We received requests that we clarify the application of the rule to
some common circumstances that may arise in the course of an adviser's
relationship with a government client.\156\ We would not consider a
donation of time by an individual to be a contribution, provided the
adviser has not solicited the individual's efforts and the adviser's
resources, such as office space and telephones, are not used.\157\
Similarly, we would not consider a charitable donation made by an
investment adviser to an organization that qualifies for an exemption
from Federal taxation under the Internal Revenue Code,\158\ or its
equivalent in a foreign jurisdiction, at the request of an official of
a government entity to be a contribution for purposes of rule 206(4)-
5.\159\
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    \156\ See, e.g., Caplin & Drysdale Letter; Callcott Letter I
(volunteer activities); NASP Letter (charitable contributions);
Sutherland Letter; IAA Letter (entertainment expenses and conference
expenses). We address entertainment and conference expenses in
section II.B.2(c) of this Release (which discusses the prohibition
on soliciting or coordinating contributions from others).
    \157\ See Proposing Release, at n.91. A covered associate's
donation of his or her time generally would not be viewed as a
contribution if such volunteering were to occur during non-work
hours, if the covered associate were using vacation time, or if the
adviser is not otherwise paying the employee's salary (e.g., an
unpaid leave of absence). But see rule 206(4)-5(d) (prohibiting an
adviser from doing indirectly what the rule would prohibit if done
directly). The MSRB deals similarly with this issue. See MSRB Rule
G-37 Q&A, Question II.19.
    \158\ Section 501(c)(3) of the Internal Revenue Code (26 U.S.C.
501(c)(3)) contains a list of charitable organizations that are
exempt from Federal income taxation.
    \159\ The MSRB deals similarly with this issue. See MSRB Rule G-
37 Q&A, Question II.18. But see rule 206(4)-5(d) (prohibiting an
adviser from doing indirectly what the rule would prohibit if done
directly).
---------------------------------------------------------------------------

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

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

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

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

    The MSRB rule G-37 definition of ``contribution'' has, in our view,
proved to be workable. The types of contributions relevant to money
managers and elected officials are unlikely to be different than those
made to influence the awarding of municipal securities business by
broker-dealers. On balance, we believe that the MSRB's definition of
``contribution,'' which we mirrored in our proposal, achieves the goals
of this rulemaking. Therefore, we are adopting the definition as
proposed.
(4) Covered Associates
    Contributions made to influence the selection process are typically
made not by the firm itself, but by officers and employees of the firm
who have a direct economic stake in the business relationship with the
government client.\167\ Accordingly, under the rule, contributions by
each of these persons, which the rule defines as ``covered
associates,'' trigger the two-year time out.\168\ A ``covered
associate'' of an investment adviser is defined as: (i) Any general
partner, managing member or executive officer, or other individual with
a similar status or function; (ii) any employee who solicits a
government entity for the investment adviser and any person who
supervises, directly or indirectly, such employee; and (iii) any
political action committee controlled by the investment adviser or by
any of its covered associates.\169\
---------------------------------------------------------------------------

    \167\ Proposing Release, at section II.A.3(a)(4). Based on
enforcement actions, we believe that such persons are more likely to
have an economic incentive to make contributions to influence the
advisory firm's selection. See id.
    \168\ Rule 206(4)-5(a)(1).
    \169\ Rule 206(4)-5(f)(2).
---------------------------------------------------------------------------

    Owners. Contributions by sole proprietors are contributions by the
adviser itself.\170\ If the adviser is a partnership, the rule covers
contributions by the adviser's general partners.\171\ If the adviser is
a limited liability company, the rule covers contributions made by
managing members.\172\ A contribution by an owner that is a limited
partner or non-managing member (of a limited liability company) is not
covered, however, unless the limited partner or non-managing member is
also an executive officer or solicitor (or person who supervises a
solicitor) covered by the rule, or unless the contribution is an
indirect contribution by the adviser, executive officer, solicitor, or
supervisor.\173\ Similarly, if the adviser is a corporation,
shareholder contributions are not covered unless the shareholder is
also an executive officer or solicitor covered by the rule, or unless
the contribution is an indirect contribution by the adviser, executive
officer, solicitor, or supervisor.\174\
---------------------------------------------------------------------------

    \170\ We note, however, that a sole proprietor may, in a
personal capacity, avail herself or himself of the de minimis
exceptions described in section II.B.2(a)(6) of this Release.
    \171\ Rule 206(4)-5(f)(2)(i).
    \172\ Id.
    \173\ See rule 206(4)-5(a)(1), (d) and (f)(2)(i)-(ii).
    \174\ Id.
---------------------------------------------------------------------------

