The SEC’s recent settlement involving a “pay-to-play” rule violation by a private equity firm is a timely reminder for fund managers, especially with the November elections approaching. 

As a refresher, Rule 206(4)-5 of the Investment Advisers Act – known as the “pay to play” rule – prohibits investment advisers from receiving compensation for providing advisory services to state and municipal entities for two years after the adviser or one of its “covered associates” makes certain political contribution to candidates for public office. Note that the SEC Enforcement Division staff periodically reviews public campaign contribution reports (which are publicly available online) to identify donations by individuals associated with investment advisers.

In the recent SEC settlement, an employee and covered associate of an SEC-registered investment adviser contributed $4,000 to the political campaign of a state government official, whose position had the ability to influence the selection of investment advisers for the state board of investment. The state had a pre-existing investment in private equity funds managed by the firm. This contribution triggered the pay-to-play rule restrictions and as a result, the entity was fined as part of a cease and desist order.

Pitfalls to Avoid

Despite the rule’s complexities, fund managers who permit political contributions can avoid common mistakes by being aware of these key points: 

  • Look back for new covered associates:
    • The rule applies to certain contributions made by new covered associates (e.g., newly promoted to a covered associate role or newly hired employees) before they start at the firm.  Specifically, the rule applies to their political contributions made within two years of becoming a covered associate if the individual solicits government clients, or six months if not. (Rule 206(4)-5(b)(2))
  • Contributions to federal candidates holding state office:
    • The rule also applies to contributions to federal candidates if they hold a state or municipal government position at the time of the contribution (e.g., a state governor running for federal office). (Rule 206(4)-5(f)(6))
  • PACs or party donations earmarked for a candidate:
    • The rule prohibits doing indirectly what the rule would prohibit if done directly. Contributions to PACs or political parties can potentially trigger the rule if they are specifically earmarked for a particular candidate.
  • VC firms are not exempt from the rule:
    • The pay-to-play rule applies to all investment advisers, including exempt reporting advisers, not just registered ones.   

Steps to Stay Compliant

With the November elections drawing near, political donation requests will increase.  Fund managers should keep these four strategies in mind:

  • Follow your policies:
    • Adhere to the written compliance policy, including the maintenance of any preclearance logs and proper documentation.
  • Train your personnel:
    •  Ensure all covered associates understand the pay to play rule, its application to their donations, and the firm’s internal policies and preclearance requirements.
  • Be vigilant:
    • Provide personnel with questionnaires and pre-approval reminders. Investigate any prior political donations by new hires.
  • Act quickly:
    •  If a potential issue arises, take immediate steps to mitigate. Early detection can allow for corrections, such as using the exception for “returned” contributions if the amount does not exceed $350, is discovered within four months, and then returned within 60 days after discovery. (Rule 206(4)-5(b)(3))

By keeping these tips in mind, fund managers can smoothly navigate the pay-to-play rule and steer clear of potential issues.

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Photo of Joshua M. Newville Joshua M. Newville

Joshua M. Newville is a partner in the Litigation Department and a member of Proskauer’s White Collar Defense & Investigations Group and the Asset Management Litigation team.

Josh handles securities litigation, enforcement and regulatory matters, representing corporations and senior executives in civil and…

Joshua M. Newville is a partner in the Litigation Department and a member of Proskauer’s White Collar Defense & Investigations Group and the Asset Management Litigation team.

Josh handles securities litigation, enforcement and regulatory matters, representing corporations and senior executives in civil and criminal investigations. In addition, Josh advises registered investment advisers and private fund managers on regulatory compliance, SEC exams, MNPI/insider trading and related risks.

Before joining Proskauer, Josh was senior counsel in the U.S. Securities and Exchange Commission’s Division of Enforcement, where he investigated and prosecuted violations of the federal securities laws. Josh served in the Enforcement Division’s Asset Management Unit, a specialized unit focusing on investment advisers and the asset management industry. His prior experience with the SEC provides a unique perspective to help asset managers manage risk and handle regulatory issues.

Photo of Robert Pommer Robert Pommer

Robert W. Pommer III is a partner in the Litigation Department and a member of Proskauer’s Securities Litigation, White Collar Defense & Investigations groups and the Asset Management Litigation team.

Bob’s practice focuses on a broad range of securities-related enforcement and compliance issues.

Robert W. Pommer III is a partner in the Litigation Department and a member of Proskauer’s Securities Litigation, White Collar Defense & Investigations groups and the Asset Management Litigation team.

Bob’s practice focuses on a broad range of securities-related enforcement and compliance issues. He represents private fund managers, financial institutions, public companies, and their senior executives in enforcement investigations and litigation conducted by the SEC, the U.S. Department of Justice, and other governmental entities and financial services regulators. He also conducts internal investigations and counsels investment advisers and public companies on regulatory compliance, corporate governance and other SEC-related issues.

Prior to his career in private practice, Bob served as Assistant Chief Litigation Counsel in the SEC’s Division of Enforcement for nine years. While there, he investigated and litigated several high-profile cases involving complex financial fraud and audit failures. Bob also worked on enforcement actions involving insider trading, investment adviser and broker-dealer issues, market manipulation and other violations of the federal securities laws.

Photo of Julia M. Ansanelli Julia M. Ansanelli

Julia Ansanelli is an associate in the Litigation Department and a member of the firm’s White Collar Defense & Investigations, Securities Litigation, and Asset Management Litigation Practice Groups.  She has worked extensively defending clients facing criminal and regulatory investigations by the Securities and…

Julia Ansanelli is an associate in the Litigation Department and a member of the firm’s White Collar Defense & Investigations, Securities Litigation, and Asset Management Litigation Practice Groups.  She has worked extensively defending clients facing criminal and regulatory investigations by the Securities and Exchange Commission, the U.S. Department of Justice, and the Federal Trade Commission.  She is also a member of the litigation team that represents the Financial Oversight and Management Board in the Commonwealth of Puerto Rico’s bankruptcy proceedings.  Julia has experience with various stages of complex commercial litigation, both in federal and state courts.

Julia maintains an active pro bono practice, with an emphasis on immigration law, and in particular, special immigrant juvenile status.  In recognition of her pro bono efforts, Julia received a Proskauer Golden Gavel award in 2018 in connection with an amicus brief she helped prepare in support of a class of thousands of immigrant youth that had been denied special immigrant juvenile status in New York based on a then-new USCIS policy.  The class of immigrant youth were ultimately successful when the Southern District of New York judge agreed that the USCIS policy violated federal immigration law.

During law school, she served as Case Note Editor of the Touro Law Review, in which she published two case notes of her own, and Vice President of Touro’s Latin American Law School Association. Julia also interned for the Honorable Magistrate Kathleen Tomlinson in the Eastern District of New York.

Julia is a frequent contributor to Proskauer’s Minding Your Business and Capital Commitment blogs.  She has also been recognized as a Super Lawyers “Rising Star” from 2020-2023.