively 

impacting the public perception of government decision making and, in some cases, 

costing the taxpayer millions of dollars and placing billions of dollars in pension funds at 

risk.”). See also Dempsey Letter (noting applause for efforts “to stop the ‘pay-to-play’ 

practice which only serves to undermine public trust in investment advisors and 

regulators”). 

462	 See Comment Letter of Budge Collins (Sept. 30, 2009) (the rule would “level the playing 

field for the rest of us who have never made contributions to elected officials who sit on 

investment management committees”). 

463	 One commenter cited a study containing evidence that before rule G-37 was adopted, 

underwriters’ pay to play practices distorted underwriting fees as well as which firms 

were hired by government issuers. See Butler Letter. 
 

 

 

 

 

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enables advisers and pension plans (and their beneficiaries) to continue to benefit from 

the services of third-party solicitors, such as the placement of interests in private funds, 

while at the same time benefitting from a Commission rule that prohibits pay to play 

practices.464 

Our rule may also benefit pension plans by preventing harms that can result when 

an adviser is not negotiating at arm’s length with a government official. For example, as 

a result of pay to play, an adviser may obtain greater ancillary benefits, such as “soft 

dollars,” from the advisory relationship, which may be directed for the benefit of the 

adviser, potentially at the expense of the pension plan, thereby using a pension plan asset 

for the adviser’s own purposes.465 Additionally, taxpayers may benefit from our rule 

because they might otherwise bear the financial burden of bailing out a government 

pension fund that has ended up with a shortfall due to poor performance or excessive fees 

that might result from pay to play.466 

In addition to the general benefits of addressing pay to play practices by 

investment advisers noted above, we believe the specific provisions of the rule, including 

the two-year time out, the ban on using third parties to solicit government business, and 

464	 Commenters, both on the Proposing Release and our 1999 proposal, argued that treating 

third-party solicitors as covered associates would create significant compliance 

challenges because these solicitors were not controlled by advisers. See supra note 264 

and accompanying text. 

465	 See supra note 55 and accompanying text. 

466	 See Kozel Letter (supporting the Commission’s proposal and asserting that the persons 

who engage in pay to play practices know that any shortfalls would be covered by 

taxpayers); Bloomberg Letter (“Because the City is legally obligated to make up any 

short fall in the pension system assets to ensure full payment of pension benefits, pay to 

play practices can potentially harm all New Yorkers.”). See also Common Cause Letter; 

1997 SURVEY, supra note 8 (“[t]he investment of plan assets is an issue of immense 

consequence to plan participants, taxpayers, and to the economy as a whole” as a low rate 

of return will require additional funding from the sponsoring government, which “can 

place an additional strain on the sponsoring government and may require tax increases”). 
 

 

 

 

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the restrictions on soliciting and coordinating contributions and payments will likely 

result in similar benefits to those that have resulted from MSRB rules G-37 and G-38, on 

which our rule is closely modeled. The MSRB rules have prohibited municipal securities 

dealers from participating in pay to play practices since 1994.467 As we have stated 

previously, we believe these rules have significantly curbed pay to play practices in the 

municipal securities market, and are likely to be similarly effective in deterring pay to 

play activities by investment advisers.468 

Applying the rule to government entity investments in certain pooled investment 

vehicles or where a pooled investment vehicle is an investment option in a governmentsponsored plan or program will extend the same benefits regardless of whether an adviser 

subject to the rule is providing advice directly to the government entity or is managing 

assets for the government entity indirectly through a pooled investment vehicle. By 

addressing distortions in the process by which investment decisions are made regarding 

public investments, we are providing important protections to public pension plans and 

their beneficiaries, as well as participants in other important plans or programs sponsored 

by government entities. Other investors in a pooled investment vehicle also will be better 

protected from, among other things, the effects of fraud that may result from an adviser’s 

participation in pay to play activities, such as higher advisory fees. 

Finally, the amendments to rule 204-2 will benefit the public plans and their 

beneficiaries and participants in state plans or programs as well as investment advisers 

that keep the required records. The public pension plans, beneficiaries, and participants 

467	 MSRB rule G-37 was approved by the Commission and adopted by the MSRB in 1994. 

See supra note 66. 

468	 See supra notes 101–107 and accompanying text. 
 

 

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will benefit from these amendments because the records required to be kept will provide 

Commission staff with information to review an adviser’s compliance with rule 206(4)-5 

and thereby may promote improved compliance. Advisers will benefit from the 

amendments to the recordkeeping rule as these records will assist the Commission in 

enforcing the rule against, for example, a competitor whose pay to play activities, if not 

uncovered, could adversely affect the competitive position of a compliant adviser. 

B. Costs 

We acknowledge that the rule and rule amendments will impose costs on advisers 

that provide or seek to provide advisory services to government clients directly, or 

indirectly through pooled investment vehicles. We discuss these costs below, along with 

a number of modifications we have made to the proposed rule and proposed amendments 

that will reduce costs. 

1. Compliance Costs Related to Rule 206(4)-5 

Rule 206(4)-5 requires an adviser with government clients to incur costs to 

monitor contributions made by the adviser and its covered associates and to establish 

procedures to comply with the rule. The initial and ongoing compliance costs imposed 

by the rule will vary significantly among firms, depending on a number of factors. Our 

estimated compliance costs, discussed below, take into account different ways a firm 

might comply with the rule. These factors include the number of covered associates of 

the adviser, the degree to which compliance procedures are automated (including policies 

and procedures that could require pre-clearance), the extent to which an adviser has a preexisting policy under its code of ethics or compliance program,469 and whether the 

One commenter stated that many investment advisers already have pay to play policies 

and procedures in place within the framework of their codes of ethics. See IAA Letter 

469 
 

 

 

 

 

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adviser is affiliated with a broker-dealer firm that is subject to MSRB rules G-37 and G38. A smaller adviser, for example, will likely have a small number of covered 

associates, and thus expend less resources to comply with the rule and rule amendments 

than a larger adviser. 

Although a larger adviser is likely to spend more resources to comply with the 

rule, based on staff observations, a larger adviser is more likely to have an affiliated 

broker-dealer that is required to comply with MSRB rules G-37 and G-38.470 As we 

learned from a broker-dealer with an investment adviser affiliate that commented on our 

1999 proposal, “the more the Rule mirrors G-37, the more firms can borrow from or 

build upon compliance procedures already in place. . . .”471 Accordingly, we believe 

(advocating for regulation that would address pay to play practices through an adviser’s 

code of ethics, as an alternative to the approach taken in proposed rule 206(4)-5). 

470	 According to registration information available from Investment Adviser Registration 

Depository (“IARD”) as of April 1, 2010, there are 1,332 SEC-registered investment 

advisers (or 11.48% of the total 11,607 registered advisers) that indicate in Item 5.D.(9) 

of Form ADV that they have state or municipal government clients. Of those 1,332 

advisers, 113 (or 85.0%) of the largest 10% have one or more affiliated broker-dealers or 

are, themselves, also registered as a broker-dealer. 204 of the largest 20% (or 76.7%) 

have one or more affiliated broker-dealers or are, themselves, also registered as a brokerdealer. Conversely, only 40 (or 30.1%) of the smallest 10% have one or more affiliated 

broker-dealers or are, themselves, also registered as a broker-dealer; and only 67 of the 

smallest 20% (or 25.2%) have one or more affiliated broker-dealers or are, themselves, 

also registered as a broker-dealer. With respect to broker-dealer affiliates, however, we 

note that our IARD data does not indicate whether the affiliated broker-dealer is a 

municipal securities dealer subject to MSRB rules G-37 and G-38. Also, as one 

commenter asserted, private fund managers may be among the larger advisers, based on 

assets under management, but they are unlikely to have an affiliated broker-dealer that 

has already adopted similar procedures to comply with MSRB rules G-37 and G-38 

because most private fund managers are not involved in municipal underwriting. MFA 

Letter. We acknowledge that a private fund manager generally would be less likely to 

have an affiliated broker-dealer from which it can borrow or build upon compliance 

procedures; however, we also expect that a private fund manager would use less 

resources than other large registered advisers to comply with the rule because a private 

fund manager is not subject to rule 206(4)-7, the Advisers Act compliance rule, and 

would likely have fewer employees and covered associates than a larger organization. 

471	 Comment Letter of US Bancorp Piper Jaffray Inc. (now, “Piper Jaffray & Co.”) (Nov. 15, 

1999). 
 

 

 

 

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some advisers with broker-dealer affiliates may spend fewer resources to comply with the 

rule and rule amendments. We recognize, as some commenters pointed out, that MSRB 

rules G-37 and G-38 compliance systems may not be easily extensible in all cases, and 

we acknowledge that the range of efficiencies created in these circumstances will vary.472 

A prominent concern of these commenters related to a proposed recordkeeping 

amendment which would have required advisers to keep records of solicitations— 

something that is not required under MSRB recordkeeping rule G-8. As previously 

discussed, we are not adopting that proposed amendment, which may address the concern 

noted by commenters. 

We anticipate that advisory firms subject to rule 206(4)-5 will develop 

compliance procedures to monitor the political contributions made by the adviser and its 

covered associates.473 We estimate that the costs imposed by the rule will be higher 

initially, as firms establish and implement procedures and systems to comply with the 

rule and rule amendments. We expect that compliance expenses would then decline to a 

relatively constant amount in future years, and annual expenses are likely to be lower for 

small advisers as the systems and processes should be less complex than for a large 

adviser. 

472	 SIFMA Letter. See also ICI Letter. 

473	 Investment advisers registered with the Commission are required to adopt and implement 

policies and procedures reasonably designed to prevent violation by the adviser or its 

supervised persons of the Advisers Act and the rules the Commission has adopted 

thereunder. See rule 206(4)-7. 
 

 

 

 

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We estimate that approximately 1,697 investment advisers registered with the 

Commission may be affected by the rule and rule amendments.474 Of the 1,697 advisers, 

we estimate that approximately 1,271 advisers have fewer than five covered associates 

that would be subject to the rule (each, a “smaller firm”); approximately 304 advisers 

have between five and 15 covered associates (each, a “medium firm”); and approximately 

122 advisers have more than 15 covered associates that would be subject to the 

prohibitions of the rule (each, a “larger firm”).475 

474	 This estimate is based on registration information from IARD as of April 1, 2010, 

applying the same methodology as in the Proposing Release. As previously noted, 

according to responses to Item 5.D(9) of Part 1 of Form ADV, 1,332 advisers have clients 

that are state or municipal government entities, which represents 11.48% of all advisers 

registered with us. 10,275 advisers have not responded that they have clients that are state 

or municipal government entities. Of those, however, responses to Item 5.D(6) of Part 1 

of Form ADV indicate that 2,486 advisers have some clients that are other pooled 

investment vehicles. Estimating that the same percentage of these advisers advise pools 

with government entity investors as advisers that have direct government entity clients— 

i.e.,11.48%. 285 of these advisers would be subject to the rule (2,486 x 11.48 % = 285). 

Out of the 10,275 that have not responded that they have clients that are state or 

municipal government entities, after backing out the 2,486 which have clients that are 

other pooled investment vehicles, responses to Item 5.D(4) of Part 1 of Form ADV 

indicate that 699 advisers have some clients that are registered investment companies. 

Estimating that roughly the same percentage of these advisers advise pools with 

government entity investors as advisers that have direct government entity clients— 

i.e.,11.48%. 80 of these advisers would be subject to the rule (699 x 11.48% = 80). 

Although we limited the application of rule 206(4)-5 with respect to registered 

investment companies to those that are investment options of a plan or program of a 

government entity, we continue to estimate that 80 advisers would have to comply with 

the recordkeeping provisions because of the difficulty in further delineating this 

estimated number. Therefore, we estimate that the total number of advisers subject to the 

rule would be: 1,332 advisers with state or municipal clients + 285 advisers with other 

pooled investment vehicle clients + 80 advisers with registered investment company 

clients = 1,697 advisers subject to rule. We expect certain additional advisers may incur 

compliance costs associated with rule 206(4)-5. We anticipate some advisers may be 

subject to the rule because they solicit government entities on behalf of other investment 

advisers. Additionally, some advisers that do not currently have government clients may 

seek to obtain them in the future. In doing so, they likely would conduct due diligence to 

confirm they would not be prohibited from receiving compensation for providing 

investment advisory services to the government client. 

475	 This estimate is based on registration information from IARD as of April 1, 2010. These 

estimates are based on IARD data, specifically the responses to Item 5.B.(1) of Form 

ADV, that 997 (or 74.9%) of the 1,332 registered investment advisers that have 
 

 

 

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One commenter disagreed with us basing our cost estimates on an assumption that 

most registered advisers would have fewer than five covered associates because the 

commenter expects most advisers to require all or most of their employees to receive 

approval prior to making any political contributions in order to avoid inadvertently 

triggering the rule.476 Although the rule does not require this approach and the changes 

we have made to the rule (e.g., modified definition of covered associate) should help 

address the concerns of this commenter that led to the assertion, we recognize that some 

advisers may voluntarily restrict all of their employees’ political contributions in such a 

manner. This type of pre-screening process could be perceived by the individuals subject 

to them as costs imposed on their ability to express their support for certain candidates 

for elected office and government officials. We also received a comment that our 

estimates should take into account turnover of personnel.477 Our cost estimate assumes a 

certain level of turnover; although these categories are based on an adviser’s number of 

covered associates, we have not calculated per-covered associate costs associated with 

this rulemaking. The categories of smaller, medium and larger advisers are based on an 

estimated number of covered associates, but are not intended to represent a static 

population of covered associates within each category. For instance, in estimating the 

ongoing burdens on advisers to comply with the rule, we implicitly incorporated a greater 

government clients have fewer than five employees who perform investment advisory 

functions, 239 (or 17.9%) have five to 15 such employees, and 96 (or 7.2%) have more 

than 15 such employees. We then applied those percentages to the 1,697 advisers we 

believe will be subject to the proposed rule for a total of 1,271 smaller, 304 medium and 

122 larger firms. 

476 See MFA Letter. 

477 ICI Letter. 
 

 

 

 

 

 

 

 

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degree of turnover at larger advisers in estimating that they would incur 1,000 hours 

annually as compared to the estimated 10 hours for a small adviser. 