    Executive Officers. Contributions by an executive officer of an
investment adviser trigger the two-year time out.\175\ Executive
officers include: (i) The president; (ii) any vice president in charge
of a principal business unit, division or function (such as sales,
administration or finance); (iii) any other officer of the investment
adviser who performs a policy-making function; or (iv) any other person
who performs similar policy-making functions for the investment
adviser.\176\ Whether a person is an executive officer depends on his
or her function, not title; for example, an officer who is the chief
executive of an advisory firm but whose title does not include
``president'' is nonetheless an executive officer for purposes of the
rule.
---------------------------------------------------------------------------

    \175\ The definition of ``covered associate'' includes, among
others, any executive officer or other individual with a similar
status or function. Rule 206(4)-5(f)(2)(i).
    \176\ Rule 206(4)-5(f)(4).
---------------------------------------------------------------------------

    The definition reflects changes we have made from our proposal that
are designed to clarify the rule and to tailor it to apply to those
officers of an investment adviser whose position in the organization is
more likely to incentivize them to obtain or retain clients for the
investment adviser (and, therefore, to engage in pay to play practices)
while still achieving our objectives. We have clarified that ``other
executive officers'' under the rule--i.e., those other than the
president and vice presidents in charge of principal business units or
functions--include only those officers or other persons who perform a
policy-making function for the investment adviser.\177\ This
limitation, which was recommended by commenters,\178\ excludes persons
who enjoy certain titles as a formal matter but do not engage in the
kinds of activities that we believe should trigger the prohibitions in
the rule.\179\ We have

also modified the definition to remove the limitation that the officer,
as part of his or her regular duties, performs or supervises any person
who performs advisory services for the adviser, or solicits or
supervises any person who solicits for the adviser. We agree with the
commenter who asserted that ``* * * all of the adviser's executive
officers should be included because the nature of their status alone
creates a strong incentive to engage in pay to play practices.'' \180\
Even if these senior officers are not directly involved in advisory or
solicitation activities, as part of senior management, their success
within the advisory firm is likely to be tied to the firm's success in
obtaining clients.\181\
---------------------------------------------------------------------------

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

    Employees who Solicit Government Clients. Contributions by any
employee who solicits a government entity for the adviser would trigger
the two-year time out.\182\ An employee need not be primarily engaged
in solicitation activities to be a ``covered associate'' under the
rule.\183\ We are also including persons who supervise employees who
solicit government entities because we believe these persons are
strongly incentivized to engage in pay to play activities to obtain
government entity clients.\184\ We have revised this aspect of the
definition to include all supervisors of those solicitors that solicit
government entities because we believe the incentives to engage in pay
to play exist for all such supervisors, not just those that have a
certain level of seniority.
---------------------------------------------------------------------------

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

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

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

    Political Action Committees. A covered associate includes a
political action committee controlled by the investment adviser or by
any of its covered associates.\188\ Under the rule, we would regard an
adviser or its covered associate to have ``control'' over a political
action committee if the adviser or its covered associate has the
ability to direct or cause the direction of the governance or
operations of the PAC.\189\
---------------------------------------------------------------------------

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

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

recommended changes would permit an executive of the adviser or another
covered person of the adviser to use a PAC he or she controls to evade
the rule. Even where the adviser itself does not control such PACs
directly, we are concerned about their use to evade our rule where they
are controlled by covered associates (whose positions in the
organization, as we note above, are more likely to incentivize them to
obtain or retain clients for the investment adviser).\193\
---------------------------------------------------------------------------

    \190\ SIFMA Letter; Sutherland Letter.
    \191\ Id.
    \192\ Proposing Release, at n.101.
    \193\ Advisers are responsible for supervising their supervised
persons, including their covered associates. We have the authority
to seek sanctions where an investment adviser, or an associated
person, has failed reasonably to supervise, with a view to
preventing violations of the Federal securities laws or rules, a
person who is subject to the adviser's (or its associated person's)
supervision and who commits such violations. Sections 203(e)(6) and
203(f) of the Advisers Act [15 U.S.C. 80b-3(e)(6) and (f)].
---------------------------------------------------------------------------

