Political Contributions by Certain Investment Advisers, 41018-41071 [2010-16559]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 75, Number 134 (Wednesday, July 14, 2010)]
[Rules and Regulations]
[Pages 41018-41071]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-16559]



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Part IV





Securities and Exchange Commission





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17 CFR Part 275



Political Contributions by Certain Investment Advisers; Final Rule

Federal Register / Vol. 75, No. 134 / Wednesday, July 14, 2010 / 
Rules and Regulations

[[Page 41018]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-3043; File No. S7-18-09]
RIN 3235-AK39


Political Contributions by Certain Investment Advisers

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission is adopting a new rule 
under the Investment Advisers Act of 1940 that prohibits 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 also prohibits 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, unless such third parties 
are registered broker-dealers or registered investment advisers, in 
each case themselves subject to pay to play restrictions. Additionally, 
the new rule prevents 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 adopting rule 
amendments that 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 
address ``pay to play'' practices by investment advisers.

DATES: Effective Date: September 13, 2010.
    Compliance Dates: Investment advisers subject to rule 206(4)-5 must 
be in compliance with the rule on March 14, 2011. Investment advisers 
may no longer use third parties to solicit government business except 
in compliance with the rule on September 13, 2011. Advisers to 
registered investment companies that are covered investment pools must 
comply with the rule by September 13, 2011. Advisers subject to rule 
204-2 must comply with amended rule 204-2 on March 14, 2011. However, 
if they advise registered investment companies that are covered 
investment pools, they have until September 13, 2011 to comply with the 
amended recordkeeping rule with respect to those registered investment 
companies. See section III of this Release for further discussion of 
compliance dates.

FOR FURTHER INFORMATION CONTACT: Melissa A. Roverts, Senior Counsel, 
Matthew N. Goldin, Branch Chief, 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 adopting rule 206(4)-5 [17 
CFR 275.206(4)-5] and 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'').\1\
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    \1\ 15 U.S.C. 80b. Unless otherwise noted, when we refer to the 
Advisers Act, or any paragraph of the Advisers Act, we are referring 
to 15 U.S.C. 80b of the United States Code, at which the Advisers 
Act is codified, and when we refer to rule 206(4)-5, rule 204-2, 
rule 204A-1, rule 206(4)-3, or any paragraph of these rules, we are 
referring to 17 CFR 275.206(4)-5, 17 CFR 275.204-2, 17 CFR 275.204A-
1 and 17 CFR 275.206(4)-3, respectively, of the Code of Federal 
Regulations, in which these rules are published.
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Table of Contents

I. Background
II. Discussion
    A. First Amendment Considerations
    B. Rule 206(4)-5
    1. Advisers Subject to the Rule
    2. Pay to Play Restrictions
    (a) Two-Year ``Time Out'' for Contributions
    (1) Prohibition on Compensation
    (2) Officials of a Government Entity
    (3) Contributions
    (4) Covered Associates
    (5) ``Look Back''
    (6) Exceptions for De Minimis Contributions
    (7) Exception for Certain Returned Contributions
    (b) Ban on Using Third Parties to Solicit Government Business
    (1) Registered Broker-Dealers
    (2) Registered Investment Advisers
    (c) Restrictions on Soliciting and Coordinating Contributions 
and Payments
    (d) Direct and Indirect Contributions or Solicitations
    (e) Covered Investment Pools
    (1) Definition of ``Covered Investment Pool''
    (2) Application of the Rule
    (3) Subadvisory Arrangements
    (f) Exemptions
    D. Recordkeeping
    E. Amendment to Cash Solicitation Rule
III. Effective and Compliance Dates
    A. Two-Year Time Out and Prohibition on Soliciting or 
Coordinating Contributions
    B. Prohibition on Using Third Parties to Solicit Government 
Business and Cash Solicitation Rule Amendment
    C. Recordkeeping
    D. Registered Investment Companies
IV. Cost-Benefit Analysis
    A. Benefits
    B. Costs
    1. Compliance Costs Related to Rule 206(4)-5
    2. Other Costs Related to Rule 206(4)-5
    (a) Two-Year Time Out
    (b) Third-Party Solicitor Ban
    3. Costs Related to the Amendments to Rule 204-2
V. Paperwork Reduction Act
    A. Rule 204-2
    B. Rule 206(4)-3
    C. Rule 206(4)-7
    D. Rule 0-4
VI. Final Regulatory Flexibility Analysis
    A. Need for the Rule
    B. Significant Issues Raised by Public Comment
    C. Small Entities Subject to Rule
    D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements
    E. Agency Action to Minimize Effect on Small Entities
VII. Effects on Competition, Efficiency and Capital Formation
VIII. Statutory Authority

I. Background

    Investment advisers provide a wide variety of advisory services to 
State and local governments,\2\ including managing their public pension 
plans.\3\ These pension plans have over $2.6 trillion of assets and 
represent one-third of all U.S. pension assets.\4\ They are among the 
largest and most active institutional investors in the United 
States;\5\ the management of these funds affects