Advisers that are unregistered in reliance on the exemption available under 

section 203(b)(3) of the Advisers Act [15 U.S.C. 80b-3(b)(3)] would be subject to rule 

206(4)-5.478 Based on our review of registration information on IARD and outside 

sources and reports, we estimate that there are approximately 2,000 advisers that are 

unregistered in reliance on section 203(b)(3).479 Applying the same principles we used 

with respect to registered investment advisers, we estimate that 230 of those advisers 

manage pooled investment vehicles in which government client assets are invested and 

would therefore be subject to the rule.480 For purposes of this analysis, it is assumed that 

each unregistered advisory firm that would be subject to the rule would either be a 

smaller firm or a medium firm in terms of number of covered associates because it is 

unlikely that an adviser that operates outside of public view and is limited to fewer than 

15 clients481 would have a large number of advisory personnel that would be covered 

associates. One commenter agreed that most of these unregistered advisers would be 

small, although the commenter based its assessment on assets under management, not on 

the adviser’s likely number of covered associates.482 

478	 The amendments to rules 204-2 and 206(4)-3, however, only apply to advisers that are 

registered, or required to be registered, with the Commission. 

479	 This number is based on our review of registration information on IARD as of April 1, 

2010, IARD data from the peak of hedge fund adviser registration in 2005, and a 

distillation of numerous third-party sources including news organizations and industry 

trade groups. 

480	 11.48% of 2000 is 230. See supra note 474. 

481	 See section 203(b)(3) of the Advisers Act [15 U.S.C. 80b-3(b)(3)] (advisers who rely on 

this exception from registration must have fewer than 15 clients in a 12-month period) . 

482	 3PM Letter. 
 

 

 

 

 

 

 

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Some commenters asserted that our estimated number of advisers subject to the 

proposed rule was too low.483 One claimed that the number of advisory firms exempted 

from registration in reliance on Section 203(b)(3) may be “over two times our estimate,” 

but provided statistics about the number of unregistered pooled investment vehicles, not 

the number of advisers to those pools.484 Other commenters did not provide empirical 

data or suggest alternative formulas by which to recalculate our estimate. Additionally, 

another seemed to misunderstand our estimates.485 

As we stated in the Proposing Release,486 although the time needed to comply 

with the rule will vary significantly from adviser to adviser, as discussed in detail below, 

the Commission staff estimates that firms with government clients will spend between 8 

hours and 250 hours to establish policies and procedures to comply with the rule. 

Commission staff further estimates that ongoing compliance with the rule will require 

between 10 and 1,000 hours annually. In addition, advisory firms may incur one-time 

costs to establish or enhance current systems to assist in their compliance with the rule. 

These costs would vary widely among firms. Small advisers may not incur any system 

costs if they determine a system is unnecessary due to the limited number of employees 

they have or the limited number of government entity clients they have. Large firms 

likely already have devoted significant resources into automating compliance and 

reporting and the new rule could result in enhancements to these existing systems. We 

483 See Davis Polk Letter; MFA Letter; 3PM Letter. 

484 3PM Letter. See also Davis Polk Letter (citing to 3PM Letter on this proposition). 

485 Davis Polk Letter (suggesting that we failed to take into account the costs likely to be 

borne by unregistered investment advisers). See supra notes 479 and 480 and 

accompanying text; Proposing Release, nn.219-20 and accompanying text (providing an 

estimate of the number of unregistered advisers we expect to be subject to this rule, and 

that must develop compliance systems). 

486 See Proposing Release, at section III.B. 
 

 

 

 

 

 

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believe such system costs could range from the tens of thousands of dollars for simple 

reporting systems, to hundreds of thousands of dollars for complex systems used by the 

large advisers. 

Initial compliance procedures would likely be designed, and ongoing 

administration of them performed, by compliance managers and compliance clerks. We 

estimate that the hourly wage rate for compliance managers is $294, including benefits, 

and for compliance clerks, $59 per hour, including benefits.487 To establish and 

implement adequate compliance procedures, we estimate that the rule would impose 

initial compliance costs of approximately $2,352 per smaller firm,488 approximately 

$29,407 per medium firm,489 and approximately $58,813 per larger firm.490 It is 

487	 Our hourly wage rate estimate for a compliance manager and compliance clerk is based 

on data from the Securities Industry Financial Markets Association’s Management & 

Professional Earnings in the Securities Industry 2009, modified by Commission staff to 

account for an 1800-hour work-year and multiplied by 5.35 (in the case of compliance 

managers) or 2.93 (in the case of compliance clerks) to account for bonuses, firm size, 

employee benefits and overhead. The calculations discussed in this release are updated 

from those included in the Proposing Release to incorporate data from the most recently 

updated version of this publication. 

488	 The per firm cost estimate is based on our estimate that development of initial 

compliance procedures for smaller firms would take 8 hours of compliance manager time 

(at $294 per hour). Accordingly, the per firm cost estimate is $2,352 (8 x $294). 

489	 With respect to our estimated range of 8-250 hours, we assume a medium firm would 

take 125 hours to develop initial compliance procedures, and such a firm would likely 

have support staff. We also anticipate that a compliance manager would do 

approximately 75% of the work because he or she is responsible for implementing the 

policy for the entire firm. Accordingly, the per firm cost estimate is based on our 

estimate that development of initial compliance procedures for medium firms would take 

93.75 hours of compliance manager time, at $294 per hour (or $27,563), and 31.25 hours 

of clerical time, at $59 per hour (or $1,844), for a total estimated cost of $29,407. 

490	 With respect to our estimated range of 8-250 hours, we assume a larger firm would take 

250 hours to develop initial compliance procedures, and such a firm would likely have 

support staff. We also anticipate that a compliance manager would do approximately 

75% of the work because he/she is responsible for implementing the policy for the entire 

firm. Accordingly, the per firm cost estimate is based on our estimate that development 

of initial compliance procedures for larger firms would take 187.50 hours of compliance 
 

 

 

 

 

 

 

 

 

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estimated that the rule would impose annual, ongoing compliance expenses of 

approximately $2,940 per smaller firm,491 $117,625 per medium firm,492 and $235,250 

per larger firm.493 

In establishing these estimates, which are calculated in the same manner as those 

we included in the Proposing Release, we took into consideration comments in 1999 that 

suggested our cost estimates were too low.494 Our staff, in developing the estimates 

contained in the Proposing Release, also engaged in conversations with industry 

professionals regarding broker-dealer compliance with rules G-37 and G-38 and 

representatives of investment advisers that have pay to play policies in place.495 We 

significantly increased our cost estimates from the 1999 proposal as a result. Some 

commenters on the proposed rule asserted that our projected costs are too low, but did not 

provide empirical data or formulas for us to review.496 One commenter indicated that, 

“as a practical matter, although there may be significant differences in the number of 

hours dedicated to ongoing annual compliance between firms of different sizes, the 

manager time, at $294 per hour (or $55,125), and 62.5 hours of clerical time, at $59 per 

hour (or $3,688), for a total estimated cost of $58,813. 

491	 The per firm cost estimate is based on our estimate that ongoing compliance procedures 

for smaller firms would take 10 hours of compliance manager time, at $294 per hour, for 

a total estimated cost of $2,940 per year. 

492	 The per firm cost estimate is based on our estimate that ongoing compliance procedures 

for medium firms would take 375 hours of compliance manager time, at $294 per hour 

(or $110,250), and 125 hours of clerical time, at $59 per hour (or $7,375), for a total 

estimated cost of $117,625 per year. 

493	 The per firm cost estimate is based on our estimate that ongoing compliance procedures 

for larger firms would take 750 hours of compliance manager time, at $294 per hour (or 

$220,500) and 250 hours of clerical time, at $59 per hour (or $14,750), for a total cost of 

$235,250 per year. 

494	 See Proposing Release, at n.226 and accompanying text. 

495	 Id. at section III.B. 

496	 See, e.g., ICI Letter; MFA Letter; SIFMA Letter. 
 

 

 

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estimated number of hours needed to develop initial compliance procedures will be 

similar for all firms, regardless of size. The initial effort of designing and implementing 

new policies and procedures and educating personnel will require similar effort and 

upfront fixed costs.”497 We disagree. Although there are some aspects of implementing a 

compliance program that would be similar among all firms regardless of their number of 

covered associates, we expect most costs will vary significantly among firms of different 

sizes as they engage in such activities as developing and monitoring reporting 

mechanisms to track covered associate contributions, revising their codes of ethics, 

training their employees, and performing routine quality control tests. 

In the Proposing Release, we estimated that 75% of larger advisory firms, 50% of 

medium firms, and 25% of smaller firms that are subject to the rule may also engage 

outside legal services to assist in drafting policies and procedures, based on staff 

observations. In addition, we also estimated the cost associated with such an engagement 

would include fees for approximately three hours of outside legal review for a smaller 

firm, 10 hours for a medium firm, and 30 hours for a larger firm. One commenter 

suggested that we had underestimated both the percentage of advisers that would engage 

outside counsel and the number of hours that outside counsel would spend lending their 

assistance, but did not provide alternative estimates.498 Based on our staff’s experience 

administering the compliance program rule, we continue to believe that our estimates for 

the number of firms that will retain outside counsel for review of policies and procedures 

are appropriate. Based on this comment, however, we have revisited the number of hours 

we estimated outside counsel would spend reviewing policies and procedures and have 

497 See Davis Polk Letter. 

498 Id. 
 

 

 

 

 

 

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increased these estimates. We now estimate the cost associated with such an engagement 

would include fees for approximately eight hours of outside legal review for a smaller 

firm, 16 hours for a medium firm, and 40 hours for a larger firm, at a rate of $400 per 

hour.499 Consequently, for a smaller firm we estimate a total of $3,200 in outside legal 

fees for each of the estimated 318 advisers that would seek assistance, for a medium firm 

we estimate a total of $6,400 for the estimated 152 advisers that would seek assistance, 

and for each of the 92 larger firms we estimate a total of $16,000. Thus, we estimate that 

approximately 562 investment advisers will incur these additional costs, for a total cost of 

$3,462,400500 among advisers affected by the rule amendments.501 

One commenter suggested that, due to the complexity of, and variation among, 

state and local laws, it might be more difficult than we had accounted for in the proposal 

for an adviser to determine with certainty who could be a covered official, and as a result, 

a greater number of advisers would seek the help of outside counsel to make this 

determination than we estimated.502 Although the commenter did not provide an estimate 

of how many firms might seek such assistance, we believe that the additional guidance 

we have provided in the discussion of officials will address this commenter’s concerns 

and result in fewer consultations with outside counsel than anticipated. In addition, it is 

our understanding from discussions with those involved in advising on compliance with 

499	 In the Proposing Release we estimated the hourly cost of outside counsel to be $400 

based on our consultation with advisers and law firms who regularly assist them in 

compliance matters. We did not receive comment on this estimate and continue to 

believe that it is an accurate estimate. 

500	 (318 x $3,200 = $1,017,600) + (152 x $6,400 = $972,800) + (92 x $16,000 = $1,472,000) 

= $3,462,400. 

501	 One commenter asserted that a greater number of firms would seek assistance of counsel, 

regardless of size, but did not provide data to support its assertion. Davis Polk Letter. 

502	 Caplin & Drysdale Letter. See also IAA Letter; MFA Letter. 
 

 

 

 

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MSRB rules G-37 and G-38 that a small percentage of persons subject to the rule seek 

legal assistance to make these determinations. Our rule uses substantially similar 

definitions of “official” of a “government entity” to those used in the MSRB rules; 

therefore we expect that the percentage of advisory firms that would retain legal counsel 

to make these determinations would be similarly small. Moreover, we anticipate that the 

advisers that are most likely to need assistance identifying officials of government 

entities are larger advisers, whose businesses tend to be national in scope and whose 

clients are located throughout the country. If all 122 of the larger advisory firms we 

estimate are subject to the rule retain legal counsel at a rate of $400 per hour, for 

approximately 20 hours per year, those advisers would incur an estimated total of 

$976,000 in legal fees.503 

In the Proposing Release, we estimated that approximately five advisers annually 

would apply to the Commission for an exemption from the rule, based on staff 

discussions with the FINRA staff responsible for reviewing exemptive applications 

submitted under MSRB rule G-37, and that outside counsel would spend 16 hours 

preparing and submitting an application. We received criticism that these approximations 

were too low.504 Given that the advisory industry is much larger than the municipal 

securities industry, and in light of the number of comment letters we received that 

expressed concern about inadvertent violations of the rule that would not qualify for the 

exception for returned contributions, our staff estimates that approximately seven 

advisers annually would apply to the Commission for an exemption from the rule. 

Although we may initially receive more than seven applications a year for an exemption, 

503 $400 x 20 = $8,000, and $8,000 x 122 = $976,000. 

504 See Davis Polk Letter; ICI Letter. 
 

 

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over time, we expect the number of applications we receive will significantly decline to 

an average of approximately seven annually. We continue to believe that a firm that 

applies for an exemption will hire outside counsel to prepare an exemptive request, but 

based on commenters concerns have raised the number of hours counsel will spend 

preparing and submitting an application from 16 hours to 32 hours, at a rate of $400 per 

hour.505 As a result, each application will cost approximately $12,800, and the total 

estimated cost for seven applications annually will be $89,600. 

2. Other Costs Related to Rule 206(4)-5 

The prohibitions of the rule may also impose other costs on advisers, covered 

associates, third-party solicitors, and political officials. 

(a) Two-Year Time Out 

An adviser that becomes subject to the prohibitions of the rule would no longer be 

eligible to receive advisory fees from its government client. This would result in a direct 

loss to the adviser of revenues and profits relating to that government client, although 

another adviser that the government client subsequently chose to retain would see an 

increase in revenues and profits. The two-year time out could also limit the number of 

advisers able to provide services to potential government entity clients. An adviser that 

triggers the two-year time out may be obligated to provide (uncompensated) advisory 

services for a reasonable period of time until the government client finds a successor to 

ensure its withdrawal did not harm the client, or the contractual arrangement between the 

adviser and the government client might obligate the adviser to continue to perform under 

the contract at no fee. An adviser that provides uncompensated advisory services to a 

The hourly cost estimate of $400 is based on our consultation with advisers and law firms 

who regularly assist them in compliance matters. 

505 
 

 

 

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government client would, at a minimum, incur the direct cost of providing 

uncompensated services, and may incur opportunity costs if the adviser is unable to 

pursue other business opportunities for a period of time. 

Advisers to government clients, as well as covered associates of the adviser, also 

may be less likely to make contributions to government officials, including candidates, 

potentially resulting in less funding for these officials. Under the rule, advisers and 

covered associates will be subject to new limitations on the amounts and to whom they 

can contribute without triggering the rule’s time out provision. In addition, these same 

persons will be prohibited from soliciting others to contribute or from coordinating 

contributions to government officials, including candidates, or payments to political 

parties in certain circumstances. These limitations and prohibitions, including if a firm 

chooses to adopt policies or procedures that are more restrictive than the rule, could be 

perceived by the individuals subject to them as costs imposed on their ability to express 

their support for certain candidates for elected office and government officials.506 In 

addition to these costs, the rule’s impact on advisers’ and employees’ contributions will 

introduce some inefficiency into the allocation of contributions to candidates and officials 

as the rule impacts contributions regardless of whether they are being made for the 

purpose of engaging in pay to play. 

