39840 Federal Register / Vol. 74, No. 151 / Friday, August 7, 2009 / Proposed Rules 

1See Sofia Anastopoulos, An Introduction to 

Investment Advisers for State and Local 

Governments (2d ed. 2007); Werner Paul Zorn, 

Public Employee Retirement Systems and Benefits, 

in Local Government Finance, Concepts and 

Practices 376 (John E. Peterson and Dennis R. 

Strachota, eds., 1st ed. 1991) (discussing the 

services investment advisers provide for public 

funds). 

2See Robert A. Fippinger, The Securities Law of 

Public Finance 669 (2d ed. 2004). 

3See, e.g., John H. Ilkiw, Investment Policies, 

Processes and Problems in U.S. Public Sector 

Pension Plans: Some Observations and Solutions 

from a Practitioner, in Public Pension Fund 

Management: Governance, Accountability and 

Investment Policies (Alberto R. Musalem and 

Robert J. Palacios, eds. 2004). See also Barry B. 

Burr, The New $100 Billion Club, Pens. & Inv. (May 

4, 1998), at 1. 

4See Cal. Ed. Code § 22303.5 (2008) (requiring 

teachers’ retirement system to offer retirement 

planning services to beneficiaries); CalSTRS 

Counseling and Workshops, available at 

http://www.calstrs.com/ 

Counseling%20and%20Workshops/index.aspx. 

Other funds also offer financial planning services to 

their beneficiaries. See, e.g., CalPERS Launches 

Online Education Classes, U.S. States News (Mar. 

3, 2008). 

5See Government Finance Officers Association, 

An Introduction to External Money Management for 

Public Cash Managers 5 (1991). 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 275 

[Release No. IA–2910; File No. S7–18–09] 

RIN 3235–AK39 

Political Contributions by Certain 

Investment Advisers 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed rule. 

SUMMARY: The Securities and Exchange 

Commission is proposing for comment a 

new rule under the Investment Advisers 

Act of 1940 that would prohibit 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 would also prohibit 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. 

Additionally, the new rule would 

prevent 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 proposing rule amendments that 

would 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 

would address ‘‘pay to play’’ practices 

by investment advisers. 

DATES: Comments should be received on 

or before October 6, 2009. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/proposed.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number S7–18–09 on the subject line; 

or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–1090. 

All submissions should refer to File 

Number S7–18–09. This file number 

should be included on the subject line 

if e-mail is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s Internet Web site 

(http://www.sec.gov/rules/ 

proposed.shtml). Comments are also 

available for public inspection and 

copying in the Commission’s Public 

Reference Room, 100 F Street, NE., 

Washington, DC 20549 on official 

business days between the hours of 10 

a.m. and 3 p.m. All comments received 

will be posted without change; we do 

not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly. 

FOR FURTHER INFORMATION CONTACT: 

Melissa A. Roverts, Attorney-Adviser, 

Matthew N. Goldin, Senior Counsel, 

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 requesting public 

comment on proposed rule 206(4)–5 [17 

CFR 275.206(4)–5] and proposed 

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’’). 

I. Background and Introduction 

II. Discussion 

A. Rule 206(4)–5: ‘‘Pay to Play’’ 

Restrictions 

1. Advisers Subject to the Rule 

2. Relationship with MSRB Rules; 

Alternative Approaches 

3. Pay to Play Restrictions 

(a) Two-Year ‘‘Time Out’’ for Contributors 

(1) Prohibition on Compensation 

(2) Officials of a Government Entity 

(3) Contributions 

(4) Covered Associates 

(5) ‘‘Look Back’’ 

(6) Exception for De Minimis Contributions 

(7) Exception for Certain Returned 

Contributions 

(b) Ban on Using Third Parties To Solicit 

Government Business 

(c) Restrictions on Soliciting and 

Coordinating Contributions and 

Payments 

(d) Direct and Indirect Contributions or 

Solicitations 

(e) Investment Pools 

(1) Application of the Rule to Pooled 

Investment Vehicles 

(2) Covered Investment Pools 

(3) Applying the Compensation Limit to 

Covered Investment Pools 

(f) Exemptions 

B. Recordkeeping 

C. Amendment to Cash Solicitation Rule 

D. Transition Period 

E. General Request for Comment 

III. Cost/Benefit Analysis 

A. Benefits 

B. Costs 

C. Request for Comment 

IV. Paperwork Reduction Act 

A. Rule 204–2 

B. Rule 206(4)–3 

C. Request for Comment 

V. Initial Regulatory Flexibility Analysis 

A. Reasons for Proposed Action 

B. Objectives and Legal Basis 

C. Small Entities Subject to Rule 

D. Reporting, Recordkeeping, and Other 

Compliance Requirements 

E. Duplicative, Overlapping, or Conflicting 

Federal Rules 

F. Significant Alternatives 

G. Solicitation of Comments 

VI. Effects on Competition, Efficiency and 

Capital Formation 

VII. Consideration of Impact on the Economy 

VIII. Statutory Authority 

I. Background and Introduction 

Investment advisers provide a wide 

variety of advisory services to State and 

local governments.1 Advisers manage 

public monies that fund pension plans 

and a number of other important public 

programs, including transportation, 

children’s programs, arts programs, 

environmental reclamation, and 

financial aid for education. In addition, 

advisers provide risk management,2

asset allocation,3 financial planning 4

and cash management services; 5 assist 

in investing proceeds from bond 


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6See In the Matter of O’Brien Partners, Inc., 

Investment Advisers Act Release No. 1772 (Oct. 27, 

1998) (settled enforcement action in which 

financial advisor was deemed subject to the 

Advisers Act for rendering advice to municipal 

securities issuers ‘‘concerning their investment of 

bond proceeds in securities, including [nongovernment securities], and was compensated for 

that advice’’). 

7 In addition to assisting public funds in selecting 

investment advisers, pension consultants may also 

provide advice to State and local governments on 

such things as designing investment objectives, or 

recommending specific securities or investments for 

the fund. Pension consultants may be investment 

advisers subject to the Advisers Act. See 

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)] (‘‘Release 1092’’). 

8For example, public funds may retain advisers 

to perform custodial services. See, e.g., Public 

Employee Retirement Systems, supra note 1, at 376– 

77. 

9For this reason, in this Release, we use the term 

‘‘public pension plan’’ interchangeably with 

‘‘government client’’ and ‘‘government entity’’; 

however, our proposed rule would apply broadly to 

investment advisory activities for government 

clients, such as those mentioned here in this 

Background and Introduction, 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 infra section II.A.3(e) of this Release. 

10Board of Governors of the Federal Reserve 

System, Flow of Funds Accounts of the United 

States, Flows and Outstandings, First Quarter 2009 

(June 11, 2009) (at table L.119). Since 2002, total 

financial assets of public pension funds have grown 

by 13% Id. 

11According 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. 

12See Stephen J. Choi & Jill E. Fisch, On Beyond 

CalPERS: Survey Evidence on the Developing Role 

of Public Pension Funds in Corporate Governance, 

61 Vanderbilt L.Rev. 315 (Mar. 2008) (noting, 

‘‘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.’’). 

13Federal Reserve reports indicate that, of the 

$2.2 trillion in non-Federal government plans, $1.1 

trillion are invested in corporate equities. Flow of 

Funds Accounts of the United States, supra note 10 

(at table L.119). 

14See Paul Zorn, 1997 Survey of State and Local 

Government Employee Retirement Systems 61 

(1997) (‘‘[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’’). 

15The 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. 

16Blount v. SEC, 61 F.3d 938, 945 (DC Cir. 1995), 

cert. denied, 517 U.S. 1119 (1996). 

17 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’’). The 

Commission also proposed amendments in 1999 to 

rule 204–2 [17 CFR 275.204–2] under the Advisers 

Act, which would have required advisers with 

government clients to keep certain records relating 

to the 1999 proposed rule. See id., at section II.B. 

We are not re-proposing that rule or those rule 

amendments today; we are withdrawing our 1999 

proposal and proposing a new rule 206(4)-5 as well 

as new amendments to rule 204–2. 

18MSRB rule G–37 and G–38 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. 

19See In the Matter of Self-Regulatory 

Organizations; Order Approving Proposed Rule 

Change by the Municipal Securities Rulemaking 

Continued 

offerings; 6 help State and local 

governments find and evaluate other 

advisers that manage public funds 

(‘‘pension consultants’’); 7 and provide 

other types of services.8

Most of the public funds managed by 

investment advisers fund State and 

municipal pension plans.9 These 

pension plans have over $2.2 trillion of 

assets and represent one-third of all U.S. 

pension assets.10 They are among the 

largest and most active institutional 

investors in the United States.11 The 

management of these funds significantly 

affects publicly held companies 12 and 

the securities markets.13 But most 

significantly, their management affects 

taxpayers and the beneficiaries of these 

funds, including the millions of present 

and future State and municipal 

retirees 14 who rely on the funds for 

their pensions and other benefits.15

Public pension plan assets are held, 

administered and managed by elected 

officials who often are responsible for 

selecting investment advisers to manage 

the funds they oversee. Pay to play 

practices undermine the fairness of the 

selection process when advisers seeking 

to do business with the governments of 

States and municipalities make political 

contributions to elected officials or 

candidates, hoping to influence the 

selection process. In other cases, 

political contributions may be solicited 

from advisers, or it is simply understood 

that only contributors will be 

considered for selection. Contributions, 

in this circumstance, may not always 

guarantee an award of business to the 

contributor, but the failure to contribute 

will guarantee that another is selected. 

Hence the term ‘‘pay to play.’’ 

Elected officials who allow political 

contributions to play a role in the 

management of these assets violate the 

public trust by rewarding those who 

make political contributions. Similarly, 

investment advisers that seek to 

influence the award of advisory 

contracts by public entities, by making 

or soliciting political contributions to 

those officials who are in a position to 

influence the awards, compromise their 

fiduciary obligations. Pay to play 

practices can distort the process by 

which investment advisers are selected 

and can harm advisers’ public pension 

plan clients, and the pension plan 

beneficiaries, which may receive 

inferior advisory services and pay 

higher fees because, for instance, 

advisers must recoup contributions, or 

because contract negotiations are not 

handled on an arm’s-length basis. Pay to 

play practices also 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. We believe that advisers’ 

participation in pay to play practices is 

inconsistent with the high standards of 

ethical conduct required of them under 

the Advisers Act. 

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, in its 

decision upholding one of the rules on 

which the proposed rule is modeled, 

‘‘[w]hile the risk of corruption is 

obvious and substantial, actors in this 

field are presumably shrewd enough to 

structure their relations rather 

indirectly.’’ 16 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. 

The rule we are proposing today is 

modeled on rules G–37 and G–38 of the 

Municipal Securities Rulemaking Board 

(‘‘MSRB’’),17 which address pay to play 

practices in the municipal securities 

markets.18 The Commission approved 

rule G–37 in 1994, after concluding that 

pay to play practices harm municipal 

securities markets.19 MSRB rule G–37 


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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)] 

(‘‘MSRB Rule G–37 Approval Order’’), at sections 

V.A.1 and 2. In approving MSRB rule G–37, we 

concluded that pay to play practices may harm the 

municipal markets by fostering a selection process 

that excludes those firms that do not make 

contributions, causes less qualified underwriters to 

be retained, and undermines equitable practices in 

the municipal securities industry. Id. at section V. 

20MSRB rule G–37(b). Shortly after MSRB rule 

G–37 became effective, a municipal securities 

dealer challenged it as an infringement on the 

constitutional rights of municipal securities 

professionals. A Federal appeals court upheld the 

constitutionality of MSRB rule G–37, finding that 

the rule is narrowly tailored to serve a compelling 

government interest. See Blount, supra note 16. 

21MSRB rule G–37(c). A ‘‘municipal finance 

professional’’ is an associated person of a brokerdealer who is ‘‘primarily engaged’’ in municipal 

securities activities, who solicits municipal 

securities business on behalf of a broker-dealer, 

who supervises associated persons primarily 

engaged in municipal securities activities ‘‘up 

through and including’’ the chief executive officer 

of the firm (or person performing similar functions), 

or who is a member of the firm’s executive or 

management committee (or person performing 

similar functions). MSRB rule G–37(g)(iv). 

22MSRB rule G–38(a). 

23Others, including the MSRB, agree. See, e.g., 

MSRB Notice 2009–35, Request for Comment: Rule 

G–37 on Political Contributions and Prohibitions on 

Municipal 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 Notice 2003–32, Notice Concerning Indirect 

Rule Violations: Rules G–37 and G–38 (Aug. 6, 

2003) (‘‘The impact of Rules G–37 and G–38 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, dated 

Oct. 19, 2001, available at http:// 

www.cfainstitute.org/centre/topics/comment/2001/ 

01msrb_ruleg37.html (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.’’); Cmte. on Cap. Mkts. Reg., 

Interim Report of the Cmte. on Cap. Mkts. Reg. 

(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.’’). 

24 1999 Proposing Release, supra note 17, at 

section I (‘‘We have become particularly concerned 

about the possibility that the adoption of rule G– 

37 has resulted in a shift of pay to play practices 

to [the management of public pension funds] as 

political contributions by broker-dealers are 

curtailed.’’). See also Bill Krueger, Money Managers 

Giving to Boyles, News & Observer (May 2, 1996), 

at A1 (noting that rule G–37 ‘‘dried up’’ a 

contribution source for a State treasurer, ‘‘so now 

he is getting campaign contributions from a group 

[investment advisers] that is not subject to [rule G– 

37]’’); Gerri Willis, Filling Carl’s War Chest: 

Comptroller Getting Thousands From State’s Money 

Managers, Crain’s N.Y. Bus. (Sept. 16, 1996), at 1 

(noting the observation of a securities executive that 

‘‘[b]ecause of the SEC’s crackdown on the pay to 

play nature of the muni bond business, the game 

has shifted to asset management and brokerage’’). 

25See, e.g., 2 NYCRR § 320.2 (placement of State 

and local government retirement systems assets 

(valued at $109 billion as of Mar. 2009) is under the 

sole custodianship of the New York State 

Comptroller). 

26See, 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 

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). 

27See, 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 § 59–1304 (2008) 

(governor appoints all five members). 

28See 1999 Proposing Release, supra note 17. 

29See id., at section II.A.1. 

30We received 59 comment letters on our 1999 

proposal. Commenters representing beneficiaries 

and public pension plans expressed concern about 

pay to play practices and generally favored our 

proposed rule. State government officials and 

investment advisers generally opposed the rule. 

State government officials generally argued that 

there was no demonstrated need for the proposed 

rule and that State laws are adequate to address any 

concerns. Most advisers submitting comments 

opposed the rule’s breadth and complained that the 

consequences of violating the rule were too harsh; 

some denied the existence of the problem we 

sought to address. Comment letters on our 1999 

proposal and a summary of comments prepared by 

our staff are available in our Public Reference Room 

in File No. S7–19–99. Comment letters we received 

electronically are also available at http:// 

www.sec.gov/rules/proposed/s71999.shtml. 

31See SEC v. Henry Morris, et al., Litigation 

Release No. 21036 (May 12, 2009). 

prohibits a broker-dealer from engaging 

in municipal securities business with a 

municipal issuer for two years after 

making a political contribution to an 

elected official of the issuer who can 

influence the selection of the brokerdealer.20 The rule also prohibits a 

broker-dealer from providing or seeking 

to provide underwriting services to a 

government if the firm or any of its 

‘‘municipal finance professionals’’ 

solicit contributions for a candidate or 

an elected official of that government, or 

if they solicit payments to political 

parties where the firm is providing or 

seeking to provide services to a 

government client.21 MSRB rule G–38 

prohibits municipal securities dealers 

from making payments to consultants 

for soliciting municipal securities 

business.22 We believe that MSRB rules 

G–37 and G–38 have been successful in 

addressing pay to play practices in the 

municipal securities market.23

Following the adoption of MSRB rule 

G–37, we were increasingly concerned 

that the very success of the rule may 

have caused pay to play practices to 

migrate to an area not covered by the 

MSRB rules—the management of public 

pension plans.24 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 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,25 may be 

members of a governing board that 

selects advisers,26 or may appoint some 

or all of the board members who make 

the selection.27

In response to these concerns, in 1999 

we proposed a rule under the Advisers 

Act, modeled substantially on MSRB 

rule G–37, that was designed to prevent 

advisers from participating in pay to 

play practices affecting the management 

of public pension plans.28 In particular, 

the 1999 rule proposal would have 

prohibited an adviser from receiving 

compensation for the provision of 

advisory services for two years after the 

advisory firm or any of its partners, 

executive officers or solicitors, directly 

or indirectly, made a contribution to an 

elected official who (or a candidate for 

an elected office that) has the ability to 

influence the selection of the adviser.29

Comments on the proposal were mixed, 

and some commenters that objected 

asserted that pay to play was not a 

problem in the management of public 

funds.30

Since then, it has become increasingly 

clear that pay to play is a significant 

problem in the management of public 

funds by investment advisers. In recent 

years, we and criminal authorities have 

brought a number of actions charging 

investment advisers with participating 

in pay to play schemes. We recently 

brought a civil action in Federal court 

charging former New York State 

officials, as well as a ‘‘placement agent,’’ 

with engaging in a fraudulent scheme to 

extract kickbacks from investment 

advisers seeking to manage assets of the 

New York State Common Retirement 

Fund.31 Investment advisers allegedly 

paid sham ‘‘placement agent’’ fees, 

portions of which were funneled to 

public officials, as a means of obtaining 

public pension fund investments in the 


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32See id. 

33See In the Matter of Kent D. Nelson, Investment 

Advisers Act Release No. 2765 (Aug. 1, 2008); 

Initial Decision Release No. 371 (Feb. 24, 2009); 

Investment Advisers Act Release No. 2868 (Apr. 17, 

2009) (in which investment adviser was barred from 

association with any broker, dealer or investment 

adviser). 

34See 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). See 

also U.S. v. Ben F. Andrews, Litigation Release No. 

19566 (Feb. 15, 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). 

35See 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). 

36See 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’s 

successor 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). 

37See Jeff Coen et al., State’s Ultimate Insider 

Indicted, Chicago Tribune (Oct. 31, 2008) 

(describing the thirteenth indictment in an Illinois 

pay to play probe). 

38See 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). 

39See 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. 

filed Oct. 10, 2000) (the former treasurer, along with 

certain others, pleaded guilty—while others were 

ultimately convicted). 

40See 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 

found liable for conspiracy and wire fraud for 

fraudulently paying $40,000 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). 

41See, e.g., David Zahniser, California; Private 

Finances, Public Role Intersect; Former Pension 

Board Member Had Consulted for a Firm that 

Sought Work with the Panel on Which He Served, 

Los Angeles Times (May 9, 2009) (discussing 

alleged pay to play activities relating to a former 

member of the Los Angeles Fire and Police 

Pensions Board); Rick Rothacker & David Ingram, 

Moore Defends Pension System, Charlotte Observer 

(Feb. 25, 2007) (discussing alleged pay to play 

activities involving North Carolina’s State 

treasurer); Len Boselovic, Pensions, Politics and 

Consultants Make for Unsavory Bedfellows, 

Pittsburgh Post-Gazzette (Aug. 13, 2006) and Jeffrey 

Cohan, Fund Managers ‘Pay to Play’: Six Firms 

Managing County’s Pension Investments Gave to 

Board Members’ Campaigns, Pittsburgh PostGazzette (Feb. 22, 2001) (discussing alleged pay to 

play activities relating to the Allegheny County 

Retirement Board); Mary Williams Walsh, Political 

Money Said to Sway Pension Investments, N.Y. 

Times (Feb. 10, 2004) (regarding a 2002 audit by 

then-new controller of Luzerne County, 

Pennsylvania alleging pay to play activities among 

various parties involved with county pension 

funds). 

42For example, we recently brought a case against 

the mayor of Birmingham, Alabama, and other 

defendants, alleging that while the mayor served as 

president of the County Commission of Jefferson 

County, Alabama, he accepted undisclosed cash 

and benefits through a lobbyist as a conduit from 

the chairman of a Montgomery, Alabama-based 

broker-dealer, in return for awarding municipal 

bond business and swap transactions to the brokerdealer. See SEC v. Larry P. Langford et al., 

Litigation Release No. 20545 (Apr. 30, 2008). 

Several years earlier, we brought an enforcement 

action against the former treasurer of the City of 

Chicago, to whom two registered representatives 

were alleged to have made secret cash payments to 

obtain a share of the city’s lucrative securities 

investments. See SEC v. Miriam Santos et al., 

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

Litigation Release No. 19269 (June 14, 2005). We 

also brought enforcement actions against the 

registered representatives allegedly involved in the 

scheme. See SEC v. Miriam Santos, Peter J. Burns, 

and Michael F. Hollendoner, Litigation Release Nos. 

19270 and 19271 (June 14, 2005). In addition, we 

brought a case against a broker-dealer, two of its 

officers and a city official for participating in a 

scheme to defraud the City of Atlanta in connection 

with the purchase and sale of certain securities 

while providing substantial, undisclosed monetary 

benefits to the city’s investment officer who was 

authorized to select a broker-dealer for the 

transactions. See In the Matter of Pryor, McClendon, 

Counts & Co., Inc. et al., Securities Act Release No. 

7673 (Apr. 29, 1999); Securities Act Release No. 

8062 (Feb. 6, 2002); Exchange Act Release No. 

48095 (June 26, 2003); Securities Act Release No. 

8245 (June 26, 2003); Securities Act Release No. 

8246 (June 26, 2003). 

43For an example of a State statutory restriction 

on pay to play activities, see Ill. Pub. Act 095–0971 

(2008). For an example of a restriction pursuant to 

a State constitutional amendment, see Colo. Const. 

amend. LIV (2008). For an example of a county 

restriction, see Resolution No. 08–397 (May 8, 2008) 

Special Pay to Play Restrictions for Professional 

Service Contracts and Extraordinary Unspecifiable 

Service Contracts, Monmouth County, NJ. For an 

example of a city restriction, see Ordinance 3663 

(July 2, 2007), Prohibition of Redevelopment with 

Certain Contributors, Township of Franklin, NJ. For 

an example of a particular local government agency 

restriction, see Cal. Pub. Util. Code § 130051.20 

(2008), Contributions to Authority Members, Los 

Angeles County Metropolitan Transportation 

Authority. For an example of a particular public 

pension fund restriction, see Prohibitions on 

Campaign Contributions, California State Teachers’ 

Retirement System, 5 CCR § 24010 (2009). 

44See, e.g., Letter from New York City 

Comptroller William C. Thompson, Jr., to Securities 

and Exchange Commission Chairman Mary L. 

Schapiro, dated May 12, 2009, available at http:// 

www.comptroller.nyc.gov/press/pdfs/05-13-09_SECletter.pdf, at 2; Letter from New York State 

Comptroller Thomas P. DiNapoli to Securities and 

Exchange Commission Chairman Mary L. Schapiro, 

dated May 7, 2009, available at http:// 

www.osc.state.ny.us/press/releases/may09/ 

sec050709.pdf, at 1–2. 

