[Federal Register: August 7, 2009 (Volume 74, Number 151)]
[Proposed Rules]
[Page 39839-39870]
[DOCID:fr07au09-18]

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Part IV

Securities and Exchange Commission

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17 CFR Part 275

Political Contributions by Certain Investment Advisers; Proposed Rule

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-2910; File No. S7-18-09]
RIN 3235-AK39

Political Contributions by Certain Investment Advisers

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission is proposing for
comment a new rule under the Investment Advisers Act of 1940 that would
prohibit 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 would also prohibit 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. Additionally, the new
rule would prevent 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 proposing rule
amendments that would 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 would
address ``pay to play'' practices by investment advisers.

DATES: Comments should be received on or before October 6, 2009.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number S7-18-09 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number S7-18-09. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for public inspection and copying in the
Commission's Public Reference Room, 100 F Street, NE., Washington, DC
20549 on official business days between the hours of 10 a.m. and 3 p.m.
All comments received will be posted without change; we do not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Melissa A. Roverts, Attorney-Adviser,
Matthew N. Goldin, Senior Counsel, Daniel S. Kahl, Branch Chief, or
Sarah A. Bessin, Assistant Director, at<PHONE_NUMBER> or
<EMAIL_ADDRESS>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 requesting public comment
on proposed rule 206(4)-5 [17 CFR 275.206(4)-5] and proposed 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'').

I. Background and Introduction
II. Discussion
    A. Rule 206(4)-5: ``Pay to Play'' Restrictions
    1. Advisers Subject to the Rule
    2. Relationship with MSRB Rules; Alternative Approaches
    3. Pay to Play Restrictions
    (a) Two-Year ``Time Out'' for Contributors
    (1) Prohibition on Compensation
    (2) Officials of a Government Entity
    (3) Contributions
    (4) Covered Associates
    (5) ``Look Back''
    (6) Exception for De Minimis Contributions
    (7) Exception for Certain Returned Contributions
    (b) Ban on Using Third Parties To Solicit Government Business
    (c) Restrictions on Soliciting and Coordinating Contributions
and Payments
    (d) Direct and Indirect Contributions or Solicitations
    (e) Investment Pools
    (1) Application of the Rule to Pooled Investment Vehicles
    (2) Covered Investment Pools
    (3) Applying the Compensation Limit to Covered Investment Pools
    (f) Exemptions
    B. Recordkeeping
    C. Amendment to Cash Solicitation Rule
    D. Transition Period
    E. General Request for Comment
III. Cost/Benefit Analysis
    A. Benefits
    B. Costs
    C. Request for Comment
IV. Paperwork Reduction Act
    A. Rule 204-2
    B. Rule 206(4)-3
    C. Request for Comment
V. Initial Regulatory Flexibility Analysis
    A. Reasons for Proposed Action
    B. Objectives and Legal Basis
    C. Small Entities Subject to Rule
    D. Reporting, Recordkeeping, and Other Compliance Requirements
    E. Duplicative, Overlapping, or Conflicting Federal Rules
    F. Significant Alternatives
    G. Solicitation of Comments
VI. Effects on Competition, Efficiency and Capital Formation
VII. Consideration of Impact on the Economy
VIII. Statutory Authority

I. Background and Introduction

    Investment advisers provide a wide variety of advisory services to
State and local governments.\1\ Advisers manage public monies that fund
pension plans and a number of other important public programs,
including transportation, children's programs, arts programs,
environmental reclamation, and financial aid for education. In
addition, advisers provide risk management,\2\ asset allocation,\3\
financial planning \4\ and cash management services; \5\ assist in
investing proceeds from bond

offerings; \6\ help State and local governments find and evaluate other
advisers that manage public funds (``pension consultants''); \7\ and
provide other types of services.\8\
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    \1\ 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, in Local
Government Finance, Concepts and Practices 376 (John E. Peterson and
Dennis R. Strachota, eds., 1st ed. 1991) (discussing the services
investment advisers provide for public funds).
    \2\ See Robert A. Fippinger, The Securities Law of Public
Finance 669 (2d ed. 2004).
    \3\ See, e.g., John H. Ilkiw, Investment Policies, Processes and
Problems in U.S. Public Sector Pension Plans: Some Observations and
Solutions from a Practitioner, in Public Pension Fund Management:
Governance, Accountability and Investment Policies (Alberto R.
Musalem and Robert J. Palacios, eds. 2004). See also Barry B. Burr,
The New $100 Billion Club, Pens. & Inv. (May 4, 1998), at 1.
    \4\ See Cal. Ed. Code Sec.  22303.5 (2008) (requiring teachers'
retirement system to offer retirement planning services to
beneficiaries); CalSTRS Counseling and Workshops, available at
http://www.calstrs.com/Counseling%20and%20Workshops/index.aspx.
Other funds also offer financial planning services to their
beneficiaries. See, e.g., CalPERS Launches Online Education Classes,
U.S. States News (Mar. 3, 2008).
    \5\ See Government Finance Officers Association, An Introduction
to External Money Management for Public Cash Managers 5 (1991).
    \6\ See In the Matter of O'Brien Partners, Inc., Investment
Advisers Act Release No. 1772 (Oct. 27, 1998) (settled enforcement
action in which financial advisor was deemed subject to the Advisers
Act for rendering advice to municipal securities issuers
``concerning their investment of bond proceeds in securities,
including [non-government securities], and was compensated for that
advice'').
    \7\ In addition to assisting public funds in selecting
investment advisers, pension consultants may also provide advice to
State and local governments on such things as designing investment
objectives, or recommending specific securities or investments for
the fund. Pension consultants may be investment advisers subject to
the Advisers Act. See 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)] (``Release 1092'').
    \8\ For example, public funds may retain advisers to perform
custodial services. See, e.g., Public Employee Retirement Systems,
supra note 1, at 376-77.
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    Most of the public funds managed by investment advisers fund State
and municipal pension plans.\9\ These pension plans have over $2.2
trillion of assets and represent one-third of all U.S. pension
assets.\10\ They are among the largest and most active institutional
investors in the United States.\11\ The management of these funds
significantly affects publicly held companies \12\ and the securities
markets.\13\ But most significantly, their management affects taxpayers
and the beneficiaries of these funds, including the millions of present
and future State and municipal retirees \14\ who rely on the funds for
their pensions and other benefits.\15\
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    \9\ For this reason, in this Release, we use the term ``public
pension plan'' interchangeably with ``government client'' and
``government entity''; however, our proposed rule would apply
broadly to investment advisory activities for government clients,
such as those mentioned here in this Background and Introduction,
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 infra section II.A.3(e) of this Release.
    \10\ Board of Governors of the Federal Reserve System, Flow of
Funds Accounts of the United States, Flows and Outstandings, First
Quarter 2009 (June 11, 2009) (at table L.119). Since 2002, total
financial assets of public pension funds have grown by 13% Id.
    \11\ 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.
    \12\ See Stephen J. Choi & Jill E. Fisch, On Beyond CalPERS:
Survey Evidence on the Developing Role of Public Pension Funds in
Corporate Governance, 61 Vanderbilt L.Rev. 315 (Mar. 2008) (noting,
``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.'').
    \13\ Federal Reserve reports indicate that, of the $2.2 trillion
in non-Federal government plans, $1.1 trillion are invested in
corporate equities. Flow of Funds Accounts of the United States,
supra note 10 (at table L.119).
    \14\ See Paul Zorn, 1997 Survey of State and Local Government
Employee Retirement Systems 61 (1997) (``[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'').
    \15\ 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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    Public pension plan assets are held, administered and managed by
elected officials who often are responsible for selecting investment
advisers to manage the funds they oversee. Pay to play practices
undermine the fairness of the selection process when advisers seeking
to do business with the governments of States and municipalities make
political contributions to elected officials or candidates, hoping to
influence the selection process. In other cases, political
contributions may be solicited from advisers, or it is simply
understood that only contributors will be considered for selection.
Contributions, in this circumstance, may not always guarantee an award
of business to the contributor, but the failure to contribute will
guarantee that another is selected. Hence the term ``pay to play.''
    Elected officials who allow political contributions to play a role
in the management of these assets violate the public trust by rewarding
those who make political contributions. Similarly, investment advisers
that seek to influence the award of advisory contracts by public
entities, by making or soliciting political contributions to those
officials who are in a position to influence the awards, compromise
their fiduciary obligations. Pay to play practices can distort the
process by which investment advisers are selected and can harm
advisers' public pension plan clients, and the pension plan
beneficiaries, which may receive inferior advisory services and pay
higher fees because, for instance, advisers must recoup contributions,
or because contract negotiations are not handled on an arm's-length
basis. Pay to play practices also 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. We believe that advisers'
participation in pay to play practices is inconsistent with the high
standards of ethical conduct required of them under the Advisers Act.
    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, in its decision upholding one of the rules
on which the proposed rule is modeled, ``[w]hile the risk of corruption
is obvious and substantial, actors in this field are presumably shrewd
enough to structure their relations rather indirectly.'' \16\ 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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    \16\ Blount v. SEC, 61 F.3d 938, 945 (DC Cir. 1995), cert.
denied, 517 U.S. 1119 (1996).
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    The rule we are proposing today is modeled on rules G-37 and G-38
of the Municipal Securities Rulemaking Board (``MSRB''),\17\ which
address pay to play practices in the municipal securities markets.\18\
The Commission approved rule G-37 in 1994, after concluding that pay to
play practices harm municipal securities markets.\19\ MSRB rule G-37

