Tag: Rule 206(4)-5

Another Fund Manager Falls Victim to a Political Contribution

Another fund manager was heavily fined for an employee making a political contribution. Wayzata Investment Partners had to pay a $60,000 fine.

The Minnesota State Board of Investments made $300 million in commitments to Wayzata funds from 2007 to 2013. In 2022 a Wayzata employee made a $4000 campaign contribution to a Minnesota elected official who was up for re-election. The board of the Minnesota State Board of Investments consists of the Governor, State Auditor, Secretary of State, and Attorney General. All are elected offices. Neither the name of the employee or the politician are named in the SEC action.

Under SEC Rule 206(4)-5 a covered associate of a registered investment adviser can not make a contribution of more than $150 to a elected official who can directly or indirectly influence investment decisions. The Minnesota State Board of Investments falls under the coverage of the Rule.

The $60,000 fine was levied even though the funds were closed-end funds with no opportunity for withdrawal. The contribution was years after the commitments were made. There was no finding that there was a connection between the government investment and the political contribution. Under the Rule, the SEC does not have to prove any connection.

The fine is much less than the full penalty under the SEC rule which would be forfeiture of 2 years of management fees and carried interest. 

As with some other political contribution fines, Commissioner Peirce dissented from the decision in this case. She points out the stifling of political participation.

I’ll point out the magnitude of the fine. In most SEC cases the subject ends up paying a fine that matches the damage. In these political contribution cases, the subject is paying over a 10x penalty.

More Reading:

The Pay to Play Rule and Political Endorsements

It’s not often that I open The Boston Globe and see a front page story about compliance with Security and Exchange Commission’s Rule 206(4)-5: Patrick stays quiet as his former aide runs for governor. Jay Gonzalez was the former Secretary of Administration and Finance for the state of Massachusetts under Governor Deval Patrick. Mr. Gonzalez is now running for governor.

Former Massachusetts Governor Deval Patrick states that he is barred under federal “pay-to-play” rules from saying anything about any candidates for state or local office because he now works a firm that is registered with the Securities and Exchange Commission as a registered investment adviser. I’m sure the firm has many investors that are state or local pension funds. That makes the firm subject to the pay-to-play rule.

Rule 206(4)-5 was put in place to prevent political support from driving investment choices made by government investors. In that article, the reporter cites a lawyer and professor that both take a much tighter interpretation of the rule. They both say that the rule is limited to monetary contributions. They both say that the rule should not prohibit the ability of someone to voice his or her preference for a candidate.

In the release for Rule 206(4)-5, the SEC states in footnote 154 that:

“it is our intent that, under the rule, advisers and their covered associates ‘are not in any way restricted from engaging in the vast majority of political activities, including making direct expenditures for the expression of their views, giving speeches, soliciting votes, writing books, or appearing at fundraising events.'”

That would seem to fall in favor of the legal experts and conclude that Mr. Patrick and his firm are being too conservative in their interpretation of the rule.

But let’s take a closer look at the rule. A contribution is defined to include a “gift, subscription, loan, advance, deposit of money, or anything of value made for the purpose of influencing an election for a federal, state or local office…” Contributions are limited to the de minimis amounts of $150, or $350 if you can vote for the candidate.

Certainly, my endorsement of a candidate has little to no value. I don’t have a following of political supporters and campaign backers. But Deval Patrick does. I don’t know the value of his endorsement. But I would say that it is worth much more than $350. The SEC rule does not anticipate a high profile person like Deval Patrick at a firm subject to the pay-to-play rule.

You can also credit the “further prohibition” section of the rule that prohibits a covered associate from doing “anything indirectly which, if done directly, would result in a violation of” the rule. Would Deval Patrick’s endorsement be an indirect call for giving campaign contributions to Jay Gonzalez?

I have heard an SEC official state that putting a yard sale on your lawn is a violation of the pay-to-play rule. She was wrong and other senior SEC officials emphatically stated that she was wrong. But we all heard that there is a willingness of the SEC to take a hard position under the pay-to-play rule.

I think the position of Deval Patrick and his firm is correct under the rule. It’s the rule that has problems.

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More Political Contribution Problems

There is too much money in a politics. I understand the Securities and Exchange Commission’s desire to purge political contributions from the investment adviser business for state and local government money. But I’ve never been a fan of Rule 206(4)-5, the pay-to-play rule. It’s continuing to ensnare companies in ways that highlight problems with the rule and the very low limits in the rule.