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publicly held companies \6\ and the securities markets.\7\ But most 
significantly, their management affects taxpayers and the beneficiaries 
of these funds, including the millions of present and future State and 
municipal retirees \8\ who rely on the funds for their pensions and 
other benefits.\9\ Public pension plan assets are held, administered 
and managed by government officials who often are responsible for 
selecting investment advisers to manage the funds they oversee.
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    \2\ See Sofia Anastopoulos, An Introduction to Investment 
Advisers for State and Local Governments (2d ed. 2007); Werner Paul 
Zorn, Public Employee Retirement Systems and Benefits, Local 
Government Finance, Concepts and Practices 376 (John E. Peterson & 
Dennis R. Strachota eds., 1st ed. 1991) (discussing the services 
investment advisers provide for public funds).
    \3\ To simplify the discussion, we use the term ``public pension 
plan'' interchangeably with ``government client'' and ``government 
entity'' in this Release. However, our rule applies broadly to 
investment advisory activities for government clients, such as those 
mentioned here in this Section of the Release, 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 section 
II.B.2(e) of this Release.
    \4\ Board of Governors of the Federal Reserve System, Flow of 
Funds Accounts of the United States, Flows and Outstandings, Fourth 
Quarter 2009 78 tbl.L.119 (Mar. 11, 2010). Since 2002, total 
financial assets of public pension funds have grown by 28%. Id.
    \5\ According 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 https://www.pionline.com/article/20090126/CHART/901209995.
    \6\ See Stephen J. Choi & Jill E. Fisch, On Beyond CalPERS: 
Survey Evidence on the Developing Role of Public Pension Funds in 
Corporate Governance, 61 Vand. L. Rev. 315 (2008) (``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.'').
    \7\ Federal Reserve reports indicate that, of the $2.6 trillion 
in non-Federal government plans, $1.5 trillion is invested in 
corporate equities. Board of Governors of the Federal Reserve 
System, supra note 4, at 78 tbl.L.119.
    \8\ See Paul Zorn, 1997 Survey of State and Local Government 
Employee Retirement Systems 61 (1997) (hereinafter ``1997 Survey'') 
(``[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'').
    \9\ The 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 https://www.census.gov/govs/retire/2007ret05.html.
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    Elected officials who allow political contributions to play a role 
in the management of these assets and who use these assets to reward 
contributors violate the public trust. Moreover, they undermine the 
fairness of the process by which public contracts are awarded. 
Similarly, investment advisers that seek to influence government 
officials' awards of advisory contracts by making or soliciting 
political contributions to those officials compromise their fiduciary 
duties to the pension plans they advise and defraud prospective 
clients. These practices, known as ``pay to play,'' distort the process 
by which advisers are selected.\10\ They can harm pension plans that 
may subsequently receive inferior advisory services and pay higher 
fees. Ultimately, these violations of trust can harm the millions of 
retirees that rely on the plan or the taxpayers of the State and 
municipal governments that must honor those obligations.\11\
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    \10\ Among other things, pay to play practices 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.
    \11\ See 1997 Survey, supra note 8.
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    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, ``[w]hile the risk of corruption is 
obvious and substantial, actors in this field are presumably shrewd 
enough to structure their relations rather indirectly.'' \12\ 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.
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    \12\ Blount v. SEC, 61 F.3d 938, 945 (D.C. Cir. 1995), cert. 
denied, 517 U.S. 1119 (1996).
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    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 
or appointed trustees 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,\13\ may be members of a governing board that selects 
advisers,\14\ or may appoint some or all of the board members who make 
the selection.\15\
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    \13\ See, e.g., 2 N.Y. Comp. Codes R. & Regs. tit. 2 Sec.  320.2 
(2009) (placement of State and local government retirement systems 
assets (valued at $109 billion as of March 2009) is under the sole 
custodianship of the New York State Comptroller).
    \14\ See, e.g., S.C. Code Ann. Sec. Sec.  9-1-20, 1-11-10 (2008) 
(board consists of all elected officials); Cal. Gov't Code Sec.  
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. Sec.  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).
    \15\ See, e.g., Ariz. Rev. Stat. Ann. Sec.  38-713 (2008) 
(governor appoints all nine members); Hawaii Rev. Stat. Sec.  88-24 
(2008) (governor appoints three of eight members); Idaho Code Ann. 
Sec.  59-1304 (2008) (governor appoints all five members).
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    Numerous developments in recent years have led us to conclude that 
the selection of advisers, whom we regulate under the Investment 
Advisers Act, has been influenced by political contributions and that, 
as a result, the quality of management service provided to public funds 
may be negatively affected. We have been particularly concerned that 
these contributions have been funneled through ``solicitors'' and 
``placement agents'' that advisers engage (or believe they must engage) 
in order to secure a client relationship with a public pension plan or 
an investment from one.\16\ As we will discuss in more detail below, in 
such an arrangement the contribution may be made in the form of a 
substantial fee for what may constitute no more than an introduction 
service by a ``well connected'' individual who may use the proceeds of 
the fee to make (or reimburse himself for having made) political 
contributions or provide some form of a ``kickback'' to an official or 
his or her family or friends.\17\
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    \16\ For example, in one recent action we alleged that, in 
connection with a pay to play scheme in New York State, investment 
advisers paid sham ``placement agent'' fees, portions of which were 
funneled to public officials, as a means of obtaining public pension 
fund investments in the funds those advisers managed and that 
participants, in some instances, concealed the third-party 
solicitor's role in transactions from the investment management 
firms that paid fees to the solicitor by making misrepresentations 
about the solicitor's involvement and covertly using one of the 
solicitor's legal entities as an intermediary to funnel payments to 
the solicitor. SEC v. Henry Morris, et al., Litigation Release No. 
20963 (Mar. 19, 2009).
    \17\ See id. (along with the Commission's complaint in the 
action, available by way of a hyperlink from the litigation 
release). See also, e.g., In the Matter of Quadrangle Group LLC, 
AGNY Investigation No. 2010-044 (Apr. 15, 2010) (finding 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* * *''); Complaint, Cal. v. Villalobos, et 
al., No. SC107850 (Cal. Super. Ct., W. Dist. of L.A. County, May 5, 
2010), available at https://ag.ca.gov/cms_attachments/press/pdfs/n1915_filed_complaint_for_civil_penalties.pdf (alleging, inter 
alia, that a top executive and a board member at CalPERS accepted 
various gifts from a former CalPERS board member, ``known among 
private equity firms as a person who attempts to exert pressure on 
CalPERS' representatives,'' who was acting as a placement agent 
trying to secure investments from the California public pension 
fund).
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    The details of pay to play arrangements have been widely reported 
as a consequence of the growing number of actions that we and State 
authorities have brought involving investment advisers seeking to 
manage the considerable assets of the New York State Common Retirement 
Fund.\18\ In