prohibits a broker-dealer from engaging in municipal securities
business with a municipal issuer for two years after making a political
contribution to an elected official of the issuer who can influence the
selection of the broker-dealer.\20\ The rule also prohibits a broker-
dealer from providing or seeking to provide underwriting services to a
government if the firm or any of its ``municipal finance
professionals'' solicit contributions for a candidate or an elected
official of that government, or if they solicit payments to political
parties where the firm is providing or seeking to provide services to a
government client.\21\ MSRB rule G-38 prohibits municipal securities
dealers from making payments to consultants for soliciting municipal
securities business.\22\ We believe that MSRB rules G-37 and G-38 have
been successful in addressing pay to play practices in the municipal
securities market.\23\
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    \17\ 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'').
The Commission also proposed amendments in 1999 to rule 204-2 [17
CFR 275.204-2] under the Advisers Act, which would have required
advisers with government clients to keep certain records relating to
the 1999 proposed rule. See id., at section II.B. We are not re-
proposing that rule or those rule amendments today; we are
withdrawing our 1999 proposal and proposing a new rule 206(4)-5 as
well as new amendments to rule 204-2.
    \18\ MSRB rule G-37 and G-38 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.
    \19\ 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)] (``MSRB Rule G-37 Approval Order''), at sections V.A.1 and 2.
In approving MSRB rule G-37, we concluded that pay to play practices
may harm the municipal markets by fostering a selection process that
excludes those firms that do not make contributions, causes less
qualified underwriters to be retained, and undermines equitable
practices in the municipal securities industry. Id. at section V.
    \20\ MSRB rule G-37(b). Shortly after MSRB rule G-37 became
effective, a municipal securities dealer challenged it as an
infringement on the constitutional rights of municipal securities
professionals. A Federal appeals court upheld the constitutionality
of MSRB rule G-37, finding that the rule is narrowly tailored to
serve a compelling government interest. See Blount, supra note 16.
    \21\ MSRB rule G-37(c). A ``municipal finance professional'' is
an associated person of a broker-dealer who is ``primarily engaged''
in municipal securities activities, who solicits municipal
securities business on behalf of a broker-dealer, who supervises
associated persons primarily engaged in municipal securities
activities ``up through and including'' the chief executive officer
of the firm (or person performing similar functions), or who is a
member of the firm's executive or management committee (or person
performing similar functions). MSRB rule G-37(g)(iv).
    \22\ MSRB rule G-38(a).
    \23\ Others, including the MSRB, agree. See, e.g., 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 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, dated Oct. 19, 2001, available at http://www.cfainstitute.org/
centre/topics/comment/2001/01msrb_ruleg37.html (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.''); Cmte. on Cap. Mkts. Reg., Interim Report of the Cmte.
on Cap. Mkts. Reg. (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.'').
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    Following the adoption of MSRB rule G-37, we were increasingly
concerned that the very success of the rule may have caused pay to play
practices to migrate to an area not covered by the MSRB rules--the
management of public pension plans.\24\ 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 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,\25\ may be members of a governing
board that selects advisers,\26\ or may appoint some or all of the
board members who make the selection.\27\
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    \24\ 1999 Proposing Release, supra note 17, at section I (``We
have become particularly concerned about the possibility that the
adoption of rule G-37 has resulted in a shift of pay to play
practices to [the management of public pension funds] as political
contributions by broker-dealers are curtailed.''). See also Bill
Krueger, Money Managers Giving to Boyles, News & Observer (May 2,
1996), at A1 (noting that rule G-37 ``dried up'' a contribution
source for a State treasurer, ``so now he is getting campaign
contributions from a group [investment advisers] that is not subject
to [rule G-37]''); Gerri Willis, Filling Carl's War Chest:
Comptroller Getting Thousands From State's Money Managers, Crain's
N.Y. Bus. (Sept. 16, 1996), at 1 (noting the observation of a
securities executive that ``[b]ecause of the SEC's crackdown on the
pay to play nature of the muni bond business, the game has shifted
to asset management and brokerage'').
    \25\ See, e.g., 2 NYCRR Sec.  320.2 (placement of State and
local government retirement systems assets (valued at $109 billion
as of Mar. 2009) is under the sole custodianship of the New York
State Comptroller).
    \26\ 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).
    \27\ 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 Sec.
59-1304 (2008) (governor appoints all five members).
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    In response to these concerns, in 1999 we proposed a rule under the
Advisers Act, modeled substantially on MSRB rule G-37, that was
designed to prevent advisers from participating in pay to play
practices affecting the management of public pension plans.\28\ In
particular, the 1999 rule proposal would have prohibited an adviser
from receiving compensation for the provision of advisory services for
two years after the advisory firm or any of its partners, executive
officers or solicitors, directly or indirectly, made a contribution to
an elected official who (or a candidate for an elected office that) has
the ability to influence the selection of the adviser.\29\ Comments on
the proposal were mixed, and some commenters that objected asserted
that pay to play was not a problem in the management of public
funds.\30\
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    \28\ See 1999 Proposing Release, supra note 17.
    \29\ See id., at section II.A.1.
    \30\ We received 59 comment letters on our 1999 proposal.
Commenters representing beneficiaries and public pension plans
expressed concern about pay to play practices and generally favored
our proposed rule. State government officials and investment
advisers generally opposed the rule. State government officials
generally argued that there was no demonstrated need for the
proposed rule and that State laws are adequate to address any
concerns. Most advisers submitting comments opposed the rule's
breadth and complained that the consequences of violating the rule
were too harsh; some denied the existence of the problem we sought
to address. Comment letters on our 1999 proposal and a summary of
comments prepared by our staff are available in our Public Reference
Room in File No. S7-19-99. Comment letters we received
electronically are also available at http://www.sec.gov/rules/
proposed/s71999.shtml.
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    Since then, it has become increasingly clear that pay to play is a
significant problem in the management of public funds by investment
advisers. In recent years, we and criminal authorities have brought a
number of actions charging investment advisers with participating in
pay to play schemes. We recently brought a civil action in Federal
court charging former New York State officials, as well as a
``placement agent,'' with engaging in a fraudulent scheme to extract
kickbacks from investment advisers seeking to manage assets of the New
York State Common Retirement Fund.\31\ Investment advisers allegedly
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.\32\ Another settled administrative action
involved an investment adviser who allegedly paid kickbacks in return
for investment advisory business awarded by the New Mexico State
treasurer's office.\33\ In addition, we brought two separate cases
against the former treasurer of the State of Connecticut and various
other parties in which we alleged that the former treasurer awarded
State pension fund investments to private equity fund managers in
exchange for fees paid to the former treasurer's friends and political
associates.\34\ Criminal authorities have in recent years also brought
cases in New York,\35\ New Mexico,\36\ Illinois,\37\ Ohio,\38\
Connecticut,\39\ and Florida,\40\ charging defendants with the same or
similar conduct. In addition, there are a growing number of reports
about pay to play activities involving investment advisers in other
jurisdictions.\41\ These cases involving investment advisers, as well
as others involving broker-dealers, may reflect more widespread
involvement by securities professionals in pay to play activities.\42\
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    \31\ See SEC v. Henry Morris, et al., Litigation Release No.
21036 (May 12, 2009).
    \32\ See id.
    \33\ See In the Matter of Kent D. Nelson, Investment Advisers
Act Release No. 2765 (Aug. 1, 2008); Initial Decision Release No.
371 (Feb. 24, 2009); Investment Advisers Act Release No. 2868 (Apr.
17, 2009) (in which investment adviser was barred from association
with any broker, dealer or investment adviser).
    \34\ 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). 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).
    \35\ 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).
    \36\ 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's
successor 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).
    \37\ See Jeff Coen et al., State's Ultimate Insider Indicted,
Chicago Tribune (Oct. 31, 2008) (describing the thirteenth
indictment in an Illinois pay to play probe).
    \38\ 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).
    \39\ 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.
filed Oct. 10, 2000) (the former treasurer, along with certain
others, pleaded guilty--while others were ultimately convicted).
    \40\ See 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 found liable 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).
    \41\ See, e.g., David Zahniser, California; Private Finances,
Public Role Intersect; Former Pension Board Member Had Consulted for
a Firm that Sought Work with the Panel on Which He Served, Los
Angeles Times (May 9, 2009) (discussing alleged pay to play
activities relating to a former member of the Los Angeles Fire and
Police Pensions Board); Rick Rothacker & David Ingram, Moore Defends
Pension System, Charlotte Observer (Feb. 25, 2007) (discussing
alleged pay to play activities involving North Carolina's State
treasurer); Len Boselovic, Pensions, Politics and Consultants Make
for Unsavory Bedfellows, Pittsburgh Post-Gazzette (Aug. 13, 2006)
and Jeffrey Cohan, Fund Managers `Pay to Play': Six Firms Managing
County's Pension Investments Gave to Board Members' Campaigns,
Pittsburgh Post-Gazzette (Feb. 22, 2001) (discussing alleged pay to
play activities relating to the Allegheny County Retirement Board);
Mary Williams Walsh, Political Money Said to Sway Pension
Investments, N.Y. Times (Feb. 10, 2004) (regarding a 2002 audit by
then-new controller of Luzerne County, Pennsylvania alleging pay to
play activities among various parties involved with county pension
funds).
    \42\ For example, we recently brought a case against the mayor
of Birmingham, Alabama, and other defendants, alleging that while
the mayor served as president of the County Commission of Jefferson
County, Alabama, he accepted undisclosed cash and benefits through a
lobbyist as a conduit from the chairman of a Montgomery, Alabama-
based broker-dealer, in return for awarding municipal bond business
and swap transactions to the broker-dealer. See SEC v. Larry P.
Langford et al., Litigation Release No. 20545 (Apr. 30, 2008).
Several years earlier, we brought an enforcement action against the
former treasurer of the City of Chicago, to whom two registered
representatives were alleged to have made secret cash payments to
obtain a share of the city's lucrative securities investments. See
SEC v. Miriam Santos et al., Litigation Release No. 17839 (Nov. 14,
2002); Litigation Release No. 19269 (June 14, 2005). We also brought
enforcement actions against the registered representatives allegedly
involved in the scheme. See SEC v. Miriam Santos, Peter J. Burns,
and Michael F. Hollendoner, Litigation Release Nos. 19270 and 19271
(June 14, 2005). In addition, we brought a case against a broker-
dealer, two of its officers and a city official for participating in
a scheme to defraud the City of Atlanta in connection with the
purchase and sale of certain securities while providing substantial,
undisclosed monetary benefits to the city's investment officer who
was authorized to select a broker-dealer for the transactions. See
In the Matter of Pryor, McClendon, Counts & Co., Inc. et al.,
Securities Act Release No. 7673 (Apr. 29, 1999); Securities Act
Release No. 8062 (Feb. 6, 2002); Exchange Act Release No. 48095
(June 26, 2003); Securities Act Release No. 8245 (June 26, 2003);
Securities Act Release No. 8246 (June 26, 2003).
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    Recognizing the harm pay to play practices cause in the management
of public funds, several States, counties, localities, and even
individual public pension funds, have undertaken to prohibit or
regulate these practices in recent years.\43\ And, most recently, in
response to pay to play scandals that have emerged in their
jurisdictions, public officials with oversight of public pension funds
have written to us expressing support for a Commission rule to prohibit
investment advisers from participating in pay to play practices,
including prohibiting the use by advisers of placement agents (or other
types of consultants) to help secure government business.\44\
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    \43\ For an example of a State statutory restriction on pay to
play activities, see Ill. Pub. Act 095-0971 (2008). For an example
of a restriction pursuant to a State constitutional amendment, see
Colo. Const. amend. LIV (2008). For an example of a county
restriction, see Resolution No. 08-397 (May 8, 2008) Special Pay to
Play Restrictions for Professional Service Contracts and
Extraordinary Unspecifiable Service Contracts, Monmouth County, NJ.
For an example of a city restriction, see Ordinance 3663 (July 2,
2007), Prohibition of Redevelopment with Certain Contributors,
Township of Franklin, NJ. For an example of a particular local
government agency restriction, see Cal. Pub. Util. Code Sec.
130051.20 (2008), Contributions to Authority Members, Los Angeles
County Metropolitan Transportation Authority. For an example of a
particular public pension fund restriction, see Prohibitions on
Campaign Contributions, California State Teachers' Retirement
System, 5 CCR Sec.  24010 (2009).
    \44\ See, e.g., Letter from New York City Comptroller William C.
Thompson, Jr., to Securities and Exchange Commission Chairman Mary
L. Schapiro, dated May 12, 2009, available at http://
www.comptroller.nyc.gov/press/pdfs/05-13-09_SEC-letter.pdf, at 2;
Letter from New York State Comptroller Thomas P. DiNapoli to
Securities and Exchange Commission Chairman Mary L. Schapiro, dated
May 7, 2009, available at http://www.osc.state.ny.us/press/releases/
may09/sec050709.pdf, at 1-2.
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    These developments indicate that investment advisers may be playing
an increasing role in pay to play activities. We therefore believe it
is time for us to act with respect to investment advisers who may
engage in such activities.\45\
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    \45\ Another reason we believe it is important for us to act is
because pay to play practices are characterized by what the Blount
court called a ``collective action problem [that tends] to make the
misallocation of resources persist.'' Blount, supra note 16 at 945-
46. Elected officials that accept contributions from State
contractors may believe they have an advantage over their opponents
that forswear the contributions, and firms that do not ``pay'' may
fear they will lose government business to those that do. See id.
See generally Mancur Olson, The Logic of Collective Action; Public
Goods and the Theory of Groups 44 (17th ed. 1998) (group members
that seek to maximize their individual personal welfare will not act
to advance common objectives absent coercion or other incentive).
See also Paul Jacobs, Donations to Pension Officials Scrutinized;
Politics: Connell, Fong Say They Are not Influenced by Contributions
from Firms Doing Business with State Systems, L.A. Times, Aug. 21,
1997, at A41 (fund contractor quoted as saying, ``[i]f you don't
contribute, you're subject to the concern that others might make
contributions'').

