The Securities and Exchange Commission recently announced that ten investment advisory firms agreed to pay penalties in the tens of thousands of dollars to settle SEC charges that they violated the SEC's pay-to-play rule, Investment Advisers Act Rule 206(4)-5 (the "Pay-to-Play Rule"), by receiving compensation for investment advisory services that they provided for managing public pension fund assets within two years after the firms' covered associates made prohibited campaign contributions.1

The Rule

"Pay-to-play", as used in the investment management industry, generally refers to the practice of making contributions to elected officials to influence awarding contracts to manage public pension plan assets and other government investment accounts. It is assumed that such pay-to-play practices result in higher fees for inferior advisory services because the advisory contracts are not negotiated at arm's length. For these reasons, the SEC adopted the so-called Pay-to-Play Rule in 2010.

Under the rule, investment advisers registered, or required to register, with the SEC, or which are "exempt reporting advisers" to private funds or venture capital funds, may not receive compensation for providing investment advice -- either directly or through fund vehicles2 -- to government entities for two years after they or their "covered associates"3 make direct or indirect contributions to officials of such governments who are directly or indirectly responsible for hiring investment advisers. The rule also prohibits covered investment advisers or their associates from providing or agreeing to provide, directly or indirectly, payment to any person to solicit a government entity for investment advisory services on behalf of an adviser, unless that person is a "regulated person."4


The SEC Pay-to-Play Rule contains three exceptions:

  • De minimis contributions: covered associates, who are natural persons, may contribute up to $350 per election to an official for whom that covered associate is entitled to vote, and a maximum contribution of $150 for any other official.5
  • New covered associates: provides an exception where a covered associate made a contribution more than six months prior to becoming a covered associate of the adviser, unless the covered associate engages in, or seeks to engage in, the distribution or solicitation activities with a government entity on behalf of the adviser.6
  • Returned contributions: an adviser will not be in violation of the rule if the contribution in question is returned to the contributor within the stipulated grace period: the adviser discovers the contribution within four months and obtains the refund within 60 days of discovery. Reliance on this exception is subject to certain additional conditions, however. For example, an adviser that has more than 150 registered persons can rely on this exception only three times in any calendar year, while an adviser with fewer than 150 registered persons may rely on this exception twice per calendar year, and never more than once for the same covered associate.7

The Violations

The SEC's orders found that ten investment firms violated the two-year timeout period because they accepted advisory fees from city or state pension funds after their associates made campaign contributions to candidates or elected officials. The ten firms consented to the SEC's orders, finding that they violated Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-5.8

The following firms are censured and must pay the following penalties:

  • Adams Capital Management: $45,000
  • Aisling Capital: $70,456
  • Alta Communications: $35,000
  • Commonwealth Venture Management Corporation: $75,000
  • Cypress Advisors: $35,000
  • FFL Partners: $75,000
  • Lime Rock Management: $75,000
  • NGN Capital: $100,000
  • Pershing Square Capital Management: $75,000
  • The Banc Funds Company: $75,000

Several key factors make these settlements particularly noteworthy and instructive going forward, namely:

  • The contributions in question were small.
  • Several of the advisers charged were only "exempt reporting advisers".
  • The public officials receiving contributions in several cases were gubernatorial candidates.
  • Several of the advisers charged have obtained returns of the prohibited contribution.

Small Contribution Size

The amount of the contributions made in all the cases was relatively small and in most cases only a few hundred dollars above the permissible limit. A few of the advisers contributed a total of $500, and in one instance a covered associate of the adviser charged made a contribution of only $400, and there appears to have been no specific indication that these contributions were made as part of a quid pro quo arrangement or attempt to induce an investment by a government entity. Considering that contributions of up to $350 to a candidate for whom a covered associate is entitled to vote are permitted under the de minimus contribution exception, in reality the amounts contributed in excess of the allowed amount were extremely small in these cases -- either $150 or, in the case of Cypress Advisors, merely $50 above the permitted amount. The largest contribution identified in any of the settlements was a $10,000 contribution in the Wisconsin governor's race, and in only a few of the settlements did the contributions in question exceed $1,000.

Exempt Reporting Advisers

Another characteristic that these firms shared is that several are "exempt reporting advisers", which, as advisers only to private funds such as hedge funds or venture capital funds, are not fully registered with the SEC under the Advisers Act.9 While advisers to these types of funds are included within the scope of the rule, it is interesting that the SEC chose to pursue these advisers every bit as aggressively as fully registered advisers, particularly when, as noted above, the amounts of the contributions in question were very small. That the SEC pursued violations by multiple exempt reporting advisers here implies that it will proceed against any and all violators, including those only in the hedge fund and venture capital fund sector.

