SEC Announces First Investment Adviser ‘Pay-to-Play’ Enforcement Action

by Ballard Spahr LLP
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The U.S. Securities and Exchange Commission (SEC) announced its first enforcement action under "pay-to-play" rules for investment advisers since those rules were adopted nearly four years ago. TL Ventures Inc., a Philadelphia-area private equity firm, has agreed to pay nearly $300,000 in disgorgement and penalties to settle the charges that it continued to receive advisory fees from city and state pension funds after making mayoral and gubernatorial campaign contributions.

TL Ventures is an advisor to venture capital funds that invest in early-stage technology companies. In 1999, the Pennsylvania State Employees' Retirement System (SERS) invested $35 million of public pension funds in one of the company's funds, TL Ventures IV. In 2000, SERS invested $40 million of public pension funds in another of TL Ventures' funds, TL Ventures V. Also in 2000, the City of Philadelphia Board of Pensions and Retirement (the Retirement Board) invested $10 million of its public pension funds in TL Ventures V. Although both funds have been in wind-down mode in recent years, both SERS and the Retirement Board have remained investors in the funds.

On April 12, 2011, a TL Ventures executive made a $2,500 contribution to the campaign of a candidate for Mayor of Philadelphia. Later that year, the executive made a $2,000 campaign contribution to the Governor of Pennsylvania. Both are officials covered by the pay-to-play rules — the Mayor appoints three of the nine Retirement Board members, and the Governor appoints six of the 11 SERS members. The contributions triggered a two-year ban on business under SEC Rule 206(4)-5 prohibiting TL Ventures' advisory services to those government entities. Nevertheless, TL Ventures continued to receive advisory fees from SERS and the Retirement Board attributable to the prior investments in TL Ventures IV and TL Ventures V.

To settle the SEC's charges, TL Ventures, without admitting or denying any wrongdoing, agreed to cease and desist from future violations of the law, and further agreed to pay disgorgement of $256,697, prejudgment interest of $3,197, and a civil penalty of $35,000 to the SEC.

The SEC’s pay-to-play rule is modeled after the Municipal Securities Rulemaking Board’s (MSRB’s) pay-to-play rules for brokers, dealers, and municipal securities dealers, Rules G-37 and G-38. The MSRB recently announced it is planning to extend the rules to apply to municipal advisors. As the SEC and MSRB have publicly stated, pay-to-play rules are designed to prevent corruption by breaking the link between business generation and political contributions.

The rules are applied formulaically: they do not require that an advisor intend to influence the government official to award the advisor business or any evidence that the contribution generated business from the recipient. Further, the rules broadly define a political “contribution” as including any gift, subscription, loan, advance, or deposit of money, or anything of value. This action, while the first against an investment adviser, is the second the SEC recently has brought relating to pay-to-play; in 2012, the SEC settled its first action for pay-to-play violations under MSRB Rule G-37 involving “in-kind” non-cash political contributions.

In adopting the release of SEC Rule 206(4)-5, the SEC stated: “Public pension plans are particularly vulnerable to pay-to-play practices.” In its press release announcing the enforcement action, the chief of the SEC’s Municipal Securities and Public Pensions Unit warned: “Public pension funds are increasingly investing in alternative investment vehicles such as hedge funds and private equity funds. When dealing with public pension fund clients, advisers to those kinds of investment vehicles should be mindful of the restrictions that can arise from political contributions.”

To avoid political contributions that may result in inadvertent bans on business with government entities, investment advisers should ensure their policies and procedures cover:

  • Direct and indirect political contributions by the adviser and its general partners, managing members, executive officers, and similar individuals 
  • Direct and indirect political contributions by the adviser’s employees who solicit government entities for the adviser and the employees’ supervisors 
  • Direct and indirect political contributions by political action committees (PACs) controlled by the adviser or its general partners, managing members, and executive officers, solicitation employees, and their supervisors
  • Direct or indirect payments made by the above entities and individuals to any person to solicit a government entity for investment advisory services 
  • Coordination or solicitation by the above entities and individuals of direct or indirect contributions by any person or PAC to officials of a government entity to which the adviser is providing or seeking to provide investment advisory services
  • Direct or indirect payments made by the above entities and individuals to a state or local political party where the adviser provides or seeks to provide investment advisory services to a government entity   

Such policies and procedures are not only designed to prevent prohibited political contributions, but are also a consideration of the SEC under Rule 206(4)-5(e) in determining whether to exempt the adviser from a two-year ban on business if a prohibited political contribution has occurred.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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