For the first time since it issued its pay-to-play rule in 2010, the SEC has charged a private equity firm with violating Rule 206(4)-5. The company charged agreed to disgorge nearly $260,000 in fees earned and to pay a $35,000 penalty as a result of two impermissible contributions made by the same “covered associate.” This initial enforcement action likely signals enhanced regulatory enforcement in this area.
Rule 206(4)-5 prohibits firms from receiving compensation for investment advisory services for government entities if the firm or any “covered associate” makes contributions above a de minimus amount ($350 if the person is eligible to vote for the candidate, $150 if he is not) to a government official who can directly or indirectly influence the hiring of an investment adviser by a governmental entity. Indirect influence includes appointing board members who make investment decisions. The ban applies for two years from the date the contributions are made. Under the rule, covered associates generally include general partners, managing members, executive officers (e.g., president, vice president in charge of a principal business unit or function, and those who perform policy-making functions), any employees who solicit government business, and their supervisors.
The case involves a Philadelphia-based investment adviser that managed money on behalf of several public pension funds, including the Pennsylvania State Employees’ Retirement System (“SERS”) and the City of Philadelphia Retirement Board (“PRB”). In April 2011, a “covered associate” of the firm made a $2,500 campaign contribution to a candidate running for Mayor of Philadelphia. The Mayor of Philadelphia appoints three of the nine members of PRB. In November 2011, the same covered associate made a $2,000 campaign contribution to a candidate running for Governor of Pennsylvania. The Governor of Pennsylvania appoints six of the eleven members of SERS.
Because the Mayor of Philadelphia and the Governor of Pennsylvania can influence the hiring of investment advisers by PRB and SERS, respectively, the company was subject to a two-year ban on compensation from both PRB and SERS. The ban became effective as of the date of the political contributions to the candidates for Mayor of Philadelphia and Governor of Pennsylvania.
This case is another example of the SEC’s increased focus on compliance under the Investment Advisers Act (IAA), which is the statutory basis for the pay-to-play rule. Registered investment advisers are urged to verify that they are complying with all aspects of the IAA, including Rule 206(4)-5.