45Another reason we believe it is important for 

us to act is because pay to play practices are 

characterized by what the Blount court called a 

‘‘collective action problem [that tends] to make the 

misallocation of resources persist.’’ Blount, supra 

note 16 at 945–46. Elected officials that accept 

contributions from State contractors may believe 

Continued 

funds those advisers managed.32

Another settled administrative action 

involved an investment adviser who 

allegedly paid kickbacks in return for 

investment advisory business awarded 

by the New Mexico State treasurer’s 

office.33 In addition, we brought two 

separate cases against the former 

treasurer of the State of Connecticut and 

various other parties in which we 

alleged that the former treasurer 

awarded State pension fund 

investments to private equity fund 

managers in exchange for fees paid to 

the former treasurer’s friends and 

political associates.34 Criminal 

authorities have in recent years also 

brought cases in New York,35 New 

Mexico,36 Illinois,37 Ohio,38

Connecticut,39 and Florida,40 charging 

defendants with the same or similar 

conduct. In addition, there are a 

growing number of reports about pay to 

play activities involving investment 

advisers in other jurisdictions.41 These 

cases involving investment advisers, as 

well as others involving broker-dealers, 

may reflect more widespread 

involvement by securities professionals 

in pay to play activities.42

Recognizing the harm pay to play 

practices cause in the management of 

public funds, several States, counties, 

localities, and even individual public 

pension funds, have undertaken to 

prohibit or regulate these practices in 

recent years.43 And, most recently, in 

response to pay to play scandals that 

have emerged in their jurisdictions, 

public officials with oversight of public 

pension funds have written to us 

expressing support for a Commission 

rule to prohibit investment advisers 

from participating in pay to play 

practices, including prohibiting the use 

by advisers of placement agents (or 

other types of consultants) to help 

secure government business.44

These developments indicate that 

investment advisers may be playing an 

increasing role in pay to play activities. 

We therefore believe it is time for us to 

act with respect to investment advisers 

who may engage in such activities.45


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they have an advantage over their opponents that 

forswear the contributions, and firms that do not 

‘‘pay’’ may fear they will lose government business 

to those that do. See id. See generally Mancur 

Olson, The Logic of Collective Action; Public Goods 

and the Theory of Groups 44 (17th ed. 1998) (group 

members that seek to maximize their individual 

personal welfare will not act to advance common 

objectives absent coercion or other incentive). See 

also Paul Jacobs, Donations to Pension Officials 

Scrutinized; Politics: Connell, Fong Say They Are 

not Influenced by Contributions from Firms Doing 

Business with State Systems, L.A. Times, Aug. 21, 

1997, at A41 (fund contractor quoted as saying, ‘‘[i]f 

you don’t contribute, you’re subject to the concern 

that others might make contributions’’). 

46 15 U.S.C. 80b–6(1). 

47 15 U.S.C. 80b–6(2). 

48Transamerica 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). 

49See 1999 Proposing Release, supra note 17, at 

3. 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, 191–192; Release 1092, supra note 

7. 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 meritbased 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). Even if the 

conflict was acknowledged and disclosed by the 

adviser, disclosure may not be effective in 

protecting the plan from harm. Disclosure to the 

trustee or board of trustees may be futile in 

protecting the plan since the trustees may be 

similarly conflicted, having accepted the 

contribution. Disclosure to beneficiaries may also 

be inadequate as they may be unable to act on the 

disclosure—beneficiaries generally cannot fire the 

adviser or find another pension plan. 

50See Blount, supra note 16, at 944–45. 

51Cf. 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). 

52 15 U.S.C. 80b–6(4). 

53S. 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 the 

adviser’s financial condition and disciplinary 

history, 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. 

54Section 206(4) was added to the Advisers Act 

in Public Law 86–750, 74 Stat. 885 (1960) at sec. 

9. See H.R. Rep. No. 2197, 86th Cong., 2d Sess. 

(1960) at 7–8 (‘‘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. (1960) at 8 (‘‘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, 

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, at 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.’’). 

55Cf. Blount, supra note 16 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’’). 

56Proposed rule 206(4)–5(a)(1) states: ‘‘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: 

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.’’ 46 Section 206(2) 

prohibits advisers from engaging in 

‘‘any transaction, practice or course of 

business which operates as a fraud or 

deceit on any client or prospective 

client.’’ 47 The Supreme Court has 

construed section 206 as establishing a 

Federal fiduciary standard governing 

the conduct of advisers.48

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.49 In making such contributions, 

the adviser hopes to benefit from 

officials that ‘‘award the contracts on 

the basis of benefit to their campaign 

chests rather than to the governmental 

entity.’’ 50 If pay to play is a factor in the 

selection process, the public pension 

plan can be harmed in several ways. 

The most qualified adviser may not be 

selected, potentially leading to inferior 

management, diminished returns or 

greater losses. 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 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.51

We believe that play 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.’’ 52 Congress 

gave us this authority to prohibit 

‘‘specific evils’’ that the broad anti-fraud 

provisions may be incapable of 

covering.53 The provision thus permits 

the Commission to adopt prophylactic 

rules that may prohibit acts that are not 

themselves fraudulent.54 As noted 

above, pay to play practices are rarely 

explicit and often hard to prove, which 

makes a prophylactic rule particularly 

appropriate.55 We are today proposing 

new rule 206(4)–5 under the Advisers 

Act designed to eliminate adviser 

participation in pay to play practices. 

II. Discussion 

A. Rule 206(4)–5: ‘‘Pay To Play’’ 

Restrictions 

The rule we are proposing today is 

designed to protect public pension 

plans from the consequences of pay to 

play practices by preventing advisers’ 

participation in such practices. As a 

result, advisers and government officials 

may attempt to structure their 

transactions in a manner intended to 

hide the true purpose of a contribution 

or a payment. For that reason, our 

proposed pay to play restrictions would 

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 would 

accomplish this through three measures. 

First, the rule would make 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 that is in a position to influence 

the award of advisory business.56


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(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).’’ 

57Proposed rule 206(4)–5(a)(2)(i). 

58MSRB rule G–38 was amended in 2005 to 

prohibit municipal securities dealers from paying 

third-party solicitors to solicit municipal securities 

business. In the Matter of Self-Regulatory 

Organizations; Municipal Securities Rulemaking 

Board; Order Approving Proposed Rule Change and 

Notice of Filing and Order Granting Accelerated 

Approval to Amendment No. 1 to the Proposed Rule 

Change Relating to Solicitation of Municipal 

Securities Business under MSRB Rule G–38, 

Exchange Act Release No. 52278 (Aug. 17, 2005) [70 

FR 49342 (Aug. 23, 2005)]. Our 1999 proposal did 

not include an analogous prohibition. 

59See MSRB rule G–37(c); 1999 Proposing 

Release, supra note 17, at section II.A.2. 

60Proposed 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. 

61See discussion infra section II.A.3(e). 

62Section 203A of the Advisers Act [15 U.S.C. 

80b–3A] prohibits investment advisers with less 

than $25 million in assets under management from 

registering with the Commission; although we do 

not propose to include them within the coverage of 

this rule, they remain subject to the Act’s general 

anti-fraud authority. See, e.g., Rules Implementing 

Amendments to the Investment Advisers Act of 

1940, Investment Advisers Act Release No. 1633, 

n.154 and accompanying text (May 15, 1997) [62 FR 

28112 (May 22, 1997)] (‘‘Both the Commission and 

the States will be able to continue bringing 

antifraud actions against investment advisers 

regardless of whether the investment adviser is 

registered with the State or the SEC.’’). See also S. 

Rep. No. 293, 104th Cong., 2d Sess. 3–4 (1996) 

(‘‘1996 Senate Report’’) at 4. 

63See, e.g, exemption for intrastate investment 

advisers under section 203(b)(1) [15 U.S.C. 80b– 

3(b)(1)]. 

64With the exception of the exemption from 

registration provided for by section 203(b)(3) [15 

U.S.C. 80b–3(b)(3)], advisers that are exempt from 

SEC registration are unlikely to have State or 

municipal government clients as providing advisory 

services to them would result in the adviser no 

longer being eligible for the exemption, e.g., section 

203(b)(2) [15 U.S.C. 80b–3(b)(2)] and section 

203(b)(4) [15 U.S.C. 80b–3(b)(4)]. Moreover, based 

on a review of a sampling of requests for proposals 

from State and municipal governments for 

investment advisory services, a common 

requirement is that the adviser be registered with 

the SEC or a State. See, e.g., Request for Information 

Vermont Pension Investment Committee—Vermont 

Manager Program RFI (Feb. 27, 2009) (stating that 

eligible investment advisers must be SEC-registered 

with at least $100 million in assets under 

management), available at: http:// 

www.vermonttreasurer.gov/documents/rfp/ 

20090316_VPICVermontManagerProgram.pdf. It 

also is our understanding from discussions with 

representatives of the State securities regulators that 

a very small percentage of State-registered advisers 

have State or municipal government clients. 

65Our 1999 proposed rule would have applied to 

all investment advisers not prohibited from 

registering with the Commission. See 1999 

Proposing Release, supra note 17. 

Proposed rule 206(4)–5 would not, 

therefore, 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 is made. This aspect of 

the proposed rule is modeled on MSRB 

rule G–37 and is consistent with our 

1999 proposal. 

Second, the rule would prohibit 

advisers from paying third parties to 

solicit government entities for advisory 

business.57 That is, an adviser would be 

prohibited from providing or agreeing to 

provide, directly or indirectly, payment 

to any person who is not a related 

person of the adviser for solicitation of 

government advisory business on behalf 

of such adviser. This aspect of our 

proposed rule is modeled on MSRB rule 

G–38.58 Third, the rule would also make 

it unlawful for an adviser itself or 

through any of its covered associates to 

solicit or to coordinate contributions for 

an official of a government entity to 

which the investment adviser is seeking 

to provide investment advisory services, 

or 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. MSRB rule G–37 

contains a similar prohibition, as did 

our 1999 proposal.59

We recognize that we cannot 

anticipate all of the ways advisers and 

government officials may structure pay 

to play arrangements to attempt to evade 

the prohibitions of our proposed rule. 

For that reason, we are also proposing 

to include a provision that would make 

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 

proposed rule. Finally, for purposes of 

the proposed rule, an investment 

adviser to certain pooled investment 

vehicles in which a government entity 

invests or is solicited to invest would be 

treated as though the adviser were 

providing or seeking to provide 

investment advisory services directly to 

the government entity. 

Although today’s proposal is similar 

to the one we made in 1999, we are 

proposing a few critical changes in 

response to intervening developments 

that we highlight in the discussion 

below. We have made these changes to 

conform our proposal to measures 

undertaken in recent years to curtail pay 

to play activities by the MSRB and 

various State and local authorities and 

to deter circumvention of the 

restrictions through the use of thirdparty placement agents or through an 

adviser obtaining government clients 

indirectly by soliciting investment in 

funds it manages. 

1. Advisers Subject to the Rule 

Proposed rule 206(4)–5 would apply 

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. 80b–3(b)(3)].60 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.61 The rule would not apply, 

however, to most small advisers that are 

registered with the State securities 

authorities,62 and certain other advisers 

that are exempt from registration with 

us.63 We believe that the rule would 

apply to most advisers to public pension 

plans.64 We request comment on the 

scope of the proposed rule. Should we 

apply the rule to State-registered 

advisers? Should we limit the rule only 

to advisers registered (or required to be 

registered) with us? Should we apply 

the rule to advisers that are exempt from 

registration in reliance on Advisers Act 

section 203(b)(3)? We request comment 

on whether we should extend the scope 

of the rule to apply to advisers exempt 

from registering with us pursuant to any 

or all of the other categories under 

Advisers Act section 203(b). For 

example, should we include advisers 

exempt from registration pursuant to 

any or all of Advisers Act sections 

203(b)(1) (intrastate advisers), 203(b)(2) 

(advisers with only insurance company 

clients), 203(b)(4) (investments advisers 

that are charitable organizations), 

203(b)(5) (advisers that are plans 

described in section 414(e) of the 

Internal Revenue Code of 1986 or 

certain persons associated with such 

plans), or 203(b)(6) (certain commodity 

trading advisors)? 65 To the extent that 

they are able to have government clients 

at all, are any of these advisers likely to 

engage in pay to play? 

We note that proposed rule 206(4)–5 

would regulate the activities of 

investment advisers—business 

organizations over which we have clear 

regulatory authority under the Advisers 

Act. The rule would have no effect on 

State laws, codes of ethics or other rules 

governing the activities of State and 

municipal officials or employees of 


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66A number of commenters in 1999, including 

those representing State and local officials, argued 

that the rule would be an intrusion on State 

sovereignty. We disagree. We have a responsibility 

to regulate the activities of investment advisers. Our 

objectives in the proposed rule do not relate to 

campaign finance, but rather to prohibiting 

fraudulent activity by investment advisers. We 

believe our proposed rule is appropriately tailored 

to those ends. 

67For instance, in 1999, we requested comment 

on our use of MSRB rule G–37 as a model, and 

several commenters responded that, because of 

distinctions between the investment adviser 

profession and the municipal securities industry, 

we should not follow the approach of MSRB rule 

G–37. Some commenters asserted that, unlike 

municipal underwriters, advisers’ business 

relationships with State and municipal clients are 

ongoing and long-term and thus the two-year ban 

is much more harsh a consequence. While 

municipal underwritings themselves tend to be 

episodic, underwriting relationships are often 

longstanding. As a result, the rules’ time outs may 

have similar effects. 

68Rule 204A–1 under the Advisers Act [17 CFR 

275.204A–1]. 

69Rule 206(4)–7 under the Advisers Act [17 CFR 

275.206(4)–7]. 

70Some commenters in 1999 suggested that the 

better approach would be to require advisers to 

adopt codes of ethics designed to prevent pay to 

play practices. The Investment Counsel Association 

of America (subsequently renamed the Investment 

Advisers Association) submitted to the comment 

file relating to our 1999 proposal ‘‘Best Practice 

Pay-to-Play Guidelines for Adviser Codes of Ethics,’’ 

advocating such an approach as an alternative to 

our 1999 proposal. See http://www.sec.gov/rules/ 

proposed/s71999/tittswo2.htm. The ICAA offered 

the following three alternative policies on political 

contributions, and suggested that advisers should 

tailor these policies to fit their respective 

circumstances: (1) A contribution ban above a 

certain de minimis amount (either with respect to 

all political contributions or ones that fall within 

certain specified parameters); (2) a pre-clearance 

process for contributions; or (3) a disclosure policy 

with respect to contributions. At that time, codes of 

ethics were voluntary. However, in 2004, the 

Commission adopted a requirement that advisers 

adopt and implement codes of ethics that include 

a standard of conduct that reflects the adviser’s 

fiduciary obligations, although the code of ethics 

rule does not directly address pay to play practices. 

See Advisers Act rule 204A–1 [17 CFR 275.204A– 

1]; Investment Adviser Codes of Ethics, Investment 

Advisers Act Release No. 2256 (July 2, 2004) [69 FR 

41696 (July 9, 2004)]. See also Investment Counsel 

Association of America, Report on Pay-to-Play and 

the Investment Advisory Profession (May 15, 2000), 

available at http://www.investmentadviser.org/ 

eweb/docs/Publications_News/ 

PublicDocs_UsefulWebsites/PubDoc/report 

(condemning practices by which investment 

professionals try to gain access to business through 

political contributions, and urging its members to 

adopt codes of ethics designed to prevent pay to 

play). 

71 In response to our 1999 Proposal, some 

commenters suggested requiring advisers to 

disclose publicly their contributions to State and 

local officials. Statutes requiring disclosure of 

political contributions are 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. But, as several other 

commenters correctly pointed out, our goal is not 

campaign finance reform, and how voters might 

react to such disclosure is not, for us, the relevant 

concern. Our primary concern is the protection of 

advisory clients and investors who are affected by 

pay to play practices whom we have the 

responsibility to protect under the Advisers Act. 

72See infra note 158 and accompanying text 

regarding swap arrangements that may be used to 

circumvent public disclosure. 

73MSRB rule G–37, however, does establish a 

reporting and disclosure system for broker-dealers 

subject to that rule. MSRB rule G–37(e)(ii). 

74 ‘‘Government entity’’ is defined by the 

proposed rule as ‘‘any State or political subdivision 

of a State, including any agency, authority, or 

instrumentality of the State or political subdivision, 

a plan, program, or pool of assets sponsored or 

established by the State or political subdivision or 

any agency, authority or instrumentality thereof; 

and officers, agents, or employees of the State or 

political subdivision or any agency, authority or 

instrumentality thereof, acting in their official 

capacity.’’ Proposed rule 206(4)–5(f)(5). 

75Proposed rule 206(4)–5(a)(1). 

76We note that, notwithstanding the proposed 

duration of the rule’s ‘‘time out’’—two years—the 

reach of the time out is relatively narrow in the 

sense that it only prohibits advisers from receiving 

compensation for providing advice from the 

particular government entities to whose officials 

triggering contributions have been made. It does not 

limit the adviser from receiving compensation from 

other government entities as to which triggering 

contributions have not been made. 

public pension plans over whom we 

have no regulatory jurisdiction.66

2. Relationship With MSRB Rules; 

Alternative Approaches 

As discussed above, we modeled 

proposed rule 206(4)–5 on MSRB rules 

G–37 and G–38, which we believe have 

successfully addressed pay to play in 

the municipal bond market. This 

approach should minimize the 

compliance burdens on firms that 

would be subject to both rule regimes 

because firms that are already subject to 

MSRB rules would already have 

developed policies and systems for 

compliance that could be adapted to 

meet investment adviser requirements. 

Certain provisions of our proposed rule, 

however, are somewhat different in 

ways that reflect the different statutory 

framework under which the rule would 

be adopted and the differences between 

municipal underwriting and asset 

management. Comment is requested on 

whether we should use rules G–37 and 

G–38 as the models for proposed rule 

206(4)–5.67 If not, are there alternative 

models that would be more appropriate? 

Are there significant differences in 

governments’ selection process for 

municipal underwriters and investment 

advisers that we have not addressed but 

that should be reflected in the rule? 

Would our approach adequately protect 

public pension plans, their sponsors 

and participants against the adverse 

effects of pay to play practices? 

We understand many advisers have 

established restrictions on pay to play 

practices in their codes of ethics and 

compliance policies. Instead of, or in 

addition to, adopting a new rule to 

address pay to play practices, should we 

amend our code of ethics rule 68 or our 

compliance rule 69 to require all 

registered advisers to adopt policies and 

procedures designed to prevent them 

from engaging in pay to play 

practices? 70 Should we instead, or also, 

require an executive officer of each 

adviser to certify annually that the 

adviser or its covered associates did not 

participate in pay to play? Should some 

other employee of the adviser, such as 

the chief compliance officer, make the 

certification? 

In 1999, we considered proposing a 

different approach to address pay to 

play, which would have required an 

adviser to disclose information about its 

political contributions to officials of 

government entities to which it 

provided or was seeking to provide 

investment advisory services. We 

decided not to propose such an 

approach at that time because we 

thought that disclosure would not be 

effective to protect public pension plan 

clients.71 Disclosure to a pension plan’s 

trustees might be insufficient because, 

in some cases, the trustees would have 

received the contributions. Disclosure to 

plan beneficiaries also would likely be 

insufficient because they are generally 

unable to act on the information by 

moving their pension assets to a 

different plan or reversing adviser hiring 

decisions. Moreover, disclosure 

requirements may not stop pay to play 

practices and can be circumvented.72

Accordingly, we do not believe that 

relying on disclosure is sufficient to 

address these problematic practices.73

We request comment on whether we 

should, nonetheless, consider this 

approach, as well as potential 

alternative approaches that may be more 

effective or less costly. 

3. Pay To Play Restrictions 

(a) Two-Year ‘‘Time Out’’ for 

Contributors 

Proposed rule 206(4)–5(a)(1) would 

prohibit investment advisers from 

providing advice for compensation to a 

‘‘government entity’’ 74 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.’’ 75 We are 

proposing that the time out be two years 

long because the duration needs to be 

sufficiently long to have a deterrent 

effect. We recognize, however, that a 

longer ban could be overly harsh.76 We 

note that MSRB rule G–37 contains a 

two-year time out, which appears, based 

on the success of the MSRB rules, to 

have operated as an effective deterrent 


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77See supra note 24. Several commenters in 1999 

suggested that, because advisers’ business 

relationships with State and municipal clients are 

ongoing and long-term, as compared to the 

relationships between municipal underwriters and 

their clients, the two-year ban is much more harsh 

a consequence. As we note above, while municipal 

underwritings themselves tend to be episodic, 

underwriting relationships are often longstanding, 

which may result in the rules’ time outs having 

similar effects. See supra note 67. 78Some commenters in 1999 objected to two 

years as being too long a period of time (arguing, 

for example, that because changing investment 

advisers can be so disruptive to a pension fund that 

such a fund would be extremely unlikely to return 

to an adviser after a ‘‘time out,’’ thereby rendering 

the two-year ban tantamount to a permanent one), 

whereas others suggested that the period be longer 

or that it track the remainder of the term of the 

government official to whom the contribution was 

made. 

79Some commenters in 1999 indicated concern 

that government entities that retain advisers who 

trigger the two-year time out—and would therefore 

be unable to receive compensation for two years— 

might try to delay an adviser’s ability to withdraw 

in order to enjoy the benefits of investment advice 

for free. We believe that while an adviser’s fiduciary 

obligations require it to act in the best interests of 

its clients, they do not require it to provide 

uncompensated advice indefinitely because it is 

prohibited from receiving compensation under the 

rule—rather, the adviser may need to continue to 

provide advice for only a reasonable period of time. 

80An investment adviser that violates the rule 

may be required, under its fiduciary duties, to 

continue providing advisory services to the public 

pension plan, for a reasonable period of time, until 

the plan obtains a new adviser. See Temporary 

Exemption for Certain Investment Advisers, 

Investment Advisers Act Release No. 1846 (Nov. 29, 

1999) [64 FR 68019, 68024 (Dec. 6, 1999)] 

(describing an investment adviser’s fiduciary duties 

to an investment company in the case of an 

assignment of the advisory contract). 

We note that the two-year time out in MSRB rule 

G–37 operates to prohibit a broker, dealer or 

municipal securities dealer from engaging in all 

municipal securities business; it does not 

distinguish between providing compensated and 

uncompensated services. MSRB Rule G–37(b)(i). 

See also MSRB Rule G–37 Interpretive Notices, 

Interpretation of Prohibition on Municipal 

Securities Business Pursuant to Rule G–37 (Feb. 21, 

1997) (determining that once a dealer enters into 

contract and a subsequent contribution results in a 

prohibition, the dealer ‘‘should not be allowed to 

continue with the municipal securities business, 

subject to an orderly transition to another entity to 

perform such business’’). But see infra note 189 

(discussing MSRB’s approach to transitions in the 

context of pre-existing engagements relating to 

municipal fund securities, such as interests in 

Section 529 plans). 

81See supra note 74. 

82Proposed rule 206(4)–5(f)(6). The two-year time 

out would be triggered by contributions, not only 

to elected officials who have legal authority to hire 

or select the adviser, but to elected officials (such 

as persons with appointment authority) who can 

influence the hiring of the adviser. A person who 

serves at the will of an elected official is likely to 

be subject to that official’s influences and 

recommendations. We note that MSRB rule G–37 

also applies to elected officials empowered to 

appoint persons with the authority to select which 

broker-dealers will receive government business. 

83 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. 

84See MSRB rule G–37(g)(ii) and (g)(vi). 

