Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving a Proposed Rule Change To Adopt FINRA Rule 2030 and FINRA Rule 4580 To Establish “Pay-To-Play” and Related Rules, 60051-60070 [2016-20888]

Download as PDF Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: SECURITIES AND EXCHANGE COMMISSION Electronic Comments Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving a Proposed Rule Change To Adopt FINRA Rule 2030 and FINRA Rule 4580 To Establish ‘‘Pay-To-Play’’ and Related Rules • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number SR– BX–2016–047 on the subject line. Paper Comments mstockstill on DSK3G9T082PROD with NOTICES • Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–BX–2016–047. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (http://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission’s Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–BX– 2016–047 and should be submitted on or before September 21, 2016. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.17 Brent J. Fields, Secretary. [FR Doc. 2016–20961 Filed 8–30–16; 8:45 am] BILLING CODE 8011–01–P 17 17 CFR 200.30–3(a)(12). VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 [Release No. 34–78683; File No. SR–FINRA– 2015–056] August 25, 2016. I. Introduction On December 16, 2015, Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’ or ‘‘Exchange Act’’) 1 and Rule 19b–4 thereunder,2 a proposed rule change to adopt FINRA Rules 2030 (Engaging in Distribution and Solicitation Activities with Government Entities) and 4580 (Books and Records Requirements for Government Distribution and Solicitation Activities) to establish ‘‘pay-to-play’’ 3 and related rules that would regulate the activities of member firms that engage in distribution or solicitation activities for compensation with government entities on behalf of investment advisers. Member firms serving this role— sometimes referred to as ‘‘placement agents’’ or ‘‘solicitors’’ (collectively referred to herein as ‘‘placement agents’’)—assist investment advisers with obtaining advisory business from such entities. In this context, pay-toplay has historically presented a problem, including when investment advisers retain placement agents who have made contributions to government officials who are responsible for, or can influence the outcome of, the selection process for investment advisers. When investment advisers are chosen on the basis of a placement agent’s political contributions, rather than on, for example, the adviser’s merit, performance, or costs, the market and selection process for advisers becomes distorted. Ultimately, pay-to-play harms investors and the public interest if government entities, including public 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 ‘‘Pay-to-play practices,’’ ‘‘play-to-play arrangements’’ or ‘‘play-to-play activities,’’ as referred to throughout this order, typically involve a person making cash or in-kind political contributions (or soliciting or coordinating others to make such contributions) to help finance the election campaigns of state or local officials or bond ballot initiatives as a quid pro quo for the receipt of government contracts. 2 17 PO 00000 Frm 00076 Fmt 4703 Sfmt 4703 60051 pension plans, and their beneficiaries receive inferior services or pay higher fees. The proposed rule change was published for comment in the Federal Register on December 30, 2015.4 The Commission received ten comment letters, from nine different commenters, in response to the Notice.5 On February 8, 2016, FINRA extended the time period by which the Commission must approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to approve or disapprove the proposed rule change to March 29, 2016.6 On March 28, 2016, FINRA filed a letter with the Commission stating that it considered the comments received by the Commission in response to the Notice, and that FINRA is not intending to make changes to the proposed rule text in response to the comments.7 On March 29, 2016, pursuant to delegated authority, the Commission issued an order instituting proceedings pursuant to Section 19(b)(2)(B) of the Act 8 to determine whether to approve or disapprove the proposed rule change, 4 See Exchange Act Rel. No. 76767 (Dec. 24, 2015), 80 FR 81650 (Dec. 30, 2015) (File No. SR– FINRA–2015–056) (‘‘Notice’’). 5 See Letters from David Keating, President, Center for Competitive Politics (‘‘CCP’’), dated Jan. 20, 2016 (‘‘CCP Letter 1’’); Clifford Kirsch and Michael Koffler, Sutherland Asbill & Brennan LLP, for the Committee of Annuity Insurers (‘‘CAI’’), dated Jan. 20, 2016 (‘‘CAI Letter 1’’); Clifford Kirsch and Michael Koffler, Sutherland Asbill & Brennan LLP, for the CAI, dated Feb. 5, 2016 (‘‘CAI Letter 2’’); David T. Bellaire, Executive Vice President and General Counsel, Financial Services Institute (‘‘FSI’’), dated Jan. 20, 2016 (‘‘FSI Letter 1’’); Tamara K. Salmon, Assistant General Counsel, Investment Company Institute (‘‘ICI’’), dated Jan. 20, 2016 (‘‘ICI Letter’’); Patrick J Moran, Esq., dated Dec. 29, 2015 (‘‘Moran Letter’’); Gary A. Sanders, Counsel and Vice President, National Association of Insurance and Financial Advisors (‘‘NAIFA’’), dated Jan. 20, 2016 (‘‘NAIFA Letter’’); Judith M. Shaw, President, North American Securities Administrators Association, Inc. (‘‘NASAA’’), dated Jan. 20, 2016 (‘‘NASAA Letter’’); Hugh D. Berkson, President, Public Investors Arbitration Bar Association (‘‘PIABA’’), dated Jan. 20, 2016 (‘‘PIABA Letter’’); and H. Christopher Bartolomucci and Brian J. Field, Bancroft PLLC, for the New York Republican State Committee and the Tennessee Republican Party (‘‘State Parties’’), dated Jan. 20, 2016 (‘‘State Parties Letter 1’’). The comment letters filed with the Commission in connection with the proposed rule change are available at: http://www.sec.gov/ comments/sr-finra-2015-056/finra2015056.shtml. 6 See Letter from Victoria Crane, Associate General Counsel, FINRA, to Lourdes Gonzalez, Assistant Chief Counsel—Sales Practices, Division of Trading and Markets, Commission, dated Feb. 8, 2016. 7 See Letter from Victoria Crane, Associate General Counsel, FINRA, to Brent J. Fields, Secretary, Commission, dated Mar. 28, 2016 (‘‘FINRA Response Letter 1’’). 8 15 U.S.C. 78s(b)(2)(B). E:\FR\FM\31AUN1.SGM 31AUN1 60052 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices and solicited additional comment.9 The Commission received an additional four comments regarding the proceedings,10 including two letters requesting an opportunity to make an oral presentation in the proceedings.11 On July 6, 2016, FINRA submitted a letter responding to all comments and to the Order Instituting Proceedings.12 On June 21, 2016, FINRA extended the time period by which the Commission must determine whether to approve or disapprove the proposed rule change to August 26, 2016.13 This order approves the rule change as proposed. Section II provides an overview of the rule and summarizes the rule as described by FINRA in its filing and as published in the Notice, Section III is a summary of the comments received and FINRA’s responses, and Section IV contains the Commission’s findings in approving the proposal. mstockstill on DSK3G9T082PROD with NOTICES II. Description of the Proposed Rule Change 14 As described more fully in the Notice, FINRA modeled proposed Rule 2030 15 on the Commission’s Rule 206(4)–5 under the Investment Advisers Act of 1940 (‘‘Advisers Act’’), which addresses pay-to-play practices by investment 9 See Securities Exchange Act Release No. 77465 (Mar. 29, 2016), 81 FR 19260 (Apr. 4, 2016) (‘‘Order Instituting Proceedings’’). 10 See Letters from David T. Bellaire, Executive Vice President and General Counsel, FSI, dated Apr. 27, 2016 (‘‘FSI Letter 2’’); Jason Torchinsky, Holtzman Vogel Josefiak Torchinsky PLLC, on behalf of the Georgia Republican Party and the State Parties, dated April 12, 2016, filed April 21, 2016 (‘‘State Parties Letter 2’’); Allen Dickerson, Legal Director, CCP, dated April 21, 2016 (‘‘CCP Letter 2’’); Allen Dickerson, Legal Director, CCP, dated April 15, 2016 (‘‘CCP Letter 3’’). 11 See CCP Letter 2; State Parties Letter 2. The Commission denied both requests. See Letter from Brent J. Fields, Secretary, Commission, to Allen Dickerson, Legal Director, CCP dated July 11, 2016; Brent J. Fields, Secretary, Commission, to Jason Torchinsky, Holtzman Vogel Josefiak Torchinsky PLLC, on behalf the State Parties, dated July 11, 2016. 12 See Letter from Victoria Crane, Associate General Counsel, FINRA, to Brent J. Fields, Secretary, Commission, dated July 6, 2016 (‘‘FINRA Response Letter 2’’). Both of FINRA’s Responses Letters are available on FINRA’s Web site at http:// www.finra.org, at the principal office of FINRA, and at the Commission’s Public Reference Room. 13 See Letter from Victoria Crane, Associate General Counsel, FINRA, to Lourdes Gonzalez, Assistant Chief Counsel—Sales Practices, Division of Trading and Markets, Commission, dated June 21, 2016. 14 The proposed rule change, as described in Item II, is excerpted, in part, from the Notice, which was substantially prepared by FINRA. See supra note 4. A more detailed description of the proposed rule change is in the Notice. 15 See Notice, 80 FR at 81650–51 (citing Advisers Act Release No. 3043 (July 1, 2010), 75 FR 41018 (July 14, 2010) (Political Contributions by Certain Investment Advisers) (‘‘SEC Pay-to-Play Rule Adopting Release’’)). VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 advisers (the ‘‘SEC Pay-to-Play Rule’’).16 The SEC Pay-to-Play Rule, in part, prohibits any investment adviser covered under the rule 17 or any of its covered associates from providing or agreeing to provide, directly or indirectly, payment to any person to solicit a government entity for investment advisory services on behalf of such investment adviser unless such person is a ‘‘regulated person,’’ 18 as defined under the rule, or an executive officer, general partner, managing member, or employee of the investment adviser.19 A ‘‘regulated person,’’ as defined in the SEC Pay-to-Play Rule, includes a registered broker-dealer, provided that: (a) FINRA rules prohibit member firms from engaging in distribution or solicitation activities if certain political contributions have been made to certain public officials; and (b) the Commission finds, by order, that such rules impose substantially equivalent or more stringent restrictions on member firms than the SEC Pay-toPlay Rule imposes on investment advisers and that such rules are consistent with the objectives of the SEC Pay-to-Play Rule.20 In light of this regulatory framework, FINRA proposed its own pay-to-play rule to enable its member firms to continue to engage in distribution and solicitation activities for compensation with government entities on behalf of investment advisers, while subjecting its 16 FINRA also published the proposed rule change in Regulatory Notice 14–50 (Nov. 2014) (‘‘Regulatory Notice 14–50’’) and sought comment on the proposal. FINRA states that commenters were generally supportive of the proposed rule change, but also expressed some concerns. As such, FINRA revised the proposed rule change as published in Regulatory Notice 14–50 in response to those comments. As described more fully in the Notice, FINRA believes that the revisions it made more closely align FINRA’s proposed rule with the SEC Pay-to-Play Rule and should help reduce cost and compliance burden concerns raised by commenters. See Notice, 80 FR at 81651 n.16. 17 The SEC Pay-to-Play Rule applies to investment advisers registered or required to be registered with the Commission, foreign private advisers that are unregistered in reliance on Section 203(b)(3) of the Advisers Act, and exempt reporting advisers as defined in Rule 204–4(a) under the Advisers Act. See 17 CFR 275.206(4)–5(a)(2). 18 See Notice, 80 FR at 81650 n.6, 81656. See also 17 CFR 275.206(4)–5(a)(2)(i)(A). 19 See 17 CFR 275.206(4)–5(a)(2)(i)(B) (or, in each case, a person with a similar status or function to an executive officer, general partner, or managing member of the investment adviser). 20 See Notice, 80 FR at 81650 n.6 (citing 17 CFR 275.206(4)–5(f)(9)). The definition of ‘‘regulated person’’ also includes SEC-registered investment advisers and SEC-registered municipal advisors, subject to specified conditions. The Commission amended the SEC Pay-to-Play Rule to add SECregistered municipal advisors to the definition of ‘‘regulated persons.’’ See Rules Implementing Amendments to the Investment Advisers Act of 1940, Investment Advisers Act Rel. No. 3221 (June 22, 2011), 76 FR 42950 (July 19, 2011). PO 00000 Frm 00077 Fmt 4703 Sfmt 4703 member firms to appropriate safeguards that will discourage them from engaging in pay-to-play practices.21 Because one of the objectives of FINRA’s proposal is to satisfy the ‘‘regulated person’’ definition in the SEC Pay-to-Play Rule, the elements of and terms used in FINRA’s proposal are substantially equivalent to and consistent with the objectives of the SEC Pay-to-Play Rule.22 As discussed below, this threshold objective precludes many of the modifications proposed by commenters given that a more permissive FINRA proposal would not meet the stringency requirements of the SEC Pay-to-Play Rule. FINRA believes that its proposed rule would establish a comprehensive regime to regulate the activities of its member firms that engage in distribution or solicitation activities with government entities on behalf of investment advisers, and would impose substantially equivalent restrictions on FINRA member firms engaging in distribution or solicitation activities to those that the SEC Pay-to-Play Rule imposes on investment advisers.23 Furthermore, FINRA’s proposed Rule 4580 would impose recordkeeping requirements on FINRA member firms in connection with its pay-to-play rule that would allow examination of member firms’ books and records for compliance with Rule 2030.24 FINRA believes that proposed Rule 4580 is consistent with similar recordkeeping requirements imposed on investment advisers in connection with the SEC Pay-to-Play Rule.25 The following is an overview of the key provisions in FINRA’s proposed rules, as described by FINRA in the Notice. A. Proposed Rule 2030(a): Limitation on Distribution and Solicitation Activities Proposed Rule 2030(a) would prohibit a covered member from engaging in distribution or solicitation activities for compensation with a government entity on behalf of an investment adviser that provides or is seeking to provide investment advisory services to such government entity within two years after a contribution to an official of the 21 See Notice, 80 FR at 81651, 81656. August 25, 2016, the Commission issued a notice stating that it intends to issue an order pursuant to Section 206 of the Advisers Act and SEC Pay-to-Play Rule 206(4)–5 finding that FINRA’s proposed Rule 2030 (i) imposes substantially equivalent or more stringent restrictions on brokerdealers than the SEC Pay-to-Play Rule imposes on investment advisers and (ii) is consistent with the objectives of the SEC Pay-to-Play Rule. 23 See Notice, 80 FR at 81651, 81656. 24 See id. at 81651, 81655–56. 25 See id. at 81655 n.60 (citing Advisers Act Rule 204–2(a)(18) and (h)(1)). 22 On E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices government entity is made by the covered member or a covered associate, including a person who becomes a covered associate within two years after the contribution is made.26 FINRA states that the terms and scope of the prohibitions in proposed Rule 2030(a) are modeled on the SEC Pay-to-Play Rule.27 According to FINRA, the twoyear time-out period is intended to discourage covered members from participating in pay-to-play practices by requiring a cooling-off period during which the effects of a political contribution on the selection process can be expected to dissipate.28 The following is an overview of some of the key terms used in FINRA’s proposed Rule 2030, as discussed by FINRA in its filing and published in the Notice or as defined in proposed Rule 2030(g). 1. Covered Members The SEC Pay-to-Play Rule includes within its definition of ‘‘regulated person’’ SEC-registered municipal advisors, subject to specified conditions.29 Specifically, the SEC Payto-Play Rule prohibits an investment adviser from providing or agreeing to provide, directly or indirectly, payment to an SEC-registered municipal advisor unless the municipal advisor is subject to a Municipal Securities Rulemaking Board (‘‘MSRB’’) pay-to-play rule.30 FINRA addresses the interplay between its proposed rule and the application of the MSRB’s municipal advisor pay-to-play rule by exempting from the definition of ‘‘covered member’’ a member when it is ‘‘engaging in activities that would cause the member to be a municipal advisor as defined in Exchange Act Section 15B(e)(4), SEA Rule 15Ba1–1(d)(1) through (4) and other rules and regulations thereunder.’’ 31 FINRA states that a member firm that solicits a government entity for investment advisory services on behalf of an unaffiliated investment adviser may be required to register with the SEC as a municipal advisor as a result of such 26 See Notice, 80 FR at 81651. id. at 81651. See also id. at 81651 n.19 (citing 17 CFR 275.206(4)–5(a)(1)). 28 Notice, 80 FR at 81651, 81659. 29 See 17 CFR 275.206(4)–5(a)(2)(i)(A) and 17 CFR 275.206(4)–5(f)(9). 30 See supra note 29. 31 Proposed Rule 2030(g)(4). See also Notice, 80 FR at 81652 (explaining that the SEC Pay-to-Play Rule includes within its definition of ‘‘regulated person’’ SEC-registered municipal advisors, subject to specified conditions, and prohibits an investment adviser from providing or agreeing to provide, directly or indirectly, payment to an SEC-registered municipal advisor unless the municipal advisor is subject to a MSRB pay-to-play rule). mstockstill on DSK3G9T082PROD with NOTICES 27 See VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 activity.32 Under such circumstances, FINRA notes that the MSRB rules applicable to municipal advisors, including the pay-to-play rule adopted by the MSRB,33 would apply to the member firm.34 On the other hand, if the member firm solicits a government entity on behalf of an affiliated investment adviser, such activity would not cause the firm to be a municipal advisor.35 Under such circumstances, the member firm would be a ‘‘covered member’’ subject to the requirements of proposed Rule 2030.36 This distinction is the result of the definitions of ‘‘municipal advisor’’ and ‘‘solicitation of a municipal entity or obligated person’’ in the Exchange Act, which only covers a person who is not affiliated with the broker, dealer, municipal securities dealer, municipal advisor, or investment adviser for whom the person is soliciting.37 2. Distribution Activities With respect to the triggering activities for FINRA’s proposed Rule 2030(a), FINRA states that, based on the 32 See Notice, 80 FR at 81652. February 17, 2016, the MSRB published a regulatory notice announcing that its pay-to-play rule was deemed approved pursuant to section 19(b)(2)(D) of the Exchange Act on February 13, 2016 and that the effective date of the rule is August 17, 2016. See Amendments to MSRB Rule G–37 on Political Contributions and Prohibitions on Municipal Securities Business and Related Amendments are Deemed Approved under the Securities Exchange Act of 1934, Regulatory Notice 2016–06, dated February 17, 2016 (the ‘‘MSRB Regulatory Notice’’), available at http:// www.msrb.org/∼/media/Files/Regulatory-Notices/ Announcements/2016-06.ashx?n=1. 34 See Notice, 80 FR at 81652. 35 See id. 36 See id. FINRA also notes that a person that is registered under the Exchange Act as a brokerdealer and municipal advisor, and under the Advisers Act as an investment adviser could potentially be a ‘‘regulated person’’ for purposes of the SEC Pay-to-Play Rule and that such a regulated person would be subject to the rules that apply to the services the regulated person is performing. See id. at n.24. 37 Exchange Act Section 15B(e)(4) provides that a ‘‘municipal advisor’’ includes a person that undertakes solicitation of a municipal entity or obligated person. 15 U.S.C. 78o–4(e)(4). Exchange Act Section 15B(e)(9) provides that the term ‘‘solicitation of a municipal entity or obligated person’’ means ‘‘a direct or indirect communication with a municipal entity or obligated person made by a person, for direct or indirect compensation, on behalf of a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser (as defined in section 202 of the Investment Advisers Act of 1940) that does not control, is not controlled by, or is not under common control with the person undertaking such solicitation for the purpose of obtaining or retaining an engagement by a municipal entity or obligated person of a broker, dealer, municipal securities dealer, or municipal advisor for or in connection with municipal financial products, the issuance of municipal securities, or of an investment adviser to provide investment advisory services to or on behalf of a municipal entity.’’ 15 U.S.C. 78o–4(e)(9). 33 On PO 00000 Frm 00078 Fmt 4703 Sfmt 4703 60053 definition of ‘‘regulated person’’ in the SEC Pay-to-Play Rule,38 it is proposing a rule that prohibits its member firms from engaging in distribution activities (as well as solicitation activities) for compensation with government entities for two years after certain political contributions have been made to certain officials.39 FINRA also notes, in response to certain comments discussed below, that certain language in the SEC Pay-to-Play Rule Adopting Release further supports the inclusion of distribution activities by broker-dealers in FINRA’s proposed Rule 2030.40 FINRA explains that the proposed rule would not apply to distribution activities related to registered investment companies that are not investment options of a government entity’s plan or program because in these circumstances a member firm is not providing or seeking to provide investment advisory services to a government entity.41 Therefore, the proposed rule would apply to distribution activities involving unregistered pooled investment vehicles such as hedge funds, private equity funds, venture capital funds, collective investment trusts, and registered pooled investment vehicles such as mutual funds, but only if those registered pools are an investment option of a participant-directed plan or program of a government entity.42 FINRA also notes that, consistent with the SEC Pay-toPlay Rule, to the extent mutual fund distribution fees are paid by the fund 38 A ‘‘regulated person,’’ as defined in the SEC Pay-to-Play Rule, includes a FINRA member firm, provided that: (a) FINRA rules ‘‘prohibit member firms from engaging in distribution or solicitation activities if certain political contributions have been made;’’ and (b) ‘‘[t]he Commission finds, by order, that such rules impose substantially equivalent or more stringent restrictions on broker-dealers than [the SEC Pay-to-Play Rule] imposes on investment advisers and that such rules are consistent with the objectives of [the SEC Pay-to-Play Rule].’’ 17 CFR 275.206(4)–5(f)(9)(ii). 39 See Notice, 80 FR at 81660–61 (explaining that FINRA believes its proposed rule must apply to member firms engaging in distribution activities and that FINRA did not revise the proposed rule to remove references to the term ‘‘distribution’’ as requested by comments received in response to Regulatory Notice 14–50). 40 See Notice, 80 FR at 81660. See also id. at 81661 n.103 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298 where, according to FINRA, the Commission ‘‘clarif[ied] under what circumstances distribution payments would violate the SEC’s Pay-to-Play Rule’’). 41 See Notice, 80 FR at 81661 n.106 (explaining that, although the proposed rule would not apply to distribution activities relating to all registered pooled investment vehicles, pursuant to proposed Rule 2030(e) ‘‘[i]t shall be a violation of this Rule for any covered member or any of its covered associates to do anything indirectly that, if done directly, would result in a violation of this Rule’’). 42 See id. at 81661. See also id. at 81651 n.17 and 81654 n.46. E:\FR\FM\31AUN1.SGM 31AUN1 60054 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices using fund assets pursuant to a 12b-1 plan, such payments generally would not constitute payments by the fund’s investment adviser.43 However, if the adviser pays for the fund’s distribution out of its ‘‘legitimate profits,’’ the proposed rule would generally be implicated.44 3. Solicitation Activities FINRA states that, consistent with the SEC Pay-to-Play Rule, proposed Rule 2030(g)(11) defines the term ‘‘solicit’’ to mean: (A) With respect to investment advisory services, to communicate, directly or indirectly, for the purpose of obtaining or retaining a client for, or referring a client to, an investment adviser; and (B) With respect to a contribution or payment, to communicate, directly or indirectly, for the purpose of obtaining or arranging a contribution or payment.45 FINRA notes that, although the determination of whether a particular communication would be a solicitation would depend on the facts and circumstances relating to such communication, as a general proposition FINRA believes that any communication made under circumstances reasonably calculated to obtain or retain an advisory client would be considered a solicitation unless the circumstances otherwise indicate that the communication does not have the purpose of obtaining or retaining an advisory client.46 mstockstill on DSK3G9T082PROD with NOTICES 4. Investment Advisers Proposed Rule 2030 would apply to covered members acting on behalf of (as defined in proposed Rule 2030(g)(7)) any investment adviser registered (or required to be registered) with the Commission, or unregistered in reliance on the exemption available under Section 203(b)(3) of the Advisers Act for foreign private advisers, or that is an 43 See id. at 81661 n.103. See also SEC Pay-toPlay Rule Adopting Release, 75 FR at 41040 n.298 (discussing how broker-dealers may be compensated by advisers according to distribution arrangements and noting that ‘‘[m]utual fund distribution fees are typically paid by the fund pursuant to a 12b-1 plan, and therefore generally would not constitute payment by the fund’s adviser. As a result, such payments would not be prohibited [under the SEC Pay-to-Play Rule] by its terms’’). 44 See Notice, 80 FR at 81661 n.103 (noting, among other things, that ‘‘for private funds, third parties are often compensated by the investment adviser or its affiliated general partner’’). For a discussion of a mutual fund adviser’s ability to use ‘‘legitimate profits’’ for fund distribution, see Investment Company Act of 1940 Release No. 11414 (Oct. 28, 1980), 45 FR 73898 (Nov. 7, 1980) (Bearing of Distribution Expenses by Mutual Funds). 45 Notice, 80 FR at 81651 n.18. See also id. at 81653–54 n.40. 46 See id. at 81651 n.18. See also id. at 81653– 54 n.40. VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 exempt reporting adviser under Advisers Act Rule 204–4(a).47 Thus, proposed Rule 2030 would not apply to member firms acting on behalf of advisers that are registered with state securities authorities instead of the SEC, or advisers that are unregistered in reliance on exemptions other than Section 203(b)(3) of the Advisers Act or Advisers Act Rule 204–4(a). The proposed rule’s definition of ‘‘investment adviser’’ is consistent with the definition of ‘‘investment adviser’’ in the SEC Pay-to-Play Rule.48 5. Official of a Government Entity FINRA explains that an ‘‘official’’ (as defined in proposed Rule 2030(g)(8)) of a ‘‘government entity’’ (as defined in proposed Rule 2030(g)(7))—both of which FINRA states are consistent with the SEC Pay-to-Play Rule definitions— would include an incumbent, candidate or successful candidate for elective office of a government entity if the office is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser or has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser.49 FINRA also notes that it is the scope of authority of the particular office of an official, not the influence actually exercised by the individual, that would determine whether the individual has influence over the awarding of an investment advisory contract under the definition.50 FINRA also explains that government entities would include all state and local governments, their agencies and instrumentalities, and all public pension plans and other collective government funds, including participant-directed plans such as 403(b), 457, and 529 plans.51 6. Contributions Proposed Rule 2030(g)(1) defines ‘‘contribution’’ to mean any gift, subscription, loan, advance, deposit of money, or anything of value made for the purpose of influencing the election for a federal, state or local office, and includes any payments for debts incurred in such an election or transition or inaugural expenses incurred by a successful candidate for state or local office.52 FINRA states that this definition is consistent with the SEC Pay-to-Play Rule.53 FINRA also states that it would not consider a donation of time by an individual to be a contribution, provided the covered member has not solicited the individual’s efforts and the covered member’s resources, such as office space and telephones, are not used.54 FINRA further states that it would not consider a charitable donation made by a covered member to an organization that qualifies for an exemption from federal taxation under the Internal Revenue Code, or its equivalent in a foreign jurisdiction, at the request of an official of a government entity to be a contribution for purposes of the proposed rule.55 7. Covered Associates Proposed Rule 2030(g)(2) defines the term ‘‘covered associates’’ to mean: (A) Any general partner, managing member or executive officer of a covered member, or other individual with a similar status or function; (B) Any associated person of a covered member who engages in distribution or solicitation activities with a government entity for such covered member; (C) Any associated person of a covered member who supervises, directly or indirectly, the government entity distribution or solicitation activities of a person in subparagraph (B) above; and (D) Any political action committee controlled by a covered member or a covered associate.56 FINRA states that, as also noted in the SEC Pay-to-Play Rule Adopting Release, contributions made to influence the selection process are typically made not by the firm itself, but by officers and employees of the firm who have a direct economic stake in the business relationship with the government client.57 For example, contributions by an ‘‘executive officer of a covered member’’ (as defined in proposed Rule 2030(g)(5)) would trigger the two-year ‘‘time-out.’’ 58 FINRA also notes that whether a person is an executive officer would depend on his or her function or activities and not his or her title.59 In addition, FINRA states that a covered associate would include a PAC controlled by the covered member or any of its covered associates.60 FINRA explains that it would consider a ‘‘covered member’’ (as defined in proposed Rule 2030(g)(4)) or its covered associates to have ‘‘control’’ over a PAC if the covered member or covered 53 See id. at 81652 n.32. See also id. at 81653. id. at 81653 n.33 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41030). 55 See Notice, 80 FR at 81653. 56 Id. at 81653 n.37. 57 See id. (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41031). 58 See Notice, 80 FR at 81653. 59 See id. 60 See id. 54 See 47 See Proposed Rule 2030(g)(7). 17 CFR 275.206(4)–5(a)(1). 49 See Notice, 80 FR at 81652. 50 See id. (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41029 (discussing the terms ‘‘official’’ and ‘‘government entity’’). 51 See Notice, 80 FR at 81652. 52 See id. at 81652. 48 See PO 00000 Frm 00079 Fmt 4703 Sfmt 4703 E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices associate has the ability to direct or cause the direction of governance or operations of the PAC.61 B. Proposed Rule 2030(b): Prohibition on Soliciting and Coordinating Contributions Proposed Rule 2030(b) also would prohibit a covered member or covered associate from soliciting or coordinating any person or political action committee (‘‘PAC’’) to make any: (1) Contribution to an official of a government entity in respect of which the covered member is engaging in, or seeking to engage in, distribution or solicitation activities on behalf of an investment adviser; or (2) payment to a political party of a state or locality of a government entity with which the covered member is engaging in, or seeking to engage in, distribution or solicitation activities on behalf of an investment adviser.62 FINRA states that this provision is modeled on a similar provision in the SEC Pay-to-Play Rule 63 and is intended to prevent covered members or covered associates from circumventing the proposed rule’s twoyear ‘‘time-out’’ by ‘‘bundling,’’ either by soliciting a large number of contributions by employees, or by soliciting payments to a State or local political party.64 C. Proposed Rule 2030(c): Exceptions FINRA’s proposed pay-to-play rule contains three exceptions from the proposed rule’s prohibitions: (1) de minimis contributions; (2) new covered associates; and (3) certain returned contributions.65 FINRA states that these exceptions are modeled on similar exceptions in the SEC Pay-to-Play Rule.66 mstockstill on DSK3G9T082PROD with NOTICES 1. De Minimis Contribution Exception Proposed Rule 2030(c)(1) would except from the rule’s restrictions contributions made by a covered associate who is a natural person to government entity officials for whom the covered associate was entitled to vote at the time of the contributions, provided the contributions do not exceed $350 in the aggregate to any one official per election.67 If the covered associate was not entitled to vote for the official at the time of the contribution, the contribution must not exceed $150 in the aggregate per election.68 FINRA 61 See id. id. at 81653–54. See also id. at 81662. 63 See id. at 81654 n.42 (citing 17 CFR 275.206(4)–5(a)(2)). 64 See Notice, 80 FR at 81654. 65 See id. 66 See id. at n.51 (citing 17 CFR 275.206(4)–5(b)). 67 See Notice, 80 FR at 81655. 68 See id. 62 See VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 states that, consistent with the SEC Payto-Play Rule, under this exception, primary and general elections would be considered separate elections.69 FINRA also explains that this exception is based on the theory that such contributions are typically made without the intent or ability to influence the selection process of the investment adviser.70 2. Exception for Certain New Covered Associates The proposed rule would attribute to a covered member contributions made by a person within two years (or, in some cases, six months) of becoming a covered associate. However, proposed Rule 2030(c)(2) would provide an exception from the proposed rule’s restrictions for covered members if a natural person made a contribution more than six months prior to becoming a covered associate of the covered member unless the covered associate engages in, or seeks to engage in, distribution or solicitation activities with a government entity on behalf of the covered member.71 FINRA states that this exception is consistent with the SEC Pay-to-Play Rule 72 and is intended to balance the need for covered members to be able to make hiring decisions against the need to protect against individuals marketing to prospective employers their connections to, or influence over, government entities the employer might be seeking as clients.73 FINRA also provides, with respect to the ‘‘look back’’ provisions in the proposed rules generally, the following illustrations of how the ‘‘look back’’ provisions will work: If, for example, the contributions were made more than two years (or six months for new covered associates) prior to the employee becoming a covered associate, the ‘‘time-out’’ has run.74 According to FINRA, however, if the contribution was made less than two years (or six months, as applicable) from the time the person becomes a covered associate, the proposed rule would prohibit the covered member that hires or promotes the contributing covered associate from receiving compensation for engaging in distribution or solicitation activities on behalf of an investment adviser from the hiring or promotion date until the applicable period has run.75 69 See id. at 81655 n.54 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41034). 70 See Notice, 80 FR at 81655. 71 See id. 72 See id. at 81655 n.55 (citing 17 CFR 275.206(4)–5(b)(2)). 73 See Notice, 80 FR at 81655. 74 See id. at 81656. 75 See id. at 81655–56. PO 00000 Frm 00080 Fmt 4703 Sfmt 4703 60055 3. Exception for Certain Returned Contributions Proposed Rule 2030(c)(3) would provide an exception from the proposed rule’s restrictions for covered members if the restriction is due to a contribution made by a covered associate and: (1) The covered member discovered the contribution within four months of it being made; (2) the contribution was less than $350; and (3) the contribution is returned within 60 days of the discovery of the contribution by the covered member.76 FINRA explains that, consistent with the SEC Pay-toPlay Rule, this exception would allow a covered member to cure the consequences of an inadvertent political contribution.77 The proposed rule also would provide that covered members with 150 or fewer registered representatives would be able to rely on this exception no more than two times per calendar year, while covered members with more than 150 registered representatives would be permitted to rely on this exception no more than three times per calendar year.78 Furthermore, a covered member would not be able to rely on an exception more than once with respect to contributions by the same covered associate regardless of the time period, which is consistent with similar provisions in the SEC Payto-Play Rule.79 D. Proposed Rule 2030(d): Prohibitions as Applied to Covered Investment Pools Proposed Rule 2030(d)(1) provides that a covered member that engages in distribution or solicitation activities with a government entity on behalf of a covered investment pool,80 in which a government entity invests or is solicited to invest, shall be treated as though the covered member was engaging in or seeking to engage in distribution or solicitation activities with the government entity on behalf of the investment adviser to the covered 76 See id. at 81655. id. 78 See id. FINRA notes that these limitations are consistent with similar provisions in the SEC Payto-Play Rule 206(4)–5(b)(3), although the SEC Payto-Play Rule includes different allowances for larger and smaller investment advisers based on the number of employees they report on Form ADV. See id. at 81655 n.59. 79 See Notice, 80 FR at 81655. 80 See id. at 81654 n.46 (proposed Rule 2030(g)(3) defines a ‘‘covered investment pool’’ to mean: ‘‘(A) Any investment company registered under the Investment Company Act that is an investment option of a plan or program of a government entity; or (B) Any company that would be an investment company under Section 3(a) of the Investment Company Act but for the exclusion provided from that definition by either Section 3(c)(1), 3(c)(7) or 3(c)(11) of that Act’’). 77 See E:\FR\FM\31AUN1.SGM 31AUN1 60056 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices mstockstill on DSK3G9T082PROD with NOTICES investment pool directly.81 Proposed Rule 2030(d)(2) provides that an investment adviser to a covered investment pool in which a government entity invests or is solicited to invest shall be treated as though that investment adviser were providing or seeking to provide investment advisory services directly to the government entity.82 FINRA states that proposed Rule 2030(d) is modeled on a similar prohibition in the SEC Pay-to-Play Rule and would apply the prohibitions of the proposed rule to situations in which an investment adviser manages assets of a government entity through a hedge fund or other type of pooled investment vehicle.83 Therefore, according to FINRA, the provision would extend the protection of the proposed rule to public pension plans that access the services of investment advisers through hedge funds and other types of pooled investment vehicles sponsored or advised by investment advisers as a funding vehicle or investment option in a government-sponsored plan, such as a 529 plan.84 As noted above, the proposed rule would not apply to distribution activities related to registered investment companies that are not investment options of a government entity’s plan or program because in these circumstances a member firm is not providing or seeking to provide investment advisory services to a government entity.85 The proposed rule would apply to distribution activities involving unregistered pooled investment vehicles such as hedge funds, private equity funds, venture capital funds, collective investment trusts, and registered pooled investment vehicles such as mutual funds, but only if those registered pools are an investment option of a participant81 See Notice, 80 FR at 81654 n.47 (FINRA notes that, consistent with the SEC Pay-to-Play Rule, under the proposed rule, if a government entity is an investor in a covered investment pool at the time a contribution triggering a two-year time-out is made, the covered member must forgo any compensation related to the assets invested or committed by the government entity in the covered investment pool) (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41047). 82 See Notice, 80 FR at 81654 n.48 (FINRA states that it added proposed Rule 2030(d)(2) in response to comments on Regulatory Notice 14–50 to clarify, for purposes of the proposed rule, the relationship between an investment adviser to a covered investment pool and a government entity that invests in the covered investment pool). 83 See Notice, 80 FR at 81654 n.49 (citing 17 CFR 275.206(4)–5(c)). 84 See Notice, 80 FR at 81654 n.50 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044, which discusses the applicability of the SEC Payto-Play Rule to covered investment pools). 85 See Notice, 80 FR at 81661. VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 directed plan or program of a government entity.86 E. Proposed Rule 2030(e): Prohibition on Indirect Contributions or Solicitations Proposed Rule 2030(e) provides that it shall be a violation of Rule 2030 for any covered member or any of its covered associates to do anything indirectly that, if done directly, would result in a violation of the rule.87 FINRA states that this provision is consistent with a similar provision in the SEC Pay-to-Play Rule 88 and would prevent a covered member or its covered associates from funneling payments through third parties, including, for example, consultants, attorneys, family members, friends, or companies affiliated with the covered member as a means to circumvent the proposed rule.89 FINRA also notes that, consistent with guidance provided by the Commission in connection with SEC Pay-to-Play Rule 206(4)–5(d), proposed Rule 2030(e) requires a showing of intent to circumvent the rule for such persons to trigger the two-year ‘‘time-out.’’ 90 F. Proposed Rule 2030(f): Exemptions Proposed Rule 2030(f) includes an exemptive provision for covered members, modeled on the exemptive provision in the SEC Pay-to-Play Rule, that would allow covered members to apply to FINRA for an exemption from the proposed rule’s two-year ‘‘timeout.’’ 91 As proposed, FINRA states that this provision would allow FINRA to exempt covered members, either conditionally or unconditionally, from the proposed rule’s time-out requirement where the covered member discovers contributions that would trigger the compensation ban after they have been made, and when imposition of the prohibition would be unnecessary to achieve the rule’s intended purpose.92 In determining whether to grant an exemption, FINRA would take into account varying facts and circumstances, outlined in the proposed 86 See id. 87 See Notice, 80 FR at 81654. 88 See id. at n.44 (citing 17 CFR 275.206(4)–5(d)). 89 See Notice, 80 FR at 81654 n.45 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044, which discusses direct and indirect contributions or solicitations). 90 See Notice, 80 FR at 81654. See also SEC Payto-Play Rule Adopting Release, 75 FR at 41044 n.340 (explaining that like MSRB Rule G–37(d), SEC Pay-to-Play Rule 206(4)–5(d) ‘‘requires a showing of intent to circumvent the rule for such persons to trigger the time out’’) (citing Blount, 61 F.3d at 948 (‘‘In short, according to the SEC, the rule restricts such gifts and contributions only when they are intended as end-runs around the direct contribution limitations.’’)). 91 See Notice, 80 FR at 81654–55. 92 See id. at 81655. PO 00000 Frm 00081 Fmt 4703 Sfmt 4703 rule, that each application presents 93 (e.g., the timing and amount of the contribution, the nature of the election, and the contributor’s apparent intent or motive in making the contribution).94 FINRA notes that this provision would provide covered members with an additional avenue by which to seek to cure the consequences of an inadvertent violation by the covered member or its covered associates that falls outside the limits of one of the proposed rule’s exceptions.95 G. Proposed Rule 4580: Recordkeeping Requirements Proposed Rule 4580 would require covered members that engage in distribution or solicitation activities with a government entity on behalf of any investment adviser that provides or is seeking to provide investment advisory services to such government entity to maintain books and records that would allow FINRA to examine for compliance with its pay-to-play rule.96 FINRA states that this provision is consistent with similar recordkeeping requirements imposed on investment advisers in connection with the SEC Pay-to-Play Rule.97 The proposed rule also would require covered members to maintain a list or other record of certain specific information.98 FINRA states that the proposed rule would require, among other things, that the direct and indirect contributions or payments made by the covered member or any of its covered associates be listed in chronological order and indicate the name and title of each contributor and each recipient of the contribution or payment, as well as the amount and date of each contribution or payment, and whether the contribution was the subject of the exception for returned contributions in proposed Rule 2030.99 III. Summary of Comments and FINRA’s Responses In response to the Notice, the Commission received ten comment letters, from nine different commenters.100 Six commenters generally express support for FINRA’s 93 See 94 See id. Order Instituting Proceedings, 81 FR at 19263. 95 See Notice, 80 FR at 81655. 96 See id. 97 See id. (citing 17 CFR 275.204–2(a)(18) and (h)(1)). 98 See Notice, 80 FR at 81655–56. 99 See id. 100 See supra note 5. CAI submitted two separate comment letters in response to the Notice. See CAI Letter 1 and CAI Letter 2. E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices proposal.101 However, five of those commenters, while generally expressing support for the goals of the proposal, also raise certain concerns regarding various aspects of the proposal as drafted and recommended amendments to the proposal.102 The other three commenters did not support the proposed rule as drafted based largely on concerns involving the First Amendment to the U.S. Constitution.103 FINRA responded, stating that it considered the comments received by the Commission in response to the Notice, and that FINRA is not intending to make changes to the proposed rule text in response to the comments.104 The Commission received an additional four comments in response to the Order Instituting Proceedings.105 On July 6, 2016, FINRA submitted a letter responding to all comments and to the Order Instituting Proceedings.106 The comments, as well as FINRA’s responses, are summarized below.107 mstockstill on DSK3G9T082PROD with NOTICES A. First Amendment Comments and FINRA’s Responses As noted above, five commenters either oppose the proposed rule 108 or raise certain issues regarding the proposed rule as drafted based largely on First Amendment concerns.109 As a general matter, these commenters argue that FINRA’s proposed rule is not narrowly tailored to serve a compelling government interest. While acknowledging that the D.C. Circuit upheld the constitutionality of a comparable MSRB pay-to-play rule in 101 See CAI Letter 1; CAI Letter 2; FSI Letter 1; ICI Letter; NAIFA Letter; NASAA Letter; and PIABA Letter. 102 See CAI Letter 1; CAI Letter 2; FSI Letter 1; NAIFA Letter; NASAA Letter; and PIABA Letter. ICI did not raise additional concerns, but states that it is satisfied with FINRA’s revisions and responses to the proposal as drafted in Regulatory Notice 14–50. See ICI Letter. 103 See CCP Letter 1; Moran Letter; and State Parties Letter 1. Other commenters also raise certain First Amendment-related concerns. See FSI Letter 1; and CAI Letter 1. 104 See FINRA Response Letter 1. 105 See supra note 10. See also Memorandum from the Division of Trading and Markets regarding a May 10, 2016 conference call with representatives of CAI; Memorandum from the Division of Trading and Markets regarding a May 19, 2016 conference call with representatives of FSI. 106 See supra note 12. 107 The comments received in response to the Notice were summarized when the Commission instituted proceedings. See supra note 9. For further detail, the comments that the Commission received on both the Notice and the Order Instituting Proceedings are available on the Commission’s Web site at http://www.sec.gov/comments/sr-finra-2015056/finra2015056.shtml. 108 See CCP Letter 1; and State Parties Letter 1. See also CCP Letter 2; CCP Letter 3; and State Parties Letter 2. 109 See CAI Letter 1; FSI Letter 1; FSI Letter 2; and Moran Letter. VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 Blount v. SEC, 61 F.3d 938 (D.C. Cir. 1995), which also used analogous restrictions to discourage pay-to-play practices, these commenters believe that Supreme Court precedent has changed since Blount was decided. In response to these comments, FINRA states that the points raised by the commenters do not warrant changes to, or disapproval of, its proposed rule change.110 FINRA notes that the Commission has already reviewed and rejected these arguments in a nearly identical context.111 As FINRA explains, the State Parties filed an unsuccessful lawsuit in 2014 challenging the SEC Pay-to-Play Rule on First Amendment grounds.112 FINRA explains that the State Parties’ comments opposing FINRA’s proposed rule reiterate the arguments advanced in their suit against the Commission and, although the court of appeals decided the challenge on jurisdictional grounds, the brief that the Commission filed in the D.C. Circuit is persuasive in demonstrating that the State Parties’ arguments lack merit.113 FINRA also notes that the SEC Pay-toPlay Rule, upon which FINRA’s proposed rule change is based, was modeled on pay-to-play rules that the MSRB drafted, that the Commission approved, and that the D.C. Circuit upheld against a constitutional challenge in Blount.114 Furthermore, FINRA states that the proposed rule change is justified by a sufficiently important governmental interest to withstand constitutional scrutiny. For example, FINRA explains that, as in Blount, the Commission’s interest in preventing fraud and in protecting market actors from ‘‘unfair, corrupt market practices,’’ are ‘‘not only substantial, but . . . compelling.’’ 115 FINRA also notes that the Commission’s interest in ‘‘clean advisory markets is equally important.’’ 116 FINRA acknowledges the D.C. Circuit’s 110 See FINRA Response Letter 2 at 3 (noting that FINRA’s responses to the First Amendment arguments raised by the State Parties and CCP also address the concerns raised by CAI, FSI and Moran). A copy of FINRA Response Letter 2 is available at: https://www.sec.gov/comments/srfinra-2015-056/finra2015056-18.pdf. 111 See id. (citing N.Y. Republican State Comm. v. SEC, 799 F.3d 1126 (D.C. Cir. 2015) (affirming dismissal of the petition for lack of subject matter jurisdiction and also dismissing the petition as time-barred). 112 See FINRA Response Letter 2 at 3. 113 See id. at 3–4. 114 See id. at 5 (citing Blount, 61 F.3d at 944). 115 See, e.g., FINRA Response Letter 2 at 5 (quoting Blount, 61 F.3d at 944). 116 See, e.g., FINRA Response Letter 2 at 5 (quoting an observation made in Blount that the Commission’s interest ‘‘in clean bond markets’’ is just as important as a legislature’s interest ‘‘in clean elections’’) (quoting Blount, 61 F.3d at 944)). PO 00000 Frm 00082 Fmt 4703 Sfmt 4703 60057 observation in Blount that ‘‘the link between eliminating pay-to-play practices and the Commission’s goals of ‘perfecting the mechanism of a free and open market’ and promoting ‘just and equitable principles of trade’ is selfevident.’’ 117 In addition to noting the important interests served by its proposal, FINRA also notes that, as explained in Blount, the proposed rule change advances this government interest by seeking to halt an existing pay-to-play problem, even though, in terms of a record, ‘‘no smoking gun is needed;’’ however, ‘‘here, the conflict of interest is apparent, the likelihood of stealth great, and the [Commission’s] purpose prophylactic.’’ 118 FINRA further believes that the proposed rule change also is ‘‘closely drawn’’ to avoid unnecessary abridgment of associational freedoms.119 FINRA explains that, like the pay-toplay rule upheld in Blount, its proposed rule change only ‘‘restricts a narrow range of . . . activities for a relatively short period of time,’’ and leaves available the ‘‘vast majority of political activities.’’ 