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

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

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

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

(5) ``Look Back''
    The rule attributes to an adviser contributions made by a person
within two years (or, in some cases, six months) of becoming a covered
associate of that adviser.\203\ In other words, when an employee
becomes a covered associate, the adviser must ``look back'' in time to
that employee's contributions to determine whether the time out applies
to the adviser.\204\ If, for example, the contributions were made more
than two years (or, pursuant to the exception described below for non-
solicitors, six months) prior to the employee becoming a covered
associate, the time out has run; if the contribution was made less than
two years (or six months) from the time the person becomes a covered
associate, the rule prohibits the adviser that hires or promotes the
contributing covered associate from receiving compensation for
providing advisory services from the hiring or promotion date until the
two-year period has run.\205\ The look-back provision, which is similar
to that in MSRB rule G-37, is designed to prevent advisers from
circumventing the rule by influencing the selection process by hiring
persons who have made political contributions.\206\
---------------------------------------------------------------------------

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

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

prohibitions on pay to play.\209\ Most commenters, however, argued that
the rule should not contain a look-back provision or should contain a
shorter one because it could prevent advisers from hiring qualified
individuals who have made unrelated political contributions,\210\ or it
could be disruptive to public pension plans seeking to hire qualified
managers.\211\ While some urged that we eliminate the look-back
provision altogether,\212\ most asked us to shorten the period to three
to six months.\213\ Others suggested alternative approaches to the look
back, including adopting a higher contribution threshold to trigger the
look-back provision \214\ or permitting advisers to hire and promote
persons to be covered associates who have made prohibited
contributions, but not permitting them to solicit government clients or
otherwise create firewalls between them and government clients.\215\
---------------------------------------------------------------------------

    \207\ See, e.g., Fund Democracy/Consumer Federation Letter; ICI
Letter; Davis Polk Letter; NY City Bar Letter; Fidelity Letter;
Wells Fargo Letter; MFA Letter; IAA Letter; NASP Letter; American
Bankers Letter; Comment Letter of Seward & Kissel LLP (Oct. 6. 2009)
(``Seward & Kissel Letter''); Park Hill Letter; Dechert Letter;
Skadden Letter.
    \208\ See Proposing Release, at section II.A.3(a)(5).
    \209\ Fund Democracy/Consumer Federation Letter.
    \210\ See, e.g., ICI Letter; Davis Polk Letter; NY City Bar
Letter; Fidelity Letter; Wells Fargo Letter; MFA Letter.
    \211\ See, e.g., Comment Letter of Connecticut Treasurer Denise
L. Nappier (Sept. 10, 2009) (``CT Treasurer Letter''); CalPERS
Letter.
    \212\ See, e.g., IAA Letter; ICI Letter; Wells Fargo Letter;
NASP Letter; American Bankers Letter; MFA Letter; Seward & Kissel
Letter.
    \213\ See, e.g., ICI Letter (three-month look back); IAA Letter
(six-month look back); Park Hill Letter (six-month look back); Wells
Fargo Letter (six-month look back); Davis Polk Letter (six-month
look back); Dechert Letter (six-month look back); MFA Letter (six-
month look back).
    \214\ See, e.g., Wells Fargo Letter; NSCP Letter.
    \215\ See, e.g., Comment Letter of Strategic Capital Partners
(Oct. 1, 2009) (``Strategic Capital Letter''); Comment Letter of B.
Jack Miller (Oct. 3, 2009); Comment Letter of RP Realty Partners,
LLC Chief Financial Officer Jerry Gold (Oct. 2, 2009); SIFMA Letter.
---------------------------------------------------------------------------