85Proposed rule 206(4)–5(f)(6), in relevant part, 

defines ‘‘official’’ as any person * * * who was, at 

the time of the contribution, an incumbent, 

candidate or successful candidate for elective office 

of a government entity * * *, ’’ and a ‘‘government 

entity,’’ in relevant part, as ‘‘any State or political 

subdivision of a State’’ (emphasis added). 

Accordingly, any person, including a person 

running for Federal office, who meets the definition 

of ‘‘official’’ would be covered under the rule. See 

also MSRB rule G–37(g)(ii) and (g)(vi) (defining 

‘‘issuer’’ and ‘‘official of an issuer’’, respectively); 

MSRB Qs & As, Question IV.2 and IV.3, available 

at http://www.msrb.org/msrb1/rules/QAG372003.htm (explaining how G–37 applies to 

candidates for Federal office). 

86Some 1999 commenters urged that 

contributions to candidates for Federal office be 

excluded from the rule, while others agreed these 

contributions should be covered. In particular, 

certain commenters asserted that this aspect of the 

proposed rule would have a disparate effect on 

candidates for Federal office because State and local 

politicians would experience limitations on their 

ability to receive Federal campaign contributions 

while their opponents would be subject to no such 

limitations. These commenters also claimed the 

rule would have little effect because if the 

candidate for Federal office was successful, he or 

she would quickly lose his or her ability to 

influence the selection of an investment adviser at 

the State or local level. Other commenters thought 

it appropriate that the rule apply to candidates for 

Federal office. As noted above, our emphasis in the 

proposed rule remains on the current office of an 

elected official and his or her ability to affect the 

selection of an investment adviser, regardless of 

what outside positions that official may seek. 

87A contribution to an official, as opposed to a 

committee, for inauguration or transition expenses 

would be a contribution under the proposed rule. 

See infra note 93 and accompanying text. This 

approach is consistent with the approach in MSRB 

rule G–37. We are proposing a similar approach for 

reasons of regulatory consistency; nonetheless, we 

have included this request for comment on whether 

we should include contributions to such 

committees. 

88Under the proposed rule, such contributions or 

payments by an adviser (or its covered associates) 

would only trigger the rule’s provisions to the 

extent that an adviser was trying to do indirectly 

Continued 

in the municipal securities context.77

We request comment on whether two 

years is an appropriate length of time.78

(1) Prohibition on Compensation 

Investment advisers making 

contributions covered by the proposed 

rule would not be prohibited from 

providing advisory services to a 

government client, even after triggering 

the two-year time out. Instead, an 

adviser would be prohibited from 

receiving compensation for providing 

advisory services to the government 

client during the time out. This 

approach is intended to avoid requiring 

an adviser to abandon a government 

client after the adviser or any of its 

covered associates makes a political 

contribution covered by the rule. An 

adviser subject to the prohibition would 

likely, at a minimum, be obligated to 

provide (uncompensated) advisory 

services for a reasonable period of 

time 79 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.80 We request 

comment on our proposed approach. Is 

there another approach that would 

cause less disruption to the government 

client? 

(2) Officials of a Government Entity 

The prohibitions in the rule would be 

triggered by a contribution to an 

‘‘official’’ of a ‘‘government entity.’’ 

Government entities under the proposed 

rule include all State and local 

governments, their agencies and 

instrumentalities, and all public 

pension plans and other collective 

government funds.81 An official would 

include 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 

selection 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 

selection of an investment adviser.82

Generally, executive or legislative 

officers who hold a position with 

influence over the hiring of an 

investment adviser are government 

officials under the proposed rule.83

These definitions are substantively the 

same as those in MSRB rule G–37.84

We request comment on our proposed 

definition of ‘‘official.’’ For instance, a 

candidate for Federal office may be an 

‘‘official’’ under the rule, just as such a 

person may be under MSRB rule G–37, 

not because of the office he or she is 

running for, but as a result of an office 

he or she currently holds.85 As a 

preliminary matter, we do not believe 

that an incumbent State or local official 

should be excluded from the definition 

solely because he or she is running for 

Federal office, but we request comment 

on this aspect of the proposed rule. 

Should such a candidate for Federal 

office be excluded? 86 Are there other 

persons to whom an adviser or its 

covered associates might make a 

contribution to influence the selection 

of that adviser? For example, should we 

expand the rule’s prohibitions to apply 

expressly in cases where an adviser or 

a covered associate gives a contribution 

to others closely associated with the 

official—such as an official’s political 

action committee (‘‘PAC’’), his or her 

inauguration or transition committee,87

a local or State political party that 

provides assistance to such official,88 or 


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what it is prohibited from doing directly. See infra 

section II.A.3(d) of this Release. In contrast, the 

prohibition on advisers soliciting contributions or 

payments from others in proposed rule 206(4)– 

5(a)(2)(ii) would expressly include 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. See infra section II.A.3(c) of this 

Release. Further, our proposed amendments to rule 

204–2 (in particular, rule 204–2(a)(18)(i)(D)) would 

expressly include a requirement that an adviser 

subject to the rule make and keep records of, among 

other things, all direct or indirect contributions or 

payments made by the investment adviser or any 

of its covered associates to a political party of a 

State or political subdivision thereof. Our proposed 

approach to these provisions generally tracks the 

MSRB approach. 

89For a discussion of associated recordkeeping 

requirements, see infra note 206 and accompanying 

text. 

90MSRB rule G–37(g)(i). 

91Commenters to our 1999 proposal raised 

concerns that volunteer campaign work by advisory 

employees could trigger the proposed rule’s time 

out provision. We would not consider volunteer 

campaign work 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, are not used. Cf. MSRB Qs & 

As, Question II.12, available at http:// 

www.msrb.org/msrb1/rules/QAG-372003.htm. 

92Proposed rule 206(4)–5(f)(1). Commenters in 

1999 expressed concern that the scope of our 

proposed rule was too broad. These commenters, 

many of whom represented investment advisers, 

raised concerns that the rule as proposed could 

unnecessarily restrict their employees from making 

any political contributions. Some commenters 

questioned the constitutionality of our proposal, 

arguing that the proposed rule would violate First 

Amendment protections for free speech. In Blount, 

supra note 16, a Federal appeals court upheld a 

First Amendment challenge to MSRB rule G–37. 

The Court left open the question of the appropriate 

level of scrutiny to be applied, but concluded that 

the rule satisfied even a strict scrutiny test. We 

believe that the rule we are proposing today 

similarly is consistent with the First Amendment. 

Absent provisions to limit the application of the 

rule’s prohibitions, it could result in frequent 

inadvertent violations that would carry harsh 

consequences for advisers. Accordingly, we refined 

the categories of persons whose personal political 

contributions would be covered under the rule and 

provided for a self-executing exception that should 

prevent many inadvertent violations. We believe 

these changes will address many of the 

commenters’ concerns about the rule we proposed 

in 1999. 

93Proposed rule 206(4)–5(f)(1)(iii). Transition or 

inaugural expenses of a successful candidate for 

Federal office are not included. Contributions to 

political parties are not specifically covered by the 

definition and thus would not trigger the proposed 

rule’s two-year timeout unless they are a means to 

do indirectly what the proposed rule would 

prohibit if done directly (for example, the 

contributions are earmarked or known to be 

provided for the benefit of a particular political 

official). See proposed rule 206(4)–5(d). 

Contributions to State and local political parties are, 

however, subject to the proposed rule’s 

recordkeeping requirements. See infra section II.B 

and proposed rule 204–2(a)(18)(i)(D). 

94Commenters in 1999 urged us to adopt a rule 

prohibiting only political contributions intended to 

influence, or made for the purpose of influencing, 

adviser selection. This approach, they argued, 

would eliminate the risk that innocent campaign 

contributions would trigger application of the ‘‘twoyear time out.’’ Political contributions are made 

ostensibly to support a candidate, however, and the 

burden of proving a different intent is very difficult 

absent unusual evidence. As one court noted, 

‘‘actors in this field are presumably shrewd enough 

to structure their relations rather indirectly.’’ 

Blount, supra note 16. As a result, requiring proof 

of such an intent would greatly diminish, if not 

eliminate, the prophylactic value of the proposed 

rule. 

95Under the proposed rule, an adviser would be 

prohibited from soliciting contributions for the 

official. Proposed rule 206(4)–5(a)(2)(ii). 

96Cf. 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 of 

this nature in its rules directly, the MSRB applies 

a facts-and-circumstances test on a case-by-case 

basis). 

97See, e.g., In the Matter of Barrett N. Wissman, 

Investment Advisers Act Release No. 2879 (May 22, 

2009) (in a settled action, the Commission alleged 

that managing director of registered investment 

adviser engaged in a fraudulent scheme involving 

undisclosed kickback payments made by 

investment management firms and others in 

connection with the sale of securities to the New 

York Common Retirement Fund and the investment 

of the fund’s assets in the purchase and sale of 

securities); 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 a settled action, the Commission alleged 

that unregistered adviser, through its chairman, 

agreed to hire an inexperienced associate of the 

Connecticut Treasurer as a consultant as a 

condition to securing a State pension fund 

investment); In the Matter of Frederick W. 

McCarthy, Investment Advisers Act Release No. 

2218 (Mar. 5, 2004) (in a settled action, the 

Commission alleged that principal and chairman of 

investment management firm provided $2 million 

in consulting contracts to associates of the 

Connecticut Treasurer in order to secure the 

Treasurer’s decision to invest). We have also 

observed this pattern of contributions in pay to play 

arrangements in other contexts, including those 

involving union pension funds. See, e.g., In the 

Matter of William M. Stephens, Investment 

Advisers Act Release No. 2076 (Nov. 4, 2002) (in 

a settled action, the Commission alleged that 

executive vice president and chief investment 

strategist of registered investment adviser met with 

people who offered to introduce him to the trustees 

of union pension funds, and he agreed that after he 

and his firm became the funds’ adviser, he would 

arrange to divert a portion of the funds into 

investments controlled by the people who made the 

introductions, who would, in turn, pay kickbacks 

to the pension fund trustees who hired him and his 

firm); In the Matter of Chris Woessner, Investment 

Advisers Act Release No. 2164 (Aug. 26, 2003) 

(Commission alleged that former vice president of 

sales at registered investment adviser who was in 

charge of marketing to pension plans caused his 

firm to direct client commissions for the benefit of 

a broker-dealer and pension consultant in exchange 

for the referral of a union pension fund client to the 

firm). 

98Proposed rule 206(4)–5(f)(2)(i). Under our 1999 

proposal, the rule would have applied more broadly 

to ‘‘partners’’ (not just a general partner or 

equivalent) and ‘‘executive officers’’ (which we 

proposed to define as ‘‘the president, any vice 

president in charge of a principal business unit, 

division or function (such as sales, administration 

or finance), any other officer who performs a policymaking function, or any other person who performs 

similar policy-making functions, for the investment 

adviser’’). See 1999 Proposing Release, supra note 

17, at section II.A.1. Commenters in 1999 suggested 

that, instead of applying the rule to all partners, we 

a foundation or other charitable 

institution associated with such 

official? 89

(3) Contributions 

The proposed rule covers 

‘‘contributions’’ made by an investment 

adviser and its covered associates. The 

proposed rule uses the same definition 

of contribution as MSRB rule G–37.90 A 

contribution would generally be any 

gift, subscription, loan, advance, deposit 

of money, or anything of value 91 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.92 It would 

also include transition or inaugural 

expenses incurred by a successful 

candidate for State or local office.93 We 

request comment on our proposed 

definition of ‘‘contribution.’’ 94 Are 

there additional items of value that, as 

with transitional or inaugural expenses, 

should be specified in and covered by 

the definition? For instance, should we 

include the expenses an investment 

adviser would incur in organizing or 

sponsoring a conference at which a 

government official is invited to attend 

or is a speaker? 95 If so, how should our 

rule distinguish legitimate conferences 

or meetings from those that are more 

akin to fundraising events? 96 Are there 

items that should be excluded from the 

definition? 

(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. 

For this reason, MSRB rule G–37 limits 

its prohibitions to contributions made 

by ‘‘municipal finance professionals’’ 

employed by a broker-dealer. No group 

analogous to municipal finance 

professionals, however, exists within 

the typical investment advisory firm. In 

many of the pay to play enforcement 

actions we have brought involving 

investment advisers, we have alleged 

that political contributions or other 

payments were made to influence the 

selection of the advisory firm by 

executives of the adviser or persons who 

solicit government clients on behalf of 

the adviser.97 We therefore are 

proposing to limit application of the 

rule’s ‘‘time out’’ provision to 

contributions made by the adviser and 

its ‘‘covered associates,’’ which would 

include the adviser’s general partners, 

managing members, executive officers, 

or other individual with a similar status 

or function.98 Any employee of the 


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narrow the rule to apply only to a firm’s general 

partner (or equivalent) and other owners that have 

a significant ownership interest in the firm. 

Commenters also suggested that we either exclude 

executive officers of divisions unrelated to the 

firm’s solicitation and/or advisory functions or limit 

the rule’s application to only the most senior 

officers of an adviser, such as persons required to 

be listed on Schedule A of Form ADV. In light of 

these comments, we have included in our proposed 

definition of ‘‘covered associates’’ only those 

persons associated with an investment adviser who 

we believe are more likely to have an economic 

incentive to make contributions to influence the 

advisory firm’s selection and who we have found, 

in our enforcement actions, typically make 

contributions. 

99See proposed rule 206(4)–5(f)(10) (defining 

‘‘solicit’’). 

100Proposed rule 206(4)–5(f)(2)(ii). Several 

commenters in 1999 argued that we would have 

included too broad a category of solicitors because 

our definition of ‘‘solicitor’’ would have included 

any person who solicited any client for or referred 

any client to the adviser. The two-year time out 

would have been triggered, for example, by 

registered representatives who solicited brokerage 

business for a firm dually registered as a brokerdealer and as an adviser, even though the registered 

representatives had no involvement with 

government clients. See 1999 Proposing Release, 

supra note 17, at section II.A.1. We have included 

a narrower category of solicitors in our current 

proposed rule; the two-year time out provisions 

would be triggered by a contribution by a person 

who solicits government entities for advisory 

services. Many commenters also urged that the 

definition of ‘‘solicitor’’ exclude third-party 

solicitors. They asserted that it was unfair to hold 

advisers responsible for the actions of these 

solicitors, arguing that the advisers did not control 

their activities. We have excluded third-party 

solicitors from this two-year time out provision; 

instead we are proposing to prohibit advisers from 

soliciting government business through third 

parties, as discussed in detail in section II.A.3(b) of 

this Release. 

101Proposed rule 206(4)–5(f)(2)(iii). Our 1999 

proposal would also have included PACs controlled 

by the investment adviser and the individuals 

associated with the investment adviser whose 

contributions would have triggered the ‘‘time out.’’ 

See 1999 Proposing Release, supra note 17, at 

section II.A.1. We have proposed to include PACs 

because these vehicles, which may be regulated by 

State and/or Federal election law, are often used by 

corporations, interest groups, or others to make 

political contributions. See, e.g., Tennessee Registry 

of Election Finance, PACs FAQ, available at http:// 

www.state.tn.us/tref/pacs/pacs_faq.htm; Federal 

Election Commission, Quick Answers to PAC 

Questions, available at http://www.fec.gov/ans/ 

answers_pac.shtml. 

102See discussion of covered investment pools, 

infra, section II.A.3(e). 

103Proposed rule 206(4)–5(f)(4). Our proposed 

definition of ‘‘executive officer’’ in rule 206(4)– 

5(f)(4) is based on the same considerations as a 

similar definition in Advisers Act rule 205–3 [17 

CFR 275.205–3]. Whether a person is an executive 

officer depends on his or her function, not title; a 

chief executive officer whose title does not include 

‘‘president’’ is clearly an executive officer. 

104Proposed rule 206(4)–5(d). 

105See id. See also discussion of indirect 

contributions, infra section II.A.3(c). 

106Many 1999 commenters argued that our 

proposal included too many persons whose 

activities are unconnected to managing public 

pension money, making it too likely that an 

innocent political contribution would trigger a twoyear time out. We considered these comments in 

narrowing the scope of persons covered by our 

current proposed rule, as described above. 

107See discussion at section II.A.3(b), infra . 

108See proposed rule 206(4)–5(d), however. 

adviser who solicits 99 government 

entity clients for the investment adviser 

would also be a covered associate,100 as 

would any PAC controlled by the 

investment adviser or any of the 

adviser’s covered associates.101

Under the proposed rule, the term 

‘‘executive officer’’ includes the 

adviser’s president and any vice 

president in charge of a principal 

business unit, division or function (such 

as sales, administration or finance) or 

any other executive officer who, in each 

case, in connection with his or her 

regular duties: (i) Performs investment 

advisory services (or supervises 

someone who performs them) for an 

adviser; (ii) solicits (or supervises 

someone who solicits) for an adviser, 

including with respect to investors for a 

covered investment pool; 102 or (iii) 

supervises, directly or indirectly, 

executive officers described in (i) or 

(ii).103 Accordingly, for instance, the 

proposed rule would cover 

contributions by a portfolio manager 

who is an executive officer, as well as 

contributions by anyone in the portfolio 

manager’s chain of supervision up to 

and including the president of the 

adviser. The rule would also cover 

contributions by an executive officer 

who supervises personnel who solicit 

advisory clients and contributions by 

anyone in that executive’s chain of 

supervision. The rule would not, 

however, cover contributions by the 

adviser’s other executives, such as its 

comptroller, its head of human 

resources, or its director of information 

services, unless the contribution is an 

indirect contribution for the adviser, 

because the compensation of these 

individuals is likely to be tied less 

directly to obtaining or retaining clients. 

Contributions by non-executive 

employees (other than those who solicit 

government entity clients) would not 

trigger the rule’s prohibitions, unless the 

adviser or any of its covered associates 

used the person to indirectly make a 

contribution.104 This could occur, for 

example, if a firm paid a non-executive 

employee a bonus with the 

understanding that the bonus would be 

used by the employee to make a 

political contribution that, if made by 

the firm, would trigger the rule’s 

prohibition.105

As noted above, the Commission has 

drafted the proposed rule so that its 

prohibitions are triggered by political 

contributions by persons who, in the 

context of an advisory firm, are likely to 

have an economic incentive to make 

contributions to influence the advisory 

firm’s selection and the categories of 

executives and employees of an adviser 

that we have seen, most typically, to 

make political contributions and 

payments in pay to play situations. We 

are mindful of the burdens the proposed 

rule would place on advisory firms and 

on the ability of persons associated with 

an adviser to participate in civic affairs. 

We thus have narrowly tailored the rule 

to achieve our goal of preventing adviser 

participation in pay to play practices. 

We request comment on the scope of 

the proposed rule and, in particular, 

those persons associated with the 

advisers whose political contributions 

would trigger the application of the twoyear ‘‘time out’’ and would be 

prohibited from soliciting political 

contributions from others. Have we 

included persons most likely to have an 

economic incentive to make political 

contributions for the purpose of 

influencing the selection of the adviser? 

Have we covered too many persons? 

If so, how should we narrow the rule? 

For example, are there certain executive 

officers of the adviser we should not 

include? The proposed rule would cover 

all executive officers who, as part of 

their regular duties, perform investment 

advisory services or supervise someone 

who performs them. Should we instead 

limit the scope to a subset of such 

officers? If so, how should we define 

that subset? 106 Should we extend the 

rule to cover all portfolio managers, or 

just those portfolio managers 

responsible for managing government 

client assets? Are there other types of 

employees whose contributions should 

trigger the time out? 

Have we too narrowly drawn the rule 

to achieve our goals? Should we, for 

example, include employees of 

companies that are related persons of an 

adviser who solicit government entity 

clients for the investment adviser? As 

discussed further below, we propose 

permitting payments to these persons 

under the proposed ban on payments to 

third parties because we recognize that 

an adviser may rely on them to assist it 

in seeking government clients.107 Would 

that same rationale support including 

them as ‘‘covered associates’’ of the 

adviser (whose contributions would be 

subject the proposed rule’s two-year 

time out provision)? Would not 

including them be likely to encourage 

circumvention of the rule’s 

requirements? 108 We also request 

comment on whether we should, for 

example, include certain family 

members who, and related businesses 

that, might give political contributions 

on the adviser’s behalf to try to 


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109See, e.g., Martin Z. Braun et al., A Political 

Family Affair?, The Bond Buyer (Oct. 21, 2002) 

(noting that spouses of municipal finance 

professionals in dealer firms are making campaign 

contributions to issuer officials who can influence 

the award of bond business). 

110Paragraph (d) of proposed rule 206(4)–5. See 

section II.A.3(d) of this Release. 

111Proposed rule 206(4)–5(a)(1). In no case would 

the prohibition imposed by the proposed 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 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. 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 

employed by the adviser. See infra section II.B. 

112MSRB rule G–37(g)(iv). Cf. MSRB Qs & As, 

Question II.12, available at http://www.msrb.org/ 

msrb1/rules/QAG-372003.htm. 

113Commenters in 1999 urged us to reduce the 

look back period, arguing that politically active 

individuals might be discouraged from joining 

advisory firms. However, we are concerned about 

the prospect of advisers seeking to circumvent the 

rule by hiring individuals shortly after they have 

made significant contributions that could influence 

government officials. 

114Under the proposed rule, each covered 

associate, taken separately, would be subject to the 

$250 de minimis exception for elections in which 

he or she is entitled to vote. In other words, the 

$250 limit applies per covered associate and is not 

an aggregate limit for all of an adviser’s covered 

associates. 

115Proposed rule 206(4)–5(b)(1). Under the 

proposed rule, primary and general elections would 

be considered separate elections. Accordingly, a 

covered person of an investment adviser could, 

without triggering the prohibitions of the rule, 

contribute up to $250 in both the primary election 

campaign and the general election campaign (up to 

$500) of each official for whom the person making 

the contribution would be entitled to vote. For 

purposes of this rule, 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. See, e.g., In the Matter of Pryor, 

McClendon, Counts & Co., Inc. et al., Exchange Act 

Release No. 48095 (June 26, 2003) (noting that Rule 

G–37 allows a person to contribute $250 to a 

candidate’s campaign in the primary and in the 

general election, for a total of $500 during the 

election cycle, and clarifying that contributions 

must be limited to $250 before the primary, with 

an additional $250 allowed after the primary for the 

general election). See also MSRB Qs & As, Question 

II.8, available at http://www.msrb.org/msrb1/rules/ 

QAG-372003.htm. 

116See MSRB rule G–37(b)(i). 

117Some commenters in 1999 suggested that the 

amount be substantially higher. Some commenters 

thought we should raise the de minimis amount to 

$1,000 to be consistent with the limits on private 

contributions for candidates for Federal office. We 

believe that a higher threshold—such as $1,000— 

would be significantly more likely to enable a 

contributor to seek to exert influence over an 

official with the ability to select an investment 

adviser, especially in a local election. We also 

believe a lower amount might be too restrictive— 

it could preclude individuals from supporting 

candidates for whom they are able to vote at levels 

that are less likely to facilitate undue influence. 

