Surprisingly broad regs kick in next quarter, covering RIAs that do business with the government

November 30, 2010 — 4:12 AM UTC by Les Abromovitz, Columnist

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Although the election season is over, you should not elect to ignore the new pay-to-play rule. Complying with the rule is an ongoing endeavor if your firm markets advisory services to government entities.

Among the many regulatory changes the SEC made in 2010, the commission unanimously adopted Rule 206(4)-5 under the Investment Advisers Act of 1940. Known better as the pay-to-play rule, it is designed to stop investment advisers from making campaign contributions with the hope of winning contracts to manage government investment accounts or public pension plan assets.

If a Registered Investment Adviser (“RIA”) violates the pay-to-play rule, the firm may not be compensated for providing advisory services to local and state government clients for two years. An RIA violates the rule if the firm or covered associates made certain types of contributions to elected officials or candidates who might influence the government contract selection process. Although the rule does not apply to state-registered advisers, there may be state or local restrictions on political contributions made for the purpose of winning government contracts.

The definition of a contribution is broad

Contributions come in different forms besides cash and checks. Contributions include loans, advances, gifts and items of value provided with the goal of influencing a government official. The pay-to-play rule also applies to direct or indirect contributions to political party or a political action committee.

Judging by the number of political commercials I stopped watching in October, campaigns are expensive. You’re viewed as having made a contribution if you help pay off a political official’s election debt. Helping to pay transition or inaugural expenses incurred by a successful candidate is also considered a contribution. Working on an elected official or candidate’s campaign may also fall within the definition of “contribution” found in the pay-to-play rule.

You should be thinking about the pay-to-play rule when you hire a new associate. Certain contributions made by a covered associate will be attributed to the RIA that hires the individual. In certain instances, the two-year time-out from receiving payment from a government entity may not apply if a newly hired covered associate made the contribution more than six months prior to being hired. Subject to the many exceptions that you will find in rules enacted by the government, returning the contribution may undo the damage if the RIA is awarded an advisory services contract.

Solid records and air-tight policies

RIAs must keep records detailing contributions made by Investment Adviser Representatives and other covered associates. You must also retain records relating to contributions made by registered persons who solicit a government entity on your behalf.

An RIA is only required to create and retain records to comply with the pay-to-play rule if the firm provides investment advisory services to a government entity. These pay-to-play rule records are also required if a government entity is an investor in any covered investment pool to which the RIA is providing investment advisory services. Such pools include mutual funds, but only if those registered pools are an investment option of a participant-directed plan or program of a government entity. These plans or programs also may include college savings plans and retirement plans like 403(b) plans and 457 plans.

Assuming your advisory firm is required to keep records to satisfy the pay-to-play rule, you have until March 14, 2011 to create and start maintaining them.

If the pay-to-play rule applies to your RIA, you should implement thorough and effective policies and procedures to ensure compliance by everyone in your firm. These policies and procedures should also establish how your firm oversees the conduct of registered persons soliciting government advisory business on your behalf. When an RIA has thorough policies and procedures in place, the SEC may spare you if your firm inadvertently violates the pay-to-play rule.

Now that elections are behind us, I hope all of us will be spared from watching political commercials for a while.

Les Abromovitz is a senior consultant with National Compliance Services Inc. Les, an attorney, is the author of Growing Within the Lines: The Investment Adviser’s Advertising and Marketing Compliance Guide (Available on Amazon.com or through NationalUnderwriterStore.com). He can be reached at 561-330-7645, Ext. 213, or at LAbromovitz@ncsonline.com.


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