    Upon consideration of the comments, we believe that applying the
full two-year look back to all new covered associates may be
unnecessary to achieve the goals of the rulemaking. We are adopting a
suggestion offered by several commenters to shorten the look-back
period with respect to certain new covered associates whose
contributions are less likely to be involved in pay to play.\216\ Under
an exception to the rule, the two-year time out is not triggered by a
contribution made by a natural person more than six months prior to
becoming a covered associate, unless he or she, after becoming a
covered associate, solicits clients.\217\ As a result, the two-year
look back applies only to covered associates who solicit for the
investment adviser.\218\
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    \216\ See, e.g., MFA Letter; Fidelity Letter; Dechert Letter;
Wells Fargo Letter; Skadden Letter. The MSRB shortened the look-back
period under MSRB rule G-37 to six months for certain municipal
finance professionals in response to similar industry concerns about
the impact on hiring. See MSRB, Amendments Filed to Rule G-37
Concerning the Exemption Process and the Definition of Municipal
Finance Professional (Sept. 26, 2002), available at http://
www.msrb.org/msrb1/archive/g%2D37902notice.htm.
    \217\ Rule 206(4)-5(b)(2). An adviser is subject to the two-year
time out regardless of whether it is ``aware'' of the political
contributions. Thus, statements by prospective employees regarding
whether they have made relevant contributions are insufficient to
inoculate the adviser, as some commenters urged (see, e.g., IAA
Letter; ICI Letter; NSCP Letter; Caplin & Drysdale Letter), to
ensure that investment advisers are not encouraged to relax their
efforts to promote compliance with the rule's prohibitions.
Nonetheless, advisers who advise or are considering advising any
government entity should consider requiring full disclosure of any
relevant political contributions from covered associates or
potential covered associates to ensure compliance with rule 206(4)-
5. Advisers are required to request similar reports about securities
holdings by Advisers Act rule 204A-1(b)(1)(ii) [17 CFR 275.204A-
1(b)(1)(ii)], which requires each of a firm's ``access persons'' to
submit an initial ``holdings report'' of securities he or she
beneficially owns at the time he or she becomes an access person,
even though the securities would likely have been acquired in
transactions prior to becoming an access person. For a discussion of
an adviser's recordkeeping obligations with regard to records of
contributions by a new covered associate during that new covered
associate's look-back period, see infra note 428.
    \218\ See rule 206(4)-5(f)(2) (defining covered associate of an
investment adviser as: (i) Any general partner, managing member or
executive officer, or other individual with a similar status or
function; (ii) any employee who solicits a government entity for the
investment adviser and any person who supervises, directly or
indirectly, such employee).
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    The potential link between obtaining advisory business and
contributions made by an individual prior to his or her becoming a
covered associate that is uninvolved in solicitation activities is
likely more attenuated and therefore, in our judgment, should be
subject to a shorter look back. We have modeled this shortened look-
back period \219\ on the MSRB's six-month look back for certain
personnel, which it implemented as a result of feedback it received
from dealers that indicated the two-year look back was negatively
affecting in-firm transfers and promotions and ``preclud[ing] them from
hiring individuals who had made contributions, even though the
contributions (which may have been relatively small) were made at a
time when the individuals had no reason to be familiar with Rule G-
37.'' \220\ This approach balances commenters' concerns about the
implications for their hiring decisions with the need to protect
against individuals marketing to prospective investment adviser
employers their connections to, or influence over, government entities
those advisers might be seeking as clients.\221\
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    \219\ See rule 206(4)-5(b)(2).
    \220\ MSRB, Self-Regulatory Organizations; Notice of Filing of
Proposed Rule Change by the Municipal Securities Rulemaking Board
Relating to Amendments to Rules G-37, on Political Contributions and
Prohibitions on Municipal Securities Business, G-8, on Books and
Records, Revisions to Form G-37/G-38 and the Withdrawal of Certain
Rule G-37 Questions and Answers, Exchange Act Release No. 47609
(April 1, 2003) [67 FR 17122 (Apr. 8, 2003)]. See also MSRB, Self-
Regulatory Organizations; Order Granting Approval of a Proposed Rule
Change and Amendment No. 1 Thereto by the Municipal Securities
Rulemaking Board Relating to Amendments to Rules G-37, on Political
Contributions and Prohibitions on Municipal Securities Business, G-
8, on Books and Records, Revisions to Form G-37/G-38 and the
Withdrawal of Certain Rule G-37 Questions and Answers, Exchange Act
Release No. 47814 (May 8, 2003) [68 FR 25917 (May 14, 2003)]
(Commission order approving amendments to MSRB rule G-37); MSRB rule
G-37(b)(iii).
    \221\ We are not adopting the suggestion of commenters to
exclude from the look-back provision contributions made before a
merger or acquisition by an adviser by not attributing the
contributions of the acquired adviser to the acquiring adviser. See,
e.g., Dechert Letter; ICI Letter. We believe that an acquisition of
another adviser could raise identical concerns where the acquired
adviser has made political contributions designed to benefit the
acquiring adviser. Rule 206(4)-5 is not intended to prevent mergers
in the investment advisory industry or, once a merger is
consummated, to hinder the surviving adviser's government advisory
business unless the merger was an attempt to circumvent rule 206(4)-
5. Thus, the adviser may wish to seek an exemption from the ban on
receiving compensation pursuant to rule 206(4)-5(a) from the
Commission. The MSRB takes the same approach to this issue. See MSRB
Rule G-37 Q&A, Question II.16.
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(6) Exceptions for De Minimis Contributions
    Rule 206(4)-5 permits individuals to make aggregate contributions
without triggering the two-year time out of up to $350, per election,
to an elected official or candidate for whom the individual is entitled
to vote,\222\ and up to $150, per election, to an elected official or
candidate for whom the individual is not entitled to vote.\223\ These
de minimis exceptions are available only for contributions by
individual covered associates, not the investment adviser itself.\224\
Under both exceptions,