120 For example, FINRA notes that the proposal does not attempt to regulate State and local elections, nor does it impose restrictions on independent expenditures or ban political contributions, and that each of those significant avenues for political expression remains unaffected by the proposed rule change.121 FINRA also does not agree with arguments made by a commenter that FINRA did not consider less restrictive alternatives in drafting its proposal and that aspects of the proposal are vague or overbroad. FINRA notes that, because the Commission must find that FINRA’s proposal imposes substantially equivalent or more stringent restrictions on its member firms as the SEC Pay-toPlay Rule imposes on investment advisers for FINRA members to be ‘‘regulated persons’’ under the SEC Payto-Play Rule, the provisions and definitions to which the commenter objects are modeled on and substantially similar to provisions in the 117 See, e.g., FINRA Response Letter 2 at 5 (quoting Blount, 61 F.3d at 945). 118 See, e.g., FINRA Response Letter 2 at 6 (quoting Blount, 61 F.3d at 945). 119 See, e.g., FINRA Response Letter 2 at 6. 120 See, e.g., id. (quoting Blount, 61 F.3d at 947– 48). 121 See, e.g., FINRA Response Letter 2 at 4. See also SEC Pay-to-Play Rule Adopting Release, 75 FR at 41024 n.71 (explaining that the SEC Pay-to-Play rule ‘‘imposes no restrictions on activities such as making independent expenditures to express support for candidates, volunteering, making speeches, and other conduct’’). E:\FR\FM\31AUN1.SGM 31AUN1 60058 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices SEC Pay-to-Play Rule.122 FINRA also states that it will work with the industry and Commission to address interpretive questions and provide additional guidance, as needed, to the extent that questions arise regarding the application and scope of the provisions and terms used in the proposed rule change.123 B. Comments Regarding FINRA’s Authority To Propose a Pay-to-Play Rule and FINRA’s Responses Several commenters contend that FINRA does not have the authority to adopt a pay-to-play rule because only Congress or the Federal Election Commission may regulate contributions for federal elections. In response, FINRA states that the proposed rule change is consistent with the authority Congress granted a registered national securities association like FINRA under Section 15A(b)(6) of the Act to adopt rules that are designed, among other things, to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to perfect the mechanism of a free and open market and a national market system and, in general, to protect investors and the public interest.124 FINRA believes that the proposed rule change accomplishes the goals of Section 15A(b)(6) by, for example, allowing member firms to continue to engage in distribution or solicitation activities for compensation with governmental entities on behalf of investment advisers, while at the same time deterring member firms from engaging in pay-to-play practices.125 FINRA also believes that the proposed rule change is reasonably designed to address the distortion of the investment advisory market and collective action problems created by pay-to-play practices.126 Although FINRA acknowledges that the proposed rule’s two-year ‘‘time-out’’ provision might result in fewer covered members and their covered associates making certain political contributions to certain officials, FINRA notes that if it did not adopt a pay-to-play rule, the 122 See, e.g., FINRA Response Letter 2 at 7. e.g., id. 124 See id. 125 See id. 126 See id. at 9. As outlined in the SEC Pay-toPlay Adopting Release, pay-to-play activities create a ‘‘collective action’’ problem in two respects. First, government officials who participate in such activities 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 a contribution. See SEC Pay-to-Play Rule Adopting Release, 75 FR at 40122. mstockstill on DSK3G9T082PROD with NOTICES 123 See, VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 SEC Pay-to-Play Rule would prohibit member firms from soliciting government entities for investment advisory services for compensation on behalf of investment advisers.127 FINRA explains that the SEC Pay-to-Play Rule provides that the rules of a selfregulatory organization (‘‘SRO’’), like FINRA, must impose ‘‘substantially equivalent or more stringent restrictions’’ on its member firms that wish to act as ‘‘regulated persons’’ as the SEC Pay-to-Play Rule imposes on investment advisers.128 Therefore, unless FINRA imposes sufficiently stringent restrictions, investment advisers and covered associates will be barred from providing or agreeing to provide, directly or indirectly, payment to FINRA member firms to solicit a government entity for investment advisory services on behalf of the investment adviser.129 FINRA believes that the proposed rule change is a more effective response to the issues addressed in the SEC Pay-to-Play Rule than a complete ban on solicitation,130 and notes throughout its response that the proposal imposes substantially equivalent restrictions on FINRA member firms as the SEC Pay-to-Play Rule imposes on investment advisers.131 C. Variable Annuity-Related Comments and FINRA’s Responses Two commenters raise concerns regarding the application of the proposed rules to variable annuities.132 Both of these commenters request, as a threshold matter, that FINRA confirm that Rule 2030 would not apply to variable annuities.133 One of these commenters requests that the proposed rule not apply to the sales of variable annuity contracts supported by a separate account that invests in mutual funds, arguing that the nature of variable annuities and the way investment options are selected does not implicate the investment advisory solicitation activities contemplated by the SEC Pay-to-Play Rule.134 This commenter claims that the relationship between a variable annuity contract holder and the investment adviser to a 127 See FINRA Response Letter 2 at 4–5. id. at 4. 129 See id. See also Notice, 80 FR at 81659. 130 See FINRA Response Letter 2 at 4. 131 See, e.g., id. at 4, 7. 132 See CAI Letter 1 and FSI Letter 1. See also CAI Letter 2 (reflecting CAI’s suggested revisions to the certain language in some of FINRA’s proposed rules). 133 See CAI Letter 1 and FSI Letter 1. 134 See FSI Letter 1 (claiming that applying the proposed rule to variable annuities will significantly increase the compliance burden and as such may limit the options their members make available to 403(b) and 457 plans). 128 See PO 00000 Frm 00083 Fmt 4703 Sfmt 4703 mutual fund supporting the variable annuity does not rise to a level such that it should implicate the proposed pay-toplay rule’s restrictions.135 The other commenter claims, in support of its argument that Rule 2030 should not apply to variable annuities, that compliance with Rule 2030 would be impractical for broker-dealers selling variable annuities in the government market.136 This commenter also argues, for example, that a covered member selling a variable annuity, particularly where the separate account is registered as a unit investment trust, cannot fairly be seen to be engaging in solicitation activities on behalf of all of the investment advisers and sub-advisers that manage the covered investment pools available as investment options under the separate account and subaccounts.137 This commenter also requests that proposed Rule 2030 be modified to, among other things, clarify that the distribution of a two-tiered product such as a variable annuity is not solicitation activity for an investment adviser and sub-advisers managing the funds available as investment options.138 Furthermore, this same commenter states that if FINRA or the Commission determines that brokerdealers selling variable annuities constitute solicitation activities for purposes of Rule 2030, that determination raises a host of interpretive questions that, in this commenter’s view, would require further guidance from FINRA or the Commission.139 In response, FINRA states that its proposed rules must impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on 135 See FSI Letter 1. CAI Letter 1 (claiming that the dynamics and structure of variable annuities, particularly those with separate accounts registered as a unit investment trust, and the number of advisers and sub-advisers to the funds underlying sub-accounts, makes compliance with proposed Rule 2030 impractical). 137 See id. 138 See id. 139 See id. For example, CAI requests guidance on the following questions: Is the selling broker-dealer deemed to be soliciting on behalf of the adviser of each of the underlying funds or only of advisers and sub-advisers of funds underlying investment options that are selected by contract holders? If an underlying fund is managed by an adviser that uses multiple sub-advisers, is the selling firm deemed to be soliciting on behalf of all of the sub-advisers? How does the rule apply when a contract holder on his or her own allocates funds in the variable annuity to an option at a point of time (for example, five years) subsequent to the purchase of the variable annuity without any involvement of the selling firm? See id. 136 See E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices investment advisers.140 Therefore, because the Commission did not exclude specific products from the SEC Pay-to-Play Rule, such as variable annuities, FINRA does not believe that excluding specific products from its proposed rule would satisfy the Commission’s stringency requirements.141 FINRA notes, however, that to the extent interpretive questions arise regarding the application and scope of the provisions and terms used in its proposed rules, FINRA will work with the industry and Commission to address those interpretive questions and provide additional guidance as needed.142 D. Comments Regarding the Scope of the Proposed Rule and FINRA’s Responses Two commenters also express concern that proposed Rule 2030(d) would, in their view, re-characterize ‘‘ordinary’’ or ‘‘customary’’ distribution activities for covered investment pools as the solicitation of clients on behalf of the investment adviser to the covered investment pools.143 One of these commenters requests that such customary distribution activity by member firms for covered investment pools sold to government entities not be treated as solicitation activity for an investment adviser for purposes of Rule 2030 simply because an investment adviser provides advisory services to a covered investment pool that is available as an investment option.144 As more fully explained in the commenter’s letter, the commenter claims, for example, that proposed Rule 2030(d) would recast ‘‘traditional’’ broker-dealer activity (i.e., the offer and sale of covered investment pool securities pursuant to a selling or placement agent agreement) into something it is not: The solicitation of investment advisory services on behalf of an investment adviser.145 This commenter also claims that the decision in Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006) and the Commission staff’s interpretive position under Advisers Act Rule 206(4)–3 suggest that proposed Rule 2030(d) would be impractical.146 This commenter also notes that Rule 140 See FINRA Response Letter 2 at 16. id. 142 See id. 143 See CAI Letter 1 and FSI Letter 1. 144 See CAI Letter 1. 145 See id. 146 See id. (claiming that ‘‘[i]t would create significant confusion in the industry and undermine settled practices and understandings, while creating doubt as to the application of the Goldstein case and the Commission staff’s guidance in the Mayer Brown no-action letter’’). mstockstill on DSK3G9T082PROD with NOTICES 141 See VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 206(4)–3 puts selling firms in a contradictory position under FINRA rules and Advisers Act rules.147 This commenter further states that, in its view, a broker-dealer that offers and sells interests in a mutual fund or private fund cannot be characterized as soliciting on behalf of the investment adviser to a covered investment pool.148 Similarly, another commenter expresses concern with the apparent application of proposed Rule 2030(d) to ‘‘traditional’’ brokerage sales of mutual funds and variable annuities to participant-directed governmentsponsored retirement plans.149 As more fully explained in the commenter’s letter, this commenter continues to be concerned that the provisions in proposed Rule 2030(d) go beyond that which is required under Rule 206(4)– 5(a)(2)(i) and Rule 206(4)–5(c) to the detriment of investors.150 This same commenter also claims that mutual fund sales, as well as variable annuity sales, should be excluded, claiming that the proposed rules serve to redefine the sale of mutual funds as solicitation by a broker-dealer on behalf of an investment adviser and also conflict with the realities of conventional mutual fund selling agreements.151 In response, FINRA explains that, in proposing FINRA Rule 2030(d), it did not intend to re-characterize brokerdealers’ selling interests in variable annuities, mutual funds and private funds as soliciting an investment advisory relationship with investors who invest in those products.152 Rather, FINRA states that the purpose of proposed Rule 2030(d) is to clarify that the prohibition of proposed Rule 2030(a) would apply when the covered member is engaging in distribution or solicitation activities with a government entity on behalf of a covered investment pool.153 FINRA further explains that proposed Rule 2030(d) is modeled on a similar provision in the SEC Pay-to-Play Rule, Rule 206(4)–5(c).154 As such, and consistent with SEC Pay-to-Play Rule 206(4)–5(c), proposed Rule 2030(d) is intended to extend the protections of the proposed rule to government entities that access the services of investment advisers through hedge funds and other types of pooled investment vehicles sponsored or advised by investment 147 See id. id. 149 See FSI Letter 1. See also FSI Letter 2 150 See FSI Letter 1. See also FSI Letter 2. 151 See FSI Letter 1. See also FSI Letter 2. 152 See FINRA Response Letter 2 at 14. 153 See id. 154 See id. 148 See PO 00000 Frm 00084 Fmt 4703 Sfmt 4703 60059 advisers.155 Finally, FINRA notes that the applicability of proposed Rule 2030(d) is for purposes of FINRA’s payto-play rule only and, as such, would not impact or otherwise affect other FINRA rules or guidance. Therefore, FINRA has determined not to make the changes suggested by the commenters.156 E. Comments Regarding the Inclusion of Distribution Activity in the Proposed Rule and FINRA’s Responses One commenter generally expresses concern that proposed Rule 2030 is unnecessarily ambiguous regarding the term ‘‘distribution’’ activities in Rule 2030(a).157 This commenter claims that it is unclear what distribution activities ‘‘with’’ a government entity would be prohibited, what compensation is covered by the proposed rule and who must pay it, and when a member firm might be deemed to be acting ‘‘on behalf of’’ an investment adviser.158 This commenter states that the ambiguity of proposed Rule 2030 may result in its misapplication in a variety of contexts, such as: Where a selling firm is affiliated with one, but not all, underlying fund advisers and none of the sub-adviser(s) to any underlying funds, or none of the underlying fund advisers, but some of the subadvisers.159 This commenter also claims that, while the SEC Pay-to-Play Rule requires regulated persons to be subject to rules that prohibit them from engaging in certain distribution activities if certain political contributions have been made, SEC Pay-to-Play Rule 206(4)–5 does not mandate the use of the term ‘‘distribution’’ in describing the conduct prohibited by the proposed rule, and suggested revised rule text reflecting that assertion.160 The commenter believes that its suggested revisions would eliminate, among other things, the potential concern that a selling firm might violate proposed Rule 2030 unknowingly due to being deemed to be acting on behalf of investment advisers 155 See id. at 15 (noting that when adopting SEC Pay-to-Play Rule 206(4)–5(c), the Commission stated that although ‘‘an investment in a pooled investment vehicle may not involve a direct advisory relationship with a government sponsored plan [that] does not change the nature of the fraud or the harm that may be inflicted as a consequence of the adviser’s pay-to-play activity’’) (quoting SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044– 45)). 156 See FINRA Response Letter 2 at 15. 157 See CAI Letter 1. 158 See id. 159 See id. 160 See CAI Letter 1 and CAI Letter 2 (reflecting CAI’s suggested revisions to certain language in some of FINRA’s proposed rules). E:\FR\FM\31AUN1.SGM 31AUN1 60060 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices or sub-advisers of underlying funds with which it has no relationship.161 In response, FINRA states that it continues to maintain the position, outlined in the Notice, that it will not remove references to the term ‘‘distribution.’’ 162 FINRA explains that the Notice pointed to language in the SEC Pay-to-Play Rule Adopting Release supporting the inclusion of distribution activities by broker-dealers in FINRA’s proposed Rule 2030.163 Specifically, FINRA pointed to the Commission’s discussion regarding under what circumstances distribution payments would violate the SEC’s Pay-to-Play Rule.164 FINRA also notes that based on the Commission’s definition of ‘‘regulated person’’ 165 in the SEC’s Payto-Play Rule, as well as the Commission’s discussion regarding the treatment of distribution fees paid pursuant to a 12b–1 plan as compared to legitimate profits, FINRA believes that its proposed rule must apply to member firms engaging in distribution activities.166 FINRA mentioned previously, to the extent that interpretive questions arise regarding the application and scope of the provisions and terms used in the proposed rule change, FINRA will work with the industry and Commission to address the interpretive questions and provide additional guidance as needed.167 mstockstill on DSK3G9T082PROD with NOTICES F. Comments Regarding Defined Terms Used in the Proposed Rules and FINRA’s Responses Two commenters request clarification of certain defined terms used in the proposed rules.168 One commenter urged FINRA, or the Commission, to clarify the meaning of the term ‘‘instrumentality’’ as it is used in the definition of ‘‘government entity.’’ 169 This commenter claims that, ‘‘[w]ithout 161 See CAI Letter 1 (claiming that the commenter’s suggested revisions would not result in any inappropriate narrowing of the scope of Rule 2030). 162 See FINRA Response Letter 2 at 12. 163 See id. at 11–12 (citing Notice, 80 FR at 81660–61). 164 See FINRA Response Letter 2 at 12 n.52 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 4104 n.298). 165 See FINRA Response Letter 2 at 12 (explaining that the SEC Pay-to-Play Rule defines a ‘‘regulated person’’ to include a member firm, provided that FINRA rules prohibit member firms from engaging in distribution or solicitation activities if political contributions have been made) (citing 17 CFR 275. 206(4)–5(f)(9)(ii)(A)) (emphasis in original). 166 See FINRA Response Letter 2 at 12 (citing Notice, 80 FR at 81660–61). 167 See id. 168 See CAI Letter 1 and NAIFA Letter. 169 See CAI Letter 1 (claiming that CAI’s members have struggled to understand the contours of this term in the context of the SEC Pay-to-Play Rule). VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 additional guidance, covered members will continue to struggle with whether a contribution to a given entity should be treated as a contribution to an ‘instrumentality’ of a state or state agency, thus triggering the two-year time out. . . .’’ 170 This same commenter also asked for clarification as to whether each and every ‘‘contribution’’ (as defined in proposed Rule 2030(g)(1)) is, by definition, also a ‘‘payment’’ (as defined in proposed Rule 2030(g)(9)).171 Another commenter requests that FINRA clarify the definition of a ‘‘covered associate’’ and clarify and delineate the positions that would qualify someone as a covered ‘‘official.’’ 172 This commenter claims that, in response to the same definition of ‘‘covered associate’’ as used in the SEC Pay-to-Play Rule, many investment advisers and broker-dealers have classified all of their representatives as covered associates regardless of whether they actually engage in the solicitation activity specified in the definition.173 This commenter believes that additional clarification on when an associated person of a covered member would (or would not) qualify as a ‘‘covered associate’’ would ease compliance burdens, curtail overly broad limits on legitimate political activity, and increase the consistency of procedures amongst member firms who seek to comply with both the letter and the spirit of the proposed rule.174 This same commenter requests additional details or guidance from the Commission with respect to this definition of ‘‘official’’ because, according to that commenter, that definition has caused, and will continue to spark confusion over exactly what offices subject the holder to be classified as an ‘‘official’’ given that the term is defined the same way in the SEC Pay-to-Play Rule.175 In response, FINRA states that it recognizes, as did the commenters, that these terms are defined in the SEC Payto-Play Rule and that FINRA modeled the definitions in its proposal on those in the SEC Pay-to-Play Rule.176 With respect to CAI’s request for clarification as to whether each and every 170 See id. CAI Letter 1 (discussing Notice, 80 FR at 81654 n.41: ‘‘Consistent with the SEC Pay-to-Play Rule, FINRA is including the broader term ‘payments,’ as opposed to ‘contributions,’ to deter a cover member from circumventing the proposed rule’s prohibitions by coordinating indirect contributions to government officials by making payments to political parties’’). 172 See NAIFA Letter. 173 See id. 174 See id. 175 See id. 176 See FINRA Response Letter 2 at 18. 171 See PO 00000 Frm 00085 Fmt 4703 Sfmt 4703 ‘‘contribution’’ (as defined in proposed FINRA Rule 2030(g)(1)) is, by definition, also a ‘‘payment’’ (as defined in proposed FINRA Rule 2030(g)(9)), FINRA states that the definition of ‘‘payment’’ is similar to the definition of ‘‘contribution,’’ but is broader because it does not include limitations on the purposes for which such money is given (e.g., it does not have to be made for the purpose of influencing an election).177 Finally, FINRA also acknowledges the concerns raised by the commenters and the requests for clarification and additional guidance from the Commission and FINRA as to certain terms.178 FINRA again states that to the extent that interpretive questions arise regarding the application and scope of the provisions and terms used in the proposed rule change, FINRA will work with the industry and Commission to address the interpretive questions and provide additional guidance as needed.179 G. Comments Regarding PAC Contributions and FINRA’s Responses One commenter claims that statements made by FINRA in the Notice regarding the proposed rule’s anti-circumvention provision, proposed Rule 2030(e), combined with statements made in Commission staff guidance concerning whether contributions through PACs would violate the SEC Pay-to-Play Rule and Section 208(d) of the Advisers Act, have the ability to chill contributions to PACs.180 This commenter claims, for example, that prospective contributors who simply want to donate to a PAC have been hesitant to or restricted from doing so out of fear that they may be making an indirect contribution in violation of the SEC Pay-to-Play Rule.181 Accordingly, this commenter requests further guidance from the Commission on the factors by which contributions to PACs would or would not trigger the anticircumvention provision of the proposed rule.182 In response, FINRA again acknowledges the concerns raised by the commenter and the requests for clarification and additional guidance from the Commission and FINRA.183 FINRA states that, to the extent that interpretive questions arise regarding the application and scope of the provisions and terms used in the 177 See id. at 17. id. at 19. 179 See id. 180 See NAIFA Letter. 181 See id. 182 See id. 183 See FINRA Response Letter 2 at 19. 178 See E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices proposed rule change, FINRA will work with the industry and Commission to address the interpretive questions and provide additional guidance as needed.184 Another commenter claims that it continues to believe that not all payments to political parties or PACs should have to be maintained under the books and records requirements of proposed Rule 4580.185 Rather, this commenter believes that only payments to political parties or PACs where the covered member or a covered associate: (i) Directs the political party or PAC to make a contribution to an official of a government entity which the covered member is soliciting on behalf of an investment adviser; or (ii) knows that the political party or PAC is going to make a contribution to an official of a government entity which the covered member is soliciting on behalf of an investment adviser, should have to be maintained.186 This commenter states that, while it appreciates FINRA’s rationale for proposed Rule 4580, it believes the costs and burdens associated with the request far outweigh the benefits to FINRA in ensuring compliance with the rule and would lead to periodic ‘‘fishing expeditions’’ by FINRA examiners.187 In response, FINRA states that it disagrees with these comments and has determined to retain the recordkeeping requirements as proposed in FINRA Rule 4580.188 FINRA notes that, as discussed in the Notice, payments to political parties or PACs can be a means for a covered member or covered associate to funnel contributions to a government official without directly contributing.189 Therefore, FINRA states that it is proposing to require a covered member to maintain a record of all payments to political parties or PACs as such records would assist FINRA in identifying situations that might suggest an intent to circumvent the rule.190 184 See id. at 18. CAI Letter 1. 186 See id. 187 See id. 188 See FINRA Response Letter 2 at 20. 189 See id. As FINRA explains in the Notice, a covered associate would include a PAC controlled by the covered member or any of its associates. FINRA states that it would consider a covered member or its covered associates to have ‘‘control’’ over a PAC if the covered member or covered associate has the ability to direct or cause the direction of governance or operations of the PAC. See Notice, 80 FR at 81653, 81660 (noting that this position is consistent with the position taken by the SEC in connection with the SEC Pay-to-Play Rule) (citing SEC Pay-to-Play Adopting Release, 75 FR at 41032). 190 See FINRA Response Letter 2 at 20–21. FINRA states in the Notice that the proposed recordkeeping requirements are intended to allow FINRA to mstockstill on DSK3G9T082PROD with NOTICES 185 See VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 H. Comments Regarding the De Minimis Exception Under Proposed Rule 2030(c) and FINRA’s Responses As discussed above, certain commenters raise concerns regarding the exception for de minimis contributions under proposed Rule 2030(c)(1) on First Amendment grounds.191 In addition, one commenter requests that the $350 and $150 amounts ‘‘be raised substantially’’ in both the SEC Pay-to-Play Rule and in proposed Rule 2030(c)(1), and further requests that the $350 limitation on the proposed exception for returned contributions under proposed Rule 2030(c)(3) be eliminated in both the SEC Pay-to-Play Rule and in FINRA’s proposed rule.192 In response, FINRA explains that its proposed rules must impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers.193 Therefore, FINRA has proposed exceptions for de minimis contributions and returned contributions that are consistent with similar exceptions in the SEC Pay-toPlay Rule.194 FINRA does not believe that raising the limits for the de minimis exception or eliminating the limit for returned contributions would impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers.195 I. Comments Regarding the Grandfathering of Existing Accounts and Contracts and FINRA’s Responses One commenter requests that FINRA clarify the application of the proposed rule to existing government entity accounts or contracts.196 FSI requests that, in the event that FINRA does not amend the application of its proposed rule to covered investment pools (as requested by this same commenter), FINRA apply the proposed rule only to accounts and variable contracts opened after the effective date.197 examine for compliance with its proposed pay-toplay rule, and the reference to indirect contributions in proposed Rule 4580(a)(4) is intended to include records of contributions or payments a covered member solicits or coordinates another person or PAC to make under proposed Rule 2030(b). See Notice, 80 FR at 81663. 191 For a discussion of these First Amendment comments and FINRA’s responses, see Section III.A, supra. 192 See CAI Letter 1 (claiming that these contribution amounts fail to take inflation into consideration and are ‘‘unreasonably low’’). 193 See FINRA Response Letter 2 at 19. 194 See id. 195 See id. 196 See FSI Letter 1. 197 See id. PO 00000 Frm 00086 Fmt 4703 Sfmt 4703 60061 In response, FINRA explains that, as discussed above, its proposed rules must impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers.198 The Commission did not apply its rule only to contracts or accounts opened after the effective date of the rule.199 FINRA also explains in the Notice that, if the Commission approves the proposed rule change, proposed Rule 2030(a) will not be triggered by contributions made prior to the rule’s effective date, and that the rule will not apply to contributions made prior to the effective date by new covered associates to which the two years or, as applicable, six months ‘‘look back’’ applies.200 FINRA states that the transition period—the time between the Commission approving the proposal and FINRA announcing the effective date of the rule—will provide member firms with time to identify their covered associates and government entity clients and to modify their supervisory systems to address new obligations under the rules.201 Therefore, FINRA does not believe that limiting the application of its rule in the way suggested by FSI would impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers.202 J. Comments Regarding Application of the Proposed Rules to the Independent Business Model and FINRA’s Responses One commenter claims that its members ‘‘will face difficulties’’ in attempting to comply with the proposed rules, and that these difficulties stem, primarily, from a requirement for independent firms to implement a rule that is premised on the notion that solicitation of clients is performed pursuant to a centralized process controlled by the management of a registered investment adviser.203 This same commenter claims that the ‘‘lack of clarity’’ as to the application of the SEC Pay-to-Play Rule to its members’ independent business model, and the scope of government officials that trigger the requirements, has led some 198 See FINRA Response Letter 2 at 16. id. See also Notice, 80 FR at 81656. 200 See Notice, 80 FR at 81656. 201 See id. (‘‘FINRA intends to establish an effective date that is no sooner than 180 days following publication of the Regulatory Notice announcing Commission approval of the proposed rule change, and no later than 365 days following Commission approval of the proposed rule change.’’). 202 See FINRA Response Letter 2 at 16. 203 See FSI Letter 1 (claiming FSI believes that the SEC Pay-to-Play Rule has inadvertently captured non-corrupting activity and fears that the proposed rule may do the same). 199 See E:\FR\FM\31AUN1.SGM 31AUN1 60062 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices firms to adopt aggressive compliance programs that prohibit political contributions.204 In response, FINRA states that, consistent with the SEC Pay-to-Play Rule, it has determined not to except from its proposed pay-to-play rule member firms engaged in the independent business model.205 FINRA, however, states that, to the extent that interpretive questions arise regarding the application and scope of the provisions and terms used in the proposed rule change, FINRA will work with the industry and Commission to address the interpretive questions and provide additional guidance as needed.206 mstockstill on DSK3G9T082PROD with NOTICES K. Comments Requesting More Stringent Requirements in the Proposed Rules and FINRA’s Responses Two commenters suggested that proposed Rule 2030 include more stringent requirements in certain respects.207 First, both commenters request that FINRA expand the applicability of its proposed rules to include state-registered investment advisers.208 More specifically, one of these commenters suggests that FINRA include state-registered investment advisers in its definition of ‘‘investment adviser’’ for the purposes of its proposed rule.209 Although FINRA states in the Notice that relatively few state-registered investment advisers manage public pension plans,210 one commenter believes that this alone does not justify permitting FINRA-member firms that do manage public pension plans, but happen to work with smaller investment advisers, to engage in payto-play activities with no repercussions.211 Another commenter claims that state-registered investment advisers now include larger firms and, therefore, it is much more likely that state-registered investment advisers will manage or advise public pension plans or similar funds.212 204 See id. (claiming that, absent clarity concerning the application of the proposed rule to the brokerage services provided to 403(b) and 457 plans, FSI’s members will be faced with the choice of either adopting similarly aggressive policies or prohibiting sales to government-sponsored retirement plans). 205 See FINRA Response Letter 2 at 18. 206 See id. 207 See NASAA Letter and PIABA Letter. 208 See NASAA Letter and PIABA Letter. 209 See NASAA Letter. 210 See NASAA Letter and PIABA Letter. 211 See PIABA Letter. Unless the commenter is discussing dually-registered intermediaries, we do not understand the commenter’s reference to ‘‘FINRA-member firms that do manage public pension plans’’ as those plans are managed by investment advisers, not broker-dealers. 212 See NASAA Letter. VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 In response, FINRA states that, as discussed in the Notice,213 to remain consistent with the SEC Pay-to-Play Rule, FINRA has determined not to expand the scope of the proposed rule as suggested by commenters to include state-registered investment advisers in its definition of ‘‘investment adviser’’ for the purposes of its proposed rule.214 As discussed in the Notice, FINRA explains that the Commission also declined to make a similar change to its proposed rule, stating that it was the Commission’s understanding that few of these smaller firms manage public pension plans or other similar funds.215 Second, these two commenters request that FINRA include a mandatory disgorgement provision for violations of its proposed rule.216 These commenters state that they are disappointed that FINRA removed the mandatory disgorgement provisions from the proposal as outlined in FINRA’s Regulatory Notice 14–50.217 These commenters believe that a mandatory disgorgement provision would act as a significant deterrent to engaging in payto-play schemes, and it should remain in FINRA’s final rule.218 In response, FINRA states that, after considering similar comments made in response to its Regulatory Notice 14–50, in particular, that FINRA has authority to require disgorgement of fees in enforcement actions, FINRA determined not to include a disgorgement requirement in its proposal.219 For those same reasons, which also are discussed in the Notice,220 FINRA also has determined not to revise the proposal to include a disgorgement requirement.221 Finally, one commenter believes that the cooling-off period in the proposal should be at least four years.222 PIABA 213 See Notice, 80 FR at 81652 n.26 (explaining that ‘‘consistent with the SEC Pay-to-Play Rule, the proposed rule would not apply to state-registered investment advisers as few of these smaller firms manage public pension plans or other similar funds’’). See also id. at 81660 n.98 (citing SEC Payto-Play Rule Adopting Release, 75 FR at 41026). 214 See FINRA Response Letter 2 at 10. 215 See Notice, 80 FR at 81652 n.26. See also id. at 81660 n.98. 216 See NASAA Letter and PIABA Letter. 217 See NASAA Letter and PIABA Letter. 218 See NASAA Letter and PIABA Letter. 219 See FINRA Response Letter 2 at 19–20. 220 See Notice, 80 FR at 81662 (noting, for example, ICI’s comment made in connection with Regulatory Notice 14–50 that ‘‘including disgorgement as a penalty is not necessary given that the SEC and FINRA both have full authority to require disgorgement of fees, and indeed, disgorgement has been the penalty universally applied (along with additional penalties) in enforcement actions under existing pay-to-play rules, such as MSRB Rule G–37 and SEC Rule 206(4)–5’’). 221 See FINRA Response Letter 2 at 20. 222 See PIABA Letter. PO 00000 Frm 00087 Fmt 4703 Sfmt 4703 believes that the two-year cooling-off period does not adequately reduce the incentive for FINRA member firms to make political contributions to obtain pay-to-play advantages.223 PIABA states FINRA should start with the most comprehensive rule, and that it would welcome the deterrent effect of a fouryear cooling off period.224 FINRA declines to make PIABA’s suggested change.225 FINRA explains that the proposed two-year time-out is consistent with the time-out period in the SEC’s Pay-to-Play Rule and, FINRA believes that a two-year time-out period from the date of a contribution is sufficient to discourage covered members from engaging in pay-to-play practices.226 As FINRA explains in the Notice, the two-year time-out in the proposed rule is intended to discourage covered members from participating in pay-to-play practices by requiring a cooling-off period during which the effects of a quid pro quo political contribution on the selection process can be expected to dissipate.227 IV. Discussion and Commission Findings After carefully considering the proposed rule change, the comments submitted, and FINRA’s responses thereto, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a registered national securities association.228 In particular, the Commission finds that the proposed rule change is consistent with Section 15A(b)(6) of the Act.229 Section 15A(b)(6), which governs registered national securities associations like FINRA, requires, among other things, that the association’s rules be ‘‘designed to prevent fraudulent and manipulative 223 See id. id. 225 See FINRA Response Letter 2 at 10. 226 See id. 227 See Notice, 80 FR at 81651. As the Commission explained, the two-year ‘‘cooling-off period’’ is not a penalty but, rather, is intended to be a period during which any effects of a quid pro quo are expected to dissipate. See SEC Pay-to-Play Adopting Release, 75 FR at 41026 n.104. 228 In approving this proposed rule change, the Commission has considered the proposed rule change’s impact on efficiency, competition, and capital formation. In this regard, the Commission considered FINRA’s extensive discussion of these effects in its Notice and FINRA’s response to comments on that discussion. Moreover, the Commission observes that, in response to the Commission’s Notice, no commenter suggested that FINRA’s analysis was incorrect or incomplete, or that the proposed rule change would have a negative effect on efficiency, competition, or capital formation. See 15 U.S.C. 78c(f). 229 15 U.S.C. 78o–3(b)(6). 224 See E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices acts and practices, to promote just and equitable principles of trade, . . . to remove impediments to and perfect the mechanism of a free and open market and a national market system and, in general, to protect investors and the public interest.’’ 230 As discussed in more detail below, we believe that FINRA’s proposal is consistent with Section 15A(b)(6). FINRA’s proposed rule will address the regulatory concerns that underlie, and thus support the objectives of, the SEC Payto-Play Rule, discussed below, by discouraging FINRA member firms and certain of their covered associates from engaging in quid pro quo corruption that may create market distortions— when, for example, an investment adviser is chosen on the basis of a placement agent’s political contributions rather than the adviser’s merit. Such conduct impedes a free and open market, and may harm investors and the public interest if government entities, including public pension plans, and their beneficiaries receive inferior services or pay higher fees.231 FINRA’s proposed rule also promotes a free and open market and the protection of investors and the public interest by avoiding the outright ban on distribution and solicitation activity that would result if FINRA member firms were not ‘‘regulated person[s]’’ under the SEC Pay-to-Play Rule.232 The fact that FINRA’s proposed rule may have implications for a small subset of political contributions made by certain covered associates to certain elected officials does not somehow eliminate FINRA’s ability to adopt rules pursuant to the Act, or the Commission’s authority to approve such rules under Section 19(b)(2) of the Act.233 As support for the need for the proposed rule, FINRA outlined certain regulatory concerns in the Notice that also were identified by the Commission in connection with its adoption of the mstockstill on DSK3G9T082PROD with NOTICES 230 Id. 231 See FINRA Response Letter 2 at 8. See also Notice, 80 FR at 81651, 81656 (discussing the regulatory objectives of and statutory basis for the proposal). 232 See FINRA Response Letter 2 at 5 (‘‘FINRA believes that the proposed rule change is a more effective response to the issues addressed in the SEC Pay-to-Play Rule than a complete ban on solicitation.’’). See also Notice, 80 FR at 81652, 81656 (discussing the regulatory objectives of and statutory basis for the proposal). 233 While FINRA’s proposed rule does not bar member firms and their covered associates from making contributions, it may affect the propensity of member firms and certain employees to make the subset of contributions that would trigger the twoyear time-out. FINRA’s rule does not impose a requirement that member firms publicly disclose political contributions. VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 SEC Pay-to-Play Rule.234 These concerns, which also implicate the investor and public interest protections described in Section 15A(b)(6) of the Act, recognize the central role intermediaries, such as ‘‘solicitors’’ or ‘‘placement agents,’’ have played in actions that the Commission and other authorities have brought involving payto-play schemes.235 FINRA also acknowledges the Commission’s observation of how investment advisers, in several instances, allegedly made significant payments to placement agents and other intermediaries to influence the award of advisory contracts.236 Moreover, FINRA points out the difficulties that investment advisers face in monitoring or controlling the activities of their thirdparty solicitors.237 As we explained in adopting the SEC Pay-to-Play Rule, public pension plans are particularly vulnerable to pay-toplay practices, and we have been particularly concerned that the engagement of placement agents who have made political contributions to key officials is viewed by investment advisers as a necessary step to securing a contract with a public pension plan.238 In connection with the SEC Pay-to-Play Rule, we initially proposed a complete bar on investment advisers engaging third parties to solicit government clients on their behalf because of concerns about investment advisers’ use of third-party solicitors and placement agents to engage in pay234 See Notice, 80 FR at 81651, nn.12–14 (discussing concerns the Commission identified in the SEC Pay-to-Play Rule Adopting Release, 75 FR at 41037). 235 See Notice, 80 FR at 81651. See also id. at nn.10–11 (explaining that ‘‘solicitors’’ typically locate investment advisory clients on behalf of an investment adviser, and that ‘‘placement agents’’ typically specialize in finding investors, often institutional investors or high net worth investors, that are willing and able to invest in a private offering of securities on behalf of the issuer of such privately offered securities) (citing Advisers Act Release No. 2910 (Aug. 3, 2009), 74 FR 39840, 39853 n.137 (Aug. 7, 2009) (Political Contributions by Certain Investment Advisers)). 236 See Notice, 80 FR at 81651. See also e.g., SEC Pay-to-Play Adopting Release, 75 FR at 41037. 237 See Notice, 80 FR at 81651. See also SEC Payto-Play Adopting Release, 75 FR at 41032 n.182, 40137 n.266 (acknowledging commenters’ concerns regarding the difficulties that advisers may have when monitoring the activities of their third-party solicitors). 238 See SEC Pay-to-Play Adopting Release, 75 FR at 41019–20, nn.16–25 (collecting examples of SEC litigation releases as well as state and federal criminal actions with pay-to-play schemes involving placement agents among other intermediaries). See also id. at 40137, n.262 (collecting examples of state and local legislative actions undertaken to prohibit or regulate pay-toplay practices involving placement agents in response to concerns about pay-to-play activities in their jurisdictions). PO 00000 Frm 00088 Fmt 4703 Sfmt 4703 60063 to-play activities.239 However, persuaded by commenters, we revised the proposed SEC Pay-to-Play Rule to permit advisers to make payments to certain ‘‘regulated persons’’ to solicit government clients on their behalf, provided that they are themselves subject to prohibitions against participating in pay-to-play practices, are subject to Commission oversight and, in the case of broker-dealers, the oversight of a registered national securities association such as FINRA.240 FINRA agreed and informed us that it would prepare rules for our consideration that would prohibit its members from soliciting advisory business from a government entity on behalf of an adviser unless they comply with pay-to-play restrictions.241 Pay-to-play practices are harmful. They create an impediment to a free and open market by, for example, distorting the investment adviser selection process from one that is based on merit, performance and cost, to one that is influenced by a placement agent’s contributions to the campaigns of government officials who are responsible for, or can influence the outcome of, selecting an investment adviser.242 As a result of this distortion, government entities, including pension funds, and their citizen beneficiaries may be harmed by receiving inferior services or paying higher fees.243 Investors and the public interest ultimately suffer, including taxpayers, residents who rely on municipal services, and the beneficiaries of public pension funds, such as firemen, police officers, teachers, and other civil 239 See id. at 41037 nn.259–68 (discussing the Commission’s observations in the SEC Pay-to-Play Rule proposing release). 240 See id. at 41041. 241 See Notice, 80 FR at 81651 n.15 (citing a letter from Richard G. Ketchum, Chairman and Chief Executive Officer, FINRA, to Andrew J. Donohue, Director, Division of Investment Management, Commission (Mar. 15, 2010) (‘‘Ketchum Letter’’), available at http://www.sec.gov/comments/s7-1809/s71809-260.pdf (stating that FINRA ‘‘believe[s] that a regulatory scheme targeting improper pay to play practices by broker-dealers acting on behalf of investment advisers is . . . a viable solution to a ban on certain private placement agents serving a legitimate function’’)). FINRA also notes that in developing its proposal it intended to draw closely upon all the substantive and technical elements of the Commission’s rule as well as FINRA’s regulatory expertise in examining and enforcing the MSRB rules, upon which the SEC Pay-to-Play Rule is based. See Ketchum Letter. See also SEC Pay-toPlay Adopting Release, 75 FR at 41042 n.317 (discussing same). 242 See, e.g., SEC Pay-to-Play Adopting Release, 75 FR at 41023, 41039. 243 SEC Pay-to-Play Adopting Release, 75 FR at 41019. E:\FR\FM\31AUN1.SGM 31AUN1 60064 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices mstockstill on DSK3G9T082PROD with NOTICES servants.244 Investment advisers also are harmed because their ability to participate in the market is impeded unless they are willing to engage in payto-play practices by, for example, hiring placement agents that make certain political contributions.245 The Commission also believes that the stealth in which pay-to-play practices occur and the inability of markets to properly address these practices argue strongly for rules like the SEC Pay-toPlay Rule and FINRA’s proposal.246 Payto-play practices create a ‘‘collective action’’ problem in two respects: (1) Government officials who participate in such activities have an incentive to continue to accept contributions to support their campaigns for fear of being disadvantaged relative to their opponents; and (2) investment advisers have an incentive to participate out of concern that they may be overlooked if they fail to make a contribution.247 We believe that application of FINRA’s proposed pay-to-play rules will effectively discourage covered members and their covered associates who act as placement agents for investment advisers from participating in pay-toplay practices because their political contributions or payments will be subject to restrictions similar to those imposed on investment advisers under the SEC Pay-to-Play Rule.248 The Commission therefore believes that FINRA’s proposed rule change will help address the concerns identified in the SEC Pay-to-Play Rule Adopting Release regarding the distortion of the investment advisory market.249 As a 244 SEC Pay-to-Play Adopting Release, 75 FR at 41019 (noting that the management of public pension plans ‘‘most significantly . . . affects taxpayers and the beneficiaries of these funds, including the millions of present and future State and municipal retirees who rely on the funds for their pensions and other benefits’’). 245 See, e.g., SEC Pay-to-Play Adopting Release, 75 FR at 41023, 41039 (explaining that ‘‘pay to play practices may hurt smaller advisers that cannot afford the required contributions. Curtailing pay to play arrangements enables advisory firms, particularly smaller advisory firms, to compete on merit, rather than their ability or willingness to make contributions’’). 246 See SEC Pay-to-Play Adopting Release, 75 FR at 40122–23. See also FINRA Response Letter at 6 (noting that, as explained in Blount, ‘‘no smoking gun is needed;’’ however, ‘‘where, as here, the conflict of interest is apparent, the likelihood of stealth great, and the [Commission’s] purpose prophylactic’’). 247 See FINRA Response Letter at 9; SEC Pay-toPlay Adopting Release, 75 FR at 40122. 248 See Notice, 80 FR at 81651. 249 See FINRA Response Letter at 9 (stating that ‘‘[f]or example, the proposed rule change is reasonably designed to address the distortion of the investment advisory market and collective action problems created by pay-to-play practices’’). As the Commission has explained, by addressing distortions in the process by which investment VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 result, like the SEC Pay-to-Play rule, FINRA’s proposal should help protect investors and the public interest by, among other things, reducing the costs to plans and their beneficiaries of inferior asset management services arising from adviser selection based on a placement agent’s political contributions rather than prudential investment considerations.250 Further, in the Commission’s view, FINRA’s proposed rule strikes an appropriate balance in addressing these regulatory concerns by providing for FINRA member firms to be ‘‘regulated person[s]’’ under the SEC Pay-to-Play Rule.251 As a result, investment advisers will be able to continue to benefit from the use of placement agents in obtaining investment advisory business with government entities without political contributions distorting the process by which a government entity, such as a public pension fund, selects an adviser.252 The two-year time-out period imposed by the proposed rule change is not a penalty but, rather, is intended to discourage participation in pay-to-play practices by requiring a ‘‘cooling-off period’’ during which the effects of a quid pro quo political contribution on the selection process are expected to dissipate.253 This time-out will help promote fair competition in the market and protect public pension funds and investors by curbing fraudulent conduct resulting from pay-to-play practices.254 In addition, according to FINRA, the proposal can be expected to help promote competition by allowing more third-party solicitors to participate in the market for solicitation services, which in turn may reduce costs to investment advisers and improve competition for advisory services.255 For these reasons and as discussed throughout, the Commission finds that the proposed rule change is consistent with Section 15A(b)(6) of the Act.256 The Commission notes that most commenters to the Notice 257 and some of the commenters responding to the Order Instituting Proceedings 258 generally express support for FINRA’s proposal. For example, one commenter states that it is pleased that, like the SEC and the MSRB, FINRA is adopting rules to govern the activities of its members that solicit government clients on behalf of an investment adviser and also is pleased that FINRA’s proposal is designed to complement, and be consistent with, the SEC’s pay-to-play rule.259 Similarly, another commenter states that, although it requests certain revisions, it also supports FINRA’s attempt to deter pay-to-play activity among covered members and supports the regulatory objectives underlying the Proposed Rules.260 The Commission acknowledges the concerns and questions raised by some commenters, which are outlined in further detail above in Section III. As discussed below, the Commission believes, however, that FINRA has responded to the commenters’ concerns and questions in light of, among other things, the regulatory framework established by the SEC Pay-to-Play Rule, which provides that FINRA’s proposed rules must impose substantially equivalent or more stringent restrictions on its members than the SEC Pay-toPlay Rule imposes on investment advisers for FINRA members to be ‘‘regulated persons’’ under the SEC Payto-Play Rule. advisers are selected regarding public investments, pay-to-play rules provide important protections to public pension plans and their beneficiaries, as well as participants in other important plans or programs sponsored by government entities. See SEC Pay-toPlay Adopting Release, 75 FR at 41023, 41054. 