We have made several modifications to the rule from the proposal that will reduce 

these costs or burdens. We are creating a new exception to the two-year time out for 

One commenter suggested that the proposed rule would inhibit individuals who work for 

an investment adviser from running for office because, if they were successful, it may 

cost their former employer business. Caplin & Drysdale Letter. We have addressed this 

comment by making it clear that an individual can contribute to his or her own campaign 

without triggering the rule. See supra note 139. 

506 
 

 

 

 

 

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contributions made by a natural person more than six months prior to becoming a covered 

associate unless he or she, after becoming a covered associate, solicits clients on behalf of 

the investment adviser.507 This modification will decrease the burdens on both 

employees and employers in terms of tracking and limiting employee contributions prior 

to becoming employed or promoted by an investment adviser. In terms of narrowing the 

scope of “covered investment pools,” we included a registered investment company in 

the definition of covered investment pool, for purposes of all three of the rule’s pay to 

play prohibitions, only if it is an investment option of a plan or program of a government 

entity.508 As noted above, we believe this approach strikes the right balance between 

applying the rule in those contexts in which advisers to registered investment companies 

are more likely to engage in pay to play conduct while recognizing the compliance 

challenges and costs that may result from a broader application of the rule. We are also 

broadening the exception to the rule’s time out provision in several respects that should 

further decrease the compliance costs associated with the two-year time out and will 

lower any perceived costs on covered associates’ ability to express their support for 

candidates. We are increasing the aggregate contribution amount eligible for the 

exception for certain returned contributions from $250 to $350 to any one official per 

election,509 and we are increasing the number of times an adviser is permitted to rely on 

the returned contributions exception from two to three per calendar year for advisers with 

more than 50 employees.510 Furthermore, we are making the same adjustment from $250 

507 Rule 206(4)-5(b)(2). 

508 Rule 206(4)-5(f)(3) and (f)(8). 

509 Rule 206(4)-5(b)(3). 

510 Id. 
 

 

 

 

 

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to $350 for contributions eligible for the de minimis exception,511 and we are adopting a 

de minimis exception for contributions not exceeding $150 made by individuals who are 

not entitled to vote for the candidate.512 

Several commenters highlighted the costs of the two-year time out to the adviser 

and government entity client, as well as pension fund beneficiaries, stating that the time 

out could force termination of long-standing relationships and may result in a permanent 

termination of the advisory relationship.513 We acknowledge that advisers subject to the 

time out may lose a government client’s business beyond the two-year period and are 

sensitive to the concerns of commenters regarding the operation of the rule on public 

pension funds, including the burdens they may face in replacing managers and the 

possibility that some managers may no longer seek to manage public plan assets as a 

result of the rule. We believe that these costs are necessary to accomplish our goal of 

addressing pay to play and are justified by the benefits of rule 206(4)-5. As discussed 

above, rule 206(4)-5 is modeled on the pay to play rules adopted by the MSRB, which 

have significantly curbed pay to play practices in the municipal securities market. We 

believe that adopting a two-year time out similar to the time out applicable under the 

MSRB rules is appropriate, and that the fiduciary relationship advisers have with public 

511	 Rule 206(4)-5(b)(1). 

512	 See id. 

513	 See, e.g., ICI Letter (“[E]xisting state and local government clients may be harmed by the 

forced termination of a mutually beneficial business relationship, despite receiving free 

services for a period of time, because the government client is subject to the costs 

associated with selecting a new adviser, and plan beneficiaries are subject to the costs 

associated with portfolio commissions and other restructuring costs. Consequently, our 

members believe that the two-year ban will operate as a permanent ban because a 

government entity will be unlikely to go through the process of identifying and hiring a 

replacement adviser, and then return to the original adviser after the ban ends.”). See also 

IAA Letter; NASP Letter; SIFMA Letter. 
 

 

 

 

 

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pension plans argues for a strong prophylactic rule. Finally, while we have designed the 

rule to reduce its impact,514 investment advisers are best positioned to protect government 

clients by developing and enforcing robust compliance programs designed to prevent 

contributions from triggering the two-year time out. 

Commenters also noted, particularly, the potential harm of the two-year time out 

to government clients and to other investors in a fund that holds illiquid securities when a 

government investor redeems its interests in the fund as a result of the fund adviser’s 

triggering contribution.515 As we note above, however, our rule does not require an 

adviser that has triggered the time out to redeem the interests of a government investor or 

cancel its commitment. The adviser may have multiple options available from which to 

select to comply with the rule in light of its fiduciary obligations and the disclosure it has 

made to investors. The adviser could instead comply with the rule by waiving or rebating 

the portion of its fees or any performance allocation or carried interest attributable to the 

government client.516 

Most of the comments we received about the costs of this aspect of the proposed 

rule, however, focused on the costs of an inadvertent violation.517 We understand that 

there will be costs, sometimes quite significant, as a result of inadvertent violations. 

However, with these potential costs in mind, we have taken additional steps to decrease 

514 See, e.g., section II.B.2(a)(6) of this Release (discussing the de minimis exceptions to the 

two-year time out); section II.B.2(f) of this Release (discussing the rule’s exemptive 

provision). 

515 CT Treasurer Letter; NY City Bar Letter. 

516 See supra note 385 and accompanying text. 

517 See, e.g., IAA Letter (“We are concerned that the Commission has not considered the 

significance of the sanctions imposed as a result of an adviser’s inadvertent violation of 

the rule.”). 
 

 

 

 

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the likelihood of inadvertent violations of the rule. First, as discussed above, we 

shortened the look back with respect to most covered associates. We expect this new 

exception will provide an additional mechanism for advisers to avoid the cost of a time 

out as a result of an inadvertent violation and will largely address commenters’ concerns 

about the screening burdens for new or promoted employees that this aspect of the 

proposal would have imposed on advisers.518 Second, as discussed above, we are 

increasing to $350 the amount eligible for an exception for certain returned contributions 

from what we had proposed, we are increasing the number of times an adviser is 

permitted to rely on the returned contributions exception, and we are also adopting an 

additional de minimis exception for certain contributions not exceeding $150. Last, we 

note that an adviser’s implementation of a strong compliance program will reduce the 

likelihood, and therefore costs, of inadvertent violations. 

One commenter asserted that the proposed rule would put advisers at a 

competitive disadvantage to other providers of advisory services to government plans that 

would not be subject to it, such as banks and insurance companies.519 As we stated 

earlier, we believe that the concerns that we are trying to address with the rule justify its 

adoption, notwithstanding the potential competitive effects that advisers may face as a 

518	 IAA Letter (“Under the Proposal, investment advisers would be required to screen for 

and eliminate potential employment candidates based upon contributions made for a 

period of up to twenty-four months before the person would begin employment with the 

adviser. This requirement . . . would be extremely costly and burdensome to 

implement.”); Wells Fargo Letter (“The “look back” provision is too draconian. . . . [A] 

compliance system [will be] costly to develop and arduous to implement . . . [and] it 

would also impose severe limitations on the career opportunities of those newly entering 

the investment advisory world who are weighed down by political contributions that were 

completely innocuous when made.”). 

519	 NY City Bar Letter. 
 

 

 

 

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result of the limits on our jurisdiction. We also do not view competition by means of 

engaging in practices such as pay to play as an interest that we need to protect. 

(b) Third-Party Solicitor Ban 

Under our proposal, advisers would have been prohibited from compensating any 

third party to solicit government entities for advisory services, other than “related 

persons.”520 As a result, advisers that rely on third-party solicitors to obtain government 

clients would have had to bear the expense of hiring and training in-house staff in order 

to continue their solicitation activities,521 a result that commenters said would be 

particularly costly for small and new investment advisers.522 In addition, third-party 

solicitors might also have experienced substantial negative consequences under the 

520	 Proposed rule 206(4)-5(a)(2)(i)(a). 

521	 See, e.g., Comment Letter of Greenhill & Co., LLC (Oct. 2, 2009) (“The elimination of 

placement agents would add a significant administrative and cost burden to fund sponsors 

seeking investors.”). See also Alta Letter; Atlantic-Pacific Letter; Braxton Letter; 

Benedetto Letter; CA Assoc. of County Retirement Letter; Capstone Letter; EVCA 

Letter; GA Firefighters Letter; Glovista Letter; IL Fund Association Letter; MN Board 

Letter; Myers Letter; NCPERS Letter; NYC Teachers Letter; PA Public School 

Retirement Letter; Reed Letter; Myers Letter; TX Public Retirement Letter; WI Board 

Letter; Credit Suisse Letter (“Moreover, by performing these functions, placement agents 

enable investment advisers to focus on their core expertise, investment management, and 

to avoid the necessity of developing the costly in-house resources necessary to raise 

capital directly.”). 

522	 See, e.g., MFA Letter (“[M]anagers that engage placement agents, particularly small and 

offshore managers, would lose the ability to market their services to government clients 

or incur significantly higher costs to hire internal marketing personnel; and managers that 

hire internal personnel could spend substantial amounts to register as a broker-dealer.”). 

See also SIFMA Letter; IAA Letter; Seward & Kissel Letter; Sadis & Goldberg Letter; 

WI Board Letter; GA Firefighters Letter; MN Board Letter; IL Fund Association Letter; 

NYC Teachers Letter; TX Public Retirement Letter; PA Public School Retirement Letter; 

Ehrmann Letter; Finn Letter; Savanna Letter; Atlantic-Pacific Letter; Peterson Letter; 

Devon Letter; Chaldon Letter; Meridian Letter; Benedetto Letter; Capstone Letter; 

Braxton Letter; Littlejohn Letter; Alta Letter; Charles River Letter; Reed Letter; Glovista 

Letter; Blackstone Letter; Park Hill Letter. 
 

 

 

 

 

 

 

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proposed rule.523 We heard from many commenters on this issue, offering various 

perspectives on how the costs would outweigh the benefits of the proposed prohibition.524 

A few commenters asserted that this proposal would have a significant adverse effect on 

efficient capital formation in that it would make it more difficult for private equity and 

venture capital managers to obtain funding that they in turn can invest in portfolio 

companies.525 As other commenters pointed out, this aspect of our proposed rule might 

also have placed a significant burden on public pension plans,526 particularly smaller 

523	 Proposing Release, at 89. See also Thomas Letter (“The ban would very likely cripple 

many legitimate placement agents – most of whom are currently regulated by the SEC 

and FINRA – as the public pension plans are the largest source of capital for alternative 

investments.”); Comment Letter of the Managing Partner of Bridge 1 Advisors, LLC 

Robert G. McGroarty (Sept. 24, 2009) (“Bridge 1 Letter”); SIFMA Letter. 

524	 See, e.g., Davis Polk Letter (“While we strongly support the underlying purpose of the 

Proposed Rule, we believe that this ban on all third-party solicitors is overly expansive 

and the costs inflicted on both investment advisers and government clients from lack of 

access to the valuable services provided by most third-party solicitors outweigh any 

expected benefits to be gained from its adoption.”); Capstone Letter (suggesting that 

many placement agent firms are small businesses helping investment managers that are, 

themselves, minority- or women-owned small businesses, and that, together, they are 

creating jobs and helping other businesses by efficiently directing capital); Monument 

Letter (making a similar comment regarding the minority and female ownership of 

placement agents); Glantz Letter; Comment Letter of Indian Harbor Partner Robert W. 

Stone (Aug. 13, 2009) (“Indian Harbor Letter”); Kurmanaliyeva Letter; M Advisory 

Letter (adding that the investment management industry as a whole will incur “dramatic 

job losses”); Parenteau Letter. 

525	 Alta Letter; Benedetto Letter; Comment Letter of Berkshire Property Advisors, LLC 

(Sept. 29, 2009) (“Berkshire Letter”); Bridge 1 Letter; Comment Letter of Hampshire 

Real Estate Companies (Sept. 29, 2009); Comment Letter of Thomas J. Mizo on behalf of 

HFF Securities L.P. (Sept. 24, 2009); M Advisory Letter; Monument Group Letter; 

Comment Letter of Psilos Group Managers, LLC (Sept. 28, 2009). 

526	 See, e.g., Park Hill Letter (“The Commission has commented that if the Placement Agent 

Ban is adopted, Public Pension Investors can seek to engage placement agents themselves 

in order to continue to have access to their services in helping to find the best Fund 

Sponsors. However, that would impose costs on Public Pension Investors that they do 

not currently incur. Moreover, as the Commission has acknowledged in its cost-benefit 

analysis, if the Placement Agent Ban were adopted, Fund Sponsors who do not have inhouse marketing staffs would be disproportionately disadvantaged relative to larger firms 

that have those internal resources in the competition for obtaining access to Public 

Pension Investors and other institutional investors.”); Thomas Letter (“A ban on 

placement agents would have significant unintended consequences for public pension 
 

 

 527 

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plans because third-party solicitors provide services that plans may value, including 

serving as placement agent for alternative investments and serving a screening function 

with respect to those investments presented to the pension plan.527 

Others argued, for similar reasons as those expressed above, that it would also 

harm public pension plans to ban payments to third parties because it would decrease 

plans. . . . [For instance, the] incremental effort by investment staffs to perform due 

diligence on promising but possibly ill-prepared investment managers will raise the cost 

and lessen the overall pension fund portfolio performance.”); Comment Letter of Austin 

F. Whitman (Sept. 21, 2009) (“Without access to placement agents, government pensions 

would be significantly disadvantaged relative to their private sector peers, with limited 

access (and benefit from) the services described above.”); ABA Letter. But see Fund 

Democracy/Consumer Federation Letter (“The proposed ban would simply replace the 

indirect cost of placement agents incurred by pension plan sponsors with the direct cost 

of hiring their own placement agents – without the conflict of interest and potential for 

abuse that relying on advisers’ placement agents creates.”). 

