How to Maintain Pay-to-Play Compliance

What went wrong: A $305,000 SEC Pay-to-Play rule violation

Financial firms should see enforcement actions as learning opportunities. The Securities and Exchange Commission (SEC) and other regulatory bodies enforce steep fines and penalties to send a clear message and deter future violations. As a result? They expect firms within the industry to pay attention and adapt their compliance programs accordingly.

With that in mind, we’re continuing our blog series, “what went wrong” in which we’ll cover enforcement actions and what your firm can do to avoid the same mistakes.

In our previous enforcement action blog post, we talked about a $2 billion record-keeping violation. Before that, we talked about a $13.1 million Regulation Best Interest (BI) violation. Today, we’re focusing on an enforcement action regarding the SEC’s Pay-to-Play rule and what investment advisers can learn from this case of noncompliance.

The case: A violation of the SEC’s Pay-to-Play rule

On Sep. 15, 2022, the SEC charged four investment firms $305,000 for violating the SEC’s pay-to-play rule for investment advisers. SEC Rule 206(4)-5, or the SEC’s Pay-to-Play rule, prohibits investment advisers from providing compensatory advisory services – either directly to a government client or through a pooled investment vehicle – for two years following a campaign contribution by the firm or certain associates to candidates or officials in a position to influence the selection or retention of investment advisers to manage the assets of public pension funds or other public entities. While the Pay-to-Play rule makes an exception for the two-year “time out” for returned contributions, this exception is only available when the contribution has been discovered within four months of being made, is less than $350 and is returned within 60 calendar days from the date of discovery. Adopted in 2010, the rule was a response to instances where government entities, such as state and municipal pension plans, were choosing investment advisers based on their political contributions.

The SEC alleged four investment advisers at these firms violated the Pay-to-Play rule by continuing to receive compensation from government entities within two years after campaign contributions to elected officials or candidates for elected office who had influence over the selection of investment advisers for advisory services for government entities (or who could appoint someone who had such influence).

According to the SEC:

  • In all four cases, personnel of investment advisers made political contributions of $1,000 or less.
  • In all four cases, contributions mandated a two-year “time-out” or wait period, because the recipient of the contribution was an “official” of the pension plan due to the recipient’s role with respect to the pension plan.
  • In all four cases, the investment advisers had established advisory relationships with the pension plans prior to the contributions.
  • None of the cases involved allegations of any intent to influence the allocation of pension investments.
  • In three of the cases, the investments by the pension plans were made years before the political contributions were made and the funds were closed-end funds with no redemption rights.

Without admitting or denying the SEC’s findings, the investment firms consented to a cease-and-desist order and a censure, agreeing to pay civil money penalties.

What can your investment advisers do to avoid violating the SEC Pay-to-Play rule?

The SEC’s strict enforcement of its Pay-to-Play rule highlights just how important it is for investment advisers to make sure they do their part to avoid political contribution compliance violations…even in off election years. Here are some steps your firm can take to avoid making the same (costly) mistakes these financial firms made:

  • Write firm policies and procedures which thoroughly address all relevant Pay-to-Play rules.
  • Incorporate a pre-clearance process for all political contributions within your firm’s compliance program. This helps to prevent improper contributions and helps your firm track when these contributions are made.
  • Maintain records to help your firm identify contributions which may not have been cleared.
  • Provide specific and up-to-date education to employees, including investment advisers, on who the Pay-to-Play rules apply to and how they can do their part to avoid noncompliance.

Election season is over, but that doesn’t mean that Pay-to-Play risk goes away. Now is the time to assess your firm’s compliance program to ensure it is fully equipped to prevent a compliance violation.

Is your firm doing all it can to avoid a compliance violation? Let’s find out. Schedule a demo today!