250 See SEC Pay-to-Play Adopting Release, 75 FR at 41039. 251 See, e.g., FINRA Response Letter at 5 (‘‘FINRA believes that the proposed rule change is a more effective response to the issues addressed in the SEC Pay-to-Play Rule than a complete ban on solicitation.’’) See also Notice, 80 FR at 81652, 81656 (discussing the regulatory objectives of and statutory basis for the proposal). 252 See, e.g., FINRA Response Letter 2 at 8 (‘‘The proposed rule change accomplishes these goals by allowing member firms to continue to engage in distribution or solicitation activities for compensation with governmental entities on behalf of investment advisers, while at the same time deterring member firms from engaging in pay-toplay practices.’’). 253 See Notice, 80 FR at 81651. See also SEC Payto-Play Adopting Release, 75 FR at 41026 n.104. 254 See Notice, 80 FR at 81657. 255 See id. Several commenters express the view that FINRA’s proposed rule violates the First Amendment.261 The Commission is sensitive to the constitutional concerns raised by the commenters, but after careful consideration of their arguments, for the reasons discussed PO 00000 Frm 00089 Fmt 4703 Sfmt 4703 A. Comments Concerning the First Amendment and Related Concerns 256 See 15 U.S.C. 78o–3(b)(6). CAI Letter 1; CAI Letter 2; FSI Letter 1; ICI Letter; NAIFA Letter; NASAA Letter; and PIABA Letter. 258 See FSI Letter 2 (claiming that the proposal creates ‘‘compliance uncertainties’’ for FSI’s members, but noting that FSI ‘‘support[s] regulatory efforts to combat pay-to-play corruption activity’’). 259 See ICI Letter. 260 See CAI Letter 1 (recognizing ‘‘the challenges in crafting the Proposed Rules so that they reach all of the activity sought to be eliminated without also prohibiting activity that is harmless’’). 261 See CCP Letter 1; FSI Letter 1; FSI Letter 2; and State Parties Letter 1. See also CCP Letter 2; CCP Letter 3; Moran Letter and State Parties Letter 2. 257 See E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices mstockstill on DSK3G9T082PROD with NOTICES below, concludes that FINRA’s rule is consistent with the First Amendment. FINRA’s rule, which focuses on covered members who serve as placement agents, tracks the SEC Pay-toPlay Rule for investment advisers, which, in turn, tracks the MSRB’s payto-play rule, Rule G–37, which the D.C. Circuit upheld against First Amendment challenge in 1995.262 The Supreme Court has issued several decisions regarding political speech since Blount was decided,263 and none of these decisions call into question Blount’s holding that a tailored pay-to-play rule, which is nearly identical in purpose and form to FINRA’s proposed rule and which also furthers an important public interest, is constitutional. Indeed, the en banc D.C. Circuit recently and unanimously upheld a broader pay-toplay restriction—a bar on all contributions to federal candidates by federal contractors—in its decision in Wagner that analyzed the post-Blount Supreme Court decisions and cited Blount with approval.264 Various payto-play restrictions imposed by other jurisdictions also have withstood First Amendment challenge in recent years.265 Decisions like Wagner confirm that even an outright limitation on contributions—as opposed to FINRA’s rule, which may indirectly discourage contributions—is permissible if it is justified by a sufficiently important government interest and is closely drawn to avoid unnecessary abridgement of the type of political speech represented by a political contribution.266 We believe that 262 Blount v. SEC, 61 F.3d 938 (D.C. Cir. 1995), cert. denied, 517 U.S. 1119 (1996). One significant difference between the MSRB rule, on one hand, and the SEC’s and FINRA’s rules, on the other, is that the MSRB rule requires the public disclosure of political contributions whereas the SEC’s and FINRA’s rules do not. 263 See, e.g., McCutcheon v. FEC, 134 S. Ct. 1434 (2014); Citizens United v. FEC, 558 U.S. 310 (2010); Davis v. FEC, 554 U.S. 724 (2008); FEC v. Wisc. Right To Life, Inc., 51 U.S. 449 (2007); Randall v. Sorrell, 548 U.S. 230 (2006); FEC v. Beaumont, 539 U.S. 146 (2003); Nixon v. Shrink Mo. Gov’t PAC, 528 U.S. 377 (2000). 264 Wagner v. FEC, 793 F.3d 1 (D.C. Cir. 2015) (en banc), cert. denied sub nom., Miller v. FEC, 136 S. Ct. 895 (2016). 265 See, e.g., Yamada v. Snipes, 786 F.3d 1182 (9th Cir.), cert. denied, 136 S. Ct. 569 (2015); Preston v. Leake, 660 F.3d 726, 729–30, 736 (4th Cir. 2011); Ognibene v. Parkes, 671 F.3d 174, 179– 80 (2d Cir. 2011); Green Party of Connecticut v. Garfield, 616 F.3d 189, 200 (2d Cir. 2010). 266 Wagner, 793 F.3d at 6–8. We note that FINRA’s rule is not an absolute bar on contributions, but the two-year time-out may have the effect of discouraging member firms and certain covered associates who may act as placement agents for investment advisers from making certain contributions to certain covered officials. To the extent that the commenters suggest that such an VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 FINRA’s proposed rule serves a vitally important governmental interest: Discouraging a specific type of quid pro quo corruption in which political contributions made by placement agents may influence the award of investment advisory business by government entities. The Supreme Court has long held that halting quid pro quo corruption is an important government interest that justifies limitations—or outright bans—on contributions.267 We do not understand FINRA to be engaging in broad electoral reform or trying to clean up the electoral process. Rather, to avoid the outright ban on placement agent activity resulting from FINRA member firms not being ‘‘regulated person[s]’’ under the SEC Pay-to-Play Rule, the two-year time-out in FINRA’s proposal, like the SEC Payto-Play Rule, discourages quid pro quos that affect government entities, including public pension funds, served by investment advisers. Quid pro quos involving placement agents, who make contributions to certain elected officials and then assist investment advisers in obtaining business from the government entities those officials serve may be: Fraudulent, run counter to just and equitable principles of trade, impede a free and open market, and harm investors and the public interest.268 When pay-to-play is a factor in the selection or retention of an investment adviser—when the adviser is chosen on the basis of a placement agent’s political contributions rather than its merit—the most qualified adviser may not be hired, which may lead to inferior performance and payment of higher fees.269 Ultimately, taxpayers and fund beneficiaries suffer the harm. Moreover, pay-to-play distorts free and open markets by requiring investment advisers and their placement agents to ‘‘play the game’’ or risk being left out.270 In short, while FINRA’s rule resembles other contribution limitations by serving indirect limitation on contributions would be reviewed by a court under strict scrutiny, they misstate applicable Supreme Court precedent, which has maintained that limitations on contributions are reviewed under a more intermediate form of scrutiny because ‘‘[c]ontribution limits impose a lesser restraint on political speech’’ that permits ‘‘‘symbolic expression of support evidence by a contribution’’ but do not ‘‘‘in any way infringe the contributor’s freedom to discuss candidates and issues.’ ’’ McCutcheon, 134 S. Ct. at 1444, quoting Buckley v. Valeo, 424 U.S. 1, 21 (1976). 267 McCutcheon, 134 S. Ct. at 1452; Buckley, 424 U.S. at 27–28 (1976). 268 Blount, 61 F.3d at 944–48. See also 15 U.S.C. 78o–3(b)(6). 269 SEC Pay-to-Play Adopting Release, 75 FR at 41022, 41053–54. 270 Id. at 41019, 41022, 41053. See also Blount, 61 F.3d at 945–46. PO 00000 Frm 00090 Fmt 4703 Sfmt 4703 60065 a government interest in discouraging quid quo pro corruption, it is a targeted effort that should protect investors and the public by promoting the integrity of the investment advisory market. FINRA’s proposed rule advances this important governmental interest because the two-year time-out discourages pay-to-play. As explained above, pay-to-play has been and is a serious problem when placement agents assist investment advisers in obtaining advisory business from government entities.271 Placement agents ‘‘played a central role in actions that [the Commission] and other authorities have brought involving pay-to-play schemes,’’ and, in several instances, advisers used placement agents, who had made campaign contributions to elected officials, to influence the award of investment advisory contracts.272 Most notably, Alan Hevesi, the Comptroller of New York State who was responsible for investment of state pension funds, accepted campaign contributions from a placement agent and steered over $250 million in pension funds to investment advisers that had retained the placement agent.273 In response to these incidents, the Commission proposed a ban on the use of placement agents by investment advisers and ultimately adopted a final rule that permitted use of placement agents so long as they were ‘‘regulated persons’’ governed by the type of payto-play rule that FINRA has proposed here.274 FINRA is not alone in addressing these issues. For example, several State and local governments have barred or restricted placement agents from playing a role in the contracting process.275 Although the Supreme Court has never required a certain amount of past quid pro quo corruption to sustain a contribution limitation, there is more than sufficient evidence of pay-to-play practices to support FINRA’s rule.276 The contours of FINRA’s proposed rule reflect how pay-to-play practices involving placement agents affect the hiring and retention of investment advisers by State and local pension funds. One scenario implicated by FINRA’s rule (and reflected in the 271 SEC Pay-to-Play Adopting Release, 75 FR at 41019–20. Pay-to-play that affects State and local pension funds is not limited to the investment advisory context. 272 SEC Pay-to-Play Adopting Release, 75 FR at 41019–20, 41037. 273 Id. at 41019–20. 274 Id. at 41037–42. 275 Id. at 41037 n. 262. 276 McCutcheon, 134 S. Ct. at 1445, 1458; Nixon, 528 U.S. at 390–91; Buckley, 424 U.S. at 29–30. E:\FR\FM\31AUN1.SGM 31AUN1 60066 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices mstockstill on DSK3G9T082PROD with NOTICES Hevesi matter) involves an investment adviser that seeks business from a State pension fund and retains a firm, or an individual at a firm, that has made contributions to an elected official responsible for selecting investment advisers.277 The elected officials who participate have no incentive to stop accepting contributions for fear of being disadvantaged relative to their opponents. Similarly neither the placement agents that make the contributions nor the investment advisers that hire the placement agents have an incentive to stop out of concern that if they abstain, their competitors will continue to engage in the practice profitably and without adverse consequences.278 FINRA’s rule should resolve this collective-action problem by interposing a time-out that creates a disincentive to engage in pay-to-play. The proposed FINRA rule, like the SEC Pay-to-Play Rule that it is modeled on, is a tailored solution to a particularly pernicious form of quid pro quo corruption that affects the beneficiaries of public pension funds, such as teachers, law enforcement officers, firefighters, and other public servants, as well as the beneficiaries of other collective government funds, including participant-directed plans such as 403(b), 457 and 529 plans. The proposed FINRA rule would affect a small segment of the electorate: In general, member firms acting as placement agents for investment advisers seeking to obtain advisory business from government entities. And the proposed FINRA rule would affect only a small number of elected officials—those who are responsible for or have authority to appoint any person who is responsible for or can influence the outcome of the hiring of an investment adviser by a government entity—and has no bearing on the vast majority of elections where the elected office’s scope of authority does not encompass the awarding of investment advisory contracts. Moreover, the proposed FINRA rule’s de minimis exception permits some campaign contributions to be made in all instances without triggering the time-out—thus allowing ‘‘the symbolic expression of support evidenced by a contribution’’— and it does not restrict other forms of 277 SEC Pay-to-Play Adopting Release, 75 FR at 41019–20 & nn.18–20 (citing examples). 278 Id. at 41022, 41040, 41053. See also Blount, 61 F.3d at 945–46. Even if the public is aware of the quid pro quo relationship, there is little that can be done because the official is compromised by the receipt of the contribution, and beneficiaries of a pension fund cannot easily shift their assets out of the fund, reverse the hiring decision, or remove the official. Id. at 41027. See also id. at 41053 n.459. VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 political speech, such as independent expenditures.279 B. Comments Regarding the Scope and Coverage of the Proposal As discussed in detail above, the commenters raise several concerns regarding the scope and coverage of the proposed rules, including with respect to: The inclusion of variable annuities and mutual funds; 280 the inclusion of distribution activities; 281 the application to covered investment pools; 282 the level of the de minimis 279 McCutcheon, 134 S. Ct. at 1444, quoting Buckley, 424 U.S. at 21 (internal quotation marks omitted). 280 See CAI Letter 1 and FSI Letter 1. See also CAI Letter 2 (reflecting CAI’s suggested revisions to certain language in some of FINRA’s proposed rules). In FINRA’s view, because the Commission did not exclude specific products from the SEC Payto-Play Rule, such as variable annuities or mutual funds, excluding specific products from its proposed rule would not satisfy the Commission’s stringency requirements. See FINRA Response Letter 2 at 16. 281 See CAI Letter 1. See also CAI Letter 2 (reflecting CAI’s suggested revisions to certain language in some of FINRA’s proposed rules). FINRA notes that, among other things, language in the SEC Pay-to-Play Rule Adopting Release supports the inclusion of ‘‘distribution’’ activities by broker-dealers in FINRA’s proposed Rule 2030(a). See Notice, 80 FR at 81660–61 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298 where, according to FINRA, the Commission ‘‘clarif[ied] under what circumstances distribution payments would violate the SEC’s Pay-to-Play Rule’’). FINRA believes that based on the Commission’s definition of ‘‘regulated person’’ in the SEC’s Pay-to-Play Rule, as well as the Commission’s discussion regarding the treatment of distribution fees paid pursuant to a 12b–1 plan as compared to legitimate profits, its proposed rule must apply to member firms engaging in distribution activities. See FINRA Response Letter 2 at 12 (citing Notice, 80 FR at 81660–61) and FINRA Response Letter 2 at 12 n.53 (explaining that the SEC Pay-to-Play Rule defines a ‘‘regulated person’’ to include a member firm, provided that FINRA rules prohibit member firms from engaging in distribution or solicitation activities if political contributions have been made, and citing SEC Payto-Play Rule 206(4)–5(f)(9)(ii)(A)) (emphasis in original). 282 See CAI Letter 1; FSI Letter 1; FSI Letter 2. FINRA clarifies that it is not intending in this proposal to re-characterize broker-dealers’ selling interests in variable annuities, mutual funds, and private funds as soliciting an investment advisory relationship with investors who invest in those products. See FINRA Response Letter 2 at 14–15 (noting, for example, that the applicability of proposed FINRA Rule 2030(d) is for purposes of FINRA’s pay-to-play rule only). FINRA also explains that FINRA Rule 2030(d) is modeled on a similar provision in the SEC Pay-to-Play Rule, Rule 206(4)–5(c) and, as such, proposed FINRA Rule 2030(d) is intended to extend the protections of the proposed rule to government entities that access the services of investment advisers through hedge funds and other types of pooled investment vehicles sponsored or advised by investment advisers. See FINRA Response Letter 2 at 15 (noting that when adopting SEC Pay-to-Play Rule 206(4)– 5(c), the Commission stated that although ‘‘an investment in a pooled investment vehicle may not involve a direct advisory relationship with a government sponsored plan [that] does not change the nature of the fraud or the harm that may be PO 00000 Frm 00091 Fmt 4703 Sfmt 4703 contribution exception and the returned contribution exception; 283 the inclusion of the independent business model; 284 and the application to existing contracts or accounts.285 FINRA generally responded that its proposed rules are designed to be at least as stringent as the SEC Pay-to-Play Rule so that FINRA’s member firms will meet the definition of ‘‘regulated persons’’ such that they are subject to rules that impose substantially equivalent or more stringent restrictions on its members than the SEC Pay-to-Play Rule imposes on investment advisers.286 As noted above, the SEC Pay-to-Play Rule, in part, prohibits any investment adviser covered under the rule or any of its covered associates from providing or agreeing to provide, directly or indirectly, payment to any person to solicit a government entity for investment advisory services on behalf of the investment adviser unless such person is a ‘‘regulated person,’’ as defined under the rule.287 The definition of ‘‘regulated person’’ inflicted as a consequence of the adviser’s pay-toplay activity’’) (quoting SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044–45). Finally, FINRA notes that the applicability of proposed FINRA Rule 2030(d) is for purposes of FINRA’s payto-play rule only. See FINRA Response Letter 2 at 15. 283 See CAI Letter 1. In response, FINRA explains that it has proposed exceptions for de minimis contributions and returned contributions that are consistent with similar exceptions in the SEC Payto-Play Rule as FINRA’s proposed rules must impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers. FINRA does not believe that raising the limits for the de minimis exception or eliminating the limit for returned contributions would satisfy the Commission’s stringency requirements set forth in the SEC Payto-Play Rule. 284 See FSI Letter and FSI Letter 2. FINRA explains that the Commission did not exempt application of the rule for firms engaged in the independent business model. See FINRA Response Letter 2 at 16. As a result, in FINRA’s view, excluding independent business model firms from its proposed rule would not satisfy the Commission’s stringency requirements, although FINRA is willing to work with the industry and Commission to address the interpretive questions and provide additional guidance as needed. 285 See FSI Letter 1. In response, FINRA explains that the Commission did not apply its rule only to contracts or accounts opened after the effective date of the rule; therefore, FINRA does not believe that limiting the application of its rule in the way suggested by FSI would satisfy the Commission’s stringency requirements set forth in the SEC Payto-Play Rule. However, FINRA also explains that, if the Commission approves the proposed rule change, proposed Rule 2030(a) will not be triggered by contributions made prior to the rule’s effective date, and that the rule will not apply to contributions made prior to the effective date by new covered associates to which the two years or, as applicable, six months ‘‘look back’’ applies. See Notice, 80 FR at 81656. 286 See, e,g., FINRA Response Letter 2 at 4, 16. 287 See Notice, 80 FR at 81650 n.6, 81656. See also 17 CFR 275.206(4)–5(a)(2)(i)(A). E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices mstockstill on DSK3G9T082PROD with NOTICES includes a FINRA member firm, provided that: (a) FINRA rules prohibit member firms from engaging in distribution or solicitation activities if political contributions have been made; and (b) the Commission finds, by order, that such rules impose substantially equivalent or more stringent restrictions on member firms than the SEC Pay-toPlay Rule imposes on investment advisers and that such rules are consistent with the objectives of the SEC Pay-to-Play Rule.288 Thus, any changes to the proposed rules that would result in FINRA’s rules not being found to impose at least substantially equivalent restrictions on its member firms and to be otherwise consistent with the objectives of the SEC Pay-to-Play Rule would result in a ban on such activity. The Commission believes that it is appropriate and consistent with Section 15A(b)(6) of the Act for FINRA to design its proposed rules to have the same scope and provisions as the SEC Pay-toPlay Rule. If the Commission were unable to make the required stringency finding, this would result in FINRA member firms not being a ‘‘regulated person’’ under the SEC Pay-to-Play Rule and therefore prohibited from receiving compensation for engaging in distribution and solicitation activities with government entities on behalf of investment advisers.289 One commenter states that the proposal is ambiguous regarding the term ‘‘distribution’’ activities in Rule 2030(a).290 This term in FINRA’s proposed rule is taken directly from the definition of ‘‘regulated person’’ in the SEC Pay-to-Play Rule.291 Although the term ‘‘distribution’’ is not defined specifically in the SEC Pay-to-Play Rule, to preserve the identified benefits of the rule, the Commission interprets the term broadly in the context of the SEC Payto-Play Rule to mean generally engaging in any activity that is primarily intended to result in the sale of securities.292 In view of the 288 See Notice, 80 FR at 81650 n.6. See also SEC Pay-to-Play Rule 206(4)–5(f)(9). The definition of ‘‘regulated person’’ also includes SEC-registered investment advisers and SEC-registered municipal advisors, subject to specified conditions. 289 See Notice, 80 FR at 81650 n.6. See also id. at 81651, 81656 (discussing the regulatory objectives of and statutory basis for the proposal). 290 See CAI Letter 1. 291 A ‘‘regulated person,’’ as defined in the SEC Pay-to-Play Rule, includes a FINRA member firm, provided that, among other things, FINRA rules ‘‘prohibit member firms from engaging in distribution or solicitation activities if certain political contributions have been made.’’ 17 CFR 275.206(4)–5(f)(9)(ii) (emphasis added). 292 By way of example in other contexts, the Commission has recognized that, because new distribution activities may continuously evolve in the future, it would be impracticable to develop, for VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 Commission’s prior statements regarding the term, including those contained in the SEC Pay-to-Play Rule Adopting Release,293 we believe the term is not ambiguous and could be applied by FINRA members for purposes of the proposed rule in a way that is consistent with the prophylactic nature of the proposal. However, we note that in connection with adopting the SEC Pay-to-Play Rule, the Commission did clarify under what circumstances distribution payments would violate the SEC’s Pay-to-Play Rule.294 For example, the Commission explained that mutual fund distribution fees are typically paid by the fund from fund assets pursuant to a 12b–1 plan and generally would not constitute payment by the fund’s adviser; therefore, such payments would not be prohibited under Rule 206(4)–5.295 The Commission also explained that where an adviser pays for the fund’s distribution out of its ‘‘legitimate profits,’’ the rule would generally be implicated.296 Based on the foregoing, we believe it is appropriate for FINRA not to have specifically defined the term ‘‘distribution’’ activities for purposes of its proposal. One commenter claims that, among other things, the ‘‘lack of clarity as to the application of the SEC Pay-to-Play Rule to [its] members’ business model, and the scope of government officials that trigger the requirements, has led some firms to adopt aggressive compliance programs that prohibit political contributions.’’ 297 As discussed above, FINRA states that, example, an all-inclusive definition or list of such activities and related expenses, and declined to do so when it adopted the SEC Pay-to-Play Rule. See Bearing of Distribution Expenses by Mutual Funds, Investment Company Act Release No. 11414 (Oct. 28, 1980), 45 FR 73898, 73903 (Nov. 7, 1980) (‘‘Rule 12b–1 Adopting Release’’). See also 17 CFR.12b– 1(a)(2) (explaining, in the context of registered open-end funds, that one will be deemed to be acting as a distributor of securities if they engage in ‘‘any activity which is primarily intended to result in the sale of shares issued by such [fund], including, but not necessary limited to, the compensation of underwriters, dealers and other sales personnel, the printing and mailing of prospectuses to other than current shareholders, and the printing and mailing of sales literature’’). 293 See infra notes 294–296 and accompanying text. 294 See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298. See also FINRA Response Letter 2 at 12 (citing Notice, 80 FR at 81660–61). 295 See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298 (citing Rule 12b–1 Adopting Release). 296 See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 (citing Rule 12b–1 Adopting Release). 297 See FSI Letter 1 (claiming FSI believes that the SEC Pay-to-Play Rule has inadvertently captured non-corrupting activity and it fears that the proposed rule may do the same). PO 00000 Frm 00092 Fmt 4703 Sfmt 4703 60067 consistent with the SEC Pay-to-Play Rule, it has determined not to except from its proposed pay-to-play rule member firms that use an independent business model.298 We note that FINRA’s rules and the federal securities laws do not distinguish so-called independent business model firms from other broker-dealer business models.299 Rather, although a broker-dealer may organize its operations under a variety of business models, and different business models may present unique compliance challenges, it is up to the broker-dealer to sufficiently discharge its regulatory obligations in light of the business model it has elected, and to tailor its supervisory system appropriately so that it is reasonably designed 300 to achieve compliance with applicable federal securities laws and regulations and FINRA rules.301 We also note that FINRA has committed to working with the industry and the Commission to address interpretive questions that may arise regarding the application and scope of the provisions and terms used in the proposed rule change and to provide additional guidance as needed.302 298 See FINRA Response Letter 2 at 18. a firm may accept independent contractor status for purposes other than the federal securities laws, such treatment does not alter such person’s status as a person associated with a broker or dealer or the firm’s responsibility to supervise under the federal securities laws. See, e.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1572–76 (9th Cir. 1990) (en banc) (explaining that, even if a broker-dealer and registered representative contractually agree that a representative is an independent contractor, the broker-dealer is still required to supervise its representatives). 300 See FINRA Rule 3110(a) (‘‘Each member shall establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations and with applicable FINRA rules.’’) and Exchange Act Section 15(b)(4)(E), 15 U.S.C. 78o(b)(4)(E) (authorizing the Commission to sanction a brokerdealer that ‘‘has failed reasonably to supervise, with a view to preventing violations of’’ the federal securities laws and rules and regulations thereunder). 301 Giving guidance on its supervision rule, FINRA (then-NASD) noted that to fulfill its obligations to establish and maintain a supervisory system, a member firm must determine the types of business it conducts, how the firm is organized and operated, and the current regulatory requirements. See NASD Notice to Members 99–45 (NASD Provides Guidance on Supervisory Responsibilities) (June 1999) (stating that this analysis will enable the member to design a supervisory system that is current and appropriately tailored to its specific attributes and structure). See also FINRA Regulatory Notice 14–10 (SEC Approves New Supervision Rules) (Mar. 2014), at 17 n.4 (discussing NASD Notice to Members 99–45). 302 See FINRA Response Letter 2 at 18. We note that the proposed rule does contain a provision— modeled on an analogous provision in the SEC Payto-Play Rule—allowing member firms to apply to FINRA for an exemption, conditional or 299 While E:\FR\FM\31AUN1.SGM Continued 31AUN1 60068 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices C. Comments Requesting Clarification of Terms and Provisions in the Proposal mstockstill on DSK3G9T082PROD with NOTICES Commenters asked for clarification of certain defined terms and provisions in the proposed rule, including clarification with respect to: The term ‘‘instrumentality’’ as it is used in the definition of ‘‘government entity;’’ 303 the definition of ‘‘covered associate’’ and the positions that would qualify someone as a covered ‘‘official;’’ 304 whether a ‘‘contribution’’ is also a ‘‘payment;’’ 305 and the factors by which contributions to a PAC would trigger the proposed anti-circumvention rule.306 In response to these comments, FINRA generally acknowledges, as did the commenters, that these terms are defined in the SEC Pay-to-Play Rule and that FINRA modeled the definitions in its proposal on those in the SEC Pay-toPlay Rule.307 The Commission believes that FINRA’s definition of ‘‘covered associate’’ in proposed Rule 2030(g) is functionally identical to the definition of the same term in the SEC Pay-to-Play Rule.308 The definition brings within the ambit of the rule—and its two-year ‘‘time-out’’—only those contributions made by employees of a member firm who, by virtue of their position or responsibilities, are best positioned to engage in pay-to-play activities as placement agents. It includes ‘‘[a]ny general partner, managing member or executive officer of a covered member,’’ any ‘‘associated person of a covered member who engages in distribution or solicitation activities with a government entity for such covered member,’’ any associated person who supervises such an employee, and any ‘‘political action committee controlled by a covered member or a covered associate.’’ FINRA’s rule also adopts the Commission’s definition of ‘‘executive officer,’’ which was designed to tailor the trigger for the time-out to those officers whose position is most likely to incentivize them to engage in solicitation or distribution activities— and thus most likely to incentivize them to engage in pay-to-play.309 unconditional, from the proposed rule’s two-year ‘‘time-out,’’ and enumerates factors for FINRA to consider in deciding whether to grant such an exemption. See Proposed Rule 2030(f). 303 See CAI Letter 1. 304 See NAIFA Letter. 305 See CAI Letter 1. 306 See NAIFA Letter. 307 See FINRA Response Letter 2 at 17, 18. 308 Compare Proposed Rule 2030(g)(2), with 17 CFR 275.206(4)–5(f)(2). 309 At least one commenter points out that some entities have precluded all employees from making contributions as a result of the Commission’s payto-play rule and that FINRA’s rule will have the VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 FINRA’s definition of ‘‘official’’ also tracks the Commission’s definition of that same term in the SEC Pay-to-Play Rule and, therefore, limits the rule so that a time-out is triggered only by contributions to certain officials.310 Under FINRA’s proposed rule, the timeout for a placement agent is not triggered by a contribution to every public official running for office; it is triggered only by contributions to a person ‘‘who was, at the time of the contribution, an incumbent, candidate or successful candidate for elective office of a government entity, if the office . . . [i]s directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser by a government entity’’ or a person with authority to appoint someone whose office had the hiring responsibility.311 FINRA’s definition, like the Commission’s, is flexible enough to accommodate the myriad State and local political structures while still limiting the reach of the rule to those officials who are responsible for or have authority to appoint any person who is responsible for or can influence the outcome of the hiring of an investment adviser by a government entity.312 Additionally, FINRA’s definitions of ‘‘contribution’’ and ‘‘payment’’ are functionally identical to those same definitions in the SEC Pay-to-Play Rule.313 We note that under FINRA’s rule, the time-out is not triggered by direct contributions to political parties. Therefore, a member firm will not violate the time-out if it receives compensation for solicitation and distribution activities in the wake of contributions that it or its covered associates make to a political party. Instead, FINRA’s proposed rule only precludes a covered member from same effect. See FSI Letter 2. However, under FINRA’s rule (and the SEC Pay-to-Play Rule), only certain employees’ contributions will trigger the time-out and the rules on their face do not cover contributions by all employees. See SEC Pay-to-Play Rule Adopting Release, 75 FR at 40131–32. 310 Compare Proposed Rule 2030(g)(8), with 17 CFR 275.206(4)–5(f)(6). 311 See supra note 310. 312 If FINRA were to define ‘‘official’’ by reference to a particular title, such as ‘‘Comptroller,’’ the definition would be both over- and underinclusive. Some officials who have hiring responsibility for investment advisers do not hold the title of ‘‘Comptroller,’’ and some officials with the title of ‘‘Comptroller’’ do not have hiring responsibility for investment advisers. Because we understand FINRA’s definition to track the definition that we adopted in the SEC Pay-to-Play Rule, we note that it is the scope of authority of the office, not de facto influence, that determines whether a contribution will trigger the time-out. See SEC Pay-to-Play Adopting Release, 75 FR at 41029. 313 Compare Proposed Rules 2030(g)(8)–(9), with 17 CFR 275.206(4)–5(f)(1), 206(4)–5(f)(7). PO 00000 Frm 00093 Fmt 4703 Sfmt 4703 soliciting or coordinating payments to a political party of a State or locality of a government entity with which the covered member is engaging in distribution or solicitation activities on behalf of an investment adviser.314 FINRA notes in response to a commenter’s request for clarification as to whether each and every ‘‘contribution’’ (as defined in proposed FINRA Rule 2030(g)(1)) is, by definition, also a ‘‘payment’’ (as defined in proposed FINRA Rule 2030(g)(9)), that the definition of ‘‘payment’’ is similar to the definition of ‘‘contribution,’’ but is broader in the sense that it does not include limitations on the purposes for which such money is given (e.g., it does not have to be made for the purpose of influencing an election).315 The Commission believes that FINRA’s definitions, which mirror or are functionally equivalent to similar definitions in the SEC’s Pay-to-Play Rule, will help to achieve the objectives of the SEC Pay-to-Play Rule and, as described above, the requirements governing the rules of a registered national securities association.316 The Commission believes that it is appropriate and consistent with the Act for FINRA to encompass in its rule the same definitions and discussion regarding its pay-to-play rules as the Commission did in adopting the SEC Pay-to-Play Rule. The Commission emphasizes that FINRA has committed to working with the industry and the Commission to address interpretive questions and provide additional guidance as needed.317 314 See Proposed Rule 2030(b). This aspect of the rule serves an anti-circumvention function, along with proposed Rule 2030(e), which makes it a violation of the rule ‘‘for any covered member or any of its covered associates to do anything indirectly that, if done directly, would result in a violation of this Rule.’’ As FINRA notes, Rule 2030(e) precludes only intentional efforts to circumvent the time-out and a covered member would not violate the rule’s prohibition on the receipt of compensation unless there is a showing that the covered member intended to evade the time-out. Thus, a contribution to a PAC—other than a PAC controlled by the covered member, which would be a ‘‘covered associate’’ for purposes of the time-out—would not trigger the time-out and the receipt of compensation in the wake of that contribution would not violate the rule unless it can be shown that the covered member or covered associate who made the contribution intended to circumvent the time-out provision. This provision, which is analogous to a provision in the Commission’s Pay-to-Play Rule, precludes a member or its covered associates from, for example, funneling contributions or payments through third parties, such as attorneys, family members, or friends, to complete a pay-to-play arrangement without triggering the time-out. 315 See FINRA Response Letter 2 at 17. 316 See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41042–44. 317 There are several ways for industry members to obtain guidance from FINRA about the E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices mstockstill on DSK3G9T082PROD with NOTICES D. Comments Regarding the Books and Records Requirements One commenter claims that not all payments to political parties or PACs should have to be maintained under the books and records requirements of proposed Rule 4580.318 In response, FINRA states that it has determined to retain the recordkeeping requirements as proposed in the Notice.319 FINRA notes that, as discussed in the Notice, payments to political parties or PACs can be a means for a covered member or covered associate to funnel contributions to a government official without directly contributing.320 FINRA states that it proposed requiring a covered member to maintain a record of all payments to political parties or PACs because such records would assist FINRA in identifying situations that might suggest an intent to circumvent the rule.321 The Commission acknowledges the comment, but agrees, as noted by FINRA, that payments to political parties or PACs can be a means for a covered member or covered associate to application of its rules. Such guidance may include FINRA’s publication of Notices to Members and Regulatory Notices, as well as interpretative and exemptive letters. Although FINRA can address interpretive questions with respect to its own rules, for its member firms to satisfy the ‘‘regulated person’’ definition in the SEC Pay-to-Play Rule, the Commission must find that FINRA’s pay-to-play rule (i) imposes substantially equivalent or more stringent restrictions on member firms than the SEC Pay-to-Play Rule imposes on investment advisers and (ii) that such rule is consistent with the objectives of the SEC Pay-to-Play Rule. See supra note 22 (discussing the Commission’s notice of stringency findings dated August 25, 2016). Given the stringency requirements of the SEC Pay-to-Play Rule, we expect our staff to work closely with FINRA regarding interpretive questions about the application and scope of the provisions and terms used in FINRA’s rule to the extent those interpretations do not otherwise require FINRA to file a proposed rule change with the Commission pursuant to Section 19(b) of the Act and the rules and regulations thereunder. 318 See CAI Letter 1. 319 See FINRA Response Letter 2 at 20–21. 320 See id. As FINRA explains in the Notice, a covered associate would include a PAC controlled by the covered member or any of its associates. FINRA states that it would consider a covered member or its covered associates to have ‘‘control’’ over a PAC if the covered member or covered associate has the ability to direct or cause the direction of governance or operations of the PAC. See Notice, 80 FR at 81653, 81660 (noting that this position is consistent with the position taken by the Commission in connection with the SEC Pay-toPlay Rule) (citing SEC Pay-to-Play Adopting Release, 75 FR at 41032). 321 See FINRA Response Letter 2 at 20. FINRA states in the Notice that the proposed recordkeeping requirements are intended to allow FINRA to examine for compliance with its proposed pay-toplay rule, and the reference to indirect contributions in proposed Rule 4580(a)(4) is intended to include records of contributions or payments a covered member solicits or coordinates another person or PAC to make under proposed Rule 2030(b). See Notice, 80 FR at 81663. VerDate Sep<11>2014 21:59 Aug 30, 2016 Jkt 238001 contribute indirectly to a government official in contravention of the proposed rule. The Commission also agrees that requiring FINRA members to maintain a record of all payments to political parties or PACs would assist FINRA in identifying situations that might suggest an intent to violate proposed Rules 2030(b) and 2030(e).322 The Commission therefore believes that it is appropriate and consistent with the Act for FINRA to require its members to keep records of all such payments to assist FINRA in carrying out its regulatory responsibilities to enforce compliance with the Act and with FINRA’s rules.323 E. Additional Comments Certain commenters also suggested that FINRA should include more stringent requirements in its proposed rule.324 Both commenters suggested that FINRA expand the applicability of its proposed rules to include stateregistered investment advisers.325 In response, FINRA explains that to remain consistent with the SEC Pay-to-Play Rule, FINRA has determined not to expand the scope of the proposed rule as suggested by commenters to include state-registered investment advisers.326 The Commission acknowledges this comment but believes that it is appropriate for FINRA to determine to provide for the same scope of its payto-play rule as that of the SEC Pay-toPlay Rule. As FINRA notes, the Commission previously declined to make a similar change to the SEC Payto-Play Rule stating, among other things, that it was the Commission’s understanding that few of these smaller state-registered firms manage public pension plans or other similar funds.327 322 We note that proposed Rule 2030(e) would require a showing of intent to circumvent the rule for such persons to trigger the two-year ‘‘time-out.’’ See Notice, 80 FR at 81654. See also SEC Pay-toPlay Rule Adopting Release, 75 FR at 41044 n.340 (explaining that like MSRB Rule G–37(d), SEC Payto-Play Rule 206(4)–5(d) also ‘‘requires a showing of intent to circumvent the rule for such persons to trigger the time out’’) (citing Blount, 61 F.3d at 948 (‘‘In short, according to the SEC, the rule restricts such gifts and contributions only when they are intended as end-runs around the direct contribution limitations.’’)). 323 Section 15A(b)(2) of the Act requires, among other things, that a registered national securities association, such as FINRA, has the capacity to enforce compliance by its members and persons associated with its members with the provisions of the Act, the rules and regulations thereunder, and the rules of the association. See 15 U.S.C. 78o– 3(b)(2). 324 See NASAA Letter and PIABA Letter. 325 See NASAA Letter and PIABA Letter. 326 See FINRA Response Letter 2 at 10. 327 See Notice, 80 FR at 81652 n.26, 81660 n.98. See also SEC Pay-to-Play Rule Adopting Release, 75 FR at 41026, 41060. The Commission also explained in connection with the SEC Pay-to-Play PO 00000 Frm 00094 Fmt 4703 Sfmt 4703 60069 These same commenters suggest that FINRA include a mandatory disgorgement provision for violations of its proposed rule.328 In response, FINRA explains that it determined not to include a disgorgement requirement in its proposal because it has existing authority to require disgorgement of fees in enforcement actions.329 The Commission believes that it is appropriate and consistent with the Act for FINRA not to separately require mandatory disgorgement for violations of its proposed rules. Finally, one of these commenters suggests that the current two-year cooling-off period in the proposal should be at least four years.330 In response, FINRA states that it believes a two-year time-out from the date of a contribution is sufficient to discourage covered members from participating in pay-to-play practices by requiring a cooling-off period during which the effects of a quid pro quo political contribution on the selection process can be expected to dissipate.331 In addition, FINRA explains that the proposed two-year time-out is consistent with the time-out period in the SEC’s Pay-to-Play Rule. The Commission believes that it is appropriate and consistent with the Act for FINRA to determine that a two-year time-out is sufficient to support the objective of the rule to deter pay-to-play activity among its covered members. The Commission notes that the same time period applies in the SEC’s Pay-toPlay Rule. The Commission recognizes these commenters suggest that the rule could have a broader scope. The Commission, however, must evaluate the proposed rule before it and approve a proposed rule if it finds that the proposed rule is consistent with the requirements of the Act and the applicable rules and regulations thereunder. As discussed above, because the rule is consistent with the Act, the Commission is required to approve the FINRA rule. Rule that we do not have regulatory authority to oversee the activities of state-registered advisers through examination and our recordkeeping rules, nor does the Commission have authority over the states to oversee their enforcement of their rules. See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41026, 41060. 328 See NASAA Letter and PIABA Letter. 329 See FINRA Response Letter 2 at 19–20. 330 See PIABA Letter. 331 See FINRA Response Letter 2 at 10. As the Commission explained, the two-year ‘‘cooling-off period’’ is not a penalty but, rather, is intended to be a period during which any effects of a quid pro quo are expected to dissipate. See SEC Pay-to-Play Adopting Release, 75 FR at 41026 n.104. E:\FR\FM\31AUN1.SGM 31AUN1 60070 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices V. Conclusion Accordingly, for the reasons discussed above, the Commission finds that the proposed rule change is consistent with the Act and the rules and regulations thereunder applicable to such organization. It is therefore ordered, pursuant to Section 19(b)(2) of the Act,332 that the proposed rule change (SR–FINRA– 2015–056) be, and hereby is, approved. By the Commission. Brent J. Fields, Secretary. [FR Doc. 2016–20888 Filed 8–30–16; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–78696; File No. SR– BatsEDGX–2016–50] Self-Regulatory Organizations; Bats EDGX Exchange, Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule Change To Amend Rule 19.6, Series of Options Contracts Open for Trading, To Allow Wednesday Expirations for SPY Options August 26, 2016. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that, on August 25, 2016, Bats EDGX Exchange, Inc. (the ‘‘Exchange’’ or ‘‘EDGX’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I and II below, which Items have been prepared by the Exchange. The Exchange has designated this proposal as a ‘‘noncontroversial’’ proposed rule change pursuant to Section 19(b)(3)(A) of the Act 3 and Rule 19b–4(f)(6) thereunder,4 which renders it effective upon filing with the Commission. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. mstockstill on DSK3G9T082PROD with NOTICES I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange filed a proposal to amend Rule 19.6, entitled ‘‘Series of Options Contracts Open for Trading,’’ related to the Short Term Option Series (‘‘STOS’’) Program to allow Wednesday expirations for SPY options. The 332 15 U.S.C. 78s(b)(2). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 15 U.S.C. 78s(b)(3)(A). 4 17 CFR 240.19b–4(f)(6). 1 15 VerDate Sep<11>2014 21:59 Aug 30, 2016 Exchange also proposes to make corresponding changes to Rule 16.1, entitled ‘‘Definitions.’’ The text of the proposed rule change is available at the Exchange’s Web site at www.batstrading.com, at the principal office of the Exchange, and at the Commission’s Public Reference Room. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in Sections A, B, and C below, of the most significant parts of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose The purpose of the proposed rule change is to harmonize the Exchange’s rules with the rules governing Short Term Options Series programs of other options exchanges. Specifically, the Exchange proposes to amend Rule 19.6, entitled ‘‘Series of Options Contracts Open for Trading,’’ related to the STOS Program to allow Wednesday expirations for SPY options. The Exchange also proposes to make certain corresponding changes to 16.1, entitled ‘‘Definitions.’’ The proposed rule change is based on the recent approval of a filing submitted by the BOX Options Exchange LLC (‘‘BOX’’).5 Currently, under the STOS Program, the Exchange may open for trading on any Thursday or Friday that is a business day series of options on that class that expire on each of the next five Fridays, provided that such Friday is not a Friday in which monthly options series or Quarterly Options Series expire (‘‘Short Term Option Series’’). The Exchange is now proposing to amend its rule to permit the listing of options expiring on Wednesdays. Specifically, the Exchange is proposing that it may open for trading on any Tuesday or Wednesday that is a business day, series of options on the SPDR S&P 500 ETF Trust (‘‘SPY’’) to expire on any Wednesday of the month that is a 5 See Securities and Exchange Act Release No. 78668 (August 24, 2016) (SR–BOX–2016–28). Jkt 238001 PO 00000 Frm 00095 Fmt 4703 Sfmt 4703 business day and is not a Wednesday in which Quarterly Options Series expire (‘‘Wednesday SPY Expirations’’).6 The proposed Wednesday SPY Expiration series will be similar to the current Short Term Option Series, with certain exceptions, as explained in greater detail below. The Exchange notes that having Wednesday expirations is not a novel proposal. Specifically, the Chicago Board Options Exchange, Incorporated (‘‘CBOE’’) recently received approval to list Wednesday expirations for broad-based indexes.7 In regards to Wednesday SPY Expirations, the Exchange is proposing to remove the current restriction preventing it from listing Short Term Option Series that expire in the same week in which monthly option series in the same class expire. Specifically, the Exchange will be allowed to list Wednesday SPY Expirations in the same week in which monthly option series in SPY expire. The current restriction to prohibit the expiration of monthly and Short Term Option Series from expiring on the same trading day is reasonable to avoid investor confusion. This confusion will not apply with Wednesday SPY Expirations and standard monthly options because they will not expire on the same trading day, as standard monthly options do not expire on Wednesdays. Additionally, it would lead to investor confusion if Wednesday SPY Expirations were not listed for one week every month because there was a monthly SPY expiration on the Friday of that week. Under the proposed Wednesday SPY Expirations, the Exchange may list up to five consecutive Wednesday SPY Expirations at one time. The Exchange may have no more than a total of five Wednesday SPY Expirations listed. This is the same listing procedure as Short Term Option Series that expire on Fridays. The Exchange is also proposing to clarify that the five series limit in the current Short Term Option Series Program Rule will not include any Wednesday SPY Expirations.8 This means, under the proposal, the Exchange would be allowed to list five Short Term Option Series expirations for SPY expiring on Friday under the current rule and five Wednesday SPY Expirations. The interval between strike prices for the proposed Wednesday SPY Expirations will be the same as those for the current Short Term Option Series. 6 See proposed paragraph (g) of Interpretation and Policy .05 to Rule 19.6. 7 See Securities Exchange Act Release No. 76909 (January 14, 2016), 81 FR 3512 (January 21, 2016) (SR–CBOE–2015–106). 8 See proposed changes to Interpretation and Policy .05 to Rule 19.6. E:\FR\FM\31AUN1.SGM 31AUN1