See, e.g., Ogburn Letter; Schmitz Letter (highlighting the valuable “pre-vetting” function 

of placement agents, especially in light of pension funds’ budgetary pressures and lean 

staffs); Savanna Letter (discussing the “pre-screening” effect that reputable placement 

agent client selection provides for pension professionals); Atlantic-Pacific Letter; Indian 

Harbor Letter; Peterson Letter; Rubenstein Letter; Comment Letter of Réal Desrochers 

(Aug. 20, 2009) (noting that from the perspective of a former pension fund investment 

officer, “[t]he skill sets of certain placement agents streamlined what they brought to our 

attention and made our internal process much more efficient.”); Devon Letter; Thomas 

Letter; Myers Letter; PRIM Board Letter (“[T]he Commission should strongly resist the 

politically expedient suggestion that an outright ban on the use of placement agents is 

somehow good for plan sponsors; nothing could be further than the truth.”); Meridian 

Letter; Comment Letter of Norman G. Benedict (Sept. 30, 2009) (indicating that, from 

the perspective of a retired public pension chief investment officer, placement agents 

provide an essential and invaluable service, particularly with providing access to private 

equity fund investments, which often yielded higher returns than more traditional, 

publicly traded securities); Berkshire Letter; Comment Letter of The British Private 

Equity and Venture Capital Association (Sept. 18, 2009) (“BVCA Letter”) (“Placement 

agents are not just a crude middleman in the fundraising process”); CT Treasurer Letter; 

Credit Suisse Letter (describing four key functions its placement agent group performs); 

Portfolio Advisors Letter (noting that among the valuable services provided are: “(1) 

helping new fund sponsors to become more established among the institutional investor 

community; (ii) helping sponsors to complete RFPs, provide information and respond to 

questions, which, in turn, gives the public pension plans and other investors a broader 

pool of investment options; and (iii) serving as intermediaries in uniting capital with fund 

sponsors who can put the money to work by investing in businesses and creating value”); 

George Letter; Comment Letter of Rahul Mehta (Sept. 11, 2009); Touchstone Letter; 

SIFMA Letter. 
 

 

 

 

 

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competition by reducing the number of advisers competing for government business528 

and limit the universe of investment opportunities presented to public pension funds.529 

We believe our decision to modify the proposed rule to permit advisers to make 

payments to certain “regulated persons” to solicit government clients on their behalf,530 

as described in more detail above, should alleviate many of these concerns, including 

those from private equity and venture capital managers on capital formation.531 In 

particular, we believe the concerns expressed by private equity and venture capital 

managers regarding the effects of the rule on capital formation have been substantially 

addressed by the modification for payments to “regulated persons.” We expect advisers 

that engage the services of regulated person solicitors will incur limited costs to initially 

confirm and subsequently monitor the solicitor’s eligibility to be a “regulated person.” 

Nevertheless, we expect this exception to the third-party solicitor ban will substantially 

reduce the costs commenters associated with this aspect of the proposal. 

We acknowledge, however, that the third-party solicitor ban will nonetheless have 

a substantial negative impact on persons who provide third-party solicitation services that 

528	 See, e.g., Seward & Kissel Letter; Meridian Letter; SIFMA Letter; Comment Letter of 

Oakpoint Advisors (Aug. 26, 2009); Comment Letter of SeaCrest Investment 

Management, LLC (Sept. 25, 2009). 

529	 See, e.g., Braxton Letter (stressing not only the increased costs that public pension funds 

will likely face, but also the likely reduction in creative investment strategies and 

opportunities available as a result of smaller and emerging funds being forced out of the 

market); BVCA Letter; CT Treasurer Letter; SIFMA Letter; IAA Letter; Strategic Capital 

Letter; Alta Letter; Benedetto Letter; Glantz Letter; Kurmanaliyeva Letter; Park Hill 

Letter. 

530	 See Rule 206(4)-5(a)(2)(i). 

531	 Our decision not to adopt the “related person” exception contained in the proposed rule 

does not diminish our belief. As we noted above, we believe our modification of the ban 

to allow advisers to pay “regulated persons” to solicit government entities on their behalf 

will still allow advisers to use employees of certain related companies—i.e., of those 

related companies that qualify as “regulated persons”—as solicitors. 
 

 

 

 

 

 

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are not regulated persons, including state-registered advisers.532 If their businesses 

consist solely of soliciting government entities on behalf of investment advisers, the rule 

could result in these persons instead being employed directly by regulated persons, 

shifting the focus of their solicitation activities, seeking to change their business model to 

shift their source of payment from investment advisers to pension plans, or going out of 

business.533 In addition, we acknowledge that the third-party solicitor ban may adversely 

affect both competition and allocative efficiency in the market for advisory services 

where third-party solicitors that are not regulated persons participate. We have carefully 

considered these effects. As discussed above, however, we do not have regulatory 

authority to oversee the activities of state-registered advisers through examination and 

our recordkeeping rules. Nor do we have authority over the states to oversee their 

enforcement of their rules, as we do with FINRA. As a result, we have not included 

state-registered advisers in the definition of regulated person.534 

In addition, some commenters suggested that the third-party prohibition could 

have a negative impact on the efficient allocation of capital for government plans, 

particularly small ones, and advisers that seek to manage these assets directly (not 

through a covered investment pool).535 These small government plans may, as a result of 

the rule’s ban on payments to third parties, have fewer managers to select from to the 

extent that larger advisers choose not to participate in this market. In addition, both 

government plans and advisers that seek these government clients may have to hire 

532 As we note above, state-registered advisers are subject neither to our oversight nor to the 

recordkeeping rules we are adopting today. 

533 See supra note 523. 

534 See supra note 325 and accompanying text. 

535 See, e.g., 3PM Letter; Bryant Law Letter. 
 

 

 

 

 

 

 

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internal staff, respectively, to identify potential advisers and potential government clients 

to the extent these functions are not internalized. However, these commenters did not 

discuss the potentially significant costs that exist today of hiring third-party solicitors, 

and that eliminating the cost of pay to play may, in fact, provide greater access to pension 

plans by those advisers that are currently unable to afford the costs of direct or indirect 

political contributions or third-party solicitor fees.536 We expect that prohibiting pay to 

play will reduce the costs to plans and their beneficiaries that may result when adviser 

selection is based on political contributions rather than investment considerations.537 

3. Costs Related to the Amendments to Rule 204-2 

The amendments to rule 204-2 require SEC-registered advisers with government 

clients to maintain certain records of campaign contributions by certain advisory 

personnel and records of the regulated persons the adviser pays or agrees to pay to solicit 

government entities on its behalf.538 Records are a critical complement to rule 206(4)-5. 

In particular, such records are necessary for examiners to inspect advisers for compliance 

with the terms of the rule. 

536	 At least one commenter agreed. See Butler Letter (“[W]e find some evidence that the pay 

to play practices by underwriters [before rule G-37 was adopted] distorted not only the 

fees, but which firms were allocated business. The current proposal mentions that pay to 

play practices may create an uneven playing field among investment advisers by hurting 

smaller advisers that cannot afford to make political contributions. We find evidence that 

is consistent with this view [in our research on pay to play by municipal underwriters]. 

During the pay to play era, municipal bonds were underwritten by investment banks with 

larger underwriting market shares compared to afterward. One interpretation of this result 

is that smaller underwriters were passed over in favor of larger underwriters (who 

presumably had deeper pockets for political contributions).”). 

537	 See supra notes 452 & 453 and accompanying text (describing commenters’ observations 

about some of the pay to play costs to plans and their beneficiaries). 

538	 Unregistered advisers that would be subject to rule 206(4)-5 would not be subject to the 

amendments to rule 204-2. 
 

 

 

 

 

 

 

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As described below, for purposes of the Paperwork Reduction Act of 1995 

(“PRA”),539 we have estimated that Commission-registered advisers would incur 

approximately 3,394 additional hours annually to comply with the amendments to rule 

204-2.540 Based on this estimate, we anticipate that advisers would incur an aggregate 

cost of approximately $200,246 per year for the total hours advisory personnel would 

spend in complying with the recordkeeping requirements.541 In addition, we expect 

advisory firms may incur one-time costs to establish or enhance current systems to assist 

in their compliance with the amendments to rule 204-2. For purposes of the PRA, we 

have estimated that some small and medium firms will incur start-up costs, on average, of 

$10,000, and larger firms will incur, on average, $100,000. As a result, the amendments 

to rule 204-2 are estimated to increase the PRA non-labor cost burden by $20,080,000.542 

We received a number of specific comments on this aspect of the proposal, many 

of which included assertions about cost burdens associated with maintaining records 

related to unsuccessful solicitations, and urged us to reconsider the benefits to be gained 

from such a requirement in light of the costs.543 We were persuaded by these 

539	 44 U.S.C. 3501. 

540	 See infra note 559 and accompanying text. 

541	 We expect that the function of recording and maintaining records of political 

contributions would be performed by a compliance clerk at a cost of $59 per hour. See 

supra note 487. Therefore, the total costs would be $200,246 (3,394 hours x $59 

per/hour). 

542	 ($10,000 x 788) + ($100,000 x 122) = $7,880,000 + $12,200,000 = $20,080,000. 

543	 MassMutual Letter (“[T]he requirement to maintain records of each governmental entity 

being solicited would require a diverse financial services company like MassMutual to 

undertake significant legacy software system modifications or build an entirely new 

system to track each instance of a “solicitation,” which could include phone calls, 

meetings, or responses to governmental requests. This system would then need to 

aggregate data across multiple business lines, many with existing systems that may not 

have the ability to share this data in a useful format. All of these are costly and time 

consuming activities to meet a requirement that appears to add little value to the 
 

 

 

 

 

 

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commenters to eliminate provisions of the proposed amendments to the recordkeeping 

rule that would have required advisers to maintain a list of government entities that the 

adviser solicits.544 Instead, an adviser must only retain records of existing government 

entity clients and investors as well as records of regulated persons that the adviser pays or 

agrees to pay to solicit government entities on its behalf for a five-year period. 

Additionally, we have narrowed the scope of the amended rule to apply only to advisers 

with government entity clients; an adviser is only required to make and keep these 

records if it provides investment advisory services to a government entity or a 

government entity is an investor in any covered investment pool to which the investment 

adviser provides investment advisory services.545 We have also limited the rule to 

provide that only records of contributions, not payments, to government officials and 

candidates are required to be kept under the rule. Additionally, because rule 206(4)-5 

applies to an adviser to a registered investment company only if it is an investment option 

of a participant-directed plan or program of a government entity,546 such investment 

advisers will only have to identify government entities that provide plan or program 

participants the option of investing in the fund, which addresses many commenters’ 

concerns about recordkeeping burdens that would have been imposed on advisers to 

registered investment companies under the proposed rule.547 

Commission’s efforts to ensure compliance with the Proposed Rule.”). See also Davis 

Polk Letter; Dechert Letter; Holl Letter; SIFMA Letter; Skadden Letter. 

544	 See proposed rule 204-2(a)(18)(i)(B). 

545	 Rule 204-2(a)(18)(iii). See NASP Letter (“Many advisers do not have governmental 

clients but will still have to collect the information or attestations which would increase 

compliance costs while providing no public benefit at all.”) 

546	 See supra note 353 and accompanying text. 

547	 See, e.g., ICI Letter. 
 

 

 

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We anticipate that commenters’ general concerns that we may have 

underestimated the burdens we presented in our proposal will be offset by what we 

believe will be a reduction in burdens as a result of the various modifications from our 

proposal described above. In addition, we have revised the rule to require advisers to 

maintain a list of regulated persons that solicit on an adviser’s behalf, but expect advisers 

to already have this information in the normal course of business, including in some 

instances, to comply with existing requirements of rule 206(4)-3. 

V. PAPERWORK REDUCTION ACT 

A. Rule 204-2 

The amendment to rule 204-2 contains a “collection of information” requirement 

within the meaning of the PRA. In the Proposing Release, the Commission solicited 

comment on the proposed amendment to the collection of information requirement.548 

The Commission also submitted the proposed amendment’s collection of information 

requirement to the Office of Management and Budget (“OMB”) for review in accordance 

with 44 U.S.C. 3507(d) and 5 CFR 1320.11 under control number 3235-0278. The title 

for the collection of information is “Rule 204-2 under the Investment Advisers Act of 

1940.” Rule 204-2 contains a currently approved collection of information number under 

OMB control number 3235-0278. An agency may not sponsor, or conduct, and a person 

is not required to respond to, a collection of information unless it displays a currently 

valid OMB control number. 

Section 204 of the Advisers Act provides that investment advisers registered or 

required to be registered with the Commission must make and keep certain records for 

See Proposing Release, at section IV. 548 
 

 

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prescribed periods, and make and disseminate certain reports. Rule 204-2 sets forth the 

requirements for maintaining and preserving specified books and records. This collection 

of information is mandatory. The collection of information under rule 204-2 is necessary 

for the Commission staff to use in its examination and oversight program, and the 

information generally is kept confidential.549 The respondents are investment advisers 

registered or required to be registered with us. 

Today’s amendments to rule 204-2 require every investment adviser registered or 

required to be registered that provides advisory services to (or pays or agrees to pay 

regulated persons to solicit) government entities to maintain certain records of 

contributions made by the adviser or any of its covered associates and regarding 

regulated persons the adviser pays or agrees to pay for soliciting government entities on 

its behalf. The amendments require such an adviser to make and keep the following 

records: (i) the names, titles, and business and residence addresses of all covered 

associates of the investment adviser; (ii) all government entities to which the investment 

adviser provides or has provided investment advisory services, or which are or were 

investors in any covered investment pool to which the investment adviser provides or has 

provided investment advisory services, as applicable, in the past five years, but not prior 

to the effective date of the rule; (iii) all direct or indirect contributions made by the 

investment adviser or any of its covered associates to an official of a government entity, 

or payments to a political party of a state or political subdivision thereof, or to a political 

action committee; and (iv) the name and business address of each regulated person to 

whom the investment adviser provides or agrees to provide, directly or indirectly, 

See section 210(b) of the Advisers Act [15 U.S.C. 80b-10(b)]. 549 
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payment to solicit a government entity for investment advisory services on its behalf, in 

accordance with rule 206(4)-5(a)(2)(i). 

The adviser’s records of contributions and payments are required to be listed in 

chronological order identifying each contributor and recipient, the amounts and dates of 

each contribution or payment, and whether such contribution or payment was subject to 

the exception for certain returned contributions pursuant to rule 206(4)-5(b)(2). An 

investment adviser is only required to make and keep current the records referred to in (i) 

and (iii) above if it provides investment advisory services to a government entity or a 

government entity is an investor in any covered investment pool to which the adviser 

provides investment advisory services. The records required by amended rule 204-2 are 

required to be maintained in the same manner, and for the same period of time, as other 

books and records under rule 204-2(a). This collection of information will be found at 17 

CFR 275.204-2. Advisers that are exempt from Commission registration under section 

203(b)(3) of the Advisers Act are not subject to the recordkeeping requirements. 

