
[Federal Register: July 14, 2010 (Volume 75, Number 134)]
[Rules and Regulations]               
[Page 41017-41071]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14jy10-12]                         


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Part IV





Securities and Exchange Commission





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17 CFR Part 275



Political Contributions by Certain Investment Advisers; Final Rule


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-3043; File No. S7-18-09]
RIN 3235-AK39

 
Political Contributions by Certain Investment Advisers

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission is adopting a new rule 
under the Investment Advisers Act of 1940 that prohibits an investment 
adviser from providing advisory services for compensation to a 
government client for two years after the adviser or certain of its 
executives or employees make a contribution to certain elected 
officials or candidates. The new rule also prohibits an adviser from 
providing or agreeing to provide, directly or indirectly, payment to 
any third party for a solicitation of advisory business from any 
government entity on behalf of such adviser, unless such third parties 
are registered broker-dealers or registered investment advisers, in 
each case themselves subject to pay to play restrictions. Additionally, 
the new rule prevents an adviser from soliciting from others, or 
coordinating, contributions to certain elected officials or candidates 
or payments to political parties where the adviser is providing or 
seeking government business. The Commission also is adopting rule 
amendments that require a registered adviser to maintain certain 
records of the political contributions made by the adviser or certain 
of its executives or employees. The new rule and rule amendments 
address ``pay to play'' practices by investment advisers.

DATES: Effective Date: September 13, 2010.
    Compliance Dates: Investment advisers subject to rule 206(4)-5 must 
be in compliance with the rule on March 14, 2011. Investment advisers 
may no longer use third parties to solicit government business except 
in compliance with the rule on September 13, 2011. Advisers to 
registered investment companies that are covered investment pools must 
comply with the rule by September 13, 2011. Advisers subject to rule 
204-2 must comply with amended rule 204-2 on March 14, 2011. However, 
if they advise registered investment companies that are covered 
investment pools, they have until September 13, 2011 to comply with the 
amended recordkeeping rule with respect to those registered investment 
companies. See section III of this Release for further discussion of 
compliance dates.

FOR FURTHER INFORMATION CONTACT: Melissa A. Roverts, Senior Counsel, 
Matthew N. Goldin, Branch Chief, Daniel S. Kahl, Branch Chief, or Sarah 
A. Bessin, Assistant Director, at (202) 551-6787 or IArules@sec.gov, 
Office of Investment Adviser Regulation, Division of Investment 
Management, U.S. Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION: The Commission is adopting rule 206(4)-5 [17 
CFR 275.206(4)-5] and amendments to rules 204-2 [17 CFR 275.204-2] and 
206(4)-3 [17 CFR 275.206(4)-3] under the Investment Advisers Act of 
1940 [15 U.S.C. 80b] (``Advisers Act'' or ``Act'').\1\
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    \1\ 15 U.S.C. 80b. Unless otherwise noted, when we refer to the 
Advisers Act, or any paragraph of the Advisers Act, we are referring 
to 15 U.S.C. 80b of the United States Code, at which the Advisers 
Act is codified, and when we refer to rule 206(4)-5, rule 204-2, 
rule 204A-1, rule 206(4)-3, or any paragraph of these rules, we are 
referring to 17 CFR 275.206(4)-5, 17 CFR 275.204-2, 17 CFR 275.204A-
1 and 17 CFR 275.206(4)-3, respectively, of the Code of Federal 
Regulations, in which these rules are published.
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Table of Contents

I. Background
II. Discussion
    A. First Amendment Considerations
    B. Rule 206(4)-5
    1. Advisers Subject to the Rule
    2. Pay to Play Restrictions
    (a) Two-Year ``Time Out'' for Contributions
    (1) Prohibition on Compensation
    (2) Officials of a Government Entity
    (3) Contributions
    (4) Covered Associates
    (5) ``Look Back''
    (6) Exceptions for De Minimis Contributions
    (7) Exception for Certain Returned Contributions
    (b) Ban on Using Third Parties to Solicit Government Business
    (1) Registered Broker-Dealers
    (2) Registered Investment Advisers
    (c) Restrictions on Soliciting and Coordinating Contributions 
and Payments
    (d) Direct and Indirect Contributions or Solicitations
    (e) Covered Investment Pools
    (1) Definition of ``Covered Investment Pool''
    (2) Application of the Rule
    (3) Subadvisory Arrangements
    (f) Exemptions
    D. Recordkeeping
    E. Amendment to Cash Solicitation Rule
III. Effective and Compliance Dates
    A. Two-Year Time Out and Prohibition on Soliciting or 
Coordinating Contributions
    B. Prohibition on Using Third Parties to Solicit Government 
Business and Cash Solicitation Rule Amendment
    C. Recordkeeping
    D. Registered Investment Companies
IV. Cost-Benefit Analysis
    A. Benefits
    B. Costs
    1. Compliance Costs Related to Rule 206(4)-5
    2. Other Costs Related to Rule 206(4)-5
    (a) Two-Year Time Out
    (b) Third-Party Solicitor Ban
    3. Costs Related to the Amendments to Rule 204-2
V. Paperwork Reduction Act
    A. Rule 204-2
    B. Rule 206(4)-3
    C. Rule 206(4)-7
    D. Rule 0-4
VI. Final Regulatory Flexibility Analysis
    A. Need for the Rule
    B. Significant Issues Raised by Public Comment
    C. Small Entities Subject to Rule
    D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements
    E. Agency Action to Minimize Effect on Small Entities
VII. Effects on Competition, Efficiency and Capital Formation
VIII. Statutory Authority

I. Background

    Investment advisers provide a wide variety of advisory services to 
State and local governments,\2\ including managing their public pension 
plans.\3\ These pension plans have over $2.6 trillion of assets and 
represent one-third of all U.S. pension assets.\4\ They are among the 
largest and most active institutional investors in the United 
States;\5\ the management of these funds affects

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publicly held companies \6\ and the securities markets.\7\ But most 
significantly, their management affects taxpayers and the beneficiaries 
of these funds, including the millions of present and future State and 
municipal retirees \8\ who rely on the funds for their pensions and 
other benefits.\9\ Public pension plan assets are held, administered 
and managed by government officials who often are responsible for 
selecting investment advisers to manage the funds they oversee.
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    \2\ See Sofia Anastopoulos, An Introduction to Investment 
Advisers for State and Local Governments (2d ed. 2007); Werner Paul 
Zorn, Public Employee Retirement Systems and Benefits, Local 
Government Finance, Concepts and Practices 376 (John E. Peterson & 
Dennis R. Strachota eds., 1st ed. 1991) (discussing the services 
investment advisers provide for public funds).
    \3\ To simplify the discussion, we use the term ``public pension 
plan'' interchangeably with ``government client'' and ``government 
entity'' in this Release. However, our rule applies broadly to 
investment advisory activities for government clients, such as those 
mentioned here in this Section of the Release, regardless of whether 
they are retirement funds. For a discussion of how the proposed rule 
would apply with respect to investment programs or plans sponsored 
or established by government entities, such as ``qualified tuition 
plans'' authorized by section 529 of the Internal Revenue Code [26 
U.S.C. 529] and retirement plans authorized by section 403(b) or 457 
of the Internal Revenue Code [26 U.S.C. 403(b) or 457], see section 
II.B.2(e) of this Release.
    \4\ Board of Governors of the Federal Reserve System, Flow of 
Funds Accounts of the United States, Flows and Outstandings, Fourth 
Quarter 2009 78 tbl.L.119 (Mar. 11, 2010). Since 2002, total 
financial assets of public pension funds have grown by 28%. Id.
    \5\ According to a recent survey, seven of the ten largest 
pension funds were sponsored by State and municipal governments. The 
Top 200 Pension Funds/Sponsors, Pens. & Inv. (Sept. 30, 2008), 
available at http://www.pionline.com/article/20090126/CHART/
901209995.
    \6\ See Stephen J. Choi & Jill E. Fisch, On Beyond CalPERS: 
Survey Evidence on the Developing Role of Public Pension Funds in 
Corporate Governance, 61 Vand. L. Rev. 315 (2008) (``Collectively, 
public pension funds have the potential to be a powerful shareholder 
force, and the example of CalPERS and its activities have spurred 
many to advocate greater institutional activism.'').
    \7\ Federal Reserve reports indicate that, of the $2.6 trillion 
in non-Federal government plans, $1.5 trillion is invested in 
corporate equities. Board of Governors of the Federal Reserve 
System, supra note 4, at 78 tbl.L.119.
    \8\ See Paul Zorn, 1997 Survey of State and Local Government 
Employee Retirement Systems 61 (1997) (hereinafter ``1997 Survey'') 
(``[t]he investment of plan assets is an issue of immense 
consequence to plan participants, taxpayers, and to the economy as a 
whole'' as a low rate of return will require additional funding from 
the sponsoring government, which ``can place an additional strain on 
the sponsoring government and may require tax increases'').
    \9\ The most current census data reports that public pension 
funds have 18.6 million beneficiaries. 2007 Census of Governments, 
U.S. Bureau of Census, Number and Membership of State and Local 
Government Employee-Retirement Systems by State: 2006-2007 (2007) 
(at Table 5), available at http://www.census.gov/govs/retire/
2007ret05.html.
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    Elected officials who allow political contributions to play a role 
in the management of these assets and who use these assets to reward 
contributors violate the public trust. Moreover, they undermine the 
fairness of the process by which public contracts are awarded. 
Similarly, investment advisers that seek to influence government 
officials' awards of advisory contracts by making or soliciting 
political contributions to those officials compromise their fiduciary 
duties to the pension plans they advise and defraud prospective 
clients. These practices, known as ``pay to play,'' distort the process 
by which advisers are selected.\10\ They can harm pension plans that 
may subsequently receive inferior advisory services and pay higher 
fees. Ultimately, these violations of trust can harm the millions of 
retirees that rely on the plan or the taxpayers of the State and 
municipal governments that must honor those obligations.\11\
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    \10\ Among other things, pay to play practices may manipulate 
the market for advisory services by creating an uneven playing field 
among investment advisers. These practices also may hurt smaller 
advisers that cannot afford the required contributions.
    \11\ See 1997 Survey, supra note 8.
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    Pay to play practices are rarely explicit: participants do not 
typically let it be publicly known that contributions or payments are 
made or accepted for the purpose of influencing the selection of an 
adviser. As one court noted, ``[w]hile the risk of corruption is 
obvious and substantial, actors in this field are presumably shrewd 
enough to structure their relations rather indirectly.'' \12\ Pay to 
play practices may take a variety of forms, including an adviser's 
direct contributions to government officials, an adviser's solicitation 
of third parties to make contributions or payments to government 
officials or political parties in the State or locality where the 
adviser seeks to provide services, or an adviser's payments to third 
parties to solicit (or as a condition of obtaining) government 
business. As a result, the full extent of pay to play practice remains 
hidden and is often hard to prove.
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    \12\ Blount v. SEC, 61 F.3d 938, 945 (D.C. Cir. 1995), cert. 
denied, 517 U.S. 1119 (1996).
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    Public pension plans are particularly vulnerable to pay to play 
practices. Management decisions over these investment pools, some of 
which are quite large, are typically made by one or more trustees who 
are (or are appointed by) elected officials. And the elected officials 
or appointed trustees that govern the funds are also often involved, 
directly or indirectly, in selecting advisers to manage the public 
pension funds' assets. These officials may have the sole authority to 
select advisers,\13\ may be members of a governing board that selects 
advisers,\14\ or may appoint some or all of the board members who make 
the selection.\15\
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    \13\ See, e.g., 2 N.Y. Comp. Codes R. & Regs. tit. 2 Sec.  320.2 
(2009) (placement of State and local government retirement systems 
assets (valued at $109 billion as of March 2009) is under the sole 
custodianship of the New York State Comptroller).
    \14\ See, e.g., S.C. Code Ann. Sec. Sec.  9-1-20, 1-11-10 (2008) 
(board consists of all elected officials); Cal. Gov't Code Sec.  
20090 (Deering 2008) (board consists of some elected officials, some 
appointed members, and some representatives of interest groups 
chosen by the members of those groups); Md. Code Ann., State Pers. & 
Pens. Sec.  21-104 (2008) (pension board consists of some elected 
officials, some appointed members, and some representatives of 
interest groups chosen by the members of those groups).
    \15\ See, e.g., Ariz. Rev. Stat. Ann. Sec.  38-713 (2008) 
(governor appoints all nine members); Hawaii Rev. Stat. Sec.  88-24 
(2008) (governor appoints three of eight members); Idaho Code Ann. 
Sec.  59-1304 (2008) (governor appoints all five members).
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    Numerous developments in recent years have led us to conclude that 
the selection of advisers, whom we regulate under the Investment 
Advisers Act, has been influenced by political contributions and that, 
as a result, the quality of management service provided to public funds 
may be negatively affected. We have been particularly concerned that 
these contributions have been funneled through ``solicitors'' and 
``placement agents'' that advisers engage (or believe they must engage) 
in order to secure a client relationship with a public pension plan or 
an investment from one.\16\ As we will discuss in more detail below, in 
such an arrangement the contribution may be made in the form of a 
substantial fee for what may constitute no more than an introduction 
service by a ``well connected'' individual who may use the proceeds of 
the fee to make (or reimburse himself for having made) political 
contributions or provide some form of a ``kickback'' to an official or 
his or her family or friends.\17\
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    \16\ For example, in one recent action we alleged that, in 
connection with a pay to play scheme in New York State, investment 
advisers paid sham ``placement agent'' fees, portions of which were 
funneled to public officials, as a means of obtaining public pension 
fund investments in the funds those advisers managed and that 
participants, in some instances, concealed the third-party 
solicitor's role in transactions from the investment management 
firms that paid fees to the solicitor by making misrepresentations 
about the solicitor's involvement and covertly using one of the 
solicitor's legal entities as an intermediary to funnel payments to 
the solicitor. SEC v. Henry Morris, et al., Litigation Release No. 
20963 (Mar. 19, 2009).
    \17\ See id. (along with the Commission's complaint in the 
action, available by way of a hyperlink from the litigation 
release). See also, e.g., In the Matter of Quadrangle Group LLC, 
AGNY Investigation No. 2010-044 (Apr. 15, 2010) (finding that 
``private equity firms and hedge funds frequently use placement 
agents, finders, lobbyists, and other intermediaries * * * to obtain 
investments from public pension funds * * *, that these placement 
agents are frequently politically connected individuals selling 
access to public money* * *''); Complaint, Cal. v. Villalobos, et 
al., No. SC107850 (Cal. Super. Ct., W. Dist. of L.A. County, May 5, 
2010), available at http://ag.ca.gov/cms_attachments/press/pdfs/
n1915_filed_complaint_for_civil_penalties.pdf (alleging, inter 
alia, that a top executive and a board member at CalPERS accepted 
various gifts from a former CalPERS board member, ``known among 
private equity firms as a person who attempts to exert pressure on 
CalPERS' representatives,'' who was acting as a placement agent 
trying to secure investments from the California public pension 
fund).
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    The details of pay to play arrangements have been widely reported 
as a consequence of the growing number of actions that we and State 
authorities have brought involving investment advisers seeking to 
manage the considerable assets of the New York State Common Retirement 
Fund.\18\ In

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addition, we have brought enforcement actions against the former 
treasurer of the State of Connecticut and other parties in which we 
alleged that the former treasurer awarded State pension fund 
investments to private equity fund managers in exchange for payments, 
including political contributions, funneled through the former 
treasurer's friends and political associates.\19\ Criminal authorities 
have in recent years brought cases in New York,\20\ New Mexico,\21\ 
Illinois,\22\ Ohio,\23\ Connecticut,\24\ and Florida,\25\ charging 
defendants with the same or similar conduct.
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    \18\ See SEC v. Henry Morris, et al., Litigation Release No. 
21036 (May 12, 2009); In the Matter of Quadrangle Group LLC, AGNY 
Investigation No. 2010-044 (Apr. 15, 2010); In the Matter of GKM 
Newport Generation Capital Servs., LLC, AGNY Investigation No. 2010-
017 (Apr. 14, 2010); In the Matter of Kevin McCabe, AGNY 
Investigation No. 2009-152 (Apr. 14, 2010); In the Matter of Darius 
Anderson Platinum Advisors LLC, AGNY Investigation No. 2009-153 
(Apr. 14, 2010); In the Matter of Global Strategy Group, AGNY 
Investigation No. 2009-161 (Apr. 14, 2010); In the Matter of Freeman 
Spogli & Co., AGNY Investigation No. 2009-174 (Feb. 1, 2010); In the 
Matter of Falconhead Capital, LLC, AGNY Investigation No. 2009-125 
(Sept. 17, 2009); In the Matter of HM Capital Partners I, LP, AGNY 
Investigation No. 2009-117 (Sept. 17, 2009); In the Matter of Ares 
Management LLC, AGNY Investigation No. 2009-173 (Feb. 17, 2010); In 
the Matter of Levine Leichtman Capital Partners, AGNY Investigation 
No. 2009-124 (Sept. 17, 2009); In the Matter of Access Capital 
Partners, AGNY Investigation No. 09-135 (Sept. 17, 2009); In the 
Matter of The Markstone Group, AGNY Investigation No. 10-012 (Feb. 
28, 2010); In the Matter of Wetherly Capital Group, LLC and DAV/
Wetherly Financial, L.P., AGNY Investigation No. 2009-172 (Feb. 8, 
2010) (in each case, banning the use of third-party placement agents 
pursuant to a ``Pension Reform Code of Conduct'').
    \19\ See SEC v. Paul J. Silvester, et al., Litigation Release 
No. 16759 (Oct. 10, 2000); Litigation Release No. 20027 (Mar. 2, 
2007); Litigation Release No. 19583 (Mar. 1, 2006); Litigation 
Release No. 18461 (Nov. 17, 2003); Litigation Release No. 16834 
(Dec. 19, 2000); SEC v. William A. DiBella et al., Litigation 
Release No. 20498 (Mar. 14, 2008) (2007 U.S. Dist. LEXIS 73850 (D. 
Conn., May 8, 2007), aff'd 587 F.3d 553 (2nd Cir. 2009)). See also 
U.S. v. Ben F. Andrews, Litigation Release No. 19566 (Feb. 15, 
2006); In the Matter of Thayer Capital Partners, TC Equity Partners 
IV, L.L.C., TC Management Partners IV, L.L.C., and Frederick V. 
Malek, Investment Advisers Act Release No. 2276 (Aug. 12, 2004); In 
the Matter of Frederick W. McCarthy, Investment Advisers Act Release 
No. 2218 (Mar. 5, 2004); In the Matter of Lisa A. Thiesfield, 
Investment Advisers Act Release No. 2186 (Oct. 29, 2003).
    \20\ See New York v. Henry ``Hank'' Morris and David Loglisci, 
Indictment No. 25/2009 (NY Mar. 19, 2009) (alleging that the deputy 
comptroller and a ``placement agent'' engaged in enterprise 
corruption and State securities fraud for selling access to 
management of public funds in return for kickbacks and other 
payments for personal and political gain).
    \21\ See U.S. v. Montoya, Criminal No. 05-2050 JP (D.N.M. Nov. 
8, 2005) (the former treasurer of New Mexico pleaded guilty); U.S. 
v. Kent Nelson, Criminal Information No. 05-2021 JP, (D.N.M. 2007) 
(defendant pleaded guilty to one count of mail fraud); U.S. v. 
Vigil, 523 F.3d 1258 (10th Cir. 2008) (affirming the conviction for 
attempted extortion of the former treasurer of New Mexico for 
requiring that a friend be hired by an investment manager at a high 
salary in return for the former treasurer's willingness to accept a 
proposal from the manager for government business).
    \22\ See Jeff Coen, et al., State's Ultimate Insider Indicted, 
Chi. Trib., Oct. 31, 2008, available at http://
www.chicagotribune.com/news/local/chi-cellini-31-
oct31,0,6465036.story (describing the thirteenth indictment in an 
Illinois pay to play probe); Ellen Almer, Oct. 27, 2000, available 
at http://www.chicagobusiness.com/cgi-bin/news.pl?id=775 (discussing 
the guilty plea of Miriam Santos, the former treasurer of the City 
of Chicago, who told representatives of financial services firms 
seeking city business that they were required to raise specified 
campaign contributions for her and personally make up any shortfall 
in the amounts they raised). See also SEC v. Miriam Santos, et al., 
Litigation Release No. 17839 (Nov. 14, 2002); Litigation Release No. 
19269 (June 14, 2005) (355 F. Supp. 2d 917 (N.D. Ill. 2003)).
    \23\ See Reginald Fields, Four More Convicted in Pension Case: 
Ex-Board Members Took Gifts from Firm, Cleveland Plain Dealer, Sept. 
20, 2006 (addressing pay to play activities of members of the Ohio 
Teachers Retirement System).
    \24\ See U.S. v. Joseph P. Ganim, 2007 U.S. App. LEXIS 29367 (2d 
Cir. 2007) (affirming the district court's decision to uphold an 
indictment of the former mayor of Bridgeport, Connecticut, in 
connection with his conviction for, among other things, requiring 
payment from an investment adviser in return for city business); 
U.S. v. Triumph Capital Group, et al., No. 300CR217 JBA (D. Conn. 
2000) (the former treasurer, along with certain others, pleaded 
guilty--while others were ultimately convicted). One of the 
defendants, who had been convicted at trial, recently won a new 
trial. U.S. v. Triumph Capital Group, et al., 544 F.3d 149 (2d Cir. 
2008).
    \25\ United States v. Poirier, 321 F.3d 1024 (11th Cir.), cert. 
denied sub nom. deVegter v. United States, 540 U.S. 874 (2003) 
(partner at Lazard Freres & Co., a municipal services firm, was 
convicted for conspiracy and wire fraud for fraudulently paying 
$40,000 through an intermediary to Fulton County's independent 
financial adviser to secure an assurance that Lazard would be 
selected for the Fulton County underwriting contract).
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    Allegations of pay to play activity involving State and municipal 
pension plans in other jurisdictions continue to be reported.\26\ In 
the course of this rulemaking we received a letter from one public 
official detailing the role of pay to play arrangements in the 
selection of public pension fund managers and the harms it can inflict 
on the affected plans.\27\ In addition, other public officials wrote to 
express support for a Commission rule to prohibit investment advisers 
from participating in pay to play arrangements.\28\
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    \26\ See, e.g., Aaron Lester, et al., Cahill Taps Firms Tied to 
State Pension Investor, Boston.com, Mar. 21, 2010 (suggesting that 
an investment adviser may have bundled out-of-State donations to the 
Massachusetts State Treasurer's campaign in return for a State 
pension fund investment management contract); Kevin McCoy, Do 
Campaign Contributions Help Win Pension Fund Deals, USA Today, Aug. 
28, 2009; Ted Sherman, Pay to Play Alive and Well in New Jersey, 
NJ.com, Nov. 28, 2009 (noting more generally that pay to play 
continues to occur with government contracts of all kinds in New 
Jersey); Imogen Rose-Smith and Ed Leefeldt, Pension Pay to Play 
Casts Shadow Nationwide, Institutional Investor, Oct. 1, 2009 
(suggesting connections between a private equity fund principal's 
fundraising activities and pension investments in the fund). See 
also sources cited supra note 17.
    \27\ Comment Letter of Suzanne R. Weber, Erie County Controller 
(Oct. 6, 2009) (``Weber Letter'') (``I have seen money managers 
awarded contracts with our fund which involved payments to 
individuals who served as middlemen, creating needless expense for 
the fund. These middlemen were political contributors to the 
campaigns of board members who voted to contract for money 
management services with the companies who paid them as 
middlemen.''). See also Comment Letter of David R. Pohndorf (Aug. 4, 
2009) (``Pohndorf Letter'') (noting that when the sole trustee of a 
major pension fund changed several years ago, a firm managing some 
of the fund's assets ``began to receive invitations to fundraising 
events for the new trustee with suggested donation amounts.'').
    \28\ See, e.g., Comment Letter of New York State Comptroller 
Thomas P. DiNapoli (Oct. 2, 2009) (``DiNapoli Letter''); Comment 
Letter of New York City Mayor Michael R. Bloomberg (Sept. 9, 2009) 
(``Bloomberg Letter''). See also Comment Letter of Kentucky 
Retirement Systems Trustee Chris Tobe (Sept. 18, 2009) (``Tobe 
Letter'') (suggesting the negative effects of pay to play activities 
on the Kentucky Retirement System's investment performance).
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    On August 3, 2009, we proposed a new antifraud rule under the 
Advisers Act designed to prevent investment advisers from obtaining 
business from government entities in return for political contributions 
or fund raising--i.e., from participating in pay to play practices.\29\ 
We modeled our proposed rule on those adopted by the Municipal 
Securities Rulemaking Board, or MSRB, which since 1994 has prohibited 
municipal securities dealers from participating in pay to play 
practices.\30\ We believe these rules have significantly curbed pay to 
play practices in the municipal securities market.\31\
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    \29\ Political Contributions by Certain Investment Advisers, 
Investment Advisers Act Release No. 2910 (Aug. 3, 2009) [74 FR 39840 
(Aug. 7, 2009)] (the ``Proposing Release'').
    \30\ MSRB rule G-37 was approved by the Commission and adopted 
in 1994. See In the Matter of Self-Regulatory Organizations; Order 
Approving Proposed Rule Change by the Municipal Securities 
Rulemaking Board Relating to Political Contributions and 
Prohibitions on Municipal Securities Business and Notice of Filing 
and Order Approving on an Accelerated Basis Amendment No. 1 Relating 
to the Effective Date and Contribution Date of the Proposed Rule, 
Exchange Act Release No. 33868 (Apr. 7, 1994) [59 FR 17621 (Apr. 13, 
1994)]. The MSRB's pay to play rules include MSRB rules G-37 and G-
38. They are available on the MSRB's Web site at http://
www.msrb.org/msrb1/rules/ruleg37.htm and http://www.msrb.org/msrb1/
rules/ruleg38.htm, respectively.
    \31\ See Proposing Release, at n.23. See also infra note 101; 
Comment Letter of the Municipal Securities Rulemaking Board (Oct. 
23, 2009) (``MSRB Letter''); Comment Letter of Common Cause (Oct. 6, 
2009) (``Common Cause Letter'').

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[[Page 41021]]

    Along the lines of MSRB rule G-37,\32\ our proposed rule would have 
prohibited an investment adviser from providing advisory services for 
compensation to a government client for two years after the adviser or 
certain of its executives or employees make a contribution to certain 
elected officials or candidates.\33\ It also would have prohibited an 
adviser and certain of its executives and employees from soliciting 
from others, or coordinating, contributions to certain elected 
officials or candidates or payments to political parties where the 
adviser is providing or seeking government business.\34\ In addition, 
similar to MSRB rule G-38,\35\ our proposed rule would have prohibited 
the use of third parties to solicit government business.\36\ We also 
proposed amendments to rule 204-2 under the Advisers Act that would 
have required registered advisers to maintain certain records regarding 
political contributions and government clients. As discussed in more 
detail below, our proposed rule departed in some respects from the MSRB 
rules to reflect differences between advisers and broker-dealers and 
the scope of the statutory authority we have sought to exercise.
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    \32\ See MSRB rule G-37(b). Our proposal, like MSRB rule G-37, 
was designed to address our concern that pay to play activities were 
``undermining the integrity'' of the relevant market, in particular 
the market for the provision of investment advisory services to 
government entity clients. See Blount, 61 F.3d at 939 (referring to 
the MSRB's concerns that pay to play practices were ``undermining 
the integrity of the $250 billion municipal securities market'' as 
its motivation for proposing MSRB rule G-37).
    \33\ Proposed rule 206(4)-5(a)(1). See also MSRB rule G-37(b).
    \34\ Proposed rule 206(4)-5(a)(2)(ii). See also MSRB rule G-
37(c).
    \35\ See MSRB rule G-38(a).
    \36\ Proposed rule 206(4)-5(a)(2)(i).
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    We received some 250 comment letters on our proposal, many of which 
were from advisers, third-party solicitors, placement agents, and their 
representatives.\37\ Public pension plans and their officials were 
divided--some embraced the rule, including one that stated that the 
rule is an important means to ``increase transparency and public 
confidence in the investment activities of all public pension funds,'' 
\38\ while others were critical, arguing, for example, that our 
proposal ``may result in unintended hardships being placed upon public 
pension funds.'' \39\ We received no letters from plan beneficiaries 
whom we sought to protect with the proposed rule,\40\ although two 
public interest groups supported it strongly.\41\ Advisers, third-party 
solicitors and placement agents, fund sponsors, and others whose 
business arrangements could be affected by the rule generally supported 
our goal of eliminating advisers' participation in pay to play 
practices involving public plans.\42\ Nonetheless, most of them 
objected to our adoption under the Advisers Act of a rule similar to 
MSRB rules G-37 and G-38.\43\ Most particularly opposed the proposed 
prohibition on payments to third parties for soliciting or marketing to 
government entities modeled on MSRB rule G-38.\44\ Several urged that, 
if we were to adopt a rule based on the approach taken in our proposal, 
we should broaden exceptions and exemptions under the rule to 
accommodate certain business arrangements.\45\ We respond to these 
comments below.\46\
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    \37\ Other commenters included pension plans and their 
officials, trade associations, law firms, and public interest 
groups. Comments letters submitted in File No. S7-25-06 are 
available on the Commission's Web site at: http://www.sec.gov/
comments/s7-18-09/s71809.shtml.
    \38\ Comment Letter of New York City Comptroller William C. 
Thompson, Jr. (Oct. 6, 2009) (``Thompson Letter'').
    \39\ Comment Letter of Executive Director and Secretary to the 
Board of Trustees of the State Retirement and Pension System of 
Maryland R. Dean Kenderdine (Oct. 5, 2009).
    \40\ We note, however, that subsequent to our proposal, AFSCME, 
which represents 1.6 million State and local employees and retirees, 
issued a report that strongly endorses sanctions to prevent pay to 
play activities. AFSCME, Enhancing Public Retiree Pension Plan 
Security: Best Practice Policies for Trustees and Pension Systems 
(2010), available at http://www.afscme.org/docs/AFSCME-report-
pension-best-practices.pdf.
    \41\ See, e.g., Common Cause Letter; Comment Letter of Fund 
Democracy/Consumer Federation of America (Oct. 6, 2009) (``Fund 
Democracy/Consumer Federation Letter'').
    \42\ See, e.g., Comment Letter of the Investment Adviser 
Association (Oct. 5, 2009) (``IAA Letter'') (noting ``support [for] 
measures to combat pay to play activities, i.e., the practice of 
investment advisers or their employees making political 
contributions intended to influence the selection or retention of 
advisers by government entities. Pay to play practices undermine the 
principle that advisers are selected on the basis of competence, 
qualifications, expertise, and experience. The practice is unethical 
and undermines the integrity of the public pension plan system and 
the process of selecting investment advisers.''); Comment Letter of 
John R. Dempsey (Aug. 8, 2009) (``Dempsey Letter'') (noting applause 
for efforts ``to stop the `pay-to-play' practice which only serves 
to undermine public trust in investment advisors and regulators.''); 
Comment Letter of Barry M. Gleicher (Sept. 7, 2009) (noting strong 
support for the proposal ``with no modifications. * * * The Rule is 
necessary to curb elaborated practices that would deprive taxpayers 
and beneficiaries of cost effective and honest administration of 
pension funds''); Tobe Letter.
    \43\ See, e.g., IAA Letter (``We respectfully submit, however, 
that the structure of the MSRB rules is not appropriately tailored 
to the investment advisory business. * * * We believe the Commission 
should make significant changes to the Proposal, which would permit 
it to accomplish its important goals.''); Comment Letter of Wesley 
Ogburn (Aug. 4, 2009) (``Ogburn Letter''); Comment Letter of the 
Third Party Marketers Association (Aug. 27, 2009) (``3PM Letter''); 
Comment Letter of Preqin (Aug. 28, 2009) (``Preqin Letter I'') 
(suggesting that institutional private equity investors polled 
favored a private equity specific proposal rather than relying on 
the framework from the municipal securities industry); Comment 
Letter of Dechert LLP (Oct. 22, 2009) (``Dechert Letter''); Comment 
Letter of the Committee on Federal Regulation of Securities of the 
Section of Business Law of the American Bar Association (Oct. 13, 
2009) (``ABA Letter''); Comment Letter of Fidelity Investments (Oct. 
7, 2009) (``Fidelity Letter''); Comment Letter of Sutherland Asbill 
& Brennan LLP (Oct. 6, 2009) (``Sutherland Letter''); Comment Letter 
of the Investment Company Institute (Oct. 6, 2009) (``ICI Letter''); 
Comment Letter of the Massachusetts Mutual Life Insurance Company 
(Oct. 6, 2009) (``MassMutual Letter''); Comment Letter of Skadden, 
Arps, Slate, Meagher & Flom LLP (Oct. 6, 2009) (``Skadden Letter''); 
Comment Letter of the Managed Funds Association (Oct. 6, 2009) 
(``MFA Letter'').
    \44\ See, e.g., Comment Letter of Ounavarra Capital, LLC (Aug. 
28, 2009) (``Ounavarra Letter'') (noting that banning third-party 
marketers in the municipal securities industry did not adversely 
affect most bankers' ability to conduct basic marketing whereas 
banning third-party marketers for small advisers could have a 
stronger impact on advisers that have either no or very limited 
marketing capability of their own); Comment Letter of MVision 
Private Equity Advisers USA LLC (Sept. 2, 2009) (``MVision Letter'') 
(arguing that, whereas placement agents for municipal bond offerings 
are usually regulated entities, the restrictions in the municipal 
securities arena were targeted at consultants who offer only their 
contacts and influence with government officials and provided no 
valuable services to the financial services industry or investors); 
Comment Letter of Kalorama Capital (Sept. 8, 2009) (arguing that a 
better analogy, at least with respect to the operation of third-
party marketers, is to the licensed professional presenting an IPO 
to a pension fund). For further discussion of these comments, see 
section II.B.2(b) of this Release.
    \45\ See, e.g., Comment Letter of the Committee on Investment 
Management Regulation and the Committee on Private Investment Funds 
of the Association of the Bar of the City of New York (Oct. 26, 
2009) (``NY City Bar Letter'') (arguing that broker-dealer rules 
have sufficient safeguards and that adopting the proposed pay to 
play rule will interfere with traditional distribution 
arrangements); Dechert Letter; Sutherland Letter; MFA Letter.
    \46\ Particular comments on the various aspects of our proposal 
are summarized in the corresponding sub-sections of section II of 
this Release.
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II. Discussion

    As discussed in more detail below, we have decided to adopt rule 
206(4)-5, which we have revised to reflect comments we received. For 
the reasons we discuss above and in the Proposing Release, we believe 
rule 206(4)-5 is a proper exercise of our rulemaking authority under 
the Advisers Act to prevent fraudulent and manipulative conduct.
    The Commission regulates investment advisers under the Investment 
Advisers Act of 1940. Section 206(1) of the Advisers Act prohibits an 
investment adviser from employ[ing] any device, scheme or artifice to 
defraud any client

[[Page 41022]]

or prospective client.'' \47\ Section 206(2) prohibits an investment 
adviser from engaging in ``any transaction, practice, or course of 
business which operates as a fraud or deceit upon any client or 
prospective client.'' \48\ The Supreme Court has construed section 206 
as establishing a Federal fiduciary standard governing the conduct of 
advisers.\49\
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    \47\ 15 U.S.C. 80b-6(1).
    \48\ 15 U.S.C. 80b-6(2).
    \49\ Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 
17 (1979); SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 
191-192 (1963).
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    We believe that pay to play is inconsistent with the high standards 
of ethical conduct required of fiduciaries under the Advisers Act. We 
have authority under section 206(4) of the Act to adopt rules 
``reasonably designed to prevent, such acts, practices, and courses of 
business as are fraudulent, deceptive or manipulative.'' \50\ Congress 
gave us this authority to prohibit ``specific evils'' that the broad 
antifraud provisions may be incapable of covering.\51\ The provision 
thus permits the Commission to adopt prophylactic rules that may 
prohibit acts that are not themselves fraudulent.\52\
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    \50\ 15 U.S.C. 80b-6(4).
    \51\ S. Rep. No. 1760, 86th Cong., 2d Sess. 4, 8 (1960). The 
Commission has used this authority to adopt seven rules addressing 
abusive advertising practices, custodial arrangements, the use of 
solicitors, required disclosures regarding advisers' financial 
conditions and disciplinary histories, proxy voting, compliance 
procedures and practices, and deterring fraud with respect to pooled 
investment vehicles. 17 CFR 275.206(4)-1; 275.206(4)-2; 275.206(4)-
3; 275.206(4)-4; 275.206(4)-6; 275.206(4)-7; and 275.206(4)-8.
    \52\ Section 206(4) was added to the Advisers Act in Public Law 
86-750, 74 Stat. 885, at sec. 9 (1960). See H.R. Rep. No. 2197, 86th 
Cong., 2d Sess., at 7-8 (1960) (``Because of the general language of 
section 206 and the absence of express rulemaking power in that 
section, there has always been a question as to the scope of the 
fraudulent and deceptive activities which are prohibited and the 
extent to which the Commission is limited in this area by common law 
concepts of fraud and deceit . . . [Section 206(4)] would empower 
the Commission, by rules and regulations to define, and prescribe 
means reasonably designed to prevent, acts, practices, and courses 
of business which are fraudulent, deceptive, or manipulative. This 
is comparable to Section 15(c)(2) of the Securities Exchange Act [15 
U.S.C. 78o(c)(2)] which applies to brokers and dealers.''). See also 
S. Rep. No. 1760, 86th Cong., 2d Sess., at 8 (1960) (``This [section 
206(4) language] is almost the identical wording of section 15(c)(2) 
of the Securities Exchange Act of 1934 in regard to brokers and 
dealers.''). The Supreme Court, in United States v. O'Hagan, 
interpreted nearly identical language in section 14(e) of the 
Securities Exchange Act [15 U.S.C. 78n(e)] as providing the 
Commission with authority to adopt rules that are ``definitional and 
prophylactic'' and that may prohibit acts that are ``not themselves 
fraudulent * * * if the prohibition is `reasonably designed to 
prevent * * * acts and practices [that] are fraudulent.' '' United 
States v. O'Hagan, 521 U.S. 642, 667, 673 (1997). The wording of the 
rulemaking authority in section 206(4) remains substantially similar 
to that of section 14(e) and section 15(c)(2) of the Securities 
Exchange Act. See also Prohibition of Fraud by Advisers to Certain 
Pooled Investment Vehicles, Investment Advisers Act Release No. 2628 
(Aug. 3, 2007) [72 FR 44756 (Aug. 9, 2007)] (stating, in connection 
with the suggestion by commenters that section 206(4) provides us 
authority only to adopt prophylactic rules that explicitly identify 
conduct that would be fraudulent under a particular rule, ``We 
believe our authority is broader. We do not believe that the 
commenters' suggested approach would be consistent with the purposes 
of the Advisers Act or the protection of investors.'').
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    Investment advisers that seek to influence the award of advisory 
contracts by public pension plans, by making political contributions 
to, or soliciting them for, those officials who are in a position to 
influence the awards, compromise their fiduciary obligations to the 
public pension plans they advise and defraud prospective clients.\53\ 
In making such contributions, the adviser hopes to benefit from 
officials who ``award the contracts on the basis of benefit to their 
campaign chests rather than to the governmental entity'' \54\ or by 
retaining a contract that might otherwise not be renewed. If pay to 
play is a factor in the selection or retention process, the public 
pension plan can be harmed in several ways. The most qualified adviser 
may not be selected or retained, potentially leading to inferior 
management or performance. The pension plan may pay higher fees because 
advisers must recoup the contributions, or because contract 
negotiations may not occur on an arm's-length basis. The absence of 
arm's-length negotiations may enable advisers to obtain greater 
ancillary benefits, such as ``soft dollars,'' from the advisory 
relationship, which might be used for the benefit of the adviser, 
potentially at the expense of the pension plan, thereby using the 
pension plan's assets for the adviser's own purposes.\55\
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    \53\ See Proposing Release, at section I; Political 
Contributions by Certain Investment Advisers, Investment Advisers 
Act Release No. 1812 (Aug. 4, 1999) [64 FR 43556 (Aug. 10, 1999)] 
(``1999 Proposing Release''). As a fiduciary, an adviser has a duty 
to deal fairly with clients and prospective clients, and must make 
full disclosure of any material conflict or potential conflict. See, 
e.g., Capital Gains Research Bureau, 375 U.S. at 189, 191-92; 
Applicability of the Investment Advisers Act of 1940 to Financial 
Planners, Pension Consultants, and Other Persons Who Provide Others 
with Investment Advice as a Component of Other Financial Services, 
Investment Advisers Act Release No. 1092 (Oct. 8, 1987) [52 FR 38400 
(Oct. 16, 1987)]. Most public pension plans establish procedures for 
hiring investment advisers, the purpose of which is to obtain the 
best possible management services. When an adviser makes political 
contributions for the purpose of influencing the selection of the 
adviser to advise a public pension plan, the adviser seeks to 
interfere with the merit-based selection process established by its 
prospective clients--the public pension plan. The contribution 
creates a conflict of interest between the adviser (whose interest 
is in being selected) and its prospective client (whose interest is 
in obtaining the best possible management services).
    \54\ See Blount, 61 F.3d at 944-45.
    \55\ Cf. In re Performance Analytics, et al., Investment 
Advisers Act Release No. 2036 (June 17, 2002) (settled enforcement 
action in which an investment consultant for a union pension fund 
entered into a $100,000 brokerage arrangement with a soft dollar 
component in which the investment consultant would continue to 
recommend the investment adviser to the pension fund as long as the 
investment adviser sent its trades to one particular broker-dealer).
---------------------------------------------------------------------------

    As we discuss above, pay to play practices are rarely explicit and 
often hard to prove.\56\ In particular, when pay to play involves 
granting of government advisory business in exchange for political 
contributions, it may be difficult to prove that an adviser (or one of 
its executives or employees) made political contributions for the 
purpose of obtaining the government business, or that it engaged a 
solicitor for his or her political influence rather than substantive 
expertise.\57\ Pay to play practices by advisers to public pension 
plans, which may generate significant contributions for elected 
officials and yield lucrative management contracts for advisers, will 
not stop through voluntary efforts. This is, in part, because these 
activities create a ``collective action'' problem in two respects.\58\ 
First, government officials who participate may have an incentive to 
continue to accept contributions to support their campaigns for fear of 
being disadvantaged relative to their opponents. Second, advisers may 
have an incentive to participate out of concern that they may be 
overlooked if they fail to make contributions.\59\ Both the stealth in 
which these practices occur and the inability of markets to properly 
address them argue strongly for the need for us to adopt the type of

[[Page 41023]]

prophylactic rule that section 206(4) of the Advisers Act authorizes.
---------------------------------------------------------------------------

    \56\ Cf. Blount, 61 F.3d at 945 (``no smoking gun is needed 
where, as here, the conflict of interest is apparent, the likelihood 
of stealth great, and the legislative purpose prophylactic'').
    \57\ See id. at 944 (``actors in this field are presumably 
shrewd enough to structure their relations rather indirectly'').
    \58\ Collective action problems exist, for example, where 
participants may prefer to abstain from an unsavory practice (such 
as pay to play), but nonetheless participate out of concern that, 
even if they abstain, their competitors will continue to engage in 
the practice profitably and without adverse consequences. As a 
result, collective action problems, such as those raised by pay to 
play practices, call for a regulatory response. For further 
discussion, see infra note 459 and accompanying text.
    \59\ In our view, the collective action problem we are trying to 
address is analogous to the one noted in the case upholding MSRB 
rule G-37. See Blount, 61 F.3d at 945 (``Moreover, there appears to 
be a collective action problem tending to make the misallocation of 
resources persist''). For a discussion of concerns raised regarding 
our proposed rule that are similar to those raised regarding MSRB 
rule G-37, see section II.A of this Release.
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A. First Amendment Considerations

    The Commission believes that rule 206(4)-5 is a necessary and 
appropriate measure to prevent fraudulent acts and practices in the 
market for the provision of investment advisory services to government 
entities by prohibiting investment advisers from engaging in pay to 
play practices. We have examined a range of alternatives to our 
proposal, carefully considered some 250 comments we received on the 
proposal and made revisions to the proposed rule where we concluded it 
was appropriate. We believe the rule represents a balanced response to 
the developments we discuss above regarding pay to play activities 
occurring in the market for government investment advisory services. 
The rule provides specific prohibitions to help ensure that adviser 
selection is based on the merits, not on the amount of money given to a 
particular candidate for office, while respecting the rights of 
industry participants to participate in the political process. The rule 
is not unique; Congress, for instance, has barred Federal contractors 
from making contributions to public officials.\60\
---------------------------------------------------------------------------

    \60\ 2 U.S.C. 441c.
---------------------------------------------------------------------------

    Before we address particular aspects of the rule, we would like to 
respond to commenters' assertions that the fact that the rule's 
limitations on compensation are triggered by political contributions 
represents an infringement on the First Amendment guarantees of freedom 
of speech and association.\61\ These commenters acknowledge that 
selection of an investment adviser by a government entity should not be 
a ``pay back'' for political contributions, but argue that the rule 
impermissibly restricts the ability of advisers and certain of their 
employees to demonstrate support for State and local officials.
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    \61\ See, e.g., Comment Letter of W. Hardy Callcott (Aug. 3, 
2009) (``Callcott Letter I''); Comment Letter of W. Hardy Callcott 
(Jan. 21, 2010) (``Callcott Letter II''); Comment Letter of the 
National Association of Securities Professionals, Inc. (Oct. 6, 
2009) (``NASP Letter''); Comment Letter of Caplin & Drysdale, 
Chartered (Oct. 6, 2009) (``Caplin & Drysdale Letter''); Comment 
Letter of the Securities Industry and Financial Markets Association 
(Oct. 5, 2009) (``SIFMA Letter''); ABA Letter; Sutherland Letter; 
Comment Letter of IM Compliance LLC (Oct. 6, 2009) (``IM Compliance 
Letter''); Comment Letter of the American Bankers Association (Oct. 
6, 2009) (``American Bankers Letter'').
---------------------------------------------------------------------------

    The Commission is sensitive to, and has carefully considered, these 
constitutional concerns in adopting the rule. Though it is not a ban on 
political contributions or an attempt to regulate State and local 
elections, we acknowledge that the two-year time out provision may 
affect the propensity of investment advisers to make political 
contributions. Although political contributions involve both speech and 
associational rights protected by the First Amendment, a ``limitation 
upon the amount that any one person or group may contribute to a 
candidate or political committee entails only a marginal restriction 
upon the contributor's ability to engage in free communication.''\62\ 
Limitations on contributions are permissible if justified by a 
sufficiently important government interest that is closely drawn to 
avoid unnecessary abridgment of protected rights.\63\
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    \62\ Buckley v. Valeo, 424 U.S. 1, 20 (1976). See also 
SpeechNow.org, et al. v. FEC, 599 F.3d 686 (D.C. Cir. 2010); 
McConnell v. FEC, 540 U.S. 93, 135-36 (2003).
    \63\ Buckley, 424 U.S. at 25. See also FEC v. Wisconsin Right to 
Life, Inc., 551 U.S. 449 (2007); Republican Nat'l Comm. v. FEC, No. 
08-1953, 2010 U.S. Dist. LEXIS 29163 (D.D.C. Mar. 26, 2010) (three 
judge panel). This standard is lower than the strict scrutiny 
standard employed in reviewing such forms of expression as 
independent expenditures. Under the higher level of scrutiny, a 
restriction must be narrowly tailored to serve a compelling 
governmental interest. Blount, 61 F.3d at 943. See also Citizens 
United v. FEC, 130 S. Ct. 876 (2010) (distinguishing restrictions on 
``independent expenditures'' from restrictions on ``direct 
contributions'' and leaving restrictions on direct contributions 
untouched while striking down a restriction on independent 
expenditures as unconstitutional). We note that in Blount, 61 F.3d 
at 949, the court upheld MSRB rule G-37 even assuming that strict 
scrutiny applied. For the reasons stated by the court in that 
decision, we believe that Rule 206(4)-5 would be upheld under a 
strict scrutiny standard as well as under the standard the Supreme 
Court has applied to contribution restrictions.
---------------------------------------------------------------------------

    Prevention of fraud is a sufficiently important government 
interest.\64\ We believe that payments to State officials as a quid pro 
quo for obtaining advisory business as well as other forms of ``pay to 
play'' violate the antifraud provisions of section 206 of the Advisers 
Act. As discussed in our Proposing Release, ``pay to play'' 
arrangements are inconsistent with an adviser's fiduciary obligations, 
distort the process by which investment advisers are selected, can harm 
advisers' public pension plan clients and the beneficiaries of those 
plans, and can have detrimental effects on the market for investment 
advisory services.\65\ The restrictions inherent in rule 206(4)-5 are 
in the nature of conflict of interest limitations which are 
particularly appropriate in cases of government contracting and highly 
regulated industries.\66\ Pursuant to our authority under section 
206(4) of the Advisers Act, which we discuss above, we may adopt rules 
that are reasonably designed to prevent such acts, practices and 
courses of business.
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    \64\ Blount, 61 F.3d at 944.
    \65\ See Proposing Release, at section I. The prohibitions on 
solicitation and coordination of campaign contributions are 
justified by the same overriding purposes which support the two-year 
time out provisions. The provisions are intended to prevent 
circumvention of the time out provisions in cases where an 
investment adviser has or is seeking to establish a business 
relationship with a government entity. Absent these restrictions, 
solicitation and coordination of contributions could be used as 
effectively as political contributions to distort the adviser 
selection process. The solicitation and coordination restrictions 
relate only to fundraising activities and would not prevent advisers 
and their covered employees from expressing support for candidates 
in other ways, such as volunteering their time.
    \66\ See In the Matter of Self-Regulatory Organizations; Order 
Approving Proposed Rule Change by the Municipal Securities 
Rulemaking Board Relating to Political Contributions and 
Prohibitions on Municipal Securities Business and Notice of Filing 
and Order Approving on an Accelerated Basis Amendment No. 1 Relating 
to the Effective Date and Contribution Date of the Proposed Rule, 
Exchange Act Release No. 33868 (Apr. 7, 1994) [59 FR 17621 (Apr. 13, 
1994)] (noting, in connection with the Commission's approval of MSRB 
rule G-37, that the restrictions inherent in that pay to play rule 
``are in the nature of conflict of interest limitations which are 
particularly appropriate in cases of government contracting and 
highly regulated industries.'').
---------------------------------------------------------------------------

    As detailed in the following pages, we have closely drawn rule 
206(4)-5 to accomplish its goal of preventing quid pro quo arrangements 
while avoiding unnecessary burdens on the protected speech and 
associational rights of investment advisers and their covered 
employees. The rule is therefore closely drawn in terms of the conduct 
it prohibits, the persons who are subject to its restrictions, and the 
circumstances in which it is triggered. The United States Court of 
Appeals for the District of Columbia Circuit upheld the similarly 
designed MSRB rule G-37 in Blount v. SEC.\67\ Indeed, the Blount 
opinion has served as an important guidepost in helping us shape our 
rule.\68\
---------------------------------------------------------------------------

    \67\ 61 F.3d at 947-48.
    \68\ Notwithstanding the Blount decision, some commenters 
asserted that subsequent Supreme Court jurisprudence, including 
Randall v. Sorrell, 548 U.S. 230 (2006), and Citizens United, 130 S. 
Ct. 876 (decided following the closing of the comment period for 
rule 206(4)-5), would result in the proposed rule being found 
unconstitutional because it is not narrowly tailored to advance the 
Commission's interests in addressing pay to play by investment 
advisers. See, e.g., Callcott Letter I; Callcott Letter II; NASP 
Letter; American Bankers Letter. We disagree. The cases cited by 
commenters are distinguishable. Citizens United deals with certain 
independent expenditures (rather than contributions to candidates), 
which are not implicated by our rule. Randall involved a generally 
applicable State campaign finance law limiting overall contributions 
(and expenditures), which the Court feared would disrupt the 
electoral process by limiting a candidate's ability to amass 
sufficient resources and mount a successful campaign. Randall, 548 
U.S. at 248-49. By contrast, our rule is not a general prohibition 
or limitation, but rather is a focused effort to combat quid pro quo 
payments by investment advisers seeking governmental business. 
Comparable restrictions targeted at a particular industry have been 
upheld under Randall because the loss of contributions from such a 
small segment of the electorate ``would not significantly diminish 
the universe of funds available to a candidate to a non-viable 
level.'' Green Party of Conn. v. Garfield, 590 F. Supp. 2d 288, 316 
(D. Conn. 2008). See also Preston v. Leake, 629 F. Supp. 2d 517, 524 
(E.D.N.C. 2009) (differentiating the ``broad sweep of the Vermont 
statute'' that ``restricted essentially any potential campaign 
contribution'' from a statute that ``only applies to lobbyists''); 
In re Earle Asphalt Co., 950 A.2d 918, 927 (N.J. Super. Ct. App. 
Div. 2008), aff'd 957 A.2d 1173 (N.J. 2008) (holding that a 
limitation on campaign contributions by government contractors and 
their principals did not have the same capacity to prevent 
candidates from amassing the resources necessary for effective 
campaigning as the statute in Randall). One commenter expressly 
dismissed arguments that Randall would have implications for the 
Commission's proposed rule. Fund Democracy/Consumer Federation 
Letter.