Agencies

[Federal Register Volume 81, Number 169 (Wednesday, August 31, 2016)]
[Notices]
[Pages 60051-60070]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-20888]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-78683; File No. SR-FINRA-2015-056]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving a Proposed Rule Change To Adopt FINRA 
Rule 2030 and FINRA Rule 4580 To Establish ``Pay-To-Play'' and Related 
Rules

August 25, 2016.

I. Introduction

    On December 16, 2015, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to adopt FINRA Rules 2030 
(Engaging in Distribution and Solicitation Activities with Government 
Entities) and 4580 (Books and Records Requirements for Government 
Distribution and Solicitation Activities) to establish ``pay-to-play'' 
\3\ and related rules that would regulate the activities of member 
firms that engage in distribution or solicitation activities for 
compensation with government entities on behalf of investment advisers. 
Member firms serving this role--sometimes referred to as ``placement 
agents'' or ``solicitors'' (collectively referred to herein as 
``placement agents'')--assist investment advisers with obtaining 
advisory business from such entities. In this context, pay-to-play has 
historically presented a problem, including when investment advisers 
retain placement agents who have made contributions to government 
officials who are responsible for, or can influence the outcome of, the 
selection process for investment advisers. When investment advisers are 
chosen on the basis of a placement agent's political contributions, 
rather than on, for example, the adviser's merit, performance, or 
costs, the market and selection process for advisers becomes distorted. 
Ultimately, pay-to-play harms investors and the public interest if 
government entities, including public pension plans, and their 
beneficiaries receive inferior services or pay higher fees.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ ``Pay-to-play practices,'' ``play-to-play arrangements'' or 
``play-to-play activities,'' as referred to throughout this order, 
typically involve a person making cash or in-kind political 
contributions (or soliciting or coordinating others to make such 
contributions) to help finance the election campaigns of state or 
local officials or bond ballot initiatives as a quid pro quo for the 
receipt of government contracts.
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    The proposed rule change was published for comment in the Federal 
Register on December 30, 2015.\4\ The Commission received ten comment 
letters, from nine different commenters, in response to the Notice.\5\ 
On February 8, 2016, FINRA extended the time period by which the 
Commission must approve the proposed rule change, disapprove the 
proposed rule change, or institute proceedings to determine whether to 
approve or disapprove the proposed rule change to March 29, 2016.\6\ On 
March 28, 2016, FINRA filed a letter with the Commission stating that 
it considered the comments received by the Commission in response to 
the Notice, and that FINRA is not intending to make changes to the 
proposed rule text in response to the comments.\7\
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    \4\ See Exchange Act Rel. No. 76767 (Dec. 24, 2015), 80 FR 81650 
(Dec. 30, 2015) (File No. SR-FINRA-2015-056) (``Notice'').
    \5\ See Letters from David Keating, President, Center for 
Competitive Politics (``CCP''), dated Jan. 20, 2016 (``CCP Letter 
1''); Clifford Kirsch and Michael Koffler, Sutherland Asbill & 
Brennan LLP, for the Committee of Annuity Insurers (``CAI''), dated 
Jan. 20, 2016 (``CAI Letter 1''); Clifford Kirsch and Michael 
Koffler, Sutherland Asbill & Brennan LLP, for the CAI, dated Feb. 5, 
2016 (``CAI Letter 2''); David T. Bellaire, Executive Vice President 
and General Counsel, Financial Services Institute (``FSI''), dated 
Jan. 20, 2016 (``FSI Letter 1''); Tamara K. Salmon, Assistant 
General Counsel, Investment Company Institute (``ICI''), dated Jan. 
20, 2016 (``ICI Letter''); Patrick J Moran, Esq., dated Dec. 29, 
2015 (``Moran Letter''); Gary A. Sanders, Counsel and Vice 
President, National Association of Insurance and Financial Advisors 
(``NAIFA''), dated Jan. 20, 2016 (``NAIFA Letter''); Judith M. Shaw, 
President, North American Securities Administrators Association, 
Inc. (``NASAA''), dated Jan. 20, 2016 (``NASAA Letter''); Hugh D. 
Berkson, President, Public Investors Arbitration Bar Association 
(``PIABA''), dated Jan. 20, 2016 (``PIABA Letter''); and H. 
Christopher Bartolomucci and Brian J. Field, Bancroft PLLC, for the 
New York Republican State Committee and the Tennessee Republican 
Party (``State Parties''), dated Jan. 20, 2016 (``State Parties 
Letter 1''). The comment letters filed with the Commission in 
connection with the proposed rule change are available at: http://www.sec.gov/comments/sr-finra-2015-056/finra2015056.shtml.
    \6\ See Letter from Victoria Crane, Associate General Counsel, 
FINRA, to Lourdes Gonzalez, Assistant Chief Counsel--Sales 
Practices, Division of Trading and Markets, Commission, dated Feb. 
8, 2016.
    \7\ See Letter from Victoria Crane, Associate General Counsel, 
FINRA, to Brent J. Fields, Secretary, Commission, dated Mar. 28, 
2016 (``FINRA Response Letter 1'').
---------------------------------------------------------------------------

    On March 29, 2016, pursuant to delegated authority, the Commission 
issued an order instituting proceedings pursuant to Section 19(b)(2)(B) 
of the Act \8\ to determine whether to approve or disapprove the 
proposed rule change,

[[Page 60052]]

and solicited additional comment.\9\ The Commission received an 
additional four comments regarding the proceedings,\10\ including two 
letters requesting an opportunity to make an oral presentation in the 
proceedings.\11\ On July 6, 2016, FINRA submitted a letter responding 
to all comments and to the Order Instituting Proceedings.\12\ On June 
21, 2016, FINRA extended the time period by which the Commission must 
determine whether to approve or disapprove the proposed rule change to 
August 26, 2016.\13\
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    \8\ 15 U.S.C. 78s(b)(2)(B).
    \9\ See Securities Exchange Act Release No. 77465 (Mar. 29, 
2016), 81 FR 19260 (Apr. 4, 2016) (``Order Instituting 
Proceedings'').
    \10\ See Letters from David T. Bellaire, Executive Vice 
President and General Counsel, FSI, dated Apr. 27, 2016 (``FSI 
Letter 2''); Jason Torchinsky, Holtzman Vogel Josefiak Torchinsky 
PLLC, on behalf of the Georgia Republican Party and the State 
Parties, dated April 12, 2016, filed April 21, 2016 (``State Parties 
Letter 2''); Allen Dickerson, Legal Director, CCP, dated April 21, 
2016 (``CCP Letter 2''); Allen Dickerson, Legal Director, CCP, dated 
April 15, 2016 (``CCP Letter 3'').
    \11\ See CCP Letter 2; State Parties Letter 2. The Commission 
denied both requests. See Letter from Brent J. Fields, Secretary, 
Commission, to Allen Dickerson, Legal Director, CCP dated July 11, 
2016; Brent J. Fields, Secretary, Commission, to Jason Torchinsky, 
Holtzman Vogel Josefiak Torchinsky PLLC, on behalf the State 
Parties, dated July 11, 2016.
    \12\ See Letter from Victoria Crane, Associate General Counsel, 
FINRA, to Brent J. Fields, Secretary, Commission, dated July 6, 2016 
(``FINRA Response Letter 2''). Both of FINRA's Responses Letters are 
available on FINRA's Web site at http://www.finra.org, at the 
principal office of FINRA, and at the Commission's Public Reference 
Room.
    \13\ See Letter from Victoria Crane, Associate General Counsel, 
FINRA, to Lourdes Gonzalez, Assistant Chief Counsel--Sales 
Practices, Division of Trading and Markets, Commission, dated June 
21, 2016.
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    This order approves the rule change as proposed. Section II 
provides an overview of the rule and summarizes the rule as described 
by FINRA in its filing and as published in the Notice, Section III is a 
summary of the comments received and FINRA's responses, and Section IV 
contains the Commission's findings in approving the proposal.