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addition, we have brought enforcement actions against the former 
treasurer of the State of Connecticut and other parties in which we 
alleged that the former treasurer awarded State pension fund 
investments to private equity fund managers in exchange for payments, 
including political contributions, funneled through the former 
treasurer's friends and political associates.\19\ Criminal authorities 
have in recent years brought cases in New York,\20\ New Mexico,\21\ 
Illinois,\22\ Ohio,\23\ Connecticut,\24\ and Florida,\25\ charging 
defendants with the same or similar conduct.
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    \18\ See SEC v. Henry Morris, et al., Litigation Release No. 
21036 (May 12, 2009); In the Matter of Quadrangle Group LLC, AGNY 
Investigation No. 2010-044 (Apr. 15, 2010); In the Matter of GKM 
Newport Generation Capital Servs., LLC, AGNY Investigation No. 2010-
017 (Apr. 14, 2010); In the Matter of Kevin McCabe, AGNY 
Investigation No. 2009-152 (Apr. 14, 2010); In the Matter of Darius 
Anderson Platinum Advisors LLC, AGNY Investigation No. 2009-153 
(Apr. 14, 2010); In the Matter of Global Strategy Group, AGNY 
Investigation No. 2009-161 (Apr. 14, 2010); In the Matter of Freeman 
Spogli & Co., AGNY Investigation No. 2009-174 (Feb. 1, 2010); In the 
Matter of Falconhead Capital, LLC, AGNY Investigation No. 2009-125 
(Sept. 17, 2009); In the Matter of HM Capital Partners I, LP, AGNY 
Investigation No. 2009-117 (Sept. 17, 2009); In the Matter of Ares 
Management LLC, AGNY Investigation No. 2009-173 (Feb. 17, 2010); In 
the Matter of Levine Leichtman Capital Partners, AGNY Investigation 
No. 2009-124 (Sept. 17, 2009); In the Matter of Access Capital 
Partners, AGNY Investigation No. 09-135 (Sept. 17, 2009); In the 
Matter of The Markstone Group, AGNY Investigation No. 10-012 (Feb. 
28, 2010); In the Matter of Wetherly Capital Group, LLC and DAV/
Wetherly Financial, L.P., AGNY Investigation No. 2009-172 (Feb. 8, 
2010) (in each case, banning the use of third-party placement agents 
pursuant to a ``Pension Reform Code of Conduct'').
    \19\ See 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) (2007 U.S. Dist. LEXIS 73850 (D. 
Conn., May 8, 2007), aff'd 587 F.3d 553 (2nd Cir. 2009)). 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).
    \20\ See 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).
    \21\ See 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 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).
    \22\ See Jeff Coen, et al., State's Ultimate Insider Indicted, 
Chi. Trib., Oct. 31, 2008, available at https://www.chicagotribune.com/news/local/chi-cellini-31-oct31,0,6465036.story (describing the thirteenth indictment in an 
Illinois pay to play probe); Ellen Almer, Oct. 27, 2000, available 
at https://www.chicagobusiness.com/cgi-bin/news.pl?id=775 (discussing 
the guilty plea of Miriam Santos, the former treasurer of the City 
of Chicago, who told representatives of financial services firms 
seeking city business that they were required to raise specified 
campaign contributions for her and personally make up any shortfall 
in the amounts they raised). See also SEC v. Miriam Santos, et al., 
Litigation Release No. 17839 (Nov. 14, 2002); Litigation Release No. 
19269 (June 14, 2005) (355 F. Supp. 2d 917 (N.D. Ill. 2003)).
    \23\ See 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).
    \24\ See 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. 
2000) (the former treasurer, along with certain others, pleaded 
guilty--while others were ultimately convicted). One of the 
defendants, who had been convicted at trial, recently won a new 
trial. U.S. v. Triumph Capital Group, et al., 544 F.3d 149 (2d Cir. 
2008).
    \25\ 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 
convicted 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).
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    Allegations of pay to play activity involving State and municipal 
pension plans in other jurisdictions continue to be reported.\26\ In 
the course of this rulemaking we received a letter from one public 
official detailing the role of pay to play arrangements in the 
selection of public pension fund managers and the harms it can inflict 
on the affected plans.\27\ In addition, other public officials wrote to 
express support for a Commission rule to prohibit investment advisers 
from participating in pay to play arrangements.\28\
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    \26\ See, e.g., Aaron Lester, et al., Cahill Taps Firms Tied to 
State Pension Investor, Boston.com, Mar. 21, 2010 (suggesting that 
an investment adviser may have bundled out-of-State donations to the 
Massachusetts State Treasurer's campaign in return for a State 
pension fund investment management contract); Kevin McCoy, Do 
Campaign Contributions Help Win Pension Fund Deals, USA Today, Aug. 
28, 2009; Ted Sherman, Pay to Play Alive and Well in New Jersey, 
NJ.com, Nov. 28, 2009 (noting more generally that pay to play 
continues to occur with government contracts of all kinds in New 
Jersey); Imogen Rose-Smith and Ed Leefeldt, Pension Pay to Play 
Casts Shadow Nationwide, Institutional Investor, Oct. 1, 2009 
(suggesting connections between a private equity fund principal's 
fundraising activities and pension investments in the fund). See 
also sources cited supra note 17.
    \27\ Comment Letter of Suzanne R. Weber, Erie County Controller 
(Oct. 6, 2009) (``Weber Letter'') (``I have seen money managers 
awarded contracts with our fund which involved payments to 
individuals who served as middlemen, creating needless expense for 
the fund. These middlemen were political contributors to the 
campaigns of board members who voted to contract for money 
management services with the companies who paid them as 
middlemen.''). See also Comment Letter of David R. Pohndorf (Aug. 4, 
2009) (``Pohndorf Letter'') (noting that when the sole trustee of a 
major pension fund changed several years ago, a firm managing some 
of the fund's assets ``began to receive invitations to fundraising 
events for the new trustee with suggested donation amounts.'').
    \28\ See, e.g., Comment Letter of New York State Comptroller 
Thomas P. DiNapoli (Oct. 2, 2009) (``DiNapoli Letter''); Comment 
Letter of New York City Mayor Michael R. Bloomberg (Sept. 9, 2009) 
(``Bloomberg Letter''). See also Comment Letter of Kentucky 
Retirement Systems Trustee Chris Tobe (Sept. 18, 2009) (``Tobe 
Letter'') (suggesting the negative effects of pay to play activities 
on the Kentucky Retirement System's investment performance).
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    On August 3, 2009, we proposed a new antifraud rule under the 
Advisers Act designed to prevent investment advisers from obtaining 
business from government entities in return for political contributions 
or fund raising--i.e., from participating in pay to play practices.\29\ 
We modeled our proposed rule on those adopted by the Municipal 
Securities Rulemaking Board, or MSRB, which since 1994 has prohibited 
municipal securities dealers from participating in pay to play 
practices.\30\ We believe these rules have significantly curbed pay to 
play practices in the municipal securities market.\31\
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    \29\ Political Contributions by Certain Investment Advisers, 
Investment Advisers Act Release No. 2910 (Aug. 3, 2009) [74 FR 39840 
(Aug. 7, 2009)] (the ``Proposing Release'').
    \30\ MSRB rule G-37 was approved by the Commission and adopted 
in 1994. See In the Matter of Self-Regulatory Organizations; Order 
Approving Proposed Rule Change by the Municipal Securities 
Rulemaking 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)]. The MSRB's pay to play rules include MSRB rules G-37 and G-
38. They are available on the MSRB's Web site at https://www.msrb.org/msrb1/rules/ruleg37.htm and https://www.msrb.org/msrb1/rules/ruleg38.htm, respectively.
    \31\ See Proposing Release, at n.23. See also infra note 101; 
Comment Letter of the Municipal Securities Rulemaking Board (Oct. 
23, 2009) (``MSRB Letter''); Comment Letter of Common Cause (Oct. 6, 
2009) (``Common Cause Letter'').