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    Section 206(1) of the Advisers Act prohibits an investment adviser
from ``employ[ing] any device, scheme, or artifice to defraud any
client or prospective client.'' \46\ Section 206(2) prohibits advisers
from engaging in ``any transaction, practice or course of business
which operates as a fraud or deceit on any client or prospective
client.'' \47\ The Supreme Court has construed section 206 as
establishing a Federal fiduciary standard governing the conduct of
advisers.\48\
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    \46\ 15 U.S.C. 80b-6(1).
    \47\ 15 U.S.C. 80b-6(2).
    \48\ 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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    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.\49\ In making such contributions, the adviser
hopes to benefit from officials that ``award the contracts on the basis
of benefit to their campaign chests rather than to the governmental
entity.'' \50\ If pay to play is a factor in the selection process, the
public pension plan can be harmed in several ways. The most qualified
adviser may not be selected, potentially leading to inferior
management, diminished returns or greater losses. 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 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.\51\
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    \49\ See 1999 Proposing Release, supra note 17, at 3. 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, 191-192; Release 1092, supra note 7. 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). Even if the conflict was
acknowledged and disclosed by the adviser, disclosure may not be
effective in protecting the plan from harm. Disclosure to the
trustee or board of trustees may be futile in protecting the plan
since the trustees may be similarly conflicted, having accepted the
contribution. Disclosure to beneficiaries may also be inadequate as
they may be unable to act on the disclosure--beneficiaries generally
cannot fire the adviser or find another pension plan.
    \50\ See Blount, supra note 16, at 944-45.
    \51\ 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).
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    We believe that play 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.'' \52\ Congress
gave us this authority to prohibit ``specific evils'' that the broad
anti-fraud provisions may be incapable of covering.\53\ The provision
thus permits the Commission to adopt prophylactic rules that may
prohibit acts that are not themselves fraudulent.\54\ As noted above,
pay to play practices are rarely explicit and often hard to prove,
which makes a prophylactic rule particularly appropriate.\55\ We are
today proposing new rule 206(4)-5 under the Advisers Act designed to
eliminate adviser participation in pay to play practices.
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    \52\ 15 U.S.C. 80b-6(4).
    \53\ 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 the adviser's financial
condition and disciplinary history, 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.
    \54\ Section 206(4) was added to the Advisers Act in Public Law
86-750, 74 Stat. 885 (1960) at sec. 9. See H.R. Rep. No. 2197, 86th
Cong., 2d Sess. (1960) at 7-8 (``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. (1960) at 8 (``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, at 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.'').
    \55\ Cf. Blount, supra note 16 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'').
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II. Discussion

A. Rule 206(4)-5: ``Pay To Play'' Restrictions

    The rule we are proposing today is designed to protect public
pension plans from the consequences of pay to play practices by
preventing advisers' participation in such practices. As a result,
advisers and government officials may attempt to structure their
transactions in a manner intended to hide the true purpose of a
contribution or a payment. For that reason, our proposed pay to play
restrictions would 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 would accomplish this through three
measures. First, the rule would make 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 that is in a position to influence the award of
advisory business.\56\

Proposed rule 206(4)-5 would not, therefore, 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. This aspect of the proposed rule is modeled on
MSRB rule G-37 and is consistent with our 1999 proposal.
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    \56\ Proposed rule 206(4)-5(a)(1) states: ``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).''
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    Second, the rule would prohibit advisers from paying third parties
to solicit government entities for advisory business.\57\ That is, an
adviser would be prohibited from providing or agreeing to provide,
directly or indirectly, payment to any person who is not a related
person of the adviser for solicitation of government advisory business
on behalf of such adviser. This aspect of our proposed rule is modeled
on MSRB rule G-38.\58\ Third, the rule would also make it unlawful for
an adviser itself or through any of its covered associates to solicit
or to coordinate contributions for an official of a government entity
to which the investment adviser is seeking to provide investment
advisory services, or 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. MSRB rule
G-37 contains a similar prohibition, as did our 1999 proposal.\59\
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    \57\ Proposed rule 206(4)-5(a)(2)(i).
    \58\ MSRB rule G-38 was amended in 2005 to prohibit municipal
securities dealers from paying third-party solicitors to solicit
municipal securities business. In the Matter of Self-Regulatory
Organizations; Municipal Securities Rulemaking Board; Order
Approving Proposed Rule Change and Notice of Filing and Order
Granting Accelerated Approval to Amendment No. 1 to the Proposed
Rule Change Relating to Solicitation of Municipal Securities
Business under MSRB Rule G-38, Exchange Act Release No. 52278 (Aug.
17, 2005) [70 FR 49342 (Aug. 23, 2005)]. Our 1999 proposal did not
include an analogous prohibition.
    \59\ See MSRB rule G-37(c); 1999 Proposing Release, supra note
17, at section II.A.2.
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    We recognize that we cannot anticipate all of the ways advisers and
government officials may structure pay to play arrangements to attempt
to evade the prohibitions of our proposed rule. For that reason, we are
also proposing to include a provision that would make 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 proposed
rule. Finally, for purposes of the proposed rule, an investment adviser
to certain pooled investment vehicles in which a government entity
invests or is solicited to invest would be treated as though the
adviser were providing or seeking to provide investment advisory
services directly to the government entity.
    Although today's proposal is similar to the one we made in 1999, we
are proposing a few critical changes in response to intervening
developments that we highlight in the discussion below. We have made
these changes to conform our proposal to measures undertaken in recent
years to curtail pay to play activities by the MSRB and various State
and local authorities and to deter circumvention of the restrictions
through the use of third-party placement agents or through an adviser
obtaining government clients indirectly by soliciting investment in
funds it manages.
1. Advisers Subject to the Rule
    Proposed rule 206(4)-5 would apply 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)].\60\ 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.\61\ The rule would not apply, however, to most small advisers that
are registered with the State securities authorities,\62\ and certain
other advisers that are exempt from registration with us.\63\ We
believe that the rule would apply to most advisers to public pension
plans.\64\ We request comment on the scope of the proposed rule. Should
we apply the rule to State-registered advisers? Should we limit the
rule only to advisers registered (or required to be registered) with
us? Should we apply the rule to advisers that are exempt from
registration in reliance on Advisers Act section 203(b)(3)? We request
comment on whether we should extend the scope of the rule to apply to
advisers exempt from registering with us pursuant to any or all of the
other categories under Advisers Act section 203(b). For example, should
we include advisers exempt from registration pursuant to any or all of
Advisers Act sections 203(b)(1) (intrastate advisers), 203(b)(2)
(advisers with only insurance company clients), 203(b)(4) (investments
advisers that are charitable organizations), 203(b)(5) (advisers that
are plans described in section 414(e) of the Internal Revenue Code of
1986 or certain persons associated with such plans), or 203(b)(6)
(certain commodity trading advisors)? \65\ To the extent that they are
able to have government clients at all, are any of these advisers
likely to engage in pay to play?
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    \60\ Proposed 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.
    \61\ See discussion infra section II.A.3(e).
    \62\ Section 203A of the Advisers Act [15 U.S.C. 80b-3A]
prohibits investment advisers with less than $25 million in assets
under management from registering with the Commission; although we
do not propose to include them within the coverage of this rule,
they remain subject to the Act's general anti-fraud authority. See,
e.g., Rules Implementing Amendments to the Investment Advisers Act
of 1940, Investment Advisers Act Release No. 1633, n.154 and
accompanying text (May 15, 1997) [62 FR 28112 (May 22, 1997)]
(``Both the Commission and the States will be able to continue
bringing antifraud actions against investment advisers regardless of
whether the investment adviser is registered with the State or the
SEC.''). See also S. Rep. No. 293, 104th Cong., 2d Sess. 3-4 (1996)
(``1996 Senate Report'') at 4.
    \63\ See, e.g, exemption for intrastate investment advisers
under section 203(b)(1) [15 U.S.C. 80b-3(b)(1)].
    \64\ With the exception of the exemption from registration
provided for by section 203(b)(3) [15 U.S.C. 80b-3(b)(3)], advisers
that are exempt from SEC registration are unlikely to have State or
municipal government clients as providing advisory services to them
would result in the adviser no longer being eligible for the
exemption, e.g., section 203(b)(2) [15 U.S.C. 80b-3(b)(2)] and
section 203(b)(4) [15 U.S.C. 80b-3(b)(4)]. Moreover, based on a
review of a sampling of requests for proposals from State and
municipal governments for investment advisory services, a common
requirement is that the adviser be registered with the SEC or a
State. See, e.g., Request for Information Vermont Pension Investment
Committee--Vermont Manager Program RFI (Feb. 27, 2009) (stating that
eligible investment advisers must be SEC-registered with at least
$100 million in assets under management), available at: http://
www.vermonttreasurer.gov/documents/rfp/20090316_
VPICVermontManagerProgram.pdf. It also is our understanding from
discussions with representatives of the State securities regulators
that a very small percentage of State-registered advisers have State
or municipal government clients.
    \65\ Our 1999 proposed rule would have applied to all investment
advisers not prohibited from registering with the Commission. See
1999 Proposing Release, supra note 17.
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    We note that proposed rule 206(4)-5 would regulate the activities
of investment advisers--business organizations over which we have clear
regulatory authority under the Advisers Act. The rule would have no
effect on State laws, codes of ethics or other rules governing the
activities of State and municipal officials or employees of