II. Description of the Proposed Rule Change \14\
---------------------------------------------------------------------------

    \14\ The proposed rule change, as described in Item II, is 
excerpted, in part, from the Notice, which was substantially 
prepared by FINRA. See supra note 4. A more detailed description of 
the proposed rule change is in the Notice.
---------------------------------------------------------------------------

    As described more fully in the Notice, FINRA modeled proposed Rule 
2030 \15\ on the Commission's Rule 206(4)-5 under the Investment 
Advisers Act of 1940 (``Advisers Act''), which addresses pay-to-play 
practices by investment advisers (the ``SEC Pay-to-Play Rule'').\16\ 
The SEC Pay-to-Play Rule, in part, prohibits any investment adviser 
covered under the rule \17\ or any of its covered associates from 
providing or agreeing to provide, directly or indirectly, payment to 
any person to solicit a government entity for investment advisory 
services on behalf of such investment adviser unless such person is a 
``regulated person,'' \18\ as defined under the rule, or an executive 
officer, general partner, managing member, or employee of the 
investment adviser.\19\ A ``regulated person,'' as defined in the SEC 
Pay-to-Play Rule, includes a registered broker-dealer, provided that: 
(a) FINRA rules prohibit member firms from engaging in distribution or 
solicitation activities if certain political contributions have been 
made to certain public officials; and (b) the Commission finds, by 
order, that such rules impose substantially equivalent or more 
stringent restrictions on member firms than the SEC Pay-to-Play Rule 
imposes on investment advisers and that such rules are consistent with 
the objectives of the SEC Pay-to-Play Rule.\20\
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    \15\ See Notice, 80 FR at 81650-51 (citing Advisers Act Release 
No. 3043 (July 1, 2010), 75 FR 41018 (July 14, 2010) (Political 
Contributions by Certain Investment Advisers) (``SEC Pay-to-Play 
Rule Adopting Release'')).
    \16\ FINRA also published the proposed rule change in Regulatory 
Notice 14-50 (Nov. 2014) (``Regulatory Notice 14-50'') and sought 
comment on the proposal. FINRA states that commenters were generally 
supportive of the proposed rule change, but also expressed some 
concerns. As such, FINRA revised the proposed rule change as 
published in Regulatory Notice 14-50 in response to those comments. 
As described more fully in the Notice, FINRA believes that the 
revisions it made more closely align FINRA's proposed rule with the 
SEC Pay-to-Play Rule and should help reduce cost and compliance 
burden concerns raised by commenters. See Notice, 80 FR at 81651 
n.16.
    \17\ The SEC Pay-to-Play Rule applies to investment advisers 
registered or required to be registered with the Commission, foreign 
private advisers that are unregistered in reliance on Section 
203(b)(3) of the Advisers Act, and exempt reporting advisers as 
defined in Rule 204-4(a) under the Advisers Act. See 17 CFR 
275.206(4)-5(a)(2).
    \18\ See Notice, 80 FR at 81650 n.6, 81656. See also 17 CFR 
275.206(4)-5(a)(2)(i)(A).
    \19\ See 17 CFR 275.206(4)-5(a)(2)(i)(B) (or, in each case, a 
person with a similar status or function to an executive officer, 
general partner, or managing member of the investment adviser).
    \20\ See Notice, 80 FR at 81650 n.6 (citing 17 CFR 275.206(4)-
5(f)(9)). The definition of ``regulated person'' also includes SEC-
registered investment advisers and SEC-registered municipal 
advisors, subject to specified conditions. The Commission amended 
the SEC Pay-to-Play Rule to add SEC-registered municipal advisors to 
the definition of ``regulated persons.'' See Rules Implementing 
Amendments to the Investment Advisers Act of 1940, Investment 
Advisers Act Rel. No. 3221 (June 22, 2011), 76 FR 42950 (July 19, 
2011).
---------------------------------------------------------------------------

    In light of this regulatory framework, FINRA proposed its own pay-
to-play rule to enable its member firms to continue to engage in 
distribution and solicitation activities for compensation with 
government entities on behalf of investment advisers, while subjecting 
its member firms to appropriate safeguards that will discourage them 
from engaging in pay-to-play practices.\21\ Because one of the 
objectives of FINRA's proposal is to satisfy the ``regulated person'' 
definition in the SEC Pay-to-Play Rule, the elements of and terms used 
in FINRA's proposal are substantially equivalent to and consistent with 
the objectives of the SEC Pay-to-Play Rule.\22\ As discussed below, 
this threshold objective precludes many of the modifications proposed 
by commenters given that a more permissive FINRA proposal would not 
meet the stringency requirements of the SEC Pay-to-Play Rule. FINRA 
believes that its proposed rule would establish a comprehensive regime 
to regulate the activities of its member firms that engage in 
distribution or solicitation activities with government entities on 
behalf of investment advisers, and would impose substantially 
equivalent restrictions on FINRA member firms engaging in distribution 
or solicitation activities to those that the SEC Pay-to-Play Rule 
imposes on investment advisers.\23\
---------------------------------------------------------------------------

    \21\ See Notice, 80 FR at 81651, 81656.
    \22\ On August 25, 2016, the Commission issued a notice stating 
that it intends to issue an order pursuant to Section 206 of the 
Advisers Act and SEC Pay-to-Play Rule 206(4)-5 finding that FINRA's 
proposed Rule 2030 (i) imposes substantially equivalent or more 
stringent restrictions on broker-dealers than the SEC Pay-to-Play 
Rule imposes on investment advisers and (ii) is consistent with the 
objectives of the SEC Pay-to-Play Rule.
    \23\ See Notice, 80 FR at 81651, 81656.
---------------------------------------------------------------------------

    Furthermore, FINRA's proposed Rule 4580 would impose recordkeeping 
requirements on FINRA member firms in connection with its pay-to-play 
rule that would allow examination of member firms' books and records 
for compliance with Rule 2030.\24\ FINRA believes that proposed Rule 
4580 is consistent with similar recordkeeping requirements imposed on 
investment advisers in connection with the SEC Pay-to-Play Rule.\25\
---------------------------------------------------------------------------

    \24\ See id. at 81651, 81655-56.
    \25\ See id. at 81655 n.60 (citing Advisers Act Rule 204-
2(a)(18) and (h)(1)).
---------------------------------------------------------------------------

    The following is an overview of the key provisions in FINRA's 
proposed rules, as described by FINRA in the Notice.

A. Proposed Rule 2030(a): Limitation on Distribution and Solicitation 
Activities

    Proposed Rule 2030(a) would prohibit a covered member from engaging 
in distribution or solicitation activities for compensation with a 
government entity on behalf of an investment adviser that provides or 
is seeking to provide investment advisory services to such government 
entity within two years after a contribution to an official of the

[[Page 60053]]

government entity is made by the covered member or a covered associate, 
including a person who becomes a covered associate within two years 
after the contribution is made.\26\ FINRA states that the terms and 
scope of the prohibitions in proposed Rule 2030(a) are modeled on the 
SEC Pay-to-Play Rule.\27\ According to FINRA, the two-year time-out 
period is intended to discourage covered members from participating in 
pay-to-play practices by requiring a cooling-off period during which 
the effects of a political contribution on the selection process can be 
expected to dissipate.\28\
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    \26\ See Notice, 80 FR at 81651.
    \27\ See id. at 81651. See also id. at 81651 n.19 (citing 17 CFR 
275.206(4)-5(a)(1)).
    \28\ Notice, 80 FR at 81651, 81659.
---------------------------------------------------------------------------

    The following is an overview of some of the key terms used in 
FINRA's proposed Rule 2030, as discussed by FINRA in its filing and 
published in the Notice or as defined in proposed Rule 2030(g).
1. Covered Members
    The SEC Pay-to-Play Rule includes within its definition of 
``regulated person'' SEC-registered municipal advisors, subject to 
specified conditions.\29\ Specifically, the SEC Pay-to-Play Rule 
prohibits an investment adviser from providing or agreeing to provide, 
directly or indirectly, payment to an SEC-registered municipal advisor 
unless the municipal advisor is subject to a Municipal Securities 
Rulemaking Board (``MSRB'') pay-to-play rule.\30\
---------------------------------------------------------------------------

    \29\ See 17 CFR 275.206(4)-5(a)(2)(i)(A) and 17 CFR 275.206(4)-
5(f)(9).
    \30\ See supra note 29.
---------------------------------------------------------------------------

    FINRA addresses the interplay between its proposed rule and the 
application of the MSRB's municipal advisor pay-to-play rule by 
exempting from the definition of ``covered member'' a member when it is 
``engaging in activities that would cause the member to be a municipal 
advisor as defined in Exchange Act Section 15B(e)(4), SEA Rule 15Ba1-
1(d)(1) through (4) and other rules and regulations thereunder.'' \31\ 
FINRA states that a member firm that solicits a government entity for 
investment advisory services on behalf of an unaffiliated investment 
adviser may be required to register with the SEC as a municipal advisor 
as a result of such activity.\32\ Under such circumstances, FINRA notes 
that the MSRB rules applicable to municipal advisors, including the 
pay-to-play rule adopted by the MSRB,\33\ would apply to the member 
firm.\34\ On the other hand, if the member firm solicits a government 
entity on behalf of an affiliated investment adviser, such activity 
would not cause the firm to be a municipal advisor.\35\ Under such 
circumstances, the member firm would be a ``covered member'' subject to 
the requirements of proposed Rule 2030.\36\ This distinction is the 
result of the definitions of ``municipal advisor'' and ``solicitation 
of a municipal entity or obligated person'' in the Exchange Act, which 
only covers a person who is not affiliated with the broker, dealer, 
municipal securities dealer, municipal advisor, or investment adviser 
for whom the person is soliciting.\37\
---------------------------------------------------------------------------

    \31\ Proposed Rule 2030(g)(4). See also Notice, 80 FR at 81652 
(explaining that the SEC Pay-to-Play Rule includes within its 
definition of ``regulated person'' SEC-registered municipal 
advisors, subject to specified conditions, and prohibits an 
investment adviser from providing or agreeing to provide, directly 
or indirectly, payment to an SEC-registered municipal advisor unless 
the municipal advisor is subject to a MSRB pay-to-play rule).
    \32\ See Notice, 80 FR at 81652.
    \33\ On February 17, 2016, the MSRB published a regulatory 
notice announcing that its pay-to-play rule was deemed approved 
pursuant to section 19(b)(2)(D) of the Exchange Act on February 13, 
2016 and that the effective date of the rule is August 17, 2016. See 
Amendments to MSRB Rule G-37 on Political Contributions and 
Prohibitions on Municipal Securities Business and Related Amendments 
are Deemed Approved under the Securities Exchange Act of 1934, 
Regulatory Notice 2016-06, dated February 17, 2016 (the ``MSRB 
Regulatory Notice''), available at http://www.msrb.org/~/media/
Files/Regulatory-Notices/Announcements/2016-06.ashx?n=1.
    \34\ See Notice, 80 FR at 81652.
    \35\ See id.
    \36\ See id. FINRA also notes that a person that is registered 
under the Exchange Act as a broker-dealer and municipal advisor, and 
under the Advisers Act as an investment adviser could potentially be 
a ``regulated person'' for purposes of the SEC Pay-to-Play Rule and 
that such a regulated person would be subject to the rules that 
apply to the services the regulated person is performing. See id. at 
n.24.
    \37\ Exchange Act Section 15B(e)(4) provides that a ``municipal 
advisor'' includes a person that undertakes solicitation of a 
municipal entity or obligated person. 15 U.S.C. 78o-4(e)(4). 
Exchange Act Section 15B(e)(9) provides that the term ``solicitation 
of a municipal entity or obligated person'' means ``a direct or 
indirect communication with a municipal entity or obligated person 
made by a person, for direct or indirect compensation, on behalf of 
a broker, dealer, municipal securities dealer, municipal advisor, or 
investment adviser (as defined in section 202 of the Investment 
Advisers Act of 1940) that does not control, is not controlled by, 
or is not under common control with the person undertaking such 
solicitation for the purpose of obtaining or retaining an engagement 
by a municipal entity or obligated person of a broker, dealer, 
municipal securities dealer, or municipal advisor for or in 
connection with municipal financial products, the issuance of 
municipal securities, or of an investment adviser to provide 
investment advisory services to or on behalf of a municipal 
entity.'' 15 U.S.C. 78o-4(e)(9).
---------------------------------------------------------------------------

2. Distribution Activities
    With respect to the triggering activities for FINRA's proposed Rule 
2030(a), FINRA states that, based on the definition of ``regulated 
person'' in the SEC Pay-to-Play Rule,\38\ it is proposing a rule that 
prohibits its member firms from engaging in distribution activities (as 
well as solicitation activities) for compensation with government 
entities for two years after certain political contributions have been 
made to certain officials.\39\ FINRA also notes, in response to certain 
comments discussed below, that certain language in the SEC Pay-to-Play 
Rule Adopting Release further supports the inclusion of distribution 
activities by broker-dealers in FINRA's proposed Rule 2030.\40\
---------------------------------------------------------------------------

    \38\ A ``regulated person,'' as defined in the SEC Pay-to-Play 
Rule, includes a FINRA member firm, provided that: (a) FINRA rules 
``prohibit member firms from engaging in distribution or 
solicitation activities if certain political contributions have been 
made;'' and (b) ``[t]he Commission finds, by order, that such rules 
impose substantially equivalent or more stringent restrictions on 
broker-dealers than [the SEC Pay-to-Play Rule] imposes on investment 
advisers and that such rules are consistent with the objectives of 
[the SEC Pay-to-Play Rule].'' 17 CFR 275.206(4)-5(f)(9)(ii).
    \39\ See Notice, 80 FR at 81660-61 (explaining that FINRA 
believes its proposed rule must apply to member firms engaging in 
distribution activities and that FINRA did not revise the proposed 
rule to remove references to the term ``distribution'' as requested 
by comments received in response to Regulatory Notice 14-50).
    \40\ See Notice, 80 FR at 81660. See also id. at 81661 n.103 
(citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298 
where, according to FINRA, the Commission ``clarif[ied] under what 
circumstances distribution payments would violate the SEC's Pay-to-
Play Rule'').
---------------------------------------------------------------------------

    FINRA explains that the proposed rule would not apply to 
distribution activities related to registered investment companies that 
are not investment options of a government entity's plan or program 
because in these circumstances a member firm is not providing or 
seeking to provide investment advisory services to a government 
entity.\41\ Therefore, the proposed rule would apply to distribution 
activities involving unregistered pooled investment vehicles such as 
hedge funds, private equity funds, venture capital funds, collective 
investment trusts, and registered pooled investment vehicles such as 
mutual funds, but only if those registered pools are an investment 
option of a participant-directed plan or program of a government 
entity.\42\ FINRA also notes that, consistent with the SEC Pay-to-Play 
Rule, to the extent mutual fund distribution fees are paid by the fund

[[Page 60054]]

using fund assets pursuant to a 12b-1 plan, such payments generally 
would not constitute payments by the fund's investment adviser.\43\ 
However, if the adviser pays for the fund's distribution out of its 
``legitimate profits,'' the proposed rule would generally be 
implicated.\44\
---------------------------------------------------------------------------

    \41\ See Notice, 80 FR at 81661 n.106 (explaining that, although 
the proposed rule would not apply to distribution activities 
relating to all registered pooled investment vehicles, pursuant to 
proposed Rule 2030(e) ``[i]t shall be a violation of this Rule for 
any covered member or any of its covered associates to do anything 
indirectly that, if done directly, would result in a violation of 
this Rule'').
    \42\ See id. at 81661. See also id. at 81651 n.17 and 81654 
n.46.
    \43\ See id. at 81661 n.103. See also SEC Pay-to-Play Rule 
Adopting Release, 75 FR at 41040 n.298 (discussing how broker-
dealers may be compensated by advisers according to distribution 
arrangements and noting that ``[m]utual fund distribution fees are 
typically paid by the fund pursuant to a 12b-1 plan, and therefore 
generally would not constitute payment by the fund's adviser. As a 
result, such payments would not be prohibited [under the SEC Pay-to-
Play Rule] by its terms'').
    \44\ See Notice, 80 FR at 81661 n.103 (noting, among other 
things, that ``for private funds, third parties are often 
compensated by the investment adviser or its affiliated general 
partner''). For a discussion of a mutual fund adviser's ability to 
use ``legitimate profits'' for fund distribution, see Investment 
Company Act of 1940 Release No. 11414 (Oct. 28, 1980), 45 FR 73898 
(Nov. 7, 1980) (Bearing of Distribution Expenses by Mutual Funds).
---------------------------------------------------------------------------

3. Solicitation Activities
    FINRA states that, consistent with the SEC Pay-to-Play Rule, 
proposed Rule 2030(g)(11) defines the term ``solicit'' to mean:

    (A) With respect to investment advisory services, to 
communicate, directly or indirectly, for the purpose of obtaining or 
retaining a client for, or referring a client to, an investment 
adviser; and (B) With respect to a contribution or payment, to 
communicate, directly or indirectly, for the purpose of obtaining or 
arranging a contribution or payment.\45\
---------------------------------------------------------------------------

    \45\ Notice, 80 FR at 81651 n.18. See also id. at 81653-54 n.40.

    FINRA notes that, although the determination of whether a 
particular communication would be a solicitation would depend on the 
facts and circumstances relating to such communication, as a general 
proposition FINRA believes that any communication made under 
circumstances reasonably calculated to obtain or retain an advisory 
client would be considered a solicitation unless the circumstances 
otherwise indicate that the communication does not have the purpose of 
obtaining or retaining an advisory client.\46\
---------------------------------------------------------------------------

    \46\ See id. at 81651 n.18. See also id. at 81653-54 n.40.
---------------------------------------------------------------------------

4. Investment Advisers
    Proposed Rule 2030 would apply to covered members acting on behalf 
of (as defined in proposed Rule 2030(g)(7)) any investment adviser 
registered (or required to be registered) with the Commission, or 
unregistered in reliance on the exemption available under Section 
203(b)(3) of the Advisers Act for foreign private advisers, or that is 
an exempt reporting adviser under Advisers Act Rule 204-4(a).\47\ Thus, 
proposed Rule 2030 would not apply to member firms acting on behalf of 
advisers that are registered with state securities authorities instead 
of the SEC, or advisers that are unregistered in reliance on exemptions 
other than Section 203(b)(3) of the Advisers Act or Advisers Act Rule 
204-4(a). The proposed rule's definition of ``investment adviser'' is 
consistent with the definition of ``investment adviser'' in the SEC 
Pay-to-Play Rule.\48\
---------------------------------------------------------------------------

    \47\ See Proposed Rule 2030(g)(7).
    \48\ See 17 CFR 275.206(4)-5(a)(1).
---------------------------------------------------------------------------

5. Official of a Government Entity
    FINRA explains that an ``official'' (as defined in proposed Rule 
2030(g)(8)) of a ``government entity'' (as defined in proposed Rule 
2030(g)(7))--both of which FINRA states are consistent with the SEC 
Pay-to-Play Rule definitions--would include an incumbent, candidate or 
successful candidate for elective office of a government entity if the 
office is directly or indirectly responsible for, or can influence the 
outcome of, the hiring of an investment adviser or has authority to 
appoint any person who is directly or indirectly responsible for, or 
can influence the outcome of, the hiring of an investment adviser.\49\ 
FINRA also notes that it is the scope of authority of the particular 
office of an official, not the influence actually exercised by the 
individual, that would determine whether the individual has influence 
over the awarding of an investment advisory contract under the 
definition.\50\ FINRA also explains that government entities would 
include all state and local governments, their agencies and 
instrumentalities, and all public pension plans and other collective 
government funds, including participant-directed plans such as 403(b), 
457, and 529 plans.\51\
---------------------------------------------------------------------------

    \49\ See Notice, 80 FR at 81652.
    \50\ See id. (citing SEC Pay-to-Play Rule Adopting Release, 75 
FR at 41029 (discussing the terms ``official'' and ``government 
entity'').
    \51\ See Notice, 80 FR at 81652.
---------------------------------------------------------------------------

6. Contributions
    Proposed Rule 2030(g)(1) defines ``contribution'' to mean any gift, 
subscription, loan, advance, deposit of money, or anything of value 
made for the purpose of influencing the election for a federal, state 
or local office, and includes any payments for debts incurred in such 
an election or transition or inaugural expenses incurred by a 
successful candidate for state or local office.\52\ FINRA states that 
this definition is consistent with the SEC Pay-to-Play Rule.\53\ FINRA 
also states that it would not consider a donation of time by an 
individual to be a contribution, provided the covered member has not 
solicited the individual's efforts and the covered member's resources, 
such as office space and telephones, are not used.\54\ FINRA further 
states that it would not consider a charitable donation made by a 
covered member to an organization that qualifies for an exemption from 
federal taxation under the Internal Revenue Code, or its equivalent in 
a foreign jurisdiction, at the request of an official of a government 
entity to be a contribution for purposes of the proposed rule.\55\
---------------------------------------------------------------------------

    \52\ See id. at 81652.
    \53\ See id. at 81652 n.32. See also id. at 81653.
    \54\ See id. at 81653 n.33 (citing SEC Pay-to-Play Rule Adopting 
Release, 75 FR at 41030).
    \55\ See Notice, 80 FR at 81653.
---------------------------------------------------------------------------

7. Covered Associates
    Proposed Rule 2030(g)(2) defines the term ``covered associates'' to 
mean:

    (A) Any general partner, managing member or executive officer of 
a covered member, or other individual with a similar status or 
function; (B) Any associated person of a covered member who engages 
in distribution or solicitation activities with a government entity 
for such covered member; (C) Any associated person of a covered 
member who supervises, directly or indirectly, the government entity 
distribution or solicitation activities of a person in subparagraph 
(B) above; and (D) Any political action committee controlled by a 
covered member or a covered associate.\56\
---------------------------------------------------------------------------

    \56\ Id. at 81653 n.37.

    FINRA states that, as also noted in the SEC Pay-to-Play Rule 
Adopting Release, contributions made to influence the selection process 
are typically made not by the firm itself, but by officers and 
employees of the firm who have a direct economic stake in the business 
relationship with the government client.\57\ For example, contributions 
by an ``executive officer of a covered member'' (as defined in proposed 
Rule 2030(g)(5)) would trigger the two-year ``time-out.'' \58\ FINRA 
also notes that whether a person is an executive officer would depend 
on his or her function or activities and not his or her title.\59\ In 
addition, FINRA states that a covered associate would include a PAC 
controlled by the covered member or any of its covered associates.\60\ 
FINRA explains that it would consider a ``covered member'' (as defined 
in proposed Rule 2030(g)(4)) or its covered associates to have 
``control'' over a PAC if the covered member or covered

[[Page 60055]]

associate has the ability to direct or cause the direction of 
governance or operations of the PAC.\61\
---------------------------------------------------------------------------

    \57\ See id. (citing SEC Pay-to-Play Rule Adopting Release, 75 
FR at 41031).
    \58\ See Notice, 80 FR at 81653.
    \59\ See id.
    \60\ See id.
    \61\ See id.
---------------------------------------------------------------------------

B. Proposed Rule 2030(b): Prohibition on Soliciting and Coordinating 
Contributions

    Proposed Rule 2030(b) also would prohibit a covered member or 
covered associate from soliciting or coordinating any person or 
political action committee (``PAC'') to make any: (1) Contribution to 
an official of a government entity in respect of which the covered 
member is engaging in, or seeking to engage in, distribution or 
solicitation activities on behalf of an investment adviser; or (2) 
payment to a political party of a state or locality of a government 
entity with which the covered member is engaging in, or seeking to 
engage in, distribution or solicitation activities on behalf of an 
investment adviser.\62\ FINRA states that this provision is modeled on 
a similar provision in the SEC Pay-to-Play Rule \63\ and is intended to 
prevent covered members or covered associates from circumventing the 
proposed rule's two-year ``time-out'' by ``bundling,'' either by 
soliciting a large number of contributions by employees, or by 
soliciting payments to a State or local political party.\64\
---------------------------------------------------------------------------

    \62\ See id. at 81653-54. See also id. at 81662.
    \63\ See id. at 81654 n.42 (citing 17 CFR 275.206(4)-5(a)(2)).
    \64\ See Notice, 80 FR at 81654.
---------------------------------------------------------------------------

C. Proposed Rule 2030(c): Exceptions

    FINRA's proposed pay-to-play rule contains three exceptions from 
the proposed rule's prohibitions: (1) de minimis contributions; (2) new 
covered associates; and (3) certain returned contributions.\65\ FINRA 
states that these exceptions are modeled on similar exceptions in the 
SEC Pay-to-Play Rule.\66\
---------------------------------------------------------------------------

    \65\ See id.
    \66\ See id. at n.51 (citing 17 CFR 275.206(4)-5(b)).
---------------------------------------------------------------------------

1. De Minimis Contribution Exception
    Proposed Rule 2030(c)(1) would except from the rule's restrictions 
contributions made by a covered associate who is a natural person to 
government entity officials for whom the covered associate was entitled 
to vote at the time of the contributions, provided the contributions do 
not exceed $350 in the aggregate to any one official per election.\67\ 
If the covered associate was not entitled to vote for the official at 
the time of the contribution, the contribution must not exceed $150 in 
the aggregate per election.\68\ FINRA states that, consistent with the 
SEC Pay-to-Play Rule, under this exception, primary and general 
elections would be considered separate elections.\69\ FINRA also 
explains that this exception is based on the theory that such 
contributions are typically made without the intent or ability to 
influence the selection process of the investment adviser.\70\
---------------------------------------------------------------------------

    \67\ See Notice, 80 FR at 81655.
    \68\ See id.
    \69\ See id. at 81655 n.54 (citing SEC Pay-to-Play Rule Adopting 
Release, 75 FR at 41034).
    \70\ See Notice, 80 FR at 81655.
---------------------------------------------------------------------------

2. Exception for Certain New Covered Associates
    The proposed rule would attribute to a covered member contributions 
made by a person within two years (or, in some cases, six months) of 
becoming a covered associate. However, proposed Rule 2030(c)(2) would 
provide an exception from the proposed rule's restrictions for covered 
members if a natural person made a contribution more than six months 
prior to becoming a covered associate of the covered member unless the 
covered associate engages in, or seeks to engage in, distribution or 
solicitation activities with a government entity on behalf of the 
covered member.\71\ FINRA states that this exception is consistent with 
the SEC Pay-to-Play Rule \72\ and is intended to balance the need for 
covered members to be able to make hiring decisions against the need to 
protect against individuals marketing to prospective employers their 
connections to, or influence over, government entities the employer 
might be seeking as clients.\73\ FINRA also provides, with respect to 
the ``look back'' provisions in the proposed rules generally, the 
following illustrations of how the ``look back'' provisions will work: 
If, for example, the contributions were made more than two years (or 
six months for new covered associates) prior to the employee becoming a 
covered associate, the ``time-out'' has run.\74\ According to FINRA, 
however, if the contribution was made less than two years (or six 
months, as applicable) from the time the person becomes a covered 
associate, the proposed rule would prohibit the covered member that 
hires or promotes the contributing covered associate from receiving 
compensation for engaging in distribution or solicitation activities on 
behalf of an investment adviser from the hiring or promotion date until 
the applicable period has run.\75\
---------------------------------------------------------------------------

    \71\ See id.
    \72\ See id. at 81655 n.55 (citing 17 CFR 275.206(4)-5(b)(2)).
    \73\ See Notice, 80 FR at 81655.
    \74\ See id. at 81656.
    \75\ See id. at 81655-56.
---------------------------------------------------------------------------

3. Exception for Certain Returned Contributions
    Proposed Rule 2030(c)(3) would provide an exception from the 
proposed rule's restrictions for covered members if the restriction is 
due to a contribution made by a covered associate and: (1) The covered 
member discovered the contribution within four months of it being made; 
(2) the contribution was less than $350; and (3) the contribution is 
returned within 60 days of the discovery of the contribution by the 
covered member.\76\ FINRA explains that, consistent with the SEC Pay-
to-Play Rule, this exception would allow a covered member to cure the 
consequences of an inadvertent political contribution.\77\ The proposed 
rule also would provide that covered members with 150 or fewer 
registered representatives would be able to rely on this exception no 
more than two times per calendar year, while covered members with more 
than 150 registered representatives would be permitted to rely on this 
exception no more than three times per calendar year.\78\ Furthermore, 
a covered member would not be able to rely on an exception more than 
once with respect to contributions by the same covered associate 
regardless of the time period, which is consistent with similar 
provisions in the SEC Pay-to-Play Rule.\79\
---------------------------------------------------------------------------

    \76\ See id. at 81655.
    \77\ See id.
    \78\ See id. FINRA notes that these limitations are consistent 
with similar provisions in the SEC Pay-to-Play Rule 206(4)-5(b)(3), 
although the SEC Pay-to-Play Rule includes different allowances for 
larger and smaller investment advisers based on the number of 
employees they report on Form ADV. See id. at 81655 n.59.
    \79\ See Notice, 80 FR at 81655.
---------------------------------------------------------------------------

D. Proposed Rule 2030(d): Prohibitions as Applied to Covered Investment 
Pools

    Proposed Rule 2030(d)(1) provides that a covered member that 
engages in distribution or solicitation activities with a government 
entity on behalf of a covered investment pool,\80\ in which a 
government entity invests or is solicited to invest, shall be treated 
as though the covered member was engaging in or seeking to engage in 
distribution or solicitation activities with the government entity on 
behalf of the investment adviser to the covered

[[Page 60056]]

investment pool directly.\81\ Proposed Rule 2030(d)(2) provides that an 
investment adviser to a covered investment pool in which a government 
entity invests or is solicited to invest shall be treated as though 
that investment adviser were providing or seeking to provide investment 
advisory services directly to the government entity.\82\ FINRA states 
that proposed Rule 2030(d) is modeled on a similar prohibition in the 
SEC Pay-to-Play Rule and would apply the prohibitions of the proposed 
rule to situations in which an investment adviser manages assets of a 
government entity through a hedge fund or other type of pooled 
investment vehicle.\83\ Therefore, according to FINRA, the provision 
would extend the protection of the proposed rule to public pension 
plans that access the services of investment advisers through hedge 
funds and other types of pooled investment vehicles sponsored or 
advised by investment advisers as a funding vehicle or investment 
option in a government-sponsored plan, such as a 529 plan.\84\
---------------------------------------------------------------------------

    \80\ See id. at 81654 n.46 (proposed Rule 2030(g)(3) defines a 
``covered investment pool'' to mean: ``(A) Any investment company 
registered under the Investment Company Act that is an investment 
option of a plan or program of a government entity; or (B) Any 
company that would be an investment company under Section 3(a) of 
the Investment Company Act but for the exclusion provided from that 
definition by either Section 3(c)(1), 3(c)(7) or 3(c)(11) of that 
Act'').
    \81\ See Notice, 80 FR at 81654 n.47 (FINRA notes that, 
consistent with the SEC Pay-to-Play Rule, under the proposed rule, 
if a government entity is an investor in a covered investment pool 
at the time a contribution triggering a two-year time-out is made, 
the covered member must forgo any compensation related to the assets 
invested or committed by the government entity in the covered 
investment pool) (citing SEC Pay-to-Play Rule Adopting Release, 75 
FR at 41047).
    \82\ See Notice, 80 FR at 81654 n.48 (FINRA states that it added 
proposed Rule 2030(d)(2) in response to comments on Regulatory 
Notice 14-50 to clarify, for purposes of the proposed rule, the 
relationship between an investment adviser to a covered investment 
pool and a government entity that invests in the covered investment 
pool).
    \83\ See Notice, 80 FR at 81654 n.49 (citing 17 CFR 275.206(4)-
5(c)).
    \84\ See Notice, 80 FR at 81654 n.50 (citing SEC Pay-to-Play 
Rule Adopting Release, 75 FR at 41044, which discusses the 
applicability of the SEC Pay-to-Play Rule to covered investment 
pools).
---------------------------------------------------------------------------

    As noted above, the proposed rule would not apply to distribution 
activities related to registered investment companies that are not 
investment options of a government entity's plan or program because in 
these circumstances a member firm is not providing or seeking to 
provide investment advisory services to a government entity.\85\ The 
proposed rule would apply to distribution activities involving 
unregistered pooled investment vehicles such as hedge funds, private 
equity funds, venture capital funds, collective investment trusts, and 
registered pooled investment vehicles such as mutual funds, but only if 
those registered pools are an investment option of a participant-
directed plan or program of a government entity.\86\
---------------------------------------------------------------------------

    \85\ See Notice, 80 FR at 81661.
    \86\ See id.
---------------------------------------------------------------------------

E. Proposed Rule 2030(e): Prohibition on Indirect Contributions or 
Solicitations

    Proposed Rule 2030(e) provides that it shall be a violation of Rule 
2030 for any covered member or any of its covered associates to do 
anything indirectly that, if done directly, would result in a violation 
of the rule.\87\ FINRA states that this provision is consistent with a 
similar provision in the SEC Pay-to-Play Rule \88\ and would prevent a 
covered member or its covered associates from funneling payments 
through third parties, including, for example, consultants, attorneys, 
family members, friends, or companies affiliated with the covered 
member as a means to circumvent the proposed rule.\89\ FINRA also notes 
that, consistent with guidance provided by the Commission in connection 
with SEC Pay-to-Play Rule 206(4)-5(d), proposed Rule 2030(e) requires a 
showing of intent to circumvent the rule for such persons to trigger 
the two-year ``time-out.'' \90\
---------------------------------------------------------------------------

