SEC EXTENDS COMPLIANCE DATE: RESTRICTIONS ON POLITICAL CONTRIBUTION BY CERTAIN INVESTMENT ADVISERS AND BAN ON THIRD-PARTY SOLICITATION

On June 11, 2012, the Securities and Exchange Commission ("SEC") extended the date by which advisers must comply with the third-party solicitation ban under rule 206(4)-5 of the Investment Advisers Act of 1940 ("Advisers Act), the "Pay-to-Play Rule" (the "Rule").

Who may be impacted?

· Investment advisers that seek to manage, or managing, assets of state and local governments, including but not limited to, state pension funds.

· Employees and certain other related persons of the investment advisers described above.

· Certain third parties conducting solicitation activities on behalf of the investment advisors described above.

Purpose of Extension: to provide sufficient time for them to conform to the Rule, to revise their compliance policies and procedures, and to meet record-keeping requirements.

Effective date: The effective date for the ban on third-party solicitation under rule 206(4)-5 of the Advisers Act remains September 13, 2010.


Compliance date: The compliance date is extended until nine months after the compliance date of a final rule adopted by the SEC by which municipal advisor firms must register under the Securities Exchange Act of 1934 ("Exchange Act"). Once such final rule is adopted, the SEC will issue the new compliance date in a notice in the Federal Register.

BACKGROUND

On July 1, 2010, the SEC adopted new Rule 206(4)-5 ("Pay-to-Play Rule") under the Advisers Act in order to prohibit investment advisers from providing investment advisory services for compensation to a government client for two years after the adviser or certain of its executives and employees ("Covered Associates") make a contribution to certain elected officials or candidates. The Rule also prohibits advisers and their Covered Associates from providing or agreeing to provide, directly or indirectly, payment to any third-party for a solicitation of advisory business from any government entity on behalf of such advisor, unless such third-party is an SEC-registered investment adviser or a registered broker-dealer subject to similar pay to play restrictions of a registered national securities association.

The Rule seeks to protect the beneficiaries of invested state and municipal assets, such as state and municipal pension plans and their participants, by restricting the ability of investment advisers to use political contributions to influence those governmental officials responsible for the hiring of investment advisers. The Rule is designed to prevent higher fees paid to advisers for potentially inferior advisory services because of an attempt to recoup political contributions by the adviser; to ensure that investment advisory contracts and the terms thereof are negotiated at arms-length; and to promote the most suitable adviser for business, especially when the most suitable adviser is a smaller adviser who cannot afford to make political contributions.

The Rule does not apply to small advisers registered with a state securities authority, advisers that are unregistered in reliance on an exemption other than Section 203(b)(3), or advisers excluded from the definition of "investment adviser" under Section 202(a)(11) of the Advisers Act.

DESCRIPTION OF THE RULE

Two-Year "Time-Out" Rule. Under the Rule, if an adviser or a Covered Associate of the adviser makes a contribution to an official of a government entity who is in a position to influence the hiring of an adviser, then the adviser isprohibited from receiving compensation for providing advisory services to that government entity for two years thereafter, otherwise known as a "time-out" period.

"Contribution" is defined as any gift, subscription, loan, advance, or deposit of money, or anything of value made for:

· The purpose of influencing election for federal, state, or local office.

· The payment of debt incurred in connection with any such election.

· Transition or inaugural expenses incurred by a successful candidate for state or local office.

The definition of a "Covered Associate" of an investment adviser includes:

· General partner, managing member, executive officer or other individual with a similar status or function.

· Employee who solicits a government entity for the investment adviser and any person who supervises, directly or indirectly, such an employee.

· Political Action Committee ("PAC") controlled by the investment adviser or by any of its Covered Associates.

The Rule requires a two-year look-back period for all Covered Associates who solicit clients, but only a six month look-back for "new" Covered Associates who do not solicit clients. The "look-back" period will follow Covered Associates from firm to firm, meaning a prohibited contribution by a Covered Associate will result in a "time out" for the Covered Associate's new firm for the remainder of the two-year or six-month period, depending on whether the Covered Associate solicits clients for the new firm. In the meantime, if a Covered Associate makes a prohibited contribution and then leaves that investment adviser, the adviser will still be subject to the two-year time-out period, despite the departure of the Covered Associate who made the contribution.