The amendments to rule 204-2 that we are adopting today differ from our 

proposed amendments in several respects. We have tailored certain of the requirements 

from our proposal. First, we have limited the rule to provide that only records of 

contributions, not payments, to government officials, including candidates, are required to 

be kept under the rule. Second, investment advisers to registered investment companies 

only have to identify—and keep records regarding—government entities that invest in a 

fund as part of a plan or program of a government entity, including any government 

entity that selects the fund as an investment option for participants in the plan or 
 

 

 

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program.550 Third, we are not adopting provisions of the proposed amendments to the 

recordkeeping rule that would have required advisers to maintain a list of all government 

entities that they have solicited. In addition, we have revised the rule so that only those 

advisers that have government entity clients must make and keep certain required 

records, unlike the proposal, which would have required all registered advisers to 

maintain records of contributions and covered associates. We are also adopting a 

requirement that advisers maintain records of regulated persons they pay to solicit 

government entities on their behalf, to reflect that rule 206(4)-5 permits advisers to 

compensate these solicitors. 

As noted above, we requested comment on the PRA analysis contained in the 

Proposing Release. Although a few commenters expressed general concerns that the 

paperwork burdens associated with our proposed amendments to rule 204-2 might be 

understated, commenters representing advisers to registered investment companies 

suggested that the proposal significantly underestimated the burden attributed to these 

covered investment pools.551 With respect to registered investment companies, 

commenters noted that the proposed recordkeeping requirements required advisers to 

identify government investors in registered investment companies regardless of whether 

the fund was part of a plan or program of a government entity, and as a result the 

550 Under our proposal, investment advisers to registered investment companies would have 

had to identify and keep records regarding government entities that invest in the funds 

regardless of whether they were part of a plan or program of a government entity. For a 

discussion of this modification, see section II.B. of this Release. 

551 See ICI Letter (“[I]n relying on the estimates for compliance with the MSRB rules, the 

Commission significantly underestimates the compliance and recordkeeping burdens 

associated with the proposed rule.”). 
 

 

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proposed amendments to the recordkeeping rule would have been difficult to comply 

with as fund shareholder records do not necessarily identify government investors. 

As a result of these comments, we recognize that we may have underestimated the 

recordkeeping burden for advisers to registered investment companies that would have 

been subject to proposed rule 206(4)-5. However, we believe that our change to the 

definition of “covered investment pool” from the proposal to only include those 

registered investment companies that are an investment option of a plan or program of a 

government entity addresses the recordkeeping concerns commenters expressed 

regarding these covered investment pools and lowers recordkeeping burdens by limiting 

the records relating to registered investment companies that an investment adviser must 

keep under the rule.552 In addition, the other changes we highlight above—other than the 

requirement to keep records regarding regulated persons—would lessen the 

recordkeeping requirements relative to our proposal and thereby diminish our burden 

estimates. We anticipate that commenters’ general concerns that we may have 

underestimated the burdens we presented in our proposal, as well as the burden 

associated with the additional requirement to maintain a list of regulated persons that 

solicit on an adviser’s behalf, will be offset by what we believe will be a reduction in 

burdens as a result of the various modifications from proposed amendments to the 

recordkeeping rule, as described above. Moreover, notwithstanding the fact that the 

amendments we are adopting reduce advisers’ recordkeeping obligations relative to our 

proposal, we are increasing our estimates to address the additional investment advisers 

who have registered with us since our proposal was issued. 

See Rule 204-2(a)(18)(i)(B). 552 
 

 

 

 

 

 

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Prior to today’s amendments, the approved collection of information for rule 204­

2, set to expire on March 31, 2011, was based on an average of 181.15 burden hours each 

year, per Commission-registered adviser, for a total of 1,954,109 burden hours. In 

addition, the currently-approved collection of information for Rule 204-2 includes a nonlabor cost estimate of $13,551,390. The total burden is based on an estimate of 10,787 

registered advisers. 

Commission records indicate that currently there are approximately 11,607 

registered investment advisers subject to the collection of information imposed by rule 

204-2.553 As a result of the increase in the number of advisers registered with the 

Commission since the current total burden was approved, the total burden has increased 

by 148,543 hours.554 In addition, the total non-labor cost burden has increased to 

$14,581,509 as a result of this increase in the number of registered advisers.555 

In our Proposing Release, we estimated that approximately 1,764 Commissionregistered advisers provide, or seek to provide, advisory services to government clients 

and to certain pooled investment vehicles in which government entities invest, and would 

thus be affected by the rule amendments.556 One commenter argued that this estimate 

was too low because it underestimates the number of investment advisers unregistered in 

reliance on Section 203(b)(3) of the Advisers Act and estimated to be subject to the 

553 This figure is based on registration information from IARD as of April 1, 2010. The 

figures we relied on in our Proposing Release were based on registration information 

from IARD as of July 1, 2009. See Proposing Release, at section IV. 

554 11,607 – 10,787 = 820. 820 additional advisers x 181.15 hours = 148,543 hours. 

555 We estimate that non-labor costs attributed to rule 204-2 will increase in the same 

proportion as the increase in the estimated hour burden for the rule. (2,102,652 hours 

/1,954,109 hours) x $13,551,390 currently approved non-labor cost estimate = 

$14,581,509. 

556 See Proposing Release, at section IV. 
 

 

 

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Proposed Rule.557 Unregistered advisers are not subject to rule 204-2’s recordkeeping 

requirements. As a result, they are not included in our estimates for purposes of this 

analysis. We continue to believe our estimates are appropriate, although we have revised 

this number for purposes of both our cost-benefit analysis above and our PRA analysis to 

reflect both an increase in the number of registered advisers since the proposal and the 

modification from our proposal to not require records of unsuccessful solicitations. We 

now estimate that approximately 1,697 registered advisers provide advisory services to 

government clients and to certain pooled investment vehicles in which government 

entities invest, and would thus be affected by the rule amendments.558 

557	 Davis Polk Letter (“The cost benefit analysis is based solely on an estimated 1,764 

registered investment advisers and does not account for the costs and burdens of 

compliance attributable to investment advisers exempt from registration. The estimated 

number of investment advisers unregistered in reliance on section 203(b)(3) of the 

Advisers Act (2,000) and estimated to be subject to the Proposed Rule (231), appears to 

be low. In its comment letter, the Third Party Marketers Association notes that the 

number of advisory firms exempted from registration may be ‘over two times the 

estimate of the Commission. . . .’” (citations omitted)). The Davis Polk Letter does not 

offer any of its own estimates for the number of unregistered advisers, and the 3PM 

Letter references statistics regarding the number of funds, not the number of advisers. 

558	 This estimate is based on registration information from IARD as of April 1, 2010, 

applying the same methodology as in the Proposing Release. As previously noted, 

according to responses to Item 5.D(9) of Part 1 of Form ADV, 1,332 advisers have clients 

that are state or municipal government entities, which represents 11.48% of all advisers 

registered with us. 10,275 advisers have not responded that they have clients that are state 

or municipal government entities. Of those, however, responses to Item 5.D(6) of Part 1 

of Form ADV indicate that 2,486 advisers have some clients that are other pooled 

investment vehicles. Estimating that the same percentage of these advisers advise pools 

with government entity investors as advisers that have direct government entity clients— 

i.e.,11.48%. 285 of these advisers would be subject to the rule (2,486 x 11.48 % = 285). 

Out of the 10,275 that have not responded that they have clients that are state or 

municipal government entities, after backing out the 2,486 which have clients that are 

other pooled investment vehicles, responses to Item 5.D(4) of Part 1 of Form ADV 

indicate that 699 advisers have some clients that are registered investment companies. 

Estimating that roughly the same percentage of these advisers advise pools with 

government entity investors as advisers that have direct government entity clients— 

i.e.,11.48%. 80 of these advisers would be subject to the rule (699 x 11.48% = 80). 

Although we limited the application of rule 206(4)-5 with respect to registered 

investment companies to those that are investment options of a plan or program of a 

government entity, we continue to estimate that 80 advisers would have to comply with 
 

 

 

 

 

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Under the amendments, each respondent is required to retain the records in the 

same manner and for the same period of time as currently required under rule 204-2. The 

amendments to rule 204-2 are estimated to increase the burden by approximately 2 hours 

per Commission-registered adviser with government clients annually for a total increase 

of 3,394 hours.559 The revised annual aggregate burden for all respondents to the 

recordkeeping requirements under rule 204-2 thus would be 2,106,046 hours.560 The 

revised average burden per Commission-registered adviser would be 181.45 hours.561 

Additionally, as we noted in the Proposing Release and reiterate above, we expect 

advisory firms may incur one-time costs to establish or enhance current systems to assist 

in their compliance with the amendments to rule 204-2. These costs would vary widely 

among firms. Small advisers may not incur any system costs if they determine a system 

is unnecessary due to the limited number of employees they have or the limited number 

of government entity clients they have. Large firms likely already have devoted 

the recordkeeping provisions because of the difficulty in further delineating this 

estimated number. Therefore, we estimate that the total number of advisers subject to the 

rule would be: 1,332 advisers with state or municipal clients + 285 advisers with other 

pooled investment vehicle clients + 80 advisers with registered investment company 

clients = 1,697 advisers subject to rule. We expect certain additional advisers may incur 

compliance costs associated with rule 206(4)-5. We anticipate some advisers may be 

subject to the rule because they solicit government entities on behalf of other investment 

advisers. In the Proposing Release, our estimates included an estimated burden 

attributable to advisers that do not currently have government clients but that may begin 

to seek them. The revision to the recordkeeping rule that eliminated the requirement to 

maintain records of government entities that an adviser solicits has eliminated the need 

for this additional burden estimate. 

559	 2 x 1,697 = 3,394. 

560	 1,954,109 (current approved burden) + 148,543 (burden for additional registrants) + 

3,394 (burden for proposed amendments) = 2,106,046 hours. 

561	 2,106,046 (revised annual aggregate burden) divided by 11,607 (total number of 

registrants) = 181.45. 
 

 

 

 

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significant resources into automating compliance and reporting and the new rule could 

result in enhancements to these existing systems. 

As a result of these one-time costs, we estimate that there will be an increase to 

the total non-labor cost burden. We estimated above that the non-labor cost burden has 

increased to $14,581,509 as a result of the increase in the number of registered advisers 

since the collection was last approved.562 We believe the one-time costs could vary 

substantially among smaller, medium, and larger firms as smaller and medium firms may 

be able to use non-specialized software, such as a spreadsheet, or off-the-shelf 

compliance software to keep track of the information required by the rule while larger 

firms are more likely to have proprietary systems. Based on IARD data we estimate that 

there are approximately 1,271 smaller firms, 304 medium firms, and 122 larger firms.563 

We estimate that one half of the smaller and medium firms will not incur these one-time 

start up costs because they will use existing tools for compliance. We expect the other 

half of smaller and medium firms will incur one-time start up costs on average of 

$10,000, in the event they have a greater number of employees and government clients, 

and larger firms, that likely have the most employees and government clients, will incur 

one-time start up costs on average of $100,000. As a result, the amendments to rule 204­

562	 See supra note 555. 

563	 This estimate is based on registration information from IARD as of April 1, 2010. These 

estimates are based on IARD data, specifically the responses to Item 5.B.(1) of Form 

ADV, that 997 (or 74.9%) of the 1,332 registered investment advisers that have 

government clients have fewer than five employees who perform investment advisory 

functions, 239 (or 17.9%) have five to 15 such employees, and 96 (or 7.2%) have more 

than 15 such employees. We then applied those percentages to the 1,697 advisers we 

believe will be subject to the proposed rule for a total of 1,271 smaller, 304 medium and 

122 larger firms. 
 

 

 

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2 are estimated to increase the non-labor cost burden by $20,080,000.564 Due to this 

increase, we now estimate the revised total non-labor cost burden for rule 204-2 to be 

$34,661,509. 

B. Rule 206(4)-3 

The amendment to rule 206(4)-3 contains a revised collection of information 

requirement within the meaning of the PRA. In the Proposing Release, the Commission 

published notice soliciting comment on the collection of information requirement.565 The 

Commission submitted the revised collection of information requirement to OMB for 

review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. Rule 206(4)-3 

contains a currently approved collection of information under OMB control number 

3235-0242. The title for the collection of information is “Rule 206(4)-3 – Cash 

Payments for Client Solicitations.” As noted above, an agency may not sponsor, or 

conduct, and a person is not required to respond to, a collection of information unless it 

displays a currently valid OMB control number. 

Section 206(4) of the Advisers Act provides that it shall be unlawful for any 

investment adviser to engage in any act, practice, or course of business which is 

fraudulent, deceptive, or manipulative. Rule 206(4)-3 generally prohibits investment 

advisers from paying cash fees to solicitors for client referrals unless certain conditions 

are met. The rule requires that an adviser pay all solicitors’ fees pursuant to a written 

agreement that the adviser is required to retain. This collection of information is 

564 [$10,000 x 788] + [$100,000 x 122] = $7,880,000 + $12,200,000 = $20,080,000. 

565 See Proposing Release, at section IV. 
 

 

 

 

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mandatory. The Commission staff uses this collection of information in its examination 

and oversight program, and the information generally is kept confidential.566 

The Commission is adopting amendments to rule 206(4)-3 under the Advisers 

Act. The amendments to rule 206(4)-3, which are identical to our proposed amendments, 

require every investment adviser that relies on the rule and that provides or seeks to 

provide advisory services to government entities to also abide by the limitations provided 

in rule 206(4)-5. This collection of information is found at 17 CFR 275.206(4)-3. 

Advisers that are exempt from Commission registration under section 203(b)(3) of the 

Advisers Act would not be subject to rule 206(4)-3. 

We requested comment on the PRA analysis contained in Proposing Release. We 

received no comment on this portion of our analysis. In addition, we have not modified 

our amendments to rule 206(4)-3 relative to our proposal. 

The current approved collection of information for rule 206(4)-3, set to expire on 

March 31, 2011, is based on an estimate that 20 percent of the 10,817 Commissionregistered advisers (or 2,163 advisers) rely on the rule, at an average of 7.04 burden hours 

each year, per respondent, for a total of 15,228 burden hours (7.04 x 2,163). 

Commission records indicate that currently there are approximately 11,607 

registered investment advisers,567 20 percent of which (or 2,321) are likely subject to the 

collection of information imposed by rule 206(4)-3. As a result of the increase in the 

number of advisers registered with the Commission since the current total burden was 

566 Section 210(b) of the Advisers Act [15 U.S.C. 80b-10(b)]. 

567 This figure is based on registration information from IARD as of April 1, 2010. The 

figures we relied on in our Proposing Release were based on registration information 

from IARD as of July 1, 2009. 
 