118Our proposed de minimis exception only 

applies to contributions to a candidate for whom 

the contributor is entitled to vote. Whereas the 

outcome of an election in which a contributor is 

eligible to vote is likely to have a greater personal 

impact on the contributor, there is a significantly 

greater likelihood that a contributor’s contribution 

in an election in which he or she is not entitled to 

vote could be motivated by other factors, which 

might include influencing a candidate. In 1999, 

there was a mixture of support and criticism for 

limiting the exception to contributions to officials 

or candidates for whom the contributor is entitled 

to vote, and one commenter advocated expanding 

it to a $100 de minimis exception for candidates for 

whom the contributor is not entitled to vote. 

119Proposed rule 206(4)–5(b)(2). 

120Proposed rule 206(4)–5(b)(2)(i). To the extent 

that the contribution by a covered associate of the 

adviser was less than $250 and was for an official 

for whom the covered associate was entitled to vote 

at the time of the contributions, the contribution 

would not have triggered the two-year ban on 

account of the exception contained in paragraph 

(b)(1) of the proposed rule. 

influence officials of government 

entities? 109 Under the proposed rule, 

political contributions by such persons 

would only result in a violation under 

the rule if the adviser or its covered 

associates were acting through them to 

do indirectly what they cannot do 

directly under the rule.110 MSRB rule 

G–37 addresses this matter similarly. 

Should we include beneficial owners of 

the adviser because they have a direct 

economic stake in the adviser’s business 

relationship with the government 

client? If so, should the definition 

include all owners, or only those with 

a significant ownership stake in an 

adviser, such as those who have 

contributed (or that have the right to 

receive upon dissolution) ten percent or 

more of the company’s capital? 

(5) ‘‘Look Back’’ 

Under the proposed rule, the two-year 

time out would continue in effect after 

the covered associate who made the 

triggering contribution left the advisory 

firm. Moreover, a contribution made by 

a covered associate of an adviser would 

be attributed to any other adviser that 

employs or engages the person who 

made the contribution within two years 

after the date the contribution was 

made.111 As a result, an investment 

adviser would be required to ‘‘look 

back’’ in time to determine whether it 

would be subject to any business 

restrictions under the proposed rule 

when employing or engaging a covered 

associate. This provision, which tracks 

MSRB rule G–37,112 would prevent 

advisers from circumventing the rule by 

channeling contributions through 

departing employees, or by influencing 

the selection process by hiring persons 

who have made political contributions. 

Comment is requested on the proposed 

look-back requirement. For example, 

would a shorter period be sufficient to 

prevent circumvention of the rule? 113 If 

so, what period would be appropriate? 

Would our proposed look-back 

provision inappropriately deter 

politically active individuals from 

joining advisory firms that provide 

investment advice to government 

entities or are seeking to do so? 

(6) Exception for De Minimis 

Contributions 

Proposed rule 206(4)–5 contains a de 

minimis exception that would permit 

each covered associate who is an 

individual 114 to make aggregate 

contributions of $250 or less, per 

election, to an elected official or 

candidate without triggering the rule’s 

prohibitions if the person making the 

contribution is entitled to vote for the 

official or candidate.115 We have 

proposed $250 because we believe that 

contributions of $250 or less are 

typically made without the intent or 

ability to influence the selection process 

for investment advisers and thus do not 

involve the conflicts of interest the rule 

is intended to prevent, as well as for 

reasons of regulatory consistency. The 

$250 amount is the same as the de 

minimis amount excepted from MSRB 

rule G–37.116 Comment is requested on 

the scope of the exception.117 Should 

the amount be increased or decreased, 

and if so, on what basis? For instance, 

the MSRB has not adjusted its de 

minimis amount for inflation since it 

was established in 1994. We have not 

adjusted the $250 for inflation because 

of ease of reference to a round number 

and because an inflation adjustment 

would result in an amount not 

significantly higher. We request 

comment, however, on whether we 

should adjust our amount for inflation. 

Should we provide a de minimis 

exception for contributions to officials 

for whom an individual is not entitled 

to vote, and if so, what would be an 

appropriate de minimis amount? 118

(7) Exception for Certain Returned 

Contributions 

We are proposing a second exception 

from the two-year compensation ban 

intended to address situations in which 

the adviser triggers the ban 

inadvertently.119 We have attempted to 

limit the scope of this exception to the 

types of contributions that we believe 

are unlikely to raise pay to play 

concerns. This exception would be 

available only with respect to 

contributions made by a covered 

associate of the investment adviser to 

officials other than those for whom the 

covered associate was entitled to vote at 

the time of the contributions and which, 

in the aggregate, do not exceed $250 to 

any one official, per election.120 Further, 

the adviser must have discovered the 


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121 Id. We believe that requiring that the adviser 

must have discovered the contribution within four 

months provides an appropriate time limit for the 

exception. On one hand, 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 influence for 

too long a period of time. On the other hand, we 

believe it makes sense to give advisers sufficient 

time to discover contributions made by covered 

associates if, for example, their covered associates 

disclose their contributions to the adviser on a 

quarterly basis. Also, this provision is consistent 

with the approach taken in MSRB rule G–37(j)(i). 

122Proposed rule 206(4)–5(b)(2)(i). The prompt 

return of the contribution would provide some 

indication that the contribution would not affect an 

official of a government entity’s decision-making 

process with regard to choosing an adviser. We 

have proposed that the contribution must be 

returned within 60 days 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 proposed 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.’’ 

123MSRB rule G–37(j). We did not include an 

equivalent provision in our 1999 proposal, and 

MSRB rule G–37 contained no such provision at 

that time. However, the MSRB added an ‘‘automatic 

exemption’’ provision in 2003. Exchange Act 

Release No. 47814 (May 8, 2003) [68 FR 25917 (May 

14, 2003)]. Several of the comments we received on 

our 1999 proposal, while supporting the exemptive 

provision we proposed at that time, expressed 

concern that the scope and breadth of the rule 

would expose advisers to the risk of inadvertent 

violations, which would necessitate frequent 

exemptive applications. See, e.g., Comment Letter 

of the Securities Industry Association (Oct. 29, 

1999) (‘‘SIA Comment Letter’’); Comment Letter of 

Morgan Stanley Dean Witter Investment 

Management Inc. (Nov. 1, 1999) (‘‘MSDW Comment 

Letter’’); Comment Letter of Fidelity Investments 

(Nov. 1, 1999); Investment Counsel Association of 

America Comment Letter (Nov. 1, 1999) (‘‘Nov. 

ICAA Comment Letter’’); Comment Letter of 

Scudder Kemper Investments (Nov. 8, 1999) 

(‘‘Scudder Kemper Comment Letter’’); Comment 

Letter of Nicholas-Applegate Capital Management 

(Oct. 26, 1999) (‘‘Nicholas-Applegate Comment 

Letter’’); Comment Letter of Smith Barney Asset 

Management and Salomon Brothers Asset 

Management Inc. (Nov. 1, 1999) (‘‘Smith Barney 

Comment Letter’’) (suggesting, alternatively, that 

the time out period be 30 days for inadvertent 

violations); Comment Letter of Davis Polk & 

Wardwell (Nov. 1, 1999) (‘‘Davis Polk Comment 

Letter’’); and Comment Letter of American Bar 

Association, Subcommittees on Investment 

Companies and Investment Advisers and on Private 

Investment Entities of the Committee on Federal 

Regulation of Securities, Section of Business Law 

(Jan. 5, 2000) (‘‘ABA Comment Letter’’). The 

exception we have proposed would help address 

these concerns. 

124Proposed rule 206(4)–5(b)(2)(ii). We wanted to 

give each adviser more than one opportunity to 

refine its compliance procedures to avoid further 

violations of the proposed rule but, as noted, did 

not want to allow an adviser to relax its standards 

by making multiple exceptions available. This will 

generally create some flexibility to accommodate a 

covered associate’s inadvertent violation. 

125Proposed rule 206(4)–5(b)(2)(iii). Once a 

covered associate has been made aware of an 

‘‘inadvertent’’ violation, a justification for a second 

violation is more questionable. 

126See In the Matter of Self-Regulatory 

Organizations; Notice of Filing of Proposed Rule 

Change by the Municipal Securities Rulemaking 

Board Relating to Consultants, Exchange Act 

Release No. 36522 (Nov. 28, 1995) [60 FR 62275 

(Dec. 5, 1995)] (‘‘The Board believes that rules G– 

37 and G–20 [regarding gifts and gratuities] * * * 

along with [the rule on fair dealing] set appropriate 

standards for dealer conduct in the municipal 

securities industry. However, the Board is 

concerned about dealers’ increasing use of 

consultants to obtain or retain municipal securities 

business. While the Board believes that in many 

instances the use of consultants is appropriate, it 

also believes that, in a number of instances, the use 

of consultants may be in response to limitations 

placed on dealer activities by rule G–37 and rule 

G–20. While both of these rules prohibit dealers 

from doing indirectly what they are precluded from 

doing directly, indirect activities often are difficult 

to prove.’’ (footnotes omitted)). 

127See id. 

128See In the Matter of Self-Regulatory 

Organizations; Order Approving Proposed Rule 

Change by the Municipal Securities Rulemaking 

Board Relating to Consultants, Exchange Act 

Release No. 36727 (Jan. 17, 1996) [61 FR 1955 (Jan. 

24, 1996)] (‘‘The rule approved today is intended 

to provide additional information to issuers and to 

the public to assist in determining the extent to 

which payments to consultants influence the 

issuer’s selection process in connection with 

municipal securities business. * * *’’) (‘‘MSRB 

Rule G–38 Adoption Order’’). See also Municipal 

Securities Rulemaking Board, Request for 

Comments on Revised Draft Amendments to Rule 

G–38 Relating to Solicitation of Municipal 

Securities Business (as modified on Oct. 12, 2004) 

(Sept. 29, 2004), available at http://www.msrb.org/ 

msrb1/archive/2004/RevRuleG38Solicitation.htm#revised1 (noting, with regard to 

MSRB rule G–38, ‘‘As initially adopted, the rule 

required * * * that the dealer disclose information 

about its consulting arrangements to any issuer 

from which a consultant would solicit municipal 

securities business on its behalf [and that the dealer 

disclose] to the MSRB * * * the terms of the 

consulting agreements and the business obtained by 

the consultants * * * [with] such disclosures made 

available to the public through the MSRB Web site 

* * *’’ (footnotes omitted)). 

129See Municipal Securities Rulemaking Board, 

Amendments Relating to Solicitation of Municipal 

Securities Business Under Rule G–38, SR–MSRB– 

2005–04 (Mar. 17, 2005), available at http:// 

www.msrb.org/msrb1/rulesandforms/sec/SR-MSRB2005-04.pdf (‘‘The MSRB began its current 

rulemaking initiative on the solicitation on behalf 

of brokers, dealers and municipal securities dealers 

(‘‘dealers’’) of municipal securities business by 

consultants early last year because of certain 

practices that could present challenges to 

maintaining the integrity of the municipal securities 

market. These practices include, among other 

things, significant increases in recent years in the 

number of consultants being used, the amount these 

consultants are being paid and the level of reported 

political giving by consultants. The MSRB has been 

concerned that increases in levels of compensation 

paid to consultants for successfully obtaining 

municipal securities business may be motivating 

consultants, who currently are not subject to the 

basic standards of fair practice and professionalism 

embodied in MSRB rules, to use more aggressive or 

questionable tactics in their contacts with 

issuers.’’). 

contribution which resulted in the 

prohibition within four months of the 

date of such contribution 121 and, within 

60 days after learning of the triggering 

contribution, must cause the 

contribution to be returned to the 

contributor.122 We believe this 

exception should only be available 

when the adviser discovered the 

triggering contribution, and caused it to 

be returned, promptly. Our proposal 

generally tracks MSRB rule G–37’s 

‘‘automatic exemption’’ provision.123

To ensure that the exception for 

certain returned contributions does not 

encourage an investment adviser to 

relax its efforts to promote compliance 

with the rule’s prohibitions, no adviser 

would be entitled to rely on the 

exception more than twice per 12- 

month period.124 And an investment 

adviser would not be permitted to rely 

on the exception more than once with 

respect to contributions by the same 

covered associate of the investment 

adviser,125 regardless of the time period. 

We request comment on the proposed 

criteria for, and limitations on, the 

exception for certain returned 

contributions. Are the various time 

periods we proposed (discovery of 

contribution within four months of it 

being made, return of contribution 

within 60 days of discovery, and 

limitation of reliance on the exception 

twice per adviser per 12-month period) 

reasonable? Would they be effective? 

Are there other circumstances under 

which an adviser should be able to avail 

itself of an exception? Alternatively, 

should we require that an adviser 

institute special supervisory procedures 

(after it relies on the exception for 

certain returned contributions) for the 

covered associate making the 

contribution, including requiring preclearance of all contributions, for a 

specified period of time? 

(b) Ban on Using Third Parties To 

Solicit Government Business 

After the adoption of rule G–37 in 

1994, the MSRB observed that 

municipal securities dealers sought to 

circumvent rule G–37 by hiring thirdparty consultants to solicit government 

clients on their behalf.126 These thirdparty consultants would make political 

contributions or otherwise seek to exert 

influence designed to secure municipal 

business for the municipal securities 

firm.127 Two years later, in 1996, the 

Commission approved, and the MSRB 

adopted, rule G–38, which required 

municipal dealers to disclose publicly 

the terms of their agreements with 

consultants.128 In 2005, after concluding 

that the required disclosure was neither 

adequate to prevent circumvention of 

rule G–37, nor consistently being 

made,129 the MSRB (with the 


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130See In the Matter of Self-Regulatory 

Organizations; Order Approving Proposed Rule 

Change and Notice of Filing and Order Granting 

Accelerated Approval to Amendment No. 1 to the 

Proposed Rule Change Relating to Solicitation of 

Municipal Securities Business under MSRB Rule G– 

38, Exchange Act Release No. 52278 (Aug. 17, 2005) 

[70 FR 49342 (Aug. 23, 2005)]. As amended, MSRB 

rule G–38(a) states, ‘‘Subject to section (c) of this 

rule [regarding transitional payments], no broker, 

dealer or municipal securities dealer may provide 

or agree to provide, directly or indirectly, payment 

to any person who is not an affiliated person of the 

broker, dealer or municipal securities dealer for a 

solicitation of municipal securities business on 

behalf of such broker, dealer or municipal securities 

dealer.’’ 

131See, e.g., SEC v. Henry Morris, et al., Litigation 

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

Commission’s complaint alleges that investment 

advisers and a placement agent, among others, 

engaged in a fraudulent scheme to extract kickbacks 

from investment management firms seeking to 

manage assets of the New York State Common 

Retirement Fund); In the Matter of Kent D. Nelson, 

Investment Advisers Act Release No. 2765 (Aug. 1, 

2008); Initial Decision Release No. 371 (Feb. 24, 

2009); Investment Advisers Act Release No. 2868 

(Apr. 17, 2009) (an administrative law judge found 

that an investment adviser funneled payments 

through a third party to the New Mexico State 

treasurer in exchange for being retained as an 

adviser by the State treasurer’s office); SEC v. Paul 

J. Silvester et al., Litigation Release No. 16759 (Oct. 

10, 2000); Litigation Release No. 16834 (Dec. 19, 

2000); Litigation Release No. 18461 (Nov. 17, 2003); 

Litigation Release No. 19583 (Mar. 1, 2006); 

Litigation Release No. 20027 (Mar. 2, 2007) (alleging 

that, in order to obtain investment contracts, 

investment adviser firms made payments to 

associates of the Connecticut State treasurer, a 

portion of which were kicked back to the treasurer). 

See also supra notes 31–40 (discussing other cases 

related to these enforcement actions). 

132See, e.g., Aaron Elstein, NY Pension Fund 

Bans Controversial Middlemen, Crain’s New York 

Business (Apr. 22, 2009) (describing the New York 

State Comptroller’s ban on placement agents); Press 

Release, Office of the New York City Comptroller, 

Thompson Moves to Ban Placement Agents, Asks 

State AG to Investigate Quadrangle Transaction, 

PR–09–04–095 (Apr. 22, 2009), available at http:// 

www.comptroller.nyc.gov/press/2009_releases/ 

pr09-04-095.shtm (describing the New York City 

Comptroller’s calls on the New York City Pension 

Funds to ban placement agents); Henry Goldman, 

New York City Police Pension Bans Placement 

Agent Use, Bloomberg (May 5, 2009) (describing the 

New York City Police Pension Fund’s suspension 

on the use of placement agents); Martin Z. Braun, 

New York City’s Fire Pension Bans Middlemen, 

Joining Two Others, Bloomberg (May 16, 2009) 

(describing the New York City Fire Pension Fund’s 

suspension on the use of placement agents); Barry 

Massey, NM Agency Bans Placement Agents on 

Investments, Businessweek (May 26, 2009) 

(describing the New Mexico State Investment 

Council’s ban on placement agents). See also In the 

Matter of the Carlyle Group, AGNY Investigation 

No. 2009–071, Assurance of Discontinuance 

Pursuant to Executive Law § 63(15) (May 14, 2009), 

available at http://www.oag.state.ny.us/ 

media_center/2009/may/pdfs/Carlyle%20AOD.pdf; 

In the Matter of Riverstone Holdings, LLC, AGNY 

Investigation No. 2009–091, Assurance of 

Discontinuance Pursuant to Executive Law § 63(15) 

(June 11, 2009), available at http:// 

www.oag.state.ny.us/media_center/2009/june/pdfs/ 

Riverstone%20AOD%20FINAL%20EXECUTED.pdf; 

and In the Matter of PCG Corporate Partners 

Advisors II, LLC, AGNY Investigation No. 2009–101, 

Assurance of Discontinuance Pursuant to Executive 

Law § 63(15) (July 1, 2009), available at http:// 

www.oag.state.ny.us/media_center/2009/july/pdfs/ 

PCG%20AOD%20FINAL%20EXECUTED.pdf (in 

each case, banning the use of third-party placement 

agents pursuant to a ‘‘Public Pension Fund Reform 

Code of Conduct’’ in connection with the New York 

Attorney General’s findings 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, * * * and that the use of 

placement agents to obtain public pension fund 

investments is a practice fraught with peril and 

prone to manipulation and abuse.’’). 

133See 1999 Proposing Release, supra note 17, at 

section II.A.1. 

134See, e.g., SIA Comment Letter; T. Rowe 

Comment Letter; MSDW Comment Letter; Comment 

Letter of Legg Mason, Inc. (Nov. 1, 1999); American 

Bankers Association Comment Letter (Nov. 1, 1999); 

Nov. ICAA Comment Letter; Scudder Kemper 

Comment Letter; Nicholas-Applegate Comment 

Letter; Smith Barney Comment Letter; Davis Polk 

Comment Letter; and ABA Comment Letter. We 

note that rule 206(4)-3 (the ‘‘cash solicitation rule’’) 

under the Advisers Act, among other things, 

requires an adviser that engages a third-party 

solicitor for clients: (i) to make a bona fide effort 

to ascertain whether the solicitor has complied with 

the adviser’s agreement with the solicitor; and (ii) 

to have a reasonable basis for believing that the 

solicitor has so complied. Advisers Act rule 206(4)- 

3(a)(2)(iii)(C) [17 CFR 275.206(4)–3(a)(2)(iii)(C)]. 

135Although rule 206(4)–3 under the Advisers 

Act (the ‘‘Cash Solicitation Rule’’) contemplates 

that certain client solicitation activities of third 

parties can be undertaken where certain conditions 

are met and the adviser both ‘‘makes a bona fide 

effort to ascertain whether’’ and ‘‘has a reasonable 

basis for believing that’’ the solicitor has complied 

with certain aspects of the rule (Advisers Act rule 

206(4)–3(a)(2)(iii)(C) [17 CFR 275.206(4)– 

3(a)(2)(iii)(C)]), commenters’ concerns about the 

inability of advisers to control the political 

contribution activity of their solicitors (which is not 

restricted under the Cash Solicitation Rule) 

persuade us that a different approach is appropriate 

for solicitation of government clients. 

136Proposed rule 206(4)–5(a)(2)(i). Advisers 

making payments to solicitors must comply with 

the cash solicitation rule under the Advisers Act. 

If this component of proposed rule 206(4)–5 is 

adopted as proposed, investment advisers registered 

or required to be registered with us would no longer 

be able to rely on the cash solicitation rule to pay 

third-party solicitors to obtain government clients. 

For a discussion of proposed amendments to the 

cash solicitation rule, see infra section II.C. 

137Pension consultants provide advice to pension 

plans (public or private) and their trustees with 

respect to their investments, selection of money 

managers and other service providers, and other 

investment-related matters. Many pension plans 

rely heavily on the expertise and guidance of their 

pension consultant in helping them to manage 

pension plan assets. Pension consultants may act as 

third-party solicitors. Others may act as investment 

advisers subject to our rule. In 2005, our Office of 

Compliance Inspections and Examinations 

published a report highlighting concerns relating to 

the Advisers Act stemming from examinations of 24 

pension consultant firms, including conflicts of 

interest that arise with respect to pension 

consultants that provide products and services to 

both pension plan advisory clients and money 

managers and mutual funds on an ongoing basis. 

Office of Compliance Inspections and 

Examinations, U.S. Securities and Exchange 

Commission, Staff Report Concerning Examinations 

of Select Pension Consultants (May 16, 2005), 

available at http://www.sec.gov/news/studies/ 

pensionexamstudy.pdf. Commission staff also 

published on the Commission’s Web site, in 

cooperation with the U.S. Department of Labor, tips 

to assist fiduciaries of employee benefit plans in 

Commission’s approval) amended rule 

G–38 to impose a complete ban on the 

use of third-party consultants to solicit 

government clients.130

We are concerned that our adoption of 

a rule addressing pay to play practices 

by advisers would lead to a similar use 

of consultants or solicitors by 

investment advisers to circumvent the 

rule. Indeed, we have alleged that thirdparty solicitors have played a central 

role in each of the enforcement actions 

against investment advisers that we 

have brought in the past several years 

involving pay to play schemes.131

Government authorities in New York 

and other jurisdictions have prohibited, 

or are considering prohibiting, the use 

of consultants, solicitors, or placement 

agents by investment advisers to solicit 

government investment business.132

In our 1999 proposal, contributions to 

a government official by an adviser’s 

third-party solicitor, engaged by the 

adviser to obtain clients, would have 

triggered a two-year ‘‘time out’’ for the 

adviser.133 Several commenters opposed 

inclusion of contributions by third-party 

solicitors as a trigger for the ‘‘time out.’’ 

Most argued that this aspect of the rule 

was unfair and created significant 

compliance challenges because these 

solicitors were not, according to the 

commenters, controlled by advisers.134

In light of these considerations, 

including the apparent difficulties for 

advisers to monitor the activities of their 

third-party solicitors, we are proposing 

to prohibit investment advisers from 

using third-party solicitors to obtain 

government clients.135 Proposed rule 

206(4)–5 would make it 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 its covered 

associates, to provide or agree to 

provide, directly or indirectly, 

‘‘payment’’ to any person to solicit a 

government entity for investment 

advisory services unless such person is: 

(i) A ‘‘related person’’ of the investment 

adviser or, if the related person is a 

company, an employee of that related 

person; or (ii) any of the adviser’s 

employees, general partners, LLC 

managing members, executive officers 

(or other person with a similar status or 

function, as applicable).136 The rule’s 

prohibition on an adviser’s payments to 

third-party solicitors may apply to 

persons commonly called ‘‘finders,’’ 

‘‘solicitors,’’ ‘‘placement agents,’’ or 

‘‘pension consultants.’’ 137


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reviewing conflicts of interest of pension 

consultants. Selecting and Monitoring Pension 

Consultants: Tips for Plan Fiduciaries (June 1, 

2005), available at http://www.sec.gov/investor/ 

pubs/sponsortips.htm. 