One recent case is that of PNC Capital Advisors. One its employees in business development made a $1000 campaign contribution to John Kasich’s presidential campaign. Kasich was the governor of Ohio and able to appoint trustees to the Ohio state pension funds. That made Kasich an “Official” under the rule and firm had some Ohio state pension money under management.

As I had pointed out, only two out of the twenty-two the major candidates for the last presidential election were subject to the campaign contribution limit because they held state offices: John Kasich and Chris Christie. The rule obviously creates an unnecessary distortion in political campaigns. Adding Pence, the Governor of Indiana to the ticket caused another what do we do moment.

In PNC’s case, the employee had been listed by PNC as a “covered associate” and was in the process of being promoted when PNC discovered the campaign contribution. However, the employee was not responsible for the Ohio account. At no time had the employee been involved in soliciting the Ohio plans, and had never communicated with the Ohio plans. The Contributor had never solicited any other state or local Ohio government entity. The Contributor had never made presentations for, or met with, any representatives of the Ohio plans or with any other Ohio government entities, or supervised any person who met with any of the Ohio plans or other Ohio government entity. If promoted, the Contributor will neither meet with any Ohio government entities personally, nor supervise any person who solicits investment advisory services business from Ohio government entities.

The employee failed to disclose the contribution because he was focused the office Kasich was running for, President, and failed to realize that the rule applied to the current office as well. The PNC compliance group found the contribution in the process of running checks in connection with a promotion. A promotion that is now on hold and has been for 2017.

The SEC order prohibits the employee from soliciting government funds for several months. PNC was allowed to keep the two year worth of fees. $700,000 of fees was at risk for that $1000 contribution.

That was a $1000 contribution in a campaign in which Kasich raised over $19 million.

BlackRock had a similar problem with the Kasich campaign. One of its employees wrote a check for $2700 to the Kasich campaign. The employee was in the ETF division, but since he was on the global executive committee, he fell into the definition of “covered associate.”

Similar to PNC, that employee had never solicited government entities for investment advisory business that is covered under the Rule. To the extent the Contributor has personally solicited business from any government entities, it was exclusively for direct investments in RICs that are outside the scope of the Rule. He has never attended, or otherwise participated in, any meetings, discussions, or any other communications in which a solicitation of covered investment advisory business has taken place.

Blackrock’s compliance group found the donation while conducting a routine compliance review.

Here is a list of other exemptions granted. These were identified in the PNC application and BlackRock application.

  • Davidson Kempner Capital Management LLC, Investment Advisers Act Release Nos. IA-3693 (October 17, 2013) (notice) and IA-3715 (November 13, 2013) (order)
  • Ares Real Estate Management Holdings, LLC, Investment Advisers Act Release Nos. IA-3957 (October 22, 2014) (notice) and IA-3969 (November 18, 2014) ( order);
  • Crestview Advisors, LLC, Investment Advisers Act Release Nos. IA-3987 (December 19, 2014) (notice) and IA-3997 (January 14, 2015)(order);
  • T. Rowe Price Associates, Inc., and T. Rowe Price International Ltd., Investment Advisers Release Nos. IA-4046 (March 12, 2015) (notice) and IA-4508 (April 8, 2015)(order);
  • Crescent Capital Group, LP, Investment Advisers Release Nos. IA-4140 (July 14, 2015) (notice) and IA-4172 (August 14, 2015) (order);
  • Starwood Capital Group Management, LLC, Investment Advisers Act Release Nos. IA-4182 (August 26, 2015)(notice) and IA-4203 (September 22, 2015) (order);
  • Fidelity Management & Research Company and FMR Co., Inc., Investment Advisers Release Nos. IA-4220 (October 8, 2015) (notice) and IA-4254 (November 3, 2015) (order);
  • Brookfield Asset Management Private Institutional Capital Adviser US, LLC et. al., Investment Advisers Act Release Nos. IA-4337 (February 22, 2016) (notice) and IA-4355 (March 21, 2016) (order);
  • Angelo, Gordon & Co., LP, Investment Advisers Release Nos. IA-4418 (June 10, 2016)(notice) and IA-4444 (July 6, 2016) ( order);
  • Brown Advisory LLC, Investment Advisers Act Release Nos. IA-4605 (January 10, 2017) (notice) and IA-4642 (February 7, 2017) (order)

These all look technical violations with no evidence that there were weaknesses in policies or an intent to influence. The rule is just too broad, with dollar limits that are too low.