 

 

 

 

 

 

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approved, the total burden has increased by 1,112.32 hours (158 additional advisers568 x 

7.04 hours). We estimate that approximately 20 percent of the Commission-registered 

advisers that use rule 206(4)-3 (or 464 advisers)569 provide, or seek to provide, advisory 

services to government clients.570 Under the amendments, each respondent would be 

prohibited from certain solicitation activities, subject to the exception for “regulated 

persons,” with respect to government clients, activities that otherwise would have been 

covered by rule 206(4)-3.571 Thus, they would not need to enter into and retain the 

written agreement required under rule 206(4)-3 with respect to those third parties they are 

prohibited from paying to solicit government entities. 

In the Proposing Release, we estimated a decrease to the burden due to the 

prohibition on paying third party solicitors to be 20% of the annual burden. As a result of 

the revised ban on using third parties, we now estimate that the amendments to rule 

206(4)-3 will only decrease the burden by 15 percent,572 or approximately 1.06 hour,573 

per Commission-registered adviser that uses the rule and has or is seeking government 

568	 2,321 (20% of current registered investment advisers) – 2,163 (20% of registered 

investment advisers when burden estimate was last approved by OMB) = 158. 

569	 2,321 x 20 percent = 464. 

570	 In light of the 11.48% of registered investment advisers that indicate they have state or 

municipal government clients, we conservatively estimate that 20% of the advisers who 

rely on rule 206(4)-3 are soliciting government entities to be advisory clients or to invest 

in covered investment pools those advisers manage. See supra note 558. 

571	 Rule 206(4)-3(a). 

572	 In our proposal, which would have banned the use of third-party solicitors altogether, we 

estimated a 20 percent decrease in the burden under rule 206(4)-3. But, to account for the 

regulated persons exception to the third-party solicitor ban in adopted rule 206(4)-5, we 

have modified our estimate to only a 15 percent decrease. That is because our staff 

estimates that one quarter (or 5 percent) of the proposal’s estimated burden reduction 

relating to entering into and retaining the written agreement required under rule 206(4)-3 

will be retained as investment advisers engage third parties that are regulated persons to 

solicit on their behalf. 

573	 7.04 x 15 percent = 1.06. 
 

 

 

 

 

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clients annually, for a total decrease of 491.84 hours.574 The revised annual aggregate 

burden for all respondents to the recordkeeping requirements under rule 206(4)-3 thus 

would be 15,848.48 hours.575 The revised average burden per Commission-registered 

adviser would be 6.83 hours.576 

C. Rule 206(4)-7 

As a result of the adoption of rule 206(4)-5, rule 206(4)-7 contains a revised 

collection of information requirement within the meaning of the PRA. In the Proposing 

Release, the Commission estimated that registered advisers would spend between 8 hours 

and 250 hours to establish policies and procedures to comply with rule 206(4)-5.577 Rule 

206(4)-7 contains a currently approved collection of information under OMB control 

number 3235-0585. The title for the collection of information is “Investment Advisers 

Act Rule 206(4)-7, Compliance procedures and practices.” As noted above, an agency 

may not sponsor, or conduct, and a person is not required to respond to, a collection of 

information unless it displays a currently valid OMB control number. 

Section 206(4) of the Advisers Act provides that it shall be unlawful for any 

investment adviser to engage in any act, practice, or course of business which is 

fraudulent, deceptive, or manipulative. Rule 206(4)-7, in part, requires registered 

investment advisers to adopt and implement written policies and procedures reasonably 

designed to prevent violation of the federal securities laws. This collection of 

574 464 x 1.06 = 491.84. 

575 15,228 (current approved burden) + 1,112.32 (burden for additional registrants) - 491.84 

(reduction in burden for amendments) = 15,848.48 hours. 

576 15,848.48 (revised annual aggregate burden) divided by 2,321 (total number of 

registrants who rely on rule) = 6.83. 

577 See Proposing Release, at section III.B. 
 

 

 

 

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information is mandatory. The purpose of the information collection requirement is to 

ensure that registered advisers maintain comprehensive, written internal compliance 

programs. It also assists the Commission’s staff in its examination and oversight 

program. Information obtained in our examination and oversight program generally is 

kept confidential.578 

As we previously noted, we expect that registered investment advisers subject to 

rule 206(4)-5 will modify their compliance programs to address new obligations under 

that rule. The current approved collection of information for rule 206(4)-7, set to expire 

on March 31, 2011, is based on 10,817 registered advisers that were subject to the rule at 

an average burden of 80 hours each year per respondent for a total of 865,360 burden 

hours. 

Commission records indicate that currently there are approximately 11,607 

registered investment advisers.579 As a result of the increase in the number of advisers 

registered with the Commission since the current total burden was approved, the total 

burden has increased by 63,200 hours (790 x 80 hours). In addition, although the time 

needed to comply with rule 206(4)-5 will vary significantly from adviser to adviser, as 

discussed in detail below, the Commission staff estimates that firms with government 

clients will spend between 8 hours and 250 hours to implement policies and procedures to 

comply with the rule, depending on the firm’s number of covered associates.580 Of the 

578 Section 210(b) of the Advisers Act [15 U.S.C. 80b-10(b)].
 

579 This figure is based on registration information from IARD as of April 1, 2010. 

580 See section IV.B.1. of this Release (describing the cost estimates associated with
 

compliance with rule 206(4)-5). 
 

 

 

 

 

 

 

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1,697 registered advisers that we estimate may be affected by rule 206(4)-5,581 we 

estimate that approximately 1,271 are smaller firms, 304 are medium firms, and 122 are 

larger firms.582 We anticipate that smaller firms will spend 8 hours, medium firms will 

spend 125 hours, and larger firms will spend 250 hours,583 for a total of 78,668 hours,584 

to implement policies and procedures. Our estimates take into account our staff’s 

observation that some registered advisers have established policies regarding political 

contributions, which can be revised to reflect the new requirements. The revised annual 

aggregate burden for all respondents to comply with rule 206(4)-7 thus would be 

1,007,228 hours.585 

D. Rule 0-4 

Rule 0-4 under the Advisers Act,586 entitled “General Requirements of Papers and 

Applications,” prescribes general instructions for filing an application seeking exemptive 

relief with the Commission. The requirements of rule 0-4 are designed to provide the 

Commission with the necessary information to assess whether granting the orders of 

exemption are necessary and appropriate, in the public interest and consistent with the 

protection of investors and the intended purposes of the Act. In light of the adoption of 

rule 206(4)-5, which contains a provision for seeking an exemptive order from the 

581	 See supra note 558. Advisers that are unregistered in reliance on the exemption available 

under section 203(b)(3) of the Advisers Act [15 U.S.C. 80b-3(b)(3)] are not subject to 

rule 206(4)-7 and, therefore, are not reflected in this burden estimates pursuant to the 

PRA. 

582 See supra note 475. 

583 See supra notes 489-491. 

584 (1,271 x 8 = 10,168) + (304 x 125 = 38,000) + (122 x 250 = 30,500) = 78,668. 

585 865,360 (current approved burden) + 63,200 (burden for additional registrants) + 78,668 

(burden attributable to rule 206(4)-5) = 1,007,228 hours. 

586 17 CFR 275.0-4. 
 

 

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Commission, we are revising the collection of information requirement for rule 0-4. Rule 

0-4 contains a currently approved collection of information under OMB control number 

3235-0633. As noted above, an agency may not sponsor, or conduct, and a person is not 

required to respond to, a collection of information unless it displays a currently valid 

OMB control number. 

The current approved collection of information contains an estimated total annual 

hour burden of one hour for administrative purposes because most of the work of 

preparing an application is performed by outside counsel and, therefore, imposes 

minimal, if any, hourly burden on respondents. Because we expect that all, or 

substantially all, of the work of preparing an application for an exemptive order under 

rule 206(4)-5 will also be performed by outside counsel, we continue to believe that the 

current estimate of one hour, in the unlikely event the adviser does perform an 

administrative role, is sufficient. As a result, we are not increasing our estimated hourly 

burden in connection with the adoption of rule 206(4)-5. 

The current approved collection of information also contains an estimated total 

annual cost burden of $355,000, which is attributed to outside counsel legal fees. In the 

Proposing Release, we estimated that approximately five advisers annually would apply 

to the Commission for an exemption from rule 206(4)-5.587 We also estimated that an 

advisory firm that applies for an exemption would hire outside counsel to prepare their 

exemptive requests, and that counsel would spend 16 hours preparing an submitting an 

application for review at a rate of $400 per hour, for a per application cost of $6,400 and 

a total estimated cost for five applications annually of $32,000. 

See Proposing Release, at Section III.B. 587 
 

 

 

 

 

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The Commission requested public comment on these estimates in the Proposing 

Release, and we received comments indicating that our estimate of five exemptive 

application submissions per year is too low.588 We did not receive comments on our cost 

estimates. Given that the advisory industry is much larger than the municipal securities 

industry, and in light of the number of comment letters we received that expressed 

concern about inadvertent violations of the rule that would not qualify for the exception 

for returned contributions, our staff estimates that approximately seven advisers annually 

would apply to the Commission for an exemption from the rule. Although we may 

initially receive more than seven applications a year for an exemption, over time, we 

expect the number of applications we receive will significantly decline to an average of 

approximately seven annually. We continue to believe that a firm that applies for an 

exemption will hire outside counsel to prepare an exemptive request, but based on 

commenters concerns have raised the number of hours counsel will spend preparing and 

submitting an application from 16 hours to 32 hours, at a rate of $400 per hour.589 As a 

result, each application will cost approximately $12,800, and the total estimated cost for 

seven applications annually will be $89,600. The total estimated annual cost burden to 

applicants of filing all applications has therefore increased to $444,600.590 

VI. FINAL REGULATORY FLEXIBILITY ANALYSIS 

The Commission has prepared the following Final Regulatory Flexibility Analysis 

regarding rule 206(4)-5 and the amendments to rules 204-2 and 206(4)-3 in accordance 

588 See Davis Polk Letter; ICI Letter. 

589 The hourly cost estimate of $400 is based on our consultation with advisers and law firms 

who regularly assist them in compliance matters. 

590 $355,000 + $89,600 = $444,600. 
 

 

 

 

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with section 3(a) of the Regulatory Flexibility Act.591 We prepared an Initial Regulatory 

Flexibility Analysis (“IRFA”) in conjunction with the Proposing Release in August 

2009.592 The Proposing Release included, and solicited comment, on the IRFA. 

A. Need for the Rule 

Investment advisers that seek to influence the award of advisory contracts by 

government entities, by making or soliciting political contributions to those officials who 

are in a position to influence the awards, violate their fiduciary obligations. These 

practices—known as “pay to play”—distort the process by which investment advisers are 

selected and, as discussed in greater detail above, can harm advisers’ public pension plan 

clients, and thereby beneficiaries of those plans, which may receive inferior advisory 

services and pay higher fees.593 In addition, the most qualified adviser may not be 

selected, potentially leading to inferior management, diminished returns, or greater losses 

for the public pension plan. Pay to play is a significant problem in the management of 

public funds by investment advisers. Moreover, we believe that advisers’ participation in 

pay to play is inconsistent with the high standards of ethical conduct required of them 

under the Advisers Act. The rule and rule amendments we are adopting today are 

designed to prevent fraud, deception, and manipulation by reducing or eliminating 

adviser participation in pay to play practices. 

Rule 206(4)-5, the “pay to play” rule, prohibits an investment adviser registered 

(or required to be registered) with the Commission, or unregistered in reliance on the 

exemption available under section 203(b)(3) of the Advisers Act, from providing 

591 5 U.S.C. 604(b). 

592 See Proposing Release, at section V. 

593 See section I of this Release, for more information about the need for the Commission to 

take action to prevent pay to play practices. 
 

 

 

 

 

 

 

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advisory services for compensation to a government client for two years after the adviser, 

or any of its covered associates, makes a contribution to public officials (and candidates) 

such as state treasurers, comptrollers, or other elected executives or administrators who 

can influence the selection of the adviser.594 In addition, the rule we are adopting 

prohibits an adviser and its covered associates from soliciting contributions for an elected 

official or candidate or payments to a political party of a state or locality where the 

adviser is providing or seeking to provide advisory services to a government entity,595 

and from providing or agreeing to provide, directly or indirectly, payment to any third 

party, other than a “regulated person,” engaged to solicit advisory business from any 

government entity on behalf of the adviser.596 Further, the prohibitions in the rule also 

apply to advisers to certain investment pools in which a government entity invests or that 

are investment options of a plan or program of a government entity.597 The amendment 

we are adopting to rule 204-2 is designed to provide Commission staff with records to 

review compliance with rule 206(4)-5, and the amendment to rule 206(4)-3 clarifies the 

application of the cash solicitation rule as a result of the adoption of rule 206(4)-5.598 

B. Significant Issues Raised by Public Comment 

In the Proposing Release, we requested comment on the IRFA, in particular, on 

the number of small entities, particularly small advisers, to which the rule and rule 

amendments would apply and the effect on those entities, including whether the effects 

594 Rule 206(4)-5(a)(1). 

595 Rule 206(4)-5(a)(2)(ii). 

596 Rule 206(4)-5(a)(2)(i). “Regulated person” is defined in rule 206(4)-5(f)(9). 

597 Rule 206(4)-5(c). 

598 For a more detailed discussion of the prohibitions contained in rule 206(4)-5, see section 

II.B.2 of this Release. For a more detailed discussion of the amendments to rules 204-2 

and 206(4)-3, see sections II.D and II.E, respectively, of this Release. 
 

 

 

 

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would be economically significant; and how to quantify the number of small advisers, 

including those that are unregistered, that would be subject to the proposed rule and rule 

amendments. We received a number of comments related to the impact of our proposal 

on small advisers. The commenters argued that the proposed rule, particularly the 

provision that would have prohibited advisers from directly or indirectly compensating 

any third party to solicit government business on its behalf, would be disproportionately 

expensive for, and would impose an undue regulatory burden on, smaller firms.599 

C. Small Entities Subject to Rule 

Under Commission rules, for the purposes of the Advisers Act and the Regulatory 

Flexibility Act, an investment adviser generally is a small entity if it: (i) has assets under 

management having a total value of less than $25 million; (ii) did not have total assets of 

$5 million or more on the last day of its most recent fiscal year; and (iii) does not control, 

is not controlled by, and is not under common control with another investment adviser 

that has assets under management of $25 million or more, or any person (other than a 

natural person) that had $5 million or more on the last day of its most recent fiscal 

600 year.