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[[Page 41021]]

    Along the lines of MSRB rule G-37,\32\ our proposed rule would have 
prohibited 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.\33\ It also would have prohibited an 
adviser and certain of its executives and employees 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.\34\ In addition, 
similar to MSRB rule G-38,\35\ our proposed rule would have prohibited 
the use of third parties to solicit government business.\36\ We also 
proposed amendments to rule 204-2 under the Advisers Act that would 
have required registered advisers to maintain certain records regarding 
political contributions and government clients. As discussed in more 
detail below, our proposed rule departed in some respects from the MSRB 
rules to reflect differences between advisers and broker-dealers and 
the scope of the statutory authority we have sought to exercise.
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    \32\ See MSRB rule G-37(b). Our proposal, like MSRB rule G-37, 
was designed to address our concern that pay to play activities were 
``undermining the integrity'' of the relevant market, in particular 
the market for the provision of investment advisory services to 
government entity clients. See Blount, 61 F.3d at 939 (referring to 
the MSRB's concerns that pay to play practices were ``undermining 
the integrity of the $250 billion municipal securities market'' as 
its motivation for proposing MSRB rule G-37).
    \33\ Proposed rule 206(4)-5(a)(1). See also MSRB rule G-37(b).
    \34\ Proposed rule 206(4)-5(a)(2)(ii). See also MSRB rule G-
37(c).
    \35\ See MSRB rule G-38(a).
    \36\ Proposed rule 206(4)-5(a)(2)(i).
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    We received some 250 comment letters on our proposal, many of which 
were from advisers, third-party solicitors, placement agents, and their 
representatives.\37\ Public pension plans and their officials were 
divided--some embraced the rule, including one that stated that the 
rule is an important means to ``increase transparency and public 
confidence in the investment activities of all public pension funds,'' 
\38\ while others were critical, arguing, for example, that our 
proposal ``may result in unintended hardships being placed upon public 
pension funds.'' \39\ We received no letters from plan beneficiaries 
whom we sought to protect with the proposed rule,\40\ although two 
public interest groups supported it strongly.\41\ Advisers, third-party 
solicitors and placement agents, fund sponsors, and others whose 
business arrangements could be affected by the rule generally supported 
our goal of eliminating advisers' participation in pay to play 
practices involving public plans.\42\ Nonetheless, most of them 
objected to our adoption under the Advisers Act of a rule similar to 
MSRB rules G-37 and G-38.\43\ Most particularly opposed the proposed 
prohibition on payments to third parties for soliciting or marketing to 
government entities modeled on MSRB rule G-38.\44\ Several urged that, 
if we were to adopt a rule based on the approach taken in our proposal, 
we should broaden exceptions and exemptions under the rule to 
accommodate certain business arrangements.\45\ We respond to these 
comments below.\46\
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    \37\ Other commenters included pension plans and their 
officials, trade associations, law firms, and public interest 
groups. Comments letters submitted in File No. S7-25-06 are 
available on the Commission's Web site at: https://www.sec.gov/comments/s7-18-09/s71809.shtml.
    \38\ Comment Letter of New York City Comptroller William C. 
Thompson, Jr. (Oct. 6, 2009) (``Thompson Letter'').
    \39\ Comment Letter of Executive Director and Secretary to the 
Board of Trustees of the State Retirement and Pension System of 
Maryland R. Dean Kenderdine (Oct. 5, 2009).
    \40\ We note, however, that subsequent to our proposal, AFSCME, 
which represents 1.6 million State and local employees and retirees, 
issued a report that strongly endorses sanctions to prevent pay to 
play activities. AFSCME, Enhancing Public Retiree Pension Plan 
Security: Best Practice Policies for Trustees and Pension Systems 
(2010), available at https://www.afscme.org/docs/AFSCME-report-pension-best-practices.pdf.
    \41\ See, e.g., Common Cause Letter; Comment Letter of Fund 
Democracy/Consumer Federation of America (Oct. 6, 2009) (``Fund 
Democracy/Consumer Federation Letter'').