Although the terms are sometimes used 

interchangeably, ‘‘finders’’ typically locate buyers 

and/or sellers for a security on behalf of a brokerdealer, ‘‘solicitors’’ typically locate investment 

advisory clients on behalf of an investment adviser, 

and ‘‘placement agents’’ typically specialize in 

finding investors (often institutional investors or 

high net worth investors) that are willing and able 

to invest in a private offering of securities on behalf 

of the issuer of such privately offered securities. 

138Proposed rule 206(4)–5(a)(2)(i). 

139We would define ‘‘related person’’ as any 

person, directly or indirectly, controlling or 

controlled by the investment adviser, and any 

person that is under common control with the 

investment adviser. Proposed rule 206(4)–5(f)(9). 

The term ‘‘company’’ is defined in the Advisers 

Act, in relevant part, as ‘‘a corporation, a 

partnership, an association, a ‘joint-stock’ company, 

a trust, or any organized group of persons, whether 

incorporated or not.’’ 15 U.S.C. 80b–2(a)(5). 

140More specifically, we do not include any of 

the following within the prohibition on payments 

for solicitation of government clients: executive 

officers, general partners, managing members (or, in 

each case, persons with similar status or function), 

employees, or ‘‘related persons’’ of the investment 

adviser. Proposed rule 206(4)–5(a)(2)(i). We make 

this distinction because related person solicitors are 

subject to an adviser’s (or its affiliates’) control and 

thus should not present the compliance challenges 

that advisers pointed to with respect to third-party 

solicitors. See supra note 134 and accompanying 

text. MSRB rule G–38’s exclusions are based on two 

similar definitions—of ‘‘affiliated person of the 

broker, dealer or municipal securities dealer’’ and 

of ‘‘affiliated company of the broker, dealer or 

municipal securities dealer.’’ MSRB rule G–38(b)(i) 

and (b)(ii). 

141Pursuant to proposed rule 206(4)–5(a)(1), 

certain contributions by the investment adviser and 

its covered associates would trigger the two-year 

time out. For a discussion of the two year ‘‘time 

out’’ provision of the proposed rule, see supra 

section II.A.3(a). We are not proposing that 

contributions by ‘‘related persons’’ and their 

employees would trigger the two-year time out, 

although we request comment on whether to 

include in the definition of ‘‘covered associate’’ an 

employee of a related person who solicits a 

government entity for the adviser. See discussion at 

section II.A.3(a)(4), supra. See also proposed rule 

206(4)–5(d). 

142For example, if an adviser’s sister company 

has an office in a given location, the adviser might 

seek the assistance of a sister company’s employee 

at that location to solicit local government business 

on its behalf rather than relying on its own 

personnel who might be located a significant 

distance away. 

143Proposed rule 206(4)–5(f)(7). MSRB rule G–38 

incorporates the definition of ‘‘payment,’’ as well as 

the definitions of ‘‘issuer’’ and ‘‘municipal 

securities business’’ from MSRB rule G–37(g). 

144As well as the various means by which an 

adviser and its covered associates may seek to 

solicit other persons or coordinate donations to 

political parties. See infra section II.A.3(d). 

145The proposed rule’s prohibition on making 

payments to third-party solicitors of government 

clients would apply expressly only to investment 

advisers and their covered associates. But see 

proposed rule 206(4)–5(d) (the proposed rule’s 

prohibitions on an adviser and its covered 

associates doing indirectly what cannot be done 

directly). For a discussion of this provision, see 

infra section II.A.3.(d) of this Release. The proposed 

rule would not prohibit government entities from 

retaining ‘‘pension consultants’’ (or other thirdparties) and paying them to recommend particular 

investment advisers for the management of public 

funds. 

146See proposed rule 206(4)–5(f)(10). MSRB rule 

G–38 contains a similar definition. See MSRB rule 

G–38(b)(i). 

147See supra note 134. 

The proposed rule would only apply 

to ‘‘third-party’’ solicitors who solicit 

government entities for investment 

advisory services.138 The prohibition on 

payments to third-party solicitors would 

not cover solicitations on behalf of an 

investment adviser by a person who is 

a ‘‘related person’’ of the adviser, any of 

the related person’s employees if the 

related person is a company,139 or any 

executive officer or partner of the 

adviser.140 A contribution to a 

government official by certain of these 

persons would instead trigger the twoyear ‘‘time out’’ under paragraph (a) of 

the proposed rule, during which the 

investment adviser could not provide 

investment advisory services for 

compensation to the government entity 

whose selection of an adviser that 

official could influence.141 We have 

proposed to include related persons and 

their employees (if the related persons 

are companies) in order to enable 

advisers to compensate parent 

companies and other owners, 

subsidiaries and sister companies—as 

well as employees of related 

companies—for government entity 

solicitation activities because we 

recognize that there may be efficiencies 

in allowing advisers to rely on these 

particular types of persons to assist 

them in seeking clients.142 We request 

comment on whether we should include 

employees of an adviser’s related 

persons that are companies within the 

group of persons not subject to the ban 

on payments to third parties. Should we 

include only employees of certain 

related persons of the adviser? If so, 

how should we make that 

determination? We also request 

comment on whether there are other 

types of persons associated with an 

investment adviser who should not be 

subject to the ban on payments to third 

parties. We would define ‘‘payment’’ as 

any gift, subscription, loan, advance or 

deposit of money or anything of 

value.143 We are proposing this 

definition to cover the various means by 

which an adviser and its covered 

associates may seek to compensate a 

third-party solicitor.144 A ‘‘finder’s fee’’ 

paid for a third-party solicitation would 

be an example of a prohibited payment. 

It could also include payments made to 

pension consultants for performing 

various services, such as attending or 

sponsoring conferences, if those services 

are intended to obtain government 

clients.145 Are there other types of 

payments we should explicitly include 

in the definition? Are there others that 

we should exclude, and, if so, why? 

We would broadly define ‘‘solicit’’ to 

mean: (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 (ii) with respect to a 

contribution or payment, to 

communicate, directly or indirectly, for 

the purpose of obtaining or arranging a 

contribution or payment. We are 

proposing this definition to capture the 

types of communications in which an 

investment adviser might engage that 

we believe should trigger application of 

the rule’s prohibitions— 

communications for the purpose of 

obtaining or retaining a client or a 

contribution.146 Whether a particular 

communication constitutes a 

‘‘solicitation,’’ therefore, depends on the 

specific facts and circumstances relating 

to the communication. The nature of 

information conveyed in any 

communication and the manner in 

which it is presented would be relevant 

factors to consider. Does our proposed 

definition effectively capture the 

appropriate scope of communications? 

If not, what types of communications 

should we exclude, and why? 

We request comment on our proposal 

to prohibit the use of third-party 

solicitors of government business. Is our 

proposed prohibition on the use of 

third-party solicitors an appropriate 

means to deter pay to play practices? 

We propose to prohibit only third-party 

solicitors as likely posing a significant 

threat to investor protection; certain 

related-party solicitors would, instead, 

be subject to the time out limitations of 

proposed rule 206(4)–5(a)(1). Is this 

differentiation appropriate? If not, 

should we instead subject advisers to 

the two-year time out for contributions 

made by their third party solicitors 

although, as noted above, commenters 

in 1999 indicated that such a 

requirement may impose significant 

compliance challenges? 147 If the 

differentiation is appropriate, should we 

also have a two-year look back 

restriction for any contributions made 

by the third party? Is there a different 

approach that would be effective at 

eliminating circumvention of the rule 

through the use of third parties? For 

example, should we consider narrowing 

the prohibition to accommodate 

government solicitation activities by 

third parties if such third parties (and 


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148For examples of solicitation or coordination of 

contributions in the municipal securities dealer 

context, see In the Matter of Pryor, McClendon, 

Counts & Co., Inc. et al., Exchange Act Release No. 

48095 (June 26, 2003) (Commission alleged that a 

broker-dealer violated rule G–37(c) because its 

president delivered three $250 money orders (in 

other people’s names) in addition to his own 

personal check for $250 to the campaign of a New 

York City mayoral candidate during a period when 

the firm was engaged in municipal securities 

business with New York City); In the Matter of FAIC 

Securities, Inc., Exchange Act Release No. 36937 

(Mar. 7, 1996) (Commission alleged that the brokerdealer willfully violated G–37(c) because the firm’s 

municipal finance professionals approved its 

affiliated companies’ political contributions to 

candidates for office who could influence the 

awarding of municipal securities business by the 

State of Florida and by Dade County, Florida, and 

during the two-year period following those 

contributions, the firm continued to seek, and was 

selected, to participate in negotiated underwritings 

of certain municipal securities by both Dade County 

and a State agency). 

149See supra note 143 and accompanying text for 

the definition of ‘‘payment.’’ This definition is 

derived from the definition of ‘‘contribution,’’ but 

does not include the limits on the purposes for 

which such money is given, as currently set forth 

in the proposed definition of contribution. We are 

including ‘‘payments,’’ as opposed to 

‘‘contributions,’’ here to deter an adviser from 

circumventing the rule’s prohibitions by 

coordinating indirect contributions to government 

officials through payments to political parties. We 

noted similar concerns in the context of MSRB Rule 

G–37 when we approved a recordkeeping provision 

in rule G–8 to require persons subject to that rule 

to keep records relating to political party payments. 

See SEC Order Approving Proposed Rule Change by 

the Municipal Securities Rulemaking Board 

Relating to Rule G–37 on Political Contributions 

and Prohibitions on Municipal Securities Business, 

and Rule G–8, on Recordkeeping, Exchange Act 

Release No. 35446 (Mar. 6, 1995) (‘‘[S]ome [industry 

participants] currently are urging dealers to make 

payments to political parties earmarked for 

expenses other than political contributions (such as 

administrative expenses or voter registration 

drives). Since these payments would not constitute 

‘‘contributions’’ under the rule, the recordkeeping 

and reporting provisions would not apply. The 

MSRB is concerned, based upon this information, 

that the same pay-to-play pressures that motivated 

the MSRB to adopt rule G–37 may be emerging in 

connection with the fundraising practices of certain 

political parties described above.’’). 

150Proposed 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 proposed rule 

would not trigger a two-year ban on the provision 

of investment advisory services for compensation, 

but would be a violation of the rule. This provision 

would prohibit, for example, an adviser’s 

solicitation of a payment to the political party of the 

State in which the adviser was seeking to provide 

advisory services to a government entity of the 

State, but would not preclude that adviser from 

soliciting a payment to a local political party, 

unless the adviser was doing so as a means to do 

indirectly what the adviser could not do directly 

under the proposed rule (for example, if the adviser 

was soliciting the payment as a means to funnel 

payments to an official of the government entity 

from which the adviser was seeking business). See 

proposed rule 206(4)–5(d). 

151See MSRB rule G–37(c). We note, however, 

that G–37 did not contain a prohibition on 

soliciting or coordinating payments to political 

parties in 1999, and our 1999 proposal did not 

contain such a provision. 1999 Proposing Release, 

supra note 17. 

152See Rule G–37: Request for Comments on Draft 

Amendments to Rule G–37(c), Relating to 

Prohibiting Solicitation and Coordination of 

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 (‘‘G–37(c) Notice’’) (‘‘[T]he MSRB 

is especially troubled by the emergence of recent 

media and other reports that issuer agents have 

informed dealers and [municipal finance 

professionals] that, if they are prohibited from 

contributing directly to an issuer official’s 

campaign, they should contribute to the affiliated 

party’s ‘‘housekeeping’’ account. The MSRB is 

concerned that dealers or [municipal finance 

professionals] who make such payments may be 

doing so in an effort to avoid the political 

contribution limitations embodied in 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). 

153See G–37(c) Notice, supra note 152. (‘‘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.’’). 

154We note that a direct contribution to a 

political party by an adviser or its covered 

associates would not trigger the two-year time out 

provision of the proposed rule (although we request 

comment on our proposed definition of 

‘‘contribution’’), unless the contribution was a 

means for the adviser to do indirectly what the 

proposed 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 supra note 93. We are 

proposing, however, that an adviser be prohibited 

from soliciting others to make, or coordinating, 

payments to political parties because, as the 

MSRB’s experience has shown, advisers could 

otherwise use such means to circumvent the 

proposed rule’s limitations on direct contributions 

to government officials. 

155An employee or person acting on an adviser’s 

behalf ‘‘bundles’’ contributions or payments by 

their related persons) commit not to 

contribute to (or solicit contributions 

for) officials of any government entity 

from which any adviser that hires them 

is seeking business? To what extent 

might the proposed ban on using third 

parties to solicit government business 

disproportionately impact the ability of 

certain investment advisers, such as 

those that are smaller and less 

established, to compete in the market to 

provide advisory services to government 

clients? Conversely, to what extent 

might the proposed ban benefit smaller 

or less established advisers who are 

currently unable or unwilling to engage 

in pay to play practices to compete for 

government business? 

(c) Restrictions on Soliciting and 

Coordinating Contributions and 

Payments 

Another way an adviser can attempt 

to influence the selection process is by 

coordinating contributions for an 

elected official or payments to a 

political party, or by soliciting others to 

make contributions to an elected official 

or payments to a political party.148

Therefore, proposed rule 206(4)– 

5(a)(2)(ii) would prohibit an adviser and 

its covered associates from soliciting 

any person or PAC to make, or from 

coordinating, any contribution to an 

official of a government entity to which 

the adviser is providing or seeking to 

provide investment advisory services, or 

any payment 149 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.150 Our proposed 

restrictions on soliciting and 

coordinating contributions and 

payments generally track MSRB rule G– 

37.151 The MSRB amended its rule in 

2005, with Commission approval, 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.152 The MSRB had not 

previously been able to deter this 

misconduct, despite issuing informal 

guidance in both 1996 and in 2003.153

We are proposing a similar prohibition 

on soliciting or coordinating payments 

to political parties in States or localities 

where the investment adviser is 

providing or seeking to provide 

investment advisory services to a 

government entity because we are 

concerned that our adoption of a rule 

that only prohibits advisers from 

soliciting others to make, or 

coordinating, contributions to officials 

would lead to the development of a 

similar gap in which advisers could 

circumvent the rule by making 

payments to political parties to 

influence an official.154

Proposed rule 206(4)–5(a)(2)(ii) would 

also prohibit advisers from seeking to 

influence the selection process by, for 

example, ‘‘bundling’’ 155 contributions 


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coordinating small contributions or payments from 

several employees of the adviser or others to create 

one large contribution or payment. For an example 

of this in the context of the municipal securities 

industry, see In the Matter of Pryor, McClendon, 

Counts & Co., Inc. et al., Securities Act Release No. 

48095 (June 26, 2003) (‘‘Counts[, the president of 

the broker-dealer firm,] gave his administrative 

assistant $750 in cash, told her to purchase three 

separate money orders, and told her to make them 

payable for $250 each to the candidate’s campaign. 

Counts instructed his assistant to make out one of 

the money orders as if it were from the assistant 

herself, and to make out the other two as if they 

were from the wife of a [firm] employee and a 

friend of Counts’, respectively. Counts then caused 

those money orders to be delivered to the 

candidate’s campaign together with Counts’ own 

personal check for $250. [When two of the three 

money orders were subsequently returned,] Counts 

instructed his assistant to deposit the returned $500 

into [the firm]’s bank account, which she did.’’). 

156We are proposing that solicitation of 

contributions of others for an official of a 

government entity to which an adviser is providing 

or seeking to provide investment advisory services 

by an adviser or its covered associates be subject to 

a flat prohibition under the rule, rather than trigger 

a two-year ‘‘time out,’’ because we recognize it may 

be more difficult for an adviser to monitor 

solicitation activities (as opposed to direct 

contribution activity). For a discussion of an 

adviser’s obligation to adopt policies and 

procedures reasonably designed to prevent 

violations of the Advisers Act pursuant to our 

‘‘compliance rule,’’ see infra note 207 and 

accompanying text. 

157See, e.g., SEC v. Morris et al., Litigation 

Release No. 21001 (Apr. 15, 2009) (the 

Commission’s complaint alleges that placement 

agents acted as gatekeepers by directing investment 

management firms to funnel kickbacks through 

various entities); In the Matter of Kent D. Nelson, 

Initial Decision Release No. 371 (Feb. 24, 2009) (an 

administrative law judge found that an investment 

adviser funneled payments through a third party to 

the New Mexico State treasurer, acting as 

gatekeeper by extracting $4.4 million in finder’s 

fees from broker-dealers and siphoning $2.9 million 

to the State treasurer’s office to influence the 

office’s discretionary commitment of funds, in 

exchange for being retained as an adviser by the 

State treasurer’s office); (Investment Advisers Act 

Release No. 2868 (Apr. 17, 2009). Similar types of 

arrangements exist outside of the context of 

government investments, such as in the area of 

union pension funds. See, e.g., In the Matter of Duff 

& Phelps Investment Management Co., Inc., 

Investment Advisers Act Release No. 1984 (Sept. 

28, 2001) and related case In re Performance 

Analytics, et al., Investment Advisers Act Release 

No. 2036 (June 17, 2002) (in a settled action, the 

Commission alleged that an investment adviser 

entered into an arrangement with gatekeeper 

broker-dealer in which the adviser would direct its 

trades to broker-dealer if the broker-dealer would 

continue to recommend the adviser to the union 

pension fund board, and the broker-dealer allegedly 

funneled payments to certain trustees on the 

pension fund board to preserve its role as 

gatekeeper and to preserve the adviser’s role as 

adviser to the fund). 

158For example, Adviser A advises Plan X, while 

Adviser B advises Plan Y. The ‘‘gatekeeper’’ may 

direct a political contribution from Adviser A to the 

elected official, who is a trustee to Plan Y, and from 

Adviser B to the elected official, who is a trustee 

to Plan X, agreeing to place both advisers on each 

plan’s approved list. Persons reviewing records of 

the political contributions would have no way of 

determining that the contributions were swapped 

and that they created conflicts of interest on the 

part of the advisers as well as the elected officials. 

159Regardless of whether the gatekeeper is an 

investment adviser, a person participating in such 

a scheme could, if the rule is adopted, be 

considered to be aiding and abetting an adviser’s 

violation of the rule. See section 209(d) of the Act 

[15 U.S.C. 80b-9(d)] (authorizing Commission 

enforcement action for aiding and abetting a 

violation of the Advisers Act or any Advisers Act 

rule). 

160Proposed rule 206(4)–5(d). See also section 

208(d) of the Advisers Act [15 U.S.C. 80b–8(d)]; 

MSRB rule G–37(d). 

161 Investment pools may include, but are not 

limited to: mutual funds, hedge funds, private 

equity funds, and venture capital funds. 

162See, e.g., SEC v. Paul J. Silvester et al., 

Litigation Release No. 16759 (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 (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 third-party solicitors to obtain public 

pension fund investments in the fund); In the 

Matter of the Carlyle Group, AGNY Investigation 

No. 2009–071, Assurance of Discontinuance 

Pursuant to Executive Law § 63(15) (May 14, 2009), 

available at http://www.oag.state.ny.us/ 

media_center/2009/may/pdfs/Carlyle%20AOD.pdf; 

In the Matter of Riverstone Holdings, LLC, AGNY 

Investigation No. 2009–091, Assurance of 

Discontinuance Pursuant to Executive Law § 63(15) 

(June 11, 2009), available at http:// 

www.oag.state.ny.us/media_center/2009/june/pdfs/ 

Riverstone%20AOD%20FINAL%20EXECUTED.pdf; 

and In the Matter of PCG Corporate Partners 

Advisors II, LLC, AGNY Investigation No. 2009–101, 

Assurance of Discontinuance Pursuant to Executive 

Law § 63(15) (July 1, 2009), available at http:// 

www.oag.state.ny.us/media_center/2009/july/pdfs/ 

PCG%20AOD%20FINAL%20EXECUTED.pdf (three 

settled actions brought by New York Attorney 

General in which advisers allegedly paid thirdparty solicitors who kicked back a portion of the 

money to the former New York Deputy State 

Treasurer in order to obtain public pension 

investments in private equity funds managed by the 

advisers). 

or payments from its employees or 

others or by making or coordinating 

contributions or payments through a 

third party, such as a ‘‘gatekeeper.’’ 156

In a gatekeeper arrangement, political 

contributions or payments are arranged 

by an intermediary, typically a pension 

consultant, which distributes or directs 

contributions or payments to elected 

officials or candidates.157 The 

gatekeeper ensures that advisers not 

making a requisite amount of 

contributions or payments are not 

included among the final candidates for 

advisory contracts. In addition, a 

gatekeeper could arrange ‘‘swaps’’ of 

contributions or payments between 

elected officials in order to obscure the 

significance of the contributions or 

payments from public disclosure or to 

circumvent plan restrictions on 

contributions to trustees.158 Under the 

proposed rule, the gatekeeper in these 

arrangements would be coordinating 

political contributions or payments and, 

if the gatekeeper is an investment 

adviser, would itself violate the 

proposed rule’s restrictions on 

coordinating contributions or 

payments.159 The adviser would also 

violate the proposed rule if it paid the 

third-party solicitor to coordinate 

political contributions or payments in 

order to obtain business. 

We request comment on this aspect of 

the proposed rule, including our 

proposed definitions. Is it appropriate to 

differentiate between ‘‘contributions’’ to 

officials and ‘‘payments’’ to political 

parties? Are there alternative 

approaches that would effectively deter 

these types of indirect pay to play 

arrangements? Do commenters believe 

that our proposed inclusion of payments 

to State and local political parties closes 

an important gap in which contributions 

might be made indirectly to officials for 

the purposes of influencing their choice 

of investment advisers? Alternatively, 

do commenters believe that our 

proposed inclusion of political parties is 

unnecessary? 

(d) Direct and Indirect Contributions or 

Solicitations 

Rule 206(4)–5(d) would also prohibit 

acts done indirectly, which, if done 

directly, would result in a violation of 

the rule.160 Thus, an adviser and its 

covered associates could not circumvent 

the rule by directing or funding 

contributions through third parties, 

including, for example, consultants, 

attorneys, family members, friends or 

companies affiliated with the adviser. 

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 contribution, another contribution is 

likely to be made by a third party to an 

‘‘official of the government entity,’’ for 

the benefit of the adviser. Contributions 

made through gatekeepers (described 

above) thus would be considered made 

‘‘indirectly’’ for purposes of the 

proposed rule. We request comment on 

this aspect of the proposed rule. 

(e) Investment Pools 

(1) Application of the Rule to Pooled 

Investment Vehicles 

Pay to play activities in the context of 

investment pools 161 also raise concerns 

about the potential for fraud.162 The 

fraud that may result from pay to play 

practices can occur in a number of 

circumstances involving the government 

official and the pooled investment 

vehicle. The following are examples of 

pay to play relationships involving 


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163This practice would be covered under (a)(1) of 

the proposed rule. See supra section II.A.3.(a) of 

this release. For a specific discussion of the 

application to ‘‘529 plans,’’ see discussion below at 

footnotes 176–189 and related text. 