    \87\ See Notice, 80 FR at 81654.
    \88\ See id. at n.44 (citing 17 CFR 275.206(4)-5(d)).
    \89\ See Notice, 80 FR at 81654 n.45 (citing SEC Pay-to-Play 
Rule Adopting Release, 75 FR at 41044, which discusses direct and 
indirect contributions or solicitations).
    \90\ See Notice, 80 FR at 81654. See also SEC Pay-to-Play Rule 
Adopting Release, 75 FR at 41044 n.340 (explaining that like MSRB 
Rule G-37(d), SEC Pay-to-Play Rule 206(4)-5(d) ``requires a showing 
of intent to circumvent the rule for such persons to trigger the 
time out'') (citing Blount, 61 F.3d at 948 (``In short, according to 
the SEC, the rule restricts such gifts and contributions only when 
they are intended as end-runs around the direct contribution 
limitations.'')).
---------------------------------------------------------------------------

F. Proposed Rule 2030(f): Exemptions

    Proposed Rule 2030(f) includes an exemptive provision for covered 
members, modeled on the exemptive provision in the SEC Pay-to-Play 
Rule, that would allow covered members to apply to FINRA for an 
exemption from the proposed rule's two-year ``time-out.'' \91\ As 
proposed, FINRA states that this provision would allow FINRA to exempt 
covered members, either conditionally or unconditionally, from the 
proposed rule's time-out requirement where the covered member discovers 
contributions that would trigger the compensation ban after they have 
been made, and when imposition of the prohibition would be unnecessary 
to achieve the rule's intended purpose.\92\ In determining whether to 
grant an exemption, FINRA would take into account varying facts and 
circumstances, outlined in the proposed rule, that each application 
presents \93\ (e.g., the timing and amount of the contribution, the 
nature of the election, and the contributor's apparent intent or motive 
in making the contribution).\94\ FINRA notes that this provision would 
provide covered members with an additional avenue by which to seek to 
cure the consequences of an inadvertent violation by the covered member 
or its covered associates that falls outside the limits of one of the 
proposed rule's exceptions.\95\
---------------------------------------------------------------------------

    \91\ See Notice, 80 FR at 81654-55.
    \92\ See id. at 81655.
    \93\ See id.
    \94\ See Order Instituting Proceedings, 81 FR at 19263.
    \95\ See Notice, 80 FR at 81655.
---------------------------------------------------------------------------

G. Proposed Rule 4580: Recordkeeping Requirements

    Proposed Rule 4580 would require covered members that engage in 
distribution or solicitation activities with a government entity on 
behalf of any investment adviser that provides or is seeking to provide 
investment advisory services to such government entity to maintain 
books and records that would allow FINRA to examine for compliance with 
its pay-to-play rule.\96\ FINRA states that this provision is 
consistent with similar recordkeeping requirements imposed on 
investment advisers in connection with the SEC Pay-to-Play Rule.\97\ 
The proposed rule also would require covered members to maintain a list 
or other record of certain specific information.\98\ FINRA states that 
the proposed rule would require, among other things, that the direct 
and indirect contributions or payments made by the covered member or 
any of its covered associates be listed in chronological order and 
indicate the name and title of each contributor and each recipient of 
the contribution or payment, as well as the amount and date of each 
contribution or payment, and whether the contribution was the subject 
of the exception for returned contributions in proposed Rule 2030.\99\
---------------------------------------------------------------------------

    \96\ See id.
    \97\ See id. (citing 17 CFR 275.204-2(a)(18) and (h)(1)).
    \98\ See Notice, 80 FR at 81655-56.
    \99\ See id.
---------------------------------------------------------------------------

III. Summary of Comments and FINRA's Responses

    In response to the Notice, the Commission received ten comment 
letters, from nine different commenters.\100\ Six commenters generally 
express support for FINRA's

[[Page 60057]]

proposal.\101\ However, five of those commenters, while generally 
expressing support for the goals of the proposal, also raise certain 
concerns regarding various aspects of the proposal as drafted and 
recommended amendments to the proposal.\102\ The other three commenters 
did not support the proposed rule as drafted based largely on concerns 
involving the First Amendment to the U.S. Constitution.\103\ FINRA 
responded, stating that it considered the comments received by the 
Commission in response to the Notice, and that FINRA is not intending 
to make changes to the proposed rule text in response to the 
comments.\104\
---------------------------------------------------------------------------

    \100\ See supra note 5. CAI submitted two separate comment 
letters in response to the Notice. See CAI Letter 1 and CAI Letter 
2.
    \101\ See CAI Letter 1; CAI Letter 2; FSI Letter 1; ICI Letter; 
NAIFA Letter; NASAA Letter; and PIABA Letter.
    \102\ See CAI Letter 1; CAI Letter 2; FSI Letter 1; NAIFA 
Letter; NASAA Letter; and PIABA Letter. ICI did not raise additional 
concerns, but states that it is satisfied with FINRA's revisions and 
responses to the proposal as drafted in Regulatory Notice 14-50. See 
ICI Letter.
    \103\ See CCP Letter 1; Moran Letter; and State Parties Letter 
1. Other commenters also raise certain First Amendment-related 
concerns. See FSI Letter 1; and CAI Letter 1.
    \104\ See FINRA Response Letter 1.
---------------------------------------------------------------------------

    The Commission received an additional four comments in response to 
the Order Instituting Proceedings.\105\ On July 6, 2016, FINRA 
submitted a letter responding to all comments and to the Order 
Instituting Proceedings.\106\ The comments, as well as FINRA's 
responses, are summarized below.\107\
---------------------------------------------------------------------------

    \105\ See supra note 10. See also Memorandum from the Division 
of Trading and Markets regarding a May 10, 2016 conference call with 
representatives of CAI; Memorandum from the Division of Trading and 
Markets regarding a May 19, 2016 conference call with 
representatives of FSI.
    \106\ See supra note 12.
    \107\ The comments received in response to the Notice were 
summarized when the Commission instituted proceedings. See supra 
note 9. For further detail, the comments that the Commission 
received on both the Notice and the Order Instituting Proceedings 
are available on the Commission's Web site at http://www.sec.gov/comments/sr-finra-2015-056/finra2015056.shtml.
---------------------------------------------------------------------------

A. First Amendment Comments and FINRA's Responses

    As noted above, five commenters either oppose the proposed rule 
\108\ or raise certain issues regarding the proposed rule as drafted 
based largely on First Amendment concerns.\109\ As a general matter, 
these commenters argue that FINRA's proposed rule is not narrowly 
tailored to serve a compelling government interest. While acknowledging 
that the D.C. Circuit upheld the constitutionality of a comparable MSRB 
pay-to-play rule in Blount v. SEC, 61 F.3d 938 (D.C. Cir. 1995), which 
also used analogous restrictions to discourage pay-to-play practices, 
these commenters believe that Supreme Court precedent has changed since 
Blount was decided.
---------------------------------------------------------------------------

    \108\ See CCP Letter 1; and State Parties Letter 1. See also CCP 
Letter 2; CCP Letter 3; and State Parties Letter 2.
    \109\ See CAI Letter 1; FSI Letter 1; FSI Letter 2; and Moran 
Letter.
---------------------------------------------------------------------------

    In response to these comments, FINRA states that the points raised 
by the commenters do not warrant changes to, or disapproval of, its 
proposed rule change.\110\ FINRA notes that the Commission has already 
reviewed and rejected these arguments in a nearly identical 
context.\111\ As FINRA explains, the State Parties filed an 
unsuccessful lawsuit in 2014 challenging the SEC Pay-to-Play Rule on 
First Amendment grounds.\112\ FINRA explains that the State Parties' 
comments opposing FINRA's proposed rule reiterate the arguments 
advanced in their suit against the Commission and, although the court 
of appeals decided the challenge on jurisdictional grounds, the brief 
that the Commission filed in the D.C. Circuit is persuasive in 
demonstrating that the State Parties' arguments lack merit.\113\ FINRA 
also notes that the SEC Pay-to-Play Rule, upon which FINRA's proposed 
rule change is based, was modeled on pay-to-play rules that the MSRB 
drafted, that the Commission approved, and that the D.C. Circuit upheld 
against a constitutional challenge in Blount.\114\
---------------------------------------------------------------------------

    \110\ See FINRA Response Letter 2 at 3 (noting that FINRA's 
responses to the First Amendment arguments raised by the State 
Parties and CCP also address the concerns raised by CAI, FSI and 
Moran). A copy of FINRA Response Letter 2 is available at: https://www.sec.gov/comments/sr-finra-2015-056/finra2015056-18.pdf.
    \111\ See id. (citing N.Y. Republican State Comm. v. SEC, 799 
F.3d 1126 (D.C. Cir. 2015) (affirming dismissal of the petition for 
lack of subject matter jurisdiction and also dismissing the petition 
as time-barred).
    \112\ See FINRA Response Letter 2 at 3.
    \113\ See id. at 3-4.
    \114\ See id. at 5 (citing Blount, 61 F.3d at 944).
---------------------------------------------------------------------------

    Furthermore, FINRA states that the proposed rule change is 
justified by a sufficiently important governmental interest to 
withstand constitutional scrutiny. For example, FINRA explains that, as 
in Blount, the Commission's interest in preventing fraud and in 
protecting market actors from ``unfair, corrupt market practices,'' are 
``not only substantial, but . . . compelling.'' \115\ FINRA also notes 
that the Commission's interest in ``clean advisory markets is equally 
important.'' \116\ FINRA acknowledges the D.C. Circuit's observation in 
Blount that ``the link between eliminating pay-to-play practices and 
the Commission's goals of `perfecting the mechanism of a free and open 
market' and promoting `just and equitable principles of trade' is self-
evident.'' \117\ In addition to noting the important interests served 
by its proposal, FINRA also notes that, as explained in Blount, the 
proposed rule change advances this government interest by seeking to 
halt an existing pay-to-play problem, even though, in terms of a 
record, ``no smoking gun is needed;'' however, ``here, the conflict of 
interest is apparent, the likelihood of stealth great, and the 
[Commission's] purpose prophylactic.'' \118\
---------------------------------------------------------------------------

    \115\ See, e.g., FINRA Response Letter 2 at 5 (quoting Blount, 
61 F.3d at 944).
    \116\ See, e.g., FINRA Response Letter 2 at 5 (quoting an 
observation made in Blount that the Commission's interest ``in clean 
bond markets'' is just as important as a legislature's interest ``in 
clean elections'') (quoting Blount, 61 F.3d at 944)).
    \117\ See, e.g., FINRA Response Letter 2 at 5 (quoting Blount, 
61 F.3d at 945).
    \118\ See, e.g., FINRA Response Letter 2 at 6 (quoting Blount, 
61 F.3d at 945).
---------------------------------------------------------------------------

    FINRA further believes that the proposed rule change also is 
``closely drawn'' to avoid unnecessary abridgment of associational 
freedoms.\119\ FINRA explains that, like the pay-to-play rule upheld in 
Blount, its proposed rule change only ``restricts a narrow range of . . 
. activities for a relatively short period of time,'' and leaves 
available the ``vast majority of political activities.'' \120\ For 
example, FINRA notes that the proposal does not attempt to regulate 
State and local elections, nor does it impose restrictions on 
independent expenditures or ban political contributions, and that each 
of those significant avenues for political expression remains 
unaffected by the proposed rule change.\121\ FINRA also does not agree 
with arguments made by a commenter that FINRA did not consider less 
restrictive alternatives in drafting its proposal and that aspects of 
the proposal are vague or overbroad. FINRA notes that, because the 
Commission must find that FINRA's proposal imposes substantially 
equivalent or more stringent restrictions on its member firms as the 
SEC Pay-to-Play Rule imposes on investment advisers for FINRA members 
to be ``regulated persons'' under the SEC Pay-to-Play Rule, the 
provisions and definitions to which the commenter objects are modeled 
on and substantially similar to provisions in the

[[Page 60058]]

SEC Pay-to-Play Rule.\122\ FINRA also states that it will work with the 
industry and Commission to address interpretive questions and provide 
additional guidance, as needed, to the extent that questions arise 
regarding the application and scope of the provisions and terms used in 
the proposed rule change.\123\
---------------------------------------------------------------------------

    \119\ See, e.g., FINRA Response Letter 2 at 6.
    \120\ See, e.g., id. (quoting Blount, 61 F.3d at 947-48).
    \121\ See, e.g., FINRA Response Letter 2 at 4. See also SEC Pay-
to-Play Rule Adopting Release, 75 FR at 41024 n.71 (explaining that 
the SEC Pay-to-Play rule ``imposes no restrictions on activities 
such as making independent expenditures to express support for 
candidates, volunteering, making speeches, and other conduct'').
    \122\ See, e.g., FINRA Response Letter 2 at 7.
    \123\ See, e.g., id.
---------------------------------------------------------------------------

B. Comments Regarding FINRA's Authority To Propose a Pay-to-Play Rule 
and FINRA's Responses

    Several commenters contend that FINRA does not have the authority 
to adopt a pay-to-play rule because only Congress or the Federal 
Election Commission may regulate contributions for federal elections.
    In response, FINRA states that the proposed rule change is 
consistent with the authority Congress granted a registered national 
securities association like FINRA under Section 15A(b)(6) of the Act to 
adopt rules that are designed, among other things, to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to perfect the mechanism of a free and 
open market and a national market system and, in general, to protect 
investors and the public interest.\124\ FINRA believes that the 
proposed rule change accomplishes the goals of Section 15A(b)(6) by, 
for example, allowing member firms to continue to engage in 
distribution or solicitation activities for compensation with 
governmental entities on behalf of investment advisers, while at the 
same time deterring member firms from engaging in pay-to-play 
practices.\125\ FINRA also believes that the proposed rule change is 
reasonably designed to address the distortion of the investment 
advisory market and collective action problems created by pay-to-play 
practices.\126\
---------------------------------------------------------------------------

    \124\ See id.
    \125\ See id.
    \126\ See id. at 9. As outlined in the SEC Pay-to-Play Adopting 
Release, pay-to-play activities create a ``collective action'' 
problem in two respects. First, government officials who participate 
in such activities 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 a contribution. See SEC Pay-to-Play 
Rule Adopting Release, 75 FR at 40122.
---------------------------------------------------------------------------

    Although FINRA acknowledges that the proposed rule's two-year 
``time-out'' provision might result in fewer covered members and their 
covered associates making certain political contributions to certain 
officials, FINRA notes that if it did not adopt a pay-to-play rule, the 
SEC Pay-to-Play Rule would prohibit member firms from soliciting 
government entities for investment advisory services for compensation 
on behalf of investment advisers.\127\ FINRA explains that the SEC Pay-
to-Play Rule provides that the rules of a self-regulatory organization 
(``SRO''), like FINRA, must impose ``substantially equivalent or more 
stringent restrictions'' on its member firms that wish to act as 
``regulated persons'' as the SEC Pay-to-Play Rule imposes on investment 
advisers.\128\ Therefore, unless FINRA imposes sufficiently stringent 
restrictions, investment advisers and covered associates will be barred 
from providing or agreeing to provide, directly or indirectly, payment 
to FINRA member firms to solicit a government entity for investment 
advisory services on behalf of the investment adviser.\129\ FINRA 
believes that the proposed rule change is a more effective response to 
the issues addressed in the SEC Pay-to-Play Rule than a complete ban on 
solicitation,\130\ and notes throughout its response that the proposal 
imposes substantially equivalent restrictions on FINRA member firms as 
the SEC Pay-to-Play Rule imposes on investment advisers.\131\
---------------------------------------------------------------------------

    \127\ See FINRA Response Letter 2 at 4-5.
    \128\ See id. at 4.
    \129\ See id. See also Notice, 80 FR at 81659.
    \130\ See FINRA Response Letter 2 at 4.
    \131\ See, e.g., id. at 4, 7.
---------------------------------------------------------------------------

C. Variable Annuity-Related Comments and FINRA's Responses

    Two commenters raise concerns regarding the application of the 
proposed rules to variable annuities.\132\ Both of these commenters 
request, as a threshold matter, that FINRA confirm that Rule 2030 would 
not apply to variable annuities.\133\ One of these commenters requests 
that the proposed rule not apply to the sales of variable annuity 
contracts supported by a separate account that invests in mutual funds, 
arguing that the nature of variable annuities and the way investment 
options are selected does not implicate the investment advisory 
solicitation activities contemplated by the SEC Pay-to-Play Rule.\134\ 
This commenter claims that the relationship between a variable annuity 
contract holder and the investment adviser to a mutual fund supporting 
the variable annuity does not rise to a level such that it should 
implicate the proposed pay-to-play rule's restrictions.\135\ The other 
commenter claims, in support of its argument that Rule 2030 should not 
apply to variable annuities, that compliance with Rule 2030 would be 
impractical for broker-dealers selling variable annuities in the 
government market.\136\ This commenter also argues, for example, that a 
covered member selling a variable annuity, particularly where the 
separate account is registered as a unit investment trust, cannot 
fairly be seen to be engaging in solicitation activities on behalf of 
all of the investment advisers and sub-advisers that manage the covered 
investment pools available as investment options under the separate 
account and subaccounts.\137\
---------------------------------------------------------------------------

    \132\ See CAI Letter 1 and FSI Letter 1. See also CAI Letter 2 
(reflecting CAI's suggested revisions to the certain language in 
some of FINRA's proposed rules).
    \133\ See CAI Letter 1 and FSI Letter 1.
    \134\ See FSI Letter 1 (claiming that applying the proposed rule 
to variable annuities will significantly increase the compliance 
burden and as such may limit the options their members make 
available to 403(b) and 457 plans).
    \135\ See FSI Letter 1.
    \136\ See CAI Letter 1 (claiming that the dynamics and structure 
of variable annuities, particularly those with separate accounts 
registered as a unit investment trust, and the number of advisers 
and sub-advisers to the funds underlying sub-accounts, makes 
compliance with proposed Rule 2030 impractical).
    \137\ See id.
---------------------------------------------------------------------------

    This commenter also requests that proposed Rule 2030 be modified 
to, among other things, clarify that the distribution of a two-tiered 
product such as a variable annuity is not solicitation activity for an 
investment adviser and sub-advisers managing the funds available as 
investment options.\138\ Furthermore, this same commenter states that 
if FINRA or the Commission determines that broker-dealers selling 
variable annuities constitute solicitation activities for purposes of 
Rule 2030, that determination raises a host of interpretive questions 
that, in this commenter's view, would require further guidance from 
FINRA or the Commission.\139\
---------------------------------------------------------------------------

    \138\ See id.
    \139\ See id. For example, CAI requests guidance on the 
following questions: Is the selling broker-dealer deemed to be 
soliciting on behalf of the adviser of each of the underlying funds 
or only of advisers and sub-advisers of funds underlying investment 
options that are selected by contract holders? If an underlying fund 
is managed by an adviser that uses multiple sub-advisers, is the 
selling firm deemed to be soliciting on behalf of all of the sub-
advisers? How does the rule apply when a contract holder on his or 
her own allocates funds in the variable annuity to an option at a 
point of time (for example, five years) subsequent to the purchase 
of the variable annuity without any involvement of the selling firm? 
See id.
---------------------------------------------------------------------------

    In response, FINRA states that its proposed rules must impose 
substantially equivalent or more stringent restrictions on member firms 
as the SEC Pay-to-Play Rule imposes on

[[Page 60059]]

investment advisers.\140\ Therefore, because the Commission did not 
exclude specific products from the SEC Pay-to-Play Rule, such as 
variable annuities, FINRA does not believe that excluding specific 
products from its proposed rule would satisfy the Commission's 
stringency requirements.\141\ FINRA notes, however, that to the extent 
interpretive questions arise regarding the application and scope of the 
provisions and terms used in its proposed rules, FINRA will work with 
the industry and Commission to address those interpretive questions and 
provide additional guidance as needed.\142\
---------------------------------------------------------------------------

    \140\ See FINRA Response Letter 2 at 16.
    \141\ See id.
    \142\ See id.
---------------------------------------------------------------------------

D. Comments Regarding the Scope of the Proposed Rule and FINRA's 
Responses

    Two commenters also express concern that proposed Rule 2030(d) 
would, in their view, re-characterize ``ordinary'' or ``customary'' 
distribution activities for covered investment pools as the 
solicitation of clients on behalf of the investment adviser to the 
covered investment pools.\143\ One of these commenters requests that 
such customary distribution activity by member firms for covered 
investment pools sold to government entities not be treated as 
solicitation activity for an investment adviser for purposes of Rule 
2030 simply because an investment adviser provides advisory services to 
a covered investment pool that is available as an investment 
option.\144\ As more fully explained in the commenter's letter, the 
commenter claims, for example, that proposed Rule 2030(d) would recast 
``traditional'' broker-dealer activity (i.e., the offer and sale of 
covered investment pool securities pursuant to a selling or placement 
agent agreement) into something it is not: The solicitation of 
investment advisory services on behalf of an investment adviser.\145\ 
This commenter also claims that the decision in Goldstein v. SEC, 451 
F.3d 873 (D.C. Cir. 2006) and the Commission staff's interpretive 
position under Advisers Act Rule 206(4)-3 suggest that proposed Rule 
2030(d) would be impractical.\146\ This commenter also notes that Rule 
206(4)-3 puts selling firms in a contradictory position under FINRA 
rules and Advisers Act rules.\147\ This commenter further states that, 
in its view, a broker-dealer that offers and sells interests in a 
mutual fund or private fund cannot be characterized as soliciting on 
behalf of the investment adviser to a covered investment pool.\148\
---------------------------------------------------------------------------

    \143\ See CAI Letter 1 and FSI Letter 1.
    \144\ See CAI Letter 1.
    \145\ See id.
    \146\ See id. (claiming that ``[i]t would create significant 
confusion in the industry and undermine settled practices and 
understandings, while creating doubt as to the application of the 
Goldstein case and the Commission staff's guidance in the Mayer 
Brown no-action letter'').
    \147\ See id.
    \148\ See id.
---------------------------------------------------------------------------

    Similarly, another commenter expresses concern with the apparent 
application of proposed Rule 2030(d) to ``traditional'' brokerage sales 
of mutual funds and variable annuities to participant-directed 
government-sponsored retirement plans.\149\ As more fully explained in 
the commenter's letter, this commenter continues to be concerned that 
the provisions in proposed Rule 2030(d) go beyond that which is 
required under Rule 206(4)-5(a)(2)(i) and Rule 206(4)-5(c) to the 
detriment of investors.\150\ This same commenter also claims that 
mutual fund sales, as well as variable annuity sales, should be 
excluded, claiming that the proposed rules serve to redefine the sale 
of mutual funds as solicitation by a broker-dealer on behalf of an 
investment adviser and also conflict with the realities of conventional 
mutual fund selling agreements.\151\
---------------------------------------------------------------------------

    \149\ See FSI Letter 1. See also FSI Letter 2
    \150\ See FSI Letter 1. See also FSI Letter 2.
    \151\ See FSI Letter 1. See also FSI Letter 2.
---------------------------------------------------------------------------

    In response, FINRA explains that, in proposing FINRA Rule 2030(d), 
it did not intend to re-characterize broker-dealers' selling interests 
in variable annuities, mutual funds and private funds as soliciting an 
investment advisory relationship with investors who invest in those 
products.\152\ Rather, FINRA states that the purpose of proposed Rule 
2030(d) is to clarify that the prohibition of proposed Rule 2030(a) 
would apply when the covered member is engaging in distribution or 
solicitation activities with a government entity on behalf of a covered 
investment pool.\153\ FINRA further explains that proposed Rule 2030(d) 
is modeled on a similar provision in the SEC Pay-to-Play Rule, Rule 
206(4)-5(c).\154\ As such, and consistent with SEC Pay-to-Play Rule 
206(4)-5(c), proposed Rule 2030(d) is intended to extend the 
protections of the proposed rule to government entities that access the 
services of investment advisers through hedge funds and other types of 
pooled investment vehicles sponsored or advised by investment 
advisers.\155\ Finally, FINRA notes that the applicability of proposed 
Rule 2030(d) is for purposes of FINRA's pay-to-play rule only and, as 
such, would not impact or otherwise affect other FINRA rules or 
guidance. Therefore, FINRA has determined not to make the changes 
suggested by the commenters.\156\
---------------------------------------------------------------------------

    \152\ See FINRA Response Letter 2 at 14.
    \153\ See id.
    \154\ See id.
    \155\ See id. at 15 (noting that when adopting SEC Pay-to-Play 
Rule 206(4)-5(c), the Commission stated that although ``an 
investment in a pooled investment vehicle may not involve a direct 
advisory relationship with a government sponsored plan [that] does 
not change the nature of the fraud or the harm that may be inflicted 
as a consequence of the adviser's pay-to-play activity'') (quoting 
SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044-45)).
    \156\ See FINRA Response Letter 2 at 15.
---------------------------------------------------------------------------

E. Comments Regarding the Inclusion of Distribution Activity in the 
Proposed Rule and FINRA's Responses

    One commenter generally expresses concern that proposed Rule 2030 
is unnecessarily ambiguous regarding the term ``distribution'' 
activities in Rule 2030(a).\157\ This commenter claims that it is 
unclear what distribution activities ``with'' a government entity would 
be prohibited, what compensation is covered by the proposed rule and 
who must pay it, and when a member firm might be deemed to be acting 
``on behalf of'' an investment adviser.\158\ This commenter states that 
the ambiguity of proposed Rule 2030 may result in its misapplication in 
a variety of contexts, such as: Where a selling firm is affiliated with 
one, but not all, underlying fund advisers and none of the sub-
adviser(s) to any underlying funds, or none of the underlying fund 
advisers, but some of the sub-advisers.\159\
---------------------------------------------------------------------------

    \157\ See CAI Letter 1.
    \158\ See id.
    \159\ See id.
---------------------------------------------------------------------------

    This commenter also claims that, while the SEC Pay-to-Play Rule 
requires regulated persons to be subject to rules that prohibit them 
from engaging in certain distribution activities if certain political 
contributions have been made, SEC Pay-to-Play Rule 206(4)-5 does not 
mandate the use of the term ``distribution'' in describing the conduct 
prohibited by the proposed rule, and suggested revised rule text 
reflecting that assertion.\160\ The commenter believes that its 
suggested revisions would eliminate, among other things, the potential 
concern that a selling firm might violate proposed Rule 2030 
unknowingly due to being deemed to be acting on behalf of investment 
advisers

[[Page 60060]]

or sub-advisers of underlying funds with which it has no 
relationship.\161\
---------------------------------------------------------------------------

    \160\ See CAI Letter 1 and CAI Letter 2 (reflecting CAI's 
suggested revisions to certain language in some of FINRA's proposed 
rules).
    \161\ See CAI Letter 1 (claiming that the commenter's suggested 
revisions would not result in any inappropriate narrowing of the 
scope of Rule 2030).
---------------------------------------------------------------------------

    In response, FINRA states that it continues to maintain the 
position, outlined in the Notice, that it will not remove references to 
the term ``distribution.'' \162\ FINRA explains that the Notice pointed 
to language in the SEC Pay-to-Play Rule Adopting Release supporting the 
inclusion of distribution activities by broker-dealers in FINRA's 
proposed Rule 2030.\163\ Specifically, FINRA pointed to the 
Commission's discussion regarding under what circumstances distribution 
payments would violate the SEC's Pay-to-Play Rule.\164\ FINRA also 
notes that based on the Commission's definition of ``regulated person'' 
\165\ in the SEC's Pay-to-Play Rule, as well as the Commission's 
discussion regarding the treatment of distribution fees paid pursuant 
to a 12b-1 plan as compared to legitimate profits, FINRA believes that 
its proposed rule must apply to member firms engaging in distribution 
activities.\166\ FINRA mentioned previously, to the extent that 
interpretive questions arise regarding the application and scope of the 
provisions and terms used in the proposed rule change, FINRA will work 
with the industry and Commission to address the interpretive questions 
and provide additional guidance as needed.\167\
---------------------------------------------------------------------------

    \162\ See FINRA Response Letter 2 at 12.
    \163\ See id. at 11-12 (citing Notice, 80 FR at 81660-61).
    \164\ See FINRA Response Letter 2 at 12 n.52 (citing SEC Pay-to-
Play Rule Adopting Release, 75 FR at 4104 n.298).
    \165\ See FINRA Response Letter 2 at 12 (explaining that the SEC 
Pay-to-Play Rule defines a ``regulated person'' to include a member 
firm, provided that FINRA rules prohibit member firms from engaging 
in distribution or solicitation activities if political 
contributions have been made) (citing 17 CFR 275. 206(4)-
5(f)(9)(ii)(A)) (emphasis in original).
    \166\ See FINRA Response Letter 2 at 12 (citing Notice, 80 FR at 
81660-61).
    \167\ See id.
---------------------------------------------------------------------------

F. Comments Regarding Defined Terms Used in the Proposed Rules and 
FINRA's Responses

    Two commenters request clarification of certain defined terms used 
in the proposed rules.\168\ One commenter urged FINRA, or the 
Commission, to clarify the meaning of the term ``instrumentality'' as 
it is used in the definition of ``government entity.'' \169\ This 
commenter claims that, ``[w]ithout additional guidance, covered members 
will continue to struggle with whether a contribution to a given entity 
should be treated as a contribution to an `instrumentality' of a state 
or state agency, thus triggering the two-year time out. . . .'' \170\ 
This same commenter also asked for clarification as to whether each and 
every ``contribution'' (as defined in proposed Rule 2030(g)(1)) is, by 
definition, also a ``payment'' (as defined in proposed Rule 
2030(g)(9)).\171\
---------------------------------------------------------------------------

    \168\ See CAI Letter 1 and NAIFA Letter.
    \169\ See CAI Letter 1 (claiming that CAI's members have 
struggled to understand the contours of this term in the context of 
the SEC Pay-to-Play Rule).
    \170\ See id.
    \171\ See CAI Letter 1 (discussing Notice, 80 FR at 81654 n.41: 
``Consistent with the SEC Pay-to-Play Rule, FINRA is including the 
broader term `payments,' as opposed to `contributions,' to deter a 
cover member from circumventing the proposed rule's prohibitions by 
coordinating indirect contributions to government officials by 
making payments to political parties'').
---------------------------------------------------------------------------

    Another commenter requests that FINRA clarify the definition of a 
``covered associate'' and clarify and delineate the positions that 
would qualify someone as a covered ``official.'' \172\ This commenter 
claims that, in response to the same definition of ``covered 
associate'' as used in the SEC Pay-to-Play Rule, many investment 
advisers and broker-dealers have classified all of their 
representatives as covered associates regardless of whether they 
actually engage in the solicitation activity specified in the 
definition.\173\ This commenter believes that additional clarification 
on when an associated person of a covered member would (or would not) 
qualify as a ``covered associate'' would ease compliance burdens, 
curtail overly broad limits on legitimate political activity, and 
increase the consistency of procedures amongst member firms who seek to 
comply with both the letter and the spirit of the proposed rule.\174\ 
This same commenter requests additional details or guidance from the 
Commission with respect to this definition of ``official'' because, 
according to that commenter, that definition has caused, and will 
continue to spark confusion over exactly what offices subject the 
holder to be classified as an ``official'' given that the term is 
defined the same way in the SEC Pay-to-Play Rule.\175\
---------------------------------------------------------------------------

    \172\ See NAIFA Letter.
    \173\ See id.
    \174\ See id.
    \175\ See id.
---------------------------------------------------------------------------

    In response, FINRA states that it recognizes, as did the 
commenters, that these terms are defined in the SEC Pay-to-Play Rule 
and that FINRA modeled the definitions in its proposal on those in the 
SEC Pay-to-Play Rule.\176\ With respect to CAI's request for 
clarification as to whether each and every ``contribution'' (as defined 
in proposed FINRA Rule 2030(g)(1)) is, by definition, also a 
``payment'' (as defined in proposed FINRA Rule 2030(g)(9)), FINRA 
states that the definition of ``payment'' is similar to the definition 
of ``contribution,'' but is broader because it does not include 
limitations on the purposes for which such money is given (e.g., it 
does not have to be made for the purpose of influencing an 
election).\177\ Finally, FINRA also acknowledges the concerns raised by 
the commenters and the requests for clarification and additional 
guidance from the Commission and FINRA as to certain terms.\178\ FINRA 
again states that to the extent that interpretive questions arise 
regarding the application and scope of the provisions and terms used in 
the proposed rule change, FINRA will work with the industry and 
Commission to address the interpretive questions and provide additional 
guidance as needed.\179\
---------------------------------------------------------------------------

    \176\ See FINRA Response Letter 2 at 18.
    \177\ See id. at 17.
    \178\ See id. at 19.
    \179\ See id.
---------------------------------------------------------------------------

G. Comments Regarding PAC Contributions and FINRA's Responses

    One commenter claims that statements made by FINRA in the Notice 
regarding the proposed rule's anti-circumvention provision, proposed 
Rule 2030(e), combined with statements made in Commission staff 
guidance concerning whether contributions through PACs would violate 
the SEC Pay-to-Play Rule and Section 208(d) of the Advisers Act, have 
the ability to chill contributions to PACs.\180\ This commenter claims, 
for example, that prospective contributors who simply want to donate to 
a PAC have been hesitant to or restricted from doing so out of fear 
that they may be making an indirect contribution in violation of the 
SEC Pay-to-Play Rule.\181\ Accordingly, this commenter requests further 
guidance from the Commission on the factors by which contributions to 
PACs would or would not trigger the anti-circumvention provision of the 
proposed rule.\182\
---------------------------------------------------------------------------

    \180\ See NAIFA Letter.
    \181\ See id.
    \182\ See id.
---------------------------------------------------------------------------

    In response, FINRA again acknowledges the concerns raised by the 
commenter and the requests for clarification and additional guidance 
from the Commission and FINRA.\183\ FINRA states that, to the extent 
that interpretive questions arise regarding the application and scope 
of the provisions and terms used in the

[[Page 60061]]

proposed rule change, FINRA will work with the industry and Commission 
to address the interpretive questions and provide additional guidance 
as needed.\184\
---------------------------------------------------------------------------

    \183\ See FINRA Response Letter 2 at 19.
    \184\ See id. at 18.
---------------------------------------------------------------------------

    Another commenter claims that it continues to believe that not all 
payments to political parties or PACs should have to be maintained 
under the books and records requirements of proposed Rule 4580.\185\ 
Rather, this commenter believes that only payments to political parties 
or PACs where the covered member or a covered associate: (i) Directs 
the political party or PAC to make a contribution to an official of a 
government entity which the covered member is soliciting on behalf of 
an investment adviser; or (ii) knows that the political party or PAC is 
going to make a contribution to an official of a government entity 
which the covered member is soliciting on behalf of an investment 
adviser, should have to be maintained.\186\ This commenter states that, 
while it appreciates FINRA's rationale for proposed Rule 4580, it 
believes the costs and burdens associated with the request far outweigh 
the benefits to FINRA in ensuring compliance with the rule and would 
lead to periodic ``fishing expeditions'' by FINRA examiners.\187\
---------------------------------------------------------------------------

    \185\ See CAI Letter 1.
    \186\ See id.
    \187\ See id.
---------------------------------------------------------------------------

    In response, FINRA states that it disagrees with these comments and 
has determined to retain the recordkeeping requirements as proposed in 
FINRA Rule 4580.\188\ FINRA notes that, as discussed in the Notice, 
payments to political parties or PACs can be a means for a covered 
member or covered associate to funnel contributions to a government 
official without directly contributing.\189\ Therefore, FINRA states 
that it is proposing to require a covered member to maintain a record 
of all payments to political parties or PACs as such records would 
assist FINRA in identifying situations that might suggest an intent to 
circumvent the rule.\190\
---------------------------------------------------------------------------