The Commission estimates that as of April 2010 there are approximately 708 

small SEC-registered investment advisers.601 Of these 708 advisers, 61 indicate on Form 

ADV that they have state or local government clients, and would, therefore, be affected 

599 See supra note 522. 

600 17 CFR 275.0-7(a). 

601 This estimate is based on registration information from IARD as of April 1, 2010. We 

have estimated the number of small advisers by reference to advisers’ responses to Item 

12.A, B and C of Part 1 of Form ADV. 
 

 

 

 

 

 

 

 

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by the rule.602 The rule also applies to those advisers that are exempt from registration 

with the Commission in reliance on section 203(b)(3) of the Advisers Act. As noted 

above, based on our review of registration information on IARD and outside sources and 

reports, we estimate that there are approximately 2,000 advisers that are unregistered in 

reliance on section 203(b)(3).603 Applying the same principles we used with respect to 

registered investment advisers, we estimate that 230 of those advisers manage pooled 

investment vehicles in which government client assets are invested and would therefore 

be subject to the rule.604 Based on the current number of registered advisers subject to 

the rule that are small entities, we estimate that approximately 4 percent of unregistered 

advisers,605 or nine, would be subject to the rule are small entities.606 

602	 This estimate is based on registration information from IARD as of April 1, 2010. We 

have estimated the number of small advisers with state or local government clients by 

reference to advisers’ responses to Item 5.D(9) of Part 1 of Form ADV. 

603	 This number is based on our review of registration information on IARD as of April 1, 

2010, IARD data from the peak of hedge fund adviser registration in 2005, and a 

distillation of numerous third-party sources including news organizations and industry 

trade groups. 

604	 11.48% of 2000 is 230. See supra note 474. 

605	 61 registered small entities subject to the rule/1,697 registered advisers subject to the rule 

= 3.6%. 

606	 230 x 4% = 9.2. Because these advisers are not registered with us, we do not have more 

precise data about them, and we are not aware of any databases that compile information 

regarding how many advisers that are exempt from registration with the Commission in 

reliance on section 203(b)(3) of the Advisers Act have state or local government clients, 

and how many of these advisers would be small entities for purposes of this analysis. We 

sought comments on this issue, but none of the comments we received provided any 

estimates or empirical data. However, we address above commenters who generally 

questioned our estimates. See supra notes 482-484 and accompanying text. We expect 

certain additional advisers may incur compliance costs associated with rule 206(4)-5. 

Some advisers may be subject to the rule because they solicit government entities on 

behalf of other investment advisers. 
 

 

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D. Projected Reporting, Recordkeeping, and Other Compliance 

Requirements 

The rule imposes certain reporting, recordkeeping and compliance requirements 

on advisers, including small advisers. The rule imposes a new compliance requirement 

by: (i) prohibiting an adviser from providing investment advisory services for 

compensation to government clients for two years after the adviser or any of its covered 

associates makes a contribution to certain elected officials or candidates; (ii) prohibiting 

an adviser from providing or agreeing to provide, directly or indirectly, payment to any 

third party, other than a “regulated person,” engaged to solicit advisory business from any 

government entity on behalf of the adviser; and (iii) prohibiting an adviser or any of its 

covered associates from soliciting contributions for an elected official or candidate or 

payments to a political party of a state or locality where the adviser is providing or 

seeking to provide advisory services to a government entity. 

The rule amendments impose new recordkeeping requirements by requiring an 

adviser to maintain certain records about its covered associates, its advisory clients, 

government entities invested in certain pooled investment vehicles managed by the 

adviser, its solicitors, and its political contributions, as well as the political contributions 

of its covered associates.607 An investment adviser that does not provide or seek to 

provide advisory services to a government entity, or to a covered investment pool in 

which a government entity invests, is not subject to rule 206(4)-5 and certain 

recordkeeping requirements under amended rule 204-2. 

See supra notes 559-564 and accompanying text (providing the revised estimated hour 

burden and non-labor cost burden to comply with amended rule 204-2, for purposes of 

the PRA). 

607 
 

 

 

 

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As noted above, we believe that a limited number of small advisers608 will have to 

comply with rule 206(4)-5 and the amendments to rules 204-2 and 206(4)-3. To the 

extent small advisers tend to have fewer clients and fewer employees that would be 

covered associates for purposes of the rule, the rule should impose lower costs on small 

advisers as compared to large advisers because variable costs, such as the requirement to 

make and keep records relating to contributions, should be lower due to the likelihood 

that there would be fewer records to make and keep.609 Moreover, as discussed above, 

the rule and amendments were modified from what we had proposed in several ways that 

we expect will substantially minimize compliance burdens on small advisers. 

E. Agency Action to Minimize Effect on Small Entities 

The Regulatory Flexibility Act directs the Commission to consider significant 

alternatives that would accomplish the stated objective, while minimizing any significant 

impact on small entities.610 In considering whether to adopt rule 206(4)-5 and the 

amendments to rules 204-2 and 206(4)-3, the Commission considered the following 

alternatives: (i) the establishment of differing compliance or reporting requirements or 

timetables that take into account the resources available to small entities; (ii) the 

clarification, consolidation, or simplification of compliance and reporting requirements 

under the rule and rule amendments for such small entities; (iii) the use of performance 

608	 See section VI.C of this Release. 

609	 However, as noted above, many larger advisers with broker-dealer affiliates may spend 

fewer resources to comply with the proposed rule and rule amendments because they may 

be able to rely on compliance procedures and systems that the broker-dealer already has 

in place to comply with MSRB rules G-37 and G-38. See supra section IV.B. 

610	 As noted above, we considered two alternatives to certain aspects of proposed rule 

206(4)-5: a disclosure obligation and a two-year time out for third-party solicitors. We 

do not believe either alternative would accomplish our stated objective of curtailing pay 

to play activities and thereby address potential harms from those activities. See 

Proposing Release, at section II.A.2, including nn.133 and 134 and accompanying text. 
 

 

 

 

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rather than design standards; and (iv) an exemption from coverage of the rule and rule 

amendments, or any part thereof, for such small entities. 

Regarding the first alternative, the Commission is not adopting different 

compliance or reporting requirements for small advisers as it may be inappropriate to do 

so under the circumstances. The proposal is designed to reduce or eliminate adviser 

participation in pay to play, a practice that can distort the process by which investment 

advisers are selected to manage public pension plans that can harm public pension plan 

clients and cause advisers to violate their fiduciary obligations. To establish different 

requirements for small advisers could diminish the protections the rule and rule 

amendments would provide to public pension plan clients and their beneficiaries. 

Regarding the second alternative, we considered whether further clarification, 

consolidation, or simplification of the compliance requirements would be feasible or 

necessary, and would reduce compliance requirements. As a result, we have simplified 

the compliance requirements by limiting the recordkeeping obligations to better reflect 

the activities of an adviser or a covered associate that could result in the adviser being 

subject to the two-year time out, including not requiring advisers to maintain records of 

unsuccessful solicitations of government entities and payments (as opposed to 

contributions) by advisers or covered associates to government officials.611 Moreover, 

we are amending rule 206(4)-3, the cash solicitation rule, to clarify that the requirements 

of new rule 206(4)-5 apply to solicitation activities involving government clients.612 

611 See supra note 423 and accompanying text. 

612 See section II.D. of this Release. 
 

 

 

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Regarding the third alternative, we considered using performance rather than 

design standards with respect to pay to play practices of investment advisers to be neither 

consistent with the objectives for this rulemaking nor sufficient to protect investors in 

accordance with our statutory mandate of investor protection. Design standards, which 

we have employed, provide a base line for advisory conduct as it relates to contributions 

and other pay to play activities, which is consistent with a rule designed to prohibit pay to 

play. The use of design standards also is important to ensure consistent application of the 

rule among investment advisers to which the rule and rule amendments will apply. 

Regarding the fourth alternative, exempting small entities could compromise the 

overall effectiveness of the rule and related rule amendments. Banning pay to play 

practices benefits clients of both small and large advisers, and it would be inconsistent to 

specify different requirements for small advisers. 

As discussed above, several commenters suggested alternative approaches to our 

rule.613 Such alternatives include, for example: (i) that we require advisers to disclose 

their contributions to state and local officials; (ii) that we require advisers to include in 

their codes of ethics a policy that prohibits contributions made for the purpose of 

influencing the selection of the adviser; (iii) that we require advisers to adopt policies and 

procedures reasonably designed to prevent and detect contributions designed to influence 

the selection of an adviser; (iv) that we mandate preclearance of employee contributions; 

and (v) that we allow an adviser to customize sanctions based on the severity of the 

violation.614 While it may be true that some of these approaches could diminish the 

613 See generally section II.B.2(a) of this Release. 

614 See id. 
 

 

 

 

 

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compliance burdens on advisers, including small advisers, as we explain above, we 

considered these alternative approaches and do not believe they would appropriately 

address the kind of conduct at which our rule is directed.615 

We are sensitive to the burdens our rule amendments will have on small advisers. 

We believe that the rule we are adopting today contains a number of modifications from 

what we had proposed that will alleviate many of the commenters’ concerns regarding 

small advisers. Most notably, as described above, we have created an exception to the 

third-party solicitor ban for “regulated persons,” which will, for instance, allow advisers 

to continue to use third party placement agents to sell interests in covered investment 

pools they manage instead of incurring additional costs to hire internal marketing staff, a 

result that could have disproportionally affected small advisers.616 Moreover, as 

discussed above, we have modified the exceptions to the rule’s two-year time out 

provisions in certain respects to reduce the likelihood of an inadvertent or minor violation 

of the rule, including a shortened look back of six months for certain new covered 

associates whose contributions are less likely to involve pay to play and a new de minimis 

exception for contributions to officials for whom a covered associate is not entitled to 

vote.617 We have also limited certain recordkeeping requirements we had proposed in 

order to achieve our goals in a way that balances the costs and benefits of the rule, 

including not requiring records of unsuccessful solicitations or payments (that are not 

contributions) by advisers or covered associates to government officials.618 

615 See id. 

616 See section II.B.2(b) of this Release. 

617 See sections II.B.2(a)(5) and (6) of this Release. 

618 See sections II.D and III.B.3. of this Release. 
 

 

 

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VII. EFFECTS ON COMPETITION, EFFICIENCY AND CAPITAL 

FORMATION 

We are adopting amendments to rule 204-2 pursuant to our authority under 

sections 204 and 211. Section 204 requires the Commission, when engaging in 

rulemaking pursuant to that authority, to consider whether the rule is “necessary or 

appropriate in the public interest or for the protection of investors.”619 Section 202(c) of 

the Advisers Act requires the Commission, when engaging in rulemaking that requires it 

to consider or determine whether an action is necessary or appropriate in the public 

interest, to consider, in addition to the protection of investors, whether the action will 

promote efficiency, competition, and capital formation.620 

In the Proposing Release, we solicited comment on whether, if adopted, the 

proposed amendments to rule 204-2 would promote efficiency, competition and capital 

formation. We further encouraged commenters to provide empirical data to support their 

views on any burdens on efficiency, competition or capital formation that might result 

from adoption of the proposed amendments. We did not receive any empirical data in 

this regard concerning the proposed amendments. We received some general comments, 

addressed below, asserting that the proposed amendments to require registered advisers to 

maintain books and records relating to investment advisory services they provide to 

government entities would have an adverse impact on competition. 

We are amending rule 204-2 to require a registered adviser to make and keep a 

list of its covered associates, the government entities to which the adviser directly or 

619 15 U.S.C. 80b-4. 

620	 15 U.S.C. 80b-2(c). In contrast, we are adopting rule 206(4)-5 and amendments to rule 

206(4)-3 pursuant to our authority set forth in sections 206(4) and 211. For a discussion 

of the effects of these amendments on competition, efficiency and capital formation, see 

sections IV, V, and VI of this Release. 
 

 

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indirectly provides advisory services, the “regulated person” solicitors the adviser retains, 

and the contributions made by the firm and its covered associates, as applicable, to 

government officials and candidates.621 The amendments are designed to provide our 

examiners important information about the adviser and its covered associates’ 

contributions to government officials, the government entities to which the adviser 

directly or indirectly provides advisory services, and the solicitors it retains. These 

amendments may also benefit advisers as records required under the amended rule will 

assist the Commission in enforcing the rule against, for example, an adviser whose pay to 

play activities, if not uncovered, could adversely affect the competitive position of a 

compliant adviser. 

Although we believe that the amendments to the Advisers Act recordkeeping rule 

will require advisers to incur both one-time costs to establish and enhance current 

systems to assist in their compliance with the amendments and ongoing costs to maintain 

records, these costs will be borne by all registered advisers that have government entity 

clients or that pay regulated entities to solicit government clients on their behalf. As the 

amendments to the recordkeeping rule do not disproportionally affect any particular 

group of advisers with government entity clients and do not materially increase the 

compliance burden on advisers under rule 204-2, we do not believe that they will affect 

competition across registered investment advisers. Some commenters asserted that 

certain asset managers that provide advice to government entities but are not subject to 

the Advisers Act recordkeeping rule, such as banks and advisers that are exempt from 

registration under the Act, may be at a competitive advantage to registered advisers that 

Rule 204-2(a)(18)(i). 621 
 

 

 

 

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must incur the costs of keeping records under the rule.622 While we acknowledge these 

entities could potentially obtain a competitive advantage for this reason, we do not 

believe the costs attributable to the amendments to rule 204-2 will have a significant 

impact on registered advisers such that the advantage gained by asset managers not 

subject to the Advisers Act recordkeeping rule will be substantial.623 Moreover, exempt 

advisers or persons that do not meet the definition of investment adviser are not subject to 

rule 204-2.624 Finally, we also note that banks may be subject to laws and rules that do 

not apply to registered advisers. 

We believe that the amendments to rule 204-2 may, to a limited extent, affect 

efficiency and capital formation with respect to the allocation of public pension plan 

assets. The amendments to rule 204-2 will allow our staff to examine for compliance 

with rule 206(4)-5. Authority to examine records may improve registered investment 

advisers’ compliance with rule 206(4)-5, which may reduce the adverse effects of 

political contributions on the selection of investment advisers. While the amendments to 

the rule will not affect the aggregate amount of pension fund assets available for 

investment, limiting the effects of political contributions on the investment adviser 

622	 SIFMA Letter (“The books and records requirement under the Proposed Rule are under 

inclusive. . . . As an initial matter, the books and records requirements apply only to 

some of the advisers covered by the Proposed Rule – although the Proposed Rule applies 

to a substantial number of entities who are exempt from registration under the Advisers 

Act, the Proposed Rule’s additional books and records only modify the rules that apply to 

registered investment advisers.”). 