    \42\ See, e.g., Comment Letter of the Investment Adviser 
Association (Oct. 5, 2009) (``IAA Letter'') (noting ``support [for] 
measures to combat pay to play activities, i.e., the practice of 
investment advisers or their employees making political 
contributions intended to influence the selection or retention of 
advisers by government entities. Pay to play practices undermine the 
principle that advisers are selected on the basis of competence, 
qualifications, expertise, and experience. The practice is unethical 
and undermines the integrity of the public pension plan system and 
the process of selecting investment advisers.''); Comment Letter of 
John R. Dempsey (Aug. 8, 2009) (``Dempsey Letter'') (noting applause 
for efforts ``to stop the `pay-to-play' practice which only serves 
to undermine public trust in investment advisors and regulators.''); 
Comment Letter of Barry M. Gleicher (Sept. 7, 2009) (noting strong 
support for the proposal ``with no modifications. * * * The Rule is 
necessary to curb elaborated practices that would deprive taxpayers 
and beneficiaries of cost effective and honest administration of 
pension funds''); Tobe Letter.
    \43\ See, e.g., IAA Letter (``We respectfully submit, however, 
that the structure of the MSRB rules is not appropriately tailored 
to the investment advisory business. * * * We believe the Commission 
should make significant changes to the Proposal, which would permit 
it to accomplish its important goals.''); Comment Letter of Wesley 
Ogburn (Aug. 4, 2009) (``Ogburn Letter''); Comment Letter of the 
Third Party Marketers Association (Aug. 27, 2009) (``3PM Letter''); 
Comment Letter of Preqin (Aug. 28, 2009) (``Preqin Letter I'') 
(suggesting that institutional private equity investors polled 
favored a private equity specific proposal rather than relying on 
the framework from the municipal securities industry); Comment 
Letter of Dechert LLP (Oct. 22, 2009) (``Dechert Letter''); Comment 
Letter of the Committee on Federal Regulation of Securities of the 
Section of Business Law of the American Bar Association (Oct. 13, 
2009) (``ABA Letter''); Comment Letter of Fidelity Investments (Oct. 
7, 2009) (``Fidelity Letter''); Comment Letter of Sutherland Asbill 
& Brennan LLP (Oct. 6, 2009) (``Sutherland Letter''); Comment Letter 
of the Investment Company Institute (Oct. 6, 2009) (``ICI Letter''); 
Comment Letter of the Massachusetts Mutual Life Insurance Company 
(Oct. 6, 2009) (``MassMutual Letter''); Comment Letter of Skadden, 
Arps, Slate, Meagher & Flom LLP (Oct. 6, 2009) (``Skadden Letter''); 
Comment Letter of the Managed Funds Association (Oct. 6, 2009) 
(``MFA Letter'').
    \44\ See, e.g., Comment Letter of Ounavarra Capital, LLC (Aug. 
28, 2009) (``Ounavarra Letter'') (noting that banning third-party 
marketers in the municipal securities industry did not adversely 
affect most bankers' ability to conduct basic marketing whereas 
banning third-party marketers for small advisers could have a 
stronger impact on advisers that have either no or very limited 
marketing capability of their own); Comment Letter of MVision 
Private Equity Advisers USA LLC (Sept. 2, 2009) (``MVision Letter'') 
(arguing that, whereas placement agents for municipal bond offerings 
are usually regulated entities, the restrictions in the municipal 
securities arena were targeted at consultants who offer only their 
contacts and influence with government officials and provided no 
valuable services to the financial services industry or investors); 
Comment Letter of Kalorama Capital (Sept. 8, 2009) (arguing that a 
better analogy, at least with respect to the operation of third-
party marketers, is to the licensed professional presenting an IPO 
to a pension fund). For further discussion of these comments, see 
section II.B.2(b) of this Release.
    \45\ See, e.g., Comment Letter of the Committee on Investment 
Management Regulation and the Committee on Private Investment Funds 
of the Association of the Bar of the City of New York (Oct. 26, 
2009) (``NY City Bar Letter'') (arguing that broker-dealer rules 
have sufficient safeguards and that adopting the proposed pay to 
play rule will interfere with traditional distribution 
arrangements); Dechert Letter; Sutherland Letter; MFA Letter.
    \46\ Particular comments on the various aspects of our proposal 
are summarized in the corresponding sub-sections of section II of 
this Release.
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II. Discussion

