The SEC Wants to Delete the Rule That Freezes an Adviser's Government Business for Two Years After a Political Donation

The Securities and Exchange Commission proposed on September 3 to strike Rule 206(4)-5 under the Investment Advisers Act from its rulebook. The rule is known in the industry as the pay-to-play rule. The recordkeeping requirements that support it would go as well. This is a proposal, not a final action: nothing changes until the Commission votes to adopt a rescission after reading public comments.

What the rule does today

The Commission adopted Rule 206(4)-5 in 2010 and has administered it for more than fifteen years. In its own summary, the rule prohibits an investment adviser from providing compensated advisory services to a government client for two years after certain political contributions are made to elected officials or candidates. The period is usually described as a two-year timeout. The adviser can keep managing the money. It cannot be paid for doing so.

The design is deliberately mechanical. It does not require proof that a contribution bought anything. That is the feature the Commission now says has become the problem.

The Commission's stated reasons

• Unintended consequences, including interaction with state and local contribution prohibitions
• Practical difficulty implementing the rule inside advisory firms
• What the Commission describes as a de facto strict liability standard, where a small donation triggers a substantial penalty
• Suppression of political speech, because firms find it simpler to ban contributions outright than to administer the rule

It is overly prescriptive and has produced a host of unintended consequences. Matters involving political contributions are more properly governed by local ordinances, state laws, and federal election regulations - not by the SEC.

Atkins also described the rule as needlessly penalizing, burdensome and complex to implement, and misaligned with the SEC's mandate, and said it imposes serious penalties for small, often impulsive donations - including, in his account, donations made by employees before they joined the firm.

A separate statement from Commissioner Peirce

Commissioner Hester Peirce filed her own statement supporting the proposal on First Amendment grounds. She wrote that political speech is at the core of what the First Amendment protects and that the Commission must tread carefully in curtailing such speech. She noted that one effect of the rule has been advisers prohibiting contributions outright - the blanket-ban response the Commission cites as evidence the rule overshoots.

I am thrilled that we are proposing to eliminate rather than simply amend the rule.

Peirce also invited comment on whether comparable rules at other regulatory bodies should be rescinded. The proposal itself does not touch them.

What survives a rescission

The Commission's position is that the conduct the rule was written to stop is already illegal under other provisions. Its release states that the antifraud provisions of the Advisers Act, an adviser's fiduciary duty, the compliance rule and firms' codes of ethics all remain in effect. Peirce made the same point, adding that the Commission brought cases of this kind before Rule 206(4)-5 existed.

The practical difference is one of proof. Under the current rule, the contribution itself triggers the consequence. Under the antifraud provisions, the Commission would have to establish deception or breach of duty in a particular case.

What happens next

The proposal is published as Investment Advisers Act Release No. IA-6994. After the 60-day comment period closes, the Commission may adopt the rescission, modify it, or leave the rule in place. Advisers subject to the rule remain subject to it in the meantime.