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[[Page 41024]]

    First, the rule is limited to contributions to officials of 
government entities who can influence the hiring of an investment 
adviser in connection with money management mandates.\69\ These 
restrictions are triggered only in situations where a business 
relationship exists or will be established in the near future between 
the investment adviser and a government entity.\70\
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    \69\ See section II.B.2(a)(2) of this Release (discussing the 
definition of ``official'' of a government entity for purposes of 
rule 206(4)-5).
    \70\ See section II.B.2(a)(1) of this Release (discussing the 
prohibition on compensation for providing advisory services to the 
client during rule 206(4)-5's two-year time out).
---------------------------------------------------------------------------

    Second, the rule does not in any way impinge on a wide range of 
expressive conduct in connection with elections. For example, the rule 
imposes no restrictions on activities such as making independent 
expenditures to express support for candidates, volunteering, making 
speeches, and other conduct.\71\
---------------------------------------------------------------------------

    \71\ See Citizens United, 130 S. Ct. at 908-09 (noting that a 
government interest cannot be sufficiently compelling to limit 
independent expenditures by corporate entities). See also 
SpeechNow.org, 599 F.3d at 692 (spelling out the different standards 
of constitutional review established by the Supreme Court for 
restrictions on independent expenditures and direct contributions). 
Some commenters expressed concern, for example, that rule 206(4)-5 
may quell volunteer activities, deter employees of investment 
advisers from running for office, or chill charitable contributions. 
See, e.g., Caplin & Drysdale Letter; NASP Letter. We have expressly 
clarified that volunteer activities and charitable contributions 
generally would not trigger the rule's time out provision and that 
employees running for office would not be subject to the 
contribution limitation. See infra notes 157 and 139, respectively.
---------------------------------------------------------------------------

    Third, it does not prevent anyone from making a contribution to any 
candidate, as covered employees may contribute $350 to candidates for 
whom they may vote, and $150 to other candidates. A limitation on the 
amount of a contribution involves little direct restraint on political 
communication, because a person may still engage in the symbolic 
expression of support evidenced by a contribution.\72\ Furthermore, the 
rule takes the form of a restriction on providing compensated advisory 
business following the making of contributions rather than a 
prohibition on making contributions in excess of the relevant 
ceilings.\73\
---------------------------------------------------------------------------

    \72\ Buckley, 424 U.S. at 21. See also section II.B.2(a)(6) of 
this Release (discussing the de minimis exceptions to covered 
associates' contributions triggering the two-year time out). Some 
commenters raised constitutional concerns regarding the levels of 
the de minimis exception in our proposal. See, e.g., Callcott Letter 
I; Callcott Letter II; Caplin & Drysdale Letter; IM Compliance 
Letter; Sutherland Letter. As discussed below, we have both raised 
the amount of the de minimis exception in line with inflation and 
added an additional exception.
    \73\ See section II.B.2(a)(1) of this Release (discussing the 
two-year time out on receiving compensation for advisory services).
---------------------------------------------------------------------------

    Fourth, the rule only applies to investment advisers that are 
registered with us,\74\ or unregistered in reliance on section 
203(b)(3) of the Advisers Act, that have (or that are seeking) 
government clients.\75\ It applies only to the subset of the 
significantly broader set of advisers over which we have antifraud 
authority that we believe are most likely to be engaged by government 
clients to manage public assets either directly or though investment 
pools.\76\
---------------------------------------------------------------------------

    \74\ Unless indicated expressly otherwise, each time we refer to 
a ``registered'' investment adviser in this Release, we mean an 
adviser registered with the Commission.
    \75\ See section II.B.1 of this Release (discussing advisers 
covered by the rule). One commenter raised constitutional concerns 
by arguing that the rule would apply beyond the advisory business of 
an adviser that solicits government clients, no matter how separate 
the other product or service offerings of the adviser are from the 
governmental business. ABA Letter. But we believe we have made clear 
that the rule's time out provisions, which are designed to eliminate 
quid pro quo arrangements and ameliorate market distortions, apply 
only with respect to the provision of advisory services to 
government clients, which is consistent with our authority under the 
Advisers Act. See section II.B.2(a)(1) of this Release.
    \76\ See section II.B.1 of this Release.
---------------------------------------------------------------------------

    Finally, the rule is not a restriction on contributions that is 
applicable to the public and is not intended to eliminate corruption in 
the electoral process. Rather, it is focused exclusively on conduct by 
professionals subject to fiduciary duties, seeking profitable business 
from governmental entities. The rule is targeted at those employees of 
an adviser whose contributions raise the greatest danger of quid pro 
quo exchanges,\77\ and it covers only contributions to those 
governmental officials who would be the most likely targets of pay to 
play arrangements because of their authority to influence the award of 
advisory business.\78\
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    \77\ See section II.B.2(a)(4) of this Release (discussing the 
definition of ``covered associates,'' whose contributions could 
trigger the two-year time out).
    \78\ See section II.B.2(a)(2) of this Release (discussing the 
definition of ``official'' of a government entity for purposes of 
the rule 206(4)-(5)). Some commenters argued that the definition of 
``official'' we included in our proposal was ambiguous. See, e.g., 
Caplin & Drysdale Letter. In response, we have provided additional 
guidance. See section II.B.2(a)(2) of this Release.
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B. Rule 206(4)-5

    We are today adopting new rule 206(4)-5 under the Advisers Act that 
is designed to protect public pension plans and other government 
investors from the consequences of pay to play practices by deterring 
advisers' participation in such practices.\79\ As we noted in the 
Proposing Release, advisers and government officials might, in order to 
circumvent our rule, attempt to structure their transactions in a 
manner intended to hide the true purpose of a contribution or 
payment.\80\ Therefore, our pay to play restrictions are intended to 
capture not only direct political contributions by advisers, but also 
other ways that advisers may engage in pay to play arrangements. Rule 
206(4)-5 prohibits several principal avenues for pay to play 
activities.
---------------------------------------------------------------------------

    \79\ Rule 206(4)-5 is targeted to a concrete business 
relationship between contributors and candidates' governmental 
entities. It is not intended to restrict the voices of persons and 
interest groups, reduce the overall scope of election campaigns, or 
equalize the relative ability of all votes to affect electoral 
outcomes. Indeed, if investment advisers do not seek government 
business from those to whom they and their covered associates make 
contributions or for whom they solicit contributions, the rule's 
limitations will not be triggered. Rather, the rule is intended to 
prevent direct quid pro quo arrangements, fraudulent and 
manipulative acts and practices, and improve the mechanism of a free 
and open market for investment advisory services for government 
entity clients. With pay to play activities, the conflict of 
interest is apparent, the likelihood of stealth in the arrangements 
is great, and our regulatory purpose is prophylactic. See Blount, 61 
F.3d at 945 (describing the court's similar characterization of MSRB 
rule G-37).
    \80\ Proposing Release, at section II.A.
---------------------------------------------------------------------------

    First, the rule makes it unlawful for an adviser to receive 
compensation for providing advisory services to a government entity for 
a two-year period after the adviser or any of its covered associates 
makes a political contribution to a public official of a government 
entity or candidate for such office who is or will be in a position to 
influence the award of advisory business.\81\

[[Page 41025]]

Importantly, as we noted in the Proposing Release, rule 206(4)-5 would 
not ban or limit the amount of political contributions an adviser or 
its covered associates could make; rather, it would impose a two-year 
time out on conducting compensated advisory business with a government 
client after a contribution is made.\82\ This first prohibition is 
substantially similar to our proposal. However, as discussed below, we 
have made certain modifications to some of the definitions of terms in 
this prohibition.\83\
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    \81\ Rule 206(4)-5(a)(1) makes it unlawful for any investment 
adviser covered by the rule 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 covered associate, as defined in the rule, 
of the investment adviser (including a person who becomes a covered 
associate within two years after the contribution is made). As noted 
below, 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 
the authority to appoint any person who is directly or indirectly 
responsible for or can influence the outcome of the hiring of an 
investment adviser. See section II.B.2(a)(2) of this Release.
    \82\ Proposing Release, at section II.A.
    \83\ See generally section II.B.2(a) of this Release.
---------------------------------------------------------------------------

    Second, the rule generally prohibits advisers from paying third 
parties to solicit government entities for advisory business unless 
such third parties are registered broker-dealers or registered 
investment advisers, in each case themselves subject to pay to play 
restrictions.\84\ That is, an adviser is prohibited from providing or 
agreeing to provide, directly or indirectly, payment to any person for 
solicitation of government advisory business on behalf of such adviser 
unless that person is registered with us and subject to pay to play 
restrictions either under our rule or the rules of a registered 
national securities association.\85\ This represents a modification 
from our proposal, which included a flat ban without an exception for 
any brokers or investment advisers.\86\ As discussed below, commenters 
persuaded us that the objective of the rule in eliminating pay to play 
activities of advisers could be preserved if the third parties they 
hire are themselves registered investment advisers subject to 
Commission oversight or are broker-dealers subject to pay to play 
restrictions imposed by a registered national securities association 
that the Commission must approve.
---------------------------------------------------------------------------

    \84\ Rule 206(4)-5(a)(2)(i) makes it unlawful for any investment 
adviser covered by the rule and its covered associates (as defined 
in the rule) to provide or agree to provide, directly or indirectly, 
payment to any person to solicit a government entity for investment 
advisory services on behalf of such investment adviser unless such 
person is a regulated person or is an executive officer, general 
partner, managing member (or, in each case, a person with a similar 
status or function), or employee of the investment adviser. 
``Regulated person'' is defined in rule 206(4)-5(f)(9). See section 
II.B.2(b) of this Release for a discussion of this definition.
    \85\ See section II.B.2(b) of this Release. While our rule would 
apply to any registered national securities association, the 
Financial Industry Regulatory Authority, or FINRA, is currently the 
only registered national securities association under section 19(a) 
of the Exchange Act [15 U.S.C. 78s(b)]. As such, for convenience, we 
will refer directly to FINRA in this Release when describing the 
exception for certain broker-dealers from the rule's ban on advisers 
paying third parties to solicit government business on their behalf. 
The Commission's authority to consider rules proposed by a 
registered national securities association is governed by section 
19(b) of the Exchange Act [15 U.S.C. 78s(b)] (``No proposed rule 
change shall take effect unless approved by the Commission or 
otherwise permitted in accordance with the provisions of this 
subsection.'').
    \86\ See Proposing Release, at section II.A.3(b).
---------------------------------------------------------------------------

    Third, the rule makes it unlawful for an adviser itself or any of 
its covered associates to solicit or to coordinate: (i) Contributions 
to an official of a government entity to which the investment adviser 
is seeking to provide investment advisory services; or (ii) payments 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.\87\ We are adopting this aspect of the rule as 
proposed.
---------------------------------------------------------------------------

    \87\ Rule 206(4)-5(a)(2)(ii) makes it unlawful for any 
investment adviser covered by the rule and its covered associates to 
coordinate, or to solicit any person [including a political action 
committee] to make, any: (A) contribution to an official of a 
government entity to which the investment adviser is providing or 
seeking to provide investment advisory services; or (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. See section II.A.2.(c) of this Release.
---------------------------------------------------------------------------

    Fourth, as it is not possible for us to anticipate all of the ways 
advisers and government officials may structure pay to play 
arrangements to attempt to evade the prohibitions of our rule, the rule 
includes a provision that makes it unlawful for an adviser or any of 
its covered associates to do anything indirectly which, if done 
directly, would result in a violation of the rule.\88\ This provision 
in the rule we are adopting today is identical to our proposal.\89\
---------------------------------------------------------------------------

    \88\ Rule 206(4)-5(d) makes it unlawful for any investment 
adviser covered by the rule and its covered associates to do 
anything indirectly which, if done directly, would result in a 
violation of this section. See section II.B.2(d) of this Release.
    \89\ See Proposing Release, at section II.A.3(d).
---------------------------------------------------------------------------

    Finally, for purposes of our rule, an investment adviser to certain 
pooled investment vehicles in which a government entity invests or is 
solicited to invest will be treated as though the adviser were 
providing or seeking to provide investment advisory services directly 
to the government entity.\90\ This provision is substantially similar 
to our proposal, although we have made certain modifications described 
below.\91\
---------------------------------------------------------------------------

    \90\ Rule 206(4)-5(c) states that, for purposes of rule 206(4)-
5, an investment adviser to a covered investment pool in which a 
government entity invests or is solicited to invest, shall be 
treated as though that investment adviser were providing or seeking 
to provide investment advisory services directly to the government 
entity. See section II.B.2(e) of this Release.
    \91\ See section II.B.2(e) of this Release.
---------------------------------------------------------------------------

1. Advisers Subject to the Rule
    Rule 206(4)-5 applies to registered investment advisers and certain 
advisers exempt from registration. In particular, it applies to any 
investment adviser registered (or required to be registered) with the 
Commission, or unregistered in reliance on the exemption available 
under section 203(b)(3) of the Advisers Act (15 U.S.C. 80b-
3(b)(3)).\92\ The rule would not, however, apply to most small advisers 
that are registered with State securities authorities instead of the 
Commission,\93\ or advisers that are unregistered in reliance on 
exemptions other than section 203(b)(3) of the Advisers Act.\94\
---------------------------------------------------------------------------

    \92\ Rule 206(4)-5(a)(1) and (2). Section 203(b)(3) [15 U.S.C. 
80b-3(b)(3)] exempts from registration any investment adviser that 
is not holding itself out to the public as an investment adviser and 
had fewer than 15 clients during the last 12 months. We are 
including this category of exempt advisers within the scope of the 
rule in order to make the rule applicable to the many advisers to 
private investment companies that are not registered under the 
Advisers Act.
    \93\ Advisers with less than $25 million of assets under 
management are prohibited from registering with the Commission by 
section 203A of the Advisers Act [15 U.S.C. 80b-3A].
    \94\ The rule would also not apply to certain other advisers 
that are exempt from registration with the Commission. See, e.g., 
section 203(b)(1) of the Advisers Act [15 U.S.C. 8b-3(b)(1)] 
(exempting from registration intrastate investment advisers). As 
explained in the Proposing Release, we believe these advisers are 
unlikely to advise public pension plans. See Proposing Release, at 
n.64 and accompanying text. The rule would also not apply to persons 
who are excepted from the definition of investment adviser under 
section 202(a)(11) of the Advisers Act [15 U.S.C. 80b-2(a)(11)]. For 
a discussion, in particular, of the exclusion of banks and bank 
holding companies which are not investment companies from the 
Advisers Act's definition of ``investment adviser,'' see infra note 
274.
---------------------------------------------------------------------------

    We received limited comment on this aspect of the rule. One 
commenter explicitly agreed with the scope of our proposed rule, noting 
that it would capture most, if not all, advisers that provide 
discretionary management with respect to public pension fund assets, 
regardless of whether they are registered.\95\ Other commenters 
recommended that the rule apply more

[[Page 41026]]

broadly to all advisers that may manage assets of government 
entities.\96\ The primary effect of such an expansion of the rule would 
be to apply it to smaller firms, the regulatory responsibility for 
which Congress has previously allocated to the State securities 
authorities.\97\ It is our understanding that few of these firms manage 
public pension plans or other public funds.\98\ Accordingly, we have 
decided to adopt this provision as proposed.
---------------------------------------------------------------------------

    \95\ Comment Letter of the California Public Employees' 
Retirement System (Oct. 6, 2009) (``CalPERS Letter'') (``CalPERS 
agrees that the scope of the proposed rule would capture most if not 
all external managers who have discretion over the investment of 
public pension fund assets, including hedge fund managers, real 
estate managers, private equity managers, traditional long-only 
managers, money managers, and others, regardless of whether the 
managers are registered investment advisors. CalPERS supports 
application of the rule to investment advisers, as defined in the 
proposed rule.'').
    \96\ These suggestions included applying the rule to all 
registered (including SEC-registered and State-registered) and 
unregistered advisers (see, e.g., 3PM Letter (arguing that selective 
application of the rule could lead to convoluted organizational 
structures designed to bypass its reach and that the proposal 
represents the kind of patchwork regulation that will lead to the 
kind of inconsistency the Commission is seeking to correct), and 
extending the rule to State-registered advisers (see, e.g., Comment 
Letter of the Cornell Securities Law Clinic (Oct. 6, 2009) 
(``Cornell Law Letter'')).
    \97\ Amendments to the Advisers Act in 1996 placed the 
regulatory responsibility for these advisers in the hands of State 
regulators. See section 203A of the Advisers Act [15 U.S.C. 80b-3a] 
enacted as part of Title III of the National Securities Markets 
Improvement Act of 1996, Public Law 104-290, 110 Stat. 3416 (1996) 
(codified in scattered sections of the United States Code).
    \98\ See Proposing Release, at n.64. We did not receive any 
comment challenging our understanding.
---------------------------------------------------------------------------

2. Pay to Play Restrictions
    (a) Two-Year ``Time Out'' for Contributions
    Rule 206(4)-5(a)(1) prohibits investment advisers from receiving 
compensation for providing advice to a ``government entity'' within two 
years after a ``contribution'' to an ``official'' of the government 
entity has been made by the investment adviser or by any of its 
``covered associates.'' \99\ The rule does not ban political 
contributions and does not limit the amount of any political 
contribution. Instead, the rule imposes a ban--a ``time out''--on 
receiving compensation for conducting advisory business with a 
government client for two years after certain contributions are made. 
The two-year time out is intended to discourage advisers from 
participating in pay to play practices by requiring a ``cooling-off 
period'' during which the effects of a political contribution on the 
selection process can be expected to dissipate.
---------------------------------------------------------------------------

    \99\ Rule 206(4)-5(a)(1).
---------------------------------------------------------------------------

    Rule 206(4)-5(a)(1) is based largely on MSRB rule G-37 under which 
a broker-dealer is prohibited from engaging in the municipal securities 
business for two years after making a political contribution.\100\ As 
noted above and as explained in the Proposing Release, we modeled the 
rule on the MSRB rules because we believe that they have significantly 
curbed pay to play practices in the municipal securities market.\101\ 
We also pointed out that our approach would minimize the compliance 
burdens on firms that would be subject to both rule regimes. But we 
requested comment on our proposed approach and whether alternative 
models might be appropriate.
---------------------------------------------------------------------------

    \100\ Proposing Release, at section II.A.2.
    \101\ See id. at n.23 (citing others, including the MSRB, who 
agree that the MSRB rules have been effective: MSRB, MSRB Notice 
2009-62, Amendments Filed to Rule G-37 Regarding Contributions to 
Bond Ballot Campaigns (Dec. 4, 2009), available at http://msrb.org/
msrb1/archive/2009/2009-62.asp (``Rule G-37, in effect since 1994, 
has provided substantial benefits to the industry and the investing 
public by greatly reducing the direct connection between political 
contributions given to issuer officials and the awarding of 
municipal securities business to brokers, dealers and municipal 
securities dealers (``dealers''), thereby effectively assisting with 
eliminating pay-to-play practices in the new issue municipal 
securities market.''); MSRB, MSRB Notice 2009-35, Request for 
Comment: Rule G-37 on Political Contributions and Prohibitions on 
Municipal Securities Business--Bond Ballot Campaign Committee 
Contributions (June 22, 2009) (``The MSRB believes the rule has 
provided substantial benefits to the industry and the investing 
public by greatly reducing the direct connection between political 
contributions given to issuer officials and the awarding of 
municipal securities business to dealers, thereby effectively 
eliminating pay-to-play practices in the new issue municipal 
securities market.'' [footnote omitted]); MSRB, MSRB Notice 2003-32, 
Notice Concerning Indirect Rule Violations: Rules G-37 and G-38 
(Aug. 6, 2003) (``The impact of Rules G-37 and G-38 has been very 
positive. The rules have altered the political contribution 
practices of municipal securities dealers and opened discussion 
about the political contribution practices of the entire municipal 
industry.''); Letter from Darrick L. Hills and Linda L. Rittenhouse 
of the CFA Institute to Jill C. Finder, Asst. Gen. Counsel of the 
MSRB (Oct. 19, 2001), available at  http://www.cfainstitute.org/
Comment%20Letters/20011019.pdf (stating, ``We generally believe that 
the existing [MSRB] pay-to-play prohibitions have been effective in 
stemming practices that compromise the integrity of the [municipal 
securities] market by using political contributions to curry favor 
with politicians in positions of influence.''); Comm. on Capital 
Mkts. Regulation, Interim Report of the Committee on Capital Markets 
Regulation (Nov. 30, 2006), available at http://www.capmktsreg.org/
pdfs/11.30Committee_Interim_ReportREV2.pdf (stating, upon 
describing MSRB Rule G-37 and the 2005 amendments to MSRB Rule G-38, 
``Taken together, the MSRB's rules have largely put an end to the 
old ``pay to play'' practices in municipal underwriting.'')). See 
also Comment letter of Professors Alexander W. Butler, Larry Fauver 
and Sandra Mortal (Sept. 30, 2009) (``Butler Letter'') (citing 
Alexander W. Butler, Larry Fauver & Sandra Mortal, Corruption, 
Political Integrity, and Municipal Finance, 22 R. of Fin. Stud. 
2673-705 (2009)).
---------------------------------------------------------------------------

    Several commenters supporting the rule explicitly addressed the 
appropriateness of the MSRB approach. One, for example, asserted that 
the proposed rule ``appropriately expands upon MSRB G-37 and G-38.'' 
\102\ Another agreed that the MSRB rules ``provide an appropriate 
regulatory analogy for addressing [pay to play] issues.'' \103\ Many 
other commenters, however, sought to distinguish advisers and municipal 
securities dealers, and asserted that, because of the differences 
between the two, MSRB rule G-37 is an inappropriate model on which to 
base an investment adviser pay to play rule.\104\ Some argued that the 
long-term nature of advisory relationships is fundamentally different 
from discrete municipal underwriting transactions, and consequently, 
the two-year time out is more disruptive and severe for advisers and 
the governments that retain them than for municipal securities dealers 
who are simply banned from obtaining ``new'' business as opposed to 
terminating a long-term relationship.\105\ Some commenters asserted 
that the relationships are different because advisers provide ongoing 
and continuous advice as a fiduciary, rather than a one-time 
transaction such as an underwriting, and that advisory services are 
typically subject to an open competitive bid process instead of through 
negotiated transactions that are typical of municipal 
underwritings.\106\
---------------------------------------------------------------------------

    \102\ Common Cause Letter.
    \103\ Comment Letter of Credit Suisse Securities (USA) LLC 
(Sept. 14, 2009) (``Credit Suisse Letter'').
    \104\ See, e.g., IAA Letter; ICI Letter; SIFMA Letter; ABA 
Letter; Dechert Letter; Skadden Letter; Comment Letter of Jones Day 
(Oct. 5, 2009) (``Jones Day Letter''); Comment Letter of Simpson 
Thacher & Bartlett LLP on behalf of Park Hill Group LLC and its 
affiliates (Sept. 21, 2009) (``Park Hill Letter''); Comment Letter 
of Monument Group, Inc. (Sept. 18, 2009) (``Monument Group 
Letter''). One commenter suggested, in particular, that the rule's 
two-year time out provision is outside of our authority because it 
imposes an ``automatic penalty, subject only to discretionary post 
facto review.'' Comment Letter of Edwin C. Laurenson (Dec. 31, 
2009). We disagree. The two-year time out is not a penalty. Rather, 
it is a ``cooling-off period'' to dissipate any effects of a quid 
pro quo. A violation of the provision would result from receiving, 
or continuing to receive, payment after making the contribution, not 
from the making of the contribution itself.
    \105\ See, e.g., IAA Letter; ABA Letter; Dechert Letter; Skadden 
Letter; Jones Day Letter; Park Hill Letter; Monument Group Letter. 
But see Credit Suisse Letter (``G-37 and G-38 provide an appropriate 
regulatory analogy''); Butler Letter (``This practice [municipal 
underwriting pay to play] was analogous to the type of pay to play 
currently under consideration by the Commission'').
    \106\ See, e.g., IAA Letter; ICI Letter; SIFMA Letter; ABA 
Letter; Dechert Letter; Skadden Letter; Jones Day Letter; Park Hill 
Letter; Monument Group Letter.
---------------------------------------------------------------------------

    We disagree that the differences between municipal securities 
underwriting and money management are sufficient to warrant an 
alternative approach. Commenters are correct that municipal securities 
underwriters provide episodic services rather than ongoing services 
often provided by money managers. But underwriters seek to provide 
repeated, if not ongoing, services, and the imposition of a two-year 
time out can have considerable

[[Page 41027]]

competitive consequences to a broker-dealer whose government client 
must employ the services of a competitor whose services it may continue 
to employ after MSRB rule G-37's two-year time out has run its course. 
That advisers are in a fiduciary relationship with their public pension 
plan clients argues for at least as significant consequences for 
participation in pay to play practices that can harm these clients.
    Our decision to adopt a rule based on the MSRB model is influenced 
primarily by our judgment that the MSRB rules have significantly curbed 
pay to play practices in the municipal securities market\107\ and that 
alternative approaches, including those suggested by commenters, would 
fail to provide an adequate deterrent to pay to play activities. We 
considered each of the principal suggestions offered by commenters.
---------------------------------------------------------------------------

    \107\ See supra notes 31 and 101 and accompanying text.
---------------------------------------------------------------------------

    Some commenters suggested requiring advisers to disclose their 
contributions to State and local officials.\108\ Statutes requiring 
disclosure of political contributions are, in part, designed to inform 
voters about a candidate's financial supporters; an informed electorate 
can then use the information to vote for or against a candidate.\109\ 
But voters' possible reactions, if any, to such disclosure would not 
necessarily resolve the concerns we are trying to address in this 
rulemaking. Our concern is protecting advisory clients and investors 
whom we have the responsibility to protect under the Advisers Act--
namely, the public pension plans and their beneficiaries who are 
affected by pay to play practices.\110\ Disclosure to a plan's trustees 
might be insufficient where the trustee (particularly a sole trustee) 
has received the contributions and is presumably well aware of the 
conflicts involved. Moreover, and as we pointed out in the Proposing 
Release, requiring advisers to disclose political contributions to 
beneficiaries would be unlikely to protect them since most cannot act 
on the information by moving their pension assets to a different plan 
or by reversing the plan trustees' adviser hiring decisions.\111\ Not 
all beneficiaries may be entitled to vote (or withhold their vote) for 
the official to whom a contribution was made, and those that are may 
need to wait a substantial period of time until a future election to 
exercise their vote. Further, as beneficiaries may constitute only a 
small proportion of the electorate, they may not be able to influence 
an election; therefore, reliance on the electoral process may be 
insufficient to protect government plans and their beneficiaries from 
pay to play. In addition, even if the fact of a contribution is 
disclosed (which is required in many states), the contribution's true 
purpose is unlikely to be disclosed.
---------------------------------------------------------------------------

    \108\ See, e.g., SIFMA Letter; Preqin Letter I; Comment Letter 
of Triton Pacific Capital, LLC (Sept. 1, 2009) (``Triton Pacific 
Letter''); Comment Letter of the State Association of County 
Retirement Systems (Sept. 8, 2009); Comment Letter of CapLink 
Partners (Sept. 9, 2009) (``CapLink Letter''); Comment Letter of 
Parenteau Associates, LLC (Aug. 7, 2009) (``Parenteau Letter'').
    \109\ See Buckley, 424 U.S. at 67 (1976) (noting that campaign 
financing disclosure requirements ``deter actual corruption and 
avoid the appearance of corruption by exposing large contributions 
and expenditures to the light of publicity'').
    \110\ As discussed above, our purposes in this rulemaking are 
preventing fraud, protecting investors and maintaining the integrity 
of the adviser selection process, not campaign finance reform. See 
section I of this Release.
    \111\ See Proposing Release, at section II.A.2. Some commenters 
made the same points. See, e.g., NY City Bar Letter; Cornell Law 
Letter; 3PM Letter. See also Blount, 61 F.3d at 947 (explaining, in 
the context of the municipal securities industry, the potential 
inadequacy of disclosure to address pay to play concerns, that 
``disclosure would not likely cause market forces to erode `pay to 
play * * *''' because the ``* * * purpose of protecting the 
integrity of the market [would] * * * `be achieved less 
effectively.''').
---------------------------------------------------------------------------

    Several commenters suggested that the Commission adopt a 
requirement that an adviser include in its code of ethics\112\ a policy 
that prohibits contributions made for the purpose of influencing the 
selection of the adviser.\113\ Several commenters recommended, 
similarly, that we require advisers to adopt policies and procedures 
\114\reasonably designed to prevent and detect contributions designed 
to influence the selection of an adviser.\115\ Many of these commenters 
suggested that preclearance of employee contributions could be required 
under an adviser's code of ethics or compliance policies and 
procedures.\116\ One commenter asserted that an advantage of this 
approach is that it would allow an adviser to customize sanctions based 
on the severity of the violation.\117\
---------------------------------------------------------------------------

    \112\ Registered investment advisers are required to have codes 
of ethics under the Advisers Act. See Advisers Act rule 204A-1.
    \113\ See, e.g., IAA Letter; ABA Letter; Comment letter of the 
National Society of Compliance Professionals, Inc. (Oct. 6, 2009) 
(``NSCP Letter''); NY City Bar Letter; Fidelity Letter.
    \114\ Registered investment advisers are required to adopt and 
implement policies and procedures reasonably designed to prevent 
violation by the adviser or its supervised persons of the Advisers 
Act and the rules the Commission has adopted thereunder. See 
Advisers Act rule 206(4)-7.
    \115\ See, e.g., ABA Letter; NY City Bar Letter; IAA Letter; ICI 
Letter; NSCP Letter.
    \116\ See, e.g., IAA Letter; NY City Bar Letter; ABA Letter.
    \117\ ABA Letter.
---------------------------------------------------------------------------

    We do not, however, believe that codes of ethics or compliance 
procedures alone would be adequate to stop pay to play practices, 
particularly when the adviser or senior officers of the adviser are 
involved either directly or indirectly. First, it is those senior 
officers who, as noted below, have the greatest incentives to engage in 
pay to play and therefore are most likely to make contributions, who 
would themselves ultimately be responsible for enforcing their own 
compliance with the firm's ethics code or compliance procedures. 
Second, violations of codes of ethics or compliance procedures do not 
themselves establish violations of the Federal securities laws. 
Moreover, the comments suggesting these alternatives would have us 
require the codes or procedures be designed to prevent or detect 
contributions intended to influence the selection of the adviser by a 
government entity. As discussed extensively above and in our Proposing 
Release, pay to play is an area in which intent is often very difficult 
to prove, and is often hidden in the guise of legitimate conduct.\118\ 
Political contributions are made ostensibly to support a candidate; the 
burden on a regulator or prosecutor of proving a different intent 
presents substantial challenges absent unusual evidence. Commenters 
would thus have us give the adviser, which stands to benefit from the 
contribution, the discretion to determine whether contributions were 
intended to influence its selection by the government entity. We do not 
believe codes of ethics or policies and procedures alone, without a 
rule providing for specific, prophylactic prohibitions, are adequate to 
address this type of conduct.\119\
---------------------------------------------------------------------------

    \118\ See, e.g., Proposing Release, at n.16 and accompanying 
text.
    \119\ We note that, under our rules, an adviser's code of ethics 
must require compliance with the rule we are today adopting (rule 
204A-1(a)(2)) and the adviser must adopt policies and procedures 
designed to prevent violation of the rule (rule 206(4)-7(a)).
---------------------------------------------------------------------------

    On balance, we believe that adopting a two-year time out for 
investment advisers similar to the two-year time out applicable to 
broker-dealers underwriting municipal securities is appropriate. Our 
years of experience with MSRB rule G-37 suggests that the ``strong 
medicine'' provided by that rule has both significantly curbed 
participation in pay to play and provides a reasonable cooling-off 
period to mitigate the effect of a political contribution. We are 
sensitive about

[[Page 41028]]

potential implications of the operation of the rule on public pension 
funds, which could lose the services of an investment adviser subject 
to a time out. While we have designed the rule to reduce its 
impact,\120\ investment advisers are best positioned to protect these 
clients by developing and enforcing robust compliance programs designed 
to prevent contributions from triggering the two-year time out.
---------------------------------------------------------------------------

    \120\ See, e.g., section II.B.2(a)(6) of this Release 
(discussing the de minimis exceptions to the two-year time out); 
section II.B.2(f) of this Release (discussing the rule's exemptive 
provision).
---------------------------------------------------------------------------

(1) Prohibition on Compensation
    As noted above, investment advisers subject to new rule 206(4)-5 
are not prohibited from providing advisory services to a government 
client, even after triggering the two-year time out. Instead, an 
adviser is prohibited from receiving compensation for providing 
advisory services to the government client during the time out.\121\ We 
have taken this approach to enable an adviser to act consistently with 
its fiduciary obligations so it will not have to abandon a government 
client after making a triggering contribution, but rather may provide 
uncompensated advisory services for a reasonable period of time to 
allow the government client to replace the adviser.\122\ We are 
adopting this element of the rule as proposed.
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    \121\ Rule 206(4)-5(a)(1) makes it unlawful for investment 
advisers covered by the rule to provide investment advisory services 
for compensation to a government entity within two years after a 
triggering contribution. Under the rule, the two-year time out 
begins to run once the contribution is made and not when the 
contribution is discovered either by our examination staff or by the 
adviser. The adviser, therefore, should return all such compensation 
promptly upon discovering the triggering contribution. For the 
application of the rule to investments by government entities in 
pooled investment vehicles, see section II.B.2(e) of this Release.
    \122\ Proposing Release, at section II.A.3(a)(1). An investment 
adviser's fiduciary duties may require it to continue providing 
advisory services for a reasonable period of time under these 
circumstances. For another instance in which an adviser's fiduciary 
duties may require its continued provision of services, see 
Temporary Exemption for Certain Investment Advisers, Investment 
Advisers Act Release No. 1736 (July 22, 1998) [63 FR 40231, 40232 
(July 28, 1998)] (describing an investment adviser's fiduciary 
duties to an investment company in the case of an assignment of the 
advisory contract).
---------------------------------------------------------------------------

    One commenter supported the prohibition on compensation as the 
least disruptive option to government clients,\123\ while others argued 
that the prohibition on compensation was unreasonable and, in some 
cases, difficult or near impossible to implement.\124\ A coalition of 
commenters representing State and local governments asserted that, due 
to restrictions on accepting uncompensated services under State and 
local law, it was unlikely that government entities would accept 
uncompensated services even if an adviser were willing or required to 
provide them.\125\ Commenters representing advisers took the opposite 
view, expressing concern that they would be locked into providing 
uncompensated services for extended periods of time as a result, and 
wanted the Commission to provide guidelines as to what a reasonable 
amount of time is for a government client to claim or move its 
assets.\126\ One asserted that it would be unreasonable to require 
advisers to provide uncompensated services altogether.\127\
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    \123\ Cornell Law Letter.
    \124\ See, e.g., ICI Letter; Jones Day Letter. Some commenters 
argued for more flexibility in sanctions (Skadden Letter; ABA 
Letter; Fidelity Letter; ICI Letter; MassMutual Letter; Comment 
Letter of Wells Fargo Advisors (Oct. 6, 2009) (``Wells Fargo 
Letter''); IAA Letter).
    \125\ Comment Letter of the National Conference of State 
Legislatures, National Association of Counties, National League of 
Cities, International City/County Management Association, National 
Association of State Auditors, Comptrollers and Treasurers, 
Government Finance Officers Association, National Association of 
State Retirement Administrators, National Conference on Public 
Employee Retirement Systems, and National Council on Teacher 
Retirement (Oct. 6, 2009) (``National Organizations Letter''). With 
respect to direct advisory relationships, because restrictions on 
governments receiving services without payment would be a function 
of particular State or local laws, we believe government entities 
and their advisers are in the best position to work out arrangements 
that are consistent with both State and local law and the 
compensation prohibition of our rule. With respect to investments by 
government entities in pooled investment vehicles, in particular, 
such restrictions could be avoided. See section II.B.2(e)(2) of this 
Release (describing possible arrangements for continued payment to 
investment pools even after a time out is triggered).
    \126\ See, e.g., Comment Letter of Davis Polk & Wardwell LLP 
(Oct. 6, 2009) (``Davis Polk Letter'') (recommending that three 
months would be reasonable); ICI Letter (suggesting 30 days). Other 
commenters raised concern regarding the potential harm of a time out 
to government investors for whom identifying new managers may be a 
lengthy process. See, e.g., NASP Letter. We believe, however, that, 
on balance, pension funds and their beneficiaries are best served by 
the rule's deterrent effect against engaging in pay to play 
activities. An adviser's fiduciary obligations to continue to 
provide services for a reasonable amount of time, combined with the 
extended compliance dates described in section III of this Release 
which should afford the ability of market participants to organize 
themselves in a way to adapt to the rule's requirements, should be 
sufficient to minimize the impact on pension plans to the extent 
they need to prepare to transition to a new money manager after a 
two-year time out is triggered.
    \127\ Jones Day Letter. Other commenters argued that the specter 
of a two-year time out might cause some firms to ban or require pre-
clearance of all employees' contributions. See, e.g., Caplin & 
Drysdale Letter. Although the rule does not require this approach, 
as a result of commenters' assertions, we address this possibility 
in our cost-benefit analysis. See section IV of this Release.
---------------------------------------------------------------------------

    Few of the commenters who opposed this provision appeared to favor 
its elimination, which would require the adviser to immediately cease 
providing advisory services upon making a triggering contribution.\128\ 
Rather, they appeared to oppose the two-year time out more 
generally.\129\
---------------------------------------------------------------------------

    \128\ See, e.g., Davis Polk Letter; ICI Letter.
    \129\ See, e.g., National Organizations Letter; ICI Letter; 
Jones Day Letter; Dechert Letter.
---------------------------------------------------------------------------

    We are not persuaded by their arguments. We believe the prohibition 
on compensation is both appropriate and administrable. The incentives 
to engage in pay to play may be significant, precisely because of the 
long-term nature of many advisory relationships from which the adviser 
could benefit for several years. As a result, the consequences of 
engaging in pay to play need to be commensurate with these incentives 
for the prophylactic rule to have a meaningful deterrent effect.\130\ 
We acknowledge that the rule will involve compliance costs and could 
adversely affect an adviser's business.\131\ On the other hand, a 
political contribution would not affect the ability of an adviser to 
provide compensated services to other clients, including other 
government clients. Moreover, the fiduciary obligations of an adviser 
would not require it to provide uncompensated advice indefinitely--
rather, the adviser may need to continue to provide advice for only a 
reasonable period of time during which its client can seek to obtain 
advisory services from others.\132\
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    \130\ This deterrent effect is the basis for our view that the 
two-year time out should not apply only to ``new business'' and that 
advisers should not be able to ``negotiate'' for lesser 
consequences. See supra note 124 (pointing to commenters who called 
for more flexibility regarding the two-year time out). As we point 
out above, our concerns extend to contributions designed to enable 
advisers to retain contracts that might not otherwise be renewed.
    \131\ For a discussion of costs and other burdens that may be 
imposed by our rule, see generally sections IV-V of this Release.
    \132\ See supra note 122 and accompanying text. The amount of 
time a client might need in good faith to find and engage a 
successor to the adviser would, in our view, be the primary 
consideration of the length of a reasonable period, which may depend 
in part on such matters as applicable law, the client's customary 
process of finding and engaging advisers and the types of assets 
managed by the adviser that is subject to the time out. In some 
cases, a client may be able to quickly engage a ``transition 
adviser'' to manage its assets until a permanent successor is found. 
See, e.g., Illinois State Board Sets Transition Manager RFP, 
Pensions & Investments, Feb. 8, 2010 available at http://
www.pionline.com/article/20100208/PRINTSUB/302089976. In other 
cases, the client may be required by the law under which it operates 
to undertake a specified process to obtain a new manager, such as a 
solicitation for proposals from potential managers.

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[[Page 41029]]

    Some commenters urged us to permit advisers to continue to receive 
compensation during the two-year time out for services provided 
pursuant to an existing management contract,\133\ without 
distinguishing whether the contract was acquired as a result of 
political contributions. One commenter further suggested specifically 
that we permit advisory services to continue to be provided by the 
adviser at cost during the time out to remove the profit motive of pay 
to play.\134\ We are also not persuaded by their suggestions. Allowing 
contracts acquired as a result of political contributions to continue 
uninterrupted would eviscerate the rule. Were a ``free pass'' available 
for contracts merely because they were entered into prior to discovery 
of a contribution, advisers would be strongly incentivized against 
``discovering'' contributions.\135\ Because no new business from a 
government client may even be available to the adviser until the two-
year period has run its course, advisers whose contributions succeeded 
in acquiring a management contract for two years or more could escape 
any consequences under such an exception.\136\ Further, in our 
judgment, the potential loss of profits will not operate as an adequate 
deterrent. It is our understanding that being selected to manage public 
pension plan assets has a reputational value that itself contributes to 
advisory profits by attracting additional assets under management 
regardless of the profits derived directly from the management of 
government client assets.\137\
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    \133\ See, e.g., Dechert Letter; Fidelity Letter; ICI Letter; 
Jones Day Letter (in some instances, pointing to the MSRB's approach 
of not necessarily applying MSRB rule G-37's two-year time out when 
a contribution is made after a business contract is signed). See 
MSRB, Interpretation on the Effect of a Ban on Municipal Securities 
Business under Rule G-37 Arising During a Pre-Existing Engagement 
Related to Municipal Fund Securities, MSRB Rule G-37 Interpretive 
Notice (April 2, 2002), available at http://msrb.org/msrb1/archive/
ContributionsNotice.htm). As we explain above, due to the long-term 
nature of typical advisory contracts and our belief that the 
consequences of giving a contribution need to be commensurate with 
the potential benefits obtained, we are not taking this approach.
    \134\ Dechert Letter.
    \135\ An approach that applied the two-year time out only to new 
business would preclude the adviser from receiving compensation only 
from additional contracts that might be awarded by the government 
entity during the two-year period. In our judgment, the risk of the 
potential loss of additional advisory contracts for a two-year 
period would provide an inadequate deterrent to contributions 
designed to influence the award of such additional advisory 
contracts.
    \136\ We are concerned that limiting application of the rule to 
new business could invite abuse. For example, pension officials 
seeking contributions after a contract has been awarded could 
attempt to offer an adviser additional assets to manage under the 
existing contract with the condition that the adviser subsequently 
make political contributions.
    \137\ See, e.g., Kevin McCoy, Do Campaign Contributions Help Win 
Pension Fund Deals, USA Today, Aug. 28, 2009, available at http://
www.usatoday.com/money/perfi/funds/2009-08-26-pension-fund-
political-donations_N.htm (referring to advisory firms winning 
management mandates from pension funds, stating: ``The awards 
generate lucrative fees and lend prestige that could help lure new 
clients.''); Louise Story, Quadrangle Facing Questions Over Pension 
Funds, N.Y. Times, Apr. 21, 2009, available at http://
www.nytimes.com/2009/04/22/business/22quadrangle.html (highlighting 
an indirect benefit of a pension fund investment, stating: ``the 
prestige associated with it helped the firm lure other big 
investors.'').
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(2) Officials of a Government Entity
    The rule's two-year time out is triggered by a contribution to an 
``official'' of a ``government entity.'' \138\ 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.\139\ Government entities include all State 
and local governments, their agencies and instrumentalities, and all 
public pension plans and other collective government funds, including 
participant-directed plans such as 403(b), 457, and 529 plans.\140\
---------------------------------------------------------------------------

    \138\ Rule 206(4)-5(a)(1) makes it unlawful for covered 
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.
    \139\ Rule 206(4)-5(f)(6). For purposes of the rule, we would 
not interpret the definition of ``official'' as covering an 
individual who is also a ``covered associate'' of the adviser. 
Accordingly, under the rule, a covered associate who is an incumbent 
or candidate for office is not limited to contributing the de 
minimis amount to his or her own campaign. The MSRB takes a similar 
view with respect to its rule G-37. MSRB, Questions and Answers 
Concerning Political Contributions and Prohibitions on Municipal 
Securities Business: Rule G-37, MSRB rule G-37 Interpretive Notice, 
available at http://www.msrb.org/Rules-and-Interpretations/MSRB-
Rules/General/Rule-G37-Frequently-Asked-Questions.aspx (``MSRB Rule 
G-37 Q&A''), Question II.10 (May 24, 1994).
    \140\ Rule 206(4)-5(f)(5).
---------------------------------------------------------------------------

    The two-year time out is thus triggered by contributions, not only 
to elected officials who have legal authority to hire the adviser, but 
also to elected officials (such as persons with appointment authority) 
who can influence the hiring of the adviser. We have not modified this 
approach from our proposal.\141\ As we noted in the Proposing Release, 
a person appointed by an elected official is likely to be subject to 
that official's influences and recommendations.\142\ It is the scope of 
authority of the particular office of an official, not the influence 
actually exercised by the individual, that would determine whether the 
individual has influence over the awarding of an investment advisory 
contract under the definition.\143\ We are adopting these provisions as 
proposed.\144\
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    \141\ See Proposing Release, at section II.A.3(a)(2).
    \142\ Id.
    \143\ As such, executive officers or legislators whose official 
position gives them the authority to influence the hiring of an 
investment adviser generally would be ``government officials'' under 
the rule. For example, a State may have a pension fund whose board 
of directors, which has authority to hire an investment adviser, is 
constituted, at least in part, by appointees of the governor and 
members of the State legislature. See, e.g., The Commonwealth of 
Pennsylvania Public School Employees' Retirement Board, Statement of 
Organization, By-Laws and Other Procedures (rev. Jun. 11, 2009), 
art. II, sec. 2.1, available at http://www.psers.state.pa.us/org/
board/policies/201001_bylaws.pdf (noting that the board shall be 
composed of, inter alia, two persons appointed by the Pennsylvania 
State Governor, two Pennsylvania State senators and two members of 
the Pennsylvania State house of representatives). In such 
circumstances, the governor and the members of the State legislature 
serving on the board would be officials of the government entity. 
Conversely, a public official who is tasked with performing an audit 
of the selection process but has no influence over hiring outcomes 
would not be an official of a government entity for purposes of the 
rule.
    \144\ These definitions and their application are substantively 
the same as those in MSRB rule G-37. See MSRB rule G-37(g)(ii) and 
(g)(vi).
---------------------------------------------------------------------------

    Some commenters asserted that the rule should be more specific as 
to which public officials to whom a contribution is made would trigger 
application of the rule in order to reduce uncertainty and compliance 
burdens.\145\ But State and municipal statutes vary substantially with 
respect to whom they entrust with the management of public funds, and 
any effort we make in a rule of general application to identify 
specific officials who are in a position to influence the selection of 
an adviser would certainly be over-inclusive in some circumstances and 
under-inclusive in others.\146\ Others

[[Page 41030]]

urged that triggering contributions should be limited to contributions 
to officials directly responsible for the selection of advisers.\147\ 
Excluding from the application of the rule contributions to those who 
are in a position to indirectly influence the selection of an 
investment adviser could simply lead officials to re-structure their 
relationships to avoid application of the rule to advisers that may 
contribute to those officials.
---------------------------------------------------------------------------

    \145\ See, e.g., IAA Letter; NSCP Letter; Comment Letter of T. 
Rowe Price Associates, Inc. (Oct. 6, 2009) (``T. Rowe Letter''); MFA 
Letter; Davis Polk Letter. For a discussion of the potential costs 
involved in identifying officials to whom contributions could 
trigger the rule's prohibitions, see section IV of this Release 
(presenting our cost-benefit analysis). Another commenter suggested 
that advisers should be able to rely on certifications from 
candidates and officials regarding whether their office would render 
them an ``official'' for purposes of the rule--i.e., identifying the 
range, if any, of public investment vehicles over which the relevant 
office directly or indirectly influences the selection of investment 
advisers or appoints individuals who do). Caplin & Drysdale Letter. 
We are concerned that such a safe harbor would undercut the purposes 
of the rule, not least because officials will be incentivized to 
offer such certifications liberally (and will presumably sometimes 
do so inappropriately) to encourage contributions.
    \146\ Like us, the MSRB does not specify which officials have 
the authority to influence the granting of government business for 
purposes of its rule G-37. See MSRB, Campaign for Federal Office, 
MSRB Rule G-37 Interpretive Notice (May 31, 1995), available at 
http://msrb.org/msrb1/rules/interpg37.htm (``The Board does not make 
determinations concerning whether a particular individual meets the 
definition of ``official of an issuer.'').
    \147\ See, e.g., IAA Letter; NASP Letter; NY City Bar Letter; 
Davis Polk Letter.
---------------------------------------------------------------------------

    Two commenters argued that the rule should not cover contributions 
to candidates for Federal office,\148\ while another contended that it 
should.\149\ Under our rule, as proposed, a candidate for Federal 
office could be an ``official'' under the rule not because of the 
office he or she is running for, but as a result of an office he or she 
currently holds.\150\ So long as an official has influence over the 
hiring of investment advisers as a function of his or her current 
office, contributions by an adviser could have the same effect, 
regardless to which of the official's campaigns the adviser 
contributes. For that reason, we are not persuaded that an incumbent 
State or local official should be excluded from the definition solely 
because he or she is running for Federal office.\151\
---------------------------------------------------------------------------

    \148\ See, e.g., NSCP Letter; Dechert Letter.
    \149\ Fund Democracy/Consumer Federation Letter.
    \150\ As a result, if a State or municipal official were, for 
example, a candidate for the U.S. Senate, House of Representatives, 
or presidency, an adviser's contributions to that official would be 
covered by the rule. MSRB rule G-37's time out provision is also 
triggered by contributions to State and local officials running for 
Federal office. See MSRB Rule G-37 Q&A, Questions IV.2-3.
    \151\ Under certain circumstances, a State or municipal official 
running for Federal office could remove herself from being an 
``official'' for purposes of rule 206(4)-5 by eliminating her 
ability to influence the outcome of the hiring of an investment 
adviser. This might occur, for example, if she were to: (i) Formally 
withdraw from participation in or influencing adviser hiring 
decisions; (ii) be leaving office, so that he or she could not 
participate in subsequent decision-making; and (iii) have held 
direct influence over the adviser hiring process (as opposed to, for 
example, having designated an appointee with such influence who 
would remain in a position to influence such hiring).
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(3) Contributions
    The rule's time out provisions are triggered by contributions made 
by an adviser or any of its covered associates.\152\ 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, including any payments 
for debts incurred in such an election.\153\ It also includes 
transition or inaugural expenses incurred by a successful candidate for 
State or local office.\154\ The definition is the same as we proposed 
and as the one used in MSRB rule G-37.\155\
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    \152\ Rule 206(4)-5(a)(1) makes it unlawful for covered 
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. As suggested 
above, we are concerned that contributions may be used ``as the 
cover for what is much like a bribe: a payment that accrues to the 
private advantage of the official and is intended to induce him to 
exercise his discretion in the donor's favor, potentially at the 
expense of the polity he serves.'' Blount, 61 F.3d at 942 
(describing the Commission's approval of MSRB rule G-37 as based on 
a wish to curtail this function).
    \153\ Rule 206(4)-5(f)(1).
    \154\ MSRB rule G-37 also covers payment of transition or 
inaugural expenses as contributions for purposes of its time out 
provision. See MSRB Rule G-37 Q&A, Question II.6. However, under 
neither rule does a contribution include the transition or inaugural 
expenses of a successful candidate for Federal office. Contributions 
to political parties are not specifically covered by the definition 
and thus would not trigger the rule's two-year time out unless they 
are a means to do indirectly what the rule prohibits if done 
directly (for example, the contributions are earmarked or known to 
be provided for the benefit of a particular political official). We 
also note that ``contributions'' are not intended to include 
independent ``expenditures,'' as that term is defined in 2 U.S.C. 
431 & 441b (the Federal statutory provisions limiting contributions 
and expenditures by national banks, corporations, or labor 
organizations invalidated by Citizens United v. Federal Election 
Commission, 130 S. Ct. 876 (2010) (holding that corporate funding of 
independent political broadcasts in candidate elections cannot be 
limited under the First Amendment)). Indeed, 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.'' Blount, 61 F.3d at 948.
    \155\ MSRB rule G-37(g)(i).
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    We received requests that we clarify the application of the rule to 
some common circumstances that may arise in the course of an adviser's 
relationship with a government client.\156\ We would not consider a 
donation of time by an individual to be a contribution, provided the 
adviser has not solicited the individual's efforts and the adviser's 
resources, such as office space and telephones, are not used.\157\ 
Similarly, we would not consider a charitable donation made by an 
investment adviser to an organization that qualifies for an exemption 
from Federal taxation under the Internal Revenue Code,\158\ or its 
equivalent in a foreign jurisdiction, at the request of an official of 
a government entity to be a contribution for purposes of rule 206(4)-
5.\159\
---------------------------------------------------------------------------

