Tuesday, June 24, 2014

The First Pay-to-Play Case: A Rule that Casts a Wide Net

The First Pay-to-Play Case:  A Rule that Casts a Wide Net

During my consulting days, the SEC enacted  “pay-to-play” rules, which required money managers to disgorge management fees if a senior employee (known as a “covered employee.”) makes a campaign contribution to any elected official involved directly or indirectly in the process of hiring managers.[1]  There is a de minimis exception allowing covered persons to make $350 contributions if they can vote for a candidate and $150 if they cannot.   As a result, I urged my clients to create pre-clearance procedures so that any potential campaign contribution would be reviewed to make sure it wouldn’t jeopardize the firms’ existing fees or marketing plans.  We also engaged in extensive discussions about the scope of the new rule.  Some senior executives felt rather put out by the rule because it cut into their political activity.  Others were relieved because the rule gave them a great excuse for turning down political solicitations.

The Commission has just reached its first settlement in a pay-to-play case.  The order suggests that the SEC is going to strictly and broadly enforce the provision.  The case[2] involves TL Ventures, which manages two funds for the City of Philadelphia Retirement System.  Both funds were raised more than a decade ago and are winding up.  The campaign contributions were made to a candidate for Mayor of Philadelphia and the Governor of Pennsylvania in 2011.  The Mayor and Governor appoint members to the Retirement Board.

Pay-to-play was not involved in this situation.  The issuance of the mandate and the contributions are separated by too much time.  TL Ventures had won its mandate years ago and wasn’t marketing any new products to the pension fund.  In your run-of-the-mill pay-to-play scheme, the money manager makes sizable campaign contributions and subsequently wins a mandate, or a money manager wins a mandate and then pays back the politician with campaign contributions in subsequent years.  While the SEC rule is known as a pay-to-play regulation, that’s not how it is drafted.  Motive doesn’t matter.  If a money manager or one of his covered persons makes a campaign contribution, it’s a violation.  The penalty requires forfeiture of two years of management fees.  For a small or mid-sized firm, or in the case of large mandate, the penalty is severe.

I don’t think it is an accident that the SEC selected TL Ventures as its first case under this regulation.  There are no juicy details about influence. The case demonstrates the breadth of the rule.   It covers those indirectly involved in the hiring of money managers, encompasses candidates and incumbents, and applies to any contribution regardless of intent.  In other words, the rule casts a wide net.  I’m sure we are going to see more cases.  I’m betting that some money management firms will be surprised to find out that one of their employees made a political contribution covered by the rule.

[1] http://www.sec.gov/rules/final/2010/ia-3043.pdf
[2] http://www.sec.gov/litigation/admin/2014/ia-3858.pdf

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