    As discussed in more detail below, we have decided to adopt rule 
206(4)-5, which we have revised to reflect comments we received. For 
the reasons we discuss above and in the Proposing Release, we believe 
rule 206(4)-5 is a proper exercise of our rulemaking authority under 
the Advisers Act to prevent fraudulent and manipulative conduct.
    The Commission regulates investment advisers under the Investment 
Advisers Act of 1940. Section 206(1) of the Advisers Act prohibits an 
investment adviser from employ[ing] any device, scheme or artifice to 
defraud any client

[[Page 41022]]

or prospective client.'' \47\ Section 206(2) prohibits an investment 
adviser from engaging in ``any transaction, practice, or course of 
business which operates as a fraud or deceit upon any client or 
prospective client.'' \48\ The Supreme Court has construed section 206 
as establishing a Federal fiduciary standard governing the conduct of 
advisers.\49\
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    \47\ 15 U.S.C. 80b-6(1).
    \48\ 15 U.S.C. 80b-6(2).
    \49\ Transamerica 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).
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    We believe that pay 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.'' \50\ Congress 
gave us this authority to prohibit ``specific evils'' that the broad 
antifraud provisions may be incapable of covering.\51\ The provision 
thus permits the Commission to adopt prophylactic rules that may 
prohibit acts that are not themselves fraudulent.\52\
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    \50\ 15 U.S.C. 80b-6(4).
    \51\ S. 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 advisers' financial 
conditions and disciplinary histories, 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.
    \52\ Section 206(4) was added to the Advisers Act in Public Law 
86-750, 74 Stat. 885, at sec. 9 (1960). See H.R. Rep. No. 2197, 86th 
Cong., 2d Sess., at 7-8 (1960) (``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., at 8 (1960) (``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, 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.'').
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    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 they advise and defraud prospective clients.\53\ 
In making such contributions, the adviser hopes to benefit from 
officials who ``award the contracts on the basis of benefit to their 
campaign chests rather than to the governmental entity'' \54\ or by 
retaining a contract that might otherwise not be renewed. If pay to 
play is a factor in the selection or retention process, the public 
pension plan can be harmed in several ways. The most qualified adviser 
may not be selected or retained, potentially leading to inferior 
management or performance. 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 might be used for the benefit of the adviser, 
potentially at the expense of the pension plan, thereby using the 
pension plan's assets for the adviser's own purposes.\55\
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    \53\ See Proposing Release, at section I; Political 
Contributions by Certain Investment Advisers, Investment Advisers 
Act Release No. 1812 (Aug. 4, 1999) [64 FR 43556 (Aug. 10, 1999)] 
(``1999 Proposing Release''). 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, 191-92; 
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)]. 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 merit-based 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).
    \54\ See Blount, 61 F.3d at 944-45.
    \55\ Cf. 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).
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    As we discuss above, pay to play practices are rarely explicit and 
often hard to prove.\56\ In particular, when pay to play involves 
granting of government advisory business in exchange for political 
contributions, it may be difficult to prove that an adviser (or one of 
its executives or employees) made political contributions for the 
purpose of obtaining the government business, or that it engaged a 
solicitor for his or her political influence rather than substantive 
expertise.\57\ Pay to play practices by advisers to public pension 
plans, which may generate significant contributions for elected 
officials and yield lucrative management contracts for advisers, will 
not stop through voluntary efforts. This is, in part, because these 
activities create a ``collective action'' problem in two respects.\58\ 
First, government officials who participate may have an incentive to 
continue to accept contributions to support their campaigns for fear of 
being disadvantaged relative to their opponents. Second, advisers may 
have an incentive to participate out of concern that they may be 
overlooked if they fail to make contributions.\59\ Both the stealth in 
which these practices occur and the inability of markets to properly 
address them argue strongly for the need for us to adopt the type of

[[Page 41023]]

prophylactic rule that section 206(4) of the Advisers Act authorizes.
---------------------------------------------------------------------------

    \56\ Cf. Blount, 61 F.3d 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'').
    \57\ See id. at 944 (``actors in this field are presumably 
shrewd enough to structure their relations rather indirectly'').
    \58\ Collective action problems exist, for example, where 
participants may prefer to abstain from an unsavory practice (such 
as pay to play), but nonetheless participate out of concern that, 
even if they abstain, their competitors will continue to engage in 
the practice profitably and without adverse consequences. As a 
result, collective action problems, such as those raised by pay to 
play practices, call for a regulatory response. For further 
discussion, see infra note 459 and accompanying text.
    \59\ In our view, the collective action problem we are trying to 
address is analogous to the one noted in the case upholding MSRB 
rule G-37. See Blount, 61 F.3d at 945 (``Moreover, there appears to 
be a collective action problem tending to make the misallocation of 
resources persist''). For a discussion of concerns raised regarding 
our proposed rule that are similar to those raised regarding MSRB 
rule G-37, see section II.A of this Release.
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A. First Amendment Considerations

    The Commission believes that rule 206(4)-5 is a necessary and 
appropriate measure to prevent fraudulent acts and practices in the 
market for the provision of investment advisory services to government 
entities by prohibiting investment advisers from engaging in pay to 
play practices. We have examined a range of alternatives to our 
proposal, carefully considered some 250 comments we received on the 
proposal and made revisions to the proposed rule where we concluded it 
was appropriate. We believe the rule represents a balanced response to 
the developments we discuss above regarding pay to play activities 
occurring in the market for government investment advisory services. 
The rule provides specific prohibitions to help ensure that adviser 
selection is based on the merits, not on the amount of money given to a 
particular candidate for office, while respecting the rights of 
industry participants to participate in the political process. The rule 
is not unique; Congress, for instance, has barred Federal contractors 
from making contributions to public officials.\60\
---------------------------------------------------------------------------