    \156\ See, e.g., Caplin & Drysdale Letter; Callcott Letter I 
(volunteer activities); NASP Letter (charitable contributions); 
Sutherland Letter; IAA Letter (entertainment expenses and conference 
expenses). We address entertainment and conference expenses in 
section II.B.2(c) of this Release (which discusses the prohibition 
on soliciting or coordinating contributions from others).
    \157\ See Proposing Release, at n.91. A covered associate's 
donation of his or her time generally would not be viewed as a 
contribution if such volunteering were to occur during non-work 
hours, if the covered associate were using vacation time, or if the 
adviser is not otherwise paying the employee's salary (e.g., an 
unpaid leave of absence). But see rule 206(4)-5(d) (prohibiting an 
adviser from doing indirectly what the rule would prohibit if done 
directly). The MSRB deals similarly with this issue. See MSRB Rule 
G-37 Q&A, Question II.19.
    \158\ Section 501(c)(3) of the Internal Revenue Code (26 U.S.C. 
501(c)(3)) contains a list of charitable organizations that are 
exempt from Federal income taxation.
    \159\ The MSRB deals similarly with this issue. See MSRB Rule G-
37 Q&A, Question II.18. But see rule 206(4)-5(d) (prohibiting an 
adviser from doing indirectly what the rule would prohibit if done 
directly).
---------------------------------------------------------------------------

    The few commenters that addressed the definition of 
``contribution'' generally urged us to adopt a narrower version. Some, 
for example, recommended that contributions be expressly limited to 
political contributions and more explicitly exclude expenditures not 
clearly made for the purpose of influencing an election.\160\ We are 
not narrowing our definition. We are instead adopting our definition as 
proposed due to our concern that ``contributions'' may also take the 
form of payment of election-related debts and transition or inaugural 
expenses. Further, our definition of ``contribution'' already requires 
that the payment be made for the purpose of influencing an election for 
a Federal, State or local office.\161\ We believe that the scope of our 
proposed definition is appropriate in light of the conduct we are 
seeking to address.
---------------------------------------------------------------------------

    \160\ See, e.g., National Organizations Letter; NASP Letter.
    \161\ Rule 206(4)-5(f)(1).
---------------------------------------------------------------------------

    Commenters were divided as to whether contributions to PACs or 
local political parties should trigger the two-year time out.\162\ Such 
contributions were not explicitly covered by the proposed rule and do 
not necessarily

[[Page 41031]]

trigger the two-year time out in MSRB rule G-37.\163\ In some cases, 
such contributions may effectively operate as a funnel to the campaigns 
of the government officials.\164\ In other cases, however, they may 
fund general party political activities or the campaigns of other 
candidates.\165\ Therefore, we have decided not to explicitly include 
all such contributions among those that trigger the time out, although 
they may violate the provision of the rule, discussed below, which 
prohibits an adviser or any of its covered persons from indirect 
actions that would result in a violation of the rule if done 
directly.\166\
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    \162\ See, e.g., CalPERS Letter; NSCP Letter (should not apply 
to contributions to PACs or State or local parties, unless a 
particular candidate directly solicits contributions for those 
entities); Comment Letter of James J. Reilly (Aug. 24, 2009) 
(``Reilly Letter'') (contributions to political parties should be 
included because in State and local elections contributions to 
political parties may effectively amount to contributions to an 
individual candidate); SIFMA Letter.
    \163\ See, e.g., MSRB, Payments to Non-Political Accounts of 
Political Organizations, MSRB rule G-37 Interpretive Letter (Sept. 
25, 2007), available at http://msrb.org/msrb1/rules/interpg37.htm 
(explaining that not all payments to political organizations that, 
in turn, make contributions to officials trigger Rule G-37's time 
out). With regard to solicitations from a PAC or a political party 
with no indication of how the collected funds will be disbursed, 
advisers should inquire how any funds received from the adviser or 
its covered associates would be used. For example, if the PAC or 
political party is soliciting funds for the purpose of supporting a 
limited number of government officials, then, depending upon the 
facts and circumstances, contributions to the PAC or payments to the 
political party might well result in the same prohibition on 
compensation for providing investment advisory services to a 
government entity as would a contribution made directly to the 
official. Our approach is consistent with the MSRB's. See MSRB Rule 
G-37 Q&A, Question III.5.
    \164\ See, e.g., Reilly Letter.
    \165\ See, e.g., Caplin & Drysdale Letter (explaining that 
``leadership PACs,'' for example, are commonly established by 
officeholders to donate to other candidates and issues).
    \166\ See section II.B.2(d) of this Release. For the MSRB's 
approach to this issue, see MSRB Rule G-37 Q&A, Question III.4. But 
see rule 206(4)-5(d) (noting that the rule's definition of 
``official'' of a government entity includes any election committee 
for that person).
---------------------------------------------------------------------------

    The MSRB rule G-37 definition of ``contribution'' has, in our view, 
proved to be workable. The types of contributions relevant to money 
managers and elected officials are unlikely to be different than those 
made to influence the awarding of municipal securities business by 
broker-dealers. On balance, we believe that the MSRB's definition of 
``contribution,'' which we mirrored in our proposal, achieves the goals 
of this rulemaking. Therefore, we are adopting the definition as 
proposed.
(4) Covered Associates
    Contributions made to influence the selection process are typically 
made not by the firm itself, but by officers and employees of the firm 
who have a direct economic stake in the business relationship with the 
government client.\167\ Accordingly, under the rule, contributions by 
each of these persons, which the rule defines as ``covered 
associates,'' trigger the two-year time out.\168\ A ``covered 
associate'' of an investment adviser is defined as: (i) Any general 
partner, managing member or executive officer, or other individual with 
a similar status or function; (ii) any employee who solicits a 
government entity for the investment adviser and any person who 
supervises, directly or indirectly, such employee; and (iii) any 
political action committee controlled by the investment adviser or by 
any of its covered associates.\169\
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    \167\ Proposing Release, at section II.A.3(a)(4). Based on 
enforcement actions, we believe that such persons are more likely to 
have an economic incentive to make contributions to influence the 
advisory firm's selection. See id.
    \168\ Rule 206(4)-5(a)(1).
    \169\ Rule 206(4)-5(f)(2).
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    Owners. Contributions by sole proprietors are contributions by the 
adviser itself.\170\ If the adviser is a partnership, the rule covers 
contributions by the adviser's general partners.\171\ If the adviser is 
a limited liability company, the rule covers contributions made by 
managing members.\172\ A contribution by an owner that is a limited 
partner or non-managing member (of a limited liability company) is not 
covered, however, unless the limited partner or non-managing member is 
also an executive officer or solicitor (or person who supervises a 
solicitor) covered by the rule, or unless the contribution is an 
indirect contribution by the adviser, executive officer, solicitor, or 
supervisor.\173\ Similarly, if the adviser is a corporation, 
shareholder contributions are not covered unless the shareholder is 
also an executive officer or solicitor covered by the rule, or unless 
the contribution is an indirect contribution by the adviser, executive 
officer, solicitor, or supervisor.\174\
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    \170\ We note, however, that a sole proprietor may, in a 
personal capacity, avail herself or himself of the de minimis 
exceptions described in section II.B.2(a)(6) of this Release.
    \171\ Rule 206(4)-5(f)(2)(i).
    \172\ Id.
    \173\ See rule 206(4)-5(a)(1), (d) and (f)(2)(i)-(ii).
    \174\ Id.
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    Executive Officers. Contributions by an executive officer of an 
investment adviser trigger the two-year time out.\175\ Executive 
officers include: (i) The president; (ii) any vice president in charge 
of a principal business unit, division or function (such as sales, 
administration or finance); (iii) any other officer of the investment 
adviser who performs a policy-making function; or (iv) any other person 
who performs similar policy-making functions for the investment 
adviser.\176\ Whether a person is an executive officer depends on his 
or her function, not title; for example, an officer who is the chief 
executive of an advisory firm but whose title does not include 
``president'' is nonetheless an executive officer for purposes of the 
rule.
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    \175\ The definition of ``covered associate'' includes, among 
others, any executive officer or other individual with a similar 
status or function. Rule 206(4)-5(f)(2)(i).
    \176\ Rule 206(4)-5(f)(4).
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    The definition reflects changes we have made from our proposal that 
are designed to clarify the rule and to tailor it to apply to those 
officers of an investment adviser whose position in the organization is 
more likely to incentivize them to obtain or retain clients for the 
investment adviser (and, therefore, to engage in pay to play practices) 
while still achieving our objectives. We have clarified that ``other 
executive officers'' under the rule--i.e., those other than the 
president and vice presidents in charge of principal business units or 
functions--include only those officers or other persons who perform a 
policy-making function for the investment adviser.\177\ This 
limitation, which was recommended by commenters,\178\ excludes persons 
who enjoy certain titles as a formal matter but do not engage in the 
kinds of activities that we believe should trigger the prohibitions in 
the rule.\179\ We have

[[Page 41032]]

also modified the definition to remove the limitation that the officer, 
as part of his or her regular duties, performs or supervises any person 
who performs advisory services for the adviser, or solicits or 
supervises any person who solicits for the adviser. We agree with the 
commenter who asserted that ``* * * all of the adviser's executive 
officers should be included because the nature of their status alone 
creates a strong incentive to engage in pay to play practices.'' \180\ 
Even if these senior officers are not directly involved in advisory or 
solicitation activities, as part of senior management, their success 
within the advisory firm is likely to be tied to the firm's success in 
obtaining clients.\181\
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    \177\ Rule 206(4)-2(f)(4). This modification also aligns the 
definition more closely with the definition of ``executive officer'' 
in our other rules. See, e.g., rule 205-3(d)(4) under the Advisers 
Act [17 CFR 275.205-3(d)(4)] (defining executive officer for 
purposes of determinations of who is a qualified client exempting an 
adviser from the prohibition on entering into, performing, renewing 
or extending an investment advisory contract that provides for 
compensation on the basis of a share of the capital gains upon, or 
the capital appreciation of, the funds, or any portion of the funds, 
under the Advisers Act) and rule 3c-5(a)(3) [17 CFR 270.3c-5(a)(3)] 
under the Investment Company Act of 1940 [15 U.S.C. 80a] 
(``Investment Company Act'') (defining executive officer for 
purposes of determinations of the number of beneficial owners of a 
company excluded from the definition of ``investment company'' by 
section 3(c)(1) of the Investment Company Act, and whether the 
outstanding securities of a company excluded from the definition of 
``investment company'' by section 3(c)(7) of the Investment Company 
Act are owned exclusively by qualified purchasers, as defined in 
that Act). It also more closely aligns the definition to the MSRB 
approach. See MSRB rule G-37(g)(v).
    \178\ See, e.g., Sutherland Letter.
    \179\ Several commenters urged us expressly to exclude from the 
definition the CEO, officers and employees of a parent company. See, 
e.g., SIFMA Letter; ICI Letter; MFA Letter; Skadden Letter. 
Depending on facts and circumstances, there may be instances in 
which a supervisor of an adviser's covered associate (who, for 
example, engages in solicitation of government entity clients for 
the adviser) formally resides at a parent company, but whose 
contributions should trigger the two-year time out because they 
raise the same conflict of interest issues that we are concerned 
about, irrespective of that person's location or title. In other 
words, whether a person is a covered associate ultimately depends on 
the activities of the individual and not his or her title. We 
recently considered a similar issue in a report addressing whether 
MSRB rule G-37 could include contributions by employees of parent 
companies as triggering that rule's time out provision, see Report 
of Investigation Pursuant to Section 21(a) of the Securities 
Exchange Act of 1934: JP Morgan Securities, Inc., Exchange Act 
Release No. 61734 (Mar. 18, 2010), available at http://www.sec.gov/
litigation/investreport/34-61734.htm (``This Report serves to remind 
the financial community that placing an executive who supervises the 
activities of a broker, dealer or municipal securities dealer 
outside of the corporate governance structure of such broker, dealer 
or municipal securities dealer does not prevent the application of 
MSRB Rule G-37 to that individual's conduct.''). The MSRB also takes 
the view that it is an individual's activities and not his or her 
title that may render his or her contributions a trigger for that 
rule's time out provision. See MSRB Rule G-37 Q&A, Question IV.18.
    \180\ See Fund Democracy Letter.
    \181\ Commenters also suggested that our definition exclude vice 
presidents in charge of business units, divisions or functions whose 
function is unrelated to investment advisory or solicitation 
activities. See, e.g., IAA Letter. For the reasons described above, 
we do not believe such an exclusion is appropriate.
---------------------------------------------------------------------------

    Employees who Solicit Government Clients. Contributions by any 
employee who solicits a government entity for the adviser would trigger 
the two-year time out.\182\ An employee need not be primarily engaged 
in solicitation activities to be a ``covered associate'' under the 
rule.\183\ We are also including persons who supervise employees who 
solicit government entities because we believe these persons are 
strongly incentivized to engage in pay to play activities to obtain 
government entity clients.\184\ We have revised this aspect of the 
definition to include all supervisors of those solicitors that solicit 
government entities because we believe the incentives to engage in pay 
to play exist for all such supervisors, not just those that have a 
certain level of seniority.
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    \182\ We are not adopting the suggestion of several commenters 
that we treat third-party solicitors the same way as employees. See, 
e.g., 3PM Letter; Triton Pacific Letter; Comment Letter of Arrow 
Partners, Inc. Partner Ken Rogers (Sept. 2, 2009) (``Arrow 
Letter''). We explained in the Proposing Release that we determined 
not to propose this approach out of concern for the difficulties 
that advisers may have when monitoring the activities of their 
third-party solicitors. See Proposing Release, at nn.135 and 
accompanying text. Commenters did not persuade us that these 
concerns can reasonably be expected to be overcome. Therefore, 
whereas contributions by covered associates of the adviser trigger 
the two-year compensation time out, an adviser is prohibited from 
hiring third parties to solicit government business on its behalf 
unless the third party is a ``regulated person.'' See section 
II.B.2(b) of this Release. Our approach is similar to MSRB's rule G-
38, which restricts third-party solicitation activities differently 
from the two-year time out. See MSRB rule G-38.
    \183\ The MSRB also takes the approach that an associated person 
need not be ``primarily engaged'' in activities that would make his 
or her contributions trigger rule G-37's time out provision, 
particularly where he or she engages in soliciting business. See 
MSRB Rule G-37 Q&A, Question IV.8.
    \184\ Rule 206(4)-5(f)(2)(ii). The proposed rule would only have 
applied to senior officers who supervise employee solicitors. See 
proposed rule 206(4)-5(f)(4)(ii). MSRB rule G-37 also applies to 
supervisors of persons who solicit relevant business from government 
entities. See MSRB Rule G-37 Q&A, Question IV.14.
---------------------------------------------------------------------------

    Rule 206(4)-5 defines ``solicit'' to mean, with respect to 
investment advisory services, to communicate, directly or indirectly, 
for the purpose of obtaining or retaining a client for, or referring a 
client to, an investment adviser.\185\ Commenters asked us to provide 
further guidance on what we mean by ``solicit.'' \186\ The 
determination of whether a particular communication is a solicitation 
is dependent upon the specific facts and circumstances relating to such 
communication. As a general proposition any communication made under 
circumstances reasonably calculated to obtain or retain an advisory 
client would be considered a solicitation unless the circumstances 
otherwise indicate that the communication does not have the purpose of 
obtaining or retaining an advisory client. For example, if a government 
official asks an employee of an advisory firm whether the adviser has 
pension fund advisory capabilities, such employee generally would not 
be viewed as having solicited advisory business if he or she provides a 
limited affirmative response, together with either providing the 
government official with contact information for a covered associate of 
the adviser or informing the government official that advisory 
personnel who handle government advisory business will contact him or 
her.\187\
---------------------------------------------------------------------------

    \185\ Rule 206(4)-5(f)(10)(i). We are adopting this definition 
as proposed.
    \186\ See, e.g., Skadden Letter.
    \187\ Similarly, if a government official is discussing 
governmental asset management issues with an employee of an adviser, 
the employee generally would not be viewed as having solicited 
business if he or she provides a limited communication to the 
government official that such alternative may be appropriate, 
together with either providing the government official with contact 
information for a covered associate or informing the government 
official that advisory personnel who handle asset management for 
government clients will contact him or her. In these examples, 
however, if the adviser's employee receives compensation such as a 
finder's or referral fee for such business or if the employee 
engages in other activities that could be deemed a solicitation with 
respect to such business, the employee generally would be viewed as 
having solicited the advisory business. Our interpretation of what 
it means to ``solicit'' government business is consistent with the 
MSRB's. See MSRB, Interpretive Notice on the Definition of 
Solicitation under Rules G-37 and G-38 (June 8, 2006), available at 
http://msrb.org/msrb1/rules/notg38.htm.
---------------------------------------------------------------------------

    Political Action Committees. A covered associate includes a 
political action committee controlled by the investment adviser or by 
any of its covered associates.\188\ Under the rule, we would regard an 
adviser or its covered associate to have ``control'' over a political 
action committee if the adviser or its covered associate has the 
ability to direct or cause the direction of the governance or 
operations of the PAC.\189\
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    \188\ Rule 206(4)-5(f)(2)(iii) (which we are adopting as 
proposed). One commenter suggested that we define a ``political 
action committee,'' or PAC, as any organization required to register 
as a political committee under Federal, State or local law. Caplin & 
Drysdale Letter. But we have not included this definition of PAC 
because we do not believe a definition linked to the registration 
status of a political committee would serve our purpose of deterring 
evasion of the rule as registration requirements vary among election 
laws. We note, however, that we would construe the term PAC to 
include (but not necessarily be limited to) those political 
committees generally referred to as PACs, such as separate 
segregated funds or non-connected committees within the meaning of 
the Federal Election Campaign Act, or any State or local law 
equivalent. See Federal Election Commission, Quick Answers to PAC 
Questions, available at http://www.fec.gov/ans/answers_
pac.shtml#pac. Determination of whether an entity is a PAC covered 
by our rule would not, in our view, turn on whether the PAC was, or 
was required to be, registered under relevant law.
    \189\ One commenter suggested a similar interpretation of 
``control.'' Caplin & Drysdale Letter. For the MSRB's approach to 
this definition, see MSRB Rule G-37 Q&A, Question IV.24.
---------------------------------------------------------------------------

    Two commenters asserted that we should narrow the definition of 
``covered associate'' with respect to political action committees.\190\ 
Specifically, they asserted that the definition should only include 
PACs controlled by the adviser and not those controlled by other 
covered associates, which could be a separate legal entity over which 
the adviser may have little influence.\191\ We are not adopting this 
suggestion. As we discussed in the Proposing Release, PACs are often 
used to make political contributions.\192\ The

[[Page 41033]]

recommended changes would permit an executive of the adviser or another 
covered person of the adviser to use a PAC he or she controls to evade 
the rule. Even where the adviser itself does not control such PACs 
directly, we are concerned about their use to evade our rule where they 
are controlled by covered associates (whose positions in the 
organization, as we note above, are more likely to incentivize them to 
obtain or retain clients for the investment adviser).\193\
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    \190\ SIFMA Letter; Sutherland Letter.
    \191\ Id.
    \192\ Proposing Release, at n.101.
    \193\ Advisers are responsible for supervising their supervised 
persons, including their covered associates. We have the authority 
to seek sanctions where an investment adviser, or an associated 
person, has failed reasonably to supervise, with a view to 
preventing violations of the Federal securities laws or rules, a 
person who is subject to the adviser's (or its associated person's) 
supervision and who commits such violations. Sections 203(e)(6) and 
203(f) of the Advisers Act [15 U.S.C. 80b-3(e)(6) and (f)].
---------------------------------------------------------------------------

    Other Persons. Several commenters urged that our definitions be 
broadened to encompass other persons whose contributions should trigger 
the two-year time out.\194\ One urged that in some cases all employees 
should be covered associates because of the likelihood they could 
directly benefit from engaging in pay to play.\195\ Another urged that 
the definition of covered associate include affiliates of the adviser 
that solicit government business on the adviser's behalf, any director 
of the adviser, and any significant owner of the adviser.\196\ These 
suggestions would expand the rule to a range of persons that could 
engage in pay to play activities.\197\ In our judgment, however, 
contributions from these types of persons are less likely to involve 
pay to play unless the contributions were made by these persons for the 
purpose of avoiding application of the rule, which could result in the 
adviser's violation of a separate provision of the rule.\198\ We do not 
believe that the incremental benefits of capturing conduct of other 
individuals less likely to engage in pay to play based on the record 
before us today outweigh the additional burden such an expansion would 
impose.\199\ Thus, we are not expanding the definition as these 
commenters have suggested.
---------------------------------------------------------------------------

    \194\ See, e.g., Fund Democracy/Consumer Federation Letter; 
DiNapoli Letter (suggesting the rule also cover contributions from 
family members); Ounavarra Letter.
    \195\ Ounavarra Letter.
    \196\ Fund Democracy/Consumer Federation Letter.
    \197\ See, e.g., supra note 179 (discussing why we have chosen 
not to limit the definition of ``executive officer'' in other ways 
as suggested by some commenters).
    \198\ See Rule 206(4)-5(d). We also note that the MSRB takes a 
similar approach. See, e.g., MSRB Rule G-37 Q&A, Question IV.9 
(noting that the universe of those whose contributions above the de 
minimis level per se trigger the two-year time out is limited and 
does not include their consultants, lawyers or spouses). The MSRB 
also leaves contributions by affiliates and personnel beyond those 
identified as triggering the two-year time out to be addressed by a 
provision prohibiting municipal securities dealers from doing 
indirectly what they are prohibited from doing directly under rule 
G-37. See MSRB Rule G-37(d).
    \199\ In this instance, as in others, we are sensitive to First 
Amendment concerns that further expansion of the scope of covered 
associates could broaden the rule's scope beyond what is necessary 
to accomplish its purposes.
---------------------------------------------------------------------------

    Other commenters urged us to narrow our definition of ``covered 
associate'' to include fewer persons.\200\ For example, one commenter 
recommended that the definition of ``covered associate'' expressly 
exclude all ``support personnel.'' \201\ Another suggested that we 
limit the definition to those who solicit government clients with a 
``major purpose'' of obtaining that government client.\202\ Expressly 
excluding all ``support personnel'' is unnecessary because, in almost 
all cases, such persons would not be ``covered associates,'' as that 
term is defined in the rule. We have not limited the definition to 
those who solicit government clients with a ``major purpose'' of 
obtaining that government client because we believe that our rule's 
definition of ``solicit,'' as discussed above, adequately takes into 
account the purpose of the communication and adding an additional 
element of intent may exclude employees who have an incentive to engage 
in pay to play practices.
---------------------------------------------------------------------------

    \200\ See, e.g., T. Rowe Price Letter; NSCP Letter; Skadden 
Letter.
    \201\ T. Rowe Price Letter.
    \202\ Skadden Letter.
---------------------------------------------------------------------------

(5) ``Look Back''
    The rule attributes to an adviser contributions made by a person 
within two years (or, in some cases, six months) of becoming a covered 
associate of that adviser.\203\ In other words, when an employee 
becomes a covered associate, the adviser must ``look back'' in time to 
that employee's contributions to determine whether the time out applies 
to the adviser.\204\ If, for example, the contributions were made more 
than two years (or, pursuant to the exception described below for non-
solicitors, six months) prior to the employee becoming a covered 
associate, the time out has run; if the contribution was made less than 
two years (or six months) from the time the person becomes a covered 
associate, the rule prohibits the adviser that hires or promotes the 
contributing covered associate from receiving compensation for 
providing advisory services from the hiring or promotion date until the 
two-year period has run.\205\ The look-back provision, which is similar 
to that in MSRB rule G-37, is designed to prevent advisers from 
circumventing the rule by influencing the selection process by hiring 
persons who have made political contributions.\206\
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    \203\ Rule 206(4)-5(a)(1). The ``look back'' applies to any 
person who becomes a covered associate, including a current employee 
who has been transferred or promoted to a position covered by the 
rule. A person becomes a covered associate for purposes of the 
rule's look-back provision at the time he or she is hired or 
promoted to a position that meets the definition of ``covered 
associate'' in rule 206(4)-5(f)(2). For a discussion of the 
definition of ``covered associate,'' see section II.B.2(a)(4) of 
this Release.
    \204\ Rule 206(4)-5(a)(1) (including among those covered 
associates whose contributions can trigger the two-year time out a 
person who becomes a covered associate within two years after the 
contribution is made); Rule 206(4)-5(b)(2) (excepting from the two-
year look back those contributions made by a natural person more 
than six months prior to becoming a covered associate of the 
investment adviser unless such person, after becoming a covered 
associate, solicits clients on behalf of the investment adviser).
    \205\ In no case would the prohibition imposed by the rule be 
longer than two years from the date the covered associate makes a 
covered contribution. If, for example, a covered associate becomes 
employed by an investment adviser (and engages in solicitation 
activity for it) one year and six months after making a 
contribution, the new employer would be subject to the proposed 
rule's prohibition for the remaining six months of the two-year 
period. We also note that the rule's exemptive process may be 
available in instances where an adviser believes application of the 
look-back provision would yield an unintended result. Rule 206(4)-
5(e). For a discussion of the rule's exemptive provision, see 
section II.B.2(f) of this Release.
    \206\ Similarly, to prevent advisers from channeling 
contributions through departing employees, advisers must ``look 
forward'' with respect to covered associates who cease to qualify as 
covered associates or leave the firm. The covered associate's 
employer at the time of the contribution would be subject to the 
proposed rule's prohibition for the entire two-year period, 
regardless of whether the covered associate remains a covered 
associate or remains employed by the adviser. Thus, dismissing a 
covered associate would not relieve the adviser from the two-year 
time out. MSRB rule G-37 also includes a ``look-forward provision.'' 
See MSRB Rule G-37 Q&A, Question IV.17 (`` * * * any contributions 
by [an] associated person [who leaves the dealer's employ] (other 
than those that qualify for the de minimis exception under Rule G-
37(b)) will subject the dealer to the rule's ban on municipal 
securities business for two years from the date of the 
contribution'').
---------------------------------------------------------------------------

    We received many comments on our proposed look-back provision,\207\ 
which would have applied the two-year look back with respect to all 
contributions of new covered associates.\208\ One commenter asserted 
that such a provision is necessary to prevent advisers from 
circumventing the

[[Page 41034]]

prohibitions on pay to play.\209\ Most commenters, however, argued that 
the rule should not contain a look-back provision or should contain a 
shorter one because it could prevent advisers from hiring qualified 
individuals who have made unrelated political contributions,\210\ or it 
could be disruptive to public pension plans seeking to hire qualified 
managers.\211\ While some urged that we eliminate the look-back 
provision altogether,\212\ most asked us to shorten the period to three 
to six months.\213\ Others suggested alternative approaches to the look 
back, including adopting a higher contribution threshold to trigger the 
look-back provision \214\ or permitting advisers to hire and promote 
persons to be covered associates who have made prohibited 
contributions, but not permitting them to solicit government clients or 
otherwise create firewalls between them and government clients.\215\
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    \207\ See, e.g., Fund Democracy/Consumer Federation Letter; ICI 
Letter; Davis Polk Letter; NY City Bar Letter; Fidelity Letter; 
Wells Fargo Letter; MFA Letter; IAA Letter; NASP Letter; American 
Bankers Letter; Comment Letter of Seward & Kissel LLP (Oct. 6. 2009) 
(``Seward & Kissel Letter''); Park Hill Letter; Dechert Letter; 
Skadden Letter.
    \208\ See Proposing Release, at section II.A.3(a)(5).
    \209\ Fund Democracy/Consumer Federation Letter.
    \210\ See, e.g., ICI Letter; Davis Polk Letter; NY City Bar 
Letter; Fidelity Letter; Wells Fargo Letter; MFA Letter.
    \211\ See, e.g., Comment Letter of Connecticut Treasurer Denise 
L. Nappier (Sept. 10, 2009) (``CT Treasurer Letter''); CalPERS 
Letter.
    \212\ See, e.g., IAA Letter; ICI Letter; Wells Fargo Letter; 
NASP Letter; American Bankers Letter; MFA Letter; Seward & Kissel 
Letter.
    \213\ See, e.g., ICI Letter (three-month look back); IAA Letter 
(six-month look back); Park Hill Letter (six-month look back); Wells 
Fargo Letter (six-month look back); Davis Polk Letter (six-month 
look back); Dechert Letter (six-month look back); MFA Letter (six-
month look back).
    \214\ See, e.g., Wells Fargo Letter; NSCP Letter.
    \215\ See, e.g., Comment Letter of Strategic Capital Partners 
(Oct. 1, 2009) (``Strategic Capital Letter''); Comment Letter of B. 
Jack Miller (Oct. 3, 2009); Comment Letter of RP Realty Partners, 
LLC Chief Financial Officer Jerry Gold (Oct. 2, 2009); SIFMA Letter.
---------------------------------------------------------------------------

    Upon consideration of the comments, we believe that applying the 
full two-year look back to all new covered associates may be 
unnecessary to achieve the goals of the rulemaking. We are adopting a 
suggestion offered by several commenters to shorten the look-back 
period with respect to certain new covered associates whose 
contributions are less likely to be involved in pay to play.\216\ Under 
an exception to the rule, the two-year time out is not triggered by a 
contribution made by a natural person more than six months prior to 
becoming a covered associate, unless he or she, after becoming a 
covered associate, solicits clients.\217\ As a result, the two-year 
look back applies only to covered associates who solicit for the 
investment adviser.\218\
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    \216\ See, e.g., MFA Letter; Fidelity Letter; Dechert Letter; 
Wells Fargo Letter; Skadden Letter. The MSRB shortened the look-back 
period under MSRB rule G-37 to six months for certain municipal 
finance professionals in response to similar industry concerns about 
the impact on hiring. See MSRB, Amendments Filed to Rule G-37 
Concerning the Exemption Process and the Definition of Municipal 
Finance Professional (Sept. 26, 2002), available at http://
www.msrb.org/msrb1/archive/g%2D37902notice.htm.
    \217\ Rule 206(4)-5(b)(2). An adviser is subject to the two-year 
time out regardless of whether it is ``aware'' of the political 
contributions. Thus, statements by prospective employees regarding 
whether they have made relevant contributions are insufficient to 
inoculate the adviser, as some commenters urged (see, e.g., IAA 
Letter; ICI Letter; NSCP Letter; Caplin & Drysdale Letter), to 
ensure that investment advisers are not encouraged to relax their 
efforts to promote compliance with the rule's prohibitions. 
Nonetheless, advisers who advise or are considering advising any 
government entity should consider requiring full disclosure of any 
relevant political contributions from covered associates or 
potential covered associates to ensure compliance with rule 206(4)-
5. Advisers are required to request similar reports about securities 
holdings by Advisers Act rule 204A-1(b)(1)(ii) [17 CFR 275.204A-
1(b)(1)(ii)], which requires each of a firm's ``access persons'' to 
submit an initial ``holdings report'' of securities he or she 
beneficially owns at the time he or she becomes an access person, 
even though the securities would likely have been acquired in 
transactions prior to becoming an access person. For a discussion of 
an adviser's recordkeeping obligations with regard to records of 
contributions by a new covered associate during that new covered 
associate's look-back period, see infra note 428.
    \218\ See rule 206(4)-5(f)(2) (defining covered associate of an 
investment adviser as: (i) Any general partner, managing member or 
executive officer, or other individual with a similar status or 
function; (ii) any employee who solicits a government entity for the 
investment adviser and any person who supervises, directly or 
indirectly, such employee).
---------------------------------------------------------------------------

    The potential link between obtaining advisory business and 
contributions made by an individual prior to his or her becoming a 
covered associate that is uninvolved in solicitation activities is 
likely more attenuated and therefore, in our judgment, should be 
subject to a shorter look back. We have modeled this shortened look-
back period \219\ on the MSRB's six-month look back for certain 
personnel, which it implemented as a result of feedback it received 
from dealers that indicated the two-year look back was negatively 
affecting in-firm transfers and promotions and ``preclud[ing] them from 
hiring individuals who had made contributions, even though the 
contributions (which may have been relatively small) were made at a 
time when the individuals had no reason to be familiar with Rule G-
37.'' \220\ This approach balances commenters' concerns about the 
implications for their hiring decisions with the need to protect 
against individuals marketing to prospective investment adviser 
employers their connections to, or influence over, government entities 
those advisers might be seeking as clients.\221\
---------------------------------------------------------------------------

    \219\ See rule 206(4)-5(b)(2).
    \220\ MSRB, Self-Regulatory Organizations; Notice of Filing of 
Proposed Rule Change by the Municipal Securities Rulemaking Board 
Relating to Amendments to Rules G-37, on Political Contributions and 
Prohibitions on Municipal Securities Business, G-8, on Books and 
Records, Revisions to Form G-37/G-38 and the Withdrawal of Certain 
Rule G-37 Questions and Answers, Exchange Act Release No. 47609 
(April 1, 2003) [67 FR 17122 (Apr. 8, 2003)]. See also MSRB, Self-
Regulatory Organizations; Order Granting Approval of a Proposed Rule 
Change and Amendment No. 1 Thereto by the Municipal Securities 
Rulemaking Board Relating to Amendments to Rules G-37, on Political 
Contributions and Prohibitions on Municipal Securities Business, G-
8, on Books and Records, Revisions to Form G-37/G-38 and the 
Withdrawal of Certain Rule G-37 Questions and Answers, Exchange Act 
Release No. 47814 (May 8, 2003) [68 FR 25917 (May 14, 2003)] 
(Commission order approving amendments to MSRB rule G-37); MSRB rule 
G-37(b)(iii).
    \221\ We are not adopting the suggestion of commenters to 
exclude from the look-back provision contributions made before a 
merger or acquisition by an adviser by not attributing the 
contributions of the acquired adviser to the acquiring adviser. See, 
e.g., Dechert Letter; ICI Letter. We believe that an acquisition of 
another adviser could raise identical concerns where the acquired 
adviser has made political contributions designed to benefit the 
acquiring adviser. Rule 206(4)-5 is not intended to prevent mergers 
in the investment advisory industry or, once a merger is 
consummated, to hinder the surviving adviser's government advisory 
business unless the merger was an attempt to circumvent rule 206(4)-
5. Thus, the adviser may wish to seek an exemption from the ban on 
receiving compensation pursuant to rule 206(4)-5(a) from the 
Commission. The MSRB takes the same approach to this issue. See MSRB 
Rule G-37 Q&A, Question II.16.
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(6) Exceptions for De Minimis Contributions
    Rule 206(4)-5 permits individuals to make aggregate contributions 
without triggering the two-year time out of up to $350, per election, 
to an elected official or candidate for whom the individual is entitled 
to vote,\222\ and up to $150, per election, to an elected official or 
candidate for whom the individual is not entitled to vote.\223\ These 
de minimis exceptions are available only for contributions by 
individual covered associates, not the investment adviser itself.\224\ 
Under both exceptions,

[[Page 41035]]

primary and general elections would be considered separate 
elections.\225\
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    \222\ For purposes of rule 206(4)-5, a person would be 
``entitled to vote'' for an official if the person's principal 
residence is in the locality in which the official seeks election. 
For example, if a government official is a State governor running 
for re-election, any covered associate of an adviser who resides in 
that State may make a de minimis contribution to the official 
without causing a ban on that adviser being compensated for 
providing advisory services for that government entity. In the 
example of a government official running for President, any covered 
associate in the country can contribute the de minimis amount to the 
official's Presidential campaign. The MSRB has issued a similar 
interpretation of what it means to be ``entitled to vote'' for 
purposes of MSRB rule G-37. See MSRB Reports, Vol. 16. No. 1 
(January 1996) at 31-34.
    \223\ See Rule 206(4)-5(b)(1) (excepting ``de minimis'' 
contributions to ``officials'' (see supra note 139 and accompanying 
text) from the rule's two-year time out provision).
    \224\ Id. Under the rule, each covered associate, taken 
separately, would be subject to the de minimis exceptions. In other 
words, the limit applies per covered associate and is not an 
aggregate limit for all of an adviser's covered associates. But see 
supra note 170 (pointing out that a sole proprietor may, in a 
personal capacity, avail herself or himself of the de minimis 
exceptions even though his or her contributions are otherwise 
considered contributions of the adviser itself).
    \225\ Accordingly, a covered person of an investment adviser 
could, without triggering the prohibitions of the rule, contribute 
up to the limit in both the primary election campaign and the 
general election campaign of each official for whom the person 
making the contribution would be entitled to vote. The MSRB takes 
the same approach of excepting from rule G-37's time out trigger 
contributions up to the rule's de minimis amount for each election 
(including a primary and general election). See MSRB Rule G-37 Q&A, 
Question II.8. See also In the Matter of Pryor, McClendon, Counts & 
Co., Inc., et al., Exchange Act Release No. 48095 (June 26, 2003) 
(noting that contributions must be limited to MSRB rule G-37's de 
minimis amount before the primary, with the same de minimis amount 
allowed after the primary for the general election).
---------------------------------------------------------------------------

    We proposed a $250 de minimis exception for contributions to 
candidates for whom a covered associate is entitled to vote,\226\ which 
reflects the current de minimis exception in MSRB rule G-37.\227\ Many 
commenters urged us to increase the de minimis amount (either to a 
larger number or by indexing it to inflation), arguing that a 
contribution as large as $1,000 would be unlikely to influence the 
award of an advisory contract by a public pension plan.\228\
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    \226\ See Proposing Release, at section II.A.3(a)(6).
    \227\ See MSRB rule G-37(b)(i).
    \228\ See, e.g., SIFMA Letter; NASP Letter; Comment Letter of 
Philip K. Holl (Oct. 5, 2009) (``Holl Letter''); NSCP Letter; Caplin 
& Drysdale Letter; Cornell Law Letter; ICI Letter; MFA Letter; 
Seward & Kissel Letter; Callcott Letter II; Comment Letter of the 
California State Teachers' Retirement System (Oct. 6, 2009) (adopted 
policies that limit contributions to board members by those seeking 
investment relationships with the fund to $1,000). Several 
commenters suggested our proposed de minimis limit could be subject 
to a challenge on constitutional grounds. For a discussion of, and 
response to, these comments, see supra note 72 and accompanying 
text.
---------------------------------------------------------------------------

    The $1,000 amount suggested by some commenters strikes us as a 
rather large contribution that could influence the hiring decisions, 
depending upon the size of the jurisdiction, the amount of campaign 
contributions to opposing candidates, and the competitiveness of the 
primary or prospective election. Instead, we are taking the suggestion 
of several commenters \229\ that we should increase the de minimis 
amount to reflect the effects of inflation since the MSRB first 
established its $250 de minimis amount in 1994.\230\ We may consider 
increasing the $350 amount in the future if, for example, the value of 
it decreases materially as a result of further inflation.
---------------------------------------------------------------------------

    \229\ See, e.g., Caplin & Drysdale Letter (recommending that we 
index the de minimis threshold for inflation); Cornell Law Letter 
(recommending that we index the de minimis threshold for inflation). 
See also Callcott Letter I.
    \230\ We multiplied the $250 de minimis amount that we proposed 
(which was adopted by the MSRB in 1994) by the annual consumer price 
index (a measure of inflation) change since 1994, as reported by the 
Bureau of Labor Statistics (available at http://www.bls.gov/data/). 
The result was approximately $365 in 2009; we rounded it down to 
$350 for administrative convenience.
---------------------------------------------------------------------------

    Commenters also urged us to eliminate the condition that a covered 
associate must be able to vote for the candidate.\231\ They asserted 
that persons can have a legitimate interest in contributing to 
campaigns of people for whom they are unable to vote.\232\ We 
acknowledge that persons can have such an interest, such as in large 
metropolitan areas where a covered associate may work and live in 
different jurisdictions. But commenters did not confine their 
recommendations to such circumstances and we remain concerned that 
contributions by executives of advisers living in distant jurisdictions 
may be less likely to be made for purely civic purposes. Accordingly, 
we have added a de minimis exception for contributions of up to $150 to 
officials for whom a covered associate is not entitled to vote, which 
is lower than the de minimis exception of $350 for candidates for whom 
a covered associate is entitled to vote. We believe that $150 is a 
reasonable amount for the additional de minimis exception we are 
adopting because of the more remote interest a covered associate is 
likely to have in contributing to a person for whom he or she is not 
entitled to vote.
---------------------------------------------------------------------------

    \231\ See, e.g., T. Rowe Price Letter; Dechert Letter; MFA 
Letter; NASP Letter; Callcott Letter I; Cornell Law Letter; IAA 
Letter.
    \232\ See, e.g., T. Rowe Price Letter; Dechert Letter; MFA 
Letter; NASP Letter; Callcott Letter I; Cornell Law Letter.
---------------------------------------------------------------------------

(7) Exception for Certain Returned Contributions
    We are adopting, largely as proposed, an exception that will 
provide an adviser with a limited ability to cure the consequences of 
an inadvertent political contribution to an official for whom the 
covered associate making it is not entitled to vote.\233\ The exception 
is available for contributions that, in the aggregate, do not exceed 
$350 to any one official, per election.\234\ The adviser must have 
discovered the contribution which resulted in the prohibition within 
four months of the date of such contribution \235\ and, within 60 days 
after learning of the triggering contribution, the contributor must 
obtain the return of the contribution.\236\
---------------------------------------------------------------------------

    \233\ Rule 206(4)-5(b)(3).
    \234\ Rule 206(4)-5(b)(3)(i). We note that a contribution would 
not trigger the two-year ban at all to the extent it falls within 
the de minimis exception described in rule 206(4)-5(b)(1). See 
section II.B.2(a)(6) of this Release for a discussion of this 
exception.
    \235\ Id.
    \236\ Rule 206(4)-5(b)(3)(i).
---------------------------------------------------------------------------

    The scope of this exception is limited to the types of 
contributions that we believe are less likely to raise pay to play 
concerns. The prompt return of the contribution provides an indication 
that the contribution would not affect an official of a government 
entity's decision to award an advisory contract.\237\ The relatively 
small amount of the contribution, in conjunction with the other 
conditions of the exception, suggests that it was unlikely to be made 
for the purpose of influencing the award of an advisory contract. 
Repeated triggering contributions suggest otherwise or that the adviser 
has not implemented effective compliance controls. Therefore, the rule 
limits an adviser's reliance on the exception to no more than two or 
three per 12-month period (based on the size of the adviser),\238\ and 
no more than once for

[[Page 41036]]

each covered associate,\239\ regardless of the time period.\240\
---------------------------------------------------------------------------

    \237\ The 60-day limit is designed to give contributors 
sufficient time to seek its return, but still require that they do 
so in a timely manner. Also, this provision is consistent with MSRB 
rule G-37(j)(i). If the recipient will not return the contribution, 
the adviser would still have available the opportunity to apply for 
an exemption under paragraph (e) of the rule. Paragraph (e), which 
sets forth factors we would consider in determining whether to grant 
an exemption, includes as a factor whether the adviser has taken all 
available steps to cause the contributor involved in making the 
contribution which resulted in such prohibition to obtain a return 
of the contribution.
    \238\ Rule 206(4)-5(b)(3)(ii). The approach we have taken will 
generally create some flexibility to accommodate a limited number of 
contributions by covered associates that would otherwise trigger the 
two-year time out. In a modification from our proposal that we 
believe is responsive to certain commenters' concerns (see note 251 
and accompanying text below), ``larger'' advisers may avail 
themselves of three automatic exceptions, instead of two, in any 
calendar year. Rule 206(4)-5(b)(3)(ii). In contrast, our proposal 
would have permitted each adviser, regardless of its size, to rely 
on the automatic exception twice each year. The rule identifies a 
``larger'' adviser for these purposes as any adviser who has 
reported in response to Item 5.A on its most recently filed Form 
ADV, Part 1A [17 CFR 279.1] that it has more than 50 employees. Id. 
Investment Adviser Registration Depository (IARD) data as of April 
1, 2010 indicate that approximately 10 percent of registered 
advisers have more than 50 employees (and would therefore be limited 
to three ``automatic'' exceptions per calendar year instead of two). 
In particular, the data indicate that there are 11,607 registered 
investment advisers. Of those, 1,072 advisers (9.2% of the total) 
have indicated in their responses to Item 5.A of Part 1A of Form ADV 
that they have more than 50 employees. We chose the 50 employee cut-
off because the number of employees is independently reported on 
Form ADV (and therefore cross-verifiable)--each adviser filing Form 
ADV must check a box indicating an approximation of the number of 
employees it has, choosing among 1-5, 6-10, 11-50, 51-250, 251-500, 
501-1,000, or more than 1,000--and because we believe that 
inadvertent violations of the rule are more likely at advisers with 
greater numbers of employees. We think that the twice per year limit 
is appropriate for small advisers and the three times per year limit 
is appropriate for larger advisers. We do not believe it is 
appropriate for there to be greater variation in the number of times 
advisers may rely on the exception than that based either on their 
size or on other characteristics. We are seeking to encourage robust 
monitoring and compliance.
    \239\ Rule 206(4)-5(b)(3)(iii). Once a covered associate has 
been made aware of an ``inadvertent'' violation, a justification for 
a second violation would be more questionable.
    \240\ Although we have included different allowances for larger 
and smaller advisers (based on the number of employees they report 
on Form ADV), our approach otherwise generally tracks MSRB rule G-
37's ``automatic exemption'' provision. See MSRB rule G-37(j).
---------------------------------------------------------------------------

    Commenters who addressed it generally supported our inclusion of an 
automatic exception provision,\241\ although several suggested 
modifications.\242\ Some urged us to eliminate the requirement that the 
contributor succeed in obtaining the return of the contribution.\243\ 
We are not making this change, which could undermine our goals in 
adopting the rule if it led to contributors asking for the return of a 
contribution where such requests were expected to be refused by the 
government official. We would have to discern whether the contributor 
itself, who may (or whose employer may) be seeking to influence 
government officials, has tried ``hard enough'' to get the contribution 
back.
---------------------------------------------------------------------------

    \241\ See, e.g., T. Rowe Price Letter; NSCP Letter; CT Treasurer 
Letter; Skadden Letter; ICI Letter; IAA Letter.
    \242\ See, e.g., NY City Bar Letter; Dechert Letter; IAA Letter.
    \243\ See, e.g., T. Rowe Price Letter; NSCP Letter; CT Treasurer 
Letter.
---------------------------------------------------------------------------

    Other commenters recommended an alternative exception for 
inadvertent contributions that would not require that an otherwise-
triggering contribution be returned.\244\ They contended that such an 
exception should be available to advisers with policies and procedures 
in place to prevent pay to play that include sanctions for employees 
violating the policies.\245\ Such an approach excludes any objective 
indication that the contribution was inadvertent. As noted above, 
policies and procedures are required to ensure compliance with our 
rule. But policies and procedures alone, without critical objective 
criteria, such as obtaining a return of the contribution, are 
insufficient in our view to justify an exception to our prophylactic 
rule.
---------------------------------------------------------------------------

    \244\ See, e.g., IAA Letter (suggesting that we require, as a 
condition for such an exception, that ``such contribution resulted 
in an inadvertent violation, meaning violations that are not 
reasonably known or condoned by the investment adviser and where the 
contributor lacked intent to influence the award of the advisory 
contract or violate the rule in making the contribution, as 
evidenced by the facts and circumstances surrounding such 
contribution'').
    \245\ See, e,g., IAA Letter; Dechert Letter; NY City Bar Letter.
---------------------------------------------------------------------------

    Some commenters urged us to modify or eliminate the requirement 
that the contribution be discovered by the adviser within four 
months.\246\ We believe, however, that four months is the appropriate 
timeframe. We believe advisers should have a reasonable amount of time 
to discover contributions made by covered associates if, for example, 
their covered associates disclose their contributions to the adviser on 
a quarterly basis.\247\ The absence of such a time limitation would 
encourage advisers not to seek to discover such contributions if they 
believed they could simply rely on the exception any time a 
contribution happened to come to light.
---------------------------------------------------------------------------

    \246\ See, e.g., T. Rowe Price Letter (arguing that, if an 
adviser has in place procedures to require covered associates to 
report all contributions no less frequently than quarterly, and an 
associate fails to report a contribution in violation of the 
procedures, the discovery of a prohibited contribution outside this 
four-month window should not preclude the use of this exception.). 
But see Fund Democracy/Consumer Federation Letter (urging us to 
consider shortening the time in which a contribution must be 
discovered for the exception to be available to one month).
    \247\ Quarterly compliance reporting is familiar to advisory 
personnel. See, e.g., rule 204A-1 under the Advisers Act (requiring 
that, under an adviser's code of ethics, personnel report personal 
securities trading activity at least quarterly). We do not believe 
the exception should be available where it takes longer for advisers 
to discover contributions made by covered associates because they 
might enjoy the benefits of a contribution's potential influence for 
too long a period of time. The condition that the contribution be 
discovered within four months is consistent with the MSRB's 
approach. See MSRB rule G-37(j)(i).
---------------------------------------------------------------------------

    A number of commenters suggested the exception be allowed for all 
contributions regardless of dollar amount, while a few recommended 
raising the dollar amount to $1,000.\248\ As we noted above, we view 
the limitation on the amount of such a contribution, in conjunction 
with the other conditions of the exception, important to the rule 
because it is more likely that the contribution was, in fact, 
inadvertent. We have modified this ``automatic'' exception from our 
proposal by raising the limit on contributions eligible for the 
exception to $350, the same amount we have adopted as a de minimis 
threshold for contributions to an official for whom a covered associate 
is entitled to vote.\249\ In addition, at the suggestion of commenters 
who argued that our proposed limitation on the annual use of such 
exception failed to take into consideration the different size of 
advisers,\250\ we have modified our proposal to permit use of the 
exception three times in any year by an adviser that has reported on 
its Form ADV registration statement that it had more than 50 employees 
who perform investment advisory functions.\251\
---------------------------------------------------------------------------

    \248\ See, e.g., SIFMA Letter; NASP Letter; Holl Letter; NSCP 
Letter; ICI Letter; MFA Letter.
    \249\ Rule 206(4)-5(3)(i)(B). No automatic exception is 
available for any contributions to an official for whom the covered 
associate is entitled to vote that exceed the de minimis $350 
amount. As explained above, we believe that $350 is the appropriate 
de minimis threshold for contributions to officials for whom a 
covered associate is entitled to vote and $150 is the appropriate de 
minimis threshold for contributions to officials for whom a covered 
associate it not entitled to vote. See section II.B(6) of this 
Release. Because these thresholds are different, we anticipate that 
covered associates could mistakenly make contributions up to the 
higher threshold under the mistaken belief that they are entitled to 
vote for an official when in fact they are not entitled to do so. So 
long as those contributions are returned and the other conditions of 
the exception are met, we believe they should be eligible for the 
automatic exception.
    \250\ See, e.g., Skadden Letter; T. Rowe Price Letter; NSCP 
Letter; ICI Letter; IAA Letter.
    \251\ See supra note 238.
---------------------------------------------------------------------------

    The exception is intended to provide advisers with the ability to 
undo certain mistakes. Because it operates automatically,\252\ we 
believe it should be subject to conditions that are objective and 
limited in order to capture only those contributions that are unlikely 
to raise pay to play concerns.\253\
---------------------------------------------------------------------------

    \252\ The exception is ``automatic'' in the sense that an 
adviser relying on it may do so without notifying the Commission or 
its staff. However, we note that the recordkeeping obligations for 
registered advisers mandate specifically that an adviser maintain 
records regarding contributions with respect to which the adviser 
has invoked this exception. Rule 204-2(a)(18)(ii)(D). See also 
section II.D of this Release.
    \253\ As discussed below in section II.B.2(f) of this Release, 
in other circumstances, advisers can apply to the Commission for an 
exemption from the rule's two-year time out. See rule 206(4)-5(e).
---------------------------------------------------------------------------