164See Elliot Blair Smith, Fund Scandal Worries 

Tuition Plan Investors, USA Today (Nov. 19, 2003), 

at B1 (reporting that the former governor of 

Wisconsin received campaign contributions from 

the founder of a mutual fund company, and 

subsequently the then-governor’s staff created a 

panel of four State employees that selected the 

founder’s firm to manage the State’s 529 plan and 

provide the plan’s investment options). 

165See proposed rule 206(4)–5(c). 

166 Id. 

167See proposed rule 206(4)–5(c). As described 

below, proposed rule 206(4)–5 narrows this 

definition to exclude certain investment companies 

for the purposes of paragraph (a)(1) of the proposed 

rule. 

168Proposed rule 206(4)–5(f)(3). 

169 15 U.S.C. 80a–3(a). 

170 15 U.S.C. 80a–3(c)(1), (7) or (11). 

171See 1999 Proposing Release, supra note 17, at 

section II.A.4. 

172 15 U.S.C. 80a–3(c)(1) and (7). 

173 15 U.S.C. 80a–3(a). 

174 15 U.S.C. 80a–8. 

175 15 U.S.C. 80a–3(c)(11). We note that a bank 

maintaining a collective investment trust would not 

be subject to the proposed 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 person 

who falls within the definition of an investment 

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. 

176A 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 Securities Exchange Act of 

1934 [15 U.S.C. 78a–15(a)(1) and 15B] (‘‘Exchange 

Act’’). 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 and would therefore be subject to our 

proposed rule. 

177A 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)]. 

178A 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]. 

179For example, many 529 plans allow plan 

participants to select among various underlying 

investment options to direct the investment of their 

contributions. The participants’ contributions are 

then invested in options of the 529 plan and the 

plan, in turn, invests its assets in the investment 

companies or other investments on which the plan 

options are based. The Internal Revenue Code 

requires that in order to set up a 529 plan investor 

contributions must be held in a qualified trust. See 

26 U.S.C. 529(b). Often, the adviser to the 529 plan 

also advises the registered investment companies 

that serve as the underlying investment options for 

the plan. Sometimes, however, registered 

investment companies advised by investment 

advisers that do not provide advisory services 

directly to the government entity may serve as the 

underlying investment options for the plan. 

investment pools that implicate the 

concerns underlying this rulemaking: 

• When an investment adviser to a 

pooled investment vehicle makes a 

contribution to a government official 

and the government official directs that 

public monies (e.g., pension plan assets) 

be invested in that adviser’s pooled 

investment vehicle; 

• When an investment adviser to a 

pooled investment vehicle makes a 

contribution to a government official 

and that government official chooses 

that investment adviser to be an adviser 

to a government sponsored plan, such as 

a ‘‘529 plan;’’ 163 and 

• When an investment adviser to a 

pooled investment vehicle makes a 

contribution to a government official 

and that government official chooses 

that adviser’s pooled investment vehicle 

as an investment option in a 

government sponsored plan, such as a 

‘‘529 plan,’’ 164 regardless of whether the 

adviser is also chosen to be the adviser 

to the plan. 

Pay to play activities can harm public 

pension plans and their beneficiaries. 

Such activities can cause competition in 

the market for investments to be 

manipulated, which can distort the 

process by which investment decisions 

regarding public investments are made, 

and can result in public pension plans 

making inferior investments. In 

addition, the pension plan may pay 

higher fees because advisers must 

recoup the contributions, or because the 

contract negotiations are not handled on 

an arm’s-length basis. 

An adviser’s participation in pay to 

play activities may also defraud other 

investors in a pooled investment 

vehicle. For example, in a pay to play 

kickback scheme, the government 

investor in the pooled vehicle would 

receive a kickback payment from the 

adviser while other investors in the pool 

may pay higher advisory fees as a result 

of the adviser trying to recoup the cost 

of the kickback. As another example, a 

government investor that has engaged in 

a pay to play scheme with an 

investment adviser may leverage the fact 

of the adviser’s payment to obtain 

additional benefits for itself that may 

operate as a fraud on other investors in 

the pooled vehicle. 

Therefore, the proposed prophylactic 

rule seeks to address pay to play 

practices by advisers managing pooled 

investment vehicles.165 The proposed 

rule would subject an adviser to a 

covered investment pool to the 

prohibitions of proposed rule 

206(4)–5 166 so that the government 

entities, the pooled investment vehicles, 

and the other investors in that vehicle 

are also protected against the harms that 

may result when advisers engage in pay 

to play practices. 

(2) Covered Investment Pools 

The proposed rule’s prohibitions 

would be applicable only with respect 

to an adviser that manages a covered 

investment pool.167 The proposed rule 

would generally define ‘‘covered 

investment pool’’ 168 as: (i) Any 

investment company as defined in 

section 3(a) of the Investment Company 

Act of 1940 (‘‘Investment Company 

Act’’); 169 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.170

Our 1999 proposal would have 

applied the rule only to advisers 

managing private funds, such as hedge 

funds and private equity funds,171 that 

are typically excepted from the 

definition of investment company by 

either section 3(c)(1) or 3(c)(7) of the 

Investment Company Act.172 We have 

expanded upon that proposal to include 

advisers managing investment 

companies 173 (which are registered 

under the Investment Company Act 174) 

as well as collective investment trusts 

(which are excepted from the definition 

of investment company by section 

3(c)(11)).175 Both of these types of 

collective investment pools today are 

used as either funding vehicles for, or 

investments of, government-sponsored 

savings and retirement plans. These 

plans include, for example, college 

savings plans (such as ‘‘529 plans’’ 176) 

and retirement plans (such as ‘‘403(b) 

plans’’ 177 and ‘‘457 plans’’ 178). They 

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.179


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180See Investment Company Institute, 529 Plan 

Program Statistics, Dec. 2008 (May 22, 2009), 

available at http://www.ici.org/research/stats/529s/ 

529s_12-08 (indicating that 529 plan assets have 

increased from $8.6 billion in 2000 to $104.9 billion 

in the fourth quarter of 2008, and that 529 plan 

participants have increased from 1.3 million in 

2000 to 11.2 million in the fourth quarter of 2008); 

Investment Company Institute, The U.S. Retirement 

Market, 2008, 18 Research Fundamentals, No. 5 

(June 2009), available at http://www.ici.org/pdf/fmv18n5.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=80031025axe

139509557&

docname=SEI%20CIT%20White%20Paper

%205.08.pdf&cid=80031025&encode=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). 

181See, e.g., Charles Paikert, TIAA–CREF Stages 

Comeback in College Savings Plans, Crain’s New 

York Business (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). 

182See supra notes 16 and 55 and accompanying 

text. 

183See, e.g. Blount, supra note 16, at 945. 

184See, e.g., Restrictions Lessen Benefits of State 

College Savings Plans, USA Today (Dec. 1, 2003), 

at A20 (‘‘[M]any States offer only a few investment 

options * * * [and] limit investors to a single fund 

company. * * * While plans vary, States typically 

have negotiated an exclusive deal with one fund 

company.’’). 

185Proposed rule 206(4)–5(c), (f)(3). Accordingly, 

the time out provision would be applicable, for 

example, if a particular mutual fund is selected to 

be an investment option for participants in a 529 

plan; the time out provision would not be 

applicable if a State government invested its 

pension fund assets in that same mutual fund. We 

define a ‘‘plan or program of a government entity’’ 

in the proposed rule as any investment program or 

plan sponsored or established by a government 

entity, including, but not limited to, a ‘‘qualified 

tuition plan,’’ such as a 529 plan, a retirement plan, 

such as a 403(b) plan or 457 plan, or any similar 

program or plan. Proposed rule 206(4)–5(f)(8). 

186 In contrast, where securities are privately 

placed, such as securities of a private fund, the 

adviser (and through its compliance program, its 

personnel) should be aware that an investment from 

a government entity is being solicited and should 

therefore be in a position to refrain from making 

contributions that would trigger a ‘‘time out’’ with 

respect to receiving compensation from that 

government entity. 187See supra note 180 and accompanying text. 188Proposed rule 206(4)–5(a)(2)(i) and (ii). 189The proposed rule would prohibit the receipt 

of compensation from the investment company by 

Continued 

Government-sponsored savings plans 

have grown enormously in recent 

years.180 Competition for an adviser’s 

fund to be selected as an investment 

option in government-sponsored savings 

plans is keen,181 and we are concerned 

that advisers to pooled investment 

vehicles are making political 

contributions to influence the decision 

by government entities of the funds to 

be included as options in such plans. Of 

course, as discussed above,182 proving 

such a direct quid pro quo or intent to 

influence in a specific case often will 

not be possible. As previously stated, it 

is precisely because of that difficulty 

that a prophylactic rule is needed.183

We are concerned about the harmful 

effects pay to play activities may have 

in this context on these governmentsponsored plans and their beneficiaries. 

Plans and their beneficiaries may be 

harmed, for example, if because of an 

adviser’s political contributions, a 

government official causes a 

government-sponsored plan to invest in 

a fund managed by that adviser that 

charges higher fees or is less well 

managed than a fund that may have 

been chosen on the basis of pure merit. 

In addition, pay to play practices could 

be particularly damaging in the 529 

context if a State offers only one, or very 

few, investment options to its 

participants.184 Accordingly, we are 

proposing to include these other pooled 

investment vehicles often managed by 

investment advisers. 

Under the rule, each of the pay to play 

prohibitions (with one exception 

discussed below) would be equally 

applicable to an investment adviser that 

manages assets of a government entity 

through the entity’s investment in a 

covered investment pool managed by 

that adviser. For example, if an 

investment adviser subject to our rule 

makes a campaign contribution to an 

official of a government entity in a 

position to influence the decision to 

invest government assets in a private 

equity fund managed by that adviser, 

the investment adviser would be 

prohibited from receiving compensation 

with respect to the government entity’s 

investment in the private equity fund. 

In the case of an adviser to a publiclyoffered registered investment company, 

however, we propose to apply the twoyear ‘‘time out’’ provision only when 

the investment company is included in 

a plan or program of a government 

entity (e.g., a 529 plan).185 When a 

government entity invests in publiclyoffered securities of a registered 

investment company, we are generally 

less concerned that the investment 

company’s adviser would be motivated 

by pay to play considerations if, for 

example, the adviser has not bid for, or 

solicited, the government entity’s 

business. Moreover, in many 

circumstances in which a government 

entity determines to make an 

investment in an investment company 

for cash management or other purposes, 

the adviser may not even be aware that 

a government entity has made an 

investment.186 We are mindful that 

subjecting advisers and their covered 

associates to the two-year ‘‘time out’’ in 

these situations could create substantial 

compliance challenges because the 

adviser would have to monitor 

investments by these government 

entities in its investment companies to 

ensure that a contribution by the adviser 

or its covered associates did not trigger 

a time out. In contrast, we have 

included an exception that would 

subject to the two-year time out 

provision an adviser to a publicly 

offered registered investment company 

that is included in a plan or program of 

a government entity because we believe 

pay to play concerns are more likely to 

be present in that situation, and advisers 

will clearly know that the government 

entity is a client or investor in the 

adviser’s investment company. As noted 

above, significant competition exists 

among advisers to have their funds 

selected as investment options in 

government-sponsored savings plans, 

which we believe may contribute to the 

risk of pay to play.187

We believe it is appropriate, however, 

to apply the other two substantive 

prohibitions of the proposed rule 188 to 

advisers to pooled investment vehicles 

regardless of whether it is included in 

a plan or program of a government 

entity. We believe the same concerns 

regarding pay to play are raised under 

those prohibitions whether the adviser 

is managing the government entities’ 

assets directly or through a pooled 

investment vehicle. 

For example, an investment adviser 

subject to our proposed rule that 

manages a registered investment 

company would be prohibited from 

compensating a third party to solicit an 

investment by a government entity in 

the fund or soliciting others to make 

contributions to officials of a 

government entity that the adviser seeks 

to have invest in the fund. For purposes 

of the two-year time out, however, a 

mutual fund adviser would not need to 

screen for investments from government 

entities to determine if a disqualifying 

campaign contribution has been made if 

the fund is used for investment of a 

State government’s general assets or for 

investment by the State’s pension fund. 

If the registered investment company is 

to be included in that State’s 529 plan, 

however, the investment adviser would 

be subject to the two-year time out on 

contributions.189


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the investment adviser, not the inclusion of the 

investment company in the 529 plan, and would 

also prohibit the receipt of any advisory fee to 

which the adviser is entitled if it is also a direct 

adviser to the 529 plan. 

We note that a firm retained by a government 

entity to distribute interests in a 529 plan (i.e., 

municipal fund securities) may be subject to MSRB 

rules. See Municipal Securities Rulemaking Board, 

Interpretive Notice: Rule D–12: Interpretation 

Relating to Sales of Municipal Fund Securities in 

the Primary Market (Jan. 18, 2001), available at 

http://www.msrb.org/msrb1/rules/NewRuleD12Interpretation.htm. Such a distributor may have 

an affiliated investment adviser that is retained by 

the government entity to provide investment advice 

to the 529 plan. Thus, the distributor could be 

subject to MSRB rules G–37 and G–38, while the 

affiliated investment adviser could be subject to our 

proposed rule, if adopted. As we note above, the 

investment adviser’s fiduciary obligations could 

require it to continue to provide investment advice 

without compensation after it or a covered associate 

gives a contribution that triggers our proposed 

rule’s two-year ‘‘time out’’ while MSRB rule G–37 

typically would ban a firm from continuing to 

engage in municipal securities business for two 

years after a triggering contribution is made. See 

supra note 80. However, the MSRB has provided 

additional flexibility in the context of contracts to 

distribute securities such as interests in 529 plans. 

See Municipal Securities Rulemaking Board, 

Interpretation on the Effect of a Ban on Municipal 

Securities Business under Rule G–37 Arising During 

a Pre-Existing Engagement Relating to Municipal 

Fund Securities (Apr. 2, 2002), available at 

http://www.msrb.org/msrb1/rules/notg37.htm 

(allowing a dealer that has become subject to G–37’s 

ban on new municipal securities business to 

continue receiving compensation throughout the 

duration of the ban if certain conditions are met). 

We are not proposing a similar approach under our 

rule because it would undermine the deterrent 

effect of having a two-year time out. 

190These might include, for example, pools 

exempt from the definition of ‘‘investment 

company’’ under Section 3(c)(5) or (6) of the 

Investment Company Act [15 U.S.C. 80a–3(c)(5) and 

(6)] and pools relying on rule 3a–7 under the 

Investment Company Act. [17 CFR 270.3a–7]. 

Pursuant to our proposed definition of ‘‘covered 

investment pool,’’ the rule would apply to an 

investment by a government entity in a structured 

finance vehicle that relies on Section 3(c)(1) or 

3(c)(7) of the Investment Company Act [15 U.S.C. 

80a–3(c)(1) and (7)]. See proposed rule 206(4)– 

5(f)(3). 

191See discussion at Section II.A.3.(a)(1), supra. 

We note that the phrase ‘‘for compensation’’ 

includes both profits and the recouping of costs, so 

the proposed rule would not permit an adviser to 

continue to manage assets at cost after a 

disqualifying contribution is made. 

192Some commenters on our 1999 Proposal noted 

that a performance fee waiver raises various 

calculation issues. An adviser making a 

disqualifying contribution could comply with the 

proposed rule 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-tomarket 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. 

193See, e.g., Rule 18f–3 under the Investment 

Company Act. Moreover, other regulatory 

considerations, such as the Employee Retirement 

Income Security Act of 1974 [29 U.S.C. 18] 

(‘‘ERISA’’), may impact these arrangements with 

respect to collective investment trusts. 

194This may also be done at the class level or 

series level for private funds organized as 

corporations. 

195Rules 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 proposed rule. 

We request comment on the definition 

of covered investment pool under the 

proposed rule. Should we also apply the 

rule in the context of government 

investments in structured finance 

vehicles in which public funds may 

invest? 190 Should we, alternatively or in 

addition, limit the applicability of the 

proposed rule’s prohibitions in the 

context of registered investment 

companies to circumstances under 

which the government entity’s 

investment is of a sufficiently large size 

such that the fund adviser is more likely 

to have an incentive to attempt to 

influence the government entity’s 

decision-making process? If so, how 

should we define that threshold? 

Should we, for example, base it on the 

amount of assets in the fund, such as 5 

percent of the fund’s assets? Should we 

treat differently under the rule advisers 

to funds in plans where the adviser is 

not the sole or primary adviser to the 

plan or where a different adviser’s funds 

are included as investment options 

under the plan? For example, are there 

sub-advisory arrangements in which a 

sub-adviser would not know or be able 

to influence whether, or which, 

government entities are being solicited 

for a covered investment pool? If so, 

how should we define those subadvisers? Should we circumscribe the 

rule’s applicability so it is not triggered 

in the context of government entity 

investments in particular types of funds, 

such as money market funds, where the 

ability of the adviser to profit might be 

attenuated because, for example, those 

particular types of funds tend to 

generate lower margin or investments 

tend to be for relatively short terms? 

Should we provide exceptions to the 

provision subjecting an adviser to a twoyear ‘‘time out’’ from receiving 

compensation in the context of specific 

types of government entity investments 

(such as short-term investments for cash 

management)? 

(3) Applying the Compensation Limit to 

Covered Investment Pools 

If a government entity is an investor 

in a covered investment pool at the time 

the contribution triggering a two-year 

‘‘time out’’ is made, the proposed rule 

would require the adviser to forgo any 

compensation related to the assets 

invested or committed by that 

government entity.191 We recognize the 

provisions of the proposed rule that 

would require the adviser to either 

waive its fee or terminate the 

relationship raise different issues for 

investment pools than for separately 

managed accounts due to various 

structural and legal differences. 

In the case of a private fund, the 

adviser typically could waive or rebate 

the related fees and any performance 

allocation or carried interest.192 The 

adviser may also seek to cause the 

pooled investment vehicle to redeem 

the investment of the government entity. 

For many private funds, such as venture 

capital and private equity funds, it may 

not be possible for a government entity 

to withdraw its capital or cancel its 

commitment without harm to the other 

investors. We request comment on ways 

to prevent advisers to these funds from 

benefitting from contributions covered 

by the two-year time out, while 

protecting other investors in the funds. 

The options for restricting 

compensation involving government 

investors in registered investment 

companies are more limited, due to both 

Investment Company Act provisions 

and potential tax consequences.193 One 

approach that would meet the 

requirements of the proposed rule 

would be for the adviser of a registered 

investment company to waive its 

advisory fee for the fund as a whole in 

an amount approximately equal to fees 

attributable to the government entity.194

We request comment on other options 

that may be available, including 

alternatives that might require us to 

revise the proposed rule. 

An adviser to a covered investment 

pool that serves as an investment option 

in a government program such as a 529 

plan might seek to eliminate its 

investment pool as an option in order to 

comply with or mitigate costs arising 

from the rule’s two-year ‘‘time out.’’ As 

a result, plan investors may be denied 

an appropriate investment alternative. 

Would elimination of the option be an 

inappropriate consequence we should 

seek to prevent? Have we appropriately 

applied the rule to curb pay to play 

activities (that may be effectuated, for 

example, through revenue sharing 

arrangements) while still permitting 

funds to be marketed and distributed to 

government entities in the ordinary 

course of business through compensated 

third parties, such as registered brokerdealers? 

(f) Exemptions 

We are proposing a provision under 

which an adviser may apply to us for an 

order exempting it from the two-year 

compensation ban.195 Under the 

proposed rule, the Commission could 


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196This provision is similar to our 1999 proposal. 197Proposed rule 206(4)–5(e). If the proposed rule 

is adopted, we would grant such exemptions 

pursuant to our authority under Section 206A of the 

Advisers Act [15 U.S.C. 80b–6a]. 198See MSRB rule G–37(i). 

199An adviser applying for an exemption could 

place advisory fees earned between the date of the 

contribution triggering the prohibition and the date 

on which we determine whether to grant an 

exemption in an escrow account. 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 must be returned to the 

public fund. 

200 17 CFR 275.204–2. 

201We note that an adviser may identify its 

clients on its books through the use of codes. See 

Advisers Act rule 204–2(d) [17 CFR 275.204–2(d)]. 202See id. 203Proposed rule 204–2(a)(18)(i). We note that 

this provision is intended to include records of 

direct contributions an adviser or its covered 

associates makes under proposed rule 206(4)– 

5(a)(1), as well as records of contributions or 

payments an adviser or its covered associates 

coordinates or solicits another person or PAC to 

make under proposed rule 206(4)–5(a)(2)(ii), which 

would be considered indirect contributions or 

payments. 204Proposed rule 204–2(a)(18)(ii). 205MSRB rule G–8(a)(xvi). Like rule G–37, the 

proposed rule requires an investment adviser to 

keep, in addition to records of political 

contributions, records of any other ‘‘payments’’ 

made to officials, political parties or PACs. See 

proposed amendment to rule 204–2(a)(18)(i)(D). See 

also supra note 149 and accompanying text for an 

explanation of how the rule distinguishes between 

contributions and payments. The MSRB also 

requires certain records to be made and kept in 

accordance with disclosure requirements that our 

proposed rule does not contain. 

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 or when imposition of the 

prohibitions is unnecessary to achieve 

the rule’s intended purpose.196

In determining whether to grant an 

exemption from the two-year 

compensation ban, we would take into 

account the varying facts and 

circumstances that each application 

presents. Further, we would 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 this 

section; (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 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.197

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).198

As suggested above, when applying the 

criteria, we expect to take into account, 

among other things, the varying facts 

and circumstances presented by each 

application. The factors are intended to 

assist us in determining whether 

granting relief is appropriate. For 

example, one factor relates to whether 

the adviser had and implemented 

reasonably designed policies and 

procedures. Several other factors relate 

to the adviser’s knowledge of the 

contribution and its conduct after the 

contribution was discovered. The 

remaining factors largely relate to the 

particular facts surrounding the 

contribution that may affect whether it 

is appropriate for us to grant relief in 

that situation. For example, the same 

amount of money contributed in a local 

election may have a much greater 

impact than in a Federal election. Facts 

regarding the timing and amount of the 

contribution, the contributor’s 

employment status at the time of the 

contribution, as well as the contributor’s 

apparent intent or motive may suggest 

whether the contribution was made to 

influence the selection of the adviser. 

We would apply these exemptive 

provisions with sufficient flexibility to 

avoid consequences disproportionate to 

the situation, while effecting the 

policies underlying the rule.199 Should 

we provide for additional exemptions 

from the proposed rule? We request 

comment on the proposed criteria for 

exemptions by application. Are there 

additional criteria the Commission 

should explicitly consider when 

determining whether to grant an 

exemption? 

B. Recordkeeping 

We are also proposing amendments to 

rule 204–2 200 to require an investment 

adviser that is registered or required to 

be registered with us and (i) has or seeks 

government clients or (ii) provides 

investment advisory services to a 

covered investment pool in which a 

government entity investor invests or is 

solicited to invest, to make and keep 

certain records of contributions made by 

the adviser and its covered associates. 

We believe these records would be 

necessary to allow us to examine for 

compliance with rule 206(4)–5, if 

adopted. 

