SEC proposes rescinding 2010 pay-to-play rule for investment advisers

The Securities and Exchange Commission proposed on September 3 to rescind Investment Advisers Act Rule 206(4)-5, the 2010 pay-to-play restriction that has governed how advisers win government business, a change that would remove the two-year bar on compensated advisory work for a government client after certain political contributions and strip out the accompanying recordkeeping requirements.

Adopted in 2010 to protect the beneficiaries of invested state and municipal assets—pension plans and their participants among them—the rule rested on the premise that political contributions could otherwise be used to influence the officials responsible for hiring investment advisers. The SEC said the rest of the Advisers Act would remain in place—anti-fraud provisions, fiduciary obligations, compliance requirements and codes of ethics—and the report notes that other federal, state and local regulations would leave many existing restrictions intact regardless.

The rule's real weight was the lockout, since losing eligibility for compensated service to a government client is a revenue event for any firm with public mandates on the books, and firms responded with controls far stricter than the text demanded. Michael Koffler, a partner at Eversheds Sutherland and a former SEC staff member, explains the legal exposure.

"In case they're wrong, it's a civil fraud claim against them. So that meant firms built a natural buffer against the rule," he says. Many advisers prohibited political contributions across the board, from anyone with the firm, and monitoring often reached beyond current personnel: firms had to check contributions made by newly hired employees before those employees had joined. For a wealth practice, the discipline landed on employee conduct rather than firm books; it covered a principal weighing a contribution and followed a lateral hire into a giving history compiled before they arrived. For a firm with public pension mandates, a single covered contribution could put two years of eligible work out of reach, making the monitoring program as much a business-development control as a legal one.

Since the trigger was the contribution, not its size, SEC Chair Paul Atkins' description of the rule—significant penalties for relatively small political contributions—explains why firms did not try to calibrate: giving by anyone at the firm was either permitted or prohibited, and most firms chose prohibited. The rule's reach was set by client mix: a firm with no government clients had no direct exposure to the service bar, yet many wrote firmwide bans anyway, a measure of how broadly the penalty was read and how much of the compliance load was self-imposed. A repeal hands that choice back to the firm, a change more interesting to people who run a practice than to a legal department.

SEC Chairman Paul Atkins argued the rule was "needlessly penalizing, burdensome and complex," an example of regulation that discouraged political participation and imposed significant penalties for relatively small contributions. "Matters involving political contributions are more properly governed by local ordinances, state laws, and federal election regulations—not by the SEC," he said, adding that rescinding the rule would not open the door to fraud because "sufficient protections exist and have always existed."

Koffler did not expect the SEC to propose repealing the rule instead of revising it, a sign the agency went further than practitioners anticipated, and he agrees that advisers will not be operating without oversight if the rule goes. Which restrictions survive is the question the report leaves open: it notes that other federal, state and local regulations keep many limits in place but does not enumerate them. A firm reading one agency's retreat as the whole regulatory picture would be treating the proposal as broader permission than the rulemaking record supports.

The operational question is what stays on the shelf. Firms that keep a contributions policy still need records showing they enforced one, and the proposal would remove the recordkeeping requirement along with the rule, so a firm that wants the file has to create it voluntarily and defend the habit. Firms without public-sector clients face the opposite task: deciding whether a policy written for a rule they never triggered is worth the friction it puts on recruiting and on principals' personal politics.

On the obvious follow-up, Koffler says advisers will not be left without oversight if the rule goes, and the practical change may be smaller than the two-year bar implies. The proposal now runs through the SEC's comment process, and when the SEC's Regulation E-Delivery comment window closed it had drawn more than 80,000 letters, as this publication reported, a reminder that paperwork proposals can generate volume. The report gives no comment deadline and does not say when a rescission would take effect, so the next date that matters to a firm weighing a policy change is still unset; until it arrives, the buffer Koffler describes sits where the firms put it, in policies that remain the firm's to write.