(b) Ban on Using Third Parties To Solicit Government Business
    Rule 206(4)-5 makes it unlawful for any investment adviser subject 
to the rule or any of the adviser's covered associates to provide or 
agree to provide, directly or indirectly,

[[Page 41037]]

payment \254\ to any person to solicit \255\ government clients for 
investment advisory services on its behalf.\256\ The prohibition is 
limited to third-party solicitors. Thus, the prohibition does not apply 
to any of the adviser's employees, general partners, managing members, 
or executive officers.\257\ Contributions by these persons, however, 
may trigger the two-year time out. As discussed in more detail below, 
the prohibition also does not apply to certain ``regulated persons'' 
that themselves are subject to prohibitions against engaging in pay to 
play practices.\258\
---------------------------------------------------------------------------

    \254\ The term ``payment'' is defined in rule 206(4)-5(5)(f) as 
any gift, subscription, loan, advance, or deposit of money or 
anything of value. Depending on the specific facts and 
circumstances, payment can include quid pro quo arrangements whereby 
a non-affiliated person solicits advisory business for the adviser 
in exchange for being hired by the adviser to provide other 
unrelated services. This approach is consistent with the MSRB's with 
regard to MSRB rule G-38's third-party solicitor ban. See MSRB, 
Interpretive Notice on the Definition of Solicitation under Rules G-
37 and G-38 (June 8, 2006), available at http://msrb.org/msrb1/
rules/notg38.htm. But see infra note 257 (discussing the provision 
of professional services by third parties).
    \255\ For the definition of what it means to ``solicit'' a 
client or prospective client to provide investment advisory 
services, which we are adopting as proposed, see text accompanying 
note 185. This definition is consistent with the definition the MSRB 
employs for similar purposes in rule G-38, the MSRB's rule that 
restricts third-party solicitation activity. MSRB rule G-38(b)(i).
    \256\ Rule 206(4)-5(a)(2)(i). See also Proposing Release, at 
section II.A.3(b).
    \257\ Rule 206(4)-5(a)(2)(i). We note that, so long as non-
affiliated persons providing legal, accounting, or other 
professional services in connection with specific investment 
advisory business are not being paid directly or indirectly by an 
investment adviser for communicating with a government entity (or 
its representatives) for the purpose of obtaining or retaining 
investment advisory business for the adviser--i.e., they are paid 
solely for their provision of legal, accounting, or other 
professional services with respect to the business--they would not 
become subject to the ban on payments by advisers to third-party 
solicitors. This approach is similar to the MSRB's with regard to 
MSRB rule G-38's third-party solicitor ban. See MSRB, Interpretive 
Notice on the Definition of Solicitation under Rules G-37 and G-38 
(June 8, 2006), available at http://msrb.org/msrb1/rules/notg38.htm.
    \258\ This exception, which is responsive to commenters' 
concerns, is a modification of our proposal. As discussed below, we 
also eliminated an exception in our proposal that would have applied 
to ``related persons'' of the adviser and, if such ``related 
person'' were a company, an employee of the ``related person.'' See 
Proposing Release, at section II.A.3(b).
---------------------------------------------------------------------------

    We proposed to prohibit advisers from paying third parties in order 
to prevent advisers from circumventing the rule.\259\ We observed in 
the Proposing Release that solicitors or ``placement agents'' have 
played a central role in actions that we and other authorities have 
brought involving pay to play schemes; \260\ in several instances, 
advisers allegedly made significant payments to placement agents and 
other intermediaries in order to influence the award of advisory 
contracts.\261\ We noted that government authorities in New York and 
other jurisdictions have prohibited or are considering limiting or 
prohibiting the use of consultants, solicitors, or placement agents by 
investment advisers to solicit government business.\262\ We considered 
the MSRB's experience with solicitors, which ultimately led it to ban 
municipal securities dealers from hiring consultants to solicit 
government clients after concluding that less restrictive approaches 
were ineffective to prevent circumvention of MSRB rule G-37.\263\ We 
recalled comment letters we received in 1999 from advisers asserting 
that they should not be held accountable for the political 
contributions of their third-party solicitors whom, they asserted, 
advisers lacked the ability to control.\264\
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    \259\ See Proposing Release, at section II.A.3(b).
    \260\ Id. at sections I and II.A.3(b).
    \261\ Id. at section II.A.3(b).
    \262\ Id. Since our proposal, a few State and local governments 
have undertaken actions to prohibit or regulate pay to play 
practices involving placement agents in response to concerns about 
to pay to play activities in their jurisdictions. For example, New 
York City Comptroller John C. Liu announced reforms relating to how 
the New York City pension funds make investments (including 
prohibitions on gifts and campaign contributions, strict rules on 
employees of the Office of New York City Comptroller, employees and 
trustees of the New York City pension systems, fund managers, and 
placement agents, and an expansion of the ban on private equity 
placement agents to include placement agents to other types of funds 
while providing an exclusion for legitimate placement agents who 
provide value-added services). See Office of the New York City 
Comptroller, Comptroller Liu Announces Major Reforms to Pension Fund 
Investments, Press Release, Feb. 18, 2010, available at http://
www.comptroller.nyc.gov/press/2010_releases/pr10-02-022.shtm. A 
bill was introduced in California that would treat placement agents 
soliciting government entity clients as lobbyists and therefore 
restrict them from charging contingency fees. See Assem. B. 1743, 
2009-10 Leg., Reg. Sess. (Cal. 2010), available at http://
info.sen.ca.gov/pub/09-10/bill/asm/ab_1701-1750/ab_1743_bill_
20100208_introduced.html. See also Cal. Gov't. Code Sec.  86205(f) 
(Deering 2010). Another law was passed in California on an emergency 
basis imposing new disclosure obligations and prohibitions regarding 
placement agents. See Assem. B. 1854, 2009-10 Leg., Reg. Sess. (Cal. 
2010) available at http://info.sen.ca.gov/pub/09-10/statute/ch_
0301-0350/ch_301_st_2009_ab_1584. See also CalPERS, CalPERS 
Releases Placement Agent Disclosures, Press Release, Jan. 14, 2010, 
available at http://www.calpers.ca.gov/index.jsp?bc=/about/press/pr-
2010/jan/agent-disclosures.xml. (discussing recent actions by 
CalPERS to make public more than 600 placement agent disclosures 
from the fund's external managers).
    \263\ See Proposing Release, at n.130 and accompanying text. See 
also MSRB Letter (``Due to concerns regarding questionable practices 
by some consultants and a determination by the MSRB that it would be 
in the public interest to make the process of soliciting municipal 
securities business fully subject to the MSRB rules of fair practice 
and professionalism, the MSRB rescinded its original rule in 2005 
and adopted new Rule G-38, on solicitation of municipal securities 
business, to prohibit dealers from using paid third-party 
consultants to obtain municipal securities business on their 
behalf.'').
    \264\ In 1999, the Commission proposed a similar rule, which 
also would have been codified as rule 206(4)-5 under the Advisers 
Act, had it been adopted. See Political Contributions by Certain 
Investment Advisers, Investment Advisers Act Release No. 1812 (Aug. 
4, 1999) [64 FR 43556 (Aug. 10, 1999)] (``1999 Proposing Release''). 
Comments on that proposal received electronically (comment file S7-
19-99) are available at http://www.sec.gov/rules/proposed/
s71999.shtml. Among the commenters on the 1999 Proposing Release who 
argued that advisers should not be held accountable for the 
political contributions of their third-party solicitors are: Comment 
Letter of Davis Polk (Nov. 1, 1999); Comment Letter of Legg Mason 
(Nov. 1, 1999); Comment Letter of MSDW (Nov. 1, 1999). At least one 
commenter on our 2009 proposal, although opposing the proposed 
third-party solicitor ban, took the same view. See MFA Letter (``We 
strongly agree with the SEC's comment in the Release that ``covered 
associates'' should not include employees of entities unaffiliated 
with an investment adviser, such as the employees of a third-party 
placement agent. An investment adviser would not have the authority 
or capability to monitor and restrict political contributions made 
by individuals not employed by the adviser.'').
---------------------------------------------------------------------------

    The record before us raised deeply troubling concerns about 
advisers' use of third-party solicitors to engage in pay to play 
activities.\265\ We were concerned that a rule that failed to address 
the use of these solicitors would be ineffective were advisers simply 
to begin using solicitors and placement agents that have made political 
contributions or payments funded in part or in whole by the fees they 
receive from advisers.\266\ Therefore, we proposed to prohibit advisers 
from engaging third parties to solicit government clients on their 
behalf.\267\ In doing so, we requested comments on alternative 
approaches we could take.\268\ We wanted to know whether there might be 
a more effective means to accomplish our objectives, or means that 
would be less restrictive.
---------------------------------------------------------------------------

    \265\ See Proposing Release, at section I; section I of this 
Release. Moreover, ``no smoking gun is needed where, as here, the 
conflict of interest is apparent, the likelihood of stealth great, 
and the legislative purpose prophylactic.'' Blount, 61 F.3d at 945.
    \266\ See Proposing Release, at section II.A.3(b). Some 
commenters have supported this approach. See, e.g., Fund Democracy/
Consumer Federation Letter (``Permitting advisers to circumvent pay-
to-play restrictions by hiring solicitors would eviscerate the heart 
of the direct prohibition against advisers' bribing politicians in 
return for money management contracts.''). We also noted commenters' 
concerns regarding the difficulties advisers face in monitoring the 
activities of their third-party solicitors. See Proposing Release, 
at section II.A.3(b).
    \267\ See Proposing Release, at section II.A.3(b).
    \268\ See id.
---------------------------------------------------------------------------

    We received a large number of comments on this question. We 
received letters from the New York State Comptroller and New York City 
Comptroller that expressed strong support for the ban on using third

[[Page 41038]]

parties to solicit government plans.\269\ One commenter supporting the 
ban pointed out the key role that placement agents have played in pay 
to play practices.\270\ It expressed concern that adopting the rule 
without the ban would exacerbate the problem by placing more pressure 
on advisers to pay ``well-connected'' placement agents for access since 
the advisers will be limited in their contributions.\271\ Another 
commenter expressed the view that ``the most egregious violations of 
the public trust in this area have come from placement agents and those 
seeking finder's fees. The outright ban on their use to deter pay-to-
play schemes is entirely appropriate.'' \272\
---------------------------------------------------------------------------

    \269\ DiNapoli Letter; Thompson Letter (as indicated in note 262 
above, NYC Comptroller Liu recently announced his office's approach 
to third-party solicitors).
    \270\ Fund Democracy/Consumer Federation Letter.
    \271\ Id.
    \272\ Common Cause Letter. See also Cornell Law Letter 
(generally supporting the prohibition on using third-party 
solicitors ``given that third-party solicitors have played a central 
role in each of the enforcement actions against investment advisors 
that the Commission has brought in the past several years involving 
pay-to-play schemes.'').
---------------------------------------------------------------------------

    Most commenters, including many representing advisers, broker-
dealers, placement agents and solicitors, and some government 
officials, however, strongly opposed the ban. Many asserted that 
solicitors, consultants and placement agents provide valuable services 
both for advisers seeking clients and for the public pension plans that 
employ them and that banning their use would have several deleterious 
effects.\273\ Several claimed that the rule would favor banks because 
banks are excluded from the definition of ``investment adviser'' under 
the Advisers Act and therefore are not subject to the Commission's 
rules, including rule 206(4)-5.\274\ Others claimed the rule would 
favor larger investment advisers (which have internal marketing 
departments) over smaller firms.\275\ Other commenters asserted the ban 
would harm smaller pension funds that do not have the resources to 
conduct a search for advisers on their own, and harm advisers that rely 
on the services that placement agents provide.\276\ A number of 
commenters argued that the prohibition would reduce competition by 
reducing the number of advisers competing for government business,\277\ 
and limit the universe of investment opportunities presented to public 
pension funds.\278\
---------------------------------------------------------------------------

    \273\ See, e.g., Comment Letter of Senator Christopher J. Dodd 
(Feb. 2, 2010) (``Dodd Letter''); NY City Bar Letter; Dechert 
Letter; ABA Letter; Comment Letter of Teacher Retirement System of 
Texas (Oct. 12, 2009); Comment Letter of Bryant Law (Oct. 9, 2009) 
(``Bryant Law Letter''); Comment Letter of Probitas Partners (Oct. 
6, 2009) (``Probitas Letter''); Comment Letter of Larry Simon (Oct. 
6, 2009) (``Simon Letter''); Comment Letter of MarketCounsel, LLC 
(Oct. 6, 2009); ICI Letter; Comment Letter of Colorado Public 
Employees' Retirement Association (Oct. 6, 2009); Skadden Letter.
    \274\ See Advisers Act section 202(a)(11)(A) [15 U.S.C. 80b-
2(a)(11)(A)] (excepting from the definition of ``investment 
adviser,'' and therefore from regulation under the Advisers Act, ``a 
bank, or any bank holding company as defined in the Bank Holding 
Company Act of 1956, which is not an investment company * * *.''). 
We discuss possible competitive effects of our rule's 
inapplicability to banks in section VI of this Release. We believe 
that the concerns the rule is designed to address, as discussed 
throughout this Release, warrant its adoption, notwithstanding these 
potential competitive effects.
    \275\ See, e.g., SIFMA Letter; IAA Letter; MFA Letter; Comment 
Letter of National Conference on Public Employee Retirement Systems 
(Oct. 6, 2009) (``NCPERS Letter''); Comment Letter of European 
Private Equity & Venture Capital Association (Sept. 9, 2009) (``EVCA 
Letter''); Seward & Kissel Letter; Comment Letter of Sadis & 
Goldberg LLP (Oct. 2, 2009) (``Sadis & Goldberg Letter''); Comment 
Letter of State of Wisconsin Investment Board (Aug. 31, 2009) (``WI 
Board Letter''); Comment Letter of the Executive Director of Georgia 
Firefighters' Pension Fund, James R. Meynard, (Sept. 3, 2009) (``GA 
Firefighters Letter''); Comment Letter of Minnesota State Board of 
Investment (Sept. 8, 2009) (``MN Board Letter''); Comment Letter of 
Illinois Public Pension Fund Association (Sept. 29, 2009) (``IL Fund 
Association Letter''); Comment Letter of Melvyn Aaronson, Sandra 
March and Mona Romain, Trustees of the Teachers' Retirement System 
of the City of New York (Oct. 1, 2009) (``NYC Teachers Letter''); 
Comment Letter of the Texas Association of Public Employee 
Retirement Systems (Oct. 6, 2009) (``TX Public Retirement Letter''); 
Comment Letter of the Pennsylvania Public School Employees' 
Retirement Board (Oct. 6, 2009) (``PA Public School Retirement 
Letter''); Comment Letter of the California State Association of 
County Retirement Systems (Sept. 8, 2009) (``CA Assoc. of County 
Retirement Letter''); Caplin & Drysdale Letter; Comment Letter of 
Paul Ehrmann (Aug. 10, 2009) (``Ehrmann Letter''); Comment Letter of 
Joseph Finn (Aug. 10, 2009) (``Finn Letter''); Comment Letter of the 
Managing Partner of The Savanna Real Estate Fund I, LLP, Nicholas 
Bienstock (Aug. 11, 2009) (``Savanna Letter''); Comment Letter of 
Atlantic-Pacific Capital, Inc. (Aug. 12, 2009) (``Atlantic-Pacific 
Letter''); Comment Letter of Tricia Peterson (Aug. 14, 2009) 
(``Peterson Letter''); Comment Letter of Devon Self Storage Holdings 
(US) LLC (Aug. 21, 2009) (``Devon Letter''); Comment Letter of 
Thomas Capital Group, Inc. (Aug. 24, 2009) (``Thomas Letter''); 
Comment Letter of Stephen R. Myers (Aug. 26, 2009) (``Myers 
Letter''); Comment Letter of Chaldon Associates LLC (Aug. 26, 2009) 
(``Chaldon Letter''); Comment Letter of The Meridian Group (Aug. 26, 
2009) (``Meridian Letter''); Comment Letter of Benedetto, Gartland & 
Company, Inc. (Sept. 30, 2009) (``Benedetto Letter''); Comment 
Letter of the Partners of CSP Securities, LP and Capstone Partners, 
LP (Sept. 17, 2009) (``Capstone Letter''); Comment Letter of 
Presidio Partners LLC Managing Partner Alan R. Braxton (Sept. 21, 
2009) (``Braxton Letter''); Comment Letter of Littlejohn & Co., LLC 
(Sept. 14, 2009) (``Littlejohn Letter''); Comment Letter of Alta 
Communications (Sept. 18, 2009) (``Alta Letter''); Comment Letter of 
Charles River Realty Investors LLC (Sept. 23, 2009) (``Charles River 
Letter''); Comment Letter of W. Allen Reed (Sept. 19, 2009) (``Reed 
Letter''); Comment Letter of Glovista Investments LLC (Sept. 23, 
2009) (``Glovista Letter''); Comment Letter of The Blackstone Group 
(Sept. 14, 2009) (``Blackstone Letter''); Park Hill Letter. Two 
commenters noted that the ban would result in less transparency as 
these services go ``in-house.'' CalPERS Letter; Bryant Law Letter. 
Others commented on the effects on minority and women-owned firms. 
See, e.g., NYC Teachers Letter, Myers Letter; GA Firefighters 
Letter; MN Board Letter; Blackstone Letter.
    \276\ See, e.g., Dodd Letter; NY City Bar Letter; Dechert 
Letter; ABA Letter; Probitas Letter; Seward & Kissel Letter; MFA 
Letter.
    \277\ See, e.g., Seward & Kissel Letter; Meridian Letter; NY 
City Bar Letter; Probitas Letter; Simon Letter; MFA Letter.
    \278\ See, e.g., SIFMA Letter; IAA Letter; Strategic Capital 
Letter; Alta Letter; Benedetto Letter; Comment Letter of Jim Glantz 
(Sept. 24, 2009) (``Glantz Letter''); Comment Letter of Venera 
Kurmanaliyeva (Sept. 15, 2009) (``Kurmanaliyeva Letter''); Park Hill 
Letter.
---------------------------------------------------------------------------

    Many of these commenters conceded that there is a problem with 
placement agents and other intermediaries, but asserted it is caused by 
a few bad actors, for which an entire industry should not be 
penalized.\279\ A common theme among many commenters was that the rule 
failed to distinguish ``illegitimate'' consultants and placement agents 
from the ``legitimate'' ones who provide an important service.\280\
---------------------------------------------------------------------------

    \279\ See, e.g., Comment Letters of Brady Pyeatt (Aug. 4, 2009) 
& (Oct. 6, 2009); Comment Letter of Andrew Wang (Aug. 10, 2009); 
Comment Letter of Monomoy Capital Management, LLC (Aug. 25, 2009) 
(``Monomoy Letter''); Comment Letter of Ted Carroll (Aug. 4, 2009); 
Comment Letter of James C. George (Sept. 10, 2009) (``George 
Letter''); Comment Letter of Ariane Capital Partners LLC (Sept. 17, 
2009); Blackstone Letter; Comment Letter of Nancy Fossland (Sept. 
16, 2009); Comment Letter of Steven A. Friedmann (Sept. 14, 2009); 
Comment Letter of Keith P. Harney (Sept. 15, 2009); Comment Letter 
of Robert F. Muhlhauser III (Sept. 14, 2009); Comment Letter of XT 
Capital Partners, LLC (Sept. 30, 2009); CapLink Letter.
    \280\ See, e.g., Bryant Law Letter; Comment Letter of Hedgeforce 
(Oct. 6, 2009) (``Hedgeforce Letter'').
---------------------------------------------------------------------------

    We believe that many of the comments overstate the likely 
consequences of adoption of the rule. First, the rule will not prevent 
public pension plans from hiring their own consultants--i.e., using 
their own resources--to assist them in their search for an investment 
adviser.\281\ These consultants would have access to information about 
smaller advisers whose services may be appropriate for the plan. Many 
public pension plans already make--or are required to make--specific 
accommodations for so-called ``emerging money managers'' that otherwise 
may have difficulty getting noticed by public pension plans.\282\

[[Page 41039]]

Second, these commenters failed to consider the potentially significant 
costs of hiring consultants and placement agents,\283\ which already 
may make them unavailable to smaller advisers. Eliminating the cost of 
pay to play may, in fact, provide greater access to pension plans by 
those advisers which are unable to afford the costs of direct or 
indirect political contributions or placement agent fees.\284\ We 
expect that prohibiting pay to play may reduce the costs to plans and 
their beneficiaries of inferior asset management services arising from 
adviser selection based on political contributions rather than 
investment considerations.\285\ Finally, commenters failed to identify 
any meaningful way in which our rule might distinguish ``legitimate'' 
from ``illegitimate'' solicitors or placement agents. Even solicitors 
and placement agents that engage in pay to play may appear to operate 
``legitimately.'' \286\
---------------------------------------------------------------------------

    \281\ See Fund Democracy/Consumer Federation Letter (``The 
proposed ban would ``deny access'' to nothing. There is nothing [in 
the proposed rule] preventing pension funds from retaining their own 
consultants whose sole responsibility is to the pension fund and its 
beneficiaries.'').
    \282\ See, e.g., Randy Diamond, CalPERS CIO Joe Dear says 
Emerging Managers Don't Need Placement Agents, Pensions & 
Investments, Feb. 24, 2010, available at http://www.pionline.com/
article/20100224/REG/100229965; Michael Marois, CalPERS, Blackstone 
Clash over Placement Agent ``Jackpot'' Fees, Bloomberg (Apr. 7, 
2010), available at http://www.bloomberg.com/apps/
news?pid=newsarchive&sid=acPNrTn1q7pw (quoting CalPERS CIO Joe Dear, 
``There's clear evidence in past practice that it's possible to 
develop an investment relationship with us by making a normal 
approach, without the assistance of a contingent-paid placement 
agent.''); Ohio Pub. Employees Ret. Sys., Ohio-Qualified and 
Minority Manager Policy (May 2006), available at https://
www.opers.org/pdf/investments/policies/ Ohio-Qualified-Minority-
Manager-Policy.pdf; Teachers' Ret. Sys. of the State of Ill., Fiscal 
Year 2009 Annual Report on the use of Women, Minority and Disabled-
Owned (W/MBE) Investment Advisors and Broker/Dealers (Aug. 31, 
2009), available at http://trs.illinois.gov/subsections/investments/
minorityrpt.pdf; Md. State Ret. and Pension Sys., Terra Maria: The 
Maryland Developing Manager Program, available at http://
www.sra.state.md.us/Agency/Investment/Downloads/
TerraMariaDevelopingManagerProgram-Description.pdf; Thurman V. 
White, Jr., Progress Inv. Mgmt. Co., Successful Emerging Manager 
Strategies for the 21st Century, 3 (2008), available at http://
www.progressinvestment.com/content/files/successful_emerging_
manager_strategies.pdf (containing a ``representative list of known 
U.S. Pension Plans that have committed assets to emerging manager 
strategies'').
    \283\ One commenter made a similar point: ``The proposed ban 
would simply replace the indirect cost of placement agents incurred 
by pension plan sponsors with the direct cost of hiring their own 
placement agents--without the conflict of interest and potential for 
abuse that relying on advisers' placement agents creates. It is not 
the cost of independent advice that the Commission has not accounted 
for in its proposal, but the cost of conflicts that critics have 
failed to acknowledge in their analysis.'' Fund Democracy/Consumer 
Federation Letter.
    \284\ At least one commenter agreed. See Butler Letter (``[W]e 
find some evidence that the pay to play practices by underwriters 
[before rule G-37 was adopted] distorted not only the fees, but 
which firms were allocated business. The current proposal mentions 
that pay to play practices may create an uneven playing field among 
investment advisers by hurting smaller advisers that cannot afford 
to make political contributions. We find evidence that is consistent 
with this view [in our research on pay to play by municipal 
underwriters]. During the pay to play era, municipal bonds were 
underwritten by investment banks with larger underwriting market 
shares compared to afterward. One interpretation of this result is 
that smaller underwriters were passed over in favor of larger 
underwriters (who presumably had deeper pockets for political 
contributions).''). As we indicated in the Proposing Release, pay to 
play practices may hurt smaller advisers that cannot afford the 
required contributions. Curtailing pay to play arrangements enables 
advisory firms, particularly smaller advisory firms, to compete on 
merit, rather than their ability or willingness to make 
contributions. See Proposing Release, at sections I and IV.
    \285\ See Tobe Letter (describing an under-performing money 
manager that was fired after the commenter, a pension official, 
began to inquire into how it was selected); Weber Letter (``I have 
seen money managers awarded contracts with our fund which involved 
payments to individuals who served as middlemen, creating needless 
expense for the fund. These middlemen were political contributors to 
the campaigns of board members who voted to contract for money 
management services with the companies who paid them as 
middlemen.'').
    \286\ See Blount, 61 F.3d at 944 (``actors in this field are 
presumably shrewd enough to structure their relations rather 
indirectly'').
---------------------------------------------------------------------------

    Some commenters suggested alternatives to our proposed ban to 
address our concern that pay to play activities are often carried out 
through or with the assistance of third parties.\287\ Several 
commenters, for example, suggested that we instead require greater 
disclosure by advisers of payments to solicitors.\288\ Such an approach 
could be helpful to give plan fiduciaries information necessary for 
them to satisfy their legal obligations and uncover abuses,\289\ but it 
would not be useful when plan fiduciaries themselves are participants 
in the pay to play activities.\290\ In addition, as one commenter 
pointed out, the MSRB had already sought unsuccessfully to address the 
problem of placement agents and consultants engaging in pay to play 
activities on their principals' behalf through mandating greater 
disclosure.\291\
---------------------------------------------------------------------------

    \287\ We note that, in addition to the alternatives discussed 
below, some commenters called for approaches outside the scope of 
our authority, such as an outright ban on all political 
contributions by third-party solicitors, the imposition of criminal 
penalties, or modification of the structure of pension boards. See, 
e.g., Monomoy Letter (arguing that the Commission or the appropriate 
criminal authority should mandate jail time for public officials and 
intermediaries where the official gets a benefit from a public fund 
investment in a particular fund, that all managers of intermediaries 
who receive fees in such transactions should be banned from the 
financial services industry for life, and that all members of the 
general partner (manager) of the fund in which the investment is 
made be banned from the financial services industry for life); 
NCPERS Letter (arguing that the most effective method of eliminating 
pay to play is by having multiple trustees on public pension 
boards); Thomas Letter (suggesting that stronger internal control 
procedures, segregation of duties and dispersed or committee 
approval of granting pension business could help prevent pay to play 
activities, each of which historically has involved a complicit 
senior public plan fund official); Comment Letter of the 
Massachusetts Pension Reserves Investment Management Board (Aug. 26, 
2009) (``PRIM Board Letter''); Preqin Letter I (acknowledging that 
it is outside the remit of the Commission, but arguing that there 
should be better oversight of public pension funds, and investment 
committees should consist of a minimum number of members in order to 
prevent a sole official being responsible for the investment-
decision process); Triton Pacific Letter (arguing that the 
Commission should adopt regulation of pension officials who are 
often responsible for initiating pay to play arrangements).
    \288\ Several commenters urged us to require advisers to 
disclose to clients their payments to third-party solicitors and 
placement agents. See, e.g., ABA Letter; 3PM Letter; ICI Letter; NY 
City Bar Letter; Comment Letter of Forum Capital Securities, LLC 
(Oct. 5, 2009) (``Forum Letter''); Jones Day Letter; CapLink Letter. 
Some asserted that existing disclosure requirements, such as those 
included in the Commission's investment adviser cash solicitation 
rule, are sufficient to address pay to play. See, e.g., Comment 
Letter of Steven Rubenstein (Aug. 17, 2009) (``Rubenstein Letter'') 
(noting that Advisers Act rule 206(4)-3 [17 CFR 275.206(4)-3], the 
``cash solicitation rule,'' is adequate as is, but ``just needs to 
be followed''); Thomas Letter (supporting ``enforcement of existing 
disclosure rules''); Chaldon Letter (arguing that, in the scandals 
that have recently occurred, if the fee sharing arrangements had 
been disclosed to pension fund boards, no law or regulation would 
have been violated, and that third-party marketers should adhere to 
current law instead of banning a legitimate business practice); 
Comment Letter of Ray Wirta (Sept. 4, 2009) (arguing that all that 
is necessary is that penalties should be heightened, enforcement 
stepped up and results highly publicized); Arrow Letter (arguing 
that enforcement of the Advisers Act and FINRA requirements have 
ensured lawful and ethical business practices for decades); 3PM 
Letter (arguing that the rule's scope could be extended to include 
various additional disclosures). But we do not believe, for the 
reasons described above, that enforcement of existing obligations 
alone is sufficient to deter pay to play activities.
    \289\ Some public pension plans have adopted policies requiring 
advisers they hire to disclose information about placement agents, 
including their political connections. See, e.g., Cal. Pub. 
Employees Ret. Sys., CalPERS Adopts Placement Agent Policy--Requires 
Disclosure of Agents, Fees, Press Release (May 11, 2009), available 
at http://www.calpers.ca.gov/index.jsp?bc=/about/press/ pr-2009/may/
adopts-placement-agent-policy.xml.
    \290\ For examples of cases in which plan fiduciaries themselves 
have allegedly participated in pay to play activities involving 
placement agents, see New York v. Henry ``Hank'' Morris and David 
Loglisci, Indictment No. 25/2009 (NY Mar. 19, 2009) (a public 
official was alleged to be a beneficiary of the pay to play 
activities); SEC v. Paul J. Silvester, et al., Litigation Release 
No. 16759, Civil Action No. 3:00-CV-19411 DJS (D. Conn. 2000) 
(former Connecticut State Treasurer was alleged to be a beneficiary 
of a pay to play scheme in which an investment adviser to a private 
equity fund had paid third-party solicitors to obtain public pension 
fund investments in the fund). See also Proposing Release, at n.49 
(discussing additional reasons why we believe a disclosure approach 
would not effectively address our concerns regarding pay to play 
activities).
    \291\ Cornell Law Letter (``For example, after concluding that 
required disclosure was neither adequate to prevent circumvention 
nor consistently being made, the [MSRB] amended its own rules on 
pay-to-play practices in the municipal securities markets to impose 
a complete ban on the use of third-party consultants to solicit 
government clients.'' (citations omitted)). See also 3PM Letter 
(acknowledging that, although increased transparency by all parties 
involved in the investment process who might have the ability to 
exert influence, including advisers, third-party marketers, public 
officials or other trustees, etc., is necessary to minimize the 
adverse effects of pay to play, the issue will not be completely 
solved by disclosure).

---------------------------------------------------------------------------

[[Page 41040]]

    Other commenters recommended that we rely on voluntary industry 
codes of conduct.\292\ But we believe, in light of the growing body of 
evidence of advisers' use of third-party solicitors to engage in pay to 
play activities we describe above, that voluntary actions are 
insufficient to deter pay to play, which may yield lucrative management 
contracts.\293\ As we discuss above, pay to play involves a 
``collective action'' problem that is unlikely to be resolved by 
voluntary actions.\294\ Elected officials who accept contributions from 
State contractors may believe they have an advantage over their 
opponents who foreswear the contributions, and firms that do not 
``pay'' may fear that they will lose government business to those that 
do.\295\
---------------------------------------------------------------------------

    \292\ See, e.g., MVision Letter (arguing that self-regulatory 
initiatives such as the EVCA's Code of Conduct for Placement Agents 
are working and that many public pension plans' own anti-pay to play 
policies have been successful); EVCA Letter (describing its Code of 
Conduct that prohibits pay to play and is supported by various 
stakeholders and arguing that it, along with strong punishment of 
wrongdoers, should restore confidence in the process). Another 
commenter suggested a code of conduct enforceable by regulators. 
Comment Letter of Charlie Eaton on behalf of a Coalition of 
Professional Institutional Placement Agents (Sept. 9, 2009) 
(proposing an industry Code of Conduct that could be enforced by 
FINRA and the Commission, which should ban firms that do not adhere 
from doing business with all potential investors, public and 
private). In our view, the rule we are adopting today not only 
essentially serves this purpose, but more appropriately reflects 
prohibitions we, instead of others, have determined appropriately 
address our concerns.
    \293\ See Proposing Release, at sections I and II.A.3(b). See 
also section I of this Release.
    \294\ See supra note 58 and accompanying text.
    \295\ See Blount, 61 F.3d at 945-46 (describing the parallel 
dynamics applicable in municipal underwriting, ``As beneficiaries of 
the practice, politicians vying for State or local office may be 
reluctant to stop it legislatively; some, of course, may seek to 
exploit their rivals' cozy relation with bond dealers as a campaign 
issue, but if they refuse to enter into similar relations, their 
campaigns will be financially handicapped. Bond dealers are in a 
still worse position to initiate reform: Individual firms that 
decline to pay will have less chance to play, and may even be the 
object of explicit boycott if they do.'').
---------------------------------------------------------------------------

    Other commenters recommended that we amend our rules to require 
that advisers amend their codes of ethics to monitor contributions by 
third-party solicitors.\296\ But advisers using third-party solicitors 
to circumvent pay to play restrictions are well aware of these 
payments, and are unlikely to be deterred by a monitoring requirement. 
In addition, adviser codes of ethics are unlikely to be a sufficient 
means to induce third-party solicitors to be transparent about their 
own pay to play activities.
---------------------------------------------------------------------------

    \296\ See, e.g., ABA Letter; 3PM Letter; ICI Letter; NY City Bar 
Letter; Forum Letter; Jones Day Letter.
---------------------------------------------------------------------------

    Instead of suggesting alternative approaches, other commenters 
urged us to apply the rule more narrowly by exempting from the ban 
solicitors that are registered broker-dealers or associated persons of 
broker-dealers.\297\ Some were concerned that the rule would interfere 
with traditional distribution arrangements of mutual funds and private 
funds, which are usually distributed by registered broker-dealers that 
may be compensated by the adviser in some form.\298\ Many argued that 
registration as a broker-dealer generally differentiates placement 
agents that provide ``legitimate'' services from those that merely 
offer political influence.\299\ Others expressed concern that some 
broker-dealer firms that rely on placement agent business could be 
harmed.\300\ We recognize that services that commenters have identified 
as beneficial would typically require broker-dealer registration. But 
registration under the Exchange Act does not preclude a broker-dealer 
from participating in pay to play practices--MSRB rules G-37 and G-38 
do not apply, for example, to broker-dealers soliciting investments on 
behalf of investment companies or private funds.\301\ Thus, amending 
our rule to limit third parties soliciting governments to broker-
dealers registered under the Exchange Act would not achieve the 
prophylactic purpose of this rulemaking. We believe that our approach 
is appropriate in light of the concerns we are seeking to address.\302\
---------------------------------------------------------------------------

    \297\ See, e.g., Davis Polk Letter; Comment Letter of UBS 
Securities LLC (Oct. 2, 2009) (``UBS Letter'').
    \298\ See, e.g., SIFMA Letter; NY City Bar Letter; Monomoy 
Letter; IAA Letter. Mutual fund distribution fees are typically paid 
by the fund pursuant to a 12b-1 plan, and therefore generally would 
not constitute payment by the fund's adviser. As a result, such 
payments would not be prohibited by rule 206(4)-5 by its terms. 
Where an adviser pays for the fund's distribution out of its 
``legitimate profits,'' however, the rule would generally be 
implicated. For a discussion of a mutual fund adviser's ability to 
use ``legitimate profits'' for fund distribution, see Bearing of 
Distribution Expenses by Mutual Funds, Investment Company Act 
Release No. 11414 (Oct. 28, 1980) [45 FR 73898 (Nov. 7, 1980)] 
(explaining, in the context of the prohibition on the indirect use 
of fund assets for distribution, unless pursuant to a 12b-1 plan, 
``[h]owever, under the rule there is no indirect use of fund assets 
if an adviser makes distribution related payments out of its own 
resources * * *. Profits which are legitimate or not excessive are 
simply those which are derived from an advisory contract which does 
not result in a breach of fiduciary duty under section 36 of the 
[Investment Company] Act.''). For private funds, third parties are 
often compensated by the adviser or its affiliated general partner 
and, therefore, those payments are subject to the rule. Structuring 
such a payment to come from the private fund for the purpose of 
evading the rule would violate the rule. See Rule 206(4)-5(d).
    \299\ See, e.g., Bryant Law Letter; Hedgeforce Letter; Comment 
Letter of Girard Miller (Aug. 8, 2009); Comment Letter of Frank 
Schmitz (Aug. 11, 2009) (``Schmitz Letter''); Atlantic-Pacific 
Letter; Rubenstein Letter; Thomas Letter; Monomoy Letter; MVision 
Letter; Comment Letter of Lime Rock Management (Sept. 28, 2009); 
Benedetto Letter; Strategic Capital Letter; Comment Letter of 
Portfolio Advisors, LLC (Oct. 2, 2009) (``Portfolio Advisors 
Letter''); UBS Letter; Comment Letter of Brian Fitzgibbon (Oct. 5, 
2009); Comment Letter of GenNx360 Capital Partners, L.P. (Oct. 5, 
2009).
    \300\ Comment Letter of the National Association of Independent 
Broker-Dealers (Oct. 5, 2009).
    \301\ At least one commenter suggested that there are 
``inherent'' safeguards in the broker-dealer regulatory regime 
sufficient to protect against pay to play practices. See, e.g., ABA 
Letter. But the broker-dealer regulatory regime does not 
specifically address pay to play activities, as demonstrated by the 
MSRB's adoption of rules G-37 and G-38.
    \302\ We acknowledge that there are costs associated with our 
rule. For further analysis of these, along with the benefits, see 
sections I and IV of this Release.
---------------------------------------------------------------------------

    Several commenters proposed that we achieve our goals by permitting 
advisers to engage solicitors and placement agents that are registered 
broker-dealers and subject to rules similar to those adopted by the 
MSRB.\303\ One asserted that such rules would be ``a logical extension 
of the already-existing regulatory scheme governing broker-dealers.'' 
\304\ Another agreed, arguing that such rules would be consistent with 
the approach the MSRB took when it adopted MSRB rule G-38, the effect 
of which was to sweep ``all solicitors of municipal business 
(underwriting, sales and advisory) into the broker-dealer registration 
regime'' where they would be subject to oversight of a registered 
broker-dealer and are required to conform their municipal securities 
activities to applicable MSRB rules,

[[Page 41041]]

including MSRB rule G-37.\305\ Others suggested we could similarly 
achieve our goals by permitting advisers to engage as solicitors 
registered investment advisers that are themselves subject to pay to 
play restrictions under an Advisers Act rule.\306\
---------------------------------------------------------------------------

    \303\ Skadden Letter (``The Commission and FINRA could directly 
impose and enforce restrictions on such broker-dealers.''); Davis 
Polk Letter (``Registered broker-dealers that provide legitimate 
placement agent services could be required by the Commission to 
comply with ``pay-to-play'' restrictions''); Credit Suisse Letter 
(preclude an investment adviser from using a placement agent that is 
not subject to pay to play restrictions analogous to rule G-37); 
Comment Letter of the President of M Advisory Group J. Daniel 
Vogelzang (Sept. 18, 2009) (``M Advisory Letter'') (treat ``[a]ll 
placement agents, investment advisers and consultants * * * exactly 
the same regarding prohibited political contributions; i.e., a two-
year ban on doing business with any governmental agency to which a 
prohibited political contribution is made.''). See also Comment 
Letter of Hudson Capital Management (NY), L.P. (Oct. 5, 2009) 
(suggesting Commission take measures to properly license and 
regulate third-party solicitors); SIFMA Letter (``The pay-to-play 
and political activity of registered placement agents involved in 
soliciting government investment could * * * be directly regulated 
under the Exchange Act.''). We believe our rule, as adopted, which 
allows advisers to pay certain regulated third parties to solicit 
government clients on their behalf, addresses these concerns. See 
infra notes 312-26 and accompanying text.
    \304\ Davis Polk Letter.
    \305\ SIFMA Letter (``Although Rule G-38(a) specifically 
prohibits a municipal dealer from paying a fee to a nonaffiliated 
person for solicitation of municipal securities business, the 
policies underlying Rule G-38 were to bring solicitors within the 
purview of the Federal securities laws--not to exclude the 
involvement of registered broker-dealers, including those registered 
broker-dealers not affiliated with advisers and private funds.''). 
See also Monument Group Letter (``We believe that MSRB Rule G-38 is 
not analogous to the proposed rule. Rule G-38 permits a broker-
dealer that is unaffiliated with an issuer to market that issuer's 
securities to a public pension plan or any other investor. Proposed 
Rule 206(4)-5(a)(2)(i) prevents this and seeks to entirely 
disintermediate the process between the issuer of a security and the 
ultimate investor.''); Credit Suisse Letter (``[W]e strongly believe 
that a more complete analogy to the MSRB Pay-to-Play Rules would not 
preclude regulated broker-dealers from performing placement agent 
services in the context of municipal investors, as the Proposed Rule 
would do. Notably, the MSRB Pay-to-Play Rules do not preclude SEC-
registered broker-dealers from acting as placement agents to 
municipal issuers. Instead, the MSRB Pay-to-Play Rules subject such 
placement agents to ``pay-to-play'' restrictions and requirements 
and preclude them from retaining unregulated third-party finders and 
solicitors.'').
    \306\ See, e.g., IAA Letter.
---------------------------------------------------------------------------

    We are persuaded by these comments and have decided to revise the 
proposed rule to permit advisers to make payments to certain 
``regulated persons'' to solicit government clients on their 
behalf.\307\ As described in more detail below, ``regulated persons'' 
include certain broker-dealers and registered investment advisers that 
are themselves subject to prohibitions against participating in pay to 
play practices and are subject to our oversight and, in the case of 
broker-dealers, the oversight of a registered national securities 
association, such as FINRA.\308\ As one commenter observed, ``the 
Commission would have the direct authority to determine these 
restrictions as well as the oversight, control and enforcement of 
penalties over any violations. The restrictions could be tailored to 
operate with the same underlying purpose and effect on [solicitors] as 
the ``pay-to-play'' restrictions imposed on investment advisers.'' 
\309\ We believe that the application of such rules would provide an 
effective deterrent to these solicitors or placement agents from 
participating in pay to play arrangements because political 
contributions or payments would subject solicitors to similar 
consequences, as discussed below.\310\ Because rule 206(4)-5 prohibits 
an adviser from compensating a registered adviser solicitor for 
solicitation activities if that adviser solicitor does not meet the 
definition of ``regulated person,'' the adviser that hired the 
solicitor must immediately cease compensating a solicitor that no 
longer meets these conditions.\311\
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    \307\ See Rule 206(4)-5(a)(2)(i).
    \308\ Rule 206(4)-5(f)(9). See supra note 85 (noting that, in 
this Release, we will refer directly to FINRA, currently the only 
registered national securities association). As noted below, under 
the definition of ``regulated persons'' as it applies to brokers, 
the Commission must find, by order, that a registered national 
securities association's pay to play rule applicable to such brokers 
imposes substantially equivalent or more stringent restrictions on 
them than rule 206(4)-5 imposes on investment advisers and that such 
rule is consistent with the objectives of rule 206(4)-5. Rule 
206(4)-5(f)(9)(ii)(B).
    \309\ Davis Polk Letter.
    \310\ Another group of commenters argued that third-party 
solicitors should be treated as covered associates--that is, their 
contributions should trigger the two-year ban for advisers that hire 
them. See, e.g., ABA Letter; 3PM Letter; ICI Letter; NY City Bar 
Letter; Forum Letter; Jones Day Letter. In explaining our rejection 
of this approach in the Proposing Release, we noted that this 
approach--which we included in our 1999 pay to play proposal--was 
criticized by commenters at that time. See Proposing Release, at 
section II.A.3(b). They primarily argued that it was unfair to 
impute the activities of third parties to advisers, especially given 
what they perceived as the harsh consequences caused by a triggering 
contribution--i.e., a two-year time out imposed on the adviser. See 
id. They further argued that an approach in which contributions by 
third-party solicitors triggered a two-year time out for an adviser 
would create over-burdensome compliance challenges because the 
adviser could not meaningfully control the contribution activities 
of such third parties. See id. We continue to be sympathetic to 
these concerns and believe that an approach in which a contribution 
by a third party triggered a two-year time out for the adviser that 
hires the third party as a solicitor could lead to unfair 
consequences. See, e.g., Capstone Letter; Monument Group Letter; 
Park Hill Letter. For example, if a solicitor gives a triggering 
contribution in order to assist one client, we are concerned about 
the harsh result that such a contribution could have on all of the 
solicitor's other clients seeking business with the same prospective 
government entity client.
    \311\ It would be a violation of the rule for an adviser to 
compensate a third party for solicitation of government entity 
clients at any time that third party did not meet the definition of 
``regulated person,'' regardless of whether the ``regulated person'' 
failed to meet the definition at the time it was hired or 
subsequently.
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    In light of our decision to permit advisers to make payments to 
certain ``regulated persons,'' described below, to solicit government 
clients on their behalf, we no longer believe that our proposed 
exception from the prohibition on advisers paying third-party 
solicitors for payments to related persons and employees of related 
person companies of the adviser is necessary.\312\ We had proposed the 
exception to enable advisers to compensate these persons for government 
entity solicitation activities because we recognized there may be 
efficiencies in allowing advisers to rely on these particular types of 
persons to assist them in seeking clients. We requested comment 
regarding whether the exception would undermine the rule's efficacy by 
allowing advisers to compensate certain employees of related person 
companies whose contributions would not have triggered the two-year 
time out. Although we did not receive comment specifically addressing 
our concern,\313\ we believe the approach we are adopting that allows 
advisers to pay ``regulated persons'' to solicit government entities on 
their behalf will still allow advisers to use employees of certain 
related companies--i.e., of those related companies that qualify as 
``regulated persons''--as solicitors.\314\
---------------------------------------------------------------------------

    \312\ See Proposing Release, at section II.A.3(b).
    \313\ One commenter asked that we clarify the proposed exception 
for related parties (Sutherland Letter) and another recommended a 
case-by-case determination of whether independent contractors may be 
eligible for the exception, due to concern for life insurance agents 
who may not technically have qualified as ``employees'' for purposes 
of the exception (Skadden Letter). As noted, however, we have 
eliminated this exception in favor of allowing advisers to pay 
``regulated persons,'' affiliated or not, to solicit government 
clients on their behalf.
    \314\ We acknowledge that some advisers may have to bear certain 
additional costs of hiring outside parties as a result of our 
elimination of our proposal's ``related person'' exception, which 
would have allowed advisers to compensate related persons that are 
not registered broker-dealers or advisers for solicitation 
activities. For a discussion of costs relating to the rule, see 
section IV of this Release. But, we also note that the rule, as 
adopted, does not favor an adviser with affiliates (which our 
proposal would have allowed an adviser to use to solicit on its 
behalf) over another adviser without affiliates. Instead, our rule, 
as adopted, allows an adviser to pay a ``regulated person'' 
affiliated or not, to solicit on its behalf.
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(1) Registered Broker-Dealers
    Registered national securities association rules of similar scope 
and consequence as the rule we are today adopting could sufficiently 
satisfy the concerns that led us to propose to prohibit advisers from 
paying brokers to solicit potential government clients. Advisers could 
not easily use placement agents covered by such rules to circumvent 
rule 206(4)-5. Under this approach, placement agents would be deterred 
from engaging in pay to play directly on account of the registered 
national securities association's rules. There would be no need for the 
Commission to prove in an enforcement action that a contribution by a 
placement agent amounted to an indirect contribution by the investment 
adviser because the placement agent itself could be charged with 
violating the registered national securities association's rules. 
Therefore, as adopted, rule 206(4)-5 allows an adviser to compensate 
``regulated persons,'' which includes registered brokers subject to a 
registered national securities

[[Page 41042]]

association's rules, for soliciting government clients on its 
behalf.\315\ An adviser may engage a registered broker to solicit 
government clients on its behalf so long as the broker continues to 
meet the definition of ``regulated person'' throughout its engagement 
as a solicitor by the adviser.
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    \315\ Rule 206(4)-5(a)(2)(i) (which prohibits advisers and their 
covered associates from providing or agreeing to provide, directly 
or indirectly, payment to any third party other than a regulated 
person to solicit a government entity for investment advisory 
services on behalf of such investment adviser). Rule 206(4)-5 
defines a ``regulated person'' to include a ``broker,'' as defined 
in section 3(a)(4) of the Securities Exchange Act of 1934 [15 U.S.C. 
78c(a)(4)] or a ``dealer,'' as defined in section 3(a)(5) of that 
Act [15 U.S.C. 78c(a)(5)], that is registered with the Commission, 
and is a member of a registered national securities association 
registered under section 15A of that Act [15 U.S.C. 78o-3], provided 
that (A) the rules of the association prohibit members from engaging 
in distribution or solicitation activities if certain political 
contributions have been made; and (B) the Commission finds that such 
rules impose substantially equivalent or more stringent restrictions 
on broker-dealers than [rule 206(4)-5] imposes on investment 
advisers and that such rules are consistent with the objectives of 
[rule 206(4)-5]. The rule's definition of ``regulated person'' also 
includes certain investment advisers. See infra text accompanying 
note 323.
---------------------------------------------------------------------------

    For a broker-dealer to be a ``regulated person'' under rule 206(4)-
5, the broker-dealer must be registered with the Commission and be a 
member of a registered national securities association that has a rule: 
(i) That prohibits members from engaging in distribution or 
solicitation activities if certain political contributions have been 
made; and (ii) that the Commission finds both to impose substantially 
equivalent or more stringent restrictions on broker-dealers than rule 
206(4)-5 imposes on investment advisers and to be consistent with the 
objectives of rule 206(4)-5.\316\ We have included the requirement that 
a broker-dealer, in order to qualify as a regulated person, be subject 
to a pay to play rule of a registered national securities association 
of which it is a member so that brokers seeking to act as placement 
agents for investment advisers are, in turn, adequately deterred from 
engaging in pay to play activities on behalf of those advisers by such 
a rule.
---------------------------------------------------------------------------

    \316\ Rule 206(4)-5(f)(9)(ii).
---------------------------------------------------------------------------

    FINRA has informed us that it is preparing rules for consideration 
that would prohibit its members from soliciting advisory business from 
a government entity on behalf of an adviser unless they comply with 
requirements prohibiting pay to play activities.\317\ FINRA has said 
its rule would impose regulatory requirements on member brokers \318\ 
``as rigorous and as expansive'' as would be imposed on investment 
advisers by rule 206(4)-5, and that in developing its proposal it 
intends to ``draw closely upon all the substantive and technical 
elements of the SEC's proposal as well as our regulatory expertise in 
examining and enforcing the MSRB rules upon which the SEC's proposal is 
based.'' \319\ The rules, including any recordkeeping requirements, 
would be enforced by FINRA, which has substantial experience enforcing 
MSRB rules G-37 and G-38.\320\
---------------------------------------------------------------------------

    \317\ See Letter from Richard G. Ketchum, Chairman & Chief 
Executive Officer, FINRA, to Andrew J. Donohue, Director, Division 
of Investment Management, U.S. Securities and Exchange Commission 
(Mar. 15, 2010), available at http://www.sec.gov/comments/s7-18-09/
s71809-252.pdf (``Ketchum Letter'') (``[w]e believe that a 
regulatory scheme targeting improper pay to play practices by 
broker-dealers acting on behalf of investment advisers is * * * a 
viable solution to a ban on certain private placement agents serving 
a legitimate function''). See also Letter from Andrew J. Donohue, 
Director, Division of Investment Management, U.S. Securities and 
Exchange Commission, to Richard G. Ketchum, Chairman & Chief 
Executive Officer, FINRA (Dec. 18, 2009), available at http://
www.sec.gov/comments/s7-18-09/s71809-252.pdf.
    \318\ As used in this Section, ``broker'' means a ``broker'' or 
``dealer,'' as each term is defined in section 3(a) of the 
Securities Exchange Act of 1934 [15 U.S.C. 78c(a)].
    \319\ Ketchum Letter.
    \320\ See MSRB, About the MSRB: Enforcement of Board Rules, 
available at http://msrb.org/msrb1/whatsnew/default.asp 
(``Responsibility for examination and enforcement of Board rules is 
delegated to the Financial Industry Regulatory Authority for all 
securities firms, and to the Federal Deposit Insurance Corporation, 
the Federal Reserve Board, the Comptroller of the Currency, and the 
Office of Thrift Supervision for banks.'').
---------------------------------------------------------------------------

    For the Commission to adopt a rule prohibiting advisers from using 
placement agents until FINRA adopts a rule could impose substantial 
hardships on a significant number of advisers and solicitors that wrote 
to us. It could also disrupt pension funds' investment opportunities. 
Therefore, as we discuss in more detail below, we are delaying 
application of the prohibition on compensating third-party solicitors 
for one year from the effective date of this rule, in part to give 
FINRA time to propose such a rule.\321\
---------------------------------------------------------------------------

    \321\ For a discussion of transition issues, see section III of 
this Release.
---------------------------------------------------------------------------

(2) Registered Investment Advisers
    We are also permitting advisers covered by the rule to pay 
solicitors for government clients that are registered investment 
advisers subject to similar limitations.\322\ Under the rule, a 
``regulated person'' includes (in addition to a registered broker 
subject to the conditions described above), an investment adviser that 
is registered with the Commission under the Advisers Act, provided that 
the solicitor and its covered associates have not, within two years of 
soliciting a government entity: (i) Made a contribution to an official 
of that government entity (other than a de minimis contribution, as 
permitted by the rule); or (ii) coordinated, or solicited any person 
(including a PAC) to make, any contribution to an official of a 
government entity to which the investment adviser that hired the 
solicitor is providing or seeking to provide investment advisory 
services, or payment to a political party of a State or locality where 
the investment adviser that hired the solicitor is providing or seeking 
to provide investment advisory services to a government entity.\323\
---------------------------------------------------------------------------

    \322\ Rule 206(4)-5(a)(2)(i) (which prohibits advisers and their 
covered associates from providing or agreeing to provide, directly 
or indirectly, payment to any third party other than a regulated 
person to solicit a government entity for investment advisory 
services on behalf of such investment adviser).
    \323\ Rule 206(4)-5(f)(9)(i).
---------------------------------------------------------------------------

    We received comments urging us to permit advisers to compensate 
registered investment advisers for soliciting government officials, 
subject to rules or rule amendments the Commission could adopt under 
the Advisers Act.\324\ We believe such an allowance is appropriate for 
similar reasons to those for permitting advisers to compensate broker-
dealers subject to pay to play rules we have determined meet our 
objectives under rule 206(4)-5. We have direct oversight authority over 
investment advisers registered with us. Accordingly, we believe it is 
appropriate to allow them to act as third-party solicitors for other 
advisers. Therefore, the rule, as adopted, limits the advisers that 
another adviser may pay to solicit government entities on its behalf to 
those advisers that are registered with the Commission \325\ and that 
have neither made the types of political contributions that would 
trigger the two-year time out nor otherwise engaged in activities 
(e.g., bundling of contributions) that the adviser could not engage in 
under the rule.\326\
---------------------------------------------------------------------------

    \324\ See, e.g., IAA Letter.
    \325\ We are not including within the definition of ``regulated 
person'' investment advisers registered solely with State securities 
authorities as some commenters suggested. See id. We do not have 
regulatory authority over those advisers as we do over advisers who 
are registered with us (and as we do over FINRA in connection with 
its oversight of brokers and dealers and enforcement of its own 
rules). In fact, such advisers are subject neither to our oversight 
nor to the recordkeeping rules we are adopting today.
    \326\ Importantly, a person that is registered under the 
Exchange Act as a broker-dealer and under the Advisers Act as an 
investment adviser could potentially be a ``regulated person'' under 
the rule if it met the conditions for either prong of the 
definition. Such a regulated person should follow the rules that 
apply to the services it is performing, rather than complying with 
both investment adviser and broker-dealer pay to play requirements. 
The Exchange Act generally requires brokers and dealers to register 
with the Commission and become members of at least one self-
regulatory organization. Exchange Act sections 15(a), 15(b)(8) [15 
U.S.C. 78o(a), (b)(8)]. Section 3(a)(4)(A) of the Exchange Act 
generally defines a ``broker'' as any person engaged in the business 
of effecting transactions in securities for the account of others 
[15 U.S.C. 78c(a)(4)(A)]. See, e.g., Definition of Terms in and 
Specific Exemptions for Banks, Savings Associations, and Savings 
Banks Under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange 
Act of 1934, Exchange Act Release No. 44291, at n.124 (May 11, 2001) 
[66 FR 27759 (May 18, 2001)] (``Solicitation is one of the most 
relevant factors in determining whether a person is effecting 
transactions.''); Strengthening the Commission's Requirements 
Regarding Auditor Independence, Exchange Act Release No. 47265, at 
n.82 (Jan. 28, 2003) [68 FR 6006 (Feb. 5, 2003)] (noting that a 
person may be ``engaged in the business,'' among other ways, by 
receiving compensation tied to the successful completion of a 
securities transaction). See also Persons Deemed Not to Be Brokers, 
Exchange Act Release No. 22172, at sec. II.A (Jun. 27, 1985) [50 FR 
27940 (Jul. 9, 1985)] (noting that attorneys, accountants, insurance 
brokers, financial service organizations and financial consultants 
are engaged in the business of effecting transactions in securities 
for the account of others if they are retained by an issuer 
specifically for the purpose of selling securities to the public and 
receive transaction based-compensation for their services).