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

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

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

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

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

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

(7) Exception for Certain Returned Contributions
    We are adopting, largely as proposed, an exception that will
provide an adviser with a limited ability to cure the consequences of
an inadvertent political contribution to an official for whom the
covered associate making it is not entitled to vote.\233\ The exception
is available for contributions that, in the aggregate, do not exceed
$350 to any one official, per election.\234\ The adviser must have
discovered the contribution which resulted in the prohibition within
four months of the date of such contribution \235\ and, within 60 days
after learning of the triggering contribution, the contributor must
obtain the return of the contribution.\236\
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    \233\ Rule 206(4)-5(b)(3).
    \234\ Rule 206(4)-5(b)(3)(i). We note that a contribution would
not trigger the two-year ban at all to the extent it falls within
the de minimis exception described in rule 206(4)-5(b)(1). See
section II.B.2(a)(6) of this Release for a discussion of this
exception.
    \235\ Id.
    \236\ Rule 206(4)-5(b)(3)(i).
---------------------------------------------------------------------------

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

    Instead of suggesting alternative approaches, other commenters
urged us to apply the rule more narrowly by exempting from the ban
solicitors that are registered broker-dealers or associated persons of
broker-dealers.\297\ Some were concerned that the rule would interfere
with traditional distribution arrangements of mutual funds and private
funds, which are usually distributed by registered broker-dealers that
may be compensated by the adviser in some form.\298\ Many argued that
registration as a broker-dealer generally differentiates placement
agents that provide ``legitimate'' services from those that merely
offer political influence.\299\ Others expressed concern that some
broker-dealer firms that rely on placement agent business could be
harmed.\300\ We recognize that services that commenters have identified
as beneficial would typically require broker-dealer registration. But
registration under the Exchange Act does not preclude a broker-dealer
from participating in pay to play practices--MSRB rules G-37 and G-38
do not apply, for example, to broker-dealers soliciting investments on
behalf of investment companies or private funds.\301\ Thus, amending
our rule to limit third parties soliciting governments to broker-
dealers registered under the Exchange Act would not achieve the
prophylactic purpose of this rulemaking. We believe that our approach
is appropriate in light of the concerns we are seeking to address.\302\
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    \297\ See, e.g., Davis Polk Letter; Comment Letter of UBS
Securities LLC (Oct. 2, 2009) (``UBS Letter'').
    \298\ See, e.g., SIFMA Letter; NY City Bar Letter; Monomoy
Letter; IAA Letter. Mutual fund distribution fees are typically paid
by the fund pursuant to a 12b-1 plan, and therefore generally would
not constitute payment by the fund's adviser. As a result, such
payments would not be prohibited by rule 206(4)-5 by its terms.
Where an adviser pays for the fund's distribution out of its
``legitimate profits,'' however, the rule would generally be
implicated. For a discussion of a mutual fund adviser's ability to
use ``legitimate profits'' for fund distribution, see Bearing of
Distribution Expenses by Mutual Funds, Investment Company Act
Release No. 11414 (Oct. 28, 1980) [45 FR 73898 (Nov. 7, 1980)]
(explaining, in the context of the prohibition on the indirect use
of fund assets for distribution, unless pursuant to a 12b-1 plan,
``[h]owever, under the rule there is no indirect use of fund assets
if an adviser makes distribution related payments out of its own
resources * * *. Profits which are legitimate or not excessive are
simply those which are derived from an advisory contract which does
not result in a breach of fiduciary duty under section 36 of the
[Investment Company] Act.''). For private funds, third parties are
often compensated by the adviser or its affiliated general partner
and, therefore, those payments are subject to the rule. Structuring
such a payment to come from the private fund for the purpose of
evading the rule would violate the rule. See Rule 206(4)-5(d).
    \299\ See, e.g., Bryant Law Letter; Hedgeforce Letter; Comment
Letter of Girard Miller (Aug. 8, 2009); Comment Letter of Frank
Schmitz (Aug. 11, 2009) (``Schmitz Letter''); Atlantic-Pacific
Letter; Rubenstein Letter; Thomas Letter; Monomoy Letter; MVision
Letter; Comment Letter of Lime Rock Management (Sept. 28, 2009);
Benedetto Letter; Strategic Capital Letter; Comment Letter of
Portfolio Advisors, LLC (Oct. 2, 2009) (``Portfolio Advisors
Letter''); UBS Letter; Comment Letter of Brian Fitzgibbon (Oct. 5,
2009); Comment Letter of GenNx360 Capital Partners, L.P. (Oct. 5,
2009).
    \300\ Comment Letter of the National Association of Independent
Broker-Dealers (Oct. 5, 2009).
    \301\ At least one commenter suggested that there are
``inherent'' safeguards in the broker-dealer regulatory regime
sufficient to protect against pay to play practices. See, e.g., ABA
Letter. But the broker-dealer regulatory regime does not
specifically address pay to play activities, as demonstrated by the
MSRB's adoption of rules G-37 and G-38.
    \302\ We acknowledge that there are costs associated with our
rule. For further analysis of these, along with the benefits, see
sections I and IV of this Release.
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    Several commenters proposed that we achieve our goals by permitting
advisers to engage solicitors and placement agents that are registered
broker-dealers and subject to rules similar to those adopted by the
MSRB.\303\ One asserted that such rules would be ``a logical extension
of the already-existing regulatory scheme governing broker-dealers.''
\304\ Another agreed, arguing that such rules would be consistent with
the approach the MSRB took when it adopted MSRB rule G-38, the effect
of which was to sweep ``all solicitors of municipal business
(underwriting, sales and advisory) into the broker-dealer registration
regime'' where they would be subject to oversight of a registered
broker-dealer and are required to conform their municipal securities
activities to applicable MSRB rules,