public pension plans over whom we have no regulatory jurisdiction.\66\
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    \66\ A number of commenters in 1999, including those
representing State and local officials, argued that the rule would
be an intrusion on State sovereignty. We disagree. We have a
responsibility to regulate the activities of investment advisers.
Our objectives in the proposed rule do not relate to campaign
finance, but rather to prohibiting fraudulent activity by investment
advisers. We believe our proposed rule is appropriately tailored to
those ends.
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2. Relationship With MSRB Rules; Alternative Approaches
    As discussed above, we modeled proposed rule 206(4)-5 on MSRB rules
G-37 and G-38, which we believe have successfully addressed pay to play
in the municipal bond market. This approach should minimize the
compliance burdens on firms that would be subject to both rule regimes
because firms that are already subject to MSRB rules would already have
developed policies and systems for compliance that could be adapted to
meet investment adviser requirements. Certain provisions of our
proposed rule, however, are somewhat different in ways that reflect the
different statutory framework under which the rule would be adopted and
the differences between municipal underwriting and asset management.
Comment is requested on whether we should use rules G-37 and G-38 as
the models for proposed rule 206(4)-5.\67\ If not, are there
alternative models that would be more appropriate? Are there
significant differences in governments' selection process for municipal
underwriters and investment advisers that we have not addressed but
that should be reflected in the rule? Would our approach adequately
protect public pension plans, their sponsors and participants against
the adverse effects of pay to play practices?
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    \67\ For instance, in 1999, we requested comment on our use of
MSRB rule G-37 as a model, and several commenters responded that,
because of distinctions between the investment adviser profession
and the municipal securities industry, we should not follow the
approach of MSRB rule G-37. Some commenters asserted that, unlike
municipal underwriters, advisers' business relationships with State
and municipal clients are ongoing and long-term and thus the two-
year ban is much more harsh a consequence. While municipal
underwritings themselves tend to be episodic, underwriting
relationships are often longstanding. As a result, the rules' time
outs may have similar effects.
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    We understand many advisers have established restrictions on pay to
play practices in their codes of ethics and compliance policies.
Instead of, or in addition to, adopting a new rule to address pay to
play practices, should we amend our code of ethics rule \68\ or our
compliance rule \69\ to require all registered advisers to adopt
policies and procedures designed to prevent them from engaging in pay
to play practices? \70\ Should we instead, or also, require an
executive officer of each adviser to certify annually that the adviser
or its covered associates did not participate in pay to play? Should
some other employee of the adviser, such as the chief compliance
officer, make the certification?
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    \68\ Rule 204A-1 under the Advisers Act [17 CFR 275.204A-1].
    \69\ Rule 206(4)-7 under the Advisers Act [17 CFR 275.206(4)-7].
    \70\ Some commenters in 1999 suggested that the better approach
would be to require advisers to adopt codes of ethics designed to
prevent pay to play practices. The Investment Counsel Association of
America (subsequently renamed the Investment Advisers Association)
submitted to the comment file relating to our 1999 proposal ``Best
Practice Pay-to-Play Guidelines for Adviser Codes of Ethics,''
advocating such an approach as an alternative to our 1999 proposal.
See http://www.sec.gov/rules/proposed/s71999/tittswo2.htm. The ICAA
offered the following three alternative policies on political
contributions, and suggested that advisers should tailor these
policies to fit their respective circumstances: (1) A contribution
ban above a certain de minimis amount (either with respect to all
political contributions or ones that fall within certain specified
parameters); (2) a pre-clearance process for contributions; or (3) a
disclosure policy with respect to contributions. At that time, codes
of ethics were voluntary. However, in 2004, the Commission adopted a
requirement that advisers adopt and implement codes of ethics that
include a standard of conduct that reflects the adviser's fiduciary
obligations, although the code of ethics rule does not directly
address pay to play practices. See Advisers Act rule 204A-1 [17 CFR
275.204A-1]; Investment Adviser Codes of Ethics, Investment Advisers
Act Release No. 2256 (July 2, 2004) [69 FR 41696 (July 9, 2004)].
See also Investment Counsel Association of America, Report on Pay-
to-Play and the Investment Advisory Profession (May 15, 2000),
available at http://www.investmentadviser.org/eweb/docs/
Publications_News/PublicDocs_UsefulWebsites/PubDoc/report
(condemning practices by which investment professionals try to gain
access to business through political contributions, and urging its
members to adopt codes of ethics designed to prevent pay to play).
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    In 1999, we considered proposing a different approach to address
pay to play, which would have required an adviser to disclose
information about its political contributions to officials of
government entities to which it provided or was seeking to provide
investment advisory services. We decided not to propose such an
approach at that time because we thought that disclosure would not be
effective to protect public pension plan clients.\71\ Disclosure to a
pension plan's trustees might be insufficient because, in some cases,
the trustees would have received the contributions. Disclosure to plan
beneficiaries also would likely be insufficient because they are
generally unable to act on the information by moving their pension
assets to a different plan or reversing adviser hiring decisions.
Moreover, disclosure requirements may not stop pay to play practices
and can be circumvented.\72\ Accordingly, we do not believe that
relying on disclosure is sufficient to address these problematic
practices.\73\ We request comment on whether we should, nonetheless,
consider this approach, as well as potential alternative approaches
that may be more effective or less costly.
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    \71\ In response to our 1999 Proposal, some commenters suggested
requiring advisers to disclose publicly their contributions to State
and local officials. Statutes requiring disclosure of political
contributions are 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. But, as several
other commenters correctly pointed out, our goal is not campaign
finance reform, and how voters might react to such disclosure is
not, for us, the relevant concern. Our primary concern is the
protection of advisory clients and investors who are affected by pay
to play practices whom we have the responsibility to protect under
the Advisers Act.
    \72\ See infra note 158 and accompanying text regarding swap
arrangements that may be used to circumvent public disclosure.
    \73\ MSRB rule G-37, however, does establish a reporting and
disclosure system for broker-dealers subject to that rule. MSRB rule
G-37(e)(ii).
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3. Pay To Play Restrictions
(a) Two-Year ``Time Out'' for Contributors
    Proposed rule 206(4)-5(a)(1) would prohibit investment advisers
from providing advice for compensation to a ``government entity'' \74\
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.'' \75\ We are proposing that the time out be
two years long because the duration needs to be sufficiently long to
have a deterrent effect. We recognize, however, that a longer ban could
be overly harsh.\76\ We note that MSRB rule G-37 contains a two-year
time out, which appears, based on the success of the MSRB rules, to
have operated as an effective deterrent