    \188\ See FINRA Response Letter 2 at 20.
    \189\ See id. As FINRA explains in the Notice, a covered 
associate would include a PAC controlled by the covered member or 
any of its associates. FINRA states that it would consider a covered 
member or its covered associates to have ``control'' over a PAC if 
the covered member or covered associate has the ability to direct or 
cause the direction of governance or operations of the PAC. See 
Notice, 80 FR at 81653, 81660 (noting that this position is 
consistent with the position taken by the SEC in connection with the 
SEC Pay-to-Play Rule) (citing SEC Pay-to-Play Adopting Release, 75 
FR at 41032).
    \190\ See FINRA Response Letter 2 at 20-21. FINRA states in the 
Notice that the proposed recordkeeping requirements are intended to 
allow FINRA to examine for compliance with its proposed pay-to-play 
rule, and the reference to indirect contributions in proposed Rule 
4580(a)(4) is intended to include records of contributions or 
payments a covered member solicits or coordinates another person or 
PAC to make under proposed Rule 2030(b). See Notice, 80 FR at 81663.
---------------------------------------------------------------------------

H. Comments Regarding the De Minimis Exception Under Proposed Rule 
2030(c) and FINRA's Responses

    As discussed above, certain commenters raise concerns regarding the 
exception for de minimis contributions under proposed Rule 2030(c)(1) 
on First Amendment grounds.\191\ In addition, one commenter requests 
that the $350 and $150 amounts ``be raised substantially'' in both the 
SEC Pay-to-Play Rule and in proposed Rule 2030(c)(1), and further 
requests that the $350 limitation on the proposed exception for 
returned contributions under proposed Rule 2030(c)(3) be eliminated in 
both the SEC Pay-to-Play Rule and in FINRA's proposed rule.\192\
---------------------------------------------------------------------------

    \191\ For a discussion of these First Amendment comments and 
FINRA's responses, see Section III.A, supra.
    \192\ See CAI Letter 1 (claiming that these contribution amounts 
fail to take inflation into consideration and are ``unreasonably 
low'').
---------------------------------------------------------------------------

    In response, FINRA explains that its proposed rules must impose 
substantially equivalent or more stringent restrictions on member firms 
as the SEC Pay-to-Play Rule imposes on investment advisers.\193\ 
Therefore, FINRA has proposed exceptions for de minimis contributions 
and returned contributions that are consistent with similar exceptions 
in the SEC Pay-to-Play Rule.\194\ FINRA does not believe that raising 
the limits for the de minimis exception or eliminating the limit for 
returned contributions would impose substantially equivalent or more 
stringent restrictions on member firms as the SEC Pay-to-Play Rule 
imposes on investment advisers.\195\
---------------------------------------------------------------------------

    \193\ See FINRA Response Letter 2 at 19.
    \194\ See id.
    \195\ See id.
---------------------------------------------------------------------------

I. Comments Regarding the Grandfathering of Existing Accounts and 
Contracts and FINRA's Responses

    One commenter requests that FINRA clarify the application of the 
proposed rule to existing government entity accounts or contracts.\196\ 
FSI requests that, in the event that FINRA does not amend the 
application of its proposed rule to covered investment pools (as 
requested by this same commenter), FINRA apply the proposed rule only 
to accounts and variable contracts opened after the effective 
date.\197\
---------------------------------------------------------------------------

    \196\ See FSI Letter 1.
    \197\ See id.
---------------------------------------------------------------------------

    In response, FINRA explains that, as discussed above, its proposed 
rules must impose substantially equivalent or more stringent 
restrictions on member firms as the SEC Pay-to-Play Rule imposes on 
investment advisers.\198\ The Commission did not apply its rule only to 
contracts or accounts opened after the effective date of the rule.\199\ 
FINRA also explains in the Notice that, if the Commission approves the 
proposed rule change, proposed Rule 2030(a) will not be triggered by 
contributions made prior to the rule's effective date, and that the 
rule will not apply to contributions made prior to the effective date 
by new covered associates to which the two years or, as applicable, six 
months ``look back'' applies.\200\ FINRA states that the transition 
period--the time between the Commission approving the proposal and 
FINRA announcing the effective date of the rule--will provide member 
firms with time to identify their covered associates and government 
entity clients and to modify their supervisory systems to address new 
obligations under the rules.\201\ Therefore, FINRA does not believe 
that limiting the application of its rule in the way suggested by FSI 
would impose substantially equivalent or more stringent restrictions on 
member firms as the SEC Pay-to-Play Rule imposes on investment 
advisers.\202\
---------------------------------------------------------------------------

    \198\ See FINRA Response Letter 2 at 16.
    \199\ See id. See also Notice, 80 FR at 81656.
    \200\ See Notice, 80 FR at 81656.
    \201\ See id. (``FINRA intends to establish an effective date 
that is no sooner than 180 days following publication of the 
Regulatory Notice announcing Commission approval of the proposed 
rule change, and no later than 365 days following Commission 
approval of the proposed rule change.'').
    \202\ See FINRA Response Letter 2 at 16.
---------------------------------------------------------------------------

J. Comments Regarding Application of the Proposed Rules to the 
Independent Business Model and FINRA's Responses

    One commenter claims that its members ``will face difficulties'' in 
attempting to comply with the proposed rules, and that these 
difficulties stem, primarily, from a requirement for independent firms 
to implement a rule that is premised on the notion that solicitation of 
clients is performed pursuant to a centralized process controlled by 
the management of a registered investment adviser.\203\ This same 
commenter claims that the ``lack of clarity'' as to the application of 
the SEC Pay-to-Play Rule to its members' independent business model, 
and the scope of government officials that trigger the requirements, 
has led some

[[Page 60062]]

firms to adopt aggressive compliance programs that prohibit political 
contributions.\204\
---------------------------------------------------------------------------

    \203\ See FSI Letter 1 (claiming FSI believes that the SEC Pay-
to-Play Rule has inadvertently captured non-corrupting activity and 
fears that the proposed rule may do the same).
    \204\ See id. (claiming that, absent clarity concerning the 
application of the proposed rule to the brokerage services provided 
to 403(b) and 457 plans, FSI's members will be faced with the choice 
of either adopting similarly aggressive policies or prohibiting 
sales to government-sponsored retirement plans).
---------------------------------------------------------------------------

    In response, FINRA states that, consistent with the SEC Pay-to-Play 
Rule, it has determined not to except from its proposed pay-to-play 
rule member firms engaged in the independent business model.\205\ 
FINRA, however, states that, to the extent that interpretive questions 
arise regarding the application and scope of the provisions and terms 
used in the proposed rule change, FINRA will work with the industry and 
Commission to address the interpretive questions and provide additional 
guidance as needed.\206\
---------------------------------------------------------------------------

    \205\ See FINRA Response Letter 2 at 18.
    \206\ See id.
---------------------------------------------------------------------------

K. Comments Requesting More Stringent Requirements in the Proposed 
Rules and FINRA's Responses

    Two commenters suggested that proposed Rule 2030 include more 
stringent requirements in certain respects.\207\ First, both commenters 
request that FINRA expand the applicability of its proposed rules to 
include state-registered investment advisers.\208\ More specifically, 
one of these commenters suggests that FINRA include state-registered 
investment advisers in its definition of ``investment adviser'' for the 
purposes of its proposed rule.\209\ Although FINRA states in the Notice 
that relatively few state-registered investment advisers manage public 
pension plans,\210\ one commenter believes that this alone does not 
justify permitting FINRA-member firms that do manage public pension 
plans, but happen to work with smaller investment advisers, to engage 
in pay-to-play activities with no repercussions.\211\ Another commenter 
claims that state-registered investment advisers now include larger 
firms and, therefore, it is much more likely that state-registered 
investment advisers will manage or advise public pension plans or 
similar funds.\212\
---------------------------------------------------------------------------

    \207\ See NASAA Letter and PIABA Letter.
    \208\ See NASAA Letter and PIABA Letter.
    \209\ See NASAA Letter.
    \210\ See NASAA Letter and PIABA Letter.
    \211\ See PIABA Letter. Unless the commenter is discussing 
dually-registered intermediaries, we do not understand the 
commenter's reference to ``FINRA-member firms that do manage public 
pension plans'' as those plans are managed by investment advisers, 
not broker-dealers.
    \212\ See NASAA Letter.
---------------------------------------------------------------------------

    In response, FINRA states that, as discussed in the Notice,\213\ to 
remain consistent with the SEC Pay-to-Play Rule, FINRA has determined 
not to expand the scope of the proposed rule as suggested by commenters 
to include state-registered investment advisers in its definition of 
``investment adviser'' for the purposes of its proposed rule.\214\ As 
discussed in the Notice, FINRA explains that the Commission also 
declined to make a similar change to its proposed rule, stating that it 
was the Commission's understanding that few of these smaller firms 
manage public pension plans or other similar funds.\215\
---------------------------------------------------------------------------

    \213\ See Notice, 80 FR at 81652 n.26 (explaining that 
``consistent with the SEC Pay-to-Play Rule, the proposed rule would 
not apply to state-registered investment advisers as few of these 
smaller firms manage public pension plans or other similar funds''). 
See also id. at 81660 n.98 (citing SEC Pay-to-Play Rule Adopting 
Release, 75 FR at 41026).
    \214\ See FINRA Response Letter 2 at 10.
    \215\ See Notice, 80 FR at 81652 n.26. See also id. at 81660 
n.98.
---------------------------------------------------------------------------

    Second, these two commenters request that FINRA include a mandatory 
disgorgement provision for violations of its proposed rule.\216\ These 
commenters state that they are disappointed that FINRA removed the 
mandatory disgorgement provisions from the proposal as outlined in 
FINRA's Regulatory Notice 14-50.\217\ These commenters believe that a 
mandatory disgorgement provision would act as a significant deterrent 
to engaging in pay-to-play schemes, and it should remain in FINRA's 
final rule.\218\
---------------------------------------------------------------------------

    \216\ See NASAA Letter and PIABA Letter.
    \217\ See NASAA Letter and PIABA Letter.
    \218\ See NASAA Letter and PIABA Letter.
---------------------------------------------------------------------------

    In response, FINRA states that, after considering similar comments 
made in response to its Regulatory Notice 14-50, in particular, that 
FINRA has authority to require disgorgement of fees in enforcement 
actions, FINRA determined not to include a disgorgement requirement in 
its proposal.\219\ For those same reasons, which also are discussed in 
the Notice,\220\ FINRA also has determined not to revise the proposal 
to include a disgorgement requirement.\221\
---------------------------------------------------------------------------

    \219\ See FINRA Response Letter 2 at 19-20.
    \220\ See Notice, 80 FR at 81662 (noting, for example, ICI's 
comment made in connection with Regulatory Notice 14-50 that 
``including disgorgement as a penalty is not necessary given that 
the SEC and FINRA both have full authority to require disgorgement 
of fees, and indeed, disgorgement has been the penalty universally 
applied (along with additional penalties) in enforcement actions 
under existing pay-to-play rules, such as MSRB Rule G-37 and SEC 
Rule 206(4)-5'').
    \221\ See FINRA Response Letter 2 at 20.
---------------------------------------------------------------------------

    Finally, one commenter believes that the cooling-off period in the 
proposal should be at least four years.\222\ PIABA believes that the 
two-year cooling-off period does not adequately reduce the incentive 
for FINRA member firms to make political contributions to obtain pay-
to-play advantages.\223\ PIABA states FINRA should start with the most 
comprehensive rule, and that it would welcome the deterrent effect of a 
four-year cooling off period.\224\
---------------------------------------------------------------------------

    \222\ See PIABA Letter.
    \223\ See id.
    \224\ See id.
---------------------------------------------------------------------------

    FINRA declines to make PIABA's suggested change.\225\ FINRA 
explains that the proposed two-year time-out is consistent with the 
time-out period in the SEC's Pay-to-Play Rule and, FINRA believes that 
a two-year time-out period from the date of a contribution is 
sufficient to discourage covered members from engaging in pay-to-play 
practices.\226\ As FINRA explains in the Notice, the two-year time-out 
in the proposed rule is intended to discourage covered members from 
participating in pay-to-play practices by requiring a cooling-off 
period during which the effects of a quid pro quo political 
contribution on the selection process can be expected to 
dissipate.\227\
---------------------------------------------------------------------------

    \225\ See FINRA Response Letter 2 at 10.
    \226\ See id.
    \227\ See Notice, 80 FR at 81651. As the Commission explained, 
the two-year ``cooling-off period'' is not a penalty but, rather, is 
intended to be a period during which any effects of a quid pro quo 
are expected to dissipate. See SEC Pay-to-Play Adopting Release, 75 
FR at 41026 n.104.
---------------------------------------------------------------------------

IV. Discussion and Commission Findings

    After carefully considering the proposed rule change, the comments 
submitted, and FINRA's responses thereto, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a registered 
national securities association.\228\
---------------------------------------------------------------------------

    \228\ In approving this proposed rule change, the Commission has 
considered the proposed rule change's impact on efficiency, 
competition, and capital formation. In this regard, the Commission 
considered FINRA's extensive discussion of these effects in its 
Notice and FINRA's response to comments on that discussion. 
Moreover, the Commission observes that, in response to the 
Commission's Notice, no commenter suggested that FINRA's analysis 
was incorrect or incomplete, or that the proposed rule change would 
have a negative effect on efficiency, competition, or capital 
formation. See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    In particular, the Commission finds that the proposed rule change 
is consistent with Section 15A(b)(6) of the Act.\229\ Section 
15A(b)(6), which governs registered national securities associations 
like FINRA, requires, among other things, that the association's rules 
be ``designed to prevent fraudulent and manipulative

[[Page 60063]]

acts and practices, to promote just and equitable principles of trade, 
. . . to remove impediments to and perfect the mechanism of a free and 
open market and a national market system and, in general, to protect 
investors and the public interest.'' \230\ As discussed in more detail 
below, we believe that FINRA's proposal is consistent with Section 
15A(b)(6). FINRA's proposed rule will address the regulatory concerns 
that underlie, and thus support the objectives of, the SEC Pay-to-Play 
Rule, discussed below, by discouraging FINRA member firms and certain 
of their covered associates from engaging in quid pro quo corruption 
that may create market distortions--when, for example, an investment 
adviser is chosen on the basis of a placement agent's political 
contributions rather than the adviser's merit. Such conduct impedes a 
free and open market, and may harm investors and the public interest if 
government entities, including public pension plans, and their 
beneficiaries receive inferior services or pay higher fees.\231\ 
FINRA's proposed rule also promotes a free and open market and the 
protection of investors and the public interest by avoiding the 
outright ban on distribution and solicitation activity that would 
result if FINRA member firms were not ``regulated person[s]'' under the 
SEC Pay-to-Play Rule.\232\ The fact that FINRA's proposed rule may have 
implications for a small subset of political contributions made by 
certain covered associates to certain elected officials does not 
somehow eliminate FINRA's ability to adopt rules pursuant to the Act, 
or the Commission's authority to approve such rules under Section 
19(b)(2) of the Act.\233\
---------------------------------------------------------------------------

    \229\ 15 U.S.C. 78o-3(b)(6).
    \230\ Id.
    \231\ See FINRA Response Letter 2 at 8. See also Notice, 80 FR 
at 81651, 81656 (discussing the regulatory objectives of and 
statutory basis for the proposal).
    \232\ See FINRA Response Letter 2 at 5 (``FINRA believes that 
the proposed rule change is a more effective response to the issues 
addressed in the SEC Pay-to-Play Rule than a complete ban on 
solicitation.''). See also Notice, 80 FR at 81652, 81656 (discussing 
the regulatory objectives of and statutory basis for the proposal).
    \233\ While FINRA's proposed rule does not bar member firms and 
their covered associates from making contributions, it may affect 
the propensity of member firms and certain employees to make the 
subset of contributions that would trigger the two-year time-out. 
FINRA's rule does not impose a requirement that member firms 
publicly disclose political contributions.
---------------------------------------------------------------------------

    As support for the need for the proposed rule, FINRA outlined 
certain regulatory concerns in the Notice that also were identified by 
the Commission in connection with its adoption of the SEC Pay-to-Play 
Rule.\234\ These concerns, which also implicate the investor and public 
interest protections described in Section 15A(b)(6) of the Act, 
recognize the central role intermediaries, such as ``solicitors'' or 
``placement agents,'' have played in actions that the Commission and 
other authorities have brought involving pay-to-play schemes.\235\ 
FINRA also acknowledges the Commission's observation of how investment 
advisers, in several instances, allegedly made significant payments to 
placement agents and other intermediaries to influence the award of 
advisory contracts.\236\ Moreover, FINRA points out the difficulties 
that investment advisers face in monitoring or controlling the 
activities of their third-party solicitors.\237\
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    \234\ See Notice, 80 FR at 81651, nn.12-14 (discussing concerns 
the Commission identified in the SEC Pay-to-Play Rule Adopting 
Release, 75 FR at 41037).
    \235\ See Notice, 80 FR at 81651. See also id. at nn.10-11 
(explaining that ``solicitors'' typically locate investment advisory 
clients on behalf of an investment adviser, and that ``placement 
agents'' typically specialize in finding investors, often 
institutional investors or high net worth investors, that are 
willing and able to invest in a private offering of securities on 
behalf of the issuer of such privately offered securities) (citing 
Advisers Act Release No. 2910 (Aug. 3, 2009), 74 FR 39840, 39853 
n.137 (Aug. 7, 2009) (Political Contributions by Certain Investment 
Advisers)).
    \236\ See Notice, 80 FR at 81651. See also e.g., SEC Pay-to-Play 
Adopting Release, 75 FR at 41037.
    \237\ See Notice, 80 FR at 81651. See also SEC Pay-to-Play 
Adopting Release, 75 FR at 41032 n.182, 40137 n.266 (acknowledging 
commenters' concerns regarding the difficulties that advisers may 
have when monitoring the activities of their third-party 
solicitors).
---------------------------------------------------------------------------

    As we explained in adopting the SEC Pay-to-Play Rule, public 
pension plans are particularly vulnerable to pay-to-play practices, and 
we have been particularly concerned that the engagement of placement 
agents who have made political contributions to key officials is viewed 
by investment advisers as a necessary step to securing a contract with 
a public pension plan.\238\ In connection with the SEC Pay-to-Play 
Rule, we initially proposed a complete bar on investment advisers 
engaging third parties to solicit government clients on their behalf 
because of concerns about investment advisers' use of third-party 
solicitors and placement agents to engage in pay-to-play 
activities.\239\ However, persuaded by commenters, we revised the 
proposed SEC Pay-to-Play Rule to permit advisers to make payments to 
certain ``regulated persons'' to solicit government clients on their 
behalf, provided that they are themselves subject to prohibitions 
against participating in pay-to-play practices, are subject to 
Commission oversight and, in the case of broker-dealers, the oversight 
of a registered national securities association such as FINRA.\240\ 
FINRA agreed and informed us that it would prepare rules for our 
consideration that would prohibit its members from soliciting advisory 
business from a government entity on behalf of an adviser unless they 
comply with pay-to-play restrictions.\241\
---------------------------------------------------------------------------

    \238\ See SEC Pay-to-Play Adopting Release, 75 FR at 41019-20, 
nn.16-25 (collecting examples of SEC litigation releases as well as 
state and federal criminal actions with pay-to-play schemes 
involving placement agents among other intermediaries). See also id. 
at 40137, n.262 (collecting examples of state and local legislative 
actions undertaken to prohibit or regulate pay-to-play practices 
involving placement agents in response to concerns about pay-to-play 
activities in their jurisdictions).
    \239\ See id. at 41037 nn.259-68 (discussing the Commission's 
observations in the SEC Pay-to-Play Rule proposing release).
    \240\ See id. at 41041.
    \241\ See Notice, 80 FR at 81651 n.15 (citing a letter from 
Richard G. Ketchum, Chairman and Chief Executive Officer, FINRA, to 
Andrew J. Donohue, Director, Division of Investment Management, 
Commission (Mar. 15, 2010) (``Ketchum Letter''), available at http://www.sec.gov/comments/s7-18-09/s71809-260.pdf (stating that FINRA 
``believe[s] that a regulatory scheme targeting improper pay to play 
practices by broker-dealers acting on behalf of investment advisers 
is . . . a viable solution to a ban on certain private placement 
agents serving a legitimate function'')). FINRA also notes that in 
developing its proposal it intended to draw closely upon all the 
substantive and technical elements of the Commission's rule as well 
as FINRA's regulatory expertise in examining and enforcing the MSRB 
rules, upon which the SEC Pay-to-Play Rule is based. See Ketchum 
Letter. See also SEC Pay-to-Play Adopting Release, 75 FR at 41042 
n.317 (discussing same).
---------------------------------------------------------------------------

    Pay-to-play practices are harmful. They create an impediment to a 
free and open market by, for example, distorting the investment adviser 
selection process from one that is based on merit, performance and 
cost, to one that is influenced by a placement agent's contributions to 
the campaigns of government officials who are responsible for, or can 
influence the outcome of, selecting an investment adviser.\242\ As a 
result of this distortion, government entities, including pension 
funds, and their citizen beneficiaries may be harmed by receiving 
inferior services or paying higher fees.\243\ Investors and the public 
interest ultimately suffer, including taxpayers, residents who rely on 
municipal services, and the beneficiaries of public pension funds, such 
as firemen, police officers, teachers, and other civil

[[Page 60064]]

servants.\244\ Investment advisers also are harmed because their 
ability to participate in the market is impeded unless they are willing 
to engage in pay-to-play practices by, for example, hiring placement 
agents that make certain political contributions.\245\
---------------------------------------------------------------------------

    \242\ See, e.g., SEC Pay-to-Play Adopting Release, 75 FR at 
41023, 41039.
    \243\ SEC Pay-to-Play Adopting Release, 75 FR at 41019.
    \244\ SEC Pay-to-Play Adopting Release, 75 FR at 41019 (noting 
that the management of public pension plans ``most significantly . . 
. affects taxpayers and the beneficiaries of these funds, including 
the millions of present and future State and municipal retirees who 
rely on the funds for their pensions and other benefits'').
    \245\ See, e.g., SEC Pay-to-Play Adopting Release, 75 FR at 
41023, 41039 (explaining that ``pay to play practices may hurt 
smaller advisers that cannot afford the required contributions. 
Curtailing pay to play arrangements enables advisory firms, 
particularly smaller advisory firms, to compete on merit, rather 
than their ability or willingness to make contributions'').
---------------------------------------------------------------------------

    The Commission also believes that the stealth in which pay-to-play 
practices occur and the inability of markets to properly address these 
practices argue strongly for rules like the SEC Pay-to-Play Rule and 
FINRA's proposal.\246\ Pay-to-play practices create a ``collective 
action'' problem in two respects: (1) Government officials who 
participate in such activities have an incentive to continue to accept 
contributions to support their campaigns for fear of being 
disadvantaged relative to their opponents; and (2) investment advisers 
have an incentive to participate out of concern that they may be 
overlooked if they fail to make a contribution.\247\
---------------------------------------------------------------------------

    \246\ See SEC Pay-to-Play Adopting Release, 75 FR at 40122-23. 
See also FINRA Response Letter at 6 (noting that, as explained in 
Blount, ``no smoking gun is needed;'' however, ``where, as here, the 
conflict of interest is apparent, the likelihood of stealth great, 
and the [Commission's] purpose prophylactic'').
    \247\ See FINRA Response Letter at 9; SEC Pay-to-Play Adopting 
Release, 75 FR at 40122.
---------------------------------------------------------------------------

    We believe that application of FINRA's proposed pay-to-play rules 
will effectively discourage covered members and their covered 
associates who act as placement agents for investment advisers from 
participating in pay-to-play practices because their political 
contributions or payments will be subject to restrictions similar to 
those imposed on investment advisers under the SEC Pay-to-Play 
Rule.\248\ The Commission therefore believes that FINRA's proposed rule 
change will help address the concerns identified in the SEC Pay-to-Play 
Rule Adopting Release regarding the distortion of the investment 
advisory market.\249\ As a result, like the SEC Pay-to-Play rule, 
FINRA's proposal should help protect investors and the public interest 
by, among other things, reducing the costs to plans and their 
beneficiaries of inferior asset management services arising from 
adviser selection based on a placement agent's political contributions 
rather than prudential investment considerations.\250\ Further, in the 
Commission's view, FINRA's proposed rule strikes an appropriate balance 
in addressing these regulatory concerns by providing for FINRA member 
firms to be ``regulated person[s]'' under the SEC Pay-to-Play 
Rule.\251\ As a result, investment advisers will be able to continue to 
benefit from the use of placement agents in obtaining investment 
advisory business with government entities without political 
contributions distorting the process by which a government entity, such 
as a public pension fund, selects an adviser.\252\ The two-year time-
out period imposed by the proposed rule change is not a penalty but, 
rather, is intended to discourage participation in pay-to-play 
practices by requiring a ``cooling-off period'' during which the 
effects of a quid pro quo political contribution on the selection 
process are expected to dissipate.\253\ This time-out will help promote 
fair competition in the market and protect public pension funds and 
investors by curbing fraudulent conduct resulting from pay-to-play 
practices.\254\ In addition, according to FINRA, the proposal can be 
expected to help promote competition by allowing more third-party 
solicitors to participate in the market for solicitation services, 
which in turn may reduce costs to investment advisers and improve 
competition for advisory services.\255\ For these reasons and as 
discussed throughout, the Commission finds that the proposed rule 
change is consistent with Section 15A(b)(6) of the Act.\256\
---------------------------------------------------------------------------

    \248\ See Notice, 80 FR at 81651.
    \249\ See FINRA Response Letter at 9 (stating that ``[f]or 
example, the proposed rule change is reasonably designed to address 
the distortion of the investment advisory market and collective 
action problems created by pay-to-play practices''). As the 
Commission has explained, by addressing distortions in the process 
by which investment advisers are selected regarding public 
investments, pay-to-play rules provide important protections to 
public pension plans and their beneficiaries, as well as 
participants in other important plans or programs sponsored by 
government entities. See SEC Pay-to-Play Adopting Release, 75 FR at 
41023, 41054.
    \250\ See SEC Pay-to-Play Adopting Release, 75 FR at 41039.
    \251\ See, e.g., FINRA Response Letter at 5 (``FINRA believes 
that the proposed rule change is a more effective response to the 
issues addressed in the SEC Pay-to-Play Rule than a complete ban on 
solicitation.'') See also Notice, 80 FR at 81652, 81656 (discussing 
the regulatory objectives of and statutory basis for the proposal).
    \252\ See, e.g., FINRA Response Letter 2 at 8 (``The proposed 
rule change accomplishes these goals by allowing member firms to 
continue to engage in distribution or solicitation activities for 
compensation with governmental entities on behalf of investment 
advisers, while at the same time deterring member firms from 
engaging in pay-to-play practices.'').
    \253\ See Notice, 80 FR at 81651. See also SEC Pay-to-Play 
Adopting Release, 75 FR at 41026 n.104.
    \254\ See Notice, 80 FR at 81657.
    \255\ See id.
    \256\ See 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    The Commission notes that most commenters to the Notice \257\ and 
some of the commenters responding to the Order Instituting Proceedings 
\258\ generally express support for FINRA's proposal. For example, one 
commenter states that it is pleased that, like the SEC and the MSRB, 
FINRA is adopting rules to govern the activities of its members that 
solicit government clients on behalf of an investment adviser and also 
is pleased that FINRA's proposal is designed to complement, and be 
consistent with, the SEC's pay-to-play rule.\259\ Similarly, another 
commenter states that, although it requests certain revisions, it also 
supports FINRA's attempt to deter pay-to-play activity among covered 
members and supports the regulatory objectives underlying the Proposed 
Rules.\260\
---------------------------------------------------------------------------

    \257\ See CAI Letter 1; CAI Letter 2; FSI Letter 1; ICI Letter; 
NAIFA Letter; NASAA Letter; and PIABA Letter.
    \258\ See FSI Letter 2 (claiming that the proposal creates 
``compliance uncertainties'' for FSI's members, but noting that FSI 
``support[s] regulatory efforts to combat pay-to-play corruption 
activity'').
    \259\ See ICI Letter.
    \260\ See CAI Letter 1 (recognizing ``the challenges in crafting 
the Proposed Rules so that they reach all of the activity sought to 
be eliminated without also prohibiting activity that is harmless'').
---------------------------------------------------------------------------

    The Commission acknowledges the concerns and questions raised by 
some commenters, which are outlined in further detail above in Section 
III. As discussed below, the Commission believes, however, that FINRA 
has responded to the commenters' concerns and questions in light of, 
among other things, the regulatory framework established by the SEC 
Pay-to-Play Rule, which provides that FINRA's proposed rules must 
impose substantially equivalent or more stringent restrictions on its 
members than the SEC Pay-to-Play Rule imposes on investment advisers 
for FINRA members to be ``regulated persons'' under the SEC Pay-to-Play 
Rule.

A. Comments Concerning the First Amendment and Related Concerns

    Several commenters express the view that FINRA's proposed rule 
violates the First Amendment.\261\ The Commission is sensitive to the 
constitutional concerns raised by the commenters, but after careful 
consideration of their arguments, for the reasons discussed

[[Page 60065]]

below, concludes that FINRA's rule is consistent with the First 
Amendment.
---------------------------------------------------------------------------

    \261\ See CCP Letter 1; FSI Letter 1; FSI Letter 2; and State 
Parties Letter 1. See also CCP Letter 2; CCP Letter 3; Moran Letter 
and State Parties Letter 2.
---------------------------------------------------------------------------

    FINRA's rule, which focuses on covered members who serve as 
placement agents, tracks the SEC Pay-to-Play Rule for investment 
advisers, which, in turn, tracks the MSRB's pay-to-play rule, Rule G-
37, which the D.C. Circuit upheld against First Amendment challenge in 
1995.\262\ The Supreme Court has issued several decisions regarding 
political speech since Blount was decided,\263\ and none of these 
decisions call into question Blount's holding that a tailored pay-to-
play rule, which is nearly identical in purpose and form to FINRA's 
proposed rule and which also furthers an important public interest, is 
constitutional. Indeed, the en banc D.C. Circuit recently and 
unanimously upheld a broader pay-to-play restriction--a bar on all 
contributions to federal candidates by federal contractors--in its 
decision in Wagner that analyzed the post-Blount Supreme Court 
decisions and cited Blount with approval.\264\ Various pay-to-play 
restrictions imposed by other jurisdictions also have withstood First 
Amendment challenge in recent years.\265\
---------------------------------------------------------------------------

    \262\ Blount v. SEC, 61 F.3d 938 (D.C. Cir. 1995), cert. denied, 
517 U.S. 1119 (1996). One significant difference between the MSRB 
rule, on one hand, and the SEC's and FINRA's rules, on the other, is 
that the MSRB rule requires the public disclosure of political 
contributions whereas the SEC's and FINRA's rules do not.
    \263\ See, e.g., McCutcheon v. FEC, 134 S. Ct. 1434 (2014); 
Citizens United v. FEC, 558 U.S. 310 (2010); Davis v. FEC, 554 U.S. 
724 (2008); FEC v. Wisc. Right To Life, Inc., 51 U.S. 449 (2007); 
Randall v. Sorrell, 548 U.S. 230 (2006); FEC v. Beaumont, 539 U.S. 
146 (2003); Nixon v. Shrink Mo. Gov't PAC, 528 U.S. 377 (2000).
    \264\ Wagner v. FEC, 793 F.3d 1 (D.C. Cir. 2015) (en banc), 
cert. denied sub nom., Miller v. FEC, 136 S. Ct. 895 (2016).
    \265\ See, e.g., Yamada v. Snipes, 786 F.3d 1182 (9th Cir.), 
cert. denied, 136 S. Ct. 569 (2015); Preston v. Leake, 660 F.3d 726, 
729-30, 736 (4th Cir. 2011); Ognibene v. Parkes, 671 F.3d 174, 179-
80 (2d Cir. 2011); Green Party of Connecticut v. Garfield, 616 F.3d 
189, 200 (2d Cir. 2010).
---------------------------------------------------------------------------

    Decisions like Wagner confirm that even an outright limitation on 
contributions--as opposed to FINRA's rule, which may indirectly 
discourage contributions--is permissible if it is justified by a 
sufficiently important government interest and is closely drawn to 
avoid unnecessary abridgement of the type of political speech 
represented by a political contribution.\266\ We believe that FINRA's 
proposed rule serves a vitally important governmental interest: 
Discouraging a specific type of quid pro quo corruption in which 
political contributions made by placement agents may influence the 
award of investment advisory business by government entities. The 
Supreme Court has long held that halting quid pro quo corruption is an 
important government interest that justifies limitations--or outright 
bans--on contributions.\267\
---------------------------------------------------------------------------