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[[Page 41043]]

    Advisers compensating other advisers that qualify as ``regulated 
persons'' for soliciting government entities must adopt policies and 
procedures reasonably designed to prevent a violation of the rule.\327\ 
Such policies and procedures should include, among other things, a 
careful vetting of candidates and ongoing review of ``regulated 
person'' investment advisers acting as solicitors currently being used. 
Such review would need to determine whether the adviser (and its 
covered persons) acting as a solicitor has made political contributions 
or otherwise engaged in conduct that would disqualify it from the 
definition of ``regulated person'' and thereby preclude the hiring 
adviser from paying it for the solicitation activity.
---------------------------------------------------------------------------

    \327\ See Advisers Act rule 206(4)-7 [17 CFR 275.206(4)-7] 
(requiring advisers to adopt and implement compliance policies and 
procedures).
---------------------------------------------------------------------------

(c) Restrictions on Soliciting and Coordinating Contributions and 
Payments
    Rule 206(4)-5 prohibits advisers and covered persons from 
coordinating or soliciting \328\ any person or PAC to make (i) any 
contribution \329\ to an official of a government entity to which the 
adviser is providing or seeking to provide investment advisory 
services,\330\ or (ii) any payment \331\ 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.\332\ 
These restrictions are intended to prevent advisers from circumventing 
the rule's prohibition on direct contributions to certain elected 
officials such as by ``bundling'' a large number of small employee 
contributions to influence an election, or making contributions (or 
payments) indirectly through a State or local political party.\333\
---------------------------------------------------------------------------

    \328\ Rule 206(4)-5(f)(10)(ii) (defining ``solicit,'' with 
respect to a contribution or payment, as communicating, directly or 
indirectly, for the purpose of obtaining or arranging a contribution 
or payment). Some commenters requested that we provide guidance 
regarding when an adviser would be deemed to be soliciting 
contributions for purposes of the rule. See, e.g., Caplin & Drysdale 
Letter. An adviser that consents to the use of its name on 
fundraising literature for a candidate would be soliciting 
contributions for that candidate. Similarly, an adviser that 
sponsors a meeting or conference which features a government 
official as an attendee or guest speaker and which involves 
fundraising for the government official would be soliciting 
contributions for that government official. Whether a particular 
activity involves a solicitation or coordination of a contribution 
or payment for purposes of the rule will depend on the facts and 
circumstances, thus we have not attempted to draw a bright line. The 
MSRB takes a similar approach. See MSRB, Solicitation of 
Contributions, MSRB Interpretive Letter (May 21, 1999), available at 
http://msrb.org/msrb1/rules/interpg37.htm (determination of whether 
activity constitutes ``soliciting'' under rule G-37 is a facts and 
circumstances analysis). See also supra note 255.
    \329\ In the case of the fundraising meeting or conference 
described as an example in note 328, expenses incurred by the 
adviser for hosting the event would be a contribution by the 
adviser, thereby triggering the two-year ban on the adviser 
receiving compensation for providing advisory services to the 
government entity over which that official has influence. See 
section II.B.2(a) of this Release. Such expenses may include, but 
are not limited to, the cost of the facility, the cost of 
refreshments, any expenses paid for administrative staff, and the 
payment or reimbursement of any of the government official's 
expenses for the event. The de minimis exception under rule 206(4)-
5(b)(1) would not be available with respect to these expenses 
because they would have been incurred by the firm, not by a natural 
person. See MSRB, Supervision When Sponsoring Meetings and 
Conferences Involving Issuer Officials, MSRB Rule G-37 Interpretive 
Notice (Mar. 26, 2007), available at http://www.msrb.org/msrb1/
rules/notg37.htm (rather than addressing meetings and conferences in 
its rules directly, the MSRB applies a facts and circumstances test 
on a case-by-case basis).
    \330\ Rule 206(4)-5(a)(2)(ii). An investment adviser would be 
seeking to provide advisory services to a government entity when it 
responds to a request for proposal, communicates with a government 
entity regarding that entity's formal selection process for 
investment advisers, or engages in some other solicitation of 
investment advisory business of the government entity. A violation 
of paragraph (a)(2)(ii) of the rule would not trigger a two-year ban 
on the provision of investment advisory services for compensation, 
but would be a violation of the rule.
    \331\ A payment is defined as any gift, subscription, loan, 
advance, or deposit of money or anything of value. Rule 206(4)-
5(f)(7). This definition is similar to the definition of 
``contribution,'' but broader, in the sense that it does not include 
limitations on the purposes for which such money is given (e.g., it 
does not have to be made for the purpose of influencing an 
election). We are including the broader term ``payments,'' as 
opposed to ``contributions,'' here to deter an adviser from 
circumventing the rule's prohibitions by coordinating indirect 
contributions to government officials by making payments to 
political parties.
    \332\ Rule 206(4)-5(a)(2)(ii). This provision prohibits, for 
example, an adviser from soliciting a payment to the political party 
of a State if the adviser is providing or seeking to provide 
advisory services to the State, but would not preclude that adviser 
from soliciting a payment to a local political party (as long as the 
adviser is not also providing or seeking to provide advisory 
services to a government entity in that locality). In these 
circumstances, the rule would, however, prohibit an adviser from 
soliciting the payment to a local political party as a means to 
indirectly make payments to the State party. See rule 206(4)-5(d).
    \333\ We note that this provision is not limited to the bundling 
of employee contributions. Another example of conduct that would be 
prohibited by this section would be an adviser or its covered 
associates soliciting contributions from professional service 
providers.
---------------------------------------------------------------------------

    We received only a few comments on this provision. One supporter of 
our proposal asserted that it ``would close an important gap in which 
contributions might be made indirectly to government officials for the 
purpose of influencing their choice of investment advisers.'' \334\ 
Most commenters that addressed the provision focused on the prohibition 
relating to contributions and payments to State and local political 
parties where the adviser is providing, or seeking to provide, advisory 
services. One State official suggested that this prohibition would 
unfairly affect states with strict limitations on individual 
contributions to candidates as they are now more reliant on party money 
for campaigns.\335\ Another State official, however, explained the 
importance of the provision by pointing out that it is often difficult 
or impossible to differentiate between individuals seeking an office 
and the political party, which often merely passes contributions it 
receives on to the candidate, and may direct successful candidates to 
place pension business with contributors.\336\
---------------------------------------------------------------------------

    \334\ Cornell Law Letter.
    \335\ CT Treasurer Letter. In upholding restrictions targeted at 
a particular industry, courts have found that the loss of 
contributions from a small segment of the electorate ``would not 
significantly diminish the universe of funds available to a 
candidate to a non-viable level.'' Green Party of Conn. v. Garfield, 
590 F. Supp. 2d 288, 316 (D. Conn. 2008); see also Preston v. Leake, 
629 F. Supp. 2d 517, 524 (E.D.N.C. 2009) (differentiating the 
``broad sweep of the Vermont statute'' that ``restricted essentially 
any potential campaign contribution'' from a statute that ``only 
applies to lobbyists''); In re Earle Asphalt Co., 950 A.2d 918, 927 
(N.J. Super. Ct. App. Div. 2008), aff'd 957 A.2d 1173 (N.J. 2008) 
(holding that a limitation on campaign contributions by government 
contractors and their principals did not have the same capacity to 
prevent candidates from amassing the resources necessary for 
effective campaigning as the statute in Randall). See supra note 68.
    \336\ Reilly Letter.
---------------------------------------------------------------------------

    We are adopting this provision, as proposed. These restrictions on 
soliciting and coordinating

[[Page 41044]]

contributions and payments close what would otherwise be a potential 
gap in the rule as advisers could circumvent its limitations on direct 
contributions through soliciting and coordinating others to make 
contributions to influence an election or a government official's 
investment adviser selection process.\337\ We disagree that this 
prohibition would unfairly affect candidates in states that limit 
individual contributions, because the rule is non-discriminatory and 
would affect contributions (and payments) to all candidates equally 
that were being bundled or made through a gatekeeper for the benefit of 
an investment adviser seeking or doing business with the State or local 
government.
---------------------------------------------------------------------------

    \337\ We note that a direct contribution to a political party by 
an adviser or its covered associates would not violate the rule, 
unless the contribution was a means for the adviser to do indirectly 
what the rule would prohibit if done directly (for example, if the 
contribution was earmarked or known to be provided for the benefit 
of a particular government official). See section II.B.2(d) of this 
Release. The MSRB amended rule G-37 in 2005 to expand its 
prohibition on soliciting others to make, and on coordinating, 
payments to State and local political parties to close what the MSRB 
identified as a gap in which contributions were being made 
indirectly to officials through payments to political parties for 
the purposes of influencing their choice of municipal securities 
dealers. The MSRB had not previously been able to deter this 
misconduct, despite issuing informal guidance in both 1996 and 2003. 
See Rule G-37: Request for Comments on Draft Amendments to Rule G-
37(c), Relating to Prohibiting Solicitation and Coordination of 
Payments to Political Parties, and Draft Question and Answer 
Guidance Concerning Indirect Rule Violations, MSRB Notice 2005-11 
(Feb. 15, 2005), available at http://www.msrb.org/msrb1/archive/
2005/2005-11.asp (``Both the 1996 Q&A guidance and the 2003 Notice 
were intended to alert dealers and [municipal finance professionals] 
to the realities of political fundraising and guide them toward 
developing procedures that would lead to compliance with both the 
letter and the spirit of the rule. The MSRB continues to be 
concerned, however, that dealer, [municipal finance professional], 
and affiliated persons' payments to political parties, including 
``housekeeping'', ``conference'' or ``overhead'' type accounts, and 
PACs give rise to at least the appearance that dealers may be 
circumventing the intent of Rule G-37.''); Self-Regulatory 
Organizations; Municipal Securities Rulemaking Board; Order 
Approving Proposed Rule Change Concerning Solicitation and 
Coordination of Payments to Political Parties and Question and 
Answer Guidance on Supervisory Procedures Related to Rule G-37(d) on 
Indirect Violations, Exchange Act Release No. 52496 (Sept. 22, 2005) 
(SEC order approving change to MSRB G-37 to prohibit soliciting or 
coordinating payments to political parties).
---------------------------------------------------------------------------

(d) Direct and Indirect Contributions or Solicitations
    Rule 206(4)-5(d) prohibits acts done indirectly, which, if done 
directly, would violate the rule.\338\ As a result, an adviser and its 
covered associates could not funnel payments through third parties, 
including, for example, consultants, attorneys, family members, friends 
or companies affiliated with the adviser as a means to circumvent the 
rule.\339\ We emphasize, however, that contributions by these other 
persons would not otherwise trigger the rule's two-year time out.\340\ 
We received no comments on this aspect of the proposed rule and are 
adopting it as proposed.
---------------------------------------------------------------------------

    \338\ Paragraph (d) of the rule is substantially similar to 
section 208(d) of the Advisers Act [15 U.S.C. 80b-8(d)], which 
states, ``It shall be unlawful for any person indirectly, or through 
or by any other person, to do any act or thing which it would be 
unlawful for such person to do directly under the provisions of this 
title or any rule or regulation thereunder.'' MSRB rule G-37 
contains a similar provision. See MSRB rule G-37(d).
    \339\ This provision would also cover, for example, situations 
in which contributions by an adviser are made, directed or funded 
through a third party with an expectation that, as a result of the 
contributions, another contribution is likely to be made by a third 
party to an ``official of the government entity,'' for the benefit 
of the adviser. Contributions made through gatekeepers thus would be 
considered to be made ``indirectly'' for purposes of the rule. In 
approving MSRB rule G-37, the Commission stated: ``[rule G-37(d)] is 
intended to prevent dealers from funneling funds or payments through 
other persons or entities to circumvent the [rule]'s requirements. 
For example, a dealer would violate the [rule] if it does business 
with an issuer after contributions were made to an issuer official 
from or by associated persons, family members of associated persons, 
consultants, lobbyists, attorneys, other dealer affiliates, their 
employees or PACs, or other persons or entities as a means to 
circumvent the rule. A dealer also would violate the rule by doing 
business with an issuer after providing money to any person or 
entity when the dealer knows that the money will be given to an 
official of an issuer who could not receive the contribution 
directly from the dealer without triggering the rule's prohibition 
on business.'' Self-Regulatory Organizations; Order Approving 
Proposed Rule Change by the Municipal Securities Rulemaking Board 
Relating to Political Contributions and Prohibitions on Municipal 
Securities Business and Notice of Filing and Order Approving on an 
Accelerated Basis Amendment No. 1 Relating to the Effective Date and 
Contribution Date of the Proposed Rule, Exchange Act Release No. 
33868 (Apr. 7, 1994) [59 FR 17621 (Apr. 13, 1994)].
    \340\ Like MSRB rule G-37(d), rule 206(4)-5(d) requires a 
showing of intent to circumvent the rule in order for such persons 
to trigger the time out. See Blount, 61 F.3d at 948 (``In short, 
according to the SEC, the rule restricts such gifts and 
contributions only when they are intended as end-runs around the 
direct contribution limitations.'').
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(e) Covered Investment Pools
    Rule 206(4)-5 includes a provision that applies each of the 
prohibitions of rule 206(4)-5 to an investment adviser that manages 
assets of a government entity through a hedge fund or other type of 
pooled investment vehicle (``covered investment pool'').\341\ For 
example, a political contribution to a government official that would, 
under the rule, trigger the two-year time out from providing advice for 
compensation to the government entity would also trigger a two-year 
time out from the receipt of compensation for the management of those 
assets through a covered investment pool. This provision extends the 
protection of the rule to public pension plans that increasingly access 
the services of investment advisers through hedge funds and other types 
of pooled investment vehicles they sponsor or advise.
---------------------------------------------------------------------------

    \341\ See rule 206(4)-5(c). We discuss the types of pooled 
investment vehicles that are ``covered investment pools'' below at 
section II.B.2.(e)(1) of this release.
---------------------------------------------------------------------------

    This provision will generally affect two common types of 
arrangements in which a government official is in a position to 
influence investment of funds in pooled investment vehicles. The first 
is the investment of public funds in a hedge fund or other type of 
pooled investment vehicle. The other is the selection of a pooled 
investment vehicle sponsored or advised by an investment adviser as a 
funding vehicle or investment option in a government-sponsored plan, 
such as a ``529 plan.'' \342\
---------------------------------------------------------------------------

    \342\ We note that if an adviser is selected by a government 
entity to advise a government-sponsored plan (regardless of whether 
the plan selects one of the pools the adviser offers or manages as 
an option available under its plan), the prohibitions of the rule 
directly apply. See rule 206(4)-5(a)(1) and (a)(2).
---------------------------------------------------------------------------

    An adviser that makes political contributions to steer assets to a 
pooled investment vehicle it manages facilitates fraud by implementing 
a government official's quid pro quo scheme.\343\ Public pension plan 
beneficiaries are harmed when a government official violates the public 
trust, for example, by failing to disclose that the government official 
has directed the investment of the plan's assets in a pooled investment 
vehicle not because of the vehicle's financial merits but rather 
because the official has received a political contribution.\344\ By 
engaging in such conduct, the adviser engages in a scheme to defraud 
the beneficiaries of the government plan or program.\345\ Additionally, 
an investment adviser to a pooled investment vehicle that is an 
investment option in a government plan or program may prepare 
information about the pooled investment vehicle that may be used by 
plan officials to evaluate the vehicle and by pension plan 
beneficiaries to decide whether to allocate assets to the vehicle. Such 
an adviser engages in or facilitates an act, practice, or course of 
business which is fraudulent, deceptive, or manipulative when the 
adviser does not disclose that it made a contribution for the purpose 
of inducing an investment by the government officials and that the

[[Page 41045]]

government officials sponsoring the plan chose the vehicle as an 
investment option for beneficiaries not solely on the basis of its 
merits, but rather as the consequence of improper quid pro quo 
payments.\346\ The rule also operates to prevent an adviser from 
engaging in pay to play practices indirectly through an investment pool 
that it would not be permitted to do if it directly managed (or sought 
to directly manage) the assets of a government entity.\347\
---------------------------------------------------------------------------

    \343\ SEC v. DiBella, 587 F.3d 553, 568 (2d Cir. 2009).
    \344\ Id. at 566.
    \345\ See id. at 568-69; section 206(4) of the Advisers Act. See 
also Exchange Act rule 10b-5 [17 CFR 240.10b-5].
    \346\ See, e.g., Oran v. Stafford, 226 F.3d 275, 285-86 (3d Cir. 
2000) (``a duty to disclose may arise when there is * * * an 
inaccurate, incomplete or misleading prior disclosure''); Glazer v. 
Formica Corp., 964 F.2d 149, 157 (2d Cir. 1992) (``when a 
corporation does make a disclosure--whether it be voluntary or 
required--there is a duty to make it complete and accurate'') 
(quoting Roeder v. Alpha Industries, Inc., 814 F.2d 22, 26 (1st Cir. 
1987). See also Exchange Act Rule 10b-5(b).
    \347\ See rule 206(4)-5(d). See also section 208(d) of the Act.
---------------------------------------------------------------------------

    Although a few commenters asserted that the rule or parts of it 
should not apply to pooled investment vehicles,\348\ none made a 
persuasive argument that the problems the rule is designed to address 
are not present in the management of public pension plan and other 
public monies invested in pooled investment vehicles. As we discussed 
in the Proposing Release,\349\ when a decision to invest public funds 
in a pooled investment vehicle is based on campaign contributions, the 
public pension plan may make inferior investment choices and may pay 
higher fees. And such pension plans may invest in pooled investment 
vehicles that pay substantially higher advisory fees and assume 
significantly greater risks than other investment alternatives.\350\
---------------------------------------------------------------------------

    \348\ See, e.g., Comment Letter of Abbott Capital Management, 
LLC (Oct. 6, 2009) (``Abbott Letter''); ICI Letter; NY City Bar 
Letter; SIFMA Letter; Skadden Letter; Sutherland Letter.
    \349\ See Proposing Release, at section II.A.3.(e)(2).
    \350\ See, e.g., Nanette Burns, Can Retirees Afford This Much 
Risk? Business Week (Sept. 17, 2007), available at http://
www.businessweek.com/magazine/content/07_38/b4050048.htm (asserting 
that public pension plan assets are increasingly being invested in 
higher risk alternative investments, including hedge funds); Hannah 
M. Terhune, Accounts Training, Money Science (Dec. 11, 2006), 
available at http://www.moneyscience.com/Hedge_Fund_Tutorials/
Hedge_Fund_Management_and_Performance_Fees.html (noting an 
``enormous difference in rewards for the managers of hedge funds 
versus those of mutual funds'' because hedge fund managers are 
entitled to performance fees).
---------------------------------------------------------------------------

    We find nothing in the structure of pooled investment vehicles or 
the variety of investment strategies they employ that suggests a reason 
for treating advisers to pooled investment vehicles differently from 
advisers to separately managed advisory accounts, except, as we discuss 
below, registered investment companies to which we apply a more limited 
version of the rule. That an investment in a pooled investment vehicle 
may not involve a direct advisory relationship with a government 
sponsored plan does not change the nature of the fraud or the harm that 
may be inflicted as a consequence of the adviser's pay to play 
activity.
    Indeed, many of our recent enforcement cases alleged political 
contributions or kickbacks designed to induce public officials to 
invest public pension plan assets in pooled investment vehicles.\351\ 
We are concerned that our failure to apply the rule to advisers who 
manage assets through these vehicles would ignore an area where there 
has been considerable growth, both in the amount of public assets 
invested in such pooled investment vehicles and allegations of pay to 
play activity involving public pension plans.\352\ We believe a failure 
to apply the rule in this area could, in some cases, even encourage the 
use of covered investment pools as a means of avoiding application of 
the rule.
---------------------------------------------------------------------------

    \351\ See, e.g., SEC v. Paul J. Silvester, et al., Litigation 
Release No. 16759, Civil Action No. 3:00-CV-19411 DJS (D. Conn.) 
(Oct. 10, 2000) (action in which investment adviser allegedly paid 
third-party solicitors who kicked back a portion of the money to the 
former Connecticut State Treasurer in order to obtain public pension 
fund investments in a hedge fund managed by the adviser); SEC v. 
William A. DiBella, et al., Litigation Release No. 20498, Civil 
Action No. 3:04 CV 1342 (EBB) (D. Conn.) (Mar. 14, 2008) (consultant 
was found to have aided and abetted the former Connecticut State 
Treasurer in a pay to play scheme involving an investment adviser to 
a private equity fund who had paid third-party solicitors to obtain 
public pension fund investments in the fund). There are examples of 
pay to play activity in the context of pooled investment vehicles in 
other jurisdictions as well. See, e.g., supra note 18 (listing 
various actions relating to the recent pay to play allegations 
surrounding the New York Common Retirement Fund). See also Guilty 
Plea in Fraud Case Tied to New York Pension, Associated Press (Dec. 
4, 2009), available at hhttp://www.nytimes.com/2009/12/04/nyregion/
04pension.html (describing the guilty plea of an adviser to a 
venture capital fund to charges that he helped his company land a 
lucrative deal with New York's public pension fund by giving nearly 
$1 million worth of illegal gifts to State officials).
    \352\ See, e.g., Investment Company Institute, 529 Plan Program 
Statistics, Mar. 2009 (Feb. 5, 2010), available at http://
www.ici.org/research/stats/529s/529s_03-09 (indicating that 529 
plan assets have increased from $8.6 billion in 2000 to $100.3 
billion in the first quarter of 2009, and that 529 plan accounts 
have increased from 1.3 million in 2000 to 11.2 million in the first 
quarter of 2009); Investment Company Institute, The U.S. Retirement 
Market, 2008, 18 Research Fundamentals, No. 5 (June 2009), available 
at http://www.ici.org/pdf/fm-v18n5.pdf (indicating that 403(b) plan 
and 457 plan assets have increased from $627 billion in 2000 to $712 
billion in the fourth quarter of 2008); SEI, Collective Investment 
Trusts: The New Wave in Retirement Investing (May 2008), available 
at https://longjump.com/networking/
RepositoryPublicDocDownload?id=80031025axe139509557&docname=SEI%20CIT
%20White%20Paper%205.08.pdf&cid=80031025&encode=application/pdf 
(citing Morningstar data indicating that collective investment trust 
assets nearly tripled from 2004 to 2007 and grew by more than 150 
percent between 2005 and 2007 alone). See also Michael Marois, 
CalPERS, Blackstone Clash over Placement Agent `Jackpot' Fees, 
Bloomberg (Apr. 7, 2010), available at http://www.bloomberg.com/
apps/news?pid=newsarchive&sid=acPNrTn1q7pw (noting that placement 
agents working for private equity, hedge funds, venture capital and 
real estate firms typically earn the equivalent of 0.5 percent to 3 
percent of the money they place under the management of their 
client, quoting California State Treasurer Bill Lockyer, a member of 
the CalPERS board, ``[t]he contingency fees are too much of a 
jackpot for the placement agents * * * [they] invite corrupt 
practices'').
---------------------------------------------------------------------------

    Nonetheless, as described in more detail below, we have made 
several changes from the proposal to more narrowly tailor the 
applicability of the rule to pooled investment vehicles in order to 
achieve our regulatory purpose while reducing compliance burdens that 
commenters brought to our attention. In addition, we have made certain 
clarifying changes to the rule, as described below.
(1) Definition of ``Covered Investment Pool''
    Under the rule, a ``covered investment pool'' \353\ includes: (i) 
Any investment company registered under the Investment Company Act of 
1940 that is an investment option of a plan or program of a government 
entity; or (ii) any company that would be an investment company under 
section 3(a) of that Act but for the exclusion provided from that 
definition by section 3(c)(1), section 3(c)(7) or section 3(c)(11) of 
that Act.\354\ Accordingly, it includes such unregistered pooled 
investment vehicles as hedge funds, private equity funds, venture 
capital funds and collective investment trusts.\355\ It also

[[Page 41046]]

includes registered pooled investment vehicles, such as mutual funds, 
but only if those registered pools are an investment option of a 
participant-directed plan or program of a government entity.\356\ These 
plans or programs may include college savings plans like ``529 plans'' 
\357\ and retirement plans like ``403(b) plans'' \358\ and ``457 
plans'' \359\ that typically allow participants to select among pre-
established investment ``options,'' or particular investment pools 
(often invested in registered investment companies or funds of funds, 
such as target date funds), that a government official has directly or 
indirectly selected to include as investment choices for 
participants.\360\
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    \353\ Rule 206(4)-5(f)(3).
    \354\ 15 U.S.C. 80a-3(c)(1), (7) or (11). We note that a bank 
maintaining a collective investment trust would not be subject to 
the rule if the bank falls within the exclusion from the definition 
of ``investment adviser'' in section 202(a)(11)(A) of the Advisers 
Act [15 U.S.C. 80b-2(a)(11)(A)]. A non-bank adviser that provides 
advisory services with respect to a collective investment trust in 
which a government entity invests, however, would be subject to the 
rule's prohibitions with respect to all of its government entity 
clients, including the collective investment trust in which a 
government entity invests, unless another exemption is available.
    \355\ One commenter questioned the Commission's authority to 
apply the rule in the context of covered investment pools in light 
of the opinion of the Court of Appeals for the District of Columbia 
Circuit in Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006). 
Sutherland Letter. That case created some uncertainty regarding the 
application of sections 206(1) and 206(2) of the Advisers Act in 
certain cases where investors in a pool are defrauded by an 
investment adviser to that pool. See Prohibition of Fraud by 
Advisers to Certain Pooled Investment Vehicles, Investment Advisers 
Act Release No. 2628 (Aug. 3, 2007) [72 FR 44756 (Aug. 9, 2007)], 
(adopting rule 206(4)-8 [17 CFR 275.206(4)-8]). In addressing the 
scope of the exemption from registration in section 203(b)(3) of the 
Advisers Act and the meaning of ``client'' as used in that section, 
the Court of Appeals expressed the view that, for purposes of 
sections 206(1) and (2), the ``client'' of an investment adviser 
managing a pool is the pool itself, not an investor in the pool. In 
its opinion, the Court of Appeals distinguished sections 206(1) and 
(2) from section 206(4) of the Advisers Act, which applies to 
persons other than clients. Id. at n.6. See also United States v. 
Elliott, 62 F.3d 1304, 1311 (11th Cir. 1995). Section 206(4) permits 
us to adopt rules proscribing fraudulent conduct that is potentially 
harmful to investors in pooled investment vehicles. We are adopting 
rule 206(4)-5 under this authority.
    \356\ Rule 206(4)-5(f)(8).
    \357\ A 529 plan is a ``qualified tuition plan'' established 
under section 529 of the Internal Revenue Code of 1986 [26 U.S.C. 
529]. States generally establish 529 plans as State trusts which are 
considered instrumentalities of States for Federal securities law 
purposes. As a result, the plans themselves are generally not 
regulated under the Federal securities laws and many of the 
protections of the Federal securities laws do not apply to investors 
in them. See section 2(b) of the Investment Company Act [15 U.S.C. 
80a-2(b)] and section 202(b) of the Advisers Act [15 U.S.C. 80b-
2(b)] (exempting State-owned entities from those statutes). However, 
the Federal securities laws do generally apply to, and the 
Commission does generally regulate, the brokers, dealers, and 
municipal securities dealers that effect transactions in interests 
in 529 plans. See generally sections 15(a)(1) and 15B of the 
Exchange Act [15 U.S.C. 78a-15(a)(1) and 15B]. A bank effecting 
transactions in 529 plan interests may be exempt from the definition 
of ``broker'' or ``municipal securities dealer'' under the Exchange 
Act if it can rely on an exception from the definition of broker in 
the Exchange Act. In addition, State sponsors of 529 plans may hire 
third-party investment advisers either to manage 529 plan assets on 
their behalf or to act as investment consultants to the agency 
responsible for managing plan assets. These investment advisers, 
unless they qualify for a specific exemption from registration under 
the Advisers Act, are generally required to be registered with the 
Commission as investment advisers and would therefore be subject to 
our rule.
    \358\ A 403(b) plan is a tax-deferred employee benefit 
retirement plan established under section 403(b) of the Internal 
Revenue Code of 1986 [26 U.S.C. 403(b)].
    \359\ A 457 plan is a tax-deferred employee benefit retirement 
plan established under section 457 of the Internal Revenue Code of 
1986 [26 U.S.C. 457].
    \360\ We would consider a registered investment company to be an 
investment option of a plan or program of a government entity where 
the participant selects a model fund or portfolio (such as an age-
based investment option of a 529 plan) and the government entity 
selects the specific underlying registered investment company or 
companies in which the portfolio's assets are invested.
---------------------------------------------------------------------------

    We proposed to include in the definition of ``covered investment 
pool'' the types of pooled investment vehicles that are likely to be 
used as funding vehicles for, or investments of, government-sponsored 
savings and retirement plans. We explained that we included registered 
investment companies because of the significant growth in government-
sponsored savings plans in recent years, which increasingly use these 
funds as investment options,\361\ and the increased competition among 
advisers for selection of their fund as an investment option for these 
plans.\362\ We were concerned that advisers to pooled investment 
vehicles, including registered investment companies, may make political 
contributions to influence the decision by government officials to 
include their funds as options in such plans.
---------------------------------------------------------------------------

    \361\ See supra note 352 and accompanying text.
    \362\ See, e.g., Charles Paikert, TIAA-CREF Stages Comeback in 
College Savings Plans, Crain's New York Bus., Apr. 23, 2007 
(depicting TIAA-CREF's struggle to remain a major player in managing 
State 529 plans because of increasing competition from the 
industry's heavyweights); Beth Healy, Investment Giants Battle for 
Share of Exploding College-Savings Market, Boston Globe, Oct. 29, 
2000, at F1 (describing the increasing competition between 
investment firms for State 529 plans and increasing competition to 
market their plans nationally). See also AnnaMaria Andriotis, 529 
Plan Fees are Dropping, SmartMoney, Dec. 16, 2009, available at 
http://www.smartmoney.com/personal-finance/college-planning/529-
plan-fees-are-dropping-but-for-how-long/?hpadref=1 (``Costs on these 
plans are falling for a few reasons, and the biggest one has little 
to do with the State of the economy: The nature of their contracts 
creates competition. When a contract for a State 529 plan expires, 
program managers compete against each other and may lower their fees 
to try to secure the new contract.'').
---------------------------------------------------------------------------

    We recognized in our proposal, however, that an adviser to a 
registered investment company might have difficulty in identifying when 
or if a government investor was a fund shareholder for purposes of 
preventing the adviser (or its covered associates) from making 
contributions that would trigger a two-year time out.\363\ Therefore, 
we proposed to only include publicly offered registered investment 
companies in the definition of covered investment pool for purposes of 
the two-year time out provision to the extent they were investments or 
investment options of a plan or program of a government entity.\364\
---------------------------------------------------------------------------

    \363\ See Proposing Release, at nn. 185-87 and accompanying 
text.
    \364\ See proposed rule 206(4)-5(f)(3) (``Covered investment 
pool means any investment company, as defined in section 3(a) of the 
Investment Company Act of 1940 (15 U.S.C. 80a-3(a)) * * * except 
that for purposes of paragraph (a)(1) of this section, an investment 
company registered under the Investment Company Act of 1940 (15 
U.S.C. 80a), the shares of which are registered under the Securities 
Act of 1933 (15 U.S.C. 77a), shall be a covered investment pool only 
if it is an investment or an investment option of a plan or program 
of a government entity.'').
---------------------------------------------------------------------------

    Several commenters asserted that an adviser to a publicly offered 
investment company would have similar difficulties in identifying 
government investors in registered investment companies for purposes of 
complying with other provisions of the rule.\365\ One opposed 
application of the rule to registered investment companies ``even if 
the [company] is not included in a plan or program of a government 
entity,'' \366\ although several generally urged us to exclude 
registered investment companies from the rule altogether.\367\ Another 
commenter urged us to apply the rule's recordkeeping requirements 
(discussed below) prospectively and after a period of time that would 
be adequate to enable funds to redesign their processes and systems to 
capture information about whether an investor is a ``government 
entity,'' which would be necessary to comply with the rule and our 
proposed amendment to the Act's recordkeeping rule.\368\ Some noted 
that identifying government investors would be particularly challenging 
when shares were held through an intermediary.\369\
---------------------------------------------------------------------------

    \365\ See Davis Polk Letter; Fidelity Letter; ICI Letter; NSCP 
Letter; Comment Letter of Standard & Poor's Investment Advisory 
Services LLC and Standard & Poor's Securities Evaluations, Inc. 
(Oct. 5, 2009) (``S&P Letter''); SIFMA Letter; T. Rowe Price Letter.
    \366\ T. Rowe Price Letter.
    \367\ Fidelity Letter; ICI Letter; NSCP Letter; SIFMA Letter. We 
disagree that registered investment companies should be excluded 
from our rule. Pay to play activity is fraudulent, regardless of 
whether it occurs in the context of a pooled investment vehicle or a 
separately managed account. One commenter asserted that the 
existence of a regulatory regime applicable to investment companies 
precludes the need for pay to play prohibitions with respect to 
these pools. See ICI Letter. However, existing laws and regulations 
applicable to investment companies do not specifically address pay 
to play practices.
    \368\ ICI Letter. See also section II.D of this Release.
    \369\ See T. Rowe Price Letter; ICI Letter, Fidelity Letter.
---------------------------------------------------------------------------

    We continue to believe for the reasons discussed above \370\ and in 
the Proposing Release, that advisers to registered investment companies 
should be subject to the rule. In response to comments, we have 
modified our

[[Page 41047]]

proposal to include a registered investment company in the definition 
of covered investment pool, for purposes of all three of the rule's pay 
to play prohibitions, but only if it is an investment option of a plan 
or program of a government entity.\371\ We believe this approach 
strikes the right balance between applying the rule in those contexts, 
discussed in the Proposing Release,\372\ in which advisers to 
registered investment companies may be more likely to engage in pay to 
play conduct, while recognizing the compliance challenges relating to 
identifying government investors in registered investment companies 
\373\ that may result from a broader application of the rule. When an 
adviser's investment company is an investment option in a participant-
directed government plan or program, we believe it is reasonable to 
expect the adviser will know (or can reasonably be expected to acquire 
information about) the identity of the government plan.\374\ We 
recognize that when shares are held through an intermediary, an adviser 
may have to take additional steps to identify a government entity.\375\ 
Therefore, we have provided advisers to registered investment companies 
with additional time to modify current systems and processes.\376\
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    \370\ See supra notes 361-362 and accompanying text.
    \371\ Rule 206(4)-5(f)(3).
    \372\ Proposing Release, at nn.185-87 and accompanying text. See 
also supra notes 352 and 362 and accompanying text (describing the 
growth in government-sponsored savings plans in recent years and the 
increased competition for an adviser's fund to be selected as an 
investment option of such a plan).
    \373\ Identifying government investors in other types of covered 
investment pools does not generally present similar compliance 
challenges. See, e.g., rule 2(a)(51) under the Investment Company 
Act [17 CFR 270.2(a)(51)] (defining ``qualified purchaser,'' as that 
term is used in section 3(c)(7) of that Act); Rule 501(a) of 
Regulation D under the Securities Act of 1933 (``Securities Act'') 
[17 CFR 230.501(a)] (defining ``accredited investor'' for purposes 
of limited offerings without registration under the Securities Act 
of 1933); and Advisers Act rule 205-3 (creating an exception from 
the prohibition against an adviser receiving performance-based 
compensation from clients that are not ``qualified clients,'' and 
which is relied on by many advisers to funds that are exempt from 
Investment Company Act registration under section 3(c)(1) of that 
Act).
    \374\ With respect to a 529 plan, for example, an adviser would 
know that its investment company is an investment option of the plan 
and will know the identity of the government entity investor because 
a 529 plan can only be established by a State, which generally 
establishes a trust to serve as the direct investor in the 
investment company, while plan participants invest in various 
options offered by the 529 trust. The rule does not require an 
adviser to identify plan participants, only the government plan or 
program. See rule 206(4)-5(f)(5)(iii) (defining a ``government 
entity'' to include a plan or program of a government entity. The 
definition does not include the participants in those plans or 
programs).
    \375\ For example, while 403(b) plans and 457 plans are 
generally associated with retirement plans for government employees, 
they are not used exclusively for this purpose. For instance, 
certain non-profit or tax-exempt entities can establish these types 
of plans. We also understand that it is not uncommon for 
contributions of 403(b) and 457 plans to be commingled into an 
omnibus position that is forwarded to the fund, making it more 
challenging for an adviser to distinguish government entity 
investors from others.
    \376\ See section III.D of this Release. We received several 
letters addressing this concern. ICI Letter; T. Rowe Price Letter; 
Fidelity Letter.
---------------------------------------------------------------------------

    We have also made several minor changes from our proposal intended 
to clarify and simplify application of the rule. First, at the 
suggestion of commenters,\377\ we are clarifying that an adviser to a 
registered investment company is only subject to the rule--i.e., the 
investment company is only considered a covered investment pool--if the 
investment company is an investment option of a plan or program of a 
government entity that is participant-directed.\378\ This change 
reflects our intent, as demonstrated by the examples we give in the 
definition (i.e., 529 plans, 403(b) plans, and 457 plans) that the 
definition is intended to encompass those covered investment pools that 
have been pre-selected by the government sponsoring or establishing the 
plan or program as part of a limited menu of investment options from 
which participants in the plan or program may allocate their account. 
We have also added, as additional examples to the definition of 
``government entity,'' a defined benefit plan and a State general fund 
to better distinguish these pools of assets from a plan or program of a 
government entity.\379\ We have also made minor organizational changes 
within the definition of government entity from our proposal to make 
clear that such pools are not ``plans or programs of a government 
entity.''
---------------------------------------------------------------------------

    \377\ See, e.g., ICI Letter; Davis Polk Letter; SIFMA Letter.
    \378\ Rule 206(4)-5(f)(8).
    \379\ Rule 206(4)-5(f)(5).
---------------------------------------------------------------------------

    Finally, we have simplified the definition of ``covered investment 
pool'' as it applies to registered investment companies. The definition 
as adopted includes investment companies registered under the 
Investment Company Act that are an option of a plan or program of a 
government entity, regardless of whether, as proposed, their shares are 
registered under the Securities Act of 1933 (``1933 Act''). As 
discussed above, under the rule as adopted an adviser to a registered 
investment company is only subject to the rule if the company is an 
investment option of a plan or program. As a result, we believe it is 
unnecessary to distinguish between registered investment companies 
based on whether their shares are registered under the 1933 Act, 
although we understand that those shares will typically be registered 
where the fund is an option in a plan or program of a government 
entity.
(2) Application of the Rule
    Under rule 206(4)-5 (and as proposed) an investment adviser is 
subject to the two-year time out if it manages a covered investment 
pool in which the assets of a government entity are invested.\380\ The 
rule does not require a government entity's withdrawal of its 
investment or cancellation of any commitment it has made. Indeed, the 
rule prohibits advisers not from providing advice subsequent to a 
triggering political contribution, but rather from receiving 
compensation for providing advice. If a government entity is an 
investor in a covered investment pool at the time a contribution 
triggering a two-year ``time out'' is made, the adviser must forgo any 
compensation related to the assets invested or committed by that 
government entity.\381\
---------------------------------------------------------------------------

    \380\ Rule 206(4)-5(c).
    \381\ As we noted above and in the Proposing Release, the phrase 
``for compensation'' includes both profits and the recouping of 
costs, so an adviser is not permitted to continue to manage assets 
at cost after a disqualifying contribution is made. Proposing 
Release, at n.191. See also supra note 137 and accompanying text. As 
we discussed above in section II.B.2(a)(1) of this Release, we are 
not persuaded by commenters who suggested permitting the adviser to 
be compensated at cost following payment of a triggering 
contribution or payment. See, e.g., Dechert Letter; NY City Bar 
Letter. In our judgment, the potential loss of profits from the 
government client alone may be insufficient to deter pay to play 
activities. However, costs specifically attributable to the covered 
investment pool and not normally incurred in connection with a 
separately managed account, such as costs attributable to an annual 
audit of the pool's assets and delivery of its audited financial 
statements, would not be considered compensation to the adviser for 
these purposes.
---------------------------------------------------------------------------

    Application of the two-year time out may present different issues 
for covered investment pools than for separately managed accounts due 
to various structural and legal differences. Having made a contribution 
triggering the two-year time out, the adviser may have multiple options 
available to comply with the rule in light of its fiduciary obligations 
and the disclosure it has made to investors. For instance, in the case 
of a private pool, the adviser could seek to cause the pool to redeem 
the investment of the government entity.\382\

[[Page 41048]]

Such redemptions may be relatively simple matters in the case of, for 
example, a highly liquid private pool.\383\ Commenters pointed out to 
us that, for some private pools, such as venture capital and private 
equity funds, a government entity's withdrawal of its capital or 
cancellation of its commitment may have adverse implications for other 
investors in the fund.\384\ In such cases, the adviser could instead 
comply with the rule by waiving or rebating the portion of its fees or 
any performance allocation or carried interest attributable to assets 
of the government client.\385\
---------------------------------------------------------------------------

    \382\ To the extent the adviser may seek to cause the private 
pool to redeem the investment of a government entity investor under 
these circumstances, it should consider disclosing this as an 
investment risk in a private placement memorandum, prospectus or 
other disclosure document to current and prospective investors in 
such a fund. See, e.g., Rule 502 of Regulation D under the 
Securities Act [17 CFR 230.502] (addressing disclosure obligations 
for non-accredited investors who purchase securities in a limited 
offering pursuant to rules 505 or 506 of Regulation D under the 
Securities Act [17 CFR 230.505 or 17 CFR 230.506].
    \383\ We understand that other types of pooled investment 
vehicles, including private equity and venture capital funds, 
already have special withdrawal and transfer provisions related to 
the regulatory and tax considerations applicable to certain types of 
investors, such as those regulated by the Employee Retirement Income 
Security Act of 1974 (``ERISA'') [29 U.S.C. 18]. See generally James 
M. Schell, Private Equity Funds--Business Structure and Operations 
(Law Journal Press 2000) (2010).
    \384\ See Abbott Letter; ICI Letter; NY City Bar Letter.
    \385\ As we noted in the Proposing Release, some commenters to 
our 1999 Proposal asserted that a performance fee waiver raises 
various calculation issues. See Proposing Release, at n.192. An 
adviser making a disqualifying contribution could comply with rule 
206(4)-5 by waiving a performance fee or carried interest determined 
on the same basis as the fee or carried interest is normally 
calculated--e.g., on a mark-to-market basis. For arrangements like 
those typically found in private equity and venture capital funds 
where the fee or carry is calculated based on realized gains and 
losses and mark-to-market calculations are not feasible, advisers 
could use a straight-line method of calculation which assumes that 
the realized gains and losses were earned over the life of the 
investment.
---------------------------------------------------------------------------

    For registered investment companies, the options for restricting 
compensation involving government investors are more limited, due to 
both Investment Company Act provisions and potential tax 
consequences.\386\ In our proposal, we suggested one approach that 
would meet the requirements of the rule--an adviser of a registered 
investment company could waive its advisory fee for the fund as a whole 
in an amount approximately equal to fees attributable to the government 
entity.\387\ One commenter agreed with our approach,\388\ while another 
commenter suggested we could, alternatively, permit the government 
entity to continue to pay its portion of the advisory fee, but require 
the adviser to rebate that portion of the fee to the fund as a 
whole.\389\ We believe either approach would meet the requirements of 
the rule we are adopting today.
---------------------------------------------------------------------------

    \386\ See Proposing Release, at n.193 and accompanying text. 
See, e.g., rule 18f-3 under the Investment Company Act [17 CFR 
270.18f-3]. Moreover, other regulatory considerations, such as those 
under ERISA, may impact these arrangements with respect to 
collective investment trusts.
    \387\ This may also be done at the class level or series level 
for private funds organized as corporations.
    \388\ ICI Letter.
    \389\ NY City Bar Letter.
---------------------------------------------------------------------------

(3) Subadvisory Arrangements
    A number of commenters urged that we exclude from the rule 
subadvisers to covered investment pools because, being in a subordinate 
role to the adviser, they may have no involvement in the adviser's 
solicitation activities including no ability to identify government 
entities being solicited, and therefore should not be held accountable 
for the adviser's actions.\390\ None of these commenters, however, 
indicated that a subadviser could not obtain from the adviser the 
information necessary to comply with the rule. Additionally, no 
commenter provided us with a basis to distinguish advisers from 
subadvisers that would be adequate to avoid undermining the 
prophylactic nature of our rule. ``Subadviser'' is not defined under 
the Act,\391\ and significant variation exists in subadvisory 
relationships.\392\ There is no readily available way to draw 
meaningful distinctions between advisers and subadvisers by, for 
example, looking at who controls marketing and solicitation 
activities,\393\ who has an advisory contract directly with the 
government client,\394\ or other factors. In addition, subadvisers 
generally have the same economic incentives as advisers to obtain new 
business and increase assets under management. We are concerned that 
under the approaches suggested by commenters, an adviser that sought to 
avoid compliance with the prophylactic provisions of our rule and 
engage in pay to play could organize itself to operate as a subadviser 
in such an arrangement. We therefore believe it is not appropriate to 
exclude subadvisers from the rule.
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    \390\ See, e.g., IAA Letter; S&P Letter; Skadden Letter; Davis 
Polk Letter.
    \391\ ``Subadviser'' also is not defined under the Investment 
Company Act, which requires that both advisory and subadvisory 
contracts (``which contract, whether with such registered company or 
with an investment adviser of such registered company * * * '') be 
approved by a vote of a majority of the outstanding voting 
securities of the registered investment company. See section 15(a) 
of the Investment Company Act [15 U.S.C. 80a-15(a)].
    \392\ See, e.g., Investment Company Institute, Board Oversight 
of Subadvisers (Jan. 2010), available at http://www.ici.org/pdf/
idc_10_subadvisers.pdf (providing guidance to mutual fund boards 
of directors with respect to overseeing subadvisory arrangements and 
recognizing that ``there is no one `correct' approach to effective 
subadvisory oversight by fund boards'' because there are a wide 
variety of potential subadvisory arrangements).
    \393\ See, e.g., Davis Polk Letter (suggesting that we limit the 
application of the prohibitions to a subadviser to a covered 
investment pool that has the ability to control the soliciting, 
marketing or acceptance of government clients); S&P Letter 
(suggesting that we limit the application of the prohibitions to a 
subadviser to a covered investment pool that: (1) Has the ability to 
control the soliciting, marketing or acceptance of government 
clients; and (2) is not a related person of the investment adviser 
or distributor or other investment pool).
    \394\ See, e.g., IAA Letter; Skadden Letter. See also sections 
2(a)(20) and 15(a) of the Investment Company Act (treating a 
subadviser as an adviser to a registered investment company even in 
the absence of a direct contractual relationship with the investment 
company).
---------------------------------------------------------------------------

    We are, however, providing some guidance that may assist advisers 
in subadvisory and fund of funds arrangements in complying with the 
rule.\395\ First, by the terms of the rule, if an adviser or subadviser 
makes a contribution that triggers the two-year time out from receiving 
compensation, the subadviser or adviser, as applicable, that did not 
make the triggering contribution could continue to receive compensation 
from the government entity,\396\ unless the arrangement were a means to 
do indirectly what the adviser or subadviser could not do directly 
under the rule.\397\ Second, advisers to underlying funds in a fund of 
funds arrangement are not required to look through the investing fund 
to determine whether a government entity is an investor in the 
investing fund unless the investment were made in that manner as a 
means for the adviser to do indirectly

[[Page 41049]]

what it could not do directly under the rule.\398\
---------------------------------------------------------------------------