in the municipal securities context.\77\ We request comment on whether
two years is an appropriate length of time.\78\
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    \74\ ``Government entity'' is defined by the proposed rule as
``any State or political subdivision of a State, including any
agency, authority, or instrumentality of the State or political
subdivision, a plan, program, or pool of assets sponsored or
established by the State or political subdivision or any agency,
authority or instrumentality thereof; and officers, agents, or
employees of the State or political subdivision or any agency,
authority or instrumentality thereof, acting in their official
capacity.'' Proposed rule 206(4)-5(f)(5).
    \75\ Proposed rule 206(4)-5(a)(1).
    \76\ We note that, notwithstanding the proposed duration of the
rule's ``time out''--two years--the reach of the time out is
relatively narrow in the sense that it only prohibits advisers from
receiving compensation for providing advice from the particular
government entities to whose officials triggering contributions have
been made. It does not limit the adviser from receiving compensation
from other government entities as to which triggering contributions
have not been made.
    \77\ See supra note 24. Several commenters in 1999 suggested
that, because advisers' business relationships with State and
municipal clients are ongoing and long-term, as compared to the
relationships between municipal underwriters and their clients, the
two-year ban is much more harsh a consequence. As we note above,
while municipal underwritings themselves tend to be episodic,
underwriting relationships are often longstanding, which may result
in the rules' time outs having similar effects. See supra note 67.
    \78\ Some commenters in 1999 objected to two years as being too
long a period of time (arguing, for example, that because changing
investment advisers can be so disruptive to a pension fund that such
a fund would be extremely unlikely to return to an adviser after a
``time out,'' thereby rendering the two-year ban tantamount to a
permanent one), whereas others suggested that the period be longer
or that it track the remainder of the term of the government
official to whom the contribution was made.
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(1) Prohibition on Compensation
    Investment advisers making contributions covered by the proposed
rule would not be prohibited from providing advisory services to a
government client, even after triggering the two-year time out.
Instead, an adviser would be prohibited from receiving compensation for
providing advisory services to the government client during the time
out. This approach is intended to avoid requiring an adviser to abandon
a government client after the adviser or any of its covered associates
makes a political contribution covered by the rule. An adviser subject
to the prohibition would likely, at a minimum, be obligated to provide
(uncompensated) advisory services for a reasonable period of time \79\
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.\80\ We request
comment on our proposed approach. Is there another approach that would
cause less disruption to the government client?
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    \79\ Some commenters in 1999 indicated concern that government
entities that retain advisers who trigger the two-year time out--and
would therefore be unable to receive compensation for two years--
might try to delay an adviser's ability to withdraw in order to
enjoy the benefits of investment advice for free. We believe that
while an adviser's fiduciary obligations require it to act in the
best interests of its clients, they do not require it to provide
uncompensated advice indefinitely because it is prohibited from
receiving compensation under the rule--rather, the adviser may need
to continue to provide advice for only a reasonable period of time.
    \80\ An investment adviser that violates the rule may be
required, under its fiduciary duties, to continue providing advisory
services to the public pension plan, for a reasonable period of
time, until the plan obtains a new adviser. See Temporary Exemption
for Certain Investment Advisers, Investment Advisers Act Release No.
1846 (Nov. 29, 1999) [64 FR 68019, 68024 (Dec. 6, 1999)] (describing
an investment adviser's fiduciary duties to an investment company in
the case of an assignment of the advisory contract).
    We note that the two-year time out in MSRB rule G-37 operates to
prohibit a broker, dealer or municipal securities dealer from
engaging in all municipal securities business; it does not
distinguish between providing compensated and uncompensated
services. MSRB Rule G-37(b)(i). See also MSRB Rule G-37 Interpretive
Notices, Interpretation of Prohibition on Municipal Securities
Business Pursuant to Rule G-37 (Feb. 21, 1997) (determining that
once a dealer enters into contract and a subsequent contribution
results in a prohibition, the dealer ``should not be allowed to
continue with the municipal securities business, subject to an
orderly transition to another entity to perform such business'').
But see infra note 189 (discussing MSRB's approach to transitions in
the context of pre-existing engagements relating to municipal fund
securities, such as interests in Section 529 plans).
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(2) Officials of a Government Entity
    The prohibitions in the rule would be triggered by a contribution
to an ``official'' of a ``government entity.'' Government entities
under the proposed rule include all State and local governments, their
agencies and instrumentalities, and all public pension plans and other
collective government funds.\81\ An official would include 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 selection 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
selection of an investment adviser.\82\ Generally, executive or
legislative officers who hold a position with influence over the hiring
of an investment adviser are government officials under the proposed
rule.\83\ These definitions are substantively the same as those in MSRB
rule G-37.\84\
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    \81\ See supra note 74.
    \82\ Proposed rule 206(4)-5(f)(6). The two-year time out would
be triggered by contributions, not only to elected officials who
have legal authority to hire or select the adviser, but to elected
officials (such as persons with appointment authority) who can
influence the hiring of the adviser. A person who serves at the will
of an elected official is likely to be subject to that official's
influences and recommendations. We note that MSRB rule G-37 also
applies to elected officials empowered to appoint persons with the
authority to select which broker-dealers will receive government
business.
    \83\ 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.
    \84\ See MSRB rule G-37(g)(ii) and (g)(vi).
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    We request comment on our proposed definition of ``official.'' For
instance, a candidate for Federal office may be an ``official'' under
the rule, just as such a person may be under MSRB rule G-37, not
because of the office he or she is running for, but as a result of an
office he or she currently holds.\85\ As a preliminary matter, we do
not believe that an incumbent State or local official should be
excluded from the definition solely because he or she is running for
Federal office, but we request comment on this aspect of the proposed
rule. Should such a candidate for Federal office be excluded? \86\ Are
there other persons to whom an adviser or its covered associates might
make a contribution to influence the selection of that adviser? For
example, should we expand the rule's prohibitions to apply expressly in
cases where an adviser or a covered associate gives a contribution to
others closely associated with the official--such as an official's
political action committee (``PAC''), his or her inauguration or
transition committee,\87\ a local or State political party that
provides assistance to such official,\88\ or

a foundation or other charitable institution associated with such
official? \89\
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    \85\ Proposed rule 206(4)-5(f)(6), in relevant part, defines
``official'' as any person * * * who was, at the time of the
contribution, an incumbent, candidate or successful candidate for
elective office of a government entity * * *, '' and a ``government
entity,'' in relevant part, as ``any State or political subdivision
of a State'' (emphasis added). Accordingly, any person, including a
person running for Federal office, who meets the definition of
``official'' would be covered under the rule. See also MSRB rule G-
37(g)(ii) and (g)(vi) (defining ``issuer'' and ``official of an
issuer'', respectively); MSRB Qs & As, Question IV.2 and IV.3,
available at http://www.msrb.org/msrb1/rules/QAG-372003.htm
(explaining how G-37 applies to candidates for Federal office).
    \86\ Some 1999 commenters urged that contributions to candidates
for Federal office be excluded from the rule, while others agreed
these contributions should be covered. In particular, certain
commenters asserted that this aspect of the proposed rule would have
a disparate effect on candidates for Federal office because State
and local politicians would experience limitations on their ability
to receive Federal campaign contributions while their opponents
would be subject to no such limitations. These commenters also
claimed the rule would have little effect because if the candidate
for Federal office was successful, he or she would quickly lose his
or her ability to influence the selection of an investment adviser
at the State or local level. Other commenters thought it appropriate
that the rule apply to candidates for Federal office. As noted
above, our emphasis in the proposed rule remains on the current
office of an elected official and his or her ability to affect the
selection of an investment adviser, regardless of what outside
positions that official may seek.
    \87\ A contribution to an official, as opposed to a committee,
for inauguration or transition expenses would be a contribution
under the proposed rule. See infra note 93 and accompanying text.
This approach is consistent with the approach in MSRB rule G-37. We
are proposing a similar approach for reasons of regulatory
consistency; nonetheless, we have included this request for comment
on whether we should include contributions to such committees.
    \88\ Under the proposed rule, such contributions or payments by
an adviser (or its covered associates) would only trigger the rule's
provisions to the extent that an adviser was trying to do indirectly
what it is prohibited from doing directly. See infra section
II.A.3(d) of this Release. In contrast, the prohibition on advisers
soliciting contributions or payments from others in proposed rule
206(4)-5(a)(2)(ii) would expressly include 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. See infra section II.A.3(c) of this Release.
Further, our proposed amendments to rule 204-2 (in particular, rule
204-2(a)(18)(i)(D)) would expressly include a requirement that an
adviser subject to the rule make and keep records of, among other
things, all direct or indirect contributions or payments made by the
investment adviser or any of its covered associates to a political
party of a State or political subdivision thereof. Our proposed
approach to these provisions generally tracks the MSRB approach.
    \89\ For a discussion of associated recordkeeping requirements,
see infra note 206 and accompanying text.
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(3) Contributions
    The proposed rule covers ``contributions'' made by an investment
adviser and its covered associates. The proposed rule uses the same
definition of contribution as MSRB rule G-37.\90\ A contribution would
generally be any gift, subscription, loan, advance, deposit of money,
or anything of value \91\ 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.\92\ It would also include
transition or inaugural expenses incurred by a successful candidate for
State or local office.\93\ We request comment on our proposed
definition of ``contribution.'' \94\ Are there additional items of
value that, as with transitional or inaugural expenses, should be
specified in and covered by the definition? For instance, should we
include the expenses an investment adviser would incur in organizing or
sponsoring a conference at which a government official is invited to
attend or is a speaker? \95\ If so, how should our rule distinguish
legitimate conferences or meetings from those that are more akin to
fundraising events? \96\ Are there items that should be excluded from
the definition?
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    \90\ MSRB rule G-37(g)(i).
    \91\ Commenters to our 1999 proposal raised concerns that
volunteer campaign work by advisory employees could trigger the
proposed rule's time out provision. We would not consider volunteer
campaign work 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, are not used. Cf. MSRB Qs & As,
Question II.12, available at http://www.msrb.org/msrb1/rules/QAG-
372003.htm.
    \92\ Proposed rule 206(4)-5(f)(1). Commenters in 1999 expressed
concern that the scope of our proposed rule was too broad. These
commenters, many of whom represented investment advisers, raised
concerns that the rule as proposed could unnecessarily restrict
their employees from making any political contributions. Some
commenters questioned the constitutionality of our proposal, arguing
that the proposed rule would violate First Amendment protections for
free speech. In Blount, supra note 16, a Federal appeals court
upheld a First Amendment challenge to MSRB rule G-37. The Court left
open the question of the appropriate level of scrutiny to be
applied, but concluded that the rule satisfied even a strict
scrutiny test. We believe that the rule we are proposing today
similarly is consistent with the First Amendment. Absent provisions
to limit the application of the rule's prohibitions, it could result
in frequent inadvertent violations that would carry harsh
consequences for advisers. Accordingly, we refined the categories of
persons whose personal political contributions would be covered
under the rule and provided for a self-executing exception that
should prevent many inadvertent violations. We believe these changes
will address many of the commenters' concerns about the rule we
proposed in 1999.
    \93\ Proposed rule 206(4)-5(f)(1)(iii). Transition or inaugural
expenses of a successful candidate for Federal office are not
included. Contributions to political parties are not specifically
covered by the definition and thus would not trigger the proposed
rule's two-year timeout unless they are a means to do indirectly
what the proposed rule would prohibit if done directly (for example,
the contributions are earmarked or known to be provided for the
benefit of a particular political official). See proposed rule
206(4)-5(d). Contributions to State and local political parties are,
however, subject to the proposed rule's recordkeeping requirements.
See infra section II.B and proposed rule 204-2(a)(18)(i)(D).
    \94\ Commenters in 1999 urged us to adopt a rule prohibiting
only political contributions intended to influence, or made for the
purpose of influencing, adviser selection. This approach, they
argued, would eliminate the risk that innocent campaign
contributions would trigger application of the ``two-year time
out.'' Political contributions are made ostensibly to support a
candidate, however, and the burden of proving a different intent is
very difficult absent unusual evidence. As one court noted, ``actors
in this field are presumably shrewd enough to structure their
relations rather indirectly.'' Blount, supra note 16. As a result,
requiring proof of such an intent would greatly diminish, if not
eliminate, the prophylactic value of the proposed rule.
    \95\ Under the proposed rule, an adviser would be prohibited
from soliciting contributions for the official. Proposed rule
206(4)-5(a)(2)(ii).
    \96\ Cf. 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 of this nature in
its rules directly, the MSRB applies a facts-and-circumstances test
on a case-by-case basis).
---------------------------------------------------------------------------

