In August 2016 the SEC approved FINRA rules for a new category of advisers known as “Capital-Acquisition Brokers” or “CABs”. CABs are firms that engage in a limited range of activities, essentially advising companies and private equity funds on capital raising and corporate restructuring, and acting as placement agents for sales of unregistered securities to institutional investors under limited conditions. But, unlike full-service brokers, CABs are not authorized to handle customer accounts or trade customer securities. The CAB rules subjected CABs to certain FINRA rules, but did not expressly provide that the FINRA pay-to-play rules apply to CABs. Accordingly, CABs were not “regulated persons” under the SEC’s pay-to play rules and therefore could not be retained by investment advisors to solicit government entities.
On September 29, 2017 this loophole was addressed, and the SEC approved new rules by FINRA subjecting registered brokers and financial advisors to the same pay-to-play rules that registered investment advisors have been subjected to under the SEC. The rule now makes it possible for investment advisors to hire CABs to solicit government work since all entities are now operating under the same pay-to-play rule book.
“The commission believes that the proposal will help protect investors and the public interest by, among other things, clarifying that CABs and non-CAB member firms are subject to the same rule regime as they engage in distribution or solicitation activities with government entities on behalf of investment advisers, and by deterring pay-to-play practices,” the SEC said.
Throughout 2017 the SEC, FINRA and other primary regulatory authorities have placed an importance on their pay-to-play rules. In the month of January 2017 alone, the SEC settled 10 cases involving violations of the pay-to-play rules with investment advisory firms. These cases settled with firms paying fines ranging from $35,000-$100,000 in addition to relinquishment of 2 years of management fees. All 10 firms were punished for accepting compensation from public pension funds for advisory services before the end of the mandatory two-year time out. While it is unclear whether these violations were purposeful or an unfortunate accident all firms paid a hefty price. Now that placement agents and other firms registered with FINRA are subject to similar rules of the SEC, advisors to private funds must now also be aware of their placement agents’ contributions made to government officials or candidates for political office.
The SEC’s hypervigilance on conflicts of interest, including political contributions, warrants an equal degree of vigilance by investment advisors to make sure that their employees’ political contributions can overcome regulatory scrutiny. The SEC and FINRA are looking to draw a clear line between acquiring public pension investments through the proper channels and acquiring such business through unethical channels (i.e. making political contributions in exchange for investment business). Due to several high-profile conflicts of interest cases that necessitated the pay-to-play rule, the SEC seems to be looking to avoid another scandal by “bringing down the hammer” on any and all offenders. Firms have received significant fines in addition to imposition of the two-year waiting period mandated by the SEC and FINRA which means disgorgement of management fees received from the governmental plan for the past 2 years. Investment advisors need to stay up to date and compliant with both FINRA and SEC rules as both regulators’ rules can have a significant impact on their bottom line. Most firms recently fined for violations of the SEC rules were not even aware of political contributions made by their third-party placement agents.
A few best practices can be implemented at your firm to ensure compliance with the SEC and FINRA pay-to-play rules:
- Make sure your employees as well as your placement agents understand and adhere to the pay-to-play rules and your firm’s Political Contributions policy. Compliance training that includes a hefty dose of political contributions content can be a very effective measure.
- Require your employees and placement agents to disclose all political contributions and maintain records of all contributions. A pre-approval policy and quarterly certifications attesting to political contributions made are effective methods to ensure accurate disclosure.
- Implement effective controls to ensure adherence to your firm’s political contributions policies and procedures. Monitoring political contributions websites can identify undisclosed political contributions made by your employees and placement agents.
- When an unauthorized political contribution is discovered take immediate action to remediate the situation. Violations of the firm’s Political Contribution policy that do not involve government entities that the firm does business with or is seeking to do business with can be handled as a disciplinary matter. Contributions that would violate the pay-to-play rule itself may be cured if discovered by the advisor within 4 months of the date of the contribution and the advisor facilitates the return of the triggering contribution within 60 days of learning about. In limited situations an exemption may be requested.
With the penalty for violating the pay-to-play rule so severe, why leave it to chance? Contact ICSGroup, a firm with proven experience for help.