The proposed amendments would 

require 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 for 

which the investment adviser or any of 

its covered associates is providing or 

seeking to provide investment advisory 

services, or which are investors or are 

solicited to invest in any covered 

investment pool to which the 

investment adviser provides investment 

advisory services, as applicable; 201 (iii) 

all government entities to which the 

investment adviser has provided 

investment advisory services, along 

with any related covered investment 

pool(s) to which the investment adviser 

has provided investment advisory 

services and in which the government 

entity has invested, as applicable, in the 

past five years, but not prior to the 

effective date of the proposed rule; 202

and (iv) all direct or indirect 

contributions or payments made by the 

investment adviser or any of its covered 

associates to an official of a government 

entity, a political party of a State or 

political subdivision thereof, or a 

PAC.203 The adviser’s records of 

contributions and payments would be 

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 

proposed rule 206(4)–5(b)(2).204 These 

requirements are generally consistent 

with the MSRB recordkeeping rule for 

broker-dealers.205

Should we exclude de minimis 

contributions from the recordkeeping 

requirement? Should we expand our 

recordkeeping requirements to cover 

records of contributions or payments 

not just to government officials and 

political parties, but also persons 

associated with officials of government 

entities, regardless of whether 

contributions or payments to these 

individuals trigger the prohibitions 


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39860 Federal Register / Vol. 74, No. 151 / Friday, August 7, 2009 / Proposed Rules 

206See supra note 89 and accompanying text. 

207See Advisers Act rule 206(4)–7 [17 CFR 

275.206(4)–7] (setting forth guidelines for advisers’ 

compliance policies and procedures). 

208 17 CFR 275.206(4)–3. 

209Proposed rule 206(4)–3(e). 

210We are also proposing to make a conforming 

technical amendment to rule 206(4)–3 to address 

potential areas of conflict with proposed rule 

206(4)–5. We do not expect that this technical 

amendment will affect the costs associated with the 

rulemaking. 

contained in our proposed pay to play 

rule? 206

To manage compliance with the 

proposed rule effectively, we would 

expect that the adviser would adopt 

sufficient internal procedures—which 

would include keeping certain 

records—to prevent the rule’s 

prohibitions from being triggered.207 As 

discussed above, a single contribution 

could, under the rule, lead to a two-year 

suspension of compensated advisory 

activities for a government client. 

Therefore, we anticipate that many, if 

not all, of the records that we propose 

to require registered advisers make and 

keep under our proposed amendments 

would be those an adviser undertaking 

a serious compliance effort would 

ordinarily make and keep. We request 

that commenters opposing the new 

recordkeeping requirements suggest 

alternative means that would be 

sufficient to aid examinations for 

compliance with the proposed rule. 

C. Amendment to Cash Solicitation Rule 

We are also proposing 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.208

Because paragraph (iii) of rule 

206(4)–3 contains provisions regarding 

more general restrictions on third-party 

solicitors that would cover solicitation 

activities directed at any client— 

whether a government entity client or 

not—our proposed technical 

amendment would be designed to note 

the specialized provisions prohibiting 

payments by an adviser to third-party 

solicitors of government clients that are 

contained in proposed rule 206(4)–5. 

Specifically, we propose to add a new 

paragraph (e) to rule 206(4)–3 to alert 

advisers and others that special 

prohibitions apply to solicitation 

activities involving government entity 

clients under our proposed pay to play 

rule.209

D. Transition Period 

The prohibition and recordkeeping 

requirements under the proposed rule 

would arise from contributions made on 

or after the effective date of the rule, if 

adopted. As a result, firms would need 

to have developed and adopted 

appropriate procedures to track 

contributions and would need to begin 

monitoring contributions made by their 

covered associates on that date. The 

Commission requests comment on 

whether firms would require additional 

time to develop procedures to comply 

with the proposed rule and, if so, how 

long of a transition period following the 

rule’s adoption would be necessary? For 

example, if a transition period is 

necessary, would 90 days be an 

appropriate amount of time? Would 

longer be necessary, e.g., six months, 

and if so, why? 

E. General Request for Comment 

Any interested persons wishing to 

submit written comments on the 

proposed rule and rule amendment that 

are the subject of this Release, or to 

suggest additional changes or submit 

comments on other matters that might 

have an effect on the proposals 

described above, are requested to do so. 

Commenters suggesting alternative 

approaches are encouraged to submit 

proposed rule text. 

III. Cost/Benefit Analysis 

We are sensitive to the costs and 

benefits imposed by our rules, and 

understand that there would be 

compliance costs with proposed rule 

206(4)–5 and the proposed amendment 

to rule 204–2.210 We are mindful of the 

burdens the proposed rule would place 

on advisory firms and limitations it 

would place on 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 thus 

have narrowly tailored the rule to 

achieve our goal of ending adviser 

participation in pay to play practices, 

while seeking to limit these burdens. 

The proposed rule and rule 

amendments would address ‘‘pay to 

play’’ practices by investment advisers 

that provide, or are seeking to provide, 

advisory services to government entity 

clients and to certain covered 

investment pools in which a 

government entity invests. The 

proposed rule would prohibit 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 proposed rule would also prohibit 

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, or for a solicitation of a 

government entity to invest in certain 

covered investment pools, on behalf of 

such adviser. Additionally, the 

proposed rule would prevent an adviser 

from coordinating or soliciting from 

others contributions to certain elected 

officials or candidates or payments to 

certain political parties. Our proposed 

amendment to rule 204–2 would require 

a registered adviser (or adviser required 

to be registered) to maintain certain 

records of the political contributions 

made by the adviser or certain of its 

executive or employees. 

A. Benefits 

As discussed extensively throughout 

this release, we expect that proposed 

rule 206(4)–5 would yield several 

important direct and indirect benefits. 

At its core, the rulemaking addresses 

practices that undermine the integrity of 

our markets. Overall, the proposed 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. 

Accordingly, we believe that the 

proposed rule will achieve its goals of 

protecting public pension plans, 

beneficiaries, and other investors from 

the resulting harms. 

Curtailing 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. By addressing pay to play 

practices, we would be leveling 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 their 

skills and the quality of their advisory 

services. These benefits could result in 

substantial savings and better 

performance for the public pension 


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211According to U.S. census data as of 2007, there 

are 2,547 State and local government employee 

retirement systems. 

212See supra note 51. 

213See Investment Counsel Association of 

America Comment Letter (May 15, 2000) (‘‘May 

ICAA Comment Letter’’) (‘‘According to our 

members, many investment advisers already have 

policies and procedures in place to report 

contributions under State and local law and to 

avoid pay to play issues.’’). 

214According to registration information available 

from Investment Adviser Registration Depository 

(‘‘IARD’’) as of July 1, 2009, there are 1,312 SECregistered investment advisers (or 11.57% of the 

total 11,340 registered advisers) that indicate in 

Item 5.D.(9) of Form ADV that they have State or 

municipal government clients. Of those 1,312 

advisers, 108 (or 82.4%) of the largest 10% have 

one or more affiliated broker-dealers or are, 

themselves, also registered as a broker-dealer; and 

202 of the largest 20% (or 87.1%) have one or more 

affiliated broker-dealers or are, themselves, also 

registered as a broker-dealer. Conversely, only 46 

(or 35.1%) of the smallest 10% have one or more 

affiliated broker-dealers or are, themselves, also 

registered as a broker-dealer; and only 72 of the 

smallest 20% (or 31.0%) 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. 

215Cf. Comment Letter of US Bancorp Piper 

Jaffray (Nov. 15, 1999) (‘‘U.S. Bancorp Letter’’) 

(‘‘[T]he more the Rule mirrors G–37, the more firms 

can borrow from or build upon compliance 

procedures already in place. * * * [H]owever, 

[there are] many differences between the rules that 

would result in significant new burdens.’’). 

216This number is based on registration 

information available from IARD as of July 1, 2009. 

As noted previously, there are 1,312 SEC-registered 

investment advisers (or 11.57% of the total 11,340 

Continued 

plans, their beneficiaries, and 

participants.211

By leveling the playing field among 

advisers competing for State and local 

government business, the proposed rule 

could also eliminate or minimize 

manipulation of the market for advisory 

services provided to State and local 

governments. Payments made to thirdparty 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. They also create increased 

costs for firms that may feel they have 

no alternative but to pay to play. 

Additionally, pay to play practices 

potentially expose an adviser to other 

costs, such as liability, defense costs 

and distraction from its duties. 

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. 

Moreover, the absence of arm’s-length 

negotiations may enable advisers to 

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.212

Additionally, taxpayers could benefit 

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. 

Applying the proposed 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 would 

extend the same benefits regardless of 

whether an adviser subject to the 

proposed 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 will 

provide 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 proposed amendments to 

rule 204–2 would 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 would benefit from these 

amendments because the records 

required to be kept would provide 

Commission staff with information to 

review an adviser’s compliance with 

proposed rule 206(4)–5 and thereby may 

promote improved compliance. 

Advisers would benefit from the 

proposed amendments to the 

recordkeeping rule as these records 

would assist the Commission in 

enforcing the rule against, for example, 

competitors whose pay to play 

activities, if not uncovered, could 

adversely affect the competitive position 

of a compliant adviser. 

B. Costs 

The proposed rule and rule 

amendments would impose costs on 

advisers that provide advisory services 

to government clients, though we have 

tried to minimize the costs associated 

with an inadvertent violation of 

proposed rule 206(4)–5 by including an 

exception for certain returned 

contributions. The proposed rule would 

require an adviser with government 

clients, and an adviser that solicits 

business from government clients, to 

incur costs to monitor contributions 

made by the adviser and its covered 

associates, and to establish procedures 

to comply with the proposed rule and 

rule amendments. The initial and 

ongoing compliance costs imposed by 

the proposed rule would vary 

significantly among firms, depending on 

a number of factors. These include the 

number of covered associates of the 

adviser, the degree to which compliance 

procedures are automated, the extent to 

which an adviser has a pre-existing 

policy under its code of ethics or 

compliance program,213 and whether 

the adviser is affiliated with a brokerdealer firm that is subject to rules G–37 

and G–38. A smaller adviser, for 

example, would likely have a small 

number of covered associates, and thus 

expend less resources to comply with 

the proposed rule and rule amendments 

than a larger adviser. 

A large adviser is likely to spend more 

resources to comply with the rule than 

a smaller adviser. However, based on 

staff observations, a large adviser is 

more likely to have an affiliated brokerdealer that is required to comply with 

MSRB rules G–37 and G–38.214 Such a 

large adviser could likely use some or 

all of the compliance procedures 

established by its broker-dealer affiliate 

to facilitate its compliance with 

proposed rule 206(4)–5. As a result, 

many advisers with broker-dealer 

affiliates may spend less resources to 

comply with the proposed rule and rule 

amendments.215

We anticipate that advisory firms 

subject to proposed rule 206(4)–5 would 

develop compliance procedures to 

monitor the political contributions 

made by the adviser and its covered 

associates. We estimate that the costs 

imposed by the proposed rule would be 

higher initially, as firms establish and 

implement procedures and systems to 

comply with the rule and rule 

amendments. It is anticipated 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. 

We estimate that approximately 1,764 

investment advisers registered with the 

Commission may be affected by the 

proposed rule and rule amendments.216


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39862 Federal Register / Vol. 74, No. 151 / Friday, August 7, 2009 / Proposed Rules 

registered advisers) that indicate in Item 5.D.(9) of 

Form ADV that they have State or municipal 

government clients. Based on this data point and 

other responses to Item 5.D., we further estimate 

that 289 (or 11.57%) of the 2,502 registered 

investment advisers that manage ‘‘other pooled 

investment vehicles’’ (and do not also indicate that 

they have State or municipal government clients) 

are advising pooled investment vehicles in which 

government clients invest, and we estimate that 79 

(or 11.57%) of the 679 registered investment 

advisers that manage registered investment 

companies (and do not also indicate that they have 

State or municipal government clients) are advising 

registered investment companies that are available 

as an investment option in a government plan or 

program. The sum of 1,312, 289 and 79 is 1,680. 

The proposed rule also applies to those advisers 

that seek to obtain government clients, and we do 

not know the precise number of such advisers. We 

believe, however, that the percentage of advisers is 

likely not great because, according to IARD data, 

there has not been any appreciable growth or 

shrinkage over the past five years in the percentage 

of SEC-registered advisers who have State or 

municipal government clients; the percentage has 

been almost unchanged. Accordingly, we estimate 

that an additional 5% (or 84) of SEC-registered 

advisers are seeking government clients, for a total 

of 1,764 (1,680 + 84) registered advisers subject to 

the proposed rule. 

217These estimates are based on IARD data, 

specifically the responses to Item 5.B.(1) of Form 

ADV, that 967 (or 73.7%) of the 1,312 registered 

investment advisers that have government clients 

have fewer than five employees who perform 

investment advisory functions related to those 

government clients, 244 (or 18.6%) have five to 15 

such employees, and 101 (or 7.7%) have more than 

15 such employees. We then applied those 

percentages to the 1,764 advisers we believe will be 

subject to the proposed rule for a total of 1,300 

smaller, 328 medium and 136 larger firms. 

218The proposed amendments to rules 204–2 and 

206(4)–3 would apply only to advisers that are 

registered, or required to be registered, with the 

Commission. 

219This number is based on our review of 

registration information on IARD as of July 1, 2009, 

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. 

220 11.57% of 2000 is 231.4. See supra note 216. 

221See section 203(b)(3) of the Advisers Act [15 

U.S.C. 80b–3(b)(3)]. 

222Our 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 2008, modified 

by Commission staff to account for an 1800-hour 

work-year and multiplied by 2.93 to account for 

bonuses, firm size, employee benefits and overhead. 

223The 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 $258 per hour). 

224With respect to our estimated range of 8–250 

hours, we assume a medium-sized 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/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 

$258 per hour) and 31.25 hours of clerical time (at 

$63 per hour). 

225With 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 manager time (at $258 

per hour) and 62.5 hours of clerical time (at $63 per 

hour). 

226Some commenters in 1999 suggested that our 

cost estimates, then, were too low. See U.S. Bancorp 

Letter (‘‘[W]e believe the initial compliance cost 

estimates in the [1999] Release of $285 for a small 

firm, $13,387.50 for a medium firm and $22,312.50 

for a large firm underestimate by orders of 

magnitude the initial costs of compliance.’’); 

Comment Letter of American Council of Life 

Insurance (Nov. 1, 1999) (‘‘Many of our member 

companies have observed that the proposal’s 

compliance cost projections are speculative and 

unrealistic, especially when applied to large 

diversified financial institutions like life insurers. 

* * * Moreover, the cost estimates are greatly 

understated when the proposed rule is applied to 

large diversified life insurers offering investment 

advice as one of several products and services. 

* * * One of our larger diversified member 

companies has estimated that it would cost 

approximately $200,000 per year to administer 

compliance with the proposed rule for the 

approximately 200–300 people the rule would 

encompass. The company developing these 

estimates based its estimate of hours and labor costs 

on its actual compliance with Rule G–37.’’). We 

have significantly increased our cost estimates from 

our 1999 proposal. We also note that the scope of 

persons covered under the current rule proposal is 

narrower than the scope of persons proposed to be 

covered in 1999. See supra note 98 and 

accompanying text. 

Of the 1,764 advisers, we estimate that 

approximately 1,300 advisers have 

fewer than five covered associates that 

would be subject to the proposed rule 

each, a ‘‘smaller firm’’; approximately 

328 advisers have between five and 15 

covered associates each, a ‘‘medium 

firm’’; and approximately 136 advisers 

have more than 15 covered associates 

that would be subject to the prohibitions 

of the proposed rule each, a ‘‘larger 

firm’’ 217. 

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 proposed rule 206(4)–5.218

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).219 Applying the same 

principles we used with respect to 

registered investment advisers, we 

estimate that 231 of those advisers 

manage pooled investment vehicles in 

which government client assets are 

invested and would therefore be subject 

to the proposed rule.220

For purposes of this analysis, it is 

assumed that each exempt advisory firm 

that would be subject to the proposed 

rule would likely either be smaller firms 

or medium firms, in terms of number of 

covered associates because it is unlikely 

that an adviser that is limited to fewer 

than 15 clients would have a large 

number of advisory personnel that 

would be covered associates.221

Although the time needed to comply 

with the proposed rule would vary 

significantly from adviser to adviser, the 

Commission staff estimates that firms 

with government clients would spend 

between 8 hours and 250 hours to 

establish policies and procedures to 

comply with the proposed rule. 

Commission staff further estimates that 

ongoing compliance with the proposed 

rule would require between 10 and 

1,000 hours, annually. These estimates 

are derived in part from conversations 

with industry professionals regarding 

broker-dealer compliance with rule G– 

37 and G–38 and representatives of 

investment advisers that have pay to 

play policies in place. In addition, 

advisory firms may incur one-time costs 

to establish or enhance current systems 

to assist in their compliance with the 

proposed 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 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. As 

we noted previously, large advisers are 

more likely to have broker-dealer 

affiliates that may already have 

compliance systems in place for MSRB 

rules G–37 and G–38 that could be used 

by an adviser. 

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 $258, 

including benefits, and for compliance 

clerks, $63 per hour, including 

benefits.222 To establish and implement 

adequate compliance procedures, we 

estimate that the proposed rule would 

impose initial compliance costs of 

approximately $2,064 223 per smaller 

firm, approximately $26,156 224 per 

medium firm, and approximately 

$52,313 225 per larger firm.226 It is 

estimated that the proposed rule would 

impose annual, ongoing compliance 


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227The 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 $258 per hour) per year. 

228The 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 $258 per hour) and 125 hours of 

clerical time (at $63 per hour), per year. 

229The 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 $258 per hour) and 250 hours of 

clerical time (at $63 per hour), per year. 

230Based on staff observations, we estimate 75% 

of larger firms, 50% of medium firms, and 25% of 

smaller firms would seek to outsource all or a 

portion of this type of legal work. 

231As noted above, we estimate 75% of larger 

firms, 50% of medium firms, and 25% of smaller 

firms would seek the assistance of outside counsel. 

232This estimate is based on staff discussions 

with Financial Industry Regulatory Authority staff 

responsible for reviewing exemptive applications 

submitted under MSRB rule G–37. 

233One commenter in 1999 expressed the view 

that our proposed amendments to the 

recordkeeping rule would be burdensome. See Nov. 

ICAA Comment Letter (‘‘The proposed rule, in 

effect, requires firms to keep an ongoing, 

continuously updated list of prospective 

government clients. * * * [I]t is logistically unclear 

how a firm should compile this list. * * * [T]he 

burden of continuously compiling this list would be 

significant.’’) We have increased our burden 

estimate from our 1999 proposal. We note that 

records are a critical component of proposed rule 

206(4)–5. In particular, such records are necessary 

for examiners to inspect advisers for compliance 

with the terms of the proposed rule. We also note 

that it is typical for advisers seeking business from 

government entities to do so through a request for 

proposal or similar process, which would typically 

generate a record. 

234See infra note 242. 

235We expect that the function of recording and 

maintaining records of political contributions 

would be performed by a compliance clerk at a cost 

of $63 per hour. See supra note 222. Therefore the 

total costs would be $222,264 (3,528 hours × $63 

per/hour). 

expenses of approximately $2,580 227

per smaller firm, $104,625 228 per 

medium firm, and $209,250 229 per 

larger firm. 

We further anticipate that 

approximately one-third of advisers that 

we estimate would be subject to the rule 

may also engage outside legal services to 

assist in drafting policies and 

procedures.230 We estimate 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 large firm, at a 

rate of $400 per hour. For a smaller firm 

we estimate a total of $1,200 in outside 

legal fees for each of the estimated 325 

advisers that would seek assistance, for 

a medium firm we estimate a total of 

$4,000 for the estimated 164 advisers 

that would seek assistance, and for each 

of the 102 larger firms we estimate a 

total of $12,000.231 Thus, we estimate 

that approximately 591 investment 

advisers will incur these additional 

costs, for a total cost of $2,270,000 

among advisers affected by the proposed 

rule amendments. 

Additionally, we expect that on 

average approximately five advisers 

annually will apply to the Commission 

for an exemption from the proposed 

rule.232 We estimate that a firm that 

applies for an exemption will hire 

outside counsel to prepare an exemptive 

request, and that counsel will spend 16 

hours preparing and submitting an 

application for review at a rate of $400 

per hour. As a result, each application 

will cost approximately $6,400, and the 

total estimated cost for five applications 

annually will be $32,000. 

The prohibitions of the proposed rule 

may also impose other costs on advisers, 

covered associates, third-party 

solicitors, and political officials. An 

adviser that becomes subject to the 

prohibitions of the proposed rule would 

no longer be eligible to receive advisory 

fees from its government client. This 

could limit the number of advisers able 

to provide services to potential 

government entity clients. The adviser, 

however, 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 

government client would 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 political contributions to political 

officials, possibly imposing costs on the 

officials if they are unable to secure 

alternate funding. Under the proposed 

rule, covered associates and executives 

may face new limitations on the 

amounts and to whom they can 

contribute. In addition, these same 

individuals could be prohibited from 

soliciting others to contribute or from 

coordinating contributions to 

government officials or political parties 

in certain circumstances. These 

limitations and prohibitions, including 

if a firm chose to adopt policies or 

procedures that are more restrictive than 

the proposed 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. 

Because the proposed rule would 

prohibit advisers from compensating 

third parties to solicit government 

entities for advisory services, advisers 

that currently rely on third-party 

solicitors to obtain government clients 

may have to bear the expense of hiring 

and training in-house staff in order to 

continue their solicitation activities. 

While third-party solicitors are not 

subject to the proposed rule, the 

proposed ban on advisers’ use of thirdparty solicitors may have a substantial 

negative impact on persons who provide 

third-party solicitation services, and if 

their businesses consists solely of 

soliciting government entities on behalf 

of investment advisers, the proposed 

rule could result in these persons 

instead being employed directly by 

advisers or shifting the focus of their 

solicitation activities. In addition, small 

investment advisers and new 

investment advisers that do not have the 

capital to hire employees to obtain 

government clients may find it difficult 

to enter the market to provide advisory 

services to government pension plans or 

to obtain additional government clients. 

We also anticipate that the proposed 

amendment to rule 204–2 would impose 

additional costs. The proposed 

amendments to rule 204–2 would 

require that SEC-registered advisers 

maintain certain records of campaign 

contributions by certain advisory 

personnel.233 For purposes of the 

Paperwork Reduction Act, we have 

estimated that Commission-registered 

advisers would incur approximately 

3,528 additional hours annually to 

comply with the proposed amendments 

to rule 204–2.234 Based on this estimate, 

we anticipate that advisers would incur 

an aggregate cost of approximately 

$222,264 per year for the total hours 

advisory personnel would spend in 

complying with the proposed 

recordkeeping requirements.235

Unregistered advisers that would be 

subject to proposed rule 206(4)–5 would 

not be subject to the proposed 

amendments to rules 204–2 and 

206(4)–3. 

C. Request for Comment 

The Commission requests 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 committees. We request 

data to quantify the costs and value of 

the benefits associated with the 


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39864 Federal Register / Vol. 74, No. 151 / Friday, August 7, 2009 / Proposed Rules 

236See ABA Comment Letter (‘‘Any cost-benefit 

analysis of the Rule logically should begin, by 

analogy, with an analysis of the costs that have been 

borne by Municipal Securities Professionals in 

complying with MSRB Rule G–37, bearing in mind 

that the proposed Rule contains no reporting 

requirements.’’). 

237See section 210(b) of the Advisers Act [15 

U.S.C. 80b–10(b)]. 

238This figure is based on registration 

information from IARD as of July 1, 2009. 