    \395\ See, e.g., IAA Letter (requesting clarification as to how 
the rule would apply when an adviser becomes subject to the 
compensation ban after hiring a subadviser or vice versa). See also 
Fidelity Letter; MFA Letter; SIFMA Letter (each expressing concern 
about how the rule would apply in the fund of funds context).
    \396\ We understand that, under some advisory arrangements, the 
government entity has a contract only with the adviser and not the 
subadviser. Under those circumstances, it would be consistent with 
the rule for an adviser that has triggered the two-year time out to 
pass through to the subadviser that portion of the fee to which the 
subadviser is entitled, as long as the adviser retains no 
compensation from the government entity and the subadviser (and its 
own covered associates) has not triggered a time out as well.
    \397\ See Rule 206(4)-5(d). For instance, an adviser that hires 
an affiliated subadviser to manage a covered investment pool in 
which a government entity invests so that the adviser could make 
contributions to that government entity would be doing indirectly 
what it would be prohibited from doing directly under the rule. A 
subadviser would be providing ``investment advisory services for 
compensation to a government entity'' regardless of whether the 
subadviser is paid directly by the government entity or by the 
adviser.
    \398\ See rule 206(4)-5(d).
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    (f) Exemptions
    An adviser may apply to the Commission for an order exempting it 
from the two-year compensation ban.\399\ Under this provision, which we 
are adopting as proposed, we can exempt advisers from the rule's time 
out requirement where the adviser discovers contributions that trigger 
the compensation ban only after they have been made, and when 
imposition of the prohibition is unnecessary to achieve the rule's 
intended purpose. This provision will provide advisers with an 
additional avenue by which to seek to cure the consequences of an 
inadvertent violation by the adviser that falls outside the limits of 
the rule's de minimis exception and exception for returned 
contributions,\400\ such as when a disgruntled employee makes a greater 
than $350 contribution as he or she exits the firm. In determining 
whether to grant an exemption, we will take into account the varying 
facts and circumstances that each application presents. Among other 
factors, we will consider: (i) whether the exemption is necessary or 
appropriate in the public interest and consistent with the protection 
of investors and the purposes fairly intended by the policy and 
provisions of the Advisers Act; (ii) whether the investment adviser, 
(A) before the contribution resulting in the prohibition was made, 
adopted and implemented policies and procedures reasonably designed to 
prevent violations of rule 206(4)-5; (B) prior to or at the time the 
contribution which resulted in such prohibition was made, had no actual 
knowledge of the contribution; and (C) after learning of the 
contribution, (1) has taken all available steps to cause the 
contributor involved in making the contribution which resulted in such 
prohibition to obtain a return of the contribution; and (2) has taken 
such other remedial or preventive measures as may be appropriate under 
the circumstances; (iii) whether, at the time of the contribution, the 
contributor was a covered associate or otherwise an employee of the 
investment adviser, or was seeking such employment; (iv) the timing and 
amount of the contribution which resulted in the prohibition; (v) the 
nature of the election (e.g., Federal, State or local); and (vi) the 
contributor's apparent intent or motive in making the contribution 
which resulted in the prohibition, as evidenced by the facts and 
circumstances surrounding such contribution.\401\ We intend to apply 
these factors with sufficient flexibility to avoid consequences 
disproportionate to the violation, while effecting the policies 
underlying the rule.
---------------------------------------------------------------------------

    \399\ Rules 0-4, 0-5, and 0-6 under the Advisers Act [17 CFR 
275.0-4, 0-5, and 0-6] provide procedures for filing applications 
under the Act, including applications under the rule 206(4)-5.
    \400\ See sections II.B.2(a)(6) and (7) of this Release, 
describing exceptions to the two-year time out prohibition of the 
rule.
    \401\ See Rule 206(4)-5(e). These factors are similar to those 
considered by FINRA and the appropriate bank regulators in 
determining whether to grant an exemption under MSRB rule G-37(i).
---------------------------------------------------------------------------

    We received limited comment on this provision. A few commenters 
suggested that the operation of the rule should toll until a decision 
is made about an applicant's request.\402\ We are concerned that such 
an approach could encourage frivolous applications and encourage 
applicants to delay the disposition of their applications. As we 
explained in the Proposing Release, an adviser seeking an exemption 
could place into an escrow account any advisory fees earned between the 
date of the contribution triggering the prohibition and the date on 
which we determine whether to grant an exemption.\403\ Some commenters 
recommended the rule build in a specified length of time for the 
Commission to respond to requests for relief.\404\ We recognize that 
applications for an exemptive order will be time-sensitive and will 
consider such applications expeditiously. We note that the escrow 
arrangements discussed above may lessen the hardship on advisers.
---------------------------------------------------------------------------

    \402\ ICI Letter; Skadden Letter.
    \403\ See Proposing Release, at n.199. The escrow account would 
be payable to the adviser if the Commission grants the exemption. If 
the Commission does not grant the exemption, the fees contained in 
the account would be returned to the government entity client. In 
contrast, MSRB rule G-37, on which rule 206(4)-5 is based, does not 
permit a municipal securities dealer to continue to engage in 
municipal securities business with an issuer while an application is 
pending. See MSRB Rule G-37 Q&A, Question V.1.
    \404\ IAA Letter; ICI Letter; NASP Letter (each suggesting all 
applications be granted if they are not acted upon in 30 days); 
Skadden Letter (suggesting a 45-day deadline).
---------------------------------------------------------------------------

D. Recordkeeping

    We are adopting amendments to rule 204-2 to require registered 
investment advisers that have government clients, or that provide 
investment advisory services to a covered investment pool in which a 
government entity investor invests, to make and keep certain records 
that will allow us to examine for compliance with new rule 206(4)-
5.\405\ The rule amendments reflect several changes from our proposal, 
which are discussed below. These requirements are similar to the MSRB 
recordkeeping requirements for brokers, dealers and municipal 
securities dealers.\406\
---------------------------------------------------------------------------

    \405\ Rule 204-2(a)(18) and (h)(1). An adviser is required to 
make and keep these records only if it provides investment advisory 
services to a government entity or if a government entity is an 
investor in any covered investment pool to which the investment 
adviser provides investment advisory services. Advisers that solicit 
government clients on behalf of other advisers are also subject to 
the amended recordkeeping requirements. Advisers that are exempt 
from Commission registration under section 203(b)(3) of the Advisers 
Act, however, are not subject to the recordkeeping requirements 
under amended 204-2 unless they do register with us, although as 
discussed earlier, supra note 92 and accompanying text, they are 
subject to rule 206(4)-5. Advisers keeping substantially the same 
records under rules adopted by the MSRB are not required to keep 
duplicate records. Rule 204-2(h)(1).
    \406\ MSRB rule G-8(a)(xvi). The MSRB also requires certain 
records to be made and kept in accordance with disclosure 
requirements that our rule does not contain.
---------------------------------------------------------------------------

    Amended rule 204-2 requires registered advisers that provide 
investment advisory services to a government entity, or to a covered 
investment pool in which a government entity is an investor, to make 
and keep records of contributions made by the adviser and covered 
associates to government officials (including candidates), and of 
payments to State or local political parties and PACs.\407\ The 
adviser's records of contributions and payments must be listed in 
chronological order identifying each contributor and recipient, the 
amounts and dates of each contribution or payment and whether a 
contribution was subject to rule 206(4)-5's exception for certain 
returned contributions.\408\ The rule also requires an adviser that has 
government clients to make and keep a list of its covered 
associates,\409\ and the government entities to which the adviser has 
provided advisory services in the past five years.\410\ Similarly, 
advisers to covered investment pools must make and keep a list of 
government entities that invest, or have invested in the past five 
years, in a covered investment pool, including any government entity 
that selects a covered investment pool to be an option of a plan or 
program of a government entity, such as a 529, 457 or 403(b)

[[Page 41050]]

plan.\411\ An investment adviser, regardless of whether it currently 
has a government client, must also keep a list of the names and 
business addresses of each regulated person to whom the adviser 
provides or agrees to provide, directly or indirectly, payment to 
solicit a government entity on its behalf.\412\ The amended rule 
reflects several changes from our proposal, which we describe below.
---------------------------------------------------------------------------

    \407\ Contributions and payments by PACs controlled by the 
adviser or a covered associate would also have to be recorded as 
these PACs are ``covered associates'' under the rule. Rule 206(4)-
5(f)(2)(iii). See section II.B.2(a)(4) of this Release.
    \408\ Rule 204-2(a)(18)(ii).
    \409\ The adviser must record the name, title(s), and business 
and residence addresses of each covered associate. Rule 204-
2(a)(18)(i)(A).
    \410\ Advisers do not have to maintain a record of government 
entities that were clients before the effective date. For additional 
information regarding the implementation of rule 206(4)-5, see 
section III of this Release.
    \411\ Amended rule 204-2 does not require an adviser to a 
covered investment pool that is an option of a government plan or 
program to make and keep records of participants in the plan or 
program, but only the government entity. See supra note 374. 
Consistent with changes we have made to the definition of covered 
investment pool, we note that an adviser's recordkeeping obligations 
with respect to a registered investment company apply only if such 
an investment company is an option of a plan or program of a 
government entity. See section II.B.2(e) of this Release.
    \412\ Rule 204-2(a)(18)(i)(D).
---------------------------------------------------------------------------

    First, in response to comments,\413\ we have limited the rule to 
provide that only records of contributions,\414\ not payments,\415\ to 
government officials and candidates are required to be kept under the 
rule.\416\ We have made this change because, unlike contributions, 
which are one type of payment, all payments do not trigger the two-year 
time out. As a result of this change, the recordkeeping obligations 
better reflect the activities of an adviser or a covered associate that 
could result in the adviser being subject to the two-year time out. 
Commenters also argued that we should not require, as proposed, 
advisers to maintain records of payments to PACs.\417\ Although those 
payments do not trigger application of the two-year time out, payments 
to PACs can be a means for an adviser or covered associate to funnel 
contributions to a government official without directly contributing. 
We are, therefore, adopting the amendment to require advisers to keep 
records of payments to PACs as these records will allow our staff to 
identify situations that might suggest an intent to circumvent the 
rule.\418\
---------------------------------------------------------------------------

    \413\ Fidelity Letter; IAA Letter; SIFMA Letter.
    \414\ See supra note 153 and accompanying text (defining 
``contribution'').
    \415\ See supra note 331 (defining ``payment'').
    \416\ Rule 204-2(a)(18)(i)(C).
    \417\ See, e.g., IAA Letter; SIFMA Letter.
    \418\ Accordingly, as part of a strong compliance program, an 
adviser or covered associate that receives a general solicitation to 
make a contribution to a PAC should consider inquiring about how the 
collected funds would be used to determine whether the PAC is 
closely associated with a government official to whom a direct 
contribution would subject the adviser to the two-year time out. See 
section II.B.2(d) of this Release and rule 206(4)-5(d). The MSRB 
takes a similar approach regarding whether a payment to a PAC is an 
indirect contribution to a government official. See MSRB Rule G-37 
Q&A, Questions III.4 and III.5.
---------------------------------------------------------------------------

    Second, an investment adviser to a registered investment company 
must maintain records identifying government entity investors only if 
the investments are made as part of a plan or program of a government 
entity or provide participants in the plan or program with the option 
of investing in the fund.\419\ This change would narrow the records 
required to those necessary to support the rule as modified from our 
proposal, and we believe addresses commenters' concerns regarding the 
ability of advisers to registered investment companies to identify 
government entity investors.\420\ As discussed above, we believe it is 
reasonable to expect advisers to know the identity of the government 
entity when a registered fund they advise is part of a plan or program. 
In addition, as commenters suggested, we are providing a substantial 
transition period for advisers to registered investment companies that 
should allow these advisers to make the necessary changes to account 
documents and systems to allow them to identify government entities 
that provide one or more of the investment companies they advise as an 
investment option.\421\
---------------------------------------------------------------------------

    \419\ Rule 204-2(a)(18)(i)(B). Amended rule 204-2 does not 
require an adviser to a covered investment pool that is an option of 
a government plan or program to make and keep records of 
participants in the plan or program, but only the government entity. 
For a discussion of the application of the rule to a covered 
investment pool that is an option of a government plan or program, 
see supra note 371 and accompanying text. Consistent with changes we 
have made to the definition of covered investment pool, we note that 
an adviser's recordkeeping obligations with respect to a registered 
investment company apply only if such an investment company is an 
option of a plan or program of a government entity. See section 
II.B.2(e) of this Release.
    \420\ Advisers to covered investment pools that are relying on 
Investment Company Act exclusions in sections 3(c)(1), 3(c)(7) and 
3(c)(11) must identify government entity investors regardless of 
whether they are an investment option of a plan or program of a 
government entity. Rule 204-2(a)(18)(i)(B).
    \421\ See section III of this Release.
---------------------------------------------------------------------------

    Third, the amended rule requires an adviser to maintain a list of 
only those government entities to which it provides, or has provided in 
the past five years, investment advisory services.\422\ We are not 
requiring, as proposed, a list of government entities the adviser 
solicited for advisory business.\423\ Some commenters expressed 
concerns about the potential scope of this requirement and noted that 
solicitation does not trigger rule 206(4)-5's two-year time out, rather 
it is providing advice for compensation that does so.\424\ In light of 
these concerns, and the record before us today, we are not requiring 
advisers to maintain lists of government entities solicited that do not 
become clients.
---------------------------------------------------------------------------

    \422\ See rule 204-2(a)(18)(i)(B).
    \423\ See proposed rule 204-2(a)(18)(i)(B).
    \424\ Dechert Letter; SIFMA Letter; Skadden Letter.
---------------------------------------------------------------------------

    Fourth, as discussed above, rule 206(4)-5 permits an adviser to use 
certain third parties to solicit on its behalf. We are, therefore, 
requiring that advisers that provide or agree to provide, directly or 
indirectly, payment to advisers or broker-dealers registered with the 
Commission that act as regulated persons under rule 206(4)-5 to 
maintain a list of the names and business addresses of each such 
regulated person.\425\ These records will enable the Commission's staff 
to review and compare the regulated person's records to those of the 
adviser that hired the regulated person.
---------------------------------------------------------------------------

    \425\ Rule 204-2(a)(18)(i)(D). If an adviser does not specify 
which types of clients the regulated person should solicit on its 
behalf (e.g., that it should only solicit government entities), the 
adviser could satisfy this requirement by maintaining a list of all 
of its regulated person solicitors. Supra note 412.
---------------------------------------------------------------------------

    Finally, the amendments require advisers to make and keep records 
of their covered associates, and their own and their covered 
associates' contributions, only if they provide advisory services to a 
government client.\426\ Commenters had expressed concerns that 
requiring advisers with no government business to make and keep these 
records could be unnecessarily intrusive to employees and burdensome on 
advisers.\427\ In light of those concerns, and the record before us 
today, we are not requiring advisers with no government business to 
make and keep these records.\428\ As a consequence, an adviser with no 
government clients would not have to require employees to report their 
political contributions.
---------------------------------------------------------------------------

    \426\ Rule 204-2(a)(18)(iii).
    \427\ IAA Letter; Dechert Letter; SIFMA Letter.
    \428\ Although advisers that do not have government entity 
clients are not required to maintain records under the amendments, 
the look-back requirements of rule 206(4)-5 continue to apply. As a 
result, an adviser that has not maintained records of the firm's and 
its covered associates' contributions would have to determine 
whether any contributions by the adviser, its covered associates, 
and any former covered associates would subject the firm to the two-
year time out prior to accepting compensation from a new government 
entity client. The same applies to newly-formed advisers. The 
records an adviser develops during this determination process, would 
fall under the adviser's obligation to maintain records of all 
direct or indirect contributions made by the investment adviser or 
its covered associates to an official of a government entity, or 
payments to a political party of a State or political subdivision 
thereof, or to a political action committee. Rule 204-
2(a)(18)(i)(C).
---------------------------------------------------------------------------

E. Amendment to Cash Solicitation Rule

    We are adopting, as proposed, a technical amendment to rule 206(4)-
3 under the Advisers Act, the ``cash solicitation rule.'' That rule 
makes it

[[Page 41051]]

unlawful, except under specified circumstances and subject to certain 
conditions, for an investment adviser to make a cash payment to a 
person who directly or indirectly solicits any client for, or refers 
any client to, an investment adviser.\429\
---------------------------------------------------------------------------

    \429\ 17 CFR 275.206(4)-3.
---------------------------------------------------------------------------

    Paragraph (iii) of the cash solicitation rule contains general 
restrictions on third-party solicitors that cover solicitation 
activities directed at any client, regardless of whether it is a 
government entity client. New paragraph (e) to rule 206(4)-3 alerts 
advisers and others that special prohibitions apply to solicitation 
activities involving government entity clients under rule 206(4)-
5.\430\
---------------------------------------------------------------------------

    \430\ Rule 206(4)-3(e). We received no comments on this proposed 
amendment.
---------------------------------------------------------------------------

III. Effective and Compliance Dates

    Rule 206(4)-5 and the amendments to rules 204-2 and 206(4)-3 are 
effective on September 13, 2010. Investment advisers subject to rule 
206(4)-5 must be in compliance with the rule on March 14, 2011. 
Investment advisers may no longer use third parties to solicit 
government business except in compliance with the rule on September 13, 
2011.\431\ Advisers to registered investment companies that are covered 
investment pools must comply with the rule by September 13, 2011.\432\ 
Advisers subject to rule 204-2 must comply with amended rule 204-2 on 
March 14, 2011. However, if they advise registered investment companies 
that are covered investment pools, they have until September 13, 2011 
to comply with the amended recordkeeping rule with respect to those 
registered investment companies.
---------------------------------------------------------------------------

    \431\ Rule 206(4)-5(a)(2).
    \432\ Rule 206(4)-5(f)(3).
---------------------------------------------------------------------------

A. Two-Year Time Out and Prohibition on Soliciting or Coordinating 
Contributions

    We are providing advisers with a six month transition period to 
give them time to identify their covered associates and current 
government entity clients and to modify their compliance programs to 
address new compliance obligations under the rule.\433\ Accordingly, 
rule 206(4)-5's prohibition on providing advisory services for 
compensation within two years of a contribution will not apply to, and 
the rule's prohibition on soliciting or coordinating contributions will 
not be triggered by contributions made before March 14, 2011.\434\ We 
believe that the length of the transition period should address 
commenters' concerns that advisers have sufficient time to implement 
policies and procedures regarding contributions to avoid violations of 
the rule and that the rule not affect the 2010 elections for which some 
advisory personnel may already have committed to make political 
contributions.\435\
---------------------------------------------------------------------------

    \433\ Section III.D of this Release addresses when advisers to 
``covered investment pools'' that are registered investment 
companies must comply with the rule; section III.E of this Release 
addresses transition considerations specific to certain other pooled 
investment vehicles.
    \434\ Likewise, these prohibitions do not apply to contributions 
made before March 14, 2011 by new covered associates to which the 
look back applies. See section II.B.2(a)(5) of this Release for a 
discussion of the rule's look-back provision. For example, if an 
individual who becomes a covered associate of an adviser on or after 
March 14, 2011 made a contribution before March 14, 2011, that new 
covered associate's contribution would not trigger the two-year time 
out for the adviser. On the other hand, if an individual who later 
becomes a covered associate made the contribution on or after March 
14, 2011, the contribution would trigger the two-year time out for 
the adviser if it were made less than, as applicable, six months or 
two years before the individual became a covered associate.
    \435\ Commenters recommended that we provide advisers with six 
months to one year as a transition for rule 206(4)-5. See Davis Polk 
Letter; MFA Letter; ICI Letter; IAA Letter; NASP Letter; Skadden 
Letter.
---------------------------------------------------------------------------

B. Prohibition on Using Third Parties To Solicit Government Business 
and Cash Solicitation Rule Amendment

    Advisers must comply with the new rule's prohibition on making 
payments to third parties to solicit government entities for investment 
advisory services on September 13, 2011.\436\ Before this compliance 
date, advisers are not prohibited by the rule from making payments to 
third-party solicitors regardless of whether they are registered as 
broker-dealers or investment advisers.\437\
---------------------------------------------------------------------------

    \436\ Rule 206(4)-5(a)(2).
    \437\ We note, however, that the antifraud provisions of the 
Federal securities laws continue to apply during the transition 
period.
---------------------------------------------------------------------------

    We have provided an extended transition period to provide advisers 
and third-party solicitors with sufficient time to conform their 
business practices to the new rule, and to revise their compliance 
policies and procedures to prevent violation of the new rule. In 
addition, the transition period will provide an opportunity for a 
registered national securities association to propose a rule that would 
meet the requirements of rule 206(4)-5(f)(9)(ii)(B) and for the 
Commission to consider such a rule. If, after one year, a registered 
national securities association has not adopted such rules, advisers 
would be prohibited from making payments to broker-dealers for 
distribution or solicitation activities with respect to government 
entities, but would be permitted to make payments to registered 
investment advisers that meet the definition of ``regulated person'' 
under the rule.\438\ We understand from our staff, however, that FINRA 
plans to act within the timeframe; if they do not, we will consider 
whether we should take further action.
---------------------------------------------------------------------------

    \438\ See rule 206(4)-5(f)(9)(i).
---------------------------------------------------------------------------

    Finally, the compliance date for the technical amendment to the 
cash solicitation rule, rule 206(4)-3, which is intended to alert 
advisers that rule 206(4)-5 is applicable to solicitations of a 
government entity, is one year from the effective date, as the 
amendment to the cash solicitation rule need only be operative when 
rule 206(4)-5's third-party solicitor provisions are in effect.

C. Recordkeeping

    As discussed above, the amendments to rule 204-2 apply only to 
investment advisers with clients who are government entities. Such 
advisers must comply with the amended rule on March 14, 2011 except as 
noted below. By March 14, 2011, these advisers must begin to maintain 
records of all persons who are covered associates under the rule and 
keep records of political contributions they make on and after that 
date. Advisers must also make and keep a record of all government 
entities that they provide advisory services to on and after March 14, 
2011. Advisers are not, however, required to look back for the five 
years prior to the effective date to identify former government 
clients. Advisers that pay regulated persons to solicit government 
entities for advisory services on their behalf must make and keep a 
list of those persons beginning on and after September 13, 2011.\439\
---------------------------------------------------------------------------

    \439\ Rule 204-2(a)(18)(i)(D).
---------------------------------------------------------------------------

D. Registered Investment Companies

    Advisers to registered investment companies that are ``covered 
investment pools'' under the rule \440\ must comply with rule 205(4)-5 
with respect to those covered pools September 13, 2011. During the 
transition period, contributions by the adviser or its employees to 
government entity clients that have selected an adviser's registered 
investment company as an investment option of a plan or program will 
not trigger the prohibitions of rule 206(4)-5.\441\
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    \440\ A registered investment company is only a covered 
investment pool if it is an investment option of a plan or program 
of a government entity, such as a 529 plan, 403(b) plan or 457 plan. 
See rule 206(4)-5(f)(3).
    \441\ Advisers to covered investment pools other than registered 
investment companies--i.e., companies that would be investment 
companies under section 3(a) of the Investment Company Act but for 
the exclusion provided from that definition by either section 
3(c)(1), section 3(c)(7) or section 3(c)(11)--are subject to the 
six-month transition period. We believe advisers to these types of 
funds, because the interests in them are typically held in the name 
of the investor, should be able to identify government entities 
without significant difficulty.

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[[Page 41052]]

    We have provided for an extended compliance date to respond to 
concerns expressed by commenters that an adviser to a registered 
investment company may require additional time to identify government 
entities that have selected that registered investment company as an 
investment option when shares of the fund are held through omnibus 
arrangements such that the identity of the fund investor is not readily 
available to the adviser.\442\ The changes we have made to the proposed 
rule that limit the application of the two-year time out with respect 
to registered investment companies to those that are options in a plan 
or program of a government entity,\443\ together with this extended 
compliance date should provide advisers to registered investment 
companies sufficient time to put into place those system enhancements 
or business arrangements, such as those with intermediaries, that may 
be necessary to identify those government plans or programs in which 
the funds serve as investment options.\444\
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    \442\ See ICI Letter; T. Rowe Price Letter.
    \443\ See section II.B.2(a) of this Release.
    \444\ A few commenters recommended that the rule apply only to 
new government investors in registered investment companies after 
the effective date of the rule. See ICI Letter; T. Rowe Price 
Letter. We do not believe this would be appropriate because pay to 
play can be just as troubling in the context of an adviser renewing 
an advisory contract (or including a registered investment company 
as an investment option in a plan or program) as one that is 
endeavoring to obtain business for the first time.
---------------------------------------------------------------------------

    As noted above, we are providing for an extended compliance date 
for advisers that manage registered investment companies that are 
covered investment pools under the rule, which we are applying, for the 
same reasons, to recordkeeping obligations that arise as a result of 
those covered investment pools. Thus, advisers to these covered 
investment pools must make and keep a record of all government entity 
investors on and after September 13, 2011.\445\
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    \445\ Amended rule 204-2 does not require an adviser to a 
covered investment pool that is an option of a government plan or 
program to make and keep records of participants in the plan or 
program, but only the government entity. See supra note 411.
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IV. Cost-Benefit Analysis

    We are sensitive to the costs and benefits imposed by our rules, 
and understand that there will be costs associated with compliance with 
rule 206(4)-5 and the amendments to rule 204-2.\446\ We recognize that 
the rule and amendments will place burdens on advisers that provide or 
seek to provide advisory services to government entities, and that 
advisers may in turn choose to limit the ability of certain persons 
associated with an adviser to make contributions to candidates for 
certain offices and to solicit contributions for certain candidates and 
payments to political parties. We believe there are practical, cost-
effective means to comply with the rule without an adviser imposing a 
blanket ban on political contributions by its covered associates. We 
have closely drawn the rule, and modified it based on comments 
received, to achieve our goal of addressing adviser participation in 
pay to play practices, while seeking to limit the burdens imposed by 
the rule.
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    \446\ As proposed, we are also making a conforming technical 
amendment to rule 206(4)-3 to address potential areas of conflict 
with proposed rule 206(4)-5. We do not believe that this technical 
amendment affects the costs associated with the rulemaking. It will 
benefit advisers because it provides clarity about the application 
of our rules when they potentially overlap.
---------------------------------------------------------------------------

    The rule and rule amendments are designed to address pay to play 
practices by investment advisers that provide advisory services to 
government entity clients and to certain covered investment pools in 
which a government entity invests. The rule prohibits an investment 
adviser from providing advisory services for compensation to a 
government client for two years after the adviser or certain of its 
executives or employees make a contribution to certain elected 
officials or candidates. The rule also prohibits an adviser from 
providing or agreeing to provide, directly or indirectly, payment to 
any third party that is not a ``regulated person'' for a solicitation 
of advisory business from any government entity, or for a solicitation 
of a government entity to invest in certain covered investment pools, 
on behalf of such adviser. Additionally, the rule prevents an adviser 
from coordinating or soliciting from others contributions to certain 
elected officials or candidates or payments to certain political 
parties. The rule applies both to advisers registered with us (or 
required to be registered) and those that are unregistered in reliance 
on the exemption available under section 203(b)(3) of the Advisers Act 
(15 U.S.C. 80b-3(b)(3)). Our amendment to rule 204-2 requires a 
registered adviser to maintain certain records of the political 
contributions made by the adviser or certain of its executives or 
employees, as well as records of the regulated persons the adviser pays 
or agrees to pay to solicit government entities on the adviser's 
behalf.
    In the Proposing Release, we requested comment on the effects of 
the proposed rule and rule amendments on pension plan beneficiaries, 
participants in government plans or programs, investors in pooled 
investment vehicles, investment advisers, the advisory profession as a 
whole, government entities, third party solicitors, and political 
action committees.\447\ We requested that commenters provide analysis 
and empirical data to support their views on the costs and benefits 
associated with the proposal. For example, we requested comment on the 
costs of establishing compliance procedures to comply with the proposed 
rule, both on an initial and ongoing basis and on the costs of using 
compliance procedures of an affiliated broker-dealer that the broker-
dealer established as a result of MSRB rules G-37 and G-38. In 
addition, we requested data regarding our assumptions about the number 
of unregistered advisers that would be subject to the proposed rule, 
and the number of covered associates of these exempt advisers. Finally, 
in the context of the objectives of this rulemaking, we sought comments 
that address whether these rules will promote efficiency, competition 
and capital formation, and what effect the rule would have on the 
market for investment advisory services and third-party solicitation 
services.
---------------------------------------------------------------------------

    \447\ Proposing Release, at section III.C.
---------------------------------------------------------------------------

    We received approximately 250 comment letters on the proposal. 
Almost all of the commenters agreed that pay to play is a serious issue 
that should be addressed. One commenter stated that ``the benefits 
derived from the application of pay to play limitations to public 
sector advisory services will far outweigh any temporary dislocations 
that may occur as private and public sector professionals make the 
necessary adjustments to their activities to transition to the 
Commission's new standards.'' \448\ Many, however, expressed concern 
about costs,\449\ particularly those related to the proposed ban on 
payments to third parties. Some suggested that the

[[Page 41053]]

Commission underestimated the costs of compliance with the rule and 
rule amendments.\450\ As discussed below, many of the commenters that 
did comment specifically on the costs and benefits of the proposal did 
not provide empirical data to support their views.
---------------------------------------------------------------------------

    \448\ MSRB Letter. See also Thompson Letter; Common Cause 
Letter; Fund Democracy/Consumer Federation Letter (each identifying 
benefits of the rule).
    \449\ See, e.g., Davis Polk Letter (generally commenting that 
any benefits of the proposed rule were outweighed by its likely 
costs). See also ICI Letter; Monument Group Letter.
    \450\ See, e.g., SIFMA Letter (``While SIFMA believes that 
addressing practices that potentially undermine the merit-based 
selection of investment advisers is an important and laudable 
effort, the SEC appears to have underestimated the compliance costs 
the Proposed Rule will impose on covered parties.''); ICI Letter 
([I]n relying on the estimates for compliance with the MSRB rules, 
the Commission significantly underestimates the compliance and 
recordkeeping burdens associated with the proposed rule.''); Davis 
Polk Letter (``We believe that the Commission may have substantially 
underestimated the number of investment advisers that will be 
affected by the Proposed Rule and its costs and market effects in 
concluding that many of the aspects of the Rule would impose only 
minimal additional costs and burdens on investors and investment 
advisers.''). The commenters who addressed our estimates, however, 
did so in general terms and did not provide specific suggestions as 
to how they should be modified. See the discussion below regarding 
changes from the proposed rule that we believe mitigate some of the 
costs.
---------------------------------------------------------------------------

A. Benefits

    As we discuss extensively throughout this Release, we expect that 
rule 206(4)-5 will yield several important direct and indirect 
benefits. Overall, the rule is intended to address pay to play 
relationships that interfere with the legitimate process by which 
advisers are chosen based on the merits rather than on their 
contributions to political officials. The potential for fraud to invade 
the various, intertwined relationships created by pay to play 
arrangements is without question. We believe that rule 206(4)-5 will 
reduce the occurrence of fraudulent conduct resulting from pay to play 
and thus will achieve its goals of protecting public pension plans, 
beneficiaries, and other investors from the resulting harms. One 
commenter who agreed with us commended the proposed rule as a ``strong 
start in controlling corruption, balancing the rights of the advisors 
and their executives with the very real detriment to the public which 
the numerous cases of pay-to-play involving public pension funds and 
other public entities have caused.'' \451\
---------------------------------------------------------------------------

    \451\ Common Cause Letter.
---------------------------------------------------------------------------

    Addressing pay to play practices will help protect public pension 
plans and investments of the public in government-sponsored savings and 
retirement plans and programs by addressing situations in which a more 
qualified adviser may not be selected, potentially leading to inferior 
management, diminished returns or greater losses. One commenter who 
agreed, observed, ``[w]hen lucrative investment contracts are awarded 
to those who pay to play, public pension funds may end up receiving 
substandard services and higher fees, resulting in lower earnings.'' 
\452\ One public official commenter detailed the role of pay to play 
arrangements in the selection of public pension fund managers and the 
harm it can inflict on the affected plans,\453\ while other officials 
wrote to us explicitly expressing support for a Commission rule.\454\ 
By addressing pay to play practices, we will help level the playing 
field so that the advisers selected to manage retirement funds and 
other investments for the public are more likely to be selected based 
on the quality of their advisory services. These benefits, although 
difficult to quantify, could result in substantial savings and better 
performance for the public pension plans, their beneficiaries, and 
participants.\455\ Two commenters noted that the rule would promote the 
interests of plan beneficiaries.\456\
---------------------------------------------------------------------------

    \452\ Bloomberg Letter.
    \453\ Weber Letter (``I have seen money managers awarded 
contracts with our fund which involved payments to individuals who 
served as middlemen, creating needless expense for the fund. These 
middlemen were political contributors to the campaigns of board 
members who voted to contract for money management services with the 
companies who paid them as middlemen.''). See also Pohndorf Letter 
(noting that when the sole trustee of a major pension fund changed 
several years ago, a firm managing some of the fund's assets ``began 
to receive invitations to fundraising events for the new trustee 
with suggested donation amounts''); Tobe Letter (suggesting the 
negative effects of pay to play activities on the Kentucky 
Retirement System's investment performance).
    \454\ See, e.g., DiNapoli Letter; Bloomberg Letter.
    \455\ According to the most recently available US census data, 
as of 2008, there are 2,550 State and local government employee 
retirement systems. http://www.census.gov/govs/retire/. See also 
Fund Democracy/Consumer Federation Letter (``These practices 
adversely affect the economic interests of millions of America's 
public servants.'').
    \456\ Comment Letter of John C. Emmel (Sept. 18, 2009) (``one 
more step to foster a level playing field for investors * * * where 
advisors' priorities trump those of the investing public''); Comment 
Letter of George E. Kozel (Aug. 31, 2009) (``Kozel Letter'') 
(``Their interests lie in obtaining the highest fees not in 
producing benefits for the pensioners. * * *'').
---------------------------------------------------------------------------

    By leveling the playing field among advisers competing for State 
and local government business, the rule will help minimize or eliminate 
manipulation of the market for advisory services provided to State and 
local governments.\457\ For example, direct political contributions or 
payments made to third-party solicitors as part of pay to play 
practices create artificial barriers to competition for firms that 
cannot, or will not, make those contributions or payments.\458\ They 
also increase costs for firms that may feel they have no alternative 
but to pay to play. The rule addresses a collective action problem 
created by this dynamic analogous to the one identified in the Blount 
opinion.\459\ One commenter emphasized the importance of restoring 
public confidence in the investment activities of all public pension 
funds.\460\ Indeed, at its core, the rulemaking addresses practices 
that undermine the integrity of the market for advisory services, as 
underscored by another commenter.\461\
---------------------------------------------------------------------------

    \457\ See DiNapoli Letter (advocating for a ``level playing 
field for investors and investment advisers that protects the 
integrity of the decision-making process [for hiring an investment 
adviser]''); Bloomberg Letter (``Pay to play practices clearly 
undermine the open competitive process by which government contracts 
are to be awarded.'').
    \458\ See supra note 453.
    \459\ See Blount, 61 F.3d at 945-46 (discussing the harms of pay 
to play: ``Moreover, there appears to be a collective action problem 
tending to make the misallocation of resources persist.''). See also 
text accompanying notes 291-294 of this release. Collective action 
problems are a class of market failures calling for a regulatory 
response, and exist, for example, where participants may prefer to 
abstain from an unsavory practice (such as pay to play), but 
nonetheless participate out of concern that, even if they abstain, 
their competitors will continue to engage in the practice profitably 
and without adverse consequences.
    \460\ Thompson Letter. See also Bloomberg Letter.
    \461\ Common Cause Letter (``Pay-to-play has not only the 
potential to compromise an investment adviser's ethical and legal 
duties under the Investment Advisers Act of 1940, but in several 
high profile cases across the nation, has already done so, 
negatively impacting the public perception of government decision 
making and, in some cases, costing the taxpayer millions of dollars 
and placing billions of dollars in pension funds at risk.''). See 
also Dempsey Letter (noting applause for efforts ``to stop the `pay-
to-play' practice which only serves to undermine public trust in 
investment advisors and regulators'').
---------------------------------------------------------------------------

    Allocative efficiency is enhanced when government clients award 
advisory business to advisers that compete based on price, performance 
and service and not the influence of pay to play, which in turn enables 
advisory firms, particularly smaller advisory firms, to compete on 
merit, rather than their ability or willingness to make 
contributions.\462\ In addition, taking into account the effects of 
analogous practices in the underwriting of municipal securities prior 
to MSRB rule G-37,\463\ we believe a merit-based competitive process 
may result in the allocation of public pension monies to different 
advisers who may well deliver better investment performance and lower 
advisory fees than those advisers

[[Page 41054]]

whose selection was influenced by pay to play.
---------------------------------------------------------------------------

    \462\ See Comment Letter of Budge Collins (Sept. 30, 2009) (the 
rule would ``level the playing field for the rest of us who have 
never made contributions to elected officials who sit on investment 
management committees'').
    \463\ One commenter cited a study containing evidence that 
before rule G-37 was adopted, underwriters' pay to play practices 
distorted underwriting fees as well as which firms were hired by 
government issuers. See Butler Letter.
---------------------------------------------------------------------------

    As adopted, the rule contains a prohibition against advisers 
directly or indirectly compensating a third party to solicit government 
entities on its behalf, unless the third-party solicitor is a 
``regulated person'' subject to pay to play restrictions. This 
exception enables advisers and pension plans (and their beneficiaries) 
to continue to benefit from the services of third-party solicitors, 
such as the placement of interests in private funds, while at the same 
time benefitting from a Commission rule that prohibits pay to play 
practices.\464\
---------------------------------------------------------------------------

    \464\ Commenters, both on the Proposing Release and our 1999 
proposal, argued that treating third-party solicitors as covered 
associates would create significant compliance challenges because 
these solicitors were not controlled by advisers. See supra note 264 
and accompanying text.
---------------------------------------------------------------------------

    Our rule may also benefit pension plans by preventing harms that 
can result when an adviser is not negotiating at arm's length with a 
government official. For example, as a result of pay to play, an 
adviser may obtain greater ancillary benefits, such as ``soft 
dollars,'' from the advisory relationship, which may be directed for 
the benefit of the adviser, potentially at the expense of the pension 
plan, thereby using a pension plan asset for the adviser's own 
purposes.\465\ Additionally, taxpayers may benefit from our rule 
because they might otherwise bear the financial burden of bailing out a 
government pension fund that has ended up with a shortfall due to poor 
performance or excessive fees that might result from pay to play.\466\
---------------------------------------------------------------------------

    \465\ See supra note 55 and accompanying text.
    \466\ See Kozel Letter (supporting the Commission's proposal and 
asserting that the persons who engage in pay to play practices know 
that any shortfalls would be covered by taxpayers); Bloomberg Letter 
(``Because the City is legally obligated to make up any short fall 
in the pension system assets to ensure full payment of pension 
benefits, pay to play practices can potentially harm all New 
Yorkers.''). See also Common Cause Letter; 1997 Survey, supra note 8 
(``[t]he investment of plan assets is an issue of immense 
consequence to plan participants, taxpayers, and to the economy as a 
whole'' as a low rate of return will require additional funding from 
the sponsoring government, which ``can place an additional strain on 
the sponsoring government and may require tax increases'').
---------------------------------------------------------------------------

    In addition to the general benefits of addressing pay to play 
practices by investment advisers noted above, we believe the specific 
provisions of the rule, including the two-year time out, the ban on 
using third parties to solicit government business, and the 
restrictions on soliciting and coordinating contributions and payments 
will likely result in similar benefits to those that have resulted from 
MSRB rules G-37 and G-38, on which our rule is closely modeled. The 
MSRB rules have prohibited municipal securities dealers from 
participating in pay to play practices since 1994.\467\ As we have 
stated previously, we believe these rules have significantly curbed pay 
to play practices in the municipal securities market, and are likely to 
be similarly effective in deterring pay to play activities by 
investment advisers.\468\
---------------------------------------------------------------------------

    \467\ MSRB rule G-37 was approved by the Commission and adopted 
by the MSRB in 1994. See supra note 66.
    \468\ See supra notes 101-107 and accompanying text.
---------------------------------------------------------------------------

    Applying the rule to government entity investments in certain 
pooled investment vehicles or where a pooled investment vehicle is an 
investment option in a government-sponsored plan or program will extend 
the same benefits regardless of whether an adviser subject to the rule 
is providing advice directly to the government entity or is managing 
assets for the government entity indirectly through a pooled investment 
vehicle. By addressing distortions in the process by which investment 
decisions are made regarding public investments, we are providing 
important protections to public pension plans and their beneficiaries, 
as well as participants in other important plans or programs sponsored 
by government entities. Other investors in a pooled investment vehicle 
also will be better protected from, among other things, the effects of 
fraud that may result from an adviser's participation in pay to play 
activities, such as higher advisory fees.
    Finally, the amendments to rule 204-2 will benefit the public plans 
and their beneficiaries and participants in State plans or programs as 
well as investment advisers that keep the required records. The public 
pension plans, beneficiaries, and participants will benefit from these 
amendments because the records required to be kept will provide 
Commission staff with information to review an adviser's compliance 
with rule 206(4)-5 and thereby may promote improved compliance. 
Advisers will benefit from the amendments to the recordkeeping rule as 
these records will assist the Commission in enforcing the rule against, 
for example, a competitor whose pay to play activities, if not 
uncovered, could adversely affect the competitive position of a 
compliant adviser.

B. Costs

    We acknowledge that the rule and rule amendments will impose costs 
on advisers that provide or seek to provide advisory services to 
government clients directly, or indirectly through pooled investment 
vehicles. We discuss these costs below, along with a number of 
modifications we have made to the proposed rule and proposed amendments 
that will reduce costs.
1. Compliance Costs Related to Rule 206(4)-5
    Rule 206(4)-5 requires an adviser with government clients to incur 
costs to monitor contributions made by the adviser and its covered 
associates and to establish procedures to comply with the rule. The 
initial and ongoing compliance costs imposed by the rule will vary 
significantly among firms, depending on a number of factors. Our 
estimated compliance costs, discussed below, take into account 
different ways a firm might comply with the rule. These factors include 
the number of covered associates of the adviser, the degree to which 
compliance procedures are automated (including policies and procedures 
that could require pre-clearance), the extent to which an adviser has a 
pre-existing policy under its code of ethics or compliance 
program,\469\ and whether the adviser is affiliated with a broker-
dealer firm that is subject to MSRB rules G-37 and G-38. A smaller 
adviser, for example, will likely have a small number of covered 
associates, and thus expend less resources to comply with the rule and 
rule amendments than a larger adviser.
---------------------------------------------------------------------------

    \469\ One commenter stated that many investment advisers already 
have pay to play policies and procedures in place within the 
framework of their codes of ethics. See IAA Letter (advocating for 
regulation that would address pay to play practices through an 
adviser's code of ethics, as an alternative to the approach taken in 
proposed rule 206(4)-5).
---------------------------------------------------------------------------

    Although a larger adviser is likely to spend more resources to 
comply with the rule, based on staff observations, a larger adviser is 
more likely to have an affiliated broker-dealer that is required to 
comply with MSRB rules G-37 and G-38.\470\ As we learned from a broker-

[[Page 41055]]

dealer with an investment adviser affiliate that commented on our 1999 
proposal, ``the more the Rule mirrors G-37, the more firms can borrow 
from or build upon compliance procedures already in place. * * *''\471\ 
Accordingly, we believe some advisers with broker-dealer affiliates may 
spend fewer resources to comply with the rule and rule amendments. We 
recognize, as some commenters pointed out, that MSRB rules G-37 and G-
38 compliance systems may not be easily extensible in all cases, and we 
acknowledge that the range of efficiencies created in these 
circumstances will vary.\472\ A prominent concern of these commenters 
related to a proposed recordkeeping amendment which would have required 
advisers to keep records of solicitations-- something that is not 
required under MSRB recordkeeping rule G-8. As previously discussed, we 
are not adopting that proposed amendment, which may address the concern 
noted by commenters.
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    \470\ According to registration information available from 
Investment Adviser Registration Depository (``IARD'') as of April 1, 
2010, there are 1,332 SEC-registered investment advisers (or 11.48% 
of the total 11,607 registered advisers) that indicate in Item 
5.D.(9) of Form ADV that they have State or municipal government 
clients. Of those 1,332 advisers, 113 (or 85.0%) of the largest 10% 
have one or more affiliated broker-dealers or are, themselves, also 
registered as a broker-dealer. 204 of the largest 20% (or 76.7%) 
have one or more affiliated broker-dealers or are, themselves, also 
registered as a broker-dealer. Conversely, only 40 (or 30.1%) of the 
smallest 10% have one or more affiliated broker-dealers or are, 
themselves, also registered as a broker-dealer; and only 67 of the 
smallest 20% (or 25.2%) have one or more affiliated broker-dealers 
or are, themselves, also registered as a broker-dealer. With respect 
to broker-dealer affiliates, however, we note that our IARD data 
does not indicate whether the affiliated broker-dealer is a 
municipal securities dealer subject to MSRB rules G-37 and G-38. 
Also, as one commenter asserted, private fund managers may be among 
the larger advisers, based on assets under management, but they are 
unlikely to have an affiliated broker-dealer that has already 
adopted similar procedures to comply with MSRB rules G-37 and G-38 
because most private fund managers are not involved in municipal 
underwriting. MFA Letter. We acknowledge that a private fund manager 
generally would be less likely to have an affiliated broker-dealer 
from which it can borrow or build upon compliance procedures; 
however, we also expect that a private fund manager would use less 
resources than other large registered advisers to comply with the 
rule because a private fund manager is not subject to rule 206(4)-7, 
the Advisers Act compliance rule, and would likely have fewer 
employees and covered associates than a larger organization.
    \471\ Comment Letter of US Bancorp Piper Jaffray Inc. (now, 
``Piper Jaffray & Co.'') (Nov. 15, 1999).
    \472\ SIFMA Letter. See also ICI Letter.
---------------------------------------------------------------------------

    We anticipate that advisory firms subject to rule 206(4)-5 will 
develop compliance procedures to monitor the political contributions 
made by the adviser and its covered associates.\473\ We estimate that 
the costs imposed by the rule will be higher initially, as firms 
establish and implement procedures and systems to comply with the rule 
and rule amendments. We expect that compliance expenses would then 
decline to a relatively constant amount in future years, and annual 
expenses are likely to be lower for small advisers as the systems and 
processes should be less complex than for a large adviser.
---------------------------------------------------------------------------

    \473\ Investment advisers registered with the Commission are 
required to adopt and implement policies and procedures reasonably 
designed to prevent violation by the adviser or its supervised 
persons of the Advisers Act and the rules the Commission has adopted 
thereunder. See rule 206(4)-7.
---------------------------------------------------------------------------

    We estimate that approximately 1,697 investment advisers registered 
with the Commission may be affected by the rule and rule 
amendments.\474\ Of the 1,697 advisers, we estimate that approximately 
1,271 advisers have fewer than five covered associates that would be 
subject to the rule (each, a ``smaller firm''); approximately 304 
advisers have between five and 15 covered associates (each, a ``medium 
firm''); and approximately 122 advisers have more than 15 covered 
associates that would be subject to the prohibitions of the rule (each, 
a ``larger firm'').\475\
---------------------------------------------------------------------------

    \474\ This estimate is based on registration information from 
IARD as of April 1, 2010, applying the same methodology as in the 
Proposing Release. As previously noted, according to responses to 
Item 5.D(9) of Part 1 of Form ADV, 1,332 advisers have clients that 
are State or municipal government entities, which represents 11.48% 
of all advisers registered with us. 10,275 advisers have not 
responded that they have clients that are State or municipal 
government entities. Of those, however, responses to Item 5.D(6) of 
Part 1 of Form ADV indicate that 2,486 advisers have some clients 
that are other pooled investment vehicles. Estimating that the same 
percentage of these advisers advise pools with government entity 
investors as advisers that have direct government entity clients--
i.e.,11.48%. 285 of these advisers would be subject to the rule 
(2,486 x 11.48% = 285). Out of the 10,275 that have not responded 
that they have clients that are State or municipal government 
entities, after backing out the 2,486 which have clients that are 
other pooled investment vehicles, responses to Item 5.D(4) of Part 1 
of Form ADV indicate that 699 advisers have some clients that are 
registered investment companies. Estimating that roughly the same 
percentage of these advisers advise pools with government entity 
investors as advisers that have direct government entity clients--
i.e.,11.48%. 80 of these advisers would be subject to the rule (699 
x 11.48% = 80). Although we limited the application of rule 206(4)-5 
with respect to registered investment companies to those that are 
investment options of a plan or program of a government entity, we 
continue to estimate that 80 advisers would have to comply with the 
recordkeeping provisions because of the difficulty in further 
delineating this estimated number. Therefore, we estimate that the 
total number of advisers subject to the rule would be: 1,332 
advisers with State or municipal clients + 285 advisers with other 
pooled investment vehicle clients + 80 advisers with registered 
investment company clients = 1,697 advisers subject to rule. We 
expect certain additional advisers may incur compliance costs 
associated with rule 206(4)-5. We anticipate some advisers may be 
subject to the rule because they solicit government entities on 
behalf of other investment advisers. Additionally, some advisers 
that do not currently have government clients may seek to obtain 
them in the future. In doing so, they likely would conduct due 
diligence to confirm they would not be prohibited from receiving 
compensation for providing investment advisory services to the 
government client.
    \475\ This estimate is based on registration information from 
IARD as of April 1, 2010. These estimates are based on IARD data, 
specifically the responses to Item 5.B.(1) of Form ADV, that 997 (or 
74.9%) of the 1,332 registered investment advisers that have 
government clients have fewer than five employees who perform 
investment advisory functions, 239 (or 17.9%) have five to 15 such 
employees, and 96 (or 7.2%) have more than 15 such employees. We 
then applied those percentages to the 1,697 advisers we believe will 
be subject to the proposed rule for a total of 1,271 smaller, 304 
medium and 122 larger firms.
---------------------------------------------------------------------------

    One commenter disagreed with us basing our cost estimates on an 
assumption that most registered advisers would have fewer than five 
covered associates because the commenter expects most advisers to 
require all or most of their employees to receive approval prior to 
making any political contributions in order to avoid inadvertently 
triggering the rule.\476\ Although the rule does not require this 
approach and the changes we have made to the rule (e.g., modified 
definition of covered associate) should help address the concerns of 
this commenter that led to the assertion, we recognize that some 
advisers may voluntarily restrict all of their employees' political 
contributions in such a manner. This type of pre-screening process 
could be perceived by the individuals subject to them as costs imposed 
on their ability to express their support for certain candidates for 
elected office and government officials. We also received a comment 
that our estimates should take into account turnover of personnel.\477\ 
Our cost estimate assumes a certain level of turnover; although these 
categories are based on an adviser's number of covered associates, we 
have not calculated per-covered associate costs associated with this 
rulemaking. The categories of smaller, medium and larger advisers are 
based on an estimated number of covered associates, but are not 
intended to represent a static population of covered associates within 
each category. For instance, in estimating the ongoing burdens on 
advisers to comply with the rule, we implicitly incorporated a greater 
degree of turnover at larger advisers in estimating that they would 
incur 1,000 hours annually as compared to the estimated 10 hours for a 
small adviser.
---------------------------------------------------------------------------

    \476\ See MFA Letter.
    \477\ ICI Letter.
---------------------------------------------------------------------------

    Advisers that are unregistered in reliance on the exemption 
available under section 203(b)(3) of the Advisers Act [15 U.S.C. 80b-
3(b)(3)] would be subject to rule 206(4)-5.\478\ Based on our review of 
registration information on IARD and outside sources and reports, we 
estimate that there are approximately 2,000 advisers that are 
unregistered in reliance on section 203(b)(3).\479\ Applying the same

[[Page 41056]]

principles we used with respect to registered investment advisers, we 
estimate that 230 of those advisers manage pooled investment vehicles 
in which government client assets are invested and would therefore be 
subject to the rule.\480\ For purposes of this analysis, it is assumed 
that each unregistered advisory firm that would be subject to the rule 
would either be a smaller firm or a medium firm in terms of number of 
covered associates because it is unlikely that an adviser that operates 
outside of public view and is limited to fewer than 15 clients \481\ 
would have a large number of advisory personnel that would be covered 
associates. One commenter agreed that most of these unregistered 
advisers would be small, although the commenter based its assessment on 
assets under management, not on the adviser's likely number of covered 
associates.\482\
---------------------------------------------------------------------------