(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. For this reason, MSRB rule G-37 limits its
prohibitions to contributions made by ``municipal finance
professionals'' employed by a broker-dealer. No group analogous to
municipal finance professionals, however, exists within the typical
investment advisory firm. In many of the pay to play enforcement
actions we have brought involving investment advisers, we have alleged
that political contributions or other payments were made to influence
the selection of the advisory firm by executives of the adviser or
persons who solicit government clients on behalf of the adviser.\97\ We
therefore are proposing to limit application of the rule's ``time out''
provision to contributions made by the adviser and its ``covered
associates,'' which would include the adviser's general partners,
managing members, executive officers, or other individual with a
similar status or function.\98\ Any employee of the

adviser who solicits \99\ government entity clients for the investment
adviser would also be a covered associate,\100\ as would any PAC
controlled by the investment adviser or any of the adviser's covered
associates.\101\
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    \97\ See, e.g., In the Matter of Barrett N. Wissman, Investment
Advisers Act Release No. 2879 (May 22, 2009) (in a settled action,
the Commission alleged that managing director of registered
investment adviser engaged in a fraudulent scheme involving
undisclosed kickback payments made by investment management firms
and others in connection with the sale of securities to the New York
Common Retirement Fund and the investment of the fund's assets in
the purchase and sale of securities); 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 a settled action, the
Commission alleged that unregistered adviser, through its chairman,
agreed to hire an inexperienced associate of the Connecticut
Treasurer as a consultant as a condition to securing a State pension
fund investment); In the Matter of Frederick W. McCarthy, Investment
Advisers Act Release No. 2218 (Mar. 5, 2004) (in a settled action,
the Commission alleged that principal and chairman of investment
management firm provided $2 million in consulting contracts to
associates of the Connecticut Treasurer in order to secure the
Treasurer's decision to invest). We have also observed this pattern
of contributions in pay to play arrangements in other contexts,
including those involving union pension funds. See, e.g., In the
Matter of William M. Stephens, Investment Advisers Act Release No.
2076 (Nov. 4, 2002) (in a settled action, the Commission alleged
that executive vice president and chief investment strategist of
registered investment adviser met with people who offered to
introduce him to the trustees of union pension funds, and he agreed
that after he and his firm became the funds' adviser, he would
arrange to divert a portion of the funds into investments controlled
by the people who made the introductions, who would, in turn, pay
kickbacks to the pension fund trustees who hired him and his firm);
In the Matter of Chris Woessner, Investment Advisers Act Release No.
2164 (Aug. 26, 2003) (Commission alleged that former vice president
of sales at registered investment adviser who was in charge of
marketing to pension plans caused his firm to direct client
commissions for the benefit of a broker-dealer and pension
consultant in exchange for the referral of a union pension fund
client to the firm).
    \98\ Proposed rule 206(4)-5(f)(2)(i). Under our 1999 proposal,
the rule would have applied more broadly to ``partners'' (not just a
general partner or equivalent) and ``executive officers'' (which we
proposed to define as ``the president, any vice president in charge
of a principal business unit, division or function (such as sales,
administration or finance), any other officer who performs a policy-
making function, or any other person who performs similar policy-
making functions, for the investment adviser''). See 1999 Proposing
Release, supra note 17, at section II.A.1. Commenters in 1999
suggested that, instead of applying the rule to all partners, we
narrow the rule to apply only to a firm's general partner (or
equivalent) and other owners that have a significant ownership
interest in the firm. Commenters also suggested that we either
exclude executive officers of divisions unrelated to the firm's
solicitation and/or advisory functions or limit the rule's
application to only the most senior officers of an adviser, such as
persons required to be listed on Schedule A of Form ADV. In light of
these comments, we have included in our proposed definition of
``covered associates'' only those persons associated with an
investment adviser who we believe are more likely to have an
economic incentive to make contributions to influence the advisory
firm's selection and who we have found, in our enforcement actions,
typically make contributions.
    \99\ See proposed rule 206(4)-5(f)(10) (defining ``solicit'').
    \100\ Proposed rule 206(4)-5(f)(2)(ii). Several commenters in
1999 argued that we would have included too broad a category of
solicitors because our definition of ``solicitor'' would have
included any person who solicited any client for or referred any
client to the adviser. The two-year time out would have been
triggered, for example, by registered representatives who solicited
brokerage business for a firm dually registered as a broker-dealer
and as an adviser, even though the registered representatives had no
involvement with government clients. See 1999 Proposing Release,
supra note 17, at section II.A.1. We have included a narrower
category of solicitors in our current proposed rule; the two-year
time out provisions would be triggered by a contribution by a person
who solicits government entities for advisory services. Many
commenters also urged that the definition of ``solicitor'' exclude
third-party solicitors. They asserted that it was unfair to hold
advisers responsible for the actions of these solicitors, arguing
that the advisers did not control their activities. We have excluded
third-party solicitors from this two-year time out provision;
instead we are proposing to prohibit advisers from soliciting
government business through third parties, as discussed in detail in
section II.A.3(b) of this Release.
    \101\ Proposed rule 206(4)-5(f)(2)(iii). Our 1999 proposal would
also have included PACs controlled by the investment adviser and the
individuals associated with the investment adviser whose
contributions would have triggered the ``time out.'' See 1999
Proposing Release, supra note 17, at section II.A.1. We have
proposed to include PACs because these vehicles, which may be
regulated by State and/or Federal election law, are often used by
corporations, interest groups, or others to make political
contributions. See, e.g., Tennessee Registry of Election Finance,
PACs FAQ, available at http://www.state.tn.us/tref/pacs/pacs_
faq.htm; Federal Election Commission, Quick Answers to PAC
Questions, available at http://www.fec.gov/ans/answers_pac.shtml.
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    Under the proposed rule, the term ``executive officer'' includes
the adviser's president and any vice president in charge of a principal
business unit, division or function (such as sales, administration or
finance) or any other executive officer who, in each case, in
connection with his or her regular duties: (i) Performs investment
advisory services (or supervises someone who performs them) for an
adviser; (ii) solicits (or supervises someone who solicits) for an
adviser, including with respect to investors for a covered investment
pool; \102\ or (iii) supervises, directly or indirectly, executive
officers described in (i) or (ii).\103\ Accordingly, for instance, the
proposed rule would cover contributions by a portfolio manager who is
an executive officer, as well as contributions by anyone in the
portfolio manager's chain of supervision up to and including the
president of the adviser. The rule would also cover contributions by an
executive officer who supervises personnel who solicit advisory clients
and contributions by anyone in that executive's chain of supervision.
The rule would not, however, cover contributions by the adviser's other
executives, such as its comptroller, its head of human resources, or
its director of information services, unless the contribution is an
indirect contribution for the adviser, because the compensation of
these individuals is likely to be tied less directly to obtaining or
retaining clients.
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    \102\ See discussion of covered investment pools, infra, section
II.A.3(e).
    \103\ Proposed rule 206(4)-5(f)(4). Our proposed definition of
``executive officer'' in rule 206(4)-5(f)(4) is based on the same
considerations as a similar definition in Advisers Act rule 205-3
[17 CFR 275.205-3]. Whether a person is an executive officer depends
on his or her function, not title; a chief executive officer whose
title does not include ``president'' is clearly an executive
officer.
---------------------------------------------------------------------------

    Contributions by non-executive employees (other than those who
solicit government entity clients) would not trigger the rule's
prohibitions, unless the adviser or any of its covered associates used
the person to indirectly make a contribution.\104\ This could occur,
for example, if a firm paid a non-executive employee a bonus with the
understanding that the bonus would be used by the employee to make a
political contribution that, if made by the firm, would trigger the
rule's prohibition.\105\
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    \104\ Proposed rule 206(4)-5(d).
    \105\ See id. See also discussion of indirect contributions,
infra section II.A.3(c).
---------------------------------------------------------------------------

    As noted above, the Commission has drafted the proposed rule so
that its prohibitions are triggered by political contributions by
persons who, in the context of an advisory firm, are likely to have an
economic incentive to make contributions to influence the advisory
firm's selection and the categories of executives and employees of an
adviser that we have seen, most typically, to make political
contributions and payments in pay to play situations. We are mindful of
the burdens the proposed rule would place on advisory firms and on the
ability of persons associated with an adviser to participate in civic
affairs. We thus have narrowly tailored the rule to achieve our goal of
preventing adviser participation in pay to play practices.
    We request comment on the scope of the proposed rule and, in
particular, those persons associated with the advisers whose political
contributions would trigger the application of the two-year ``time
out'' and would be prohibited from soliciting political contributions
from others. Have we included persons most likely to have an economic
incentive to make political contributions for the purpose of
influencing the selection of the adviser?
    Have we covered too many persons? If so, how should we narrow the
rule? For example, are there certain executive officers of the adviser
we should not include? The proposed rule would cover all executive
officers who, as part of their regular duties, perform investment
advisory services or supervise someone who performs them. Should we
instead limit the scope to a subset of such officers? If so, how should
we define that subset? \106\ Should we extend the rule to cover all
portfolio managers, or just those portfolio managers responsible for
managing government client assets? Are there other types of employees
whose contributions should trigger the time out?
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    \106\ Many 1999 commenters argued that our proposal included too
many persons whose activities are unconnected to managing public
pension money, making it too likely that an innocent political
contribution would trigger a two-year time out. We considered these
comments in narrowing the scope of persons covered by our current
proposed rule, as described above.
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    Have we too narrowly drawn the rule to achieve our goals? Should
we, for example, include employees of companies that are related
persons of an adviser who solicit government entity clients for the
investment adviser? As discussed further below, we propose permitting
payments to these persons under the proposed ban on payments to third
parties because we recognize that an adviser may rely on them to assist
it in seeking government clients.\107\ Would that same rationale
support including them as ``covered associates'' of the adviser (whose
contributions would be subject the proposed rule's two-year time out
provision)? Would not including them be likely to encourage
circumvention of the rule's requirements? \108\ We also request comment
on whether we should, for example, include certain family members who,
and related businesses that, might give political contributions on the
adviser's behalf to try to