including MSRB rule G-37.\305\ Others suggested we could similarly
achieve our goals by permitting advisers to engage as solicitors
registered investment advisers that are themselves subject to pay to
play restrictions under an Advisers Act rule.\306\
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    \303\ Skadden Letter (``The Commission and FINRA could directly
impose and enforce restrictions on such broker-dealers.''); Davis
Polk Letter (``Registered broker-dealers that provide legitimate
placement agent services could be required by the Commission to
comply with ``pay-to-play'' restrictions''); Credit Suisse Letter
(preclude an investment adviser from using a placement agent that is
not subject to pay to play restrictions analogous to rule G-37);
Comment Letter of the President of M Advisory Group J. Daniel
Vogelzang (Sept. 18, 2009) (``M Advisory Letter'') (treat ``[a]ll
placement agents, investment advisers and consultants * * * exactly
the same regarding prohibited political contributions; i.e., a two-
year ban on doing business with any governmental agency to which a
prohibited political contribution is made.''). See also Comment
Letter of Hudson Capital Management (NY), L.P. (Oct. 5, 2009)
(suggesting Commission take measures to properly license and
regulate third-party solicitors); SIFMA Letter (``The pay-to-play
and political activity of registered placement agents involved in
soliciting government investment could * * * be directly regulated
under the Exchange Act.''). We believe our rule, as adopted, which
allows advisers to pay certain regulated third parties to solicit
government clients on their behalf, addresses these concerns. See
infra notes 312-26 and accompanying text.
    \304\ Davis Polk Letter.
    \305\ SIFMA Letter (``Although Rule G-38(a) specifically
prohibits a municipal dealer from paying a fee to a nonaffiliated
person for solicitation of municipal securities business, the
policies underlying Rule G-38 were to bring solicitors within the
purview of the Federal securities laws--not to exclude the
involvement of registered broker-dealers, including those registered
broker-dealers not affiliated with advisers and private funds.'').
See also Monument Group Letter (``We believe that MSRB Rule G-38 is
not analogous to the proposed rule. Rule G-38 permits a broker-
dealer that is unaffiliated with an issuer to market that issuer's
securities to a public pension plan or any other investor. Proposed
Rule 206(4)-5(a)(2)(i) prevents this and seeks to entirely
disintermediate the process between the issuer of a security and the
ultimate investor.''); Credit Suisse Letter (``[W]e strongly believe
that a more complete analogy to the MSRB Pay-to-Play Rules would not
preclude regulated broker-dealers from performing placement agent
services in the context of municipal investors, as the Proposed Rule
would do. Notably, the MSRB Pay-to-Play Rules do not preclude SEC-
registered broker-dealers from acting as placement agents to
municipal issuers. Instead, the MSRB Pay-to-Play Rules subject such
placement agents to ``pay-to-play'' restrictions and requirements
and preclude them from retaining unregulated third-party finders and
solicitors.'').
    \306\ See, e.g., IAA Letter.
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    We are persuaded by these comments and have decided to revise the
proposed rule to permit advisers to make payments to certain
``regulated persons'' to solicit government clients on their
behalf.\307\ As described in more detail below, ``regulated persons''
include certain broker-dealers and registered investment advisers that
are themselves subject to prohibitions against participating in pay to
play practices and are subject to our oversight and, in the case of
broker-dealers, the oversight of a registered national securities
association, such as FINRA.\308\ As one commenter observed, ``the
Commission would have the direct authority to determine these
restrictions as well as the oversight, control and enforcement of
penalties over any violations. The restrictions could be tailored to
operate with the same underlying purpose and effect on [solicitors] as
the ``pay-to-play'' restrictions imposed on investment advisers.''
\309\ We believe that the application of such rules would provide an
effective deterrent to these solicitors or placement agents from
participating in pay to play arrangements because political
contributions or payments would subject solicitors to similar
consequences, as discussed below.\310\ Because rule 206(4)-5 prohibits
an adviser from compensating a registered adviser solicitor for
solicitation activities if that adviser solicitor does not meet the
definition of ``regulated person,'' the adviser that hired the
solicitor must immediately cease compensating a solicitor that no
longer meets these conditions.\311\
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    \307\ See Rule 206(4)-5(a)(2)(i).
    \308\ Rule 206(4)-5(f)(9). See supra note 85 (noting that, in
this Release, we will refer directly to FINRA, currently the only
registered national securities association). As noted below, under
the definition of ``regulated persons'' as it applies to brokers,
the Commission must find, by order, that a registered national
securities association's pay to play rule applicable to such brokers
imposes substantially equivalent or more stringent restrictions on
them than rule 206(4)-5 imposes on investment advisers and that such
rule is consistent with the objectives of rule 206(4)-5. Rule
206(4)-5(f)(9)(ii)(B).
    \309\ Davis Polk Letter.
    \310\ Another group of commenters argued that third-party
solicitors should be treated as covered associates--that is, their
contributions should trigger the two-year ban for advisers that hire
them. See, e.g., ABA Letter; 3PM Letter; ICI Letter; NY City Bar
Letter; Forum Letter; Jones Day Letter. In explaining our rejection
of this approach in the Proposing Release, we noted that this
approach--which we included in our 1999 pay to play proposal--was
criticized by commenters at that time. See Proposing Release, at
section II.A.3(b). They primarily argued that it was unfair to
impute the activities of third parties to advisers, especially given
what they perceived as the harsh consequences caused by a triggering
contribution--i.e., a two-year time out imposed on the adviser. See
id. They further argued that an approach in which contributions by
third-party solicitors triggered a two-year time out for an adviser
would create over-burdensome compliance challenges because the
adviser could not meaningfully control the contribution activities
of such third parties. See id. We continue to be sympathetic to
these concerns and believe that an approach in which a contribution
by a third party triggered a two-year time out for the adviser that
hires the third party as a solicitor could lead to unfair
consequences. See, e.g., Capstone Letter; Monument Group Letter;
Park Hill Letter. For example, if a solicitor gives a triggering
contribution in order to assist one client, we are concerned about
the harsh result that such a contribution could have on all of the
solicitor's other clients seeking business with the same prospective
government entity client.
    \311\ It would be a violation of the rule for an adviser to
compensate a third party for solicitation of government entity
clients at any time that third party did not meet the definition of
``regulated person,'' regardless of whether the ``regulated person''
failed to meet the definition at the time it was hired or
subsequently.
---------------------------------------------------------------------------

