Private equity sponsors are using recent SEC enforcement actions as examples of what can go wrong if the Commission’s pay-to-play rule is violated, and taking the opportunity to reinforce the firm’s policies to comply with the rule.
As the midterm elections approach and people consider donating to various candidates, private equity firms are educating their employees about how best to comply with the SEC’s pay-to-play rule.
Violations of the pay-to-play rule are a real concern for the many private equity firms that manage public pension money.
Daniel Bresler, a partner in the investment management group at Seward & Kissel, says political contributions may not always be at the front of everyone’s mind, so PE managers need to educate and train employees on what the rules are.
Igor Rozenblit, managing partner with Iron Road Partners and former co-head of the SEC’s Private Funds Unit, agrees and says this is why firms should send out a reminder to employees about what the firms’ restrictions are around political contributions.
“It’s something that’s going to be on regulator’s minds right now with the November elections coming up, so it’s a good time for firms to remind employees of their policies related to campaign donations,” Rozenblit says.
The pay-to-play rule
The pay-to-play rule, or Rule 206(4)-5 under the Investment Advisers Act of 1940, broadly prohibits investment managers from making campaign contributions to elected officials or candidates who can influence decisions about hiring advisers to manage public funds.
The rule includes a de minimis exception that allows “covered associates” to make aggregate contributions of up to $350 per election to an elected official or candidate for whom the covered associate is entitled to vote, and up to $150 per election to an elected official or candidate for whom the covered associate is not entitled to vote.
Rozenblit says when reviewing political donations made by registered investment adviser employees, the SEC is looking for compliance with the pay-to-play rule and preventing public corruption.
According to Schulte Roth & Zabel partner Allison Bernbach, the rule is intended to prevent quid pro quo activities with respect to the award of state and local pension plans’ money and improper payments and political contributions.
“The rule aims to prevent agreements where someone donates to a government official expecting that person, in their position of power, to award the person’s firm a contract to manage money. Yet, there is no intent or causation requirement in the rule, meaning there is no requirement that a political contribution be given with intent to or actually influences an investment decision,” Bernbach explains.
Recent SEC enforcement
In separate enforcement actions announced on September 16, the SEC said Canaan Management, Highland Capital Partners, StarVest Management and the Asset Management Group of Bank of Hawaii violated the pay-to-play rule when they hung onto government contracts even after they or their employees donated to political campaigns in places where they did business.
The pay-to-play rule says firms are supposed to forego any payments for advisory services for at least two years when they or their employees donate to candidates for offices that can influence government procurement.
Bernbach notes that three out of the four cases in this recent string of enforcement actions were brought against exempt reporting advisers.
“The rule applies to registered investment advisers and exempt reporting advisers, so these cases serve as a good reminder to exempt reporting advisers that they’re not off the SEC’s radar in terms of compliance with the pay-to-play rule,” she explains.
Best practices relating to political contributions
When it comes to political donations, some firms have strict compliance rules that prohibit employees from contributing to candidates.
The CFO/CCO of one private fund manager said his firm thought it would be “cleaner” and easier to have a flat-out prohibition on any political donations, not just for firm employees but for their spouses as well.
“The pay-to-play rule has a provision that prohibits doing indirectly what can’t be done directly, and so this would include having your spouse make a donation that you yourself cannot. We figured it was cleaner to prohibit any political donations from our employees and their spouses; this way, there was less risk of violating the rules.”
Seward & Kissel’s Bresler says firms commonly require pre-clearance of political donations, much in the way they do for making personal trades.
“The CCO or whoever is reviewing contributions for clearance needs to determine whether or not the firm manages money from the government entity that this person might be affiliated with. They also need to consider whether the firm could accept money from a pension plan a candidate is affiliated with,” Bresler explains.
Whatever the policy, Bernbach says training is key.
“There should be periodic reminders beyond initial training on what your policies state and if your policy prohibits donations or requires pre-clearance. You also need to be very clear about who is subject to the policy,” she advises.
Firms should also have employees sign and certify that they understand and follow the policy on campaign contributions during their mandatory annual training, Rozenblit advises.
An audit firm could then follow up to ensure that employees have been compliant because most campaign donations are publicly reported.
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