Vice President Kamala Harris' selection of Minnesota Governor Tim Walz as her running mate highlights a wrinkle in Investment Advisers Act Rule 206(4)-5 (the “Pay-to-Play Rule” or “Rule”) to which investment advisers should be paying close attention in the coming months. Given Walz's current role as the governor of Minnesota, contributions to the Harris-Walz campaign following his selection could run afoul of the Pay-to-Play Rule, leading to significant consequences. Supporters of the campaign subject to the Rule can still provide financial support to the ticket in many other ways, which we outline below. Contributions to the Trump-Vance campaign do not implicate the same compliance considerations.
Background
Rule 206(4)-5 is intended to deter investment advisers and certain of their associated personnel (“covered associates”)1 from using campaign contributions to exert improper influence over state and municipal elective officeholders with authority over existing or prospective investment decisions by public-sector clients (e.g., public treasuries, endowments, pension funds). The Rule prohibits an adviser from receiving compensation for providing advisory services to a state or local public investment pool for two years after the adviser or one of its covered associates makes a campaign contribution to certain government officials or candidates for election.
Relevant here, a government “official” is defined as a candidate for or incumbent in state or local elective office if the office is responsible for, or can influence, the selection of investment advisers to provide investment services for a public investment pool. As one investment adviser recently found out the hard way, donations to Minnesota politicians serving on the Minnesota State Board of Investment can violate the Rule. In that instance, a covered associate made a $4,000 campaign contribution while the investment adviser was managing funds for the state investment board, and the adviser paid a $60,000 fine to the Securities and Exchange Commission (SEC).2 Notably, the governor of Minnesota is a member of the board and therefore donations to the governor could violate the Rule if an adviser has managed Minnesota state funds in the past two years or is seeking to do so in the future.
As many advisers are well aware, contributions to federal officials and candidates—such as a candidate for president or vice president—are typically not covered by the Pay-to-Play Rule. However, perhaps counterintuitively, the Rule does apply to contributions to campaigns for federal office by current state or local officials. Thus, the Rule could apply to contributions to a presidential ticket that includes a sitting governor running for vice president—such as Governor Walz.
Best Practices
Now more than ever, investment advisers should pay close attention to their policies and procedures to ensure that the pay-to-play risks posed by campaign contributions by certain personnel are effectively and proactively addressed. Though the impact of risk mitigation efforts on participation in the political process may be unpopular among an investment adviser's personnel, the consequences of a violation—not only fines but also potential prohibition on the investment adviser from receiving any compensation from a government entity for two years—are too significant to be ignored.
Under an exception to the Pay-to-Play Rule for de minimis contributions, any person eligible to vote in the US presidential election can make direct contributions totaling up to $350 to the Harris-Walz campaign without triggering the Rule. And as noted, there are ways that affected investment adviser personnel can provide financial support to the Harris-Walz ticket other than through direct contributions to the campaign. For example, the SEC staff has stated that so-called independent expenditures (i.e., election-related expenditures made without coordination with a candidate's campaign committee) are not subject to the Pay-to-Play Rule.3 Thus, contributions to super PACs—which by definition may not make direct contributions to candidates or political parties—should not trigger the Rule. Moreover, contributions to multi-candidate PACs will not necessarily cause a two-year time-out either, so long as contributions are neither earmarked to benefit a specific candidate nor an attempt to circumvent the intent of the Rule by doing indirectly what cannot be done directly.4 In addition, the Rule does not apply to contributions to national committees or state parties, which means that in the case of the Harris-Walz ticket, supporters could donate to the Democratic National Committee or their state Democratic Party.5 Finally, the Pay-to-Play Rule does not constrain the political contributions of family members of an investment adviser's covered associates,6 and the Rule imposes no limits on the ability of any individual to volunteer their time to assist the campaigns of candidates they support.7
Some advisers implement pre-clearance procedures for all political contributions by personnel so that compliance can review and confirm that each planned contribution is acceptable. In the case of a planned contribution to a super PAC or multi-candidate PAC, investment advisers should obtain a written confirmation of the specific practices of the recipient entity to ensure that the Pay-to-Play Rule will not be violated by a contribution. Additionally, periodic compliance checks of public campaign contribution databases for donations are prudent, as are supplemental trainings, compliance attestations, and/or compliance alerts for personnel to highlight the issue.
Our team has extensive experience designing and working with clients to implement effective pay-to-play policies and procedures focused on meeting the expectations of regulators, as well as seeking exemptions in the event of potential violations and defending conduct before the SEC.
Footnotes
1. An investment adviser's “covered associates” include: (1) any general partner, managing member or executive officer, or other individual with a similar status or function; (2) any employee who solicits a government entity for the investment adviser and any person who supervises, directly or indirectly, such employee; and (3) any political action committee controlled by the investment adviser or by a covered associate.
2. SEC, Investment Advisers Act Release No. 6590 (Apr. 15, 2024).
3. See 75 Fed. Reg. at 41024 (July 14, 2010).
4. For instance, a chain of contributions through PACs made for the purpose of avoiding the Pay-to-Play Rule would violate the Rule's prohibitions against doing anything indirectly that would be prohibited if done directly.
5. Though contributions to state parties are generally permissible, it is important to note that the Rule prohibits advisers and their covered associates from coordinating or soliciting any person or PAC to make any 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.
6. However, the SEC has emphasized that an adviser and its covered associates may not funnel payments through family members or other third parties, such as friends, consultants, or companies affiliated with them.
7. However, the Rule prohibits an adviser and its covered associates from coordinating contributions to an official of a government entity to which the adviser is providing or seeking to provide investment advisory services. Thus, any volunteer activities associated with fundraising should be closely scrutinized.
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.