Government Officials

Of the ten aforementioned settlements, the contributions in question were made to a state governor or candidate for governor in six instances, and in two cases the contributions were made to the mayor of New York City. While it is true that a governor or mayor comes within the technical definition of "elected official" in the rule,10 it is somewhat surprising that the SEC chose to focus its enforcement efforts on donations to such offices. While the principal purpose of the rule is to police the awarding of investment advisory contracts for the management of public funds, it seems, as a practical matter, that a governor of a state (or the mayor of a city like New York, with more than 8 million residents) is unlikely to involve himself in the details of such investment management decisions. The SEC nevertheless concluded that such officials (governors and mayors) have the ability to influence the hiring of an investment adviser to manage state funds and can appoint persons who often do have the authority to appoint persons, such as board of investment committee members, who are directly responsible for influencing the selection of advisers for state pensions and other assets. Accordingly, the SEC is making clear, through these settlements, that a contribution even to a governor is enough to trigger a violation of the rule regardless of how tenuous the connection may be between the donation and the award of advisory business.

Returned Contributions

As noted above there is an exception to the rule if the adviser obtains a return of the improper contribution, provided it had discovered the contribution within four months and obtained the return within 60 days of discovery and satisfies certain other technical conditions.11 In a few of the settlements, the SEC indicates that the candidate had returned the wrongful contributions, but the SEC nevertheless brought the charges, and the text of the settlement orders contain no discussion of why the return did not prevent the charges. Presumably the return was not made within the stipulated time periods or one or another of the conditions to qualify for the exemption was not met, but the text of these orders is silent in this respect.


These settlements not only indicate that the SEC will vigorously enforce compliance with its Pay-to-Play Rule, but also indicate that it will purse even the smallest contributions as well as contribution to government officials who are as a practical matter far removed from the actual process of awarding investment advisory contracts. In view of the circumstances giving rise to these settlements and the intense election season just recently completed, investment advisers would be wise to increase their focus on compliance with the Pay-to-Play Rule and in so doing review their existing internal compliance policies and practices regarding political contributions, particularly noting their policies on distribution and solicitation of activities with government entities on behalf of investment advisers.


1 10 Firms Violated Pay-to-Play Rule By Accepting Pension Fund Fees Following Campaign Contributions, SEC Press Release 2017-15, Jan. 17, 2017, available at: (the "SEC Press Release").

2 Advisory fees paid for managing funds invested in a "covered investment pool" also trigger a violation of the rule. Covered investment pools include any investment company registered under the Investment Company Act that is an investment option of a plan or program of a government entity, or a company that would be an investment company under Section 3(a) of the Investment Company Act but for the exclusions provided under Section 3(c)(1), (c)(7), or (c)(11), of that Act (i.e., funds generally referred to as "hedge funds"). See Advisers Act Rule 206(4)-5(f)(3).

3 An adviser's "Covered associates" are its general partner, managing member, executive officer, and any employee who solicits governmental entities (and their supervisor). See Advisers Act Rule 206(4)-5(f)(2).

4 See Advisers Act Rule 206(4)-5(a)(2)(i)(A).

5 See Advisers Act Rule 206(4)-5(b)(1).

6 See Advisers Act Rule 206(4)-5(b)(2).

7 See Advisers Act Rule 206(4)-5(b)(3).

8 See Investment Advisers Act Rel. No. 4,608 (Jan. 17, 2017); Investment Advisers Act Rel. No. 4,609 (Jan. 17, 2017); Investment Advisers Act Rel. No. 4,610 (Jan. 17, 2017); Investment Advisers Act Rel. No. 4,611 (Jan. 17, 2017); Investment Advisers Act Rel. No. 4,612 (Jan. 17, 2017); Investment Advisers Act Rel. No. 4,613 (Jan. 17, 2017); Investment Advisers Act Rel. No. 4,614 (Jan. 17, 2017); Investment Advisers Act Rel. No. 4,615 (Jan. 17, 2017); Investment Advisers Act Rel. No. 4,616 (Jan. 17, 2017); Investment Advisers Act Rel. No. 4,617 (Jan. 17, 2017); see also SEC Press Release.

9 See Advisers Act Rule 204-4.

10 See Advisers Act Rule 206(4)-5(f)(6).

11 See Advisers Act Rule 206(4)-5(b)(3).

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