    \60\ 2 U.S.C. 441c.
---------------------------------------------------------------------------

    Before we address particular aspects of the rule, we would like to 
respond to commenters' assertions that the fact that the rule's 
limitations on compensation are triggered by political contributions 
represents an infringement on the First Amendment guarantees of freedom 
of speech and association.\61\ These commenters acknowledge that 
selection of an investment adviser by a government entity should not be 
a ``pay back'' for political contributions, but argue that the rule 
impermissibly restricts the ability of advisers and certain of their 
employees to demonstrate support for State and local officials.
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    \61\ See, e.g., Comment Letter of W. Hardy Callcott (Aug. 3, 
2009) (``Callcott Letter I''); Comment Letter of W. Hardy Callcott 
(Jan. 21, 2010) (``Callcott Letter II''); Comment Letter of the 
National Association of Securities Professionals, Inc. (Oct. 6, 
2009) (``NASP Letter''); Comment Letter of Caplin & Drysdale, 
Chartered (Oct. 6, 2009) (``Caplin & Drysdale Letter''); Comment 
Letter of the Securities Industry and Financial Markets Association 
(Oct. 5, 2009) (``SIFMA Letter''); ABA Letter; Sutherland Letter; 
Comment Letter of IM Compliance LLC (Oct. 6, 2009) (``IM Compliance 
Letter''); Comment Letter of the American Bankers Association (Oct. 
6, 2009) (``American Bankers Letter'').
---------------------------------------------------------------------------

    The Commission is sensitive to, and has carefully considered, these 
constitutional concerns in adopting the rule. Though it is not a ban on 
political contributions or an attempt to regulate State and local 
elections, we acknowledge that the two-year time out provision may 
affect the propensity of investment advisers to make political 
contributions. Although political contributions involve both speech and 
associational rights protected by the First Amendment, a ``limitation 
upon the amount that any one person or group may contribute to a 
candidate or political committee entails only a marginal restriction 
upon the contributor's ability to engage in free communication.''\62\ 
Limitations on contributions are permissible if justified by a 
sufficiently important government interest that is closely drawn to 
avoid unnecessary abridgment of protected rights.\63\
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    \62\ Buckley v. Valeo, 424 U.S. 1, 20 (1976). See also 
SpeechNow.org, et al. v. FEC, 599 F.3d 686 (D.C. Cir. 2010); 
McConnell v. FEC, 540 U.S. 93, 135-36 (2003).
    \63\ Buckley, 424 U.S. at 25. See also FEC v. Wisconsin Right to 
Life, Inc., 551 U.S. 449 (2007); Republican Nat'l Comm. v. FEC, No. 
08-1953, 2010 U.S. Dist. LEXIS 29163 (D.D.C. Mar. 26, 2010) (three 
judge panel). This standard is lower than the strict scrutiny 
standard employed in reviewing such forms of expression as 
independent expenditures. Under the higher level of scrutiny, a 
restriction must be narrowly tailored to serve a compelling 
governmental interest. Blount, 61 F.3d at 943. See also Citizens 
United v. FEC, 130 S. Ct. 876 (2010) (distinguishing restrictions on 
``independent expenditures'' from restrictions on ``direct 
contributions'' and leaving restrictions on direct contributions 
untouched while striking down a restriction on independent 
expenditures as unconstitutional). We note that in Blount, 61 F.3d 
at 949, the court upheld MSRB rule G-37 even assuming that strict 
scrutiny applied. For the reasons stated by the court in that 
decision, we believe that Rule 206(4)-5 would be upheld under a 
strict scrutiny standard as well as under the standard the Supreme 
Court has applied to contribution restrictions.
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    Prevention of fraud is a sufficiently important government 
interest.\64\ We believe that payments to State officials as a quid pro 
quo for obtaining advisory business as well as other forms of ``pay to 
play'' violate the antifraud provisions of section 206 of the Advisers 
Act. As discussed in our Proposing Release, ``pay to play'' 
arrangements are inconsistent with an adviser's fiduciary obligations, 
distort the process by which investment advisers are selected, can harm 
advisers' public pension plan clients and the beneficiaries of those 
plans, and can have detrimental effects on the market for investment 
advisory services.\65\ The restrictions inherent in rule 206(4)-5 are 
in the nature of conflict of interest limitations which are 
particularly appropriate in cases of government contracting and highly 
regulated industries.\66\ Pursuant to our authority under section 
206(4) of the Advisers Act, which we discuss above, we may adopt rules 
that are reasonably designed to prevent such acts, practices and 
courses of business.
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    \64\ Blount, 61 F.3d at 944.
    \65\ See Proposing Release, at section I. The prohibitions on 
solicitation and coordination of campaign contributions are 
justified by the same overriding purposes which support the two-year 
time out provisions. The provisions are intended to prevent 
circumvention of the time out provisions in cases where an 
investment adviser has or is seeking to establish a business 
relationship with a government entity. Absent these restrictions, 
solicitation and coordination of contributions could be used as 
effectively as political contributions to distort the adviser 
selection process. The solicitation and coordination restrictions 
relate only to fundraising activities and would not prevent advisers 
and their covered employees from expressing support for candidates 
in other ways, such as volunteering their time.
    \66\ See In the Matter of Self-Regulatory Organizations; Order 
Approving Proposed Rule Change by the Municipal Securities 
Rulemaking 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)] (noting, in connection with the Commission's approval of MSRB 
rule G-37, that the restrictions inherent in that pay to play rule 
``are in the nature of conflict of interest limitations which are 
particularly appropriate in cases of government contracting and 
highly regulated industries.'').
---------------------------------------------------------------------------