influence officials of government entities? \109\ Under the proposed
rule, political contributions by such persons would only result in a
violation under the rule if the adviser or its covered associates were
acting through them to do indirectly what they cannot do directly under
the rule.\110\ MSRB rule G-37 addresses this matter similarly. Should
we include beneficial owners of the adviser because they have a direct
economic stake in the adviser's business relationship with the
government client? If so, should the definition include all owners, or
only those with a significant ownership stake in an adviser, such as
those who have contributed (or that have the right to receive upon
dissolution) ten percent or more of the company's capital?
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    \107\ See discussion at section II.A.3(b), infra .
    \108\ See proposed rule 206(4)-5(d), however.
    \109\ See, e.g., Martin Z. Braun et al., A Political Family
Affair?, The Bond Buyer (Oct. 21, 2002) (noting that spouses of
municipal finance professionals in dealer firms are making campaign
contributions to issuer officials who can influence the award of
bond business).
    \110\ Paragraph (d) of proposed rule 206(4)-5. See section
II.A.3(d) of this Release.
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(5) ``Look Back''
    Under the proposed rule, the two-year time out would continue in
effect after the covered associate who made the triggering contribution
left the advisory firm. Moreover, a contribution made by a covered
associate of an adviser would be attributed to any other adviser that
employs or engages the person who made the contribution within two
years after the date the contribution was made.\111\ As a result, an
investment adviser would be required to ``look back'' in time to
determine whether it would be subject to any business restrictions
under the proposed rule when employing or engaging a covered associate.
This provision, which tracks MSRB rule G-37,\112\ would prevent
advisers from circumventing the rule by channeling contributions
through departing employees, or by influencing the selection process by
hiring persons who have made political contributions. Comment is
requested on the proposed look-back requirement. For example, would a
shorter period be sufficient to prevent circumvention of the rule?
\113\ If so, what period would be appropriate? Would our proposed look-
back provision inappropriately deter politically active individuals
from joining advisory firms that provide investment advice to
government entities or are seeking to do so?
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    \111\ Proposed rule 206(4)-5(a)(1). In no case would the
prohibition imposed by the proposed 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 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. 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 employed by the adviser. See infra section II.B.
    \112\ MSRB rule G-37(g)(iv). Cf. MSRB Qs & As, Question II.12,
available at http://www.msrb.org/msrb1/rules/QAG-372003.htm.
    \113\ Commenters in 1999 urged us to reduce the look back
period, arguing that politically active individuals might be
discouraged from joining advisory firms. However, we are concerned
about the prospect of advisers seeking to circumvent the rule by
hiring individuals shortly after they have made significant
contributions that could influence government officials.
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(6) Exception for De Minimis Contributions
    Proposed rule 206(4)-5 contains a de minimis exception that would
permit each covered associate who is an individual \114\ to make
aggregate contributions of $250 or less, per election, to an elected
official or candidate without triggering the rule's prohibitions if the
person making the contribution is entitled to vote for the official or
candidate.\115\ We have proposed $250 because we believe that
contributions of $250 or less are typically made without the intent or
ability to influence the selection process for investment advisers and
thus do not involve the conflicts of interest the rule is intended to
prevent, as well as for reasons of regulatory consistency. The $250
amount is the same as the de minimis amount excepted from MSRB rule G-
37.\116\ Comment is requested on the scope of the exception.\117\
Should the amount be increased or decreased, and if so, on what basis?
For instance, the MSRB has not adjusted its de minimis amount for
inflation since it was established in 1994. We have not adjusted the
$250 for inflation because of ease of reference to a round number and
because an inflation adjustment would result in an amount not
significantly higher. We request comment, however, on whether we should
adjust our amount for inflation. Should we provide a de minimis
exception for contributions to officials for whom an individual is not
entitled to vote, and if so, what would be an appropriate de minimis
amount? \118\
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    \114\ Under the proposed rule, each covered associate, taken
separately, would be subject to the $250 de minimis exception for
elections in which he or she is entitled to vote. In other words,
the $250 limit applies per covered associate and is not an aggregate
limit for all of an adviser's covered associates.
    \115\ Proposed rule 206(4)-5(b)(1). Under the proposed rule,
primary and general elections would be considered separate
elections. Accordingly, a covered person of an investment adviser
could, without triggering the prohibitions of the rule, contribute
up to $250 in both the primary election campaign and the general
election campaign (up to $500) of each official for whom the person
making the contribution would be entitled to vote. For purposes of
this rule, 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. See, e.g., In the Matter of Pryor,
McClendon, Counts & Co., Inc. et al., Exchange Act Release No. 48095
(June 26, 2003) (noting that Rule G-37 allows a person to contribute
$250 to a candidate's campaign in the primary and in the general
election, for a total of $500 during the election cycle, and
clarifying that contributions must be limited to $250 before the
primary, with an additional $250 allowed after the primary for the
general election). See also MSRB Qs & As, Question II.8, available
at http://www.msrb.org/msrb1/rules/QAG-372003.htm.
    \116\ See MSRB rule G-37(b)(i).
    \117\ Some commenters in 1999 suggested that the amount be
substantially higher. Some commenters thought we should raise the de
minimis amount to $1,000 to be consistent with the limits on private
contributions for candidates for Federal office. We believe that a
higher threshold--such as $1,000--would be significantly more likely
to enable a contributor to seek to exert influence over an official
with the ability to select an investment adviser, especially in a
local election. We also believe a lower amount might be too
restrictive--it could preclude individuals from supporting
candidates for whom they are able to vote at levels that are less
likely to facilitate undue influence.
    \118\ Our proposed de minimis exception only applies to
contributions to a candidate for whom the contributor is entitled to
vote. Whereas the outcome of an election in which a contributor is
eligible to vote is likely to have a greater personal impact on the
contributor, there is a significantly greater likelihood that a
contributor's contribution in an election in which he or she is not
entitled to vote could be motivated by other factors, which might
include influencing a candidate. In 1999, there was a mixture of
support and criticism for limiting the exception to contributions to
officials or candidates for whom the contributor is entitled to
vote, and one commenter advocated expanding it to a $100 de minimis
exception for candidates for whom the contributor is not entitled to
vote.
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(7) Exception for Certain Returned Contributions
    We are proposing a second exception from the two-year compensation
ban intended to address situations in which the adviser triggers the
ban inadvertently.\119\ We have attempted to limit the scope of this
exception to the types of contributions that we believe are unlikely to
raise pay to play concerns. This exception would be available only with
respect to contributions made by a covered associate of the investment
adviser to officials other than those for whom the covered associate
was entitled to vote at the time of the contributions and which, in the
aggregate, do not exceed $250 to any one official, per election.\120\
Further, the adviser must have discovered the

contribution which resulted in the prohibition within four months of
the date of such contribution \121\ and, within 60 days after learning
of the triggering contribution, must cause the contribution to be
returned to the contributor.\122\ We believe this exception should only
be available when the adviser discovered the triggering contribution,
and caused it to be returned, promptly. Our proposal generally tracks
MSRB rule G-37's ``automatic exemption'' provision.\123\
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    \119\ Proposed rule 206(4)-5(b)(2).
    \120\ Proposed rule 206(4)-5(b)(2)(i). To the extent that the
contribution by a covered associate of the adviser was less than
$250 and was for an official for whom the covered associate was
entitled to vote at the time of the contributions, the contribution
would not have triggered the two-year ban on account of the
exception contained in paragraph (b)(1) of the proposed rule.
    \121\ Id. We believe that requiring that the adviser must have
discovered the contribution within four months provides an
appropriate time limit for the exception. On one hand, 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. On the other hand, we
believe it makes sense to give advisers sufficient time to discover
contributions made by covered associates if, for example, their
covered associates disclose their contributions to the adviser on a
quarterly basis. Also, this provision is consistent with the
approach taken in MSRB rule G-37(j)(i).
    \122\ Proposed rule 206(4)-5(b)(2)(i). The prompt return of the
contribution would provide some indication that the contribution
would not affect an official of a government entity's decision-
making process with regard to choosing an adviser. We have proposed
that the contribution must be returned within 60 days 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
proposed 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.''
    \123\ MSRB rule G-37(j). We did not include an equivalent
provision in our 1999 proposal, and MSRB rule G-37 contained no such
provision at that time. However, the MSRB added an ``automatic
exemption'' provision in 2003. Exchange Act Release No. 47814 (May
8, 2003) [68 FR 25917 (May 14, 2003)]. Several of the comments we
received on our 1999 proposal, while supporting the exemptive
provision we proposed at that time, expressed concern that the scope
and breadth of the rule would expose advisers to the risk of
inadvertent violations, which would necessitate frequent exemptive
applications. See, e.g., Comment Letter of the Securities Industry
Association (Oct. 29, 1999) (``SIA Comment Letter''); Comment Letter
of Morgan Stanley Dean Witter Investment Management Inc. (Nov. 1,
1999) (``MSDW Comment Letter''); Comment Letter of Fidelity
Investments (Nov. 1, 1999); Investment Counsel Association of
America Comment Letter (Nov. 1, 1999) (``Nov. ICAA Comment
Letter''); Comment Letter of Scudder Kemper Investments (Nov. 8,
1999) (``Scudder Kemper Comment Letter''); Comment Letter of
Nicholas-Applegate Capital Management (Oct. 26, 1999) (``Nicholas-
Applegate Comment Letter''); Comment Letter of Smith Barney Asset
Management and Salomon Brothers Asset Management Inc. (Nov. 1, 1999)
(``Smith Barney Comment Letter'') (suggesting, alternatively, that
the time out period be 30 days for inadvertent violations); Comment
Letter of Davis Polk & Wardwell (Nov. 1, 1999) (``Davis Polk Comment
Letter''); and Comment Letter of American Bar Association,
Subcommittees on Investment Companies and Investment Advisers and on
Private Investment Entities of the Committee on Federal Regulation
of Securities, Section of Business Law (Jan. 5, 2000) (``ABA Comment
Letter''). The exception we have proposed would help address these
concerns.
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    To ensure that the exception for certain returned contributions
does not encourage an investment adviser to relax its efforts to
promote compliance with the rule's prohibitions, no adviser would be
entitled to rely on the exception more than twice per 12-month
period.\124\ And an investment adviser would not be permitted to rely
on the exception more than once with respect to contributions by the
same covered associate of the investment adviser,\125\ regardless of
the time period.
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    \124\ Proposed rule 206(4)-5(b)(2)(ii). We wanted to give each
adviser more than one opportunity to refine its compliance
procedures to avoid further violations of the proposed rule but, as
noted, did not want to allow an adviser to relax its standards by
making multiple exceptions available. This will generally create
some flexibility to accommodate a covered associate's inadvertent
violation.
    \125\ Proposed rule 206(4)-5(b)(2)(iii). Once a covered
associate has been made aware of an ``inadvertent'' violation, a
justification for a second violation is more questionable.
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    We request comment on the proposed criteria for, and limitations
on, the exception for certain returned contributions. Are the various
time periods we proposed (discovery of contribution within four months
of it being made, return of contribution within 60 days of discovery,
and limitation of reliance on the exception twice per adviser per 12-
month period) reasonable? Would they be effective? Are there other
circumstances under which an adviser should be able to avail itself of
an exception? Alternatively, should we require that an adviser
institute special supervisory procedures (after it relies on the
exception for certain returned contributions) for the covered associate
making the contribution, including requiring pre-clearance of all
contributions, for a specified period of time?
(b) Ban on Using Third Parties To Solicit Government Business
    After the adoption of rule G-37 in 1994, the MSRB observed that
municipal securities dealers sought to circumvent rule G-37 by hiring
third-party consultants to solicit government clients on their
behalf.\126\ These third-party consultants would make political
contributions or otherwise seek to exert influence designed to secure
municipal business for the municipal securities firm.\127\ Two years
later, in 1996, the Commission approved, and the MSRB adopted, rule G-
38, which required municipal dealers to disclose publicly the terms of
their agreements with consultants.\128\ In 2005, after concluding that
the required disclosure was neither adequate to prevent circumvention
of rule G-37, nor consistently being made,\129\ the MSRB (with the

