This year’s mid-term elections pose a compliance challenge for registered investment advisory (RIA) firms. When it comes to politics, investment advisers and their covered associates can be as passionate as any voters. But “pay-to-play” rules prohibit advisers from making political donations that many other voters could.
SEC Rule 206(4)-5 considers it to be unlawful for investment advisers to provide investment advisory services for compensation to a government entity within two years after a contribution to an ‘official’ of the government entity is made by the investment adviser or any of its covered associates, including a person who becomes a covered associate within two years after the contribution is made. Per the SEC, “An official includes an incumbent, candidate or successful candidate for elective office of a government entity if the office is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser or has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser.”
The SEC has fined dozens of firms for violating the pay-to-play rule since implementing it in 2010 and will watch advisers closely in this year’s elections. “The upcoming election season promises to be controversial and contentious with widespread contributions among voters. Firms need effective policies and procedures and efficient technology to comply with pay-to-play rules,” said Margie Webber, director of regulatory compliance for RegEd.
Other financial regulators have “pay-to-play” rules that are similar to the SEC’s provisions for investment advisers. Broker-dealers are subject to FINRA Rule 2030, for example.
With highly contested elections ahead, reminding advisers of their obligations and reviewing your firm’s compliance practices and technology will be crucial to avoiding the regulatory, financial and reputational consequences of non-compliance with pay-to-play regulation in 2022.
Advisers Act Rule 206(4)-5 is intended to combat pay-to-play arrangements in which advisers are chosen based on their campaign contributions to political officials rather than on merit, according to the SEC compliance guide issued at the rule’s release in 2010. “The potential for fraud to invade the various, intertwined relationships created by pay to play arrangements is without question, and the new rule is meant to reduce the occurrence of fraudulent conduct resulting from these practices and to protect public pension plans, beneficiaries, and other investors from the resulting harms. Pay to play practices often are not explicit, but have been widely reported,” the SEC explained.
Adopted under the Investment Advisers Act of 1940, the rule covers SEC-registered investment advisers and certain advisers exempt from registration with the SEC who provide investment advisory services or offer investment advisory services to government entities.
Under the rule:
- A firm cannot provide advisory services for compensation to a government entity, either directly or through a pooled investment vehicle, for two years after the adviser or certain executives or employees make political contributions above specified thresholds to an elected official or candidate for political office if the office is directly or indirectly responsible for, or can influence that government entity’s selection of the adviser.
- An investment advisory firm and certain executives and employees are prohibited from paying or agreeing to pay a third-party placement agent or “finder” to solicit business from a government entity on the firm’s behalf unless the third party is a registered broker-dealer or SEC-registered investment adviser subject to pay-to-play restrictions.
- Neither a firm nor certain executives and employees can solicit or coordinate contributions to a political official, candidate, or political party in a state or locality where the adviser provides or seeks to provide advisory services.
Also, a firm must keep a record of all government entities to which it provides or has provided advisory services. It must track regulated persons to whom it provides or agrees to provide, directly or indirectly, payment to solicit a government entity for investment advisory services on its behalf as well, per the SEC’s recordkeeping requirements.
Regulators have made conflicts of interest a top priority and have increased their vigilance concerning gifts, gratuities, and contributions. Political contributions are high on their focus areas for examinations, and they have frequently cited pay-to-play violations in levying costly and high-profile fines and penalties against financial services firms in recent years.
As the stakes have risen, the challenges for firms have increased. Tracking gifts, gratuities, political contributions, or other non-cash compensation across hundreds to tens of thousands of employees has evolved into a complex compliance management issue that requires a consistent and methodical process for the submission, approval, and tracking of requests and their fulfillment.
The approval process must vary based on an individual’s role in the organizational and supervisory structure, and, in the case of covered persons and specific roles in the business, the approval process can be complex and involve multiple reviewers.
While a single gift to a client or a single political contribution may be within an organization’s accepted thresholds, multiple gifts or contributions over time to that same client or campaign could violate internal policies, or worse, result in a compliance breach. In addition, because of the data-entry burden that reporting gifts, gratuities, and contributions create on employees, gaining broad adherence to an organization’s policies is often elusive, potentially placing a firm at compliance, financial, and reputational risk.
Monitoring to ensure compliant and ethical practices across an employee population is often impossible because a firm has no way to bring critical data related to gifts, gratuities, and contributions given and received into a single view for identifying outliers and negative trends that could result in consequences.
How RegEd Helps
To ensure compliance with pay-to-play rules, a firm needs organization-wide procedures and technology that enable the efficient review, approval, management, and monitoring of gifts, gratuities, and contributions against firm-defined thresholds, so that all submissions, regardless of the amount or point of origination, are tracked accurately.
RegEd’s Enterprise Gifts, Gratuities and Contributionsis the industry’s most advanced solution for managing the submissions, approvals, and tracking of political contributions and other non-cash compensation that could pose conflicts of interest.
To submit a political contribution, gift, business entertainment, or other non-cash compensation, submitters access the intuitive interface and enter details that their firm requires. The system then tracks and calculates the amounts against firm-defined threshold policies. As an extra layer of support, firms can utilize our pre-approval workflow to prevent any contributions that would violate current policy before they happen.
Gifts, Gratuities and Contributions aggregates totals for employees, clients, and third parties. Key indicators can be added to your government clients to ensure the correct threshold is applied. Compliance staff and other key stakeholders can view previous gifts or entertainment related to a specific recipient, individual giver, or multiple givers, to avoid exceeding contribution thresholds.
By automatically aggregating totals for individuals and companies, Gifts, Gratuities and Contributions:
- Reduces review time and speeds decisions by enabling management by exception.
- Eliminates the need to track gifts and gratuities with spreadsheets, thereby improving efficiency and reducing the risk of errors.
- Relieves the financial professional of the burden of tracking their limits or what they have given and received.
Complying with SEC Rule 206(4)-5 does not have to be challenging, even during heated mid-term elections in which investment advisers may be eager to make political contributions. With RegEd’s Gifts, Gratuities and Contributions solution, you can efficiently review, manage, and monitor submission requests to avoid violations.
If you are a RegEd client that would like to learn more about how our solutions can help you comply with pay-to-play rules, please reach out to your Customer Success Manager. If you do not currently use RegEd’s Gifts, Gratuities & Contributions solution, please contact firstname.lastname@example.org to learn more.
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