SEC Joins State and Local Governments in Considering Regulation of Investment Adviser Activities Related to Government Plans

Author:Mr John Janicik, Joseph Seliga and Stephanie D. Wagner
Profession:Mayer Brown

Originally published October 14, 2009

Keywords: SEC, Proposed Rule 206, Investment Advisers Act, pay-to-play abuses, government pension systems, government funds, investment adviser activities

In response to investigations into alleged corrupt practices involving the use of placement agents with respect to public pension funds, retirement systems and other government fund entities, both the Illinois legislature and the New York State Comptroller took action in April of this year to restrict the use of placement agents.1 Over the last several months, state and local pension funds, retirement systems and other government fund entities (referred to herein as government funds) have followed suit by adopting various policies regulating the use of placement agents.

Recently, the US Securities and Exchange Commission (SEC) took its own action in this area by issuing Proposed Rule 206(4)-5 under the Investment Advisers Act of 1940 (Advisers Act).2 The Proposed Rule is designed to curb pay-to-play abuses with respect to investment advisory services for such government funds. Comments on the Proposed Rule were due October 6, 2009. Now that the comment period has concluded, it is expected that the SEC will consider final action in this area.

As the SEC considers what final action to take, various government funds are adopting their own regulations, and others that are considering action in this area are likely to do so after the SEC's final determination. As a result, regulation in this area is expected to continue to evolve in the coming months.

The SEC Proposed Rule The SEC Proposed Rule aims to curb pay-to-play abuses with respect to government funds by banning the use of third-party placement agents in soliciting government funds for advisory business and by imposing limitations on certain campaign contributions. The Proposed Rule would apply to any investment adviser registered (or required to be registered) with the SEC, or advisers that are unregistered in reliance on the exemption available for advisers with fewer than 15 clients, and would prohibit doing indirectly that which if done directly would violate the Proposed Rule.

The Proposed Rule is modeled after Rules G-37 and G-38 of the Municipal Securities Rulemaking Board (MSRB), which impose similar campaign and third-party placement agent restrictions on securities dealers working with municipal bond issuers. Additionally, in 1999, the SEC proposed a pay-to-play rule similar to the campaign contribution portions of the Proposed Rule. The 1999 Rulemaking was eventually terminated in 2001. The SEC Proposed Rule was subject to a minimum 60-day comment period, which ended on October 6, 2009.

SEC BAN ON USE OF PLACEMENT AGENTS The SEC Proposed Rule would make it unlawful for any covered investment adviser, or any of the adviser's covered associates, to provide or agree to provide, directly or indirectly, payment to any unaffiliated third party (including "finders," "solicitors," "placement agents," or "pension consultants") to solicit a government fund for investment advisory services. Affiliates excluded from this provision include: (i) a "related person" of the investment adviser (defined 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), or an employee of that related person; or (ii) any of the adviser's employees, general partners, LLC managing members and executive officers. Furthermore, a contribution to a government official by certain of these persons would trigger the two-year "time out" described below.

The SEC proposes to exclude payments to related persons from the ban such that advisers are able to compensate parent companies and other owners, subsidiaries, and sister companies for governmental fund solicitation, because the SEC recognizes that there may be efficiencies in allowing advisers to rely on these particular types of persons to assist them in seeking clients.

RESTRICTIONS ON CAMPAIGN CONTRIBUTIONS The SEC Proposed Rule makes it unlawful for advisers to receive compensation for providing advisory services to a government fund for a two-year period (the two-year "time out") after the adviser or any of its covered associates makes a political contribution to a public official of a government fund that is in a position to influence the award of advisory business. The two-year "time out" would continue to apply to the adviser firm even after the covered associate who made the triggering contribution had ceased employment. Additionally...

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