623	 In addition, we note that advisers not subject to the amendments to rule 204-2 may 

nonetheless maintain some of the required records as part of a strong compliance 

program. 

624	 See section 204 of the Advisers Act, 15 U.S.C. 80b-4 (that provides the Commission 

authority to prescribe recordkeeping for advisers, other than those specifically exempted 

from registration). 
1940 

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selection process should improve the mechanism by which capital is formed and 

allocated to investment opportunities. 

VIII. STATUTORY AUTHORITY 

The Commission is adopting new rule 206(4)-5 and amending rule 206(4)-3 of the 

Advisers Act pursuant to the authority set forth in sections 206(4) and 211(a) of the 

Investment Advisers Act of 1940 [15 U.S.C. 80b-6(4), 80b-11(a)]. 

The Commission is amending rule 204-2 of the Advisers Act pursuant to the 

authority set forth in sections 204 and 211(a) of the Advisers Act [15 U.S.C. 80b-4 and 

80b-11(a)]. 

List of Subjects in 17 CFR Part 275 

Reporting and recordkeeping requirements; Securities. 

For the reasons set out in the preamble, Title 17 Chapter II of the Code of Federal 

Regulations is amended as follows. 

PART 275 -- RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 

1. The authority citation for Part 275 continues to read in part as follows: 

Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(17), 80b-3, 80b-4, 80b-4a, 80b6(4), 80b-6a, and 80b-11, unless otherwise noted. 

* * * * * 

2. Section 275.204-2 is amended by adding paragraph (a)(18) and by 

revising paragraph (h)(1) to read as follows: 

§ 275.204-2 -- Books and records to be maintained by investment advisers. 

(a) * * * 
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(18)(i) Books and records that pertain to § 275.206(4)-5 containing a list or other 

record of: 

(A) The names, titles and business and residence addresses of all covered 

associates of the investment adviser; 

(B) All government entities to which the investment adviser provides or has 

provided investment advisory services, or which are or were investors in any covered 

investment pool to which the investment adviser provides or has provided investment 

advisory services, as applicable, in the past five years, but not prior to September 13, 

2010; 

(C) All direct or indirect contributions made by the investment adviser or any of 

its covered associates to an official of a government entity, or direct or indirect payments 

to a political party of a state or political subdivision thereof, or to a political action 

committee; and 

(D) The name and business address of each regulated person to whom the 

investment adviser provides or agrees to provide, directly or indirectly, payment to solicit 

a government entity for investment advisory services on its behalf, in accordance with § 

275.206(4)-5(a)(2). 

(ii) Records relating to the contributions and payments referred to in paragraph 

(a)(18)(i)(C) of this section must be listed in chronological order and indicate: 

(A) The name and title of each contributor; 

(B) The name and title (including any city/county/state or other political 

subdivision) of each recipient of a contribution or payment; 

(C) The amount and date of each contribution or payment; and 
 

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(D) Whether any such contribution was the subject of the exception for certain 

returned contributions pursuant to § 275.206(4)-5(b)(2). 

(iii) An investment adviser is only required to make and keep current the records 

referred to in paragraphs (a)(18)(i)(A) and (C) of this section if it provides investment 

advisory services to a government entity or a government entity is an investor in any 

covered investment pool to which the investment adviser provides investment advisory 

services. 

(iv) For purposes of this section, the terms “contribution,” “covered associate,” 

“covered investment pool,” “government entity,” “official,” “payment,” “regulated 

person,” and “solicit” have the same meanings as set forth in § 275.206(4)-5. 

* * * * * 

(h)(1) Any book or other record made, kept, maintained and preserved in 

compliance with §§ 240.17a-3 and 240.17a-4 of this chapter under the Securities 

Exchange Act of 1934, or with rules adopted by the Municipal Securities Rulemaking 

Board, which is substantially the same as the book or other record required to be made, 

kept, maintained and preserved under this section, shall be deemed to be made, kept, 

maintained and preserved in compliance with this section. 

* * * * * 

3. Section 275.206(4)-3 is amended by adding paragraph (e) and removing 

the authority citation at the end of the section to read as follows: 
 

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§ 275.206(4)-3 Cash payments for client solicitations. 

* * * * * 

(e) Special rule for solicitation of government entity clients. Solicitation activities 

involving a government entity, as defined in § 275.206(4)-5, shall be subject to the 

additional limitations set forth in that section. 

4. Section 275.206(4)-5 is added to read as follows: 

§ 275.206(4)-5 Political contributions by certain investment advisers. 

(a) Prohibitions. As a means reasonably designed to prevent fraudulent, 

deceptive or manipulative acts, practices, or courses of business within the meaning of 

section 206(4) of the Act (15 U.S.C. 80b-6(4)), it shall be unlawful: 

(1) For any investment adviser registered (or required to be registered) with the 

Commission, or unregistered in reliance on the exemption available under section 

203(b)(3) of the Advisers Act (15 U.S.C. 80b-3(b)(3)) to provide investment advisory 

services for compensation to a government entity within two years after a contribution to 

an official of the government entity is made by the investment adviser or any covered 

associate of the investment adviser (including a person who becomes a covered associate 

within two years after the contribution is made); and 

(2) For any investment adviser registered (or required to be registered) with the 

Commission, or unregistered in reliance on the exemption available under section 

203(b)(3) of the Advisers Act (15 U.S.C. 80b-3(b)(3)) or any of the investment adviser’s 

covered associates: 

(i) To provide or agree to provide, directly or indirectly, payment to any person 

to solicit a government entity for investment advisory services on behalf of such 
 

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investment adviser unless such person is a regulated person or is an executive officer, 

general partner, managing member (or, in each case, a person with a similar status or 

function), or employee of the investment adviser; and 

(ii) To coordinate, or to solicit any person or political action committee to make, 

any: 

(A) Contribution to an official of a government entity to which the investment 

adviser is providing or seeking to provide investment advisory services; or 

(B) Payment to a political party of a state or locality where the investment 

adviser is providing or seeking to provide investment advisory services to a government 

entity. 

(b) Exceptions. 

(1) De minimis exception. Paragraph (a)(1) of this section does not apply to 

contributions made by a covered associate, if a natural person, to officials for whom the 

covered associate was entitled to vote at the time of the contributions and which in the 

aggregate do not exceed $350 to any one official, per election, or to officials for whom 

the covered associate was not entitled to vote at the time of the contributions and which 

in the aggregate do not exceed $150 to any one official, per election. 

(2) Exception for certain new covered associates. The prohibitions of paragraph 

(a)(1) of this section shall not apply to an investment adviser as a result of a contribution 

made by a natural person more than six months prior to becoming a covered associate of 

the investment adviser unless such person, after becoming a covered associate, solicits 

clients on behalf of the investment adviser. 

(3) Exception for certain returned contributions. 
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(i) An investment adviser that is prohibited from providing investment advisory 

services for compensation pursuant to paragraph (a)(1) of this section as a result of a 

contribution made by a covered associate of the investment adviser is excepted from such 

prohibition, subject to paragraphs (b)(3)(ii) and (b)(3)(iii) of this section, upon 

satisfaction of the following requirements: 

(A) The investment adviser must have discovered the contribution which resulted 

in the prohibition within four months of the date of such contribution; 

(B) Such contribution must not have exceeded $350; and 

(C) The contributor must obtain a return of the contribution within 60 calendar 

days of the date of discovery of such contribution by the investment adviser. 

(ii) In any calendar year, an investment adviser that has reported on its annual 

updating amendment to Form ADV (17 CFR 279.1) that it has more than 50 employees is 

entitled to no more than three exceptions pursuant to paragraph (b)(3)(i) of this section, 

and an investment adviser that has reported on its annual updating amendment to Form 

ADV that it has 50 or fewer employees is entitled to no more than two exceptions 

pursuant to paragraph (b)(3)(i) of this section. 

(iii) An investment adviser may not rely on the exception provided in paragraph 

(b)(3)(i) of this section more than once with respect to contributions by the same covered 

associate of the investment adviser regardless of the time period. 

(c) Prohibitions as applied to covered investment pools. For purposes of this 

section, an investment adviser to a covered investment pool in which a government entity 

invests or is solicited to invest shall be treated as though that investment adviser were 
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providing or seeking to provide investment advisory services directly to the government 

entity. 

(d) Further prohibition. As a means reasonably designed to prevent fraudulent, 

deceptive or manipulative acts, practices, or courses of business within the meaning of 

section 206(4) of Advisers Act (15 U.S.C. 80b-6(4)), it shall be unlawful for any 

investment adviser registered (or required to be registered) with the Commission, or 

unregistered in reliance on the exemption available under section 203(b)(3) of the 

Advisers Act (15 U.S.C. 80b-3(b)(3)), or any of the investment adviser’s covered 

associates to do anything indirectly which, if done directly, would result in a violation of 

this section. 

(e) Exemptions. The Commission, upon application, may conditionally or 

unconditionally exempt an investment adviser from the prohibition under paragraph 

(a)(1) of this section. In determining whether to grant an exemption, the Commission 

will consider, among other factors: 

(1) Whether the exemption is necessary or appropriate in the public interest and 

consistent with the protection of investors and the purposes fairly intended by the policy 

and provisions of the Advisers Act (15 U.S.C. 80b); 

(2) Whether the investment adviser: 

(i) Before the contribution resulting in the prohibition was made, adopted and 

implemented policies and procedures reasonably designed to prevent violations of this 

section; and 

(ii) Prior to or at the time the contribution which resulted in such prohibition was 

made, had no actual knowledge of the contribution; and 
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(iii) After learning of the contribution: 

(A) Has taken all available steps to cause the contributor involved in making the 

contribution which resulted in such prohibition to obtain a return of the contribution; and 

(B) Has taken such other remedial or preventive measures as may be appropriate 

under the circumstances; 

(3) Whether, at the time of the contribution, the contributor was a covered 

associate or otherwise an employee of the investment adviser, or was seeking such 

employment; 

(4) The timing and amount of the contribution which resulted in the prohibition; 

(5) The nature of the election (e.g, federal, state or local); and 

(6) The contributor’s apparent intent or motive in making the contribution which 

resulted in the prohibition, as evidenced by the facts and circumstances surrounding such 

contribution. 

(f) Definitions. For purposes of this section: 

(1) Contribution means any gift, subscription, loan, advance, or deposit of money 

or anything of value made for: 

(i) The purpose of influencing any election for federal, state or local office; 

(ii) Payment of debt incurred in connection with any such election; or 

(iii) Transition or inaugural expenses of the successful candidate for state or local 

office. 

(2) Covered associate of an investment adviser means: 

(i) Any general partner, managing member or executive officer, or other 

individual with a similar status or function; 
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(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 person described in paragraphs (f)(2)(i) and (f)(2)(ii) of this section. 

(3) Covered investment pool means: 

(i) An investment company registered under the Investment Company Act of 

1940 (15 U.S.C. 80a) that is an investment option of a plan or program of a government 

entity; or 

(ii) Any company that would be an investment company under section 3(a) of the 

Investment Company Act of 1940 (15 U.S.C. 80a-3(a)), but for the exclusion provided 

from that definition by either section 3(c)(1), section 3(c)(7) or section 3(c)(11) of that 

Act (15 U.S.C. 80a-3(c)(1), (c)(7) or (c)(11)). 

(4) Executive officer of an investment adviser means: 

(i) The president; 

(ii) Any vice president in charge of a principal business unit, division or function 

(such as sales, administration or finance); 

(iii) Any other officer of the investment adviser who performs a policy-making 

function; or 

(iv) Any other person who performs similar policy-making functions for the 

investment adviser. 

(5) Government entity means any state or political subdivision of a state, 

including: 

(i) Any agency, authority, or instrumentality of the state or political subdivision; 
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(ii) A pool of assets sponsored or established by the state or political subdivision 

or any agency, authority or instrumentality thereof, including, but not limited to a 

“defined benefit plan” as defined in section 414(j) of the Internal Revenue Code (26 

U.S.C. 414(j)), or a state general fund; 

(iii) A plan or program of a government entity; and 

(iv) Officers, agents, or employees of the state or political subdivision or any 

agency, authority or instrumentality thereof, acting in their official capacity. 

(6) Official means any person (including any election committee for the person) 

who was, at the time of the contribution, an incumbent, candidate or successful candidate 

for elective office of a government entity, if the office: 

(i) Is directly or indirectly responsible for, or can influence the outcome of, the 

hiring of an investment adviser by a government entity; or 

(ii) Has authority to appoint any person who is directly or indirectly responsible 

for, or can influence the outcome of, the hiring of an investment adviser by a government 

entity. 

(7) Payment means any gift, subscription, loan, advance, or deposit of money or 

anything of value. 

(8) Plan or program of a government entity means any participant-directed 

investment program or plan sponsored or established by a state or political subdivision or 

any agency, authority or instrumentality thereof, including, but not limited to, a “qualified 

tuition plan” authorized by section 529 of the Internal Revenue Code (26 U.S.C. 529), a 

retirement plan authorized by section 403(b) or 457 of the Internal Revenue Code (26 

U.S.C. 403(b) or 457), or any similar program or plan. 
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(9) Regulated person means: 

(i) An investment adviser registered with the Commission that has not, and whose 

covered associates have not, within two years of soliciting a government entity: 

(A) Made a contribution to an official of that government entity, other than as 

described in paragraph (b)(1) of this section; and 

(B) Coordinated or solicited any person or political action committee to make 

any contribution or payment described in paragraphs (a)(2)(ii)(A) and (B) of this section; 

or 

(ii) A “broker,” as defined in section 3(a)(4) of the Securities Exchange Act of 

1934 (15 U.S.C. 78c(a)(4)) or a “dealer,” as defined in section 3(a)(5) of that Act (15 

U.S.C. 78c(a)(5)), that is registered with the Commission, and is a member of a national 

securities association registered under section 15A of that Act (15 U.S.C. 78o-3), 

provided that: 

(A) The rules of the association prohibit members from engaging in distribution 

or solicitation activities if certain political contributions have been made; and 

(B) The Commission, by order, finds that such rules impose substantially 

equivalent or more stringent restrictions on broker-dealers than this section imposes on 

investment advisers and that such rules are consistent with the objectives of this section. 

(10) Solicit means: 

(i) With respect to investment advisory services, to communicate, directly or 

indirectly, for the purpose of obtaining or retaining a client for, or referring a client to, an 

investment adviser; and 
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(ii) With respect to a contribution or payment, to communicate, directly or 

indirectly, for the purpose of obtaining or arranging a contribution or payment. 

By the Commission. 

Elizabeth M. Murphy 

Secretary 

Dated: July 1, 2010