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Yard Signs and Pay to Play

I was fortunate to be able to attend the Securities and Exchange Commission’s CCO Outreach in Boston yesterday. I’ll post more later, but today I wanted focus on one topic that one panel discussed: the pay to play rule.

The CCO Outreach stated that they were not trying to play “gotcha” as part of the exam process. Personally, I find the pay to play rule to be one of the biggest “gotchas” in the Investment Adviser Act’s regulatory environment.

It was clear that the panelists were very focused on political contributions as part of the exam process. They slowly turned the screws.

They wanted firms to have policies and procedures around campaign contributions. Of course.

They wanted compliance to be verifying contribution disclosures against the records of campaign contributions. This is easier said than done. They noted the ease of using OpenSecrets.org. They were going off tracks. OpenSecrets has very little state information and is focused largely on federal money on federal campaigns. It is not federal candidates that are subject to the rule. The only time a federal candidate is implicated by the pay to play rule is when a state elected official is running for a federal office. Those instances are a gotcha cases. It’s the state and local campaigns that are directly in the cross-hairs of pay-to-play rule. State and local camapign contribution records vary widely from state to state.

Then a panelist said you need apply the prohibition across the whole firm. That’s a broader statement than required by the rule. The rule applies the limitation to “Covered Associates”, not all employees of an investment adviser. Perhaps the panelist misspoke. Or maybe it was a further indication that the panel had gone off the tracks.

Then, the big bang. Several of us in the audience were shocked when a panelist said yard signs were covered by the pay-to-play rule. The panelist stuck to this after some push back. Perhaps the panelist misspoke and was trying to indicate that fundraising for a Official is subject to the pay-to-play rule. Or maybe it was a further indication that the panel had gone off the tracks.

We met with the some senior SEC officials after the panel, who stated very clearly that the rule does NOT interfere with the Constitutional right to plant a political sign in your yard. [So the panelist misspoke? But now there is the specter of an examiner looking at yard signs. Are signs over a certain size covered?]

I understand the corrupting influence of money in politics. I recognize that several political officials have been convicted or accused of demanding political contributions in exchange for an assignment to invest government money.

[Begin the airing of grievances.]

But the SEC’s pay-to-play rule does little to stop that and is overreaching.

Bribing political officials is already illegal. The pay-to-play rule removes the need to prove the illicit intent and makes it a violation merely for making a contribution.

The contribution limits are absurdly low. Candidates raise tens of millions of dollars to run for governor. A contribution of $150 or $350 is meaningless. The SEC should raise the limit.

I still question the pay-to-play rule’s ability to protect investors. The decision to make the investment may be tainted, but the investment itself is not necessarily harmful to the financial returns for the pension plan. The plan is not getting the best investment choice because of an illicit bribe. What politician is going risk violating the bribery law for taking a $1000 campaign contribution to influence government pension money?

The pay-to-play rule is written overly broad and implicates failed candidates and PACs that may or may not have anything to do with state pension money. An investment adviser was trapped by the pay-to-play rule for an employee giving a $500 donation for a failed candidate for governor. That’s even though the state pension plan had already made the commitment to the private fund.

My impression from the panel is that the examiners are using the rule as a “gotcha” to trap investment advisers in foot faults that do nothing to harm or put the investing public at risk.

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The SEC’s Pay-to-Play Rule and California Labor Law

Keith Bishop chimed in on Campaign Contributions and the SEC in the context of California law: Pay-To-Play Meets The California Labor Code at the California Corporate & Securities Law blog.

He point to  California Labor Code:

Section 1101.
No employer shall make, adopt, or enforce any rule, regulation, or policy:

(a) Forbidding or preventing employees from engaging or participating in politics or from becoming candidates for public office.
(b) Controlling or directing, or tending to control or direct the political activities or affiliations of employees.

Section 1102.
No employer shall coerce or influence or attempt to coerce or influence his employees through or by means of threat of discharge or loss of employment to adopt or follow or refrain from adopting or following any particular course or line of political action or political activity.

Obviously there is some conflict from the face of the code with SEC Rule 206(4)-5 that limits certain employees of registered investment advisers from making campaign contributions to certain elected officials.

You may disagree with the rulings, but political campaign contributions are considered political activities. The SEC rule therefore limits political activities.