    \478\ The amendments to rules 204-2 and 206(4)-3, however, only 
apply to advisers that are registered, or required to be registered, 
with the Commission.
    \479\ This number is based on our review of registration 
information on IARD as of April 1, 2010, IARD data from the peak of 
hedge fund adviser registration in 2005, and a distillation of 
numerous third-party sources including news organizations and 
industry trade groups.
    \480\ 11.48% of 2000 is 230. See supra note 474.
    \481\ See section 203(b)(3) of the Advisers Act [15 U.S.C. 80b-
3(b)(3)] (advisers who rely on this exception from registration must 
have fewer than 15 clients in a 12-month period) .
    \482\ 3PM Letter.
---------------------------------------------------------------------------

    Some commenters asserted that our estimated number of advisers 
subject to the proposed rule was too low.\483\ One claimed that the 
number of advisory firms exempted from registration in reliance on 
Section 203(b)(3) may be ``over two times our estimate,'' but provided 
statistics about the number of unregistered pooled investment vehicles, 
not the number of advisers to those pools.\484\ Other commenters did 
not provide empirical data or suggest alternative formulas by which to 
recalculate our estimate. Additionally, another seemed to misunderstand 
our estimates.\485\
---------------------------------------------------------------------------

    \483\ See Davis Polk Letter; MFA Letter; 3PM Letter.
    \484\ 3PM Letter. See also Davis Polk Letter (citing to 3PM 
Letter on this proposition).
    \485\ Davis Polk Letter (suggesting that we failed to take into 
account the costs likely to be borne by unregistered investment 
advisers). See supra notes 479 and 480 and accompanying text; 
Proposing Release, nn.219-20 and accompanying text (providing an 
estimate of the number of unregistered advisers we expect to be 
subject to this rule, and that must develop compliance systems).
---------------------------------------------------------------------------

    As we stated in the Proposing Release,\486\ although the time 
needed to comply with the rule will vary significantly from adviser to 
adviser, as discussed in detail below, the Commission staff estimates 
that firms with government clients will spend between 8 hours and 250 
hours to establish policies and procedures to comply with the rule. 
Commission staff further estimates that ongoing compliance with the 
rule will require between 10 and 1,000 hours annually. In addition, 
advisory firms may incur one-time costs to establish or enhance current 
systems to assist in their compliance with the rule. These costs would 
vary widely among firms. Small advisers may not incur any system costs 
if they determine a system is unnecessary due to the limited number of 
employees they have or the limited number of government entity clients 
they have. Large firms likely already have devoted significant 
resources into automating compliance and reporting and the new rule 
could result in enhancements to these existing systems. We believe such 
system costs could range from the tens of thousands of dollars for 
simple reporting systems, to hundreds of thousands of dollars for 
complex systems used by the large advisers.
---------------------------------------------------------------------------

    \486\ See Proposing Release, at section III.B.
---------------------------------------------------------------------------

    Initial compliance procedures would likely be designed, and ongoing 
administration of them performed, by compliance managers and compliance 
clerks. We estimate that the hourly wage rate for compliance managers 
is $294, including benefits, and for compliance clerks, $59 per hour, 
including benefits.\487\ To establish and implement adequate compliance 
procedures, we estimate that the rule would impose initial compliance 
costs of approximately $2,352 per smaller firm,\488\ approximately 
$29,407 per medium firm,\489\ and approximately $58,813 per larger 
firm.\490\ It is estimated that the rule would impose annual, ongoing 
compliance expenses of approximately $2,940 per smaller firm,\491\ 
$117,625 per medium firm,\492\ and $235,250 per larger firm.\493\
---------------------------------------------------------------------------

    \487\ Our hourly wage rate estimate for a compliance manager and 
compliance clerk is based on data from the Securities Industry 
Financial Markets Association's Management & Professional Earnings 
in the Securities Industry 2009, modified by Commission staff to 
account for an 1800-hour work-year and multiplied by 5.35 (in the 
case of compliance managers) or 2.93 (in the case of compliance 
clerks) to account for bonuses, firm size, employee benefits and 
overhead. The calculations discussed in this release are updated 
from those included in the Proposing Release to incorporate data 
from the most recently updated version of this publication.
    \488\ The per firm cost estimate is based on our estimate that 
development of initial compliance procedures for smaller firms would 
take 8 hours of compliance manager time (at $294 per hour). 
Accordingly, the per firm cost estimate is $2,352 (8 x $294).
    \489\ With respect to our estimated range of 8-250 hours, we 
assume a medium firm would take 125 hours to develop initial 
compliance procedures, and such a firm would likely have support 
staff. We also anticipate that a compliance manager would do 
approximately 75% of the work because he or she is responsible for 
implementing the policy for the entire firm. Accordingly, the per 
firm cost estimate is based on our estimate that development of 
initial compliance procedures for medium firms would take 93.75 
hours of compliance manager time, at $294 per hour (or $27,563), and 
31.25 hours of clerical time, at $59 per hour (or $1,844), for a 
total estimated cost of $29,407.
    \490\ With respect to our estimated range of 8-250 hours, we 
assume a larger firm would take 250 hours to develop initial 
compliance procedures, and such a firm would likely have support 
staff. We also anticipate that a compliance manager would do 
approximately 75% of the work because he/she is responsible for 
implementing the policy for the entire firm. Accordingly, the per 
firm cost estimate is based on our estimate that development of 
initial compliance procedures for larger firms would take 187.50 
hours of compliance manager time, at $294 per hour (or $55,125), and 
62.5 hours of clerical time, at $59 per hour (or $3,688), for a 
total estimated cost of $58,813.
    \491\ The per firm cost estimate is based on our estimate that 
ongoing compliance procedures for smaller firms would take 10 hours 
of compliance manager time, at $294 per hour, for a total estimated 
cost of $2,940 per year.
    \492\ The per firm cost estimate is based on our estimate that 
ongoing compliance procedures for medium firms would take 375 hours 
of compliance manager time, at $294 per hour (or $110,250), and 125 
hours of clerical time, at $59 per hour (or $7,375), for a total 
estimated cost of $117,625 per year.
    \493\ The per firm cost estimate is based on our estimate that 
ongoing compliance procedures for larger firms would take 750 hours 
of compliance manager time, at $294 per hour (or $220,500) and 250 
hours of clerical time, at $59 per hour (or $14,750), for a total 
cost of $235,250 per year.
---------------------------------------------------------------------------

    In establishing these estimates, which are calculated in the same 
manner as those we included in the Proposing Release, we took into 
consideration comments in 1999 that suggested our cost estimates were 
too low.\494\ Our staff, in developing the estimates contained in the 
Proposing Release, also engaged in conversations with industry 
professionals regarding broker-dealer compliance with rules G-37 and G-
38 and representatives of investment advisers that have pay to play 
policies in place.\495\ We significantly increased our cost estimates 
from the 1999 proposal as a result. Some commenters on the proposed 
rule asserted that our projected costs are too low, but did not provide 
empirical data or formulas for us to review.\496\ One commenter 
indicated that, ``as a practical matter, although there may be 
significant differences in the number of hours dedicated to ongoing 
annual compliance between firms of different sizes, the estimated 
number of hours needed to develop initial compliance procedures will be 
similar for all firms, regardless of size. The initial effort of 
designing and implementing new policies and procedures and educating 
personnel will require similar effort and upfront fixed costs.'' \497\ 
We disagree. Although there are some aspects of implementing

[[Page 41057]]

a compliance program that would be similar among all firms regardless 
of their number of covered associates, we expect most costs will vary 
significantly among firms of different sizes as they engage in such 
activities as developing and monitoring reporting mechanisms to track 
covered associate contributions, revising their codes of ethics, 
training their employees, and performing routine quality control tests.
---------------------------------------------------------------------------

    \494\ See Proposing Release, at n.226 and accompanying text.
    \495\ Id. at section III.B.
    \496\ See, e.g., ICI Letter; MFA Letter; SIFMA Letter.
    \497\ See Davis Polk Letter.
---------------------------------------------------------------------------

    In the Proposing Release, we estimated that 75% of larger advisory 
firms, 50% of medium firms, and 25% of smaller firms that are subject 
to the rule may also engage outside legal services to assist in 
drafting policies and procedures, based on staff observations. In 
addition, we also estimated the cost associated with such an engagement 
would include fees for approximately three hours of outside legal 
review for a smaller firm, 10 hours for a medium firm, and 30 hours for 
a larger firm. One commenter suggested that we had underestimated both 
the percentage of advisers that would engage outside counsel and the 
number of hours that outside counsel would spend lending their 
assistance, but did not provide alternative estimates.\498\ Based on 
our staff's experience administering the compliance program rule, we 
continue to believe that our estimates for the number of firms that 
will retain outside counsel for review of policies and procedures are 
appropriate. Based on this comment, however, we have revisited the 
number of hours we estimated outside counsel would spend reviewing 
policies and procedures and have increased these estimates. We now 
estimate the cost associated with such an engagement would include fees 
for approximately eight hours of outside legal review for a smaller 
firm, 16 hours for a medium firm, and 40 hours for a larger firm, at a 
rate of $400 per hour.\499\ Consequently, for a smaller firm we 
estimate a total of $3,200 in outside legal fees for each of the 
estimated 318 advisers that would seek assistance, for a medium firm we 
estimate a total of $6,400 for the estimated 152 advisers that would 
seek assistance, and for each of the 92 larger firms we estimate a 
total of $16,000. Thus, we estimate that approximately 562 investment 
advisers will incur these additional costs, for a total cost of 
$3,462,400 \500\ among advisers affected by the rule amendments.\501\
---------------------------------------------------------------------------

    \498\ Id.
    \499\ In the Proposing Release we estimated the hourly cost of 
outside counsel to be $400 based on our consultation with advisers 
and law firms who regularly assist them in compliance matters. We 
did not receive comment on this estimate and continue to believe 
that it is an accurate estimate.
    \500\ (318 x $3,200 = $1,017,600) + (152 x $6,400 = $972,800) + 
(92 x $16,000 = $1,472,000) = $3,462,400.
    \501\ One commenter asserted that a greater number of firms 
would seek assistance of counsel, regardless of size, but did not 
provide data to support its assertion. Davis Polk Letter.
---------------------------------------------------------------------------

    One commenter suggested that, due to the complexity of, and 
variation among, State and local laws, it might be more difficult than 
we had accounted for in the proposal for an adviser to determine with 
certainty who could be a covered official, and as a result, a greater 
number of advisers would seek the help of outside counsel to make this 
determination than we estimated.\502\ Although the commenter did not 
provide an estimate of how many firms might seek such assistance, we 
believe that the additional guidance we have provided in the discussion 
of officials will address this commenter's concerns and result in fewer 
consultations with outside counsel than anticipated. In addition, it is 
our understanding from discussions with those involved in advising on 
compliance with MSRB rules G-37 and G-38 that a small percentage of 
persons subject to the rule seek legal assistance to make these 
determinations. Our rule uses substantially similar definitions of 
``official'' of a ``government entity'' to those used in the MSRB 
rules; therefore we expect that the percentage of advisory firms that 
would retain legal counsel to make these determinations would be 
similarly small. Moreover, we anticipate that the advisers that are 
most likely to need assistance identifying officials of government 
entities are larger advisers, whose businesses tend to be national in 
scope and whose clients are located throughout the country. If all 122 
of the larger advisory firms we estimate are subject to the rule retain 
legal counsel at a rate of $400 per hour, for approximately 20 hours 
per year, those advisers would incur an estimated total of $976,000 in 
legal fees.\503\
---------------------------------------------------------------------------

    \502\ Caplin & Drysdale Letter. See also IAA Letter; MFA Letter.
    \503\ $400 x 20 = $8,000, and $8,000 x 122 = $976,000.
---------------------------------------------------------------------------

    In the Proposing Release, we estimated that approximately five 
advisers annually would apply to the Commission for an exemption from 
the rule, based on staff discussions with the FINRA staff responsible 
for reviewing exemptive applications submitted under MSRB rule G-37, 
and that outside counsel would spend 16 hours preparing and submitting 
an application. We received criticism that these approximations were 
too low.\504\ Given that the advisory industry is much larger than the 
municipal securities industry, and in light of the number of comment 
letters we received that expressed concern about inadvertent violations 
of the rule that would not qualify for the exception for returned 
contributions, our staff estimates that approximately seven advisers 
annually would apply to the Commission for an exemption from the rule. 
Although we may initially receive more than seven applications a year 
for an exemption, over time, we expect the number of applications we 
receive will significantly decline to an average of approximately seven 
annually. We continue to believe that a firm that applies for an 
exemption will hire outside counsel to prepare an exemptive request, 
but based on commenters concerns have raised the number of hours 
counsel will spend preparing and submitting an application from 16 
hours to 32 hours, at a rate of $400 per hour.\505\ As a result, each 
application will cost approximately $12,800, and the total estimated 
cost for seven applications annually will be $89,600.
---------------------------------------------------------------------------

    \504\ See Davis Polk Letter; ICI Letter.
    \505\ The hourly cost estimate of $400 is based on our 
consultation with advisers and law firms who regularly assist them 
in compliance matters.
---------------------------------------------------------------------------

2. Other Costs Related to Rule 206(4)-5
    The prohibitions of the rule may also impose other costs on 
advisers, covered associates, third-party solicitors, and political 
officials.
(a) Two-Year Time Out
    An adviser that becomes subject to the prohibitions of the rule 
would no longer be eligible to receive advisory fees from its 
government client. This would result in a direct loss to the adviser of 
revenues and profits relating to that government client, although 
another adviser that the government client subsequently chose to retain 
would see an increase in revenues and profits. The two-year time out 
could also limit the number of advisers able to provide services to 
potential government entity clients. An adviser that triggers the two-
year time out may be obligated to provide (uncompensated) advisory 
services for a reasonable period of time until the government client 
finds a successor to ensure its withdrawal did not harm the client, or 
the contractual arrangement between the adviser and the government 
client might obligate the adviser to continue to perform under the 
contract at no fee. An adviser that

[[Page 41058]]

provides uncompensated advisory services to a government client would, 
at a minimum, incur the direct cost of providing uncompensated 
services, and may incur opportunity costs if the adviser is unable to 
pursue other business opportunities for a period of time.
    Advisers to government clients, as well as covered associates of 
the adviser, also may be less likely to make contributions to 
government officials, including candidates, potentially resulting in 
less funding for these officials. Under the rule, advisers and covered 
associates will be subject to new limitations on the amounts and to 
whom they can contribute without triggering the rule's time out 
provision. In addition, these same persons will be prohibited from 
soliciting others to contribute or from coordinating contributions to 
government officials, including candidates, or payments to political 
parties in certain circumstances. These limitations and prohibitions, 
including if a firm chooses to adopt policies or procedures that are 
more restrictive than the rule, could be perceived by the individuals 
subject to them as costs imposed on their ability to express their 
support for certain candidates for elected office and government 
officials.\506\ In addition to these costs, the rule's impact on 
advisers' and employees' contributions will introduce some inefficiency 
into the allocation of contributions to candidates and officials as the 
rule impacts contributions regardless of whether they are being made 
for the purpose of engaging in pay to play.
---------------------------------------------------------------------------

    \506\ One commenter suggested that the proposed rule would 
inhibit individuals who work for an investment adviser from running 
for office because, if they were successful, it may cost their 
former employer business. Caplin & Drysdale Letter. We have 
addressed this comment by making it clear that an individual can 
contribute to his or her own campaign without triggering the rule. 
See supra note 139.
---------------------------------------------------------------------------

    We have made several modifications to the rule from the proposal 
that will reduce these costs or burdens. We are creating a new 
exception to the two-year time out for contributions made by a natural 
person more than six months prior to becoming a covered associate 
unless he or she, after becoming a covered associate, solicits clients 
on behalf of the investment adviser.\507\ This modification will 
decrease the burdens on both employees and employers in terms of 
tracking and limiting employee contributions prior to becoming employed 
or promoted by an investment adviser. In terms of narrowing the scope 
of ``covered investment pools,'' we included a registered investment 
company in the definition of covered investment pool, for purposes of 
all three of the rule's pay to play prohibitions, only if it is an 
investment option of a plan or program of a government entity.\508\ As 
noted above, we believe this approach strikes the right balance between 
applying the rule in those contexts in which advisers to registered 
investment companies are more likely to engage in pay to play conduct 
while recognizing the compliance challenges and costs that may result 
from a broader application of the rule. We are also broadening the 
exception to the rule's time out provision in several respects that 
should further decrease the compliance costs associated with the two-
year time out and will lower any perceived costs on covered associates' 
ability to express their support for candidates. We are increasing the 
aggregate contribution amount eligible for the exception for certain 
returned contributions from $250 to $350 to any one official per 
election,\509\ and we are increasing the number of times an adviser is 
permitted to rely on the returned contributions exception from two to 
three per calendar year for advisers with more than 50 employees.\510\ 
Furthermore, we are making the same adjustment from $250 to $350 for 
contributions eligible for the de minimis exception,\511\ and we are 
adopting a de minimis exception for contributions not exceeding $150 
made by individuals who are not entitled to vote for the 
candidate.\512\
---------------------------------------------------------------------------

    \507\ Rule 206(4)-5(b)(2).
    \508\ Rule 206(4)-5(f)(3) and (f)(8).
    \509\ Rule 206(4)-5(b)(3).
    \510\ Id.
    \511\ Rule 206(4)-5(b)(1).
    \512\ See id.
---------------------------------------------------------------------------

    Several commenters highlighted the costs of the two-year time out 
to the adviser and government entity client, as well as pension fund 
beneficiaries, stating that the time out could force termination of 
long-standing relationships and may result in a permanent termination 
of the advisory relationship.\513\ We acknowledge that advisers subject 
to the time out may lose a government client's business beyond the two-
year period and are sensitive to the concerns of commenters regarding 
the operation of the rule on public pension funds, including the 
burdens they may face in replacing managers and the possibility that 
some managers may no longer seek to manage public plan assets as a 
result of the rule. We believe that these costs are necessary to 
accomplish our goal of addressing pay to play and are justified by the 
benefits of rule 206(4)-5. As discussed above, rule 206(4)-5 is modeled 
on the pay to play rules adopted by the MSRB, which have significantly 
curbed pay to play practices in the municipal securities market. We 
believe that adopting a two-year time out similar to the time out 
applicable under the MSRB rules is appropriate, and that the fiduciary 
relationship advisers have with public pension plans argues for a 
strong prophylactic rule. Finally, while we have designed the rule to 
reduce its impact,\514\ investment advisers are best positioned to 
protect government clients by developing and enforcing robust 
compliance programs designed to prevent contributions from triggering 
the two-year time out.
---------------------------------------------------------------------------

    \513\ See, e.g., ICI Letter (``[E]xisting State and local 
government clients may be harmed by the forced termination of a 
mutually beneficial business relationship, despite receiving free 
services for a period of time, because the government client is 
subject to the costs associated with selecting a new adviser, and 
plan beneficiaries are subject to the costs associated with 
portfolio commissions and other restructuring costs. Consequently, 
our members believe that the two-year ban will operate as a 
permanent ban because a government entity will be unlikely to go 
through the process of identifying and hiring a replacement adviser, 
and then return to the original adviser after the ban ends.''). See 
also IAA Letter; NASP Letter; SIFMA Letter.
    \514\ See, e.g., section II.B.2(a)(6) of this Release 
(discussing the de minimis exceptions to the two-year time out); 
section II.B.2(f) of this Release (discussing the rule's exemptive 
provision).
---------------------------------------------------------------------------

    Commenters also noted, particularly, the potential harm of the two-
year time out to government clients and to other investors in a fund 
that holds illiquid securities when a government investor redeems its 
interests in the fund as a result of the fund adviser's triggering 
contribution.\515\ As we note above, however, our rule does not require 
an adviser that has triggered the time out to redeem the interests of a 
government investor or cancel its commitment. The adviser may have 
multiple options available from which to select to comply with the rule 
in light of its fiduciary obligations and the disclosure it has made to 
investors. The adviser could instead comply with the rule by waiving or 
rebating the portion of its fees or any performance allocation or 
carried interest attributable to the government client.\516\
---------------------------------------------------------------------------

    \515\ CT Treasurer Letter; NY City Bar Letter.
    \516\ See supra note 385 and accompanying text.
---------------------------------------------------------------------------

    Most of the comments we received about the costs of this aspect of 
the proposed rule, however, focused on the costs of an inadvertent 
violation.\517\ We understand that there will be costs, sometimes quite 
significant, as a result

[[Page 41059]]

of inadvertent violations. However, with these potential costs in mind, 
we have taken additional steps to decrease the likelihood of 
inadvertent violations of the rule. First, as discussed above, we 
shortened the look back with respect to most covered associates. We 
expect this new exception will provide an additional mechanism for 
advisers to avoid the cost of a time out as a result of an inadvertent 
violation and will largely address commenters' concerns about the 
screening burdens for new or promoted employees that this aspect of the 
proposal would have imposed on advisers.\518\ Second, as discussed 
above, we are increasing to $350 the amount eligible for an exception 
for certain returned contributions from what we had proposed, we are 
increasing the number of times an adviser is permitted to rely on the 
returned contributions exception, and we are also adopting an 
additional de minimis exception for certain contributions not exceeding 
$150. Last, we note that an adviser's implementation of a strong 
compliance program will reduce the likelihood, and therefore costs, of 
inadvertent violations.
---------------------------------------------------------------------------

    \517\ See, e.g., IAA Letter (``We are concerned that the 
Commission has not considered the significance of the sanctions 
imposed as a result of an adviser's inadvertent violation of the 
rule.'').
    \518\ IAA Letter (``Under the Proposal, investment advisers 
would be required to screen for and eliminate potential employment 
candidates based upon contributions made for a period of up to 
twenty-four months before the person would begin employment with the 
adviser. This requirement * * * would be extremely costly and 
burdensome to implement.''); Wells Fargo Letter (``The ``look back'' 
provision is too draconian. * * * [A] compliance system [will be] 
costly to develop and arduous to implement * * * [and] it would also 
impose severe limitations on the career opportunities of those newly 
entering the investment advisory world who are weighed down by 
political contributions that were completely innocuous when 
made.'').
---------------------------------------------------------------------------

    One commenter asserted that the proposed rule would put advisers at 
a competitive disadvantage to other providers of advisory services to 
government plans that would not be subject to it, such as banks and 
insurance companies.\519\ As we stated earlier, we believe that the 
concerns that we are trying to address with the rule justify its 
adoption, notwithstanding the potential competitive effects that 
advisers may face as a result of the limits on our jurisdiction. We 
also do not view competition by means of engaging in practices such as 
pay to play as an interest that we need to protect.
---------------------------------------------------------------------------

    \519\ NY City Bar Letter.
---------------------------------------------------------------------------

(b) Third-Party Solicitor Ban
    Under our proposal, advisers would have been prohibited from 
compensating any third party to solicit government entities for 
advisory services, other than ``related persons.'' \520\ As a result, 
advisers that rely on third-party solicitors to obtain government 
clients would have had to bear the expense of hiring and training in-
house staff in order to continue their solicitation activities,\521\ a 
result that commenters said would be particularly costly for small and 
new investment advisers.\522\ In addition, third-party solicitors might 
also have experienced substantial negative consequences under the 
proposed rule.\523\ We heard from many commenters on this issue, 
offering various perspectives on how the costs would outweigh the 
benefits of the proposed prohibition.\524\ A few commenters asserted 
that this proposal would have a significant adverse effect on efficient 
capital formation in that it would make it more difficult for private 
equity and venture capital managers to obtain funding that they in turn 
can invest in portfolio companies.\525\ As other commenters pointed 
out, this aspect of our proposed rule might also have placed a 
significant burden on public pension plans,\526\ particularly smaller 
plans because third-party solicitors provide services that plans may 
value, including serving as placement agent for alternative investments 
and serving a screening function with respect to those investments 
presented to the pension plan.\527\
---------------------------------------------------------------------------

    \520\ Proposed rule 206(4)-5(a)(2)(i)(a).
    \521\ See, e.g., Comment Letter of Greenhill & Co., LLC (Oct. 2, 
2009) (``The elimination of placement agents would add a significant 
administrative and cost burden to fund sponsors seeking 
investors.''). See also Alta Letter; Atlantic-Pacific Letter; 
Braxton Letter; Benedetto Letter; CA Assoc. of County Retirement 
Letter; Capstone Letter; EVCA Letter; GA Firefighters Letter; 
Glovista Letter; IL Fund Association Letter; MN Board Letter; Myers 
Letter; NCPERS Letter; NYC Teachers Letter; PA Public School 
Retirement Letter; Reed Letter; Myers Letter; TX Public Retirement 
Letter; WI Board Letter; Credit Suisse Letter (``Moreover, by 
performing these functions, placement agents enable investment 
advisers to focus on their core expertise, investment management, 
and to avoid the necessity of developing the costly in-house 
resources necessary to raise capital directly.'').
    \522\ See, e.g., MFA Letter (``[M]anagers that engage placement 
agents, particularly small and offshore managers, would lose the 
ability to market their services to government clients or incur 
significantly higher costs to hire internal marketing personnel; and 
managers that hire internal personnel could spend substantial 
amounts to register as a broker-dealer.''). See also SIFMA Letter; 
IAA Letter; Seward & Kissel Letter; Sadis & Goldberg Letter; WI 
Board Letter; GA Firefighters Letter; MN Board Letter; IL Fund 
Association Letter; NYC Teachers Letter; TX Public Retirement 
Letter; PA Public School Retirement Letter; Ehrmann Letter; Finn 
Letter; Savanna Letter; Atlantic-Pacific Letter; Peterson Letter; 
Devon Letter; Chaldon Letter; Meridian Letter; Benedetto Letter; 
Capstone Letter; Braxton Letter; Littlejohn Letter; Alta Letter; 
Charles River Letter; Reed Letter; Glovista Letter; Blackstone 
Letter; Park Hill Letter.
    \523\ Proposing Release, at 89. See also Thomas Letter (``The 
ban would very likely cripple many legitimate placement agents--most 
of whom are currently regulated by the SEC and FINRA--as the public 
pension plans are the largest source of capital for alternative 
investments.''); Comment Letter of the Managing Partner of Bridge 1 
Advisors, LLC Robert G. McGroarty (Sept. 24, 2009) (``Bridge 1 
Letter''); SIFMA Letter.
    \524\ See, e.g., Davis Polk Letter (``While we strongly support 
the underlying purpose of the Proposed Rule, we believe that this 
ban on all third-party solicitors is overly expansive and the costs 
inflicted on both investment advisers and government clients from 
lack of access to the valuable services provided by most third-party 
solicitors outweigh any expected benefits to be gained from its 
adoption.''); Capstone Letter (suggesting that many placement agent 
firms are small businesses helping investment managers that are, 
themselves, minority- or women-owned small businesses, and that, 
together, they are creating jobs and helping other businesses by 
efficiently directing capital); Monument Letter (making a similar 
comment regarding the minority and female ownership of placement 
agents); Glantz Letter; Comment Letter of Indian Harbor Partner 
Robert W. Stone (Aug. 13, 2009) (``Indian Harbor Letter''); 
Kurmanaliyeva Letter; M Advisory Letter (adding that the investment 
management industry as a whole will incur ``dramatic job losses''); 
Parenteau Letter.
    \525\ Alta Letter; Benedetto Letter; Comment Letter of Berkshire 
Property Advisors, LLC (Sept. 29, 2009) (``Berkshire Letter''); 
Bridge 1 Letter; Comment Letter of Hampshire Real Estate Companies 
(Sept. 29, 2009); Comment Letter of Thomas J. Mizo on behalf of HFF 
Securities L.P. (Sept. 24, 2009); M Advisory Letter; Monument Group 
Letter; Comment Letter of Psilos Group Managers, LLC (Sept. 28, 
2009).
    \526\ See, e.g., Park Hill Letter (``The Commission has 
commented that if the Placement Agent Ban is adopted, Public Pension 
Investors can seek to engage placement agents themselves in order to 
continue to have access to their services in helping to find the 
best Fund Sponsors. However, that would impose costs on Public 
Pension Investors that they do not currently incur. Moreover, as the 
Commission has acknowledged in its cost-benefit analysis, if the 
Placement Agent Ban were adopted, Fund Sponsors who do not have in-
house marketing staffs would be disproportionately disadvantaged 
relative to larger firms that have those internal resources in the 
competition for obtaining access to Public Pension Investors and 
other institutional investors.''); Thomas Letter (``A ban on 
placement agents would have significant unintended consequences for 
public pension plans. * * * [For instance, the] incremental effort 
by investment staffs to perform due diligence on promising but 
possibly ill-prepared investment managers will raise the cost and 
lessen the overall pension fund portfolio performance.''); Comment 
Letter of Austin F. Whitman (Sept. 21, 2009) (``Without access to 
placement agents, government pensions would be significantly 
disadvantaged relative to their private sector peers, with limited 
access (and benefit from) the services described above.''); ABA 
Letter. But see Fund Democracy/Consumer Federation Letter (``The 
proposed ban would simply replace the indirect cost of placement 
agents incurred by pension plan sponsors with the direct cost of 
hiring their own placement agents--without the conflict of interest 
and potential for abuse that relying on advisers' placement agents 
creates.'').
    \527\ See, e.g., Ogburn Letter; Schmitz Letter (highlighting the 
valuable ``pre-vetting'' function of placement agents, especially in 
light of pension funds' budgetary pressures and lean staffs); 
Savanna Letter (discussing the ``pre-screening'' effect that 
reputable placement agent client selection provides for pension 
professionals); Atlantic-Pacific Letter; Indian Harbor Letter; 
Peterson Letter; Rubenstein Letter; Comment Letter of R[eacute]al 
Desrochers (Aug. 20, 2009) (noting that from the perspective of a 
former pension fund investment officer, ``[t]he skill sets of 
certain placement agents streamlined what they brought to our 
attention and made our internal process much more efficient.''); 
Devon Letter; Thomas Letter; Myers Letter; PRIM Board Letter 
(``[T]he Commission should strongly resist the politically expedient 
suggestion that an outright ban on the use of placement agents is 
somehow good for plan sponsors; nothing could be further than the 
truth.''); Meridian Letter; Comment Letter of Norman G. Benedict 
(Sept. 30, 2009) (indicating that, from the perspective of a retired 
public pension chief investment officer, placement agents provide an 
essential and invaluable service, particularly with providing access 
to private equity fund investments, which often yielded higher 
returns than more traditional, publicly traded securities); 
Berkshire Letter; Comment Letter of The British Private Equity and 
Venture Capital Association (Sept. 18, 2009) (``BVCA Letter'') 
(``Placement agents are not just a crude middleman in the 
fundraising process''); CT Treasurer Letter; Credit Suisse Letter 
(describing four key functions its placement agent group performs); 
Portfolio Advisors Letter (noting that among the valuable services 
provided are: ``(1) Helping new fund sponsors to become more 
established among the institutional investor community; (ii) helping 
sponsors to complete RFPs, provide information and respond to 
questions, which, in turn, gives the public pension plans and other 
investors a broader pool of investment options; and (iii) serving as 
intermediaries in uniting capital with fund sponsors who can put the 
money to work by investing in businesses and creating value''); 
George Letter; Comment Letter of Rahul Mehta (Sept. 11, 2009); 
Touchstone Letter; SIFMA Letter.

---------------------------------------------------------------------------

[[Page 41060]]

    Others argued, for similar reasons as those expressed above, that 
it would also harm public pension plans to ban payments to third 
parties because it would decrease competition by reducing the number of 
advisers competing for government business \528\ and limit the universe 
of investment opportunities presented to public pension funds.\529\
---------------------------------------------------------------------------

    \528\ See, e.g., Seward & Kissel Letter; Meridian Letter; SIFMA 
Letter; Comment Letter of Oakpoint Advisors (Aug. 26, 2009); Comment 
Letter of SeaCrest Investment Management, LLC (Sept. 25, 2009).
    \529\ See, e.g., Braxton Letter (stressing not only the 
increased costs that public pension funds will likely face, but also 
the likely reduction in creative investment strategies and 
opportunities available as a result of smaller and emerging funds 
being forced out of the market); BVCA Letter; CT Treasurer Letter; 
SIFMA Letter; IAA Letter; Strategic Capital Letter; Alta Letter; 
Benedetto Letter; Glantz Letter; Kurmanaliyeva Letter; Park Hill 
Letter.
---------------------------------------------------------------------------

    We believe our decision to modify the proposed rule to permit 
advisers to make payments to certain ``regulated persons'' to solicit 
government clients on their behalf,\530\ as described in more detail 
above, should alleviate many of these concerns, including those from 
private equity and venture capital managers on capital formation.\531\ 
In particular, we believe the concerns expressed by private equity and 
venture capital managers regarding the effects of the rule on capital 
formation have been substantially addressed by the modification for 
payments to ``regulated persons.'' We expect advisers that engage the 
services of regulated person solicitors will incur limited costs to 
initially confirm and subsequently monitor the solicitor's eligibility 
to be a ``regulated person.'' Nevertheless, we expect this exception to 
the third-party solicitor ban will substantially reduce the costs 
commenters associated with this aspect of the proposal.
---------------------------------------------------------------------------

    \530\ See Rule 206(4)-5(a)(2)(i).
    \531\ Our decision not to adopt the ``related person'' exception 
contained in the proposed rule does not diminish our belief. As we 
noted above, we believe our modification of the ban to allow 
advisers to pay ``regulated persons'' to solicit government entities 
on their behalf will still allow advisers to use employees of 
certain related companies--i.e., of those related companies that 
qualify as ``regulated persons''--as solicitors.
---------------------------------------------------------------------------

    We acknowledge, however, that the third-party solicitor ban will 
nonetheless have a substantial negative impact on persons who provide 
third-party solicitation services that are not regulated persons, 
including State-registered advisers.\532\ If their businesses consist 
solely of soliciting government entities on behalf of investment 
advisers, the rule could result in these persons instead being employed 
directly by regulated persons, shifting the focus of their solicitation 
activities, seeking to change their business model to shift their 
source of payment from investment advisers to pension plans, or going 
out of business.\533\ In addition, we acknowledge that the third-party 
solicitor ban may adversely affect both competition and allocative 
efficiency in the market for advisory services where third-party 
solicitors that are not regulated persons participate. We have 
carefully considered these effects. As discussed above, however, we do 
not have regulatory authority to oversee the activities of State-
registered advisers through examination and our recordkeeping rules. 
Nor do we have authority over the states to oversee their enforcement 
of their rules, as we do with FINRA. As a result, we have not included 
State-registered advisers in the definition of regulated person.\534\
---------------------------------------------------------------------------

    \532\ As we note above, State-registered advisers are subject 
neither to our oversight nor to the recordkeeping rules we are 
adopting today.
    \533\ See supra note 523.
    \534\ See supra note 325 and accompanying text.
---------------------------------------------------------------------------

    In addition, some commenters suggested that the third-party 
prohibition could have a negative impact on the efficient allocation of 
capital for government plans, particularly small ones, and advisers 
that seek to manage these assets directly (not through a covered 
investment pool).\535\These small government plans may, as a result of 
the rule's ban on payments to third parties, have fewer managers to 
select from to the extent that larger advisers choose not to 
participate in this market. In addition, both government plans and 
advisers that seek these government clients may have to hire internal 
staff, respectively, to identify potential advisers and potential 
government clients to the extent these functions are not internalized. 
However, these commenters did not discuss the potentially significant 
costs that exist today of hiring third-party solicitors, and that 
eliminating the cost of pay to play may, in fact, provide greater 
access to pension plans by those advisers that are currently unable to 
afford the costs of direct or indirect political contributions or 
third-party solicitor fees.\536\ We expect that prohibiting pay to play 
will reduce the costs to plans and their beneficiaries that may result 
when adviser selection is based on political contributions rather than 
investment considerations.\537\
---------------------------------------------------------------------------

    \535\ See, e.g., 3PM Letter; Bryant Law Letter.
    \536\ At least one commenter agreed. See Butler Letter (``[W]e 
find some evidence that the pay to play practices by underwriters 
[before rule G-37 was adopted] distorted not only the fees, but 
which firms were allocated business. The current proposal mentions 
that pay to play practices may create an uneven playing field among 
investment advisers by hurting smaller advisers that cannot afford 
to make political contributions. We find evidence that is consistent 
with this view [in our research on pay to play by municipal 
underwriters]. During the pay to play era, municipal bonds were 
underwritten by investment banks with larger underwriting market 
shares compared to afterward. One interpretation of this result is 
that smaller underwriters were passed over in favor of larger 
underwriters (who presumably had deeper pockets for political 
contributions).'').
    \537\ See supra notes 452 & 453 and accompanying text 
(describing commenters' observations about some of the pay to play 
costs to plans and their beneficiaries).
---------------------------------------------------------------------------

3. Costs Related to the Amendments to Rule 204-2
    The amendments to rule 204-2 require SEC-registered advisers with 
government clients to maintain certain records of campaign 
contributions by certain advisory personnel and records of the 
regulated persons the adviser pays or agrees to pay to solicit 
government entities on its behalf.\538\ Records are a critical 
complement to rule 206(4)-5. In particular, such records are necessary 
for examiners to inspect advisers for compliance with the terms of the 
rule.
---------------------------------------------------------------------------

    \538\ Unregistered advisers that would be subject to rule 
206(4)-5 would not be subject to the amendments to rule 204-2.
---------------------------------------------------------------------------

    As described below, for purposes of the Paperwork Reduction Act of 
1995 (``PRA''),\539\ we have estimated that Commission-registered 
advisers would incur approximately 3,394 additional hours annually to 
comply with the

[[Page 41061]]

amendments to rule 204-2.\540\ Based on this estimate, we anticipate 
that advisers would incur an aggregate cost of approximately $200,246 
per year for the total hours advisory personnel would spend in 
complying with the recordkeeping requirements.\541\ In addition, we 
expect advisory firms may incur one-time costs to establish or enhance 
current systems to assist in their compliance with the amendments to 
rule 204-2. For purposes of the PRA, we have estimated that some small 
and medium firms will incur start-up costs, on average, of $10,000, and 
larger firms will incur, on average, $100,000. As a result, the 
amendments to rule 204-2 are estimated to increase the PRA non-labor 
cost burden by $20,080,000.\542\
---------------------------------------------------------------------------

    \539\ 44 U.S.C. 3501.
    \540\ See infra note 559 and accompanying text.
    \541\ We expect that the function of recording and maintaining 
records of political contributions would be performed by a 
compliance clerk at a cost of $59 per hour. See supra note 487. 
Therefore, the total costs would be $200,246 (3,394 hours x $59 per/
hour).
    \542\ ($10,000 x 788) + ($100,000 x 122) = $7,880,000 + 
$12,200,000 = $20,080,000.
---------------------------------------------------------------------------

    We received a number of specific comments on this aspect of the 
proposal, many of which included assertions about cost burdens 
associated with maintaining records related to unsuccessful 
solicitations, and urged us to reconsider the benefits to be gained 
from such a requirement in light of the costs.\543\ We were persuaded 
by these commenters to eliminate provisions of the proposed amendments 
to the recordkeeping rule that would have required advisers to maintain 
a list of government entities that the adviser solicits.\544\ Instead, 
an adviser must only retain records of existing government entity 
clients and investors as well as records of regulated persons that the 
adviser pays or agrees to pay to solicit government entities on its 
behalf for a five-year period. Additionally, we have narrowed the scope 
of the amended rule to apply only to advisers with government entity 
clients; an adviser is only required to make and keep these records if 
it provides investment advisory services to a government entity or a 
government entity is an investor in any covered investment pool to 
which the investment adviser provides investment advisory 
services.\545\ We have also limited the rule to provide that only 
records of contributions, not payments, to government officials and 
candidates are required to be kept under the rule. Additionally, 
because rule 206(4)-5 applies to an adviser to a registered investment 
company only if it is an investment option of a participant-directed 
plan or program of a government entity,\546\ such investment advisers 
will only have to identify government entities that provide plan or 
program participants the option of investing in the fund, which 
addresses many commenters' concerns about recordkeeping burdens that 
would have been imposed on advisers to registered investment companies 
under the proposed rule.\547\
---------------------------------------------------------------------------

    \543\ MassMutual Letter (``[T]he requirement to maintain records 
of each governmental entity being solicited would require a diverse 
financial services company like MassMutual to undertake significant 
legacy software system modifications or build an entirely new system 
to track each instance of a ``solicitation,'' which could include 
phone calls, meetings, or responses to governmental requests. This 
system would then need to aggregate data across multiple business 
lines, many with existing systems that may not have the ability to 
share this data in a useful format. All of these are costly and time 
consuming activities to meet a requirement that appears to add 
little value to the Commission's efforts to ensure compliance with 
the Proposed Rule.''). See also Davis Polk Letter; Dechert Letter; 
Holl Letter; SIFMA Letter; Skadden Letter.
    \544\ See proposed rule 204-2(a)(18)(i)(B).
    \545\ Rule 204-2(a)(18)(iii). See NASP Letter (``Many advisers 
do not have governmental clients but will still have to collect the 
information or attestations which would increase compliance costs 
while providing no public benefit at all.'')
    \546\ See supra note 353 and accompanying text.
    \547\ See, e.g., ICI Letter.
---------------------------------------------------------------------------

    We anticipate that commenters' general concerns that we may have 
underestimated the burdens we presented in our proposal will be offset 
by what we believe will be a reduction in burdens as a result of the 
various modifications from our proposal described above. In addition, 
we have revised the rule to require advisers to maintain a list of 
regulated persons that solicit on an adviser's behalf, but expect 
advisers to already have this information in the normal course of 
business, including in some instances, to comply with existing 
requirements of rule 206(4)-3.

V. Paperwork Reduction Act

A. Rule 204-2

    The amendment to rule 204-2 contains a ``collection of 
information'' requirement within the meaning of the PRA. In the 
Proposing Release, the Commission solicited comment on the proposed 
amendment to the collection of information requirement.\548\ The 
Commission also submitted the proposed amendment's collection of 
information requirement to the Office of Management and Budget 
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 
1320.11 under control number 3235-0278. The title for the collection of 
information is ``Rule 204-2 under the Investment Advisers Act of 
1940.'' Rule 204-2 contains a currently approved collection of 
information number under OMB control number 3235-0278. An agency may 
not sponsor, or conduct, and a person is not required to respond to, a 
collection of information unless it displays a currently valid OMB 
control number.
---------------------------------------------------------------------------

    \548\ See Proposing Release, at section IV.
---------------------------------------------------------------------------

    Section 204 of the Advisers Act provides that investment advisers 
registered or required to be registered with the Commission must make 
and keep certain records for prescribed periods, and make and 
disseminate certain reports. Rule 204-2 sets forth the requirements for 
maintaining and preserving specified books and records. This collection 
of information is mandatory. The collection of information under rule 
204-2 is necessary for the Commission staff to use in its examination 
and oversight program, and the information generally is kept 
confidential.\549\ The respondents are investment advisers registered 
or required to be registered with us.
---------------------------------------------------------------------------

    \549\ See section 210(b) of the Advisers Act [15 U.S.C. 80b-
10(b)].
---------------------------------------------------------------------------

    Today's amendments to rule 204-2 require every investment adviser 
registered or required to be registered that provides advisory services 
to (or pays or agrees to pay regulated persons to solicit) government 
entities to maintain certain records of contributions made by the 
adviser or any of its covered associates and regarding regulated 
persons the adviser pays or agrees to pay for soliciting government 
entities on its behalf. The amendments require such an adviser to make 
and keep the following records: (i) The names, titles, and business and 
residence addresses of all covered associates of the investment 
adviser; (ii) all government entities to which the investment adviser 
provides or has provided investment advisory services, or which are or 
were investors in any covered investment pool to which the investment 
adviser provides or has provided investment advisory services, as 
applicable, in the past five years, but not prior to the effective date 
of the rule; (iii) all direct or indirect contributions made by the 
investment adviser or any of its covered associates to an official of a 
government entity, or payments to a political party of a State or 
political subdivision thereof, or to a political action committee; and 
(iv) the name and business address of each regulated person to whom the 
investment adviser provides or agrees to provide, directly or 
indirectly, payment to solicit a government entity for investment 
advisory services on its behalf, in accordance with rule 206(4)-
5(a)(2)(i).
    The adviser's records of contributions and payments are required to 
be listed

[[Page 41062]]

in chronological order identifying each contributor and recipient, the 
amounts and dates of each contribution or payment, and whether such 
contribution or payment was subject to the exception for certain 
returned contributions pursuant to rule 206(4)-5(b)(2). An investment 
adviser is only required to make and keep current the records referred 
to in (i) and (iii) above if it provides investment advisory services 
to a government entity or a government entity is an investor in any 
covered investment pool to which the adviser provides investment 
advisory services. The records required by amended rule 204-2 are 
required to be maintained in the same manner, and for the same period 
of time, as other books and records under rule 204-2(a). This 
collection of information will be found at 17 CFR 275.204-2. Advisers 
that are exempt from Commission registration under section 203(b)(3) of 
the Advisers Act are not subject to the recordkeeping requirements.
    The amendments to rule 204-2 that we are adopting today differ from 
our proposed amendments in several respects. We have tailored certain 
of the requirements from our proposal. First, we have limited the rule 
to provide that only records of contributions, not payments, to 
government officials, including candidates, are required to be kept 
under the rule. Second, investment advisers to registered investment 
companies only have to identify--and keep records regarding--government 
entities that invest in a fund as part of a plan or program of a 
government entity, including any government entity that selects the 
fund as an investment option for participants in the plan or 
program.\550\ Third, we are not adopting provisions of the proposed 
amendments to the recordkeeping rule that would have required advisers 
to maintain a list of all government entities that they have solicited. 
In addition, we have revised the rule so that only those advisers that 
have government entity clients must make and keep certain required 
records, unlike the proposal, which would have required all registered 
advisers to maintain records of contributions and covered associates. 
We are also adopting a requirement that advisers maintain records of 
regulated persons they pay to solicit government entities on their 
behalf, to reflect that rule 206(4)-5 permits advisers to compensate 
these solicitors.
---------------------------------------------------------------------------

    \550\ Under our proposal, investment advisers to registered 
investment companies would have had to identify and keep records 
regarding government entities that invest in the funds regardless of 
whether they were part of a plan or program of a government entity. 
For a discussion of this modification, see section II.B. of this 
Release.
---------------------------------------------------------------------------

    As noted above, we requested comment on the PRA analysis contained 
in the Proposing Release. Although a few commenters expressed general 
concerns that the paperwork burdens associated with our proposed 
amendments to rule 204-2 might be understated, commenters representing 
advisers to registered investment companies suggested that the proposal 
significantly underestimated the burden attributed to these covered 
investment pools.\551\ With respect to registered investment companies, 
commenters noted that the proposed recordkeeping requirements required 
advisers to identify government investors in registered investment 
companies regardless of whether the fund was part of a plan or program 
of a government entity, and as a result the proposed amendments to the 
recordkeeping rule would have been difficult to comply with as fund 
shareholder records do not necessarily identify government investors.
---------------------------------------------------------------------------

    \551\ See ICI Letter (``[I]n relying on the estimates for 
compliance with the MSRB rules, the Commission significantly 
underestimates the compliance and recordkeeping burdens associated 
with the proposed rule.'').
---------------------------------------------------------------------------

    As a result of these comments, we recognize that we may have 
underestimated the recordkeeping burden for advisers to registered 
investment companies that would have been subject to proposed rule 
206(4)-5. However, we believe that our change to the definition of 
``covered investment pool'' from the proposal to only include those 
registered investment companies that are an investment option of a plan 
or program of a government entity addresses the recordkeeping concerns 
commenters expressed regarding these covered investment pools and 
lowers recordkeeping burdens by limiting the records relating to 
registered investment companies that an investment adviser must keep 
under the rule.\552\ In addition, the other changes we highlight 
above--other than the requirement to keep records regarding regulated 
persons--would lessen the recordkeeping requirements relative to our 
proposal and thereby diminish our burden estimates. We anticipate that 
commenters' general concerns that we may have underestimated the 
burdens we presented in our proposal, as well as the burden associated 
with the additional requirement to maintain a list of regulated persons 
that solicit on an adviser's behalf, will be offset by what we believe 
will be a reduction in burdens as a result of the various modifications 
from proposed amendments to the recordkeeping rule, as described above. 
Moreover, notwithstanding the fact that the amendments we are adopting 
reduce advisers' recordkeeping obligations relative to our proposal, we 
are increasing our estimates to address the additional investment 
advisers who have registered with us since our proposal was issued.
---------------------------------------------------------------------------

    \552\ See Rule 204-2(a)(18)(i)(B).
---------------------------------------------------------------------------

    Prior to today's amendments, the approved collection of information 
for rule 204-2, set to expire on March 31, 2011, was based on an 
average of 181.15 burden hours each year, per Commission-registered 
adviser, for a total of 1,954,109 burden hours. In addition, the 
currently-approved collection of information for Rule 204-2 includes a 
non-labor cost estimate of $13,551,390. The total burden is based on an 
estimate of 10,787 registered advisers.
    Commission records indicate that currently there are approximately 
11,607 registered investment advisers subject to the collection of 
information imposed by rule 204-2.\553\ As a result of the increase in 
the number of advisers registered with the Commission since the current 
total burden was approved, the total burden has increased by 148,543 
hours.\554\ In addition, the total non-labor cost burden has increased 
to $14,581,509 as a result of this increase in the number of registered 
advisers.\555\
---------------------------------------------------------------------------

    \553\ This figure is based on registration information from IARD 
as of April 1, 2010. The figures we relied on in our Proposing 
Release were based on registration information from IARD as of July 
1, 2009. See Proposing Release, at section IV.
    \554\ 11,607 - 10,787 = 820. 820 additional advisers x 181.15 
hours = 148,543 hours.
    \555\ We estimate that non-labor costs attributed to rule 204-2 
will increase in the same proportion as the increase in the 
estimated hour burden for the rule. (2,102,652 hours/1,954,109 
hours) x $13,551,390 currently approved non-labor cost estimate = 
$14,581,509.
---------------------------------------------------------------------------

    In our Proposing Release, we estimated that approximately 1,764 
Commission-registered advisers provide, or seek to provide, advisory 
services to government clients and to certain pooled investment 
vehicles in which government entities invest, and would thus be 
affected by the rule amendments.\556\ One commenter argued that this 
estimate was too low because it underestimates the number of investment 
advisers unregistered in reliance on Section 203(b)(3) of the Advisers 
Act and estimated to be subject to the Proposed Rule.\557\ Unregistered

[[Page 41063]]

advisers are not subject to rule 204-2's recordkeeping requirements. As 
a result, they are not included in our estimates for purposes of this 
analysis. We continue to believe our estimates are appropriate, 
although we have revised this number for purposes of both our cost-
benefit analysis above and our PRA analysis to reflect both an increase 
in the number of registered advisers since the proposal and the 
modification from our proposal to not require records of unsuccessful 
solicitations. We now estimate that approximately 1,697 registered 
advisers provide advisory services to government clients and to certain 
pooled investment vehicles in which government entities invest, and 
would thus be affected by the rule amendments.\558\
---------------------------------------------------------------------------

    \556\ See Proposing Release, at section IV.
    \557\ Davis Polk Letter (``The cost benefit analysis is based 
solely on an estimated 1,764 registered investment advisers and does 
not account for the costs and burdens of compliance attributable to 
investment advisers exempt from registration. The estimated number 
of investment advisers unregistered in reliance on section 203(b)(3) 
of the Advisers Act (2,000) and estimated to be subject to the 
Proposed Rule (231), appears to be low. In its comment letter, the 
Third Party Marketers Association notes that the number of advisory 
firms exempted from registration may be `over two times the estimate 
of the Commission. * * *''' (citations omitted)). The Davis Polk 
Letter does not offer any of its own estimates for the number of 
unregistered advisers, and the 3PM Letter references statistics 
regarding the number of funds, not the number of advisers.
    \558\ This estimate is based on registration information from 
IARD as of April 1, 2010, applying the same methodology as in the 
Proposing Release. As previously noted, according to responses to 
Item 5.D(9) of Part 1 of Form ADV, 1,332 advisers have clients that 
are State or municipal government entities, which represents 11.48% 
of all advisers registered with us. 10,275 advisers have not 
responded that they have clients that are State or municipal 
government entities. Of those, however, responses to Item 5.D(6) of 
Part 1 of Form ADV indicate that 2,486 advisers have some clients 
that are other pooled investment vehicles. Estimating that the same 
percentage of these advisers advise pools with government entity 
investors as advisers that have direct government entity clients--
i.e.,11.48%. 285 of these advisers would be subject to the rule 
(2,486 x 11.48% = 285). Out of the 10,275 that have not responded 
that they have clients that are State or municipal government 
entities, after backing out the 2,486 which have clients that are 
other pooled investment vehicles, responses to Item 5.D(4) of Part 1 
of Form ADV indicate that 699 advisers have some clients that are 
registered investment companies. Estimating that roughly the same 
percentage of these advisers advise pools with government entity 
investors as advisers that have direct government entity clients--
i.e.,11.48%. 80 of these advisers would be subject to the rule (699 
x 11.48% = 80). Although we limited the application of rule 206(4)-5 
with respect to registered investment companies to those that are 
investment options of a plan or program of a government entity, we 
continue to estimate that 80 advisers would have to comply with the 
recordkeeping provisions because of the difficulty in further 
delineating this estimated number. Therefore, we estimate that the 
total number of advisers subject to the rule would be: 1,332 
advisers with State or municipal clients + 285 advisers with other 
pooled investment vehicle clients + 80 advisers with registered 
investment company clients = 1,697 advisers subject to rule. We 
expect certain additional advisers may incur compliance costs 
associated with rule 206(4)-5. We anticipate some advisers may be 
subject to the rule because they solicit government entities on 
behalf of other investment advisers. In the Proposing Release, our 
estimates included an estimated burden attributable to advisers that 
do not currently have government clients but that may begin to seek 
them. The revision to the recordkeeping rule that eliminated the 
requirement to maintain records of government entities that an 
adviser solicits has eliminated the need for this additional burden 
estimate.
---------------------------------------------------------------------------