Commission's approval) amended rule G-38 to impose a complete ban on
the use of third-party consultants to solicit government clients.\130\
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    \126\ See In the Matter of Self-Regulatory Organizations; Notice
of Filing of Proposed Rule Change by the Municipal Securities
Rulemaking Board Relating to Consultants, Exchange Act Release No.
36522 (Nov. 28, 1995) [60 FR 62275 (Dec. 5, 1995)] (``The Board
believes that rules G-37 and G-20 [regarding gifts and gratuities] *
* * along with [the rule on fair dealing] set appropriate standards
for dealer conduct in the municipal securities industry. However,
the Board is concerned about dealers' increasing use of consultants
to obtain or retain municipal securities business. While the Board
believes that in many instances the use of consultants is
appropriate, it also believes that, in a number of instances, the
use of consultants may be in response to limitations placed on
dealer activities by rule G-37 and rule G-20. While both of these
rules prohibit dealers from doing indirectly what they are precluded
from doing directly, indirect activities often are difficult to
prove.'' (footnotes omitted)).
    \127\ See id.
    \128\ See In the Matter of Self-Regulatory Organizations; Order
Approving Proposed Rule Change by the Municipal Securities
Rulemaking Board Relating to Consultants, Exchange Act Release No.
36727 (Jan. 17, 1996) [61 FR 1955 (Jan. 24, 1996)] (``The rule
approved today is intended to provide additional information to
issuers and to the public to assist in determining the extent to
which payments to consultants influence the issuer's selection
process in connection with municipal securities business. * * *'')
(``MSRB Rule G-38 Adoption Order''). See also Municipal Securities
Rulemaking Board, Request for Comments on Revised Draft Amendments
to Rule G-38 Relating to Solicitation of Municipal Securities
Business (as modified on Oct. 12, 2004) (Sept. 29, 2004), available
at http://www.msrb.org/msrb1/archive/2004/RevRuleG-
38Solicitation.htm#revised1 (noting, with regard to MSRB rule G-38,
``As initially adopted, the rule required * * * that the dealer
disclose information about its consulting arrangements to any issuer
from which a consultant would solicit municipal securities business
on its behalf [and that the dealer disclose] to the MSRB * * * the
terms of the consulting agreements and the business obtained by the
consultants * * * [with] such disclosures made available to the
public through the MSRB Web site * * *'' (footnotes omitted)).
    \129\ See Municipal Securities Rulemaking Board, Amendments
Relating to Solicitation of Municipal Securities Business Under Rule
G-38, SR-MSRB-2005-04 (Mar. 17, 2005), available at http://
www.msrb.org/msrb1/rulesandforms/sec/SR-MSRB-2005-04.pdf (``The MSRB
began its current rulemaking initiative on the solicitation on
behalf of brokers, dealers and municipal securities dealers
(``dealers'') of municipal securities business by consultants early
last year because of certain practices that could present challenges
to maintaining the integrity of the municipal securities market.
These practices include, among other things, significant increases
in recent years in the number of consultants being used, the amount
these consultants are being paid and the level of reported political
giving by consultants. The MSRB has been concerned that increases in
levels of compensation paid to consultants for successfully
obtaining municipal securities business may be motivating
consultants, who currently are not subject to the basic standards of
fair practice and professionalism embodied in MSRB rules, to use
more aggressive or questionable tactics in their contacts with
issuers.'').
    \130\ See In the Matter of Self-Regulatory Organizations; Order
Approving Proposed Rule Change and Notice of Filing and Order
Granting Accelerated Approval to Amendment No. 1 to the Proposed
Rule Change Relating to Solicitation of Municipal Securities
Business under MSRB Rule G-38, Exchange Act Release No. 52278 (Aug.
17, 2005) [70 FR 49342 (Aug. 23, 2005)]. As amended, MSRB rule G-
38(a) states, ``Subject to section (c) of this rule [regarding
transitional payments], no broker, dealer or municipal securities
dealer may provide or agree to provide, directly or indirectly,
payment to any person who is not an affiliated person of the broker,
dealer or municipal securities dealer for a solicitation of
municipal securities business on behalf of such broker, dealer or
municipal securities dealer.''
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    We are concerned that our adoption of a rule addressing pay to play
practices by advisers would lead to a similar use of consultants or
solicitors by investment advisers to circumvent the rule. Indeed, we
have alleged that third-party solicitors have played a central role in
each of the enforcement actions against investment advisers that we
have brought in the past several years involving pay to play
schemes.\131\ Government authorities in New York and other
jurisdictions have prohibited, or are considering prohibiting, the use
of consultants, solicitors, or placement agents by investment advisers
to solicit government investment business.\132\
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    \131\ See, e.g., SEC v. Henry Morris, et al., Litigation Release
No. 20963 (Mar. 19, 2009) (the Commission's complaint alleges that
investment advisers and a placement agent, among others, engaged in
a fraudulent scheme to extract kickbacks from investment management
firms seeking to manage assets of the New York State Common
Retirement Fund); In the Matter of Kent D. Nelson, Investment
Advisers Act Release No. 2765 (Aug. 1, 2008); Initial Decision
Release No. 371 (Feb. 24, 2009); Investment Advisers Act Release No.
2868 (Apr. 17, 2009) (an administrative law judge found that an
investment adviser funneled payments through a third party to the
New Mexico State treasurer in exchange for being retained as an
adviser by the State treasurer's office); SEC v. Paul J. Silvester
et al., Litigation Release No. 16759 (Oct. 10, 2000); Litigation
Release No. 16834 (Dec. 19, 2000); Litigation Release No. 18461
(Nov. 17, 2003); Litigation Release No. 19583 (Mar. 1, 2006);
Litigation Release No. 20027 (Mar. 2, 2007) (alleging that, in order
to obtain investment contracts, investment adviser firms made
payments to associates of the Connecticut State treasurer, a portion
of which were kicked back to the treasurer). See also supra notes
31-40 (discussing other cases related to these enforcement actions).
    \132\ See, e.g., Aaron Elstein, NY Pension Fund Bans
Controversial Middlemen, Crain's New York Business (Apr. 22, 2009)
(describing the New York State Comptroller's ban on placement
agents); Press Release, Office of the New York City Comptroller,
Thompson Moves to Ban Placement Agents, Asks State AG to Investigate
Quadrangle Transaction, PR-09-04-095 (Apr. 22, 2009), available at
http://www.comptroller.nyc.gov/press/2009_releases/pr09-04-095.shtm
(describing the New York City Comptroller's calls on the New York
City Pension Funds to ban placement agents); Henry Goldman, New York
City Police Pension Bans Placement Agent Use, Bloomberg (May 5,
2009) (describing the New York City Police Pension Fund's suspension
on the use of placement agents); Martin Z. Braun, New York City's
Fire Pension Bans Middlemen, Joining Two Others, Bloomberg (May 16,
2009) (describing the New York City Fire Pension Fund's suspension
on the use of placement agents); Barry Massey, NM Agency Bans
Placement Agents on Investments, Businessweek (May 26, 2009)
(describing the New Mexico State Investment Council's ban on
placement agents). See also In the Matter of the Carlyle Group, AGNY
Investigation No. 2009-071, Assurance of Discontinuance Pursuant to
Executive Law Sec.  63(15) (May 14, 2009), available at http://
www.oag.state.ny.us/media_center/2009/may/pdfs/Carlyle%20AOD.pdf;
In the Matter of Riverstone Holdings, LLC, AGNY Investigation No.
2009-091, Assurance of Discontinuance Pursuant to Executive Law
Sec.  63(15) (June 11, 2009), available at http://
www.oag.state.ny.us/media_center/2009/june/pdfs/
Riverstone%20AOD%20FINAL%20EXECUTED.pdf; and In the Matter of PCG
Corporate Partners Advisors II, LLC, AGNY Investigation No. 2009-
101, Assurance of Discontinuance Pursuant to Executive Law Sec.
63(15) (July 1, 2009), available at http://www.oag.state.ny.us/
media_center/2009/july/pdfs/PCG%20AOD%20FINAL%20EXECUTED.pdf (in
each case, banning the use of third-party placement agents pursuant
to a ``Public Pension Fund Reform Code of Conduct'' in connection
with the New York Attorney General's findings 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, * * * and that the use of placement agents to obtain
public pension fund investments is a practice fraught with peril and
prone to manipulation and abuse.'').
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    In our 1999 proposal, contributions to a government official by an
adviser's third-party solicitor, engaged by the adviser to obtain
clients, would have triggered a two-year ``time out'' for the
adviser.\133\ Several commenters opposed inclusion of contributions by
third-party solicitors as a trigger for the ``time out.'' Most argued
that this aspect of the rule was unfair and created significant
compliance challenges because these solicitors were not, according to
the commenters, controlled by advisers.\134\
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    \133\ See 1999 Proposing Release, supra note 17, at section
II.A.1.
    \134\ See, e.g., SIA Comment Letter; T. Rowe Comment Letter;
MSDW Comment Letter; Comment Letter of Legg Mason, Inc. (Nov. 1,
1999); American Bankers Association Comment Letter (Nov. 1, 1999);
Nov. ICAA Comment Letter; Scudder Kemper Comment Letter; Nicholas-
Applegate Comment Letter; Smith Barney Comment Letter; Davis Polk
Comment Letter; and ABA Comment Letter. We note that rule 206(4)-3
(the ``cash solicitation rule'') under the Advisers Act, among other