Need To Know

SEC Adopts Pay-To-Play Rule

In the wake of a series of pay-to-play scandals, the Securities and Exchange Commission has made it more difficult for buyout fund managers and their agents to make political contributions, although it stopped well short of an outright ban on the use of placement agents.

There are three main facets of the pay-to-play rule, adopted on June 30. First, the rule prohibits fund executives from receiving compensation, such as management fees or carried interest, from a state or local investment plan or program for two years after the fund or any of its executives have made a political contribution to the state or local government official, or to a political candidate who could influence how the state or local plan or program invests in private funds.

Second, the rule forbids executives from soliciting political contributions to an influential government official or candidate, or to a political party in cases where their firm provides advisory services to that pension assets overseen by those officials or candidates. Finally, the rule would prohibit a fund manager from paying a placement agent to ask a government plan to invest in a private fund, unless the placement agent is an SEC-registered broker-dealer subject to comparable pay-to-play restrictions.

The first two parts of the rule go into effect in March 2011, while the last aspect is effective in September 2011. The rule also applies to hedge fund managers.

Specifically, the rule applies to any fund’s general partners, presidents, or vice presidents in charge of a principal business unit, division or function; and any other executive performing a policy making function. The compensation forfeiture continues to apply for two years after the political contribution, even if the executive who made the political contribution was fired or left the firm.

One aspect of the rule could make it particularly tricky for new executives at firms. That’s because the firm would be prohibited from taking investments from a pension or other government investment plan for two years even if one of its executives made a political contribution to an influential official or candidate six months before he or she joined the firm. That means that before hiring a new executive, firms will have to perform a thorough review of his or her previous political contributions.

The SEC tries to side-step any potential free-speech objections by making it clear that the rule doesn’t forbid political contributions, but rather compensation for contributions for a two-year period after the contribution is made.

The SEC’s rule applies to all investment advisers, whether or not they are registered under the Investment Advisers Act.