239 11,340¥10,787 = 553. 

240See supra note 216. 

241This increased burden relates only to the 

recordkeeping requirements we are proposing to 

amend. See supra section III.B. of this release for 

an explanation of other estimated costs associated 

with complying with the proposed rule and rule 

amendments. 

242 1,954,109 (current approved burden) + 

100,176 (burden for additional registrants) + 3,528 

(burden for proposed amendments) = 2,057,813 

hours. 

243 2,057,813 (revised annual aggregate burden) 

divided by 11,340 (total number of registrants) = 

181.46. 

proposed rule. Specifically, comment is 

requested on the costs of establishing 

compliance procedures to comply with 

the proposed rule, both on an initial and 

ongoing basis. Comment also is 

requested on the costs of using 

compliance procedures of an affiliated 

broker-dealer that the broker-dealer 

established as a result of rule G–37 and 

G–38.236 In addition, we request 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. As discussed 

below, section 202(c)(1) of the Advisers 

Act does not apply to proposed new 

rule 206(4)–5 or the proposed 

amendments to rule 206(4)–3. 

Nonetheless, in the context of the 

objectives of this rulemaking, we are 

interested in comments that address 

whether these proposed rules will 

promote efficiency, competition and 

capital formation. We solicit comment 

on the effect the proposed rule would 

have on the market for investment 

advisory services and third-party 

solicitation services. Commenters 

should provide analysis and empirical 

data to support their views on the costs 

and benefits associated with this 

proposal. 

IV. Paperwork Reduction Act 

A. Rule 204–2 

The proposed amendment to rule 

204–2 contains a new ‘‘collection of 

information’’ requirement within the 

meaning of the PRA, and the 

Commission has submitted the 

proposed amendment to the Office of 

Management and Budget (‘‘OMB’’) for 

review in accordance with 44 U.S.C. 

3507(d) and 5 CFR 1320.11. The title for 

the collection of information is ‘‘Rule 

204–2 under the 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 conduct 

or sponsor, and a person is not required 

to respond to a collection of information 

unless it displays a currently valid 

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 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 Commission staff uses 

this collection of information in its 

examination and oversight program, and 

the information generally is kept 

confidential.237

The current approved collection of 

information for rule 204–2 is based on 

an average of 181.15 burden hours each 

year, per Commission-registered 

adviser, for a total of 1,954,109 burden 

hours. The current total burden is based 

on an estimate of 10,787 registered 

advisers. 

The proposed amendments to rule 

204–2 would require every investment 

adviser registered or required to be 

registered that provides or seeks to 

provide advisory services to government 

entities to maintain certain records of 

contributions made by the adviser or 

any of its covered associates. The 

proposed amendments would require 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 for 

which the investment adviser or any of 

its covered associates is providing or 

seeking to provide investment advisory 

services, or which are investors or are 

solicited to invest in any covered 

investment pool to which the 

investment adviser provides investment 

advisory services, as applicable; (iii) all 

government entities to which the 

investment adviser has provided 

investment advisory services, along 

with any related covered investment 

pool(s) to which the investment adviser 

has provided investment advisory 

services and in which the government 

entity has invested, as applicable, in the 

past five years, but not prior to the 

effective date of the proposed rule; and 

(iv) all direct or indirect contributions 

or payments made by the investment 

adviser or any of its covered associates 

to an official of a government entity, a 

political party of a State or political 

subdivision thereof, or a PAC. An 

adviser to a covered investment pool in 

which a government entity invests or is 

solicited to invest would be treated as 

though that investment adviser were 

providing or seeking to provide 

investment advisory services directly to 

the government client. The adviser’s 

records of contributions and payments 

would be 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 proposed rule 206(4)– 

5(b)(2). These records would be 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 would be 

found at 17 CFR 275.204–2. Advisers 

that are exempt from Commission 

registration under section 203(b)(3) of 

the Advisers Act would not be subject 

to the recordkeeping requirements. 

Commission records indicate that 

currently there are approximately 

11,340 registered investment advisers 

subject to the collection of information 

imposed by rule 204–2.238 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 

100,176 hours (553 additional 

advisers 239 × 181.15 hours). We 

estimate that approximately 1,764 

Commission-registered 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 proposed 

rule amendments.240 Under the 

proposed amendments, each respondent 

would be required to retain the records 

in the same manner and for the same 

period of time as currently required 

under rule 204–2. The proposed 

amendments to rule 204–2 are estimated 

to increase the burden by approximately 

two hours per Commission-registered 

adviser with government clients 

annually for a total increase of 3,528 

hours.241 The revised annual aggregate 

burden for all respondents to the 

recordkeeping requirements under rule 

204–2 thus would be 2,057,813 

hours.242 The revised weighted average 

burden per Commission-registered 

adviser would be 181.46 hours.243

Additionally, we expect advisory 

firms may incur one-time costs to 

establish or enhance current systems to 


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244See section 210(b) of the Advisers Act [15 

U.S.C. 80b–10(b)]. 

245This figure is based on registration 

information from IARD as of July 1, 2009. 

246 2,268 (20% of current registered investment 

advisers) ¥2,163 (20% of registered investment 

advisers when burden estimate was last approved 

by OMB) = 105. 

247 In light of the 11.57% 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 214. 

248See proposed rule 206(4)–3(a). 

249 15,228 (current approved burden) + 739.2 

(burden for additional registrants) ¥635.6 

(reduction in burden for proposed amendments) = 

15,331.6 hours. 

250 15,331.6 (revised annual aggregate burden) 

divided by 2,268 (total number of registrants who 

rely on rule) = 6.76. 251 5 U.S.C. 603(a). 

assist in their compliance with the 

proposed 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 significant 

resources into automating compliance 

and reporting and the new rule could 

result in enhancements to these existing 

systems. We believe they 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. 

B. Rule 206(4)–3 

The proposed amendment to rule 

206(4)–3 contains a revised ‘‘collection 

of information’’ requirement within the 

meaning of the PRA, and the 

Commission has submitted the 

proposed amendment to the OMB for 

review in accordance with 44 U.S.C. 

3507(d) and 5 CFR 1320.11. The title for 

the collection of information is ‘‘Rule 

206(4)–3—Cash Payments for Client 

Solicitations.’’ Rule 206(4)–3 contains a 

currently approved collection of 

information number under OMB control 

number 3235–0242. 

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 mandatory. The 

Commission staff uses this collection of 

information in its examination and 

oversight program, and the information 

generally is kept confidential.244

The current approved collection of 

information for rule 206(4)–3 is based 

on an estimate that 20% of the 10,817 

Commission-registered 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 × 2,163). 

The proposed amendments to rule 

206(4)–3 would 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 proposed rule 206(4)–5. 

This collection of information would be 

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. 

Commission records indicate that 

currently there are approximately 

11,340 registered investment 

advisers,245 20% of which (or 2,268) 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 approved, the total burden 

has increased by 739.2 hours (105 

additional advisers 246 × 7.04 hours). We 

assume that approximately 20% of the 

Commission-registered advisers that use 

rule 206(4)–3 (or 454 advisers) provide, 

or seek to provide, advisory services to 

government clients and would thus be 

affected by the proposed rule 

amendments.247 Under the proposed 

amendments, each respondent would be 

prohibited from certain solicitation 

activities with respect to government 

clients,248 which would eliminate the 

need to enter into and retain the written 

agreement required under rule 206(4)–3 

with respect to those clients. 

Accordingly, the proposed amendments 

to rule 206(4)–3 are estimated to 

decrease the burden by 20%, or 

approximately 1.4 hours, per 

Commission-registered adviser that uses 

the rule and has or is seeking 

government clients annually, for a total 

decrease of 635.6 hours. The revised 

annual aggregate burden for all 

respondents to the recordkeeping 

requirements under rule 206(4)–3 thus 

would be 15,331.6 hours.249 The revised 

weighted average burden per 

Commission-registered adviser would 

be 6.76 hours.250

C. Request for Comment 

Pursuant to 44 U.S.C. 3506(c)(2)(B), 

the Commission solicits comments to: 

(i) Evaluate whether the proposed 

amendments to the collection of 

information are necessary for the proper 

performance of the functions of the 

Commission, including whether the 

information will have practical utility; 

(ii) evaluate the accuracy of the 

Commission’s estimate of the burden of 

the proposed collection of information; 

(iii) determine whether there are ways 

to enhance the quality, utility, and 

clarity of the information to be 

collected; and (iv) determine whether 

there are ways to minimize the burden 

of the collection of information on those 

who are to respond, including through 

the use of automated collection 

techniques or other forms of information 

technology. 

Persons desiring to submit comments 

on the collection of information 

requirements should direct them to the 

Office of Management and Budget, 

Attention: Desk Officer for the 

Securities and Exchange Commission, 

Office of Information and Regulatory 

Affairs, Room 3208, Washington, DC 

20503, and also should send a copy of 

their comments to Elizabeth M. Murphy, 

Secretary, Securities and Exchange 

Commission, 100 F Street, NE., 

Washington, DC 20549–1090 with 

reference to File No. S7–18–09. 

Requests for materials submitted to 

OMB by the Commission with regard to 

this collection of information should be 

in writing, refer to File No. S7–18–09, 

and be submitted to the Securities and 

Exchange Commission, Office of 

Investor Education and Advocacy, 100 F 

Street, NE., Washington, DC 20549– 

0213. OMB is required to make a 

decision concerning the collections of 

information between 30 and 60 days 

after publication. A comment to OMB is 

best assured of having its full effect if 

OMB receives it within 30 days after 

publication of this release. 

V. Initial Regulatory Flexibility 

Analysis 

The Commission has prepared the 

following Initial Regulatory Flexibility 

Analysis (‘‘IRFA’’) regarding proposed 

rule 206(4)–5 and the amendments to 

rules 204–2 and 206(4)–3 in accordance 

with section 3(a) of the Regulatory 

Flexibility Act.251

A. Reasons for Proposed Action 

Investment advisers that seek to 

influence the award of advisory 

contracts by government entities, by 

making or soliciting political 


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252Proposed rule 206(4)–5(a)(1). 

253Proposed rule 206(4)–5(a)(2)(ii). 

254Proposed rule 206(4)–5(a)(2)(i). 

255Proposed rule 206(4)–5(c). 

256 17 CFR 275.0–7(a). 

257This estimate is based on registration 

information from IARD as of July 1, 2009. 258See supra notes 217 and 220. 

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. 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 proposed rule and rule 

amendments are designed to prevent 

fraud, deception and manipulation by 

reducing or eliminating adviser 

participation in pay to play practices. 

B. Objectives and Legal Basis 

Proposed rule 206(4)–5, the ‘‘pay to 

play’’ rule, would prohibit an 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 advisory services 

for compensation to a government client 

for two years after the adviser, or any of 

its covered associates, make 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.252 In addition, 

we are proposing to prohibit 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,253 and from 

providing or agreeing to provide, 

directly or indirectly, payment to any 

third party engaged to solicit advisory 

business from any government entity on 

behalf of the adviser.254 Further, the 

prohibitions in the proposed rule also 

would apply to advisers to certain 

investment pools in which a 

government entity invests.255 The 

proposed rule amendment to rule 204– 

2 is designed to provide Commission 

staff with records to review compliance 

with proposed rule 206(4)–5, and the 

proposed amendment to rule 206(4)–3 

would clarify the application of the cash 

solicitation rule as a result of proposed 

rule 206(4)–5. 

The Commission is proposing new 

rule 206(4)–5 and proposing to amend 

rule 206(4)–3 pursuant to the authority 

set forth in sections 206(4) and 211(a) of 

the Advisers Act [15 U.S.C. 80b–6(4) 

and 80b–11(a)]; to amend rule 204–2 

pursuant to the authority set forth in 

sections 204 and 211 of the Advisers 

Act [15 U.S.C. 80b–4 and 80b–11]. 

Section 206(4) gives us authority to 

prescribe means reasonably designed to 

prevent fraudulent, deceptive, or 

manipulative acts or practices. Section 

211 gives us authority to classify, by 

rule, persons and matters within our 

jurisdiction and to prescribe different 

requirements for different classes of 

persons, as necessary or appropriate to 

the exercise of our authority under the 

Act. Section 204 gives us authority to 

prescribe, by rule, such records and 

reports that an adviser must make, keep 

for prescribed periods, or disseminate, 

as necessary or appropriate in the public 

interest or for the protection of 

investors. 

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 year.256

The Commission estimates that as of 

July 2009 there are approximately 706 

small SEC-registered investment 

advisers.257 Of these 706 advisers, 57 

indicate on Form ADV that they have 

State or local government clients. The 

proposed rule also would apply to those 

advisers that are exempt from 

registration with the Commission in 

reliance on section 203(b)(3) of the 

Advisers Act. We estimate that 

approximately 231 such unregistered 

advisers may manage pooled investment 

vehicles in which government client 

assets are invested and would be subject 

to the proposed rule.258 We do not have 

data and are not aware of any databases 

that compile information regarding how 

may advisers that are exempt from 

registration with the Commission in 

reliance on section 203(b)(3) of the 

Advisers Act and that have State or 

local government clients. It is unclear 

how many of these advisers that are 

exempt from registration that would be 

subject to the rule are small advisers for 

purposes of this analysis. 

D. Reporting, Recordkeeping, and other 

Compliance Requirements 

The proposed rule would impose 

certain reporting, recordkeeping and 

compliance requirements on advisers, 

including small advisers. The proposed 

rule imposes a new compliance 

requirement by: (i) Prohibiting an 

adviser from providing 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 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 proposed rule amendments 

would 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, and its political 

contributions as well as the political 

contributions of its covered associates. 

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, would not be 

subject to the proposed rule and rule 

amendments. 

As noted above, we believe that a 

limited number of small advisers will 

have to comply with the proposed rule 

and rule amendments. Moreover, to the 

extent small advisers tend to have fewer 

clients and fewer employees that would 

be covered associates for purposes of the 

rule, the proposal should impose lower 

costs on small advisers as compared to 


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259However, as noted above, many larger advisers 

with broker-dealer affiliates may spend less 

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 note 214 

and accompanying text. 

260As 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 section II.A.2., as well as notes 133 

and 134 and accompanying text. 

261 15 U.S.C. 80b–4(a). 

262 15 U.S.C. 80b–2(c). 

263 In contrast, the Commission is proposing new 

rule 206(4)–5 and amendments to rule 206(4)–3 

pursuant to its authority under sections 206(4) and 

211, neither of which requires us to consider the 

factors identified in section 202(c)(1). 

264Proposed rule 204–2(a)(18)(i). 

large advisers as variable costs, such as 

the requirement to make and keep 

records relating to contributions, should 

be lower as there should be fewer 

records to make and keep.259

E. Duplicative, Overlapping, or 

Conflicting Federal Rules 

The Commission believes that there 

are no other Federal rules that 

duplicate, overlap, or conflict with the 

proposed rule amendments. As 

discussed above, to make clear the 

relationship between our rules, we 

propose making a technical amendment 

to rule 206(4)–3 to specify that 

solicitation activities involving 

government entity clients under our 

proposed rule 206(4)–5 are subject to 

limitations set forth in that rule. 

F. Significant Alternatives 

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.260

In connection with the proposed rule 

amendments, 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 

proposed rule and rule amendments for 

such small entities; (iii) the use of 

performance rather than design 

standards; and (iv) an exemption from 

coverage of the proposed rule and rule 

amendments, or any part thereof, for 

such small entities. 

Regarding the first alternative, the 

Commission is not proposing different 

compliance or reporting requirements 

for small advisers as it may be 

inappropriate 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 

proposal would provide to public 

pension plan clients and their 

beneficiaries. 

Regarding the second alternative, we 

will continue to consider whether 

further clarification, consolidation, or 

simplification of the compliance 

requirements is feasible or necessary, 

but we believe that the current proposal 

is clear. The proposed rule and rule 

amendments contain an approach to 

curtailing pay to play practices that is 

modeled on established MSRB rules that 

have already been implemented by 

financial firms of varying sizes. 

However, we note that we are proposing 

an amendment to rule 206(4)–3, the 

cash solicitation rule, to clarify that the 

requirements of new proposed rule 

206(4)–5 apply to solicitation activities 

involving government clients. 

Regarding the third alternative, we 

consider 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 baseline 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 proposed rule and related rule 

amendments. Since we intend to extend 

the benefit of banning pay to play 

practices to clients of both small and 

large advisers, it would be inconsistent 

to specify different requirements for 

small advisers. 

G. Solicitation of Comments 

We encourage written comments on 

matters discussed in this IRFA. In 

particular, the Commission seeks 

comment on: 

• The number of small entities, 

particularly small advisers, to which the 

proposed rule and rule amendments 

would apply and the effect on those 

entities, including whether the effects 

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. 

Commenters are asked to describe the 

nature of any effect and provide 

empirical data supporting the extent of 

the effect. 

VI. Effects on Competition, Efficiency 

and Capital Formation 

The Commission is proposing to 

amend rule 204–2 pursuant to its 

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.’’ 261 Section 202(c) of the 

Advisers Act 262 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.263

We are proposing to amend rule 204– 

2 to require an adviser to make and keep 

a list of its covered associates, the 

government entities the adviser 

provides advisory services to or seeks to 

provide advisory services to, and the 

contributions made by the firm and its 

covered associates, as applicable, to 

government officials and candidates.264

The proposed amendment is designed to 

provide our examiners important 

information about the adviser and its 

covered associates’ contributions to 

government officials and the 

government entities that the adviser 

provides advisory services to or seeks to 

provide those services. We believe that 

the proposed amendment to the 

Advisers Act recordkeeping rule would 

not materially increase the compliance 

burden on advisers under rule 204–2. 

Similarly, we do not believe that the 

proposed amendments to the 

recordkeeping rule would 

disproportionately affect advisers with 

government entity clients or potential 

government clients. The amendments 

will apply equally to all SEC-registered 

advisers. All registered advisers are 

already subject to a variety of 

recordkeeping requirements in the 

course of their business and, therefore, 

the proposed amendments to the 

recordkeeping rule should not affect 


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265Public Law 104–121, Title II, 110 Stat. 857 

(1996) (codified in various sections of 5 U.S.C., 15 

U.S.C. and as a note to 5 U.S.C. 601). 

efficiency. We do not anticipate that the 

proposed recordkeeping rule 

amendments would affect capital 

formation. 

The Commission requests comment 

whether the proposed amendment to 

rule 204–2, if adopted, would promote 

efficiency, competition, and capital 

formation. Commenters are requested to 

provide empirical data to support their 

views. 

VII. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996, or ‘‘SBREFA,’’ 265 the Commission 

must advise OMB whether a proposed 

regulation constitutes a ‘‘major’’ rule. 

Under SBREFA, a rule is considered 

‘‘major’’ where, if adopted, it results in 

or is likely to result in: (1) An annual 

effect on the economy of $100 million 

or more; (2) a major increase in costs or 

prices for consumers or individual 

industries; or (3) significant adverse 

effects on competition, investment or 

innovation. 

We request comment on the potential 

impact of the proposed new rule and 

proposed rule amendments on the 

economy on an annual basis. 

Commenters are requested to provide 

empirical data and other factual support 

for their views to the extent possible. 

VIII. Statutory Authority 

The Commission is proposing new 

rule 206(4)–5 and amendments to 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 proposing 

amendments to 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 proposed 

to be amended as follows. 

PART 275—RULES AND 

REGULATIONS, INVESTMENT 

ADVISERS ACT OF 1940 

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, 80b–6(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) * * * 

(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 for which 

the investment adviser or any of its 

covered associates is providing or 

seeking to provide investment advisory 

services, or which are investors or are 

solicited to invest in any covered 

investment pool to which the 

investment adviser provides investment 

advisory services, as applicable; 

(C) All government entities to which 

the investment adviser has provided 

investment advisory services, along 

with any related covered investment 

pool(s) to which the investment adviser 

has provided investment advisory 

services and in which the government 

entity has invested, as applicable, in the 

past five years, but not prior to [effective 

date of this section]; and 

(D) All direct or indirect contributions 

or payments made by the investment 

adviser or any of its covered associates 

to an official of a government entity, a 

political party of a State or political 

subdivision thereof, or a political action 

committee. 

(ii) Records relating to the 

contributions and payments referred to 

in paragraph (a)(18)(i)(D) 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 

(D) Whether any such contribution 

was the subject of the exception for 

certain returned contributions pursuant 

to § 275.206(4)–5(b)(2). 

(iii) For purposes of this section, the 

terms ‘‘contribution,’’ ‘‘covered 

associate,’’ ‘‘covered investment pool,’’ 

‘‘government entity,’’ ‘‘official,’’ 

‘‘payment,’’ and ‘‘solicit’’ have the same 

meanings as set forth in § 275.206(4)–5. 

(iv) 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 providing or 

seeking to provide investment advisory 

services directly to the government 

entity. 

* * * * * 

(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 following the 

section to read as follows: 

§ 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 


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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 investment adviser unless: 

(A) Such person is a related person of 

the investment adviser or, if the related 

person is a company, an employee of 

that related person; or 

(B) Such person 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 $250 to any one 

official, per election. 

(2) Exception for certain returned 

contributions. 

(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)(2)(ii) and (b)(2)(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 $250; 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) An investment adviser is entitled 

to no more than two exceptions 

pursuant to paragraph (b)(2)(i) of this 

section per 12-month period. 

(iii) An investment adviser may not 

rely on the exception provided in 

paragraph (b)(2)(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 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 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 

(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; 

(ii) Any employee who solicits a 

government entity for the investment 

adviser; 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 

any investment company, as defined in 

section 3(a) of the Investment Company 

Act of 1940 (15 U.S.C. 80a–3(a)), or any 

company that would be an investment 

company under section 3(a) of that Act 

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)), 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. 

(4) Executive officer of an investment 

adviser means the president, any vice 

president in charge of a principal 

business unit, division or function (such 

as sales, administration or finance), or 

any other executive officer of the 

investment adviser who, in each case, in 

connection with his or her regular 

duties: 


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(i) Performs, or supervises any person 

who performs, investment advisory 

services for the investment adviser; 

(ii) Solicits, or supervises any person 

who solicits, for the investment adviser, 

including with respect to investors for a 

covered investment pool; or 

(iii) Supervises, directly or indirectly, 

any person described in paragraph 

(f)(4)(i) or (f)(4)(ii) of this section. 

(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; 

(ii) A plan, program, or pool of assets 

sponsored or established by the State or 

political subdivision or any agency, 

authority or instrumentality thereof; and 

(iii) 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 investment program or 

plan sponsored or established by a 

government entity, 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. 

(9) Related person of an investment 

adviser means any person, directly or 

indirectly, controlling or controlled by 

the investment adviser, and any person 

that is under common control with the 

investment adviser. 

(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 

(ii) With respect to a contribution or 

payment, to communicate, directly or 

indirectly, for the purpose of obtaining 

or arranging a contribution or payment. 

(g) Effective date. The prohibitions on 

providing investment advisory services 

and payments to solicit, in each case as 

described in this section, arise only 

from contributions and payments, 

respectively, made on or after [the 

effective date of this section]. 

Dated: August 3, 2009. 

By the Commission. 

Elizabeth M. Murphy, 

Secretary. 

[FR Doc. E9–18807 Filed 8–6–09; 8:45 am] 

BILLING CODE 8010–01–P 


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