SEC proposes rescinding pay-to-play rule for advisers with government clients

After more than 15 years in which the pay-to-play rule shaped how advisers handled political contributions to win state and municipal business, the Securities and Exchange Commission proposed on Sept. 3 to take it off the books.

The proposal would rescind Advisers Act Rule 206(4)-5, which bars an investment adviser from providing compensated advisory services to a government client for two years after making a political contribution to certain elected officials or candidates, and would amend the recordkeeping rule to eliminate the provisions that correspond to it. Comment runs for 60 days after the proposing release is published in the Federal Register.

Everything else in the framework stays: the commission's release says the antifraud prohibitions, fiduciary duty requirements, compliance rule, and the code of ethics rule would continue to apply. What would go is the mechanism that converted a contribution into a two-year lockout from compensated work for a government client, along with the records advisers kept to demonstrate they had stayed clear of that trigger.

Since the rule's 2010 adoption, the SEC has determined that it produced significant unintended consequences, including blanket bans that some advisers imposed on political contributions at the state and local level, while advisers told the agency the rule is operationally difficult to implement and functions as a de facto strict liability standard in which small donations — what the release calls foot faults — can set off substantial prohibitions and fines.

A two-year ban is not a cost a practice absorbs and moves past; it removes the firm from a client segment for two years, which meant a shop weighing whether to compete for a government mandate also had to weigh the giving of every employee who could be swept into the rule, not just the person who signs the proposal response. That arithmetic turned a housekeeping rule into a business-development question.

The release flags a related friction, pointing to firms penalized over a donation an employee made before joining the business, and for a practice recruiting into a public-sector book that reading puts a candidate's contribution history into the diligence file alongside the usual questions about portable assets — likely one reason the rule drew complaints from firms that had nothing to do with the donation when it was made.

Chairman Paul S. Atkins, in a statement accompanying the proposal, called the rule overly prescriptive after more than 15 years of administration and said it penalized small, often impulsive donations to candidates in both parties. He said advisers' implementation of it has amounted to the suppression of political speech, and argued that political contributions are better governed by local ordinances, state laws, and federal election regulations than by the SEC.

If the rescission is finalized, the contribution bans some firms wrote into their manuals to stay clear of the two-year trigger would become a matter of firm preference rather than regulatory necessity, as would the contribution records the rule required them to keep, and that shift lands hardest on compliance operations rather than investment results, since those policies exist because a single misjudged donation could cost a government mandate. The fiduciary and compliance obligations attached to the client relationship itself would not move.

Whether firms unwind those policies or keep them is a question the proposal hands back to them, and it is the one worth putting to a compliance officer before the comment window closes. The SEC describes a rule that punished firms for donations made by employees before they arrived, which means some of the policies now in place may have as much to do with screening hires as with serving clients, and which of them survive once the rule that prompted them is gone is a business decision, not a regulatory one.

The calendar remains fixed: the comment period runs 60 days from publication in the Federal Register, and the recordkeeping amendment travels with the rescission rather than separately, so advisers watching this file have one date to track and one question to answer — whether the commission adopts the proposal as drafted.