    \266\ Wagner, 793 F.3d at 6-8. We note that FINRA's rule is not 
an absolute bar on contributions, but the two-year time-out may have 
the effect of discouraging member firms and certain covered 
associates who may act as placement agents for investment advisers 
from making certain contributions to certain covered officials. To 
the extent that the commenters suggest that such an indirect 
limitation on contributions would be reviewed by a court under 
strict scrutiny, they misstate applicable Supreme Court precedent, 
which has maintained that limitations on contributions are reviewed 
under a more intermediate form of scrutiny because ``[c]ontribution 
limits impose a lesser restraint on political speech'' that permits 
```symbolic expression of support evidence by a contribution'' but 
do not ```in any way infringe the contributor's freedom to discuss 
candidates and issues.' '' McCutcheon, 134 S. Ct. at 1444, quoting 
Buckley v. Valeo, 424 U.S. 1, 21 (1976).
    \267\ McCutcheon, 134 S. Ct. at 1452; Buckley, 424 U.S. at 27-28 
(1976).
---------------------------------------------------------------------------

    We do not understand FINRA to be engaging in broad electoral reform 
or trying to clean up the electoral process. Rather, to avoid the 
outright ban on placement agent activity resulting from FINRA member 
firms not being ``regulated person[s]'' under the SEC Pay-to-Play Rule, 
the two-year time-out in FINRA's proposal, like the SEC Pay-to-Play 
Rule, discourages quid pro quos that affect government entities, 
including public pension funds, served by investment advisers. Quid pro 
quos involving placement agents, who make contributions to certain 
elected officials and then assist investment advisers in obtaining 
business from the government entities those officials serve may be: 
Fraudulent, run counter to just and equitable principles of trade, 
impede a free and open market, and harm investors and the public 
interest.\268\ When pay-to-play is a factor in the selection or 
retention of an investment adviser--when the adviser is chosen on the 
basis of a placement agent's political contributions rather than its 
merit--the most qualified adviser may not be hired, which may lead to 
inferior performance and payment of higher fees.\269\ Ultimately, 
taxpayers and fund beneficiaries suffer the harm. Moreover, pay-to-play 
distorts free and open markets by requiring investment advisers and 
their placement agents to ``play the game'' or risk being left 
out.\270\ In short, while FINRA's rule resembles other contribution 
limitations by serving a government interest in discouraging quid quo 
pro corruption, it is a targeted effort that should protect investors 
and the public by promoting the integrity of the investment advisory 
market.
---------------------------------------------------------------------------

    \268\ Blount, 61 F.3d at 944-48. See also 15 U.S.C. 78o-3(b)(6).
    \269\ SEC Pay-to-Play Adopting Release, 75 FR at 41022, 41053-
54.
    \270\ Id. at 41019, 41022, 41053. See also Blount, 61 F.3d at 
945-46.
---------------------------------------------------------------------------

    FINRA's proposed rule advances this important governmental interest 
because the two-year time-out discourages pay-to-play. As explained 
above, pay-to-play has been and is a serious problem when placement 
agents assist investment advisers in obtaining advisory business from 
government entities.\271\ Placement agents ``played a central role in 
actions that [the Commission] and other authorities have brought 
involving pay-to-play schemes,'' and, in several instances, advisers 
used placement agents, who had made campaign contributions to elected 
officials, to influence the award of investment advisory 
contracts.\272\ Most notably, Alan Hevesi, the Comptroller of New York 
State who was responsible for investment of state pension funds, 
accepted campaign contributions from a placement agent and steered over 
$250 million in pension funds to investment advisers that had retained 
the placement agent.\273\
---------------------------------------------------------------------------

    \271\ SEC Pay-to-Play Adopting Release, 75 FR at 41019-20. Pay-
to-play that affects State and local pension funds is not limited to 
the investment advisory context.
    \272\ SEC Pay-to-Play Adopting Release, 75 FR at 41019-20, 
41037.
    \273\ Id. at 41019-20.
---------------------------------------------------------------------------

    In response to these incidents, the Commission proposed a ban on 
the use of placement agents by investment advisers and ultimately 
adopted a final rule that permitted use of placement agents so long as 
they were ``regulated persons'' governed by the type of pay-to-play 
rule that FINRA has proposed here.\274\ FINRA is not alone in 
addressing these issues. For example, several State and local 
governments have barred or restricted placement agents from playing a 
role in the contracting process.\275\ Although the Supreme Court has 
never required a certain amount of past quid pro quo corruption to 
sustain a contribution limitation, there is more than sufficient 
evidence of pay-to-play practices to support FINRA's rule.\276\
---------------------------------------------------------------------------

    \274\ Id. at 41037-42.
    \275\ Id. at 41037 n. 262.
    \276\ McCutcheon, 134 S. Ct. at 1445, 1458; Nixon, 528 U.S. at 
390-91; Buckley, 424 U.S. at 29-30.
---------------------------------------------------------------------------

    The contours of FINRA's proposed rule reflect how pay-to-play 
practices involving placement agents affect the hiring and retention of 
investment advisers by State and local pension funds. One scenario 
implicated by FINRA's rule (and reflected in the

[[Page 60066]]

Hevesi matter) involves an investment adviser that seeks business from 
a State pension fund and retains a firm, or an individual at a firm, 
that has made contributions to an elected official responsible for 
selecting investment advisers.\277\ The elected officials who 
participate have no incentive to stop accepting contributions for fear 
of being disadvantaged relative to their opponents. Similarly neither 
the placement agents that make the contributions nor the investment 
advisers that hire the placement agents have an incentive to stop out 
of concern that if they abstain, their competitors will continue to 
engage in the practice profitably and without adverse 
consequences.\278\ FINRA's rule should resolve this collective-action 
problem by interposing a time-out that creates a disincentive to engage 
in pay-to-play.
---------------------------------------------------------------------------

    \277\ SEC Pay-to-Play Adopting Release, 75 FR at 41019-20 & 
nn.18-20 (citing examples).
    \278\ Id. at 41022, 41040, 41053. See also Blount, 61 F.3d at 
945-46. Even if the public is aware of the quid pro quo 
relationship, there is little that can be done because the official 
is compromised by the receipt of the contribution, and beneficiaries 
of a pension fund cannot easily shift their assets out of the fund, 
reverse the hiring decision, or remove the official. Id. at 41027. 
See also id. at 41053 n.459.
---------------------------------------------------------------------------

    The proposed FINRA rule, like the SEC Pay-to-Play Rule that it is 
modeled on, is a tailored solution to a particularly pernicious form of 
quid pro quo corruption that affects the beneficiaries of public 
pension funds, such as teachers, law enforcement officers, 
firefighters, and other public servants, as well as the beneficiaries 
of other collective government funds, including participant-directed 
plans such as 403(b), 457 and 529 plans. The proposed FINRA rule would 
affect a small segment of the electorate: In general, member firms 
acting as placement agents for investment advisers seeking to obtain 
advisory business from government entities. And the proposed FINRA rule 
would affect only a small number of elected officials--those who are 
responsible for or have authority to appoint any person who is 
responsible for or can influence the outcome of the hiring of an 
investment adviser by a government entity--and has no bearing on the 
vast majority of elections where the elected office's scope of 
authority does not encompass the awarding of investment advisory 
contracts. Moreover, the proposed FINRA rule's de minimis exception 
permits some campaign contributions to be made in all instances without 
triggering the time-out--thus allowing ``the symbolic expression of 
support evidenced by a contribution''--and it does not restrict other 
forms of political speech, such as independent expenditures.\279\
---------------------------------------------------------------------------

    \279\ McCutcheon, 134 S. Ct. at 1444, quoting Buckley, 424 U.S. 
at 21 (internal quotation marks omitted).
---------------------------------------------------------------------------

B. Comments Regarding the Scope and Coverage of the Proposal

    As discussed in detail above, the commenters raise several concerns 
regarding the scope and coverage of the proposed rules, including with 
respect to: The inclusion of variable annuities and mutual funds; \280\ 
the inclusion of distribution activities; \281\ the application to 
covered investment pools; \282\ the level of the de minimis 
contribution exception and the returned contribution exception; \283\ 
the inclusion of the independent business model; \284\ and the 
application to existing contracts or accounts.\285\ FINRA generally 
responded that its proposed rules are designed to be at least as 
stringent as the SEC Pay-to-Play Rule so that FINRA's member firms will 
meet the definition of ``regulated persons'' such that they are subject 
to rules that impose substantially equivalent or more stringent 
restrictions on its members than the SEC Pay-to-Play Rule imposes on 
investment advisers.\286\
---------------------------------------------------------------------------

    \280\ See CAI Letter 1 and FSI Letter 1. See also CAI Letter 2 
(reflecting CAI's suggested revisions to certain language in some of 
FINRA's proposed rules). In FINRA's view, because the Commission did 
not exclude specific products from the SEC Pay-to-Play Rule, such as 
variable annuities or mutual funds, excluding specific products from 
its proposed rule would not satisfy the Commission's stringency 
requirements. See FINRA Response Letter 2 at 16.
    \281\ See CAI Letter 1. See also CAI Letter 2 (reflecting CAI's 
suggested revisions to certain language in some of FINRA's proposed 
rules). FINRA notes that, among other things, language in the SEC 
Pay-to-Play Rule Adopting Release supports the inclusion of 
``distribution'' activities by broker-dealers in FINRA's proposed 
Rule 2030(a). See Notice, 80 FR at 81660-61 (citing SEC Pay-to-Play 
Rule Adopting Release, 75 FR at 41040 n.298 where, according to 
FINRA, the Commission ``clarif[ied] under what circumstances 
distribution payments would violate the SEC's Pay-to-Play Rule''). 
FINRA believes that based on the Commission's definition of 
``regulated person'' in the SEC's Pay-to-Play Rule, as well as the 
Commission's discussion regarding the treatment of distribution fees 
paid pursuant to a 12b-1 plan as compared to legitimate profits, its 
proposed rule must apply to member firms engaging in distribution 
activities. See FINRA Response Letter 2 at 12 (citing Notice, 80 FR 
at 81660-61) and FINRA Response Letter 2 at 12 n.53 (explaining that 
the SEC Pay-to-Play Rule defines a ``regulated person'' to include a 
member firm, provided that FINRA rules prohibit member firms from 
engaging in distribution or solicitation activities if political 
contributions have been made, and citing SEC Pay-to-Play Rule 
206(4)-5(f)(9)(ii)(A)) (emphasis in original).
    \282\ See CAI Letter 1; FSI Letter 1; FSI Letter 2. FINRA 
clarifies that it is not intending in this proposal to re-
characterize broker-dealers' selling interests in variable 
annuities, mutual funds, and private funds as soliciting an 
investment advisory relationship with investors who invest in those 
products. See FINRA Response Letter 2 at 14-15 (noting, for example, 
that the applicability of proposed FINRA Rule 2030(d) is for 
purposes of FINRA's pay-to-play rule only). FINRA also explains that 
FINRA Rule 2030(d) is modeled on a similar provision in the SEC Pay-
to-Play Rule, Rule 206(4)-5(c) and, as such, proposed FINRA Rule 
2030(d) is intended to extend the protections of the proposed rule 
to government entities that access the services of investment 
advisers through hedge funds and other types of pooled investment 
vehicles sponsored or advised by investment advisers. See FINRA 
Response Letter 2 at 15 (noting that when adopting SEC Pay-to-Play 
Rule 206(4)-5(c), the Commission stated that although ``an 
investment in a pooled investment vehicle may not involve a direct 
advisory relationship with a government sponsored plan [that] does 
not change the nature of the fraud or the harm that may be inflicted 
as a consequence of the adviser's pay-to-play activity'') (quoting 
SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044-45). Finally, 
FINRA notes that the applicability of proposed FINRA Rule 2030(d) is 
for purposes of FINRA's pay-to-play rule only. See FINRA Response 
Letter 2 at 15.
    \283\ See CAI Letter 1. In response, FINRA explains that it has 
proposed exceptions for de minimis contributions and returned 
contributions that are consistent with similar exceptions in the SEC 
Pay-to-Play Rule as FINRA's proposed rules must impose substantially 
equivalent or more stringent restrictions on member firms as the SEC 
Pay-to-Play Rule imposes on investment advisers. FINRA does not 
believe that raising the limits for the de minimis exception or 
eliminating the limit for returned contributions would satisfy the 
Commission's stringency requirements set forth in the SEC Pay-to-
Play Rule.
    \284\ See FSI Letter and FSI Letter 2. FINRA explains that the 
Commission did not exempt application of the rule for firms engaged 
in the independent business model. See FINRA Response Letter 2 at 
16. As a result, in FINRA's view, excluding independent business 
model firms from its proposed rule would not satisfy the 
Commission's stringency requirements, although FINRA is willing to 
work with the industry and Commission to address the interpretive 
questions and provide additional guidance as needed.
    \285\ See FSI Letter 1. In response, FINRA explains that the 
Commission did not apply its rule only to contracts or accounts 
opened after the effective date of the rule; therefore, FINRA does 
not believe that limiting the application of its rule in the way 
suggested by FSI would satisfy the Commission's stringency 
requirements set forth in the SEC Pay-to-Play Rule. However, FINRA 
also explains that, if the Commission approves the proposed rule 
change, proposed Rule 2030(a) will not be triggered by contributions 
made prior to the rule's effective date, and that the rule will not 
apply to contributions made prior to the effective date by new 
covered associates to which the two years or, as applicable, six 
months ``look back'' applies. See Notice, 80 FR at 81656.
    \286\ See, e,g., FINRA Response Letter 2 at 4, 16.
---------------------------------------------------------------------------

    As noted above, the SEC Pay-to-Play Rule, in part, prohibits any 
investment adviser covered under the rule or any of its covered 
associates from providing or agreeing to provide, directly or 
indirectly, payment to any person to solicit a government entity for 
investment advisory services on behalf of the investment adviser unless 
such person is a ``regulated person,'' as defined under the rule.\287\ 
The definition of ``regulated person''

[[Page 60067]]

includes a FINRA member firm, provided that: (a) FINRA rules prohibit 
member firms from engaging in distribution or solicitation activities 
if political contributions have been made; and (b) the Commission 
finds, by order, that such rules impose substantially equivalent or 
more stringent restrictions on member firms than the SEC Pay-to-Play 
Rule imposes on investment advisers and that such rules are consistent 
with the objectives of the SEC Pay-to-Play Rule.\288\ Thus, any changes 
to the proposed rules that would result in FINRA's rules not being 
found to impose at least substantially equivalent restrictions on its 
member firms and to be otherwise consistent with the objectives of the 
SEC Pay-to-Play Rule would result in a ban on such activity.
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    \287\ See Notice, 80 FR at 81650 n.6, 81656. See also 17 CFR 
275.206(4)-5(a)(2)(i)(A).
    \288\ See Notice, 80 FR at 81650 n.6. See also SEC Pay-to-Play 
Rule 206(4)-5(f)(9). The definition of ``regulated person'' also 
includes SEC-registered investment advisers and SEC-registered 
municipal advisors, subject to specified conditions.
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    The Commission believes that it is appropriate and consistent with 
Section 15A(b)(6) of the Act for FINRA to design its proposed rules to 
have the same scope and provisions as the SEC Pay-to-Play Rule. If the 
Commission were unable to make the required stringency finding, this 
would result in FINRA member firms not being a ``regulated person'' 
under the SEC Pay-to-Play Rule and therefore prohibited from receiving 
compensation for engaging in distribution and solicitation activities 
with government entities on behalf of investment advisers.\289\
---------------------------------------------------------------------------

    \289\ See Notice, 80 FR at 81650 n.6. See also id. at 81651, 
81656 (discussing the regulatory objectives of and statutory basis 
for the proposal).
---------------------------------------------------------------------------

    One commenter states that the proposal is ambiguous regarding the 
term ``distribution'' activities in Rule 2030(a).\290\ This term in 
FINRA's proposed rule is taken directly from the definition of 
``regulated person'' in the SEC Pay-to-Play Rule.\291\ Although the 
term ``distribution'' is not defined specifically in the SEC Pay-to-
Play Rule, to preserve the identified benefits of the rule, the 
Commission interprets the term broadly in the context of the SEC Pay-
to-Play Rule to mean generally engaging in any activity that is 
primarily intended to result in the sale of securities.\292\ In view of 
the Commission's prior statements regarding the term, including those 
contained in the SEC Pay-to-Play Rule Adopting Release,\293\ we believe 
the term is not ambiguous and could be applied by FINRA members for 
purposes of the proposed rule in a way that is consistent with the 
prophylactic nature of the proposal. However, we note that in 
connection with adopting the SEC Pay-to-Play Rule, the Commission did 
clarify under what circumstances distribution payments would violate 
the SEC's Pay-to-Play Rule.\294\ For example, the Commission explained 
that mutual fund distribution fees are typically paid by the fund from 
fund assets pursuant to a 12b-1 plan and generally would not constitute 
payment by the fund's adviser; therefore, such payments would not be 
prohibited under Rule 206(4)-5.\295\ The Commission also explained that 
where an adviser pays for the fund's distribution out of its 
``legitimate profits,'' the rule would generally be implicated.\296\ 
Based on the foregoing, we believe it is appropriate for FINRA not to 
have specifically defined the term ``distribution'' activities for 
purposes of its proposal.
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    \290\ See CAI Letter 1.
    \291\ A ``regulated person,'' as defined in the SEC Pay-to-Play 
Rule, includes a FINRA member firm, provided that, among other 
things, FINRA rules ``prohibit member firms from engaging in 
distribution or solicitation activities if certain political 
contributions have been made.'' 17 CFR 275.206(4)-5(f)(9)(ii) 
(emphasis added).
    \292\ By way of example in other contexts, the Commission has 
recognized that, because new distribution activities may 
continuously evolve in the future, it would be impracticable to 
develop, for example, an all-inclusive definition or list of such 
activities and related expenses, and declined to do so when it 
adopted the SEC Pay-to-Play Rule. See Bearing of Distribution 
Expenses by Mutual Funds, Investment Company Act Release No. 11414 
(Oct. 28, 1980), 45 FR 73898, 73903 (Nov. 7, 1980) (``Rule 12b-1 
Adopting Release''). See also 17 CFR.12b-1(a)(2) (explaining, in the 
context of registered open-end funds, that one will be deemed to be 
acting as a distributor of securities if they engage in ``any 
activity which is primarily intended to result in the sale of shares 
issued by such [fund], including, but not necessary limited to, the 
compensation of underwriters, dealers and other sales personnel, the 
printing and mailing of prospectuses to other than current 
shareholders, and the printing and mailing of sales literature'').
    \293\ See infra notes 294-296 and accompanying text.
    \294\ See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 
n.298. See also FINRA Response Letter 2 at 12 (citing Notice, 80 FR 
at 81660-61).
    \295\ See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 
n.298 (citing Rule 12b-1 Adopting Release).
    \296\ See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 
(citing Rule 12b-1 Adopting Release).
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    One commenter claims that, among other things, the ``lack of 
clarity as to the application of the SEC Pay-to-Play Rule to [its] 
members' business model, and the scope of government officials that 
trigger the requirements, has led some firms to adopt aggressive 
compliance programs that prohibit political contributions.'' \297\ As 
discussed above, FINRA states that, consistent with the SEC Pay-to-Play 
Rule, it has determined not to except from its proposed pay-to-play 
rule member firms that use an independent business model.\298\ We note 
that FINRA's rules and the federal securities laws do not distinguish 
so-called independent business model firms from other broker-dealer 
business models.\299\ Rather, although a broker-dealer may organize its 
operations under a variety of business models, and different business 
models may present unique compliance challenges, it is up to the 
broker-dealer to sufficiently discharge its regulatory obligations in 
light of the business model it has elected, and to tailor its 
supervisory system appropriately so that it is reasonably designed 
\300\ to achieve compliance with applicable federal securities laws and 
regulations and FINRA rules.\301\
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    \297\ See FSI Letter 1 (claiming FSI believes that the SEC Pay-
to-Play Rule has inadvertently captured non-corrupting activity and 
it fears that the proposed rule may do the same).
    \298\ See FINRA Response Letter 2 at 18.
    \299\ While a firm may accept independent contractor status for 
purposes other than the federal securities laws, such treatment does 
not alter such person's status as a person associated with a broker 
or dealer or the firm's responsibility to supervise under the 
federal securities laws. See, e.g., Hollinger v. Titan Capital 
Corp., 914 F.2d 1564, 1572-76 (9th Cir. 1990) (en banc) (explaining 
that, even if a broker-dealer and registered representative 
contractually agree that a representative is an independent 
contractor, the broker-dealer is still required to supervise its 
representatives).
    \300\ See FINRA Rule 3110(a) (``Each member shall establish and 
maintain a system to supervise the activities of each associated 
person that is reasonably designed to achieve compliance with 
applicable securities laws and regulations and with applicable FINRA 
rules.'') and Exchange Act Section 15(b)(4)(E), 15 U.S.C. 
78o(b)(4)(E) (authorizing the Commission to sanction a broker-dealer 
that ``has failed reasonably to supervise, with a view to preventing 
violations of'' the federal securities laws and rules and 
regulations thereunder).
    \301\ Giving guidance on its supervision rule, FINRA (then-NASD) 
noted that to fulfill its obligations to establish and maintain a 
supervisory system, a member firm must determine the types of 
business it conducts, how the firm is organized and operated, and 
the current regulatory requirements. See NASD Notice to Members 99-
45 (NASD Provides Guidance on Supervisory Responsibilities) (June 
1999) (stating that this analysis will enable the member to design a 
supervisory system that is current and appropriately tailored to its 
specific attributes and structure). See also FINRA Regulatory Notice 
14-10 (SEC Approves New Supervision Rules) (Mar. 2014), at 17 n.4 
(discussing NASD Notice to Members 99-45).
---------------------------------------------------------------------------

    We also note that FINRA has committed to working with the industry 
and the Commission to address interpretive questions that may arise 
regarding the application and scope of the provisions and terms used in 
the proposed rule change and to provide additional guidance as 
needed.\302\
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    \302\ See FINRA Response Letter 2 at 18. We note that the 
proposed rule does contain a provision--modeled on an analogous 
provision in the SEC Pay-to-Play Rule--allowing member firms to 
apply to FINRA for an exemption, conditional or unconditional, from 
the proposed rule's two-year ``time-out,'' and enumerates factors 
for FINRA to consider in deciding whether to grant such an 
exemption. See Proposed Rule 2030(f).

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[[Page 60068]]

C. Comments Requesting Clarification of Terms and Provisions in the 
Proposal

    Commenters asked for clarification of certain defined terms and 
provisions in the proposed rule, including clarification with respect 
to: The term ``instrumentality'' as it is used in the definition of 
``government entity;'' \303\ the definition of ``covered associate'' 
and the positions that would qualify someone as a covered ``official;'' 
\304\ whether a ``contribution'' is also a ``payment;'' \305\ and the 
factors by which contributions to a PAC would trigger the proposed 
anti-circumvention rule.\306\ In response to these comments, FINRA 
generally acknowledges, as did the commenters, that these terms are 
defined in the SEC Pay-to-Play Rule and that FINRA modeled the 
definitions in its proposal on those in the SEC Pay-to-Play Rule.\307\
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    \303\ See CAI Letter 1.
    \304\ See NAIFA Letter.
    \305\ See CAI Letter 1.
    \306\ See NAIFA Letter.
    \307\ See FINRA Response Letter 2 at 17, 18.
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    The Commission believes that FINRA's definition of ``covered 
associate'' in proposed Rule 2030(g) is functionally identical to the 
definition of the same term in the SEC Pay-to-Play Rule.\308\ The 
definition brings within the ambit of the rule--and its two-year 
``time-out''--only those contributions made by employees of a member 
firm who, by virtue of their position or responsibilities, are best 
positioned to engage in pay-to-play activities as placement agents. It 
includes ``[a]ny general partner, managing member or executive officer 
of a covered member,'' any ``associated person of a covered member who 
engages in distribution or solicitation activities with a government 
entity for such covered member,'' any associated person who supervises 
such an employee, and any ``political action committee controlled by a 
covered member or a covered associate.'' FINRA's rule also adopts the 
Commission's definition of ``executive officer,'' which was designed to 
tailor the trigger for the time-out to those officers whose position is 
most likely to incentivize them to engage in solicitation or 
distribution activities--and thus most likely to incentivize them to 
engage in pay-to-play.\309\
---------------------------------------------------------------------------

    \308\ Compare Proposed Rule 2030(g)(2), with 17 CFR 275.206(4)-
5(f)(2).
    \309\ At least one commenter points out that some entities have 
precluded all employees from making contributions as a result of the 
Commission's pay-to-play rule and that FINRA's rule will have the 
same effect. See FSI Letter 2. However, under FINRA's rule (and the 
SEC Pay-to-Play Rule), only certain employees' contributions will 
trigger the time-out and the rules on their face do not cover 
contributions by all employees. See SEC Pay-to-Play Rule Adopting 
Release, 75 FR at 40131-32.
---------------------------------------------------------------------------

    FINRA's definition of ``official'' also tracks the Commission's 
definition of that same term in the SEC Pay-to-Play Rule and, 
therefore, limits the rule so that a time-out is triggered only by 
contributions to certain officials.\310\ Under FINRA's proposed rule, 
the time-out for a placement agent is not triggered by a contribution 
to every public official running for office; it is triggered only by 
contributions to a person ``who was, at the time of the contribution, 
an incumbent, candidate or successful candidate for elective office of 
a government entity, if the office . . . [i]s directly or indirectly 
responsible for, or can influence the outcome of, the hiring of an 
investment adviser by a government entity'' or a person with authority 
to appoint someone whose office had the hiring responsibility.\311\ 
FINRA's definition, like the Commission's, is flexible enough to 
accommodate the myriad State and local political structures while still 
limiting the reach of the rule to those officials who are responsible 
for or have authority to appoint any person who is responsible for or 
can influence the outcome of the hiring of an investment adviser by a 
government entity.\312\
---------------------------------------------------------------------------

    \310\ Compare Proposed Rule 2030(g)(8), with 17 CFR 275.206(4)-
5(f)(6).
    \311\ See supra note 310.
    \312\ If FINRA were to define ``official'' by reference to a 
particular title, such as ``Comptroller,'' the definition would be 
both over- and under- inclusive. Some officials who have hiring 
responsibility for investment advisers do not hold the title of 
``Comptroller,'' and some officials with the title of 
``Comptroller'' do not have hiring responsibility for investment 
advisers. Because we understand FINRA's definition to track the 
definition that we adopted in the SEC Pay-to-Play Rule, we note that 
it is the scope of authority of the office, not de facto influence, 
that determines whether a contribution will trigger the time-out. 
See SEC Pay-to-Play Adopting Release, 75 FR at 41029.
---------------------------------------------------------------------------

    Additionally, FINRA's definitions of ``contribution'' and 
``payment'' are functionally identical to those same definitions in the 
SEC Pay-to-Play Rule.\313\ We note that under FINRA's rule, the time-
out is not triggered by direct contributions to political parties. 
Therefore, a member firm will not violate the time-out if it receives 
compensation for solicitation and distribution activities in the wake 
of contributions that it or its covered associates make to a political 
party. Instead, FINRA's proposed rule only precludes a covered member 
from soliciting or coordinating payments to a political party of a 
State or locality of a government entity with which the covered member 
is engaging in distribution or solicitation activities on behalf of an 
investment adviser.\314\ FINRA notes in response to a commenter's 
request for clarification as to whether each and every ``contribution'' 
(as defined in proposed FINRA Rule 2030(g)(1)) is, by definition, also 
a ``payment'' (as defined in proposed FINRA Rule 2030(g)(9)), that the 
definition of ``payment'' is similar to the definition of 
``contribution,'' but is broader in the sense that it does not include 
limitations on the purposes for which such money is given (e.g., it 
does not have to be made for the purpose of influencing an 
election).\315\
---------------------------------------------------------------------------

    \313\ Compare Proposed Rules 2030(g)(8)-(9), with 17 CFR 
275.206(4)-5(f)(1), 206(4)-5(f)(7).
    \314\ See Proposed Rule 2030(b). This aspect of the rule serves 
an anti-circumvention function, along with proposed Rule 2030(e), 
which makes it a violation of the rule ``for any covered member or 
any of its covered associates to do anything indirectly that, if 
done directly, would result in a violation of this Rule.'' As FINRA 
notes, Rule 2030(e) precludes only intentional efforts to circumvent 
the time-out and a covered member would not violate the rule's 
prohibition on the receipt of compensation unless there is a showing 
that the covered member intended to evade the time-out. Thus, a 
contribution to a PAC--other than a PAC controlled by the covered 
member, which would be a ``covered associate'' for purposes of the 
time-out--would not trigger the time-out and the receipt of 
compensation in the wake of that contribution would not violate the 
rule unless it can be shown that the covered member or covered 
associate who made the contribution intended to circumvent the time-
out provision. This provision, which is analogous to a provision in 
the Commission's Pay-to-Play Rule, precludes a member or its covered 
associates from, for example, funneling contributions or payments 
through third parties, such as attorneys, family members, or 
friends, to complete a pay-to-play arrangement without triggering 
the time-out.
    \315\ See FINRA Response Letter 2 at 17.
---------------------------------------------------------------------------

    The Commission believes that FINRA's definitions, which mirror or 
are functionally equivalent to similar definitions in the SEC's Pay-to-
Play Rule, will help to achieve the objectives of the SEC Pay-to-Play 
Rule and, as described above, the requirements governing the rules of a 
registered national securities association.\316\ The Commission 
believes that it is appropriate and consistent with the Act for FINRA 
to encompass in its rule the same definitions and discussion regarding 
its pay-to-play rules as the Commission did in adopting the SEC Pay-to-
Play Rule. The Commission emphasizes that FINRA has committed to 
working with the industry and the Commission to address interpretive 
questions and provide additional guidance as needed.\317\
---------------------------------------------------------------------------

    \316\ See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41042-
44.
    \317\ There are several ways for industry members to obtain 
guidance from FINRA about the application of its rules. Such 
guidance may include FINRA's publication of Notices to Members and 
Regulatory Notices, as well as interpretative and exemptive letters. 
Although FINRA can address interpretive questions with respect to 
its own rules, for its member firms to satisfy the ``regulated 
person'' definition in the SEC Pay-to-Play Rule, the Commission must 
find that FINRA's pay-to-play rule (i) imposes substantially 
equivalent or more stringent restrictions on member firms than the 
SEC Pay-to-Play Rule imposes on investment advisers and (ii) that 
such rule is consistent with the objectives of the SEC Pay-to-Play 
Rule. See supra note 22 (discussing the Commission's notice of 
stringency findings dated August 25, 2016). Given the stringency 
requirements of the SEC Pay-to-Play Rule, we expect our staff to 
work closely with FINRA regarding interpretive questions about the 
application and scope of the provisions and terms used in FINRA's 
rule to the extent those interpretations do not otherwise require 
FINRA to file a proposed rule change with the Commission pursuant to 
Section 19(b) of the Act and the rules and regulations thereunder.

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[[Page 60069]]

D. Comments Regarding the Books and Records Requirements

    One commenter claims that not all payments to political parties or 
PACs should have to be maintained under the books and records 
requirements of proposed Rule 4580.\318\ In response, FINRA states that 
it has determined to retain the recordkeeping requirements as proposed 
in the Notice.\319\ FINRA notes that, as discussed in the Notice, 
payments to political parties or PACs can be a means for a covered 
member or covered associate to funnel contributions to a government 
official without directly contributing.\320\ FINRA states that it 
proposed requiring a covered member to maintain a record of all 
payments to political parties or PACs because such records would assist 
FINRA in identifying situations that might suggest an intent to 
circumvent the rule.\321\
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    \318\ See CAI Letter 1.
    \319\ See FINRA Response Letter 2 at 20-21.
    \320\ See id. As FINRA explains in the Notice, a covered 
associate would include a PAC controlled by the covered member or 
any of its associates. FINRA states that it would consider a covered 
member or its covered associates to have ``control'' over a PAC if 
the covered member or covered associate has the ability to direct or 
cause the direction of governance or operations of the PAC. See 
Notice, 80 FR at 81653, 81660 (noting that this position is 
consistent with the position taken by the Commission in connection 
with the SEC Pay-to-Play Rule) (citing SEC Pay-to-Play Adopting 
Release, 75 FR at 41032).
    \321\ See FINRA Response Letter 2 at 20. FINRA states in the 
Notice that the proposed recordkeeping requirements are intended to 
allow FINRA to examine for compliance with its proposed pay-to-play 
rule, and the reference to indirect contributions in proposed Rule 
4580(a)(4) is intended to include records of contributions or 
payments a covered member solicits or coordinates another person or 
PAC to make under proposed Rule 2030(b). See Notice, 80 FR at 81663.
---------------------------------------------------------------------------

    The Commission acknowledges the comment, but agrees, as noted by 
FINRA, that payments to political parties or PACs can be a means for a 
covered member or covered associate to contribute indirectly to a 
government official in contravention of the proposed rule. The 
Commission also agrees that requiring FINRA members to maintain a 
record of all payments to political parties or PACs would assist FINRA 
in identifying situations that might suggest an intent to violate 
proposed Rules 2030(b) and 2030(e).\322\ The Commission therefore 
believes that it is appropriate and consistent with the Act for FINRA 
to require its members to keep records of all such payments to assist 
FINRA in carrying out its regulatory responsibilities to enforce 
compliance with the Act and with FINRA's rules.\323\
---------------------------------------------------------------------------

    \322\ We note that proposed Rule 2030(e) would require a showing 
of intent to circumvent the rule for such persons to trigger the 
two-year ``time-out.'' See Notice, 80 FR at 81654. See also SEC Pay-
to-Play Rule Adopting Release, 75 FR at 41044 n.340 (explaining that 
like MSRB Rule G-37(d), SEC Pay-to-Play Rule 206(4)-5(d) also 
``requires a showing of intent to circumvent the rule for such 
persons to trigger the time out'') (citing Blount, 61 F.3d at 948 
(``In short, according to the SEC, the rule restricts such gifts and 
contributions only when they are intended as end-runs around the 
direct contribution limitations.'')).
    \323\ Section 15A(b)(2) of the Act requires, among other things, 
that a registered national securities association, such as FINRA, 
has the capacity to enforce compliance by its members and persons 
associated with its members with the provisions of the Act, the 
rules and regulations thereunder, and the rules of the association. 
See 15 U.S.C. 78o-3(b)(2).
---------------------------------------------------------------------------

E. Additional Comments

    Certain commenters also suggested that FINRA should include more 
stringent requirements in its proposed rule.\324\ Both commenters 
suggested that FINRA expand the applicability of its proposed rules to 
include state-registered investment advisers.\325\ In response, FINRA 
explains that to remain consistent with the SEC Pay-to-Play Rule, FINRA 
has determined not to expand the scope of the proposed rule as 
suggested by commenters to include state-registered investment 
advisers.\326\
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    \324\ See NASAA Letter and PIABA Letter.
    \325\ See NASAA Letter and PIABA Letter.
    \326\ See FINRA Response Letter 2 at 10.
---------------------------------------------------------------------------

    The Commission acknowledges this comment but believes that it is 
appropriate for FINRA to determine to provide for the same scope of its 
pay-to-play rule as that of the SEC Pay-to-Play Rule. As FINRA notes, 
the Commission previously declined to make a similar change to the SEC 
Pay-to-Play Rule stating, among other things, that it was the 
Commission's understanding that few of these smaller state-registered 
firms manage public pension plans or other similar funds.\327\
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    \327\ See Notice, 80 FR at 81652 n.26, 81660 n.98. See also SEC 
Pay-to-Play Rule Adopting Release, 75 FR at 41026, 41060. The 
Commission also explained in connection with the SEC Pay-to-Play 
Rule that we do not have regulatory authority to oversee the 
activities of state-registered advisers through examination and our 
recordkeeping rules, nor does the Commission have authority over the 
states to oversee their enforcement of their rules. See SEC Pay-to-
Play Rule Adopting Release, 75 FR at 41026, 41060.
---------------------------------------------------------------------------

    These same commenters suggest that FINRA include a mandatory 
disgorgement provision for violations of its proposed rule.\328\ In 
response, FINRA explains that it determined not to include a 
disgorgement requirement in its proposal because it has existing 
authority to require disgorgement of fees in enforcement actions.\329\ 
The Commission believes that it is appropriate and consistent with the 
Act for FINRA not to separately require mandatory disgorgement for 
violations of its proposed rules.
---------------------------------------------------------------------------

    \328\ See NASAA Letter and PIABA Letter.
    \329\ See FINRA Response Letter 2 at 19-20.
---------------------------------------------------------------------------

    Finally, one of these commenters suggests that the current two-year 
cooling-off period in the proposal should be at least four years.\330\ 
In response, FINRA states that it believes a two-year time-out from the 
date of a contribution is sufficient to discourage covered members from 
participating in pay-to-play practices by requiring a cooling-off 
period during which the effects of a quid pro quo political 
contribution on the selection process can be expected to 
dissipate.\331\ In addition, FINRA explains that the proposed two-year 
time-out is consistent with the time-out period in the SEC's Pay-to-
Play Rule. The Commission believes that it is appropriate and 
consistent with the Act for FINRA to determine that a two-year time-out 
is sufficient to support the objective of the rule to deter pay-to-play 
activity among its covered members. The Commission notes that the same 
time period applies in the SEC's Pay-to-Play Rule.
---------------------------------------------------------------------------

    \330\ See PIABA Letter.
    \331\ See FINRA Response Letter 2 at 10. As the Commission 
explained, the two-year ``cooling-off period'' is not a penalty but, 
rather, is intended to be a period during which any effects of a 
quid pro quo are expected to dissipate. See SEC Pay-to-Play Adopting 
Release, 75 FR at 41026 n.104.
---------------------------------------------------------------------------

    The Commission recognizes these commenters suggest that the rule 
could have a broader scope. The Commission, however, must evaluate the 
proposed rule before it and approve a proposed rule if it finds that 
the proposed rule is consistent with the requirements of the Act and 
the applicable rules and regulations thereunder. As discussed above, 
because the rule is consistent with the Act, the Commission is required 
to approve the FINRA rule.

[[Page 60070]]

V. Conclusion

    Accordingly, for the reasons discussed above, the Commission finds 
that the proposed rule change is consistent with the Act and the rules 
and regulations thereunder applicable to such organization.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\332\ that the proposed rule change (SR-FINRA-2015-056) be, and 
hereby is, approved.
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    \332\ 15 U.S.C. 78s(b)(2).

    By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2016-20888 Filed 8-30-16; 8:45 am]
 BILLING CODE 8011-01-P