SEC Enforcement Order Highlights Far Reach of Pay to Play Restrictions

SEC Enforcement Order Highlights Far Reach of Pay-to-Play Restrictions

August 23, 2024, Covington Alert

The Securities and Exchange Commission (SEC) this week issued a cease-and-desist order that demonstrates the SEC pay-to-play rule's expansiveness and the SEC's readiness to enforce it to the letter, even when it is virtually impossible that a political contribution could have influenced a government entity's investment decision.

The SEC "pay-to-play" rule prohibits registered investment advisers, among others, from providing paid investment advisory services to a government entity for two years after the adviser or certain employees or others affiliated with the adviser make a covered political contribution to an official of the government entity. See17 C.F.R. § 275.206(4)-5(a)(1), -5(f)(2)(ii). The rule's "lookback" provision makes clear that contributions made by new hires before joining the investment firm are still considered for purposes of triggering the two-year time out. In the case of a newly hired "covered associate," the rule considers their contributions in the previous two years if they solicit clients on behalf of the investment adviser; otherwise, it considers their contributions in the preceding six months.

The story at issue in this week's order starts in 2017, when Obra Capital Management, LLC, a registered investment advisory firm, began managing the investments of the Michigan Public Employees' Retirement fund in a closed-end pool. Two years later, an unnamed individual who was not affiliated with Obra at the time contributed to the political campaign of a Michigan state official whose office appointed members of a board that oversaw the Michigan Public Employees' Retirement Fund. More than six months after the donation, the individual was hired by Obra and dutifully requested and obtained a full refund of the Michigan contribution. He then began soliciting investments for the firm from unspecified government entities.

Even though the Michigan pension fund was largely locked into the Obra investment prior to the contribution, and even though the contribution was refunded and there was never an allegation that the new hire solicited the Michigan Public Employees' Retirement Fund for additional investments, the SEC found a violation, relying on the above-referenced lookback provision. The penalties were not a mere slap on the wrist. Obra was publicly censured by the SEC, ordered to cease and desist violations, and required to pay a civil penalty of $95,000.

As Commissioner Hester Peirce, a critic of the pay-to-play rule, noted in a dissent, neither the individual's "past contribution nor his present solicitation had any nexus to the ongoing fees received by" the firm from the investment pool. Calling the enforcement action an "inquisition," she emphasized that the case's application of the rule's "sweeping prohibition captures conduct that lacks any reasonable probability of unduly influencing actual investment decisions."

This case stands as a stark reminder that the SEC's pay-to-play rule-and many analogous rules at the federal and state levels-"do[] not require a showing of quid pro quo or actual intent to influence an elected official or candidate." A robust compliance program that requires a pre-hire review of a new employee's prior covered contributions can help protect investment advisers from becoming mired in a far-reaching pay-to-play enforcement matter like this one.

If you have any questions concerning the material discussed in this client alert, please contact the members of our Election and Political Law practice.