    In light of our decision to permit advisers to make payments to
certain ``regulated persons,'' described below, to solicit government
clients on their behalf, we no longer believe that our proposed
exception from the prohibition on advisers paying third-party
solicitors for payments to related persons and employees of related
person companies of the adviser is necessary.\312\ We had proposed the
exception to enable advisers to compensate these persons for government
entity solicitation activities because we recognized there may be
efficiencies in allowing advisers to rely on these particular types of
persons to assist them in seeking clients. We requested comment
regarding whether the exception would undermine the rule's efficacy by
allowing advisers to compensate certain employees of related person
companies whose contributions would not have triggered the two-year
time out. Although we did not receive comment specifically addressing
our concern,\313\ we believe the approach we are adopting that allows
advisers to pay ``regulated persons'' to solicit government entities on
their behalf will still allow advisers to use employees of certain
related companies--i.e., of those related companies that qualify as
``regulated persons''--as solicitors.\314\
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    \312\ See Proposing Release, at section II.A.3(b).
    \313\ One commenter asked that we clarify the proposed exception
for related parties (Sutherland Letter) and another recommended a
case-by-case determination of whether independent contractors may be
eligible for the exception, due to concern for life insurance agents
who may not technically have qualified as ``employees'' for purposes
of the exception (Skadden Letter). As noted, however, we have
eliminated this exception in favor of allowing advisers to pay
``regulated persons,'' affiliated or not, to solicit government
clients on their behalf.
    \314\ We acknowledge that some advisers may have to bear certain
additional costs of hiring outside parties as a result of our
elimination of our proposal's ``related person'' exception, which
would have allowed advisers to compensate related persons that are
not registered broker-dealers or advisers for solicitation
activities. For a discussion of costs relating to the rule, see
section IV of this Release. But, we also note that the rule, as
adopted, does not favor an adviser with affiliates (which our
proposal would have allowed an adviser to use to solicit on its
behalf) over another adviser without affiliates. Instead, our rule,
as adopted, allows an adviser to pay a ``regulated person''
affiliated or not, to solicit on its behalf.
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(1) Registered Broker-Dealers
    Registered national securities association rules of similar scope
and consequence as the rule we are today adopting could sufficiently
satisfy the concerns that led us to propose to prohibit advisers from
paying brokers to solicit potential government clients. Advisers could
not easily use placement agents covered by such rules to circumvent
rule 206(4)-5. Under this approach, placement agents would be deterred
from engaging in pay to play directly on account of the registered
national securities association's rules. There would be no need for the
Commission to prove in an enforcement action that a contribution by a
placement agent amounted to an indirect contribution by the investment
adviser because the placement agent itself could be charged with
violating the registered national securities association's rules.
Therefore, as adopted, rule 206(4)-5 allows an adviser to compensate
``regulated persons,'' which includes registered brokers subject to a
registered national securities