    Under the amendments, each respondent is required to retain the 
records in the same manner and for the same period of time as currently 
required under rule 204-2. The amendments to rule 204-2 are estimated 
to increase the burden by approximately 2 hours per Commission-
registered adviser with government clients annually for a total 
increase of 3,394 hours.\559\ The revised annual aggregate burden for 
all respondents to the recordkeeping requirements under rule 204-2 thus 
would be 2,106,046 hours.\560\ The revised average burden per 
Commission-registered adviser would be 181.45 hours.\561\
---------------------------------------------------------------------------

    \559\ 2 x 1,697 = 3,394.
    \560\ 1,954,109 (current approved burden) + 148,543 (burden for 
additional registrants) + 3,394 (burden for proposed amendments) = 
2,106,046 hours.
    \561\ 2,106,046 (revised annual aggregate burden) divided by 
11,607 (total number of registrants) = 181.45.
---------------------------------------------------------------------------

    Additionally, as we noted in the Proposing Release and reiterate 
above, we expect advisory firms may incur one-time costs to establish 
or enhance current systems to assist in their compliance with the 
amendments to rule 204-2. These costs would vary widely among firms. 
Small advisers may not incur any system costs if they determine a 
system is unnecessary due to the limited number of employees they have 
or the limited number of government entity clients they have. Large 
firms likely already have devoted significant resources into automating 
compliance and reporting and the new rule could result in enhancements 
to these existing systems.
    As a result of these one-time costs, we estimate that there will be 
an increase to the total non-labor cost burden. We estimated above that 
the non-labor cost burden has increased to $14,581,509 as a result of 
the increase in the number of registered advisers since the collection 
was last approved.\562\ We believe the one-time costs could vary 
substantially among smaller, medium, and larger firms as smaller and 
medium firms may be able to use non-specialized software, such as a 
spreadsheet, or off-the-shelf compliance software to keep track of the 
information required by the rule while larger firms are more likely to 
have proprietary systems. Based on IARD data we estimate that there are 
approximately 1,271 smaller firms, 304 medium firms, and 122 larger 
firms.\563\ We estimate that one half of the smaller and medium firms 
will not incur these one-time start up costs because they will use 
existing tools for compliance. We expect the other half of smaller and 
medium firms will incur one-time start up costs on average of $10,000, 
in the event they have a greater number of employees and government 
clients, and larger firms, that likely have the most employees and 
government clients, will incur one-time start up costs on average of 
$100,000. As a result, the amendments to rule 204-2 are estimated to 
increase the non-labor cost burden by $20,080,000.\564\ Due to this 
increase, we now estimate the revised total non-labor cost burden for 
rule 204-2 to be $34,661,509.
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    \562\ See supra note 555.
    \563\ This estimate is based on registration information from 
IARD as of April 1, 2010. These estimates are based on IARD data, 
specifically the responses to Item 5.B.(1) of Form ADV, that 997 (or 
74.9%) of the 1,332 registered investment advisers that have 
government clients have fewer than five employees who perform 
investment advisory functions, 239 (or 17.9%) have five to 15 such 
employees, and 96 (or 7.2%) have more than 15 such employees. We 
then applied those percentages to the 1,697 advisers we believe will 
be subject to the proposed rule for a total of 1,271 smaller, 304 
medium and 122 larger firms.
    \564\ [$10,000 x 788] + [$100,000 x 122] = $7,880,000 + 
$12,200,000 = $20,080,000.
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B. Rule 206(4)-3

    The amendment to rule 206(4)-3 contains a revised collection of 
information requirement within the meaning of the PRA. In the Proposing 
Release, the Commission published notice soliciting comment on the 
collection of information requirement.\565\ The Commission submitted 
the revised collection of information requirement to OMB for review in 
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. Rule 206(4)-3 
contains a currently approved collection of information under OMB 
control number 3235-0242. The title for the collection of information 
is ``Rule 206(4)-3--Cash Payments for Client Solicitations.'' As noted 
above, an agency may not sponsor, or conduct, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid OMB control number.
---------------------------------------------------------------------------

    \565\ See Proposing Release, at section IV.
---------------------------------------------------------------------------

    Section 206(4) of the Advisers Act provides that it shall be 
unlawful for any investment adviser to engage in any act, practice, or 
course of business which is fraudulent, deceptive, or manipulative. 
Rule 206(4)-3 generally prohibits investment advisers from paying cash 
fees to solicitors for client referrals unless certain conditions are

[[Page 41064]]

met. The rule requires that an adviser pay all solicitors' fees 
pursuant to a written agreement that the adviser is required to retain. 
This collection of information is mandatory. The Commission staff uses 
this collection of information in its examination and oversight 
program, and the information generally is kept confidential.\566\
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    \566\ Section 210(b) of the Advisers Act [15 U.S.C. 80b-10(b)].
---------------------------------------------------------------------------

    The Commission is adopting amendments to rule 206(4)-3 under the 
Advisers Act. The amendments to rule 206(4)-3, which are identical to 
our proposed amendments, require every investment adviser that relies 
on the rule and that provides or seeks to provide advisory services to 
government entities to also abide by the limitations provided in rule 
206(4)-5. This collection of information is found at 17 CFR 275.206(4)-
3. Advisers that are exempt from Commission registration under section 
203(b)(3) of the Advisers Act would not be subject to rule 206(4)-3.
    We requested comment on the PRA analysis contained in Proposing 
Release. We received no comment on this portion of our analysis. In 
addition, we have not modified our amendments to rule 206(4)-3 relative 
to our proposal.
    The current approved collection of information for rule 206(4)-3, 
set to expire on March 31, 2011, is based on an estimate that 20 
percent of the 10,817 Commission-registered advisers (or 2,163 
advisers) rely on the rule, at an average of 7.04 burden hours each 
year, per respondent, for a total of 15,228 burden hours (7.04 x 
2,163).
    Commission records indicate that currently there are approximately 
11,607 registered investment advisers,\567\ 20 percent of which (or 
2,321) are likely subject to the collection of information imposed by 
rule 206(4)-3. As a result of the increase in the number of advisers 
registered with the Commission since the current total burden was 
approved, the total burden has increased by 1,112.32 hours (158 
additional advisers \568\ x 7.04 hours). We estimate that approximately 
20 percent of the Commission-registered advisers that use rule 206(4)-3 
(or 464 advisers) \569\ provide, or seek to provide, advisory services 
to government clients.\570\ Under the amendments, each respondent would 
be prohibited from certain solicitation activities, subject to the 
exception for ``regulated persons,'' with respect to government 
clients, activities that otherwise would have been covered by rule 
206(4)-3.\571\ Thus, they would not need to enter into and retain the 
written agreement required under rule 206(4)-3 with respect to those 
third parties they are prohibited from paying to solicit government 
entities.
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    \567\ This figure is based on registration information from IARD 
as of April 1, 2010. The figures we relied on in our Proposing 
Release were based on registration information from IARD as of July 
1, 2009.
    \568\ 2,321 (20% of current registered investment advisers)--
2,163 (20% of registered investment advisers when burden estimate 
was last approved by OMB) = 158.
    \569\ 2,321 x 20 percent = 464.
    \570\ In light of the 11.48% of registered investment advisers 
that indicate they have State or municipal government clients, we 
conservatively estimate that 20% of the advisers who rely on rule 
206(4)-3 are soliciting government entities to be advisory clients 
or to invest in covered investment pools those advisers manage. See 
supra note 558.
    \571\ Rule 206(4)-3(a).
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    In the Proposing Release, we estimated a decrease to the burden due 
to the prohibition on paying third party solicitors to be 20% of the 
annual burden. As a result of the revised ban on using third parties, 
we now estimate that the amendments to rule 206(4)-3 will only decrease 
the burden by 15 percent,\572\ or approximately 1.06 hour,\573\ per 
Commission-registered adviser that uses the rule and has or is seeking 
government clients annually, for a total decrease of 491.84 hours.\574\ 
The revised annual aggregate burden for all respondents to the 
recordkeeping requirements under rule 206(4)-3 thus would be 15,848.48 
hours.\575\ The revised average burden per Commission-registered 
adviser would be 6.83 hours.\576\
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    \572\ In our proposal, which would have banned the use of third-
party solicitors altogether, we estimated a 20 percent decrease in 
the burden under rule 206(4)-3. But, to account for the regulated 
persons exception to the third-party solicitor ban in adopted rule 
206(4)-5, we have modified our estimate to only a 15 percent 
decrease. That is because our staff estimates that one quarter (or 5 
percent) of the proposal's estimated burden reduction relating to 
entering into and retaining the written agreement required under 
rule 206(4)-3 will be retained as investment advisers engage third 
parties that are regulated persons to solicit on their behalf.
    \573\ 7.04 x 15 percent = 1.06.
    \574\ 464 x 1.06 = 491.84.
    \575\ 15,228 (current approved burden) + 1,112.32 (burden for 
additional registrants)--491.84 (reduction in burden for amendments) 
= 15,848.48 hours.
    \576\ 15,848.48 (revised annual aggregate burden) divided by 
2,321 (total number of registrants who rely on rule) = 6.83.
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C. Rule 206(4)-7

    As a result of the adoption of rule 206(4)-5, rule 206(4)-7 
contains a revised collection of information requirement within the 
meaning of the PRA. In the Proposing Release, the Commission estimated 
that registered advisers would spend between 8 hours and 250 hours to 
establish policies and procedures to comply with rule 206(4)-5.\577\ 
Rule 206(4)-7 contains a currently approved collection of information 
under OMB control number 3235-0585. The title for the collection of 
information is ``Investment Advisers Act Rule 206(4)-7, Compliance 
procedures and practices.'' As noted above, an agency may not sponsor, 
or conduct, and a person is not required to respond to, a collection of 
information unless it displays a currently valid OMB control number.
---------------------------------------------------------------------------

    \577\ See Proposing Release, at section III.B.
---------------------------------------------------------------------------

    Section 206(4) of the Advisers Act provides that it shall be 
unlawful for any investment adviser to engage in any act, practice, or 
course of business which is fraudulent, deceptive, or manipulative. 
Rule 206(4)-7, in part, requires registered investment advisers to 
adopt and implement written policies and procedures reasonably designed 
to prevent violation of the Federal securities laws. This collection of 
information is mandatory. The purpose of the information collection 
requirement is to ensure that registered advisers maintain 
comprehensive, written internal compliance programs. It also assists 
the Commission's staff in its examination and oversight program. 
Information obtained in our examination and oversight program generally 
is kept confidential.\578\
---------------------------------------------------------------------------

    \578\ Section 210(b) of the Advisers Act [15 U.S.C. 80b-10(b)].
---------------------------------------------------------------------------

    As we previously noted, we expect that registered investment 
advisers subject to rule 206(4)-5 will modify their compliance programs 
to address new obligations under that rule. The current approved 
collection of information for rule 206(4)-7, set to expire on March 31, 
2011, is based on 10,817 registered advisers that were subject to the 
rule at an average burden of 80 hours each year per respondent for a 
total of 865,360 burden hours.
    Commission records indicate that currently there are approximately 
11,607 registered investment advisers.\579\ As a result of the increase 
in the number of advisers registered with the Commission since the 
current total burden was approved, the total burden has increased by 
63,200 hours (790 x 80 hours). In addition, although the time needed to 
comply with rule 206(4)-5 will vary significantly from adviser to 
adviser, as discussed in detail below, the Commission staff estimates 
that firms with government clients will spend between 8 hours and 250 
hours to implement policies and procedures to comply with the rule, 
depending on the

[[Page 41065]]

firm's number of covered associates.\580\ Of the 1,697 registered 
advisers that we estimate may be affected by rule 206(4)-5,\581\ we 
estimate that approximately 1,271 are smaller firms, 304 are medium 
firms, and 122 are larger firms.\582\ We anticipate that smaller firms 
will spend 8 hours, medium firms will spend 125 hours, and larger firms 
will spend 250 hours,\583\ for a total of 78,668 hours,\584\ to 
implement policies and procedures. Our estimates take into account our 
staff's observation that some registered advisers have established 
policies regarding political contributions, which can be revised to 
reflect the new requirements. The revised annual aggregate burden for 
all respondents to comply with rule 206(4)-7 thus would be 1,007,228 
hours.\585\
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    \579\ This figure is based on registration information from IARD 
as of April 1, 2010.
    \580\ See section IV.B.1. of this Release (describing the cost 
estimates associated with compliance with rule 206(4)-5).
    \581\ See supra note 558. Advisers that are unregistered in 
reliance on the exemption available under section 203(b)(3) of the 
Advisers Act [15 U.S.C. 80b-3(b)(3)] are not subject to rule 206(4)-
7 and, therefore, are not reflected in this burden estimate pursuant 
to the PRA.
    \582\ See supra note 475.
    \583\ See supra notes 489-491.
    \584\ (1,271 x 8 = 10,168) + (304 x 125 = 38,000) + (122 x 250 = 
30,500) = 78,668.
    \585\ 865,360 (current approved burden) + 63,200 (burden for 
additional registrants) + 78,668 (burden attributable to rule 
206(4)-5) = 1,007,228 hours.
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D. Rule 0-4

    Rule 0-4 under the Advisers Act,\586\ entitled ``General 
Requirements of Papers and Applications,'' prescribes general 
instructions for filing an application seeking exemptive relief with 
the Commission. The requirements of rule 0-4 are designed to provide 
the Commission with the necessary information to assess whether 
granting the orders of exemption is necessary and appropriate, in the 
public interest and consistent with the protection of investors and the 
intended purposes of the Act. In light of the adoption of rule 206(4)-
5, which contains a provision for seeking an exemptive order from the 
Commission, we are revising the collection of information requirement 
for rule 0-4. Rule 0-4 contains a currently approved collection of 
information under OMB control number 3235-0633. As noted above, an 
agency may not sponsor, or conduct, and a person is not required to 
respond to, a collection of information unless it displays a currently 
valid OMB control number.
---------------------------------------------------------------------------

    \586\ 17 CFR 275.0-4.
---------------------------------------------------------------------------

    The current approved collection of information contains an 
estimated total annual hour burden of one hour for administrative 
purposes because most of the work of preparing an application is 
performed by outside counsel and, therefore, imposes minimal, if any, 
hourly burden on respondents. Because we expect that all, or 
substantially all, of the work of preparing an application for an 
exemptive order under rule 206(4)-5 will also be performed by outside 
counsel, we continue to believe that the current estimate of one hour, 
in the unlikely event the adviser does perform an administrative role, 
is sufficient. As a result, we are not increasing our estimated hourly 
burden in connection with the adoption of rule 206(4)-5.
    The current approved collection of information also contains an 
estimated total annual cost burden of $355,000, which is attributed to 
outside counsel legal fees. In the Proposing Release, we estimated that 
approximately five advisers annually would apply to the Commission for 
an exemption from rule 206(4)-5.\587\ We also estimated that an 
advisory firm that applies for an exemption would hire outside counsel 
to prepare their exemptive requests, and that counsel would spend 16 
hours preparing and submitting an application for review at a rate of 
$400 per hour, for a per application cost of $6,400 and a total 
estimated cost for five applications annually of $32,000.
---------------------------------------------------------------------------

    \587\ See Proposing Release, at Section III.B.
---------------------------------------------------------------------------

    The Commission requested public comment on these estimates in the 
Proposing Release, and we received comments indicating that our 
estimate of five exemptive application submissions per year is too 
low.\588\ We did not receive comments on our cost estimates. Given that 
the advisory industry is much larger than the municipal securities 
industry, and in light of the number of comment letters we received 
that expressed concern about inadvertent violations of the rule that 
would not qualify for the exception for returned contributions, our 
staff estimates that approximately seven advisers annually would apply 
to the Commission for an exemption from the rule. Although we may 
initially receive more than seven applications a year for an exemption, 
over time, we expect the number of applications we receive will 
significantly decline to an average of approximately seven annually. We 
continue to believe that a firm that applies for an exemption will hire 
outside counsel to prepare an exemptive request, but based on 
commenters' concerns have raised the number of hours counsel will spend 
preparing and submitting an application from 16 hours to 32 hours, at a 
rate of $400 per hour.\589\ As a result, each application will cost 
approximately $12,800, and the total estimated cost for seven 
applications annually will be $89,600. The total estimated annual cost 
burden to applicants of filing all applications has therefore increased 
to $444,600.\590\
---------------------------------------------------------------------------

    \588\ See Davis Polk Letter; ICI Letter.
    \589\ The hourly cost estimate of $400 is based on our 
consultation with advisers and law firms who regularly assist them 
in compliance matters.
    \590\ $355,000 + $89,600 = $444,600.
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VI. Final Regulatory Flexibility Analysis

    The Commission has prepared the following Final Regulatory 
Flexibility Analysis regarding rule 206(4)-5 and the amendments to 
rules 204-2 and 206(4)-3 in accordance with section 3(a) of the 
Regulatory Flexibility Act.\591\ We prepared an Initial Regulatory 
Flexibility Analysis (``IRFA'') in conjunction with the Proposing 
Release in August 2009.\592\ The Proposing Release included, and 
solicited comment, on the IRFA.
---------------------------------------------------------------------------

    \591\ 5 U.S.C. 604(b).
    \592\ See Proposing Release, at section V.
---------------------------------------------------------------------------

A. Need for the Rule

    Investment advisers that seek to influence the award of advisory 
contracts by government entities, by making or soliciting political 
contributions to those officials who are in a position to influence the 
awards, violate their fiduciary obligations. These practices--known as 
``pay to play''--distort the process by which investment advisers are 
selected and, as discussed in greater detail above, can harm advisers' 
public pension plan clients, and thereby beneficiaries of those plans, 
which may receive inferior advisory services and pay higher fees.\593\ 
In addition, the most qualified adviser may not be selected, 
potentially leading to inferior management, diminished returns, or 
greater losses for the public pension plan. Pay to play is a 
significant problem in the management of public funds by investment 
advisers. Moreover, we believe that advisers' participation in pay to 
play is inconsistent with the high standards of ethical conduct 
required of them under the Advisers Act. The rule and rule amendments 
we are adopting today are designed to prevent fraud, deception, and 
manipulation by reducing or eliminating adviser participation in pay to 
play practices.
---------------------------------------------------------------------------

    \593\ See section I of this Release, for more information about 
the need for the Commission to take action to prevent pay to play 
practices.
---------------------------------------------------------------------------

    Rule 206(4)-5, the ``pay to play'' rule, prohibits an investment 
adviser registered (or required to be registered)

[[Page 41066]]

with the Commission, or unregistered in reliance on the exemption 
available under section 203(b)(3) of the Advisers Act, from providing 
advisory services for compensation to a government client for two years 
after the adviser, or any of its covered associates, makes a 
contribution to public officials (and candidates) such as State 
treasurers, comptrollers, or other elected executives or administrators 
who can influence the selection of the adviser.\594\ In addition, the 
rule we are adopting prohibits an adviser and its covered associates 
from soliciting contributions for an elected official or candidate or 
payments to a political party of a State or locality where the adviser 
is providing or seeking to provide advisory services to a government 
entity,\595\ and from providing or agreeing to provide, directly or 
indirectly, payment to any third party, other than a ``regulated 
person,'' engaged to solicit advisory business from any government 
entity on behalf of the adviser.\596\ Further, the prohibitions in the 
rule also apply to advisers to certain investment pools in which a 
government entity invests or that are investment options of a plan or 
program of a government entity.\597\ The amendment we are adopting to 
rule 204-2 is designed to provide Commission staff with records to 
review compliance with rule 206(4)-5, and the amendment to rule 206(4)-
3 clarifies the application of the cash solicitation rule as a result 
of the adoption of rule 206(4)-5.\598\
---------------------------------------------------------------------------

    \594\ Rule 206(4)-5(a)(1).
    \595\ Rule 206(4)-5(a)(2)(ii).
    \596\ Rule 206(4)-5(a)(2)(i). ``Regulated person'' is defined in 
rule 206(4)-5(f)(9).
    \597\ Rule 206(4)-5(c).
    \598\ For a more detailed discussion of the prohibitions 
contained in rule 206(4)-5, see section II.B.2 of this Release. For 
a more detailed discussion of the amendments to rules 204-2 and 
206(4)-3, see sections II.D and II.E, respectively, of this Release.
---------------------------------------------------------------------------

B. Significant Issues Raised by Public Comment

    In the Proposing Release, we requested comment on the IRFA, in 
particular, on the number of small entities, particularly small 
advisers, to which the rule and rule amendments would apply and the 
effect on those entities, including whether the effects would be 
economically significant; and how to quantify the number of small 
advisers, including those that are unregistered, that would be subject 
to the proposed rule and rule amendments. We received a number of 
comments related to the impact of our proposal on small advisers. The 
commenters argued that the proposed rule, particularly the provision 
that would have prohibited advisers from directly or indirectly 
compensating any third party to solicit government business on its 
behalf, would be disproportionately expensive for, and would impose an 
undue regulatory burden on, smaller firms.\599\
---------------------------------------------------------------------------

    \599\ See supra note 522.
---------------------------------------------------------------------------

C. Small Entities Subject to Rule

    Under Commission rules, for the purposes of the Advisers Act and 
the Regulatory Flexibility Act, an investment adviser generally is a 
small entity if it: (i) Has assets under management having a total 
value of less than $25 million; (ii) did not have total assets of $5 
million or more on the last day of its most recent fiscal year; and 
(iii) does not control, is not controlled by, and is not under common 
control with another investment adviser that has assets under 
management of $25 million or more, or any person (other than a natural 
person) that had $5 million or more on the last day of its most recent 
fiscal year.\600\
---------------------------------------------------------------------------

    \600\ 17 CFR 275.0-7(a).
---------------------------------------------------------------------------

    The Commission estimates that as of April 2010 there are 
approximately 708 small SEC-registered investment advisers.\601\ Of 
these 708 advisers, 61 indicate on Form ADV that they have State or 
local government clients, and would, therefore, be affected by the 
rule.\602\ The rule also applies to those advisers that are exempt from 
registration with the Commission in reliance on section 203(b)(3) of 
the Advisers Act. As noted above, based on our review of registration 
information on IARD and outside sources and reports, we estimate that 
there are approximately 2,000 advisers that are unregistered in 
reliance on section 203(b)(3).\603\ Applying the same principles we 
used with respect to registered investment advisers, we estimate that 
230 of those advisers manage pooled investment vehicles in which 
government client assets are invested and would therefore be subject to 
the rule.\604\ Based on the current number of registered advisers 
subject to the rule that are small entities, we estimate that 
approximately 4 percent of unregistered advisers,\605\ or nine, would 
be subject to the rule are small entities.\606\
---------------------------------------------------------------------------

    \601\ This estimate is based on registration information from 
IARD as of April 1, 2010. We have estimated the number of small 
advisers by reference to advisers' responses to Item 12.A, B and C 
of Part 1 of Form ADV.
    \602\ This estimate is based on registration information from 
IARD as of April 1, 2010. We have estimated the number of small 
advisers with State or local government clients by reference to 
advisers' responses to Item 5.D(9) of Part 1 of Form ADV.
    \603\ This number is based on our review of registration 
information on IARD as of April 1, 2010, IARD data from the peak of 
hedge fund adviser registration in 2005, and a distillation of 
numerous third-party sources including news organizations and 
industry trade groups.
    \604\ 11.48% of 2000 is 230. See supra note 474.
    \605\ 61 registered small entities subject to the rule/1,697 
registered advisers subject to the rule = 3.6%.
    \606\ 230 x 4% = 9.2. Because these advisers are not registered 
with us, we do not have more precise data about them, and we are not 
aware of any databases that compile information regarding how many 
advisers that are exempt from registration with the Commission in 
reliance on section 203(b)(3) of the Advisers Act have State or 
local government clients, and how many of these advisers would be 
small entities for purposes of this analysis. We sought comments on 
this issue, but none of the comments we received provided any 
estimates or empirical data. However, we address above commenters 
who generally questioned our estimates. See supra notes 482-484 and 
accompanying text. We expect certain additional advisers may incur 
compliance costs associated with rule 206(4)-5. Some advisers may be 
subject to the rule because they solicit government entities on 
behalf of other investment advisers.
---------------------------------------------------------------------------

D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The rule imposes certain reporting, recordkeeping and compliance 
requirements on advisers, including small advisers. The rule imposes a 
new compliance requirement by: (i) Prohibiting an adviser from 
providing investment advisory services for compensation to government 
clients for two years after the adviser or any of its covered 
associates makes a contribution to certain elected officials or 
candidates; (ii) prohibiting an adviser from providing or agreeing to 
provide, directly or indirectly, payment to any third party, other than 
a ``regulated person,'' engaged to solicit advisory business from any 
government entity on behalf of the adviser; and (iii) prohibiting an 
adviser or any of its covered associates from soliciting contributions 
for an elected official or candidate or payments to a political party 
of a State or locality where the adviser is providing or seeking to 
provide advisory services to a government entity.
    The rule amendments impose new recordkeeping requirements by 
requiring an adviser to maintain certain records about its covered 
associates, its advisory clients, government entities invested in 
certain pooled investment vehicles managed by the adviser, its 
solicitors, and its political contributions, as well as the political 
contributions of its covered associates.\607\ An investment adviser 
that does not provide or seek to provide advisory services to a 
government entity, or to a covered investment pool

[[Page 41067]]

in which a government entity invests, is not subject to rule 206(4)-5 
and certain recordkeeping requirements under amended rule 204-2.
---------------------------------------------------------------------------

    \607\ See supra notes 559-564 and accompanying text (providing 
the revised estimated hour burden and non-labor cost burden to 
comply with amended rule 204-2, for purposes of the PRA).
---------------------------------------------------------------------------

    As noted above, we believe that a limited number of small advisers 
\608\ will have to comply with rule 206(4)-5 and the amendments to 
rules 204-2 and 206(4)-3. To the extent small advisers tend to have 
fewer clients and fewer employees that would be covered associates for 
purposes of the rule, the rule should impose lower costs on small 
advisers as compared to large advisers because variable costs, such as 
the requirement to make and keep records relating to contributions, 
should be lower due to the likelihood that there would be fewer records 
to make and keep.\609\ Moreover, as discussed above, the rule and 
amendments were modified from what we had proposed in several ways that 
we expect will substantially minimize compliance burdens on small 
advisers.
---------------------------------------------------------------------------

    \608\ See section VI.C of this Release.
    \609\ However, as noted above, many larger advisers with broker-
dealer affiliates may spend fewer resources to comply with the 
proposed rule and rule amendments because they may be able to rely 
on compliance procedures and systems that the broker-dealer already 
has in place to comply with MSRB rules G-37 and G-38. See supra 
section IV.B.
---------------------------------------------------------------------------

E. Agency Action To Minimize Effect on Small Entities

    The Regulatory Flexibility Act directs the Commission to consider 
significant alternatives that would accomplish the stated objective, 
while minimizing any significant impact on small entities.\610\ In 
considering whether to adopt rule 206(4)-5 and the amendments to rules 
204-2 and 206(4)-3, the Commission considered the following 
alternatives: (i) The establishment of differing compliance or 
reporting requirements or timetables that take into account the 
resources available to small entities; (ii) the clarification, 
consolidation, or simplification of compliance and reporting 
requirements under the rule and rule amendments for such small 
entities; (iii) the use of performance rather than design standards; 
and (iv) an exemption from coverage of the rule and rule amendments, or 
any part thereof, for such small entities.
---------------------------------------------------------------------------

    \610\ As noted above, we considered two alternatives to certain 
aspects of proposed rule 206(4)-5: A disclosure obligation and a 
two-year time out for third-party solicitors. We do not believe 
either alternative would accomplish our stated objective of 
curtailing pay to play activities and thereby address potential 
harms from those activities. See Proposing Release, at section 
II.A.2, including nn.133 and 134 and accompanying text.
---------------------------------------------------------------------------

    Regarding the first alternative, the Commission is not adopting 
different compliance or reporting requirements for small advisers as it 
may be inappropriate to do so under the circumstances. The proposal is 
designed to reduce or eliminate adviser participation in pay to play, a 
practice that can distort the process by which investment advisers are 
selected to manage public pension plans that can harm public pension 
plan clients and cause advisers to violate their fiduciary obligations. 
To establish different requirements for small advisers could diminish 
the protections the rule and rule amendments would provide to public 
pension plan clients and their beneficiaries.
    Regarding the second alternative, we considered whether further 
clarification, consolidation, or simplification of the compliance 
requirements would be feasible or necessary, and would reduce 
compliance requirements. As a result, we have simplified the compliance 
requirements by limiting the recordkeeping obligations to better 
reflect the activities of an adviser or a covered associate that could 
result in the adviser being subject to the two-year time out, including 
not requiring advisers to maintain records of unsuccessful 
solicitations of government entities and payments (as opposed to 
contributions) by advisers or covered associates to government 
officials.\611\ Moreover, we are amending rule 206(4)-3, the cash 
solicitation rule, to clarify that the requirements of new rule 206(4)-
5 apply to solicitation activities involving government clients.\612\
---------------------------------------------------------------------------

    \611\ See supra note 423 and accompanying text.
    \612\ See section II.D. of this Release.
---------------------------------------------------------------------------

    Regarding the third alternative, we considered using performance 
rather than design standards with respect to pay to play practices of 
investment advisers to be neither consistent with the objectives for 
this rulemaking nor sufficient to protect investors in accordance with 
our statutory mandate of investor protection. Design standards, which 
we have employed, provide a baseline for advisory conduct as it relates 
to contributions and other pay to play activities, which is consistent 
with a rule designed to prohibit pay to play. The use of design 
standards also is important to ensure consistent application of the 
rule among investment advisers to which the rule and rule amendments 
will apply.
    Regarding the fourth alternative, exempting small entities could 
compromise the overall effectiveness of the rule and related rule 
amendments. Banning pay to play practices benefits clients of both 
small and large advisers, and it would be inconsistent to specify 
different requirements for small advisers.
    As discussed above, several commenters suggested alternative 
approaches to our rule.\613\ Such alternatives include, for example: 
(i) That we require advisers to disclose their contributions to State 
and local officials; (ii) that we require advisers to include in their 
codes of ethics a policy that prohibits contributions made for the 
purpose of influencing the selection of the adviser; (iii) that we 
require advisers to adopt policies and procedures reasonably designed 
to prevent and detect contributions designed to influence the selection 
of an adviser; (iv) that we mandate preclearance of employee 
contributions; and (v) that we allow an adviser to customize sanctions 
based on the severity of the violation.\614\ While it may be true that 
some of these approaches could diminish the compliance burdens on 
advisers, including small advisers, as we explain above, we considered 
these alternative approaches and do not believe they would 
appropriately address the kind of conduct at which our rule is 
directed.\615\
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    \613\ See generally section II.B.2(a) of this Release.
    \614\ See id.
    \615\ See id.
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    We are sensitive to the burdens our rule amendments will have on 
small advisers. We believe that the rule we are adopting today contains 
a number of modifications from what we had proposed that will alleviate 
many of the commenters' concerns regarding small advisers. Most 
notably, as described above, we have created an exception to the third-
party solicitor ban for ``regulated persons,'' which will, for 
instance, allow advisers to continue to use third party placement 
agents to sell interests in covered investment pools they manage 
instead of incurring additional costs to hire internal marketing staff, 
a result that could have disproportionally affected small 
advisers.\616\ Moreover, as discussed above, we have modified the 
exceptions to the rule's two-year time out provisions in certain 
respects to reduce the likelihood of an inadvertent or minor violation 
of the rule, including a shortened look back of six months for certain 
new covered associates whose contributions are less likely to involve 
pay to play and a new de minimis exception for contributions to 
officials for whom a covered associate is not entitled to vote.\617\ We 
have also limited certain recordkeeping requirements we had proposed in 
order to achieve our

[[Page 41068]]

goals in a way that balances the costs and benefits of the rule, 
including not requiring records of unsuccessful solicitations or 
payments (that are not contributions) by advisers or covered associates 
to government officials.\618\
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    \616\ See section II.B.2(b) of this Release.
    \617\ See sections II.B.2(a)(5) and (6) of this Release.
    \618\ See sections II.D and III.B.3. of this Release.
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VII. Effects on Competition, Efficiency and Capital Formation

    We are adopting amendments to rule 204-2 pursuant to our authority 
under sections 204 and 211. Section 204 requires the Commission, when 
engaging in rulemaking pursuant to that authority, to consider whether 
the rule is ``necessary or appropriate in the public interest or for 
the protection of investors.'' \619\ Section 202(c) of the Advisers Act 
requires the Commission, when engaging in rulemaking that requires it 
to consider or determine whether an action is necessary or appropriate 
in the public interest, to consider, in addition to the protection of 
investors, whether the action will promote efficiency, competition, and 
capital formation.\620\
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    \619\ 15 U.S.C. 80b-4.
    \620\ 15 U.S.C. 80b-2(c). In contrast, we are adopting rule 
206(4)-5 and amendments to rule 206(4)-3 pursuant to our authority 
set forth in sections 206(4) and 211. For a discussion of the 
effects of these amendments on competition, efficiency and capital 
formation, see sections IV, V, and VI of this Release.
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    In the Proposing Release, we solicited comment on whether, if 
adopted, the proposed amendments to rule 204-2 would promote 
efficiency, competition and capital formation. We further encouraged 
commenters to provide empirical data to support their views on any 
burdens on efficiency, competition or capital formation that might 
result from adoption of the proposed amendments. We did not receive any 
empirical data in this regard concerning the proposed amendments. We 
received some general comments, addressed below, asserting that the 
proposed amendments to require registered advisers to maintain books 
and records relating to investment advisory services they provide to 
government entities would have an adverse impact on competition.
    We are amending rule 204-2 to require a registered adviser to make 
and keep a list of its covered associates, the government entities to 
which the adviser directly or indirectly provides advisory services, 
the ``regulated person'' solicitors the adviser retains, and the 
contributions made by the firm and its covered associates, as 
applicable, to government officials and candidates.\621\ The amendments 
are designed to provide our examiners important information about the 
adviser and its covered associates' contributions to government 
officials, the government entities to which the adviser directly or 
indirectly provides advisory services, and the solicitors it retains. 
These amendments may also benefit advisers as records required under 
the amended rule will assist the Commission in enforcing the rule 
against, for example, an adviser whose pay to play activities, if not 
uncovered, could adversely affect the competitive position of a 
compliant adviser.
---------------------------------------------------------------------------

    \621\ Rule 204-2(a)(18)(i).
---------------------------------------------------------------------------

    Although we believe that the amendments to the Advisers Act 
recordkeeping rule will require advisers to incur both one-time costs 
to establish and enhance current systems to assist in their compliance 
with the amendments and ongoing costs to maintain records, these costs 
will be borne by all registered advisers that have government entity 
clients or that pay regulated entities to solicit government clients on 
their behalf. As the amendments to the recordkeeping rule do not 
disproportionally affect any particular group of advisers with 
government entity clients and do not materially increase the compliance 
burden on advisers under rule 204-2, we do not believe that they will 
affect competition across registered investment advisers. Some 
commenters asserted that certain asset managers that provide advice to 
government entities but are not subject to the Advisers Act 
recordkeeping rule, such as banks and advisers that are exempt from 
registration under the Act, may be at a competitive advantage to 
registered advisers that must incur the costs of keeping records under 
the rule.\622\ While we acknowledge these entities could potentially 
obtain a competitive advantage for this reason, we do not believe the 
costs attributable to the amendments to rule 204-2 will have a 
significant impact on registered advisers such that the advantage 
gained by asset managers not subject to the Advisers Act recordkeeping 
rule will be substantial.\623\ Moreover, exempt advisers or persons 
that do not meet the definition of investment adviser are not subject 
to rule 204-2.\624\ Finally, we also note that banks may be subject to 
laws and rules that do not apply to registered advisers.
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    \622\ SIFMA Letter (``The books and records requirement under 
the Proposed Rule are under inclusive. * * * As an initial matter, 
the books and records requirements apply only to some of the 
advisers covered by the Proposed Rule--although the Proposed Rule 
applies to a substantial number of entities who are exempt from 
registration under the Advisers Act, the Proposed Rule's additional 
books and records only modify the rules that apply to registered 
investment advisers.'').
    \623\ In addition, we note that advisers not subject to the 
amendments to rule 204-2 may nonetheless maintain some of the 
required records as part of a strong compliance program.
    \624\ See section 204 of the Advisers Act, 15 U.S.C. 80b-4 (that 
provides the Commission authority to prescribe recordkeeping for 
advisers, other than those specifically exempted from registration).
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    We believe that the amendments to rule 204-2 may, to a limited 
extent, affect efficiency and capital formation with respect to the 
allocation of public pension plan assets. The amendments to rule 204-2 
will allow our staff to examine for compliance with rule 206(4)-5. 
Authority to examine records may improve registered investment 
advisers' compliance with rule 206(4)-5, which may reduce the adverse 
effects of political contributions on the selection of investment 
advisers. While the amendments to the rule will not affect the 
aggregate amount of pension fund assets available for investment, 
limiting the effects of political contributions on the investment 
adviser selection process should improve the mechanism by which capital 
is formed and allocated to investment opportunities.

VIII. Statutory Authority

    The Commission is adopting new rule 206(4)-5 and amending rule 
206(4)-3 of the Advisers Act pursuant to the authority set forth in 
sections 206(4) and 211(a) of the Investment Advisers Act of 1940 [15 
U.S.C. 80b-6(4), 80b-11(a)].
    The Commission is amending rule 204-2 of the Advisers Act pursuant 
to the authority set forth in sections 204 and 211(a) of the Advisers 
Act [15 U.S.C. 80b-4 and 80b-11(a)].

List of Subjects in 17 CFR Part 275

    Reporting and recordkeeping requirements; Securities.

0
For the reasons set out in the preamble, Title 17 Chapter II of the 
Code of Federal Regulations is amended as follows.

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

0
1. The authority citation for Part 275 continues to read in part as 
follows:

    Authority:  15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(17), 80b-3, 80b-
4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.
* * * * *

0
2. Section 275.204-2 is amended by adding paragraph (a)(18) and by 
revising paragraph (h)(1) to read as follows:

[[Page 41069]]

Sec.  275.204-2  Books and records to be maintained by investment 
advisers.

    (a) * * *
    (18)(i) Books and records that pertain to Sec.  275.206(4)-5 
containing a list or other record of:
    (A) The names, titles and business and residence addresses of all 
covered associates of the investment adviser;
    (B) All government entities to which the investment adviser 
provides or has provided investment advisory services, or which are or 
were investors in any covered investment pool to which the investment 
adviser provides or has provided investment advisory services, as 
applicable, in the past five years, but not prior to September 13, 
2010;
    (C) All direct or indirect contributions made by the investment 
adviser or any of its covered associates to an official of a government 
entity, or direct or indirect payments to a political party of a State 
or political subdivision thereof, or to a political action committee; 
and
    (D) The name and business address of each regulated person to whom 
the investment adviser provides or agrees to provide, directly or 
indirectly, payment to solicit a government entity for investment 
advisory services on its behalf, in accordance with Sec.  275.206(4)-
5(a)(2).
    (ii) Records relating to the contributions and payments referred to 
in paragraph (a)(18)(i)(C) of this section must be listed in 
chronological order and indicate:
    (A) The name and title of each contributor;
    (B) The name and title (including any city/county/State or other 
political subdivision) of each recipient of a contribution or payment;
    (C) The amount and date of each contribution or payment; and
    (D) Whether any such contribution was the subject of the exception 
for certain returned contributions pursuant to Sec.  275.206(4)-
5(b)(2).
    (iii) An investment adviser is only required to make and keep 
current the records referred to in paragraphs (a)(18)(i)(A) and (C) of 
this section if it provides investment advisory services to a 
government entity or a government entity is an investor in any covered 
investment pool to which the investment adviser provides investment 
advisory services.
    (iv) For purposes of this section, the terms ``contribution,'' 
``covered associate,'' ``covered investment pool,'' ``government 
entity,'' ``official,'' ``payment,'' ``regulated person,'' and 
``solicit'' have the same meanings as set forth in Sec.  275.206(4)-5.
* * * * *
    (h)(1) Any book or other record made, kept, maintained and 
preserved in compliance with Sec. Sec.  240.17a-3 and 240.17a-4 of this 
chapter under the Securities Exchange Act of 1934, or with rules 
adopted by the Municipal Securities Rulemaking Board, which is 
substantially the same as the book or other record required to be made, 
kept, maintained and preserved under this section, shall be deemed to 
be made, kept, maintained and preserved in compliance with this 
section.
* * * * *

0
3. Section 275.206(4)-3 is amended by adding paragraph (e) and removing 
the authority citation at the end of the section to read as follows:


Sec.  275.206(4)-3  Cash payments for client solicitations.

* * * * *
    (e) Special rule for solicitation of government entity clients. 
Solicitation activities involving a government entity, as defined in 
Sec.  275.206(4)-5, shall be subject to the additional limitations set 
forth in that section.

0
4. Section 275.206(4)-5 is added to read as follows:


Sec.  275.206(4)-5  Political contributions by certain investment 
advisers.

    (a) Prohibitions. As a means reasonably designed to prevent 
fraudulent, deceptive or manipulative acts, practices, or courses of 
business within the meaning of section 206(4) of the Act (15 U.S.C. 
80b-6(4)), it shall be unlawful:
    (1) For any investment adviser registered (or required to be 
registered) with the Commission, or unregistered in reliance on the 
exemption available under section 203(b)(3) of the Advisers Act (15 
U.S.C. 80b-3(b)(3)) 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 covered associate of the investment adviser 
(including a person who becomes a covered associate within two years 
after the contribution is made); and
    (2) For any investment adviser registered (or required to be 
registered) with the Commission, or unregistered in reliance on the 
exemption available under section 203(b)(3) of the Advisers Act (15 
U.S.C. 80b-3(b)(3)) or any of the investment adviser's covered 
associates:
    (i) To provide or agree to provide, directly or indirectly, payment 
to any person to solicit a government entity for investment advisory 
services on behalf of such investment adviser unless such person is a 
regulated person or is an executive officer, general partner, managing 
member (or, in each case, a person with a similar status or function), 
or employee of the investment adviser; and
    (ii) To coordinate, or to solicit any person or political action 
committee to make, any:
    (A) Contribution to an official of a government entity to which the 
investment adviser is providing or seeking to provide investment 
advisory services; or
    (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.
    (b) Exceptions.
    (1) De minimis exception. Paragraph (a)(1) of this section does not 
apply to contributions made by a covered associate, if a natural 
person, to officials for whom the covered associate was entitled to 
vote at the time of the contributions and which in the aggregate do not 
exceed $350 to any one official, per election, or to officials for whom 
the covered associate was not entitled to vote at the time of the 
contributions and which in the aggregate do not exceed $150 to any one 
official, per election.
    (2) Exception for certain new covered associates. The prohibitions 
of paragraph (a)(1) of this section shall not apply to an investment 
adviser as a result of a contribution made by a natural person more 
than six months prior to becoming a covered associate of the investment 
adviser unless such person, after becoming a covered associate, 
solicits clients on behalf of the investment adviser.
    (3) Exception for certain returned contributions.
    (i) An investment adviser that is prohibited from providing 
investment advisory services for compensation pursuant to paragraph 
(a)(1) of this section as a result of a contribution made by a covered 
associate of the investment adviser is excepted from such prohibition, 
subject to paragraphs (b)(3)(ii) and (b)(3)(iii) of this section, upon 
satisfaction of the following requirements:
    (A) The investment adviser must have discovered the contribution 
which resulted in the prohibition within four months of the date of 
such contribution;
    (B) Such contribution must not have exceeded $350; and
    (C) The contributor must obtain a return of the contribution within 
60 calendar days of the date of discovery of such contribution by the 
investment adviser.

[[Page 41070]]

    (ii) In any calendar year, an investment adviser that has reported 
on its annual updating amendment to Form ADV (17 CFR 279.1) that it has 
more than 50 employees is entitled to no more than three exceptions 
pursuant to paragraph (b)(3)(i) of this section, and an investment 
adviser that has reported on its annual updating amendment to Form ADV 
that it has 50 or fewer employees is entitled to no more than two 
exceptions pursuant to paragraph (b)(3)(i) of this section.
    (iii) An investment adviser may not rely on the exception provided 
in paragraph (b)(3)(i) of this section more than once with respect to 
contributions by the same covered associate of the investment adviser 
regardless of the time period.
    (c) Prohibitions as applied to covered investment pools. For 
purposes of this section, an investment adviser to a covered investment 
pool in which a government entity invests or is solicited to invest 
shall be treated as though that investment adviser were providing or 
seeking to provide investment advisory services directly to the 
government entity.
    (d) Further prohibition. As a means reasonably designed to prevent 
fraudulent, deceptive or manipulative acts, practices, or courses of 
business within the meaning of section 206(4) of Advisers Act (15 
U.S.C. 80b-6(4)), it shall be unlawful for any investment adviser 
registered (or required to be registered) with the Commission, or 
unregistered in reliance on the exemption available under section 
203(b)(3) of the Advisers Act (15 U.S.C. 80b-3(b)(3)), or any of the 
investment adviser's covered associates to do anything indirectly 
which, if done directly, would result in a violation of this section.
    (e) Exemptions. The Commission, upon application, may conditionally 
or unconditionally exempt an investment adviser from the prohibition 
under paragraph (a)(1) of this section. In determining whether to grant 
an exemption, the Commission will consider, among other factors:
    (1) Whether the exemption is necessary or appropriate in the public 
interest and consistent with the protection of investors and the 
purposes fairly intended by the policy and provisions of the Advisers 
Act (15 U.S.C. 80b);
    (2) Whether the investment adviser:
    (i) Before the contribution resulting in the prohibition was made, 
adopted and implemented policies and procedures reasonably designed to 
prevent violations of this section; and
    (ii) Prior to or at the time the contribution which resulted in 
such prohibition was made, had no actual knowledge of the contribution; 
and
    (iii) After learning of the contribution:
    (A) Has taken all available steps to cause the contributor involved 
in making the contribution which resulted in such prohibition to obtain 
a return of the contribution; and
    (B) Has taken such other remedial or preventive measures as may be 
appropriate under the circumstances;
    (3) Whether, at the time of the contribution, the contributor was a 
covered associate or otherwise an employee of the investment adviser, 
or was seeking such employment;
    (4) The timing and amount of the contribution which resulted in the 
prohibition;
    (5) The nature of the election (e.g, Federal, State or local); and
    (6) The contributor's apparent intent or motive in making the 
contribution which resulted in the prohibition, as evidenced by the 
facts and circumstances surrounding such contribution.
    (f) Definitions. For purposes of this section:
    (1) Contribution means any gift, subscription, loan, advance, or 
deposit of money or anything of value made for:
    (i) The purpose of influencing any election for Federal, State or 
local office;
    (ii) Payment of debt incurred in connection with any such election; 
or
    (iii) Transition or inaugural expenses of the successful candidate 
for State or local office.
    (2) Covered associate of an investment adviser means:
    (i) Any general partner, managing member or executive officer, or 
other individual with a similar status or function;
    (ii) Any employee who solicits a government entity for the 
investment adviser and any person who supervises, directly or 
indirectly, such employee; and
    (iii) Any political action committee controlled by the investment 
adviser or by any person described in paragraphs (f)(2)(i) and 
(f)(2)(ii) of this section.
    (3) Covered investment pool means:
    (i) An investment company registered under the Investment Company 
Act of 1940 (15 U.S.C. 80a) that is an investment option of a plan or 
program of a government entity; or
    (ii) Any company that would be an investment company under section 
3(a) of the Investment Company Act of 1940 (15 U.S.C. 80a-3(a)), but 
for the exclusion provided from that definition by either section 
3(c)(1), section 3(c)(7) or section 3(c)(11) of that Act (15 U.S.C. 
80a-3(c)(1), (c)(7) or (c)(11)).
    (4) Executive officer of an investment adviser means:
    (i) The president;
    (ii) Any vice president in charge of a principal business unit, 
division or function (such as sales, administration or finance);
    (iii) Any other officer of the investment adviser who performs a 
policy-making function; or
    (iv) Any other person who performs similar policy-making functions 
for the investment adviser.
    (5) Government entity means any State or political subdivision of a 
State, including:
    (i) Any agency, authority, or instrumentality of the State or 
political subdivision;
    (ii) A pool of assets sponsored or established by the State or 
political subdivision or any agency, authority or instrumentality 
thereof, including, but not limited to a ``defined benefit plan'' as 
defined in section 414(j) of the Internal Revenue Code (26 U.S.C. 
414(j)), or a State general fund;
    (iii) A plan or program of a government entity; and
    (iv) Officers, agents, or employees of the State or political 
subdivision or any agency, authority or instrumentality thereof, acting 
in their official capacity.
    (6) Official means any person (including any election committee for 
the person) who was, at the time of the contribution, an incumbent, 
candidate or successful candidate for elective office of a government 
entity, if the office:
    (i) Is directly or indirectly responsible for, or can influence the 
outcome of, the hiring of an investment adviser by a government entity; 
or
    (ii) 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 by a government entity.
    (7) Payment means any gift, subscription, loan, advance, or deposit 
of money or anything of value.
    (8) Plan or program of a government entity means any participant-
directed investment program or plan sponsored or established by a State 
or political subdivision or any agency, authority or instrumentality 
thereof, including, but not limited to, a ``qualified tuition plan'' 
authorized by section 529 of the Internal Revenue Code (26 U.S.C. 529), 
a retirement plan authorized by section 403(b) or 457 of the Internal 
Revenue Code (26 U.S.C. 403(b) or 457), or any similar program or plan.
    (9) Regulated person means:
    (i) An investment adviser registered with the Commission that has 
not, and whose covered associates have not,

[[Page 41071]]

within two years of soliciting a government entity:
    (A) Made a contribution to an official of that government entity, 
other than as described in paragraph (b)(1) of this section; and
    (B) Coordinated or solicited any person or political action 
committee to make any contribution or payment described in paragraphs 
(a)(2)(ii)(A) and (B) of this section; or
    (ii) A ``broker,'' as defined in section 3(a)(4) of the Securities 
Exchange Act of 1934 (15 U.S.C. 78c(a)(4)) or a ``dealer,'' as defined 
in section 3(a)(5) of that Act (15 U.S.C. 78c(a)(5)), that is 
registered with the Commission, and is a member of a national 
securities association registered under section 15A of that Act (15 
U.S.C. 78o-3), provided that:
    (A) The rules of the association prohibit members from engaging in 
distribution or solicitation activities if certain political 
contributions have been made; and
    (B) The Commission, by order, finds that such rules impose 
substantially equivalent or more stringent restrictions on broker-
dealers than this section imposes on investment advisers and that such 
rules are consistent with the objectives of this section.
    (10) Solicit means:
    (i) With respect to investment advisory services, to communicate, 
directly or indirectly, for the purpose of obtaining or retaining a 
client for, or referring a client to, an investment adviser; and
    (ii) With respect to a contribution or payment, to communicate, 
directly or indirectly, for the purpose of obtaining or arranging a 
contribution or payment.

    By the Commission.

    Dated: July 1, 2010.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-16559 Filed 7-13-10; 8:45 am]
BILLING CODE 8010-01-P

