On August 6, 2024, the Democratic nominee for President, Kamala Harris, chose Tim Walz, Governor of Minnesota, as her running mate. This selection presents important considerations vis à vis the "Pay-to-Play Rule" (Rule 205(4)-5 under the Investment Advisers Act of 1940) for registered investment advisers and exempt reporting advisers that advise (or seek to advise) certain Minnesota "government entities" or who have (or are soliciting) investments by such entities in their investment funds.
The Securities and Exchange Commission (SEC) has pursued enforcement actions against numerous advisers under this rule resulting in severe penalties, and enforcement actions with respect to the Pay-to-Play Rule is the most common category of enforcement actions against exempt reporting advisers. Notably, these SEC enforcement actions have been brought even in the absence of any intent to influence the investment decisions of the government entities, including where the contribution was made many years after the government entity was already a client or an investor in the adviser's investment fund.
Advisers should be (i) reviewing existing client and investor lists for Minnesota government entities, (ii) engaging in training and sending reminders to their employees with respect to their policies on political contributions, and (iii) engaging in other monitoring activities to ensure all political contributions are being pre-cleared and reported to the adviser to the extent required under the applicable policies.
Background
The Pay-to-Play Rule makes it unlawful for an adviser
- to provide investment advisory services for compensation to a "government entity" (e.g., a state or local pension plan or public university endowment and any fund in which the plan invests)
- within two years after a "contribution" (defined broadly to include: (i) any gift, subscription, loan, advance, or deposit of money or anything of value (emphasis added); (ii) payment of debt incurred in connection with an election or transition; or (iii) inaugural expenses of a successful candidate for a state or local office) subject to certain limited exceptions
- made by the adviser or any of its "covered associates" (i.e., any general partner, managing member or executive officer or other individual with similar status or function; any employee who solicits a government entity for the adviser and any person who supervises, directly or indirectly, such employee, including employees of a parent company in the supervisory chain; and any political action committee (PAC) controlled by the investment adviser or any of the aforementioned persons; "covered associate" includes any person who becomes a covered associate within two years after the person made such contribution—unless the employee does not solicit government entities, in which case the look back is six months—and includes covered associates for six months once their employment ends)
- to an "official" regardless of whether successful (i.e., someone with authority, or who would have authority if elected, regarding a government entity to (i) make, or influence, the entity's appointment of an investment adviser or (ii) appoint members to a board that chooses the investment adviser).
Additionally, the Pay-to-Play Rule makes it unlawful for a covered associate to (i) coordinate or solicit any person or PAC to make such a contribution or (ii) make a payment to a political party of a state or locality where the investment adviser is providing or seeking to provide investment advisory services to a government entity, although violations of these provisions do not trigger the ban on compensation. Further, it is unlawful for an adviser or any of its covered associates to do anything indirectly which, if done directly, would result in a violation of the Pay-to-Play Rule. Contributions to a PAC may or may not violate the Pay-to-Play Rule depending on the focus of the PAC (e.g., whether it is directed to specific officials), and such contributions require careful analysis.
Prohibitions Triggered by Walz's Candidacy
A covered associate who makes a political contribution above a de minimis amount ($350 to a candidate for whom the covered associate is entitled to vote and $150 to a candidate for whom the covered associate is not entitled to vote) to an official (e.g., the Governor of Minnesota)1 triggers the two-year time out from accepting compensation from a Minnesota government entity client or investor for investment advisory services.
The Pay-to-Play Rule is often referred to as a "strict liability rule" because once a contribution in excess of the de minimis amount is made, there is no means to avoid the two-year time out other than (i) the limited exception for returned contributions or (ii) requesting and receiving exemptive relief from the SEC (an arduous and expensive process during which the applicable compensation must held in escrow).
Suggested Steps
Registered investment advisers and exempt reporting advisers should review their existing client and investor lists as well as their prospective client and investor lists to determine if there are any Minnesota government entities that would be affected by the Pay-to-Play Rule. Advisers should also review any side letters with Minnesota government entities for any relevant restrictions on political contributions.
Advisers should provide regular training and reminders to employee during election season, especially advisers that have or seek Minnesota government entities as clients or investors, regarding the adviser's pay-to-play policies and procedures and the dire consequences for the adviser of a misstep. Notably, the Pay-to-Play Rule provides an extremely limited exception for certain promptly returned contributions. Even if a contribution fails to meet the strict requirements of the exception, requesting and receiving the return of a contribution in excess of the de miminis amount is important in establishing the good faith of the adviser in trying to redress the issue to the greatest extent possible. This is an important fact in seeking exemptive relief.
Additionally, advisers should consider enhancing their monitoring of political contributions during the election season by regularly checking websites that track contributors along with contribution amounts.
Notably, there are additional state and local pay-to-play rules and lobbying rules. Advisers must be aware and observant of such rules, as applicable.
Footnote
1 For example, among other things, the Governor of Minnesota appoints three members of the Minnesota State Retirement System Board of Directors. See MSRS Board of Directors | Minnesota State Retirement System (MSRS).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.