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

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

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

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

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

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

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

(2) Registered Investment Advisers
    We are also permitting advisers covered by the rule to pay
solicitors for government clients that are registered investment
advisers subject to similar limitations.\322\ Under the rule, a
``regulated person'' includes (in addition to a registered broker
subject to the conditions described above), an investment adviser that
is registered with the Commission under the Advisers Act, provided that
the solicitor and its covered associates have not, within two years of
soliciting a government entity: (i) Made a contribution to an official
of that government entity (other than a de minimis contribution, as
permitted by the rule); or (ii) coordinated, or solicited any person
(including a PAC) to make, any contribution to an official of a
government entity to which the investment adviser that hired the
solicitor is providing or seeking to provide investment advisory
services, or payment to a political party of a State or locality where
the investment adviser that hired the solicitor is providing or seeking
to provide investment advisory services to a government entity.\323\
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    \322\ Rule 206(4)-5(a)(2)(i) (which prohibits advisers and their
covered associates from providing or agreeing to provide, directly
or indirectly, payment to any third party other than a regulated
person to solicit a government entity for investment advisory
services on behalf of such investment adviser).
    \323\ Rule 206(4)-5(f)(9)(i).
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    We received comments urging us to permit advisers to compensate
registered investment advisers for soliciting government officials,
subject to rules or rule amendments the Commission could adopt under
the Advisers Act.\324\ We believe such an allowance is appropriate for
similar reasons to those for permitting advisers to compensate broker-
dealers subject to pay to play rules we have determined meet our
objectives under rule 206(4)-5. We have direct oversight authority over
investment advisers registered with us. Accordingly, we believe it is
appropriate to allow them to act as third-party solicitors for other
advisers. Therefore, the rule, as adopted, limits the advisers that
another adviser may pay to solicit government entities on its behalf to
those advisers that are registered with the Commission \325\ and that
have neither made the types of political contributions that would
trigger the two-year time out nor otherwise engaged in activities
(e.g., bundling of contributions) that the adviser could not engage in
under the rule.\326\
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    \324\ See, e.g., IAA Letter.
    \325\ We are not including within the definition of ``regulated
person'' investment advisers registered solely with State securities
authorities as some commenters suggested. See id. We do not have
regulatory authority over those advisers as we do over advisers who
are registered with us (and as we do over FINRA in connection with