Exceptions to the "time-out" provision

The de minimis exception allows a Covered Associate of an adviser that is a natural person to contribute: (i) up to $350 to an official per election (with primary and general elections counting separately) if the Covered Associate was entitled to vote for the official at the time of the contribution, and (ii) up to $150 to an official per election (with primary and general elections counting separately) if the Covered Associate was not entitled to vote for the official at the time of the contribution.

The returned contribution exception allows an adviser to undo a prohibited contribution if the Covered Associate who made such political contribution was not entitled to vote for the official at the time of the contribution. To be eligible, the contribution had to be less than $350, the adviser must have discovered the contribution within four months of the date of such contribution, and the adviser must cause the contributor to re-collect the contribution within 60 days after the adviser discovers the contribution.

In addition, the Rule allows an adviser to apply for a relief exempting it from the two-year time-out requirement in the event of a good-faith inadvertent violation when the imposition of the time-out provision is unnecessary to achieve the Rule's intended purpose.

Ban on using third person to solicit government business. The Rule prohibits an adviser or a Covered Associate from paying (or agreeing to pay), directly or indirectly, any person to solicit a government entity for advisory services on behalf of the adviser. However, such solicitation is not prohibited if the person is:

· A "regulated person" or

· An executive officer, general partner, managing member (or person with similar status or function), or employee of the adviser.

The "regulated person" includes:

· Registered investment adviser that has not (and whose Covered Associates have not) made, coordinated, or solicited a contribution within the last two years that would violate the Rule.

· Registered broker or dealer that is a member of a registered national securities association which has rules substantially equivalent to the Pay-to-Play rules of the SEC.

· Municipal adviser that is registered with the SEC and is subject to pay to play rule adopted by the Municipal Securities Rulemaking Board ("MSPB").

The word "solicit" is defined as communicating, directly or indirectly, for the purpose of obtaining or retaining a client for, or referring a client to, an adviser, or obtaining or arranging a contribution or payment.

The Rule also prohibits "bundling" practices, whereby a person acting on behalf of the adviser collects small contributions from several employees of the adviser to create one large contribution.

Application to pooled investment vehicles. The Rule's prohibitions will apply to advisers and sub-advisers of certain pooled investment vehicles, or "covered investment pools." Under the Rule, advisers to covered investment pools in which a government entity invests or is solicited to invest are treated as though they provided or solicited services directly to that government entity.

The covered investment pool includes, but not limited to, funds exempt under Section 3(c)(1) or 3(c)(7) of the Investment Company Act.

Amendments to recordkeeping requirements. The Rule imposes additional recordkeeping obligations on advisers that provide investment advisory services to a government entity or a covered investment pool in which a government entity is an investor. Such advisers must collect and maintain:

· The names, titles, and business and residence addresses of all Covered Associates of the adviser.

· All government entities to which the adviser provides or has provided investment advisory services (directly or indirectly through a covered investment pool) in the last five years.

· All direct and indirect contributions made by the adviser or its Covered Associates to an official of a government entity or direct or indirect payments made to a political party or PAC.

· The name and business address of each regulated person to which the adviser agrees to provide direct or indirect payment to solicit a government entity.

Impact on Advisers and Covered Investment Pools

The Rule is complicated and provides significant opportunities for violations. Thus, many advisers may need to either bar all political contributions by their employees or to seek special relief from the SEC and potentially defer or hold in escrow advisory fees from government entity clients, pending receipt of such relief.

Advisers should be aware that pay-to-play practices may violate federal and state laws that carry criminal sanctions, as well as state and local laws that may disqualify advisers from providing services to government.

Advisers should consider taking the following steps:

· Impose preclearance requirements on all political contributions by Covered Associates, including employees, so that the adviser is able to assess whether they would trigger requirements under the Rule. It would also be advisable to clearly identify Covered Associates and make sure such persons are aware of their status.

· Incorporate in solicitation and placement agent agreements the Rule's requirements and bar the solicitor or placement agent from engaging in prohibited political contribution activities under the Rule.

· Put in place procedures to identify government entities invested in pooled investment funds managed by the adviser.

· Adopt pre-hire and termination procedures designed to ensure that political contribution activities by new or departing employees do not trigger a time-out under the Rule.

· Develop a surveillance process for political contribution activities by employees.

· Adopt new compliance policies and procedures to incorporate steps recommended above and roll out employee training programs to educate employees about the new requirements.

The SEC's adopting release is available at: http://www.sec.gov/rules/final/2010/ia-3043.pdf.

For further discussion of the issues addressed in this memorandum, please contact our attorneys.


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