    As detailed in the following pages, we have closely drawn rule 
206(4)-5 to accomplish its goal of preventing quid pro quo arrangements 
while avoiding unnecessary burdens on the protected speech and 
associational rights of investment advisers and their covered 
employees. The rule is therefore closely drawn in terms of the conduct 
it prohibits, the persons who are subject to its restrictions, and the 
circumstances in which it is triggered. The United States Court of 
Appeals for the District of Columbia Circuit upheld the similarly 
designed MSRB rule G-37 in Blount v. SEC.\67\ Indeed, the Blount 
opinion has served as an important guidepost in helping us shape our 
rule.\68\
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    \67\ 61 F.3d at 947-48.
    \68\ Notwithstanding the Blount decision, some commenters 
asserted that subsequent Supreme Court jurisprudence, including 
Randall v. Sorrell, 548 U.S. 230 (2006), and Citizens United, 130 S. 
Ct. 876 (decided following the closing of the comment period for 
rule 206(4)-5), would result in the proposed rule being found 
unconstitutional because it is not narrowly tailored to advance the 
Commission's interests in addressing pay to play by investment 
advisers. See, e.g., Callcott Letter I; Callcott Letter II; NASP 
Letter; American Bankers Letter. We disagree. The cases cited by 
commenters are distinguishable. Citizens United deals with certain 
independent expenditures (rather than contributions to candidates), 
which are not implicated by our rule. Randall involved a generally 
applicable State campaign finance law limiting overall contributions 
(and expenditures), which the Court feared would disrupt the 
electoral process by limiting a candidate's ability to amass 
sufficient resources and mount a successful campaign. Randall, 548 
U.S. at 248-49. By contrast, our rule is not a general prohibition 
or limitation, but rather is a focused effort to combat quid pro quo 
payments by investment advisers seeking governmental business. 
Comparable restrictions targeted at a particular industry have been 
upheld under Randall because the loss of contributions from such a 
small segment of the electorate ``would not significantly diminish 
the universe of funds available to a candidate to a non-viable 
level.'' Green Party of Conn. v. Garfield, 590 F. Supp. 2d 288, 316 
(D. Conn. 2008). See also Preston v. Leake, 629 F. Supp. 2d 517, 524 
(E.D.N.C. 2009) (differentiating the ``broad sweep of the Vermont 
statute'' that ``restricted essentially any potential campaign 
contribution'' from a statute that ``only applies to lobbyists''); 
In re Earle Asphalt Co., 950 A.2d 918, 927 (N.J. Super. Ct. App. 
Div. 2008), aff'd 957 A.2d 1173 (N.J. 2008) (holding that a 
limitation on campaign contributions by government contractors and 
their principals did not have the same capacity to prevent 
candidates from amassing the resources necessary for effective 
campaigning as the statute in Randall). One commenter expressly 
dismissed arguments that Randall would have implications for the 
Commission's proposed rule. Fund Democracy/Consumer Federation 
Letter.

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[[Page 41024]]

    First, the rule is limited to contributions to officials of 
government entities who can influence the hiring of an investment 
adviser in connection with money management mandates.\69\ These 
restrictions are triggered only in situations where a business 
relationship exists or will be established in the near future between 
the investment adviser and a government entity.\70\
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    \69\ See section II.B.2(a)(2) of this Release (discussing the 
definition of ``official'' of a government entity for purposes of 
rule 206(4)-5).
    \70\ See section II.B.2(a)(1) of this Release (discussing the 
prohibition on compensation for providing advisory services to the 
client during rule 206(4)-5's two-year time out).
---------------------------------------------------------------------------

    Second, the rule does not in any way impinge on a wide range of 
expressive conduct in connection with elections. For example, the rule 
imposes no restrictions on activities such as making independent 
expenditures to express support for candidates, volunteering, making 
speeches, and other conduct.\71\
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    \71\ See Citizens United, 130 S. Ct. at 908-09 (noting that a 
government interest cannot be sufficiently compelling to limit 
independent expenditures by corporate entities). See also 
SpeechNow.org, 599 F.3d at 692 (spelling out the different standards 
of constitutional review established by the Supreme Court for 
restrictions on independent expenditures and direct contributions). 
Some commenters expressed concern, for example, that rule 206(4)-5 
may quell volunteer activities, deter employees of investment 
advisers from running for office, or chill charitable contributions. 
See, e.g., Caplin & Drysdale Letter; NASP Letter. We have expressly 
clarified that volunteer activities and charitable contributions 
generally would not trigger the rule's time out provision and that 
employees running for office would not be subject to the 
contribution limitation. See infra notes 157 and 139, respectively.
---------------------------------------------------------------------------

    Third, it does not prevent anyone from making a contribution to any 
candidate, as covered employees may contribute $350 to candidates for 
whom they may vote, and $150 to other candidates. A limitation on the 
amount of a contribution involves little direct restraint on political 
communication, because a person may still engage in the symbolic 
expression of support evidenced by a contribution.\72\ Furthermore, the 
rule takes the form of a restriction on providing compensated advisory 
business following the making of contributions rather than a 
prohibition on making contributions in excess of the relevant 
ceilings.\73\
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    \72\ Buckley, 424 U.S. at 21. See also section II.B.2(a)(6) of 
this Release (discussing the de minimis exceptions to covered 
associates' contributions triggering the two-