That puts the CCO of a registered investment adviser in a precarious position. On the one hand, violating the SEC rule could result in the loss of a great deal of money for the adviser.  On the other hand the CCO’s policy may be violation of California law.

Mr. Bishop cites Couch v. Morgan Stanley & Co., a 2016 federal court decision that looked at those sections of the California Labor Code. That court found that it was okay to fire someone for legitimate, non-political reason even though the underlying action was related to political activity. In that case, Mr. Couch was elected to the county board of supervisors. Morgan Stanley told him he could not hold both jobs based on time constraints.

I suppose that helps a bit. The limit on campaign contributions is set by a federal agency, not an employer made rule. It’s not the employer imposed rule. The rule is non-political in that, on its face, it does not apply to a political position, but to a political office.

One problem is the perception cast by advisers who want to do business with Indiana. They are telling their employees that donations to the Republican presidential candidates are limited, but there are no limits on the other candidates. It’s to meet the standards of the rule, but comes across as very political.

Of course that does leave the problem of how to implement the rule and Goldman Sachs’ implementation of the rule. Goldman banned contributions. That seems to be more than required by the federal rule and could be seen as unduly limiting the employee’s activities.

I know many advisers have taken the same position as Goldman Sachs and banned all political contributions by all employees. The intricacies of the SEC rule make anything more tough to manage. Others have pointed out that such a position may be in conflict with California law. Thanks to Mr. Bishop for pointing out the law on the issue.

Political Party Contributions and the SEC’s Pay-to-Play Rule

I was looking through an issue under Rule 206(4)-5. The Securities and Exchange Commission limits the ability of investment advisers and fund managers to contribute to certain politicians that can influence investment decisions for state pension funds. Under Rule 206(4)-5, you can contribute up to $150 to any candidate or up to $350 if you can vote for the candidate. I was looking at how that rule applies to political parties.

Section (a)(2) makes it unlawful for an investment adviser or any of its covered associates

(ii) To coordinate, or to solicit any person or political action committee to make, any:
…

(B) Payment to a political party of a state or locality where the investment
adviser is providing or seeking to provide investment advisory services to a government
entity.

So it’s not unlawful to make a contribution to the party, but it’s unlawful to solicit others to make a contribution to the party.

Just to confirm the SEC responses seems to agree with this reading of the rule.

Question V.3. Contributions to Others.

Q: If an adviser subject to the pay to play rule, or one of the adviser’s covered associates, makes a contribution to a political party, PAC or other committee or organization, but not to an official, could the adviser still be subject to a two-year time out under rule 206(4)-5(a)(1)?

A: A contribution to a political party, PAC or other committee or organization would not trigger a two-year time out under rule 206(4)-5(a)(1), unless it is a means to do indirectly what the rule prohibits if done directly (for example, the contribution is earmarked or known to be provided for the benefit of a particular political official) (see footnote 154 of the Adopting Release).

We note, however, that the pay to play rule prohibits advisers and their covered associates from coordinating or soliciting any person (including a non-natural person) or PAC to make any payment to a political party of a state or locality where the investment adviser is providing or seeking to provide investment advisory services to a government entity (see rule 206(4)-5(a)(2)(ii)). (Posted March 22, 2011).

A covered associate at an investment adviser could attend a state political party fundraiser, but not host one.

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Compliance and the Presidential Candidates

With the New Hampshire primary complete, the field of presidential candidates will continue to become smaller. Some of those dropping out may lower their expectations to Vice President or go back to their day jobs. Registered investment advisers have to worry about those day jobs when it comes to campaign donations.

2016-presidential-candidates

Under SEC Rule 206(4)-5, investment advisors are limited in their ability to give campaign contributions to political candidates who can directly or indirectly influence the hiring of an investment advisor by a government-sponsored investment entity. A campaign contribution in violation of the rule means the investment advisor can not collect fees from the applicable government-sponsored investor for two years. The rule applies to registered investment advisors and fund managers that had been exempt under the now-repealed, private fund manager exemption.

The president of the United States is not an office that can directly or indirectly influence the hiring of an investment advisor, so that position is not one that is limited by the SEC Rule. However, you also need to look at the candidate’s current office to see if that position is one that is limited.

Two of the remaining national candidates hold state offices: John Kasich and Chris Christie. They are both subject to SEC Rule 206(4)-5 because they appoint members to the state pension fund board in their states.

It’s not clear how the addition of a state governor (or other politician subject to  Rule 206(4)-5) would affect past donations.

These are just the national candidates. As points out on his blog, there are dozens of candidates on the state primary ballots with over forty on California’s List of Generally Recognized Presidential Candidates for California Primary.

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Another Pay-to-Play Case

There are few among us who think the high cost of getting elected and fundraising that it requires is good for American politics. The SEC took a moral high ground and passed Rule 206(4)-5. That rule effectively prohibits investment managers from making political contributions to politicians who control pension money, other than small token amounts. The SEC brought another pay-to-play case last week for egregious behavior. State Street was charged with funneling campaign contributions to a state treasury official.

Politician: Holding Out a Stack of Money

When I first saw this case I thought it would be a Rule 206(4)-5 case since State Street is a big money manager. In this circumstance, the relationship was a custodial relationship and outside the Advisers Act.

The deputy treasurer of a state pension fund arranged for illicit political contributions and improper payoffs through a fundraiser/lobbyist for State Street.

According to the SEC’s complaint against the fundraiser/lobbyist, Robert Crowe, he met the state official’s demand for campaign contributions by illegally filtering cash through his personal bank account and reimbursing individuals for contributions made in their own names. Crowe made additional illicit campaign contributions in response to the official’s threats that State Street would lose the business.

The State Street employee who headed it’s public funds group was also charged for participating in the pay-to-play scheme. According to the complaint against Vincent DeBaggis, he arranged for payments through a strawman as lobbying services, knowing that a large portion of that fee would be going to the state official. The lobbying agreement called for a success fee if the state pension funds became clients of State Street. DeBaggis’ conduct was in violation of State Street’s Standard of Conduct.

“Pension fund contracts cannot be obtained on the basis of illicit political contributions and improper payoffs,” said Andrew J. Ceresney, Director of the SEC’s Enforcement Division. “DeBaggis corruptly influenced the steering of pension fund custody contracts to State Street through bribes and campaign donations.”

The state official, Amer Ahmad, has already been convicted of misconduct and is currently in federal prison.

This case was more egregious than the first case the SEC brought against a Philadelphia firm for making a $2000 contribution, with no showing that it was designed to buy influence.

Sources

Pay to Play Rule In Effect on July 31

The Securities and Exchange Commission announced the compliance date for the ban on third-party solicitation pursuant to the Pay-to-Play rule: July 31, 2015. Rule 206(4)-5 prohibits an investment adviser from providing compensated services to a government entity, following a political contribution to certain officials of that entity.

pay to play.

Rule 206(4)-5 became effective on September 13, 2010 and the compliance date for the third-party solicitor ban was set to September 13, 2011.

The third-party solicitation ban, prohibits an investment adviser from paying a third-party to solicit advisory business from any government entity, on behalf of the adviser, unless the third party is a regulated entity:

  • Registered Investment Adviser;
  • Registered Broker-Dealer; or
  • Certain Registered Municipal Advisers.

When the Commission added municipal advisors to the definition of regulated person, the Commission also extended the third-party solicitor ban’s compliance date to June 13, 2012. However, at the time the final municipal advisor registration rule was not in effect. So, the SEC extended the third-party solicitor ban’s compliance date from June 13, 2012 to nine months after the compliance date of the final rule. That date is now set at July 31, 2015.

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$250 Could Cost a Firm $6.1 Million

compliance politics and money

A T. Rowe Price vice president made a $250 contribution to the campaign of Scott Walker for governor of Wisconsin in a recall election. That small donation could have cost T. Rowe Price $6.1 million in fees. The SEC’s Rule 206(4)-5 once again shows it scary side to advisers. Fortunately, the Securities and Exchange Commission granted some relief.

T. Rowe Price Associates, Inc. and T. Rowe Price International Ltd, affiliated SEC registered advisers, have over $60 billion in assets under management. Amidst that, T. Rowe Price manages some money for the Wisconsin state public pension plan.

Governor Walker appoint some of the members to the board of trustees. That makes the Wisconsin Governor an “Official” under Rule 206(4)-5.

Unfortunately, the vice president failed to pre-clear the February 2012 contribution with his compliance group and sent in the donation. He does not live in Wisconsin and is not entitled to vote for that Official’s office. So his donation is limited to $150 under Rule 206(4)-5.

T. Rowe Price discovered the errant contribution in March 2014 while developing a testing program that includes searches of public websites for contributions made by employees.

The SEC ruling is a good result for the firm, but shows how out of proportion the SEC rule is for potential harm.

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