November 1, 1999
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W., Stop 6-9
Washington, D.C. 20549
Re: File No. S7-19-99-Political Contributions by Certain Investment Advisers
Dear Mr. Katz:
The Association for Investment Management and Research (AIMR)1 is pleased to comment on proposed rule amendments by the Securities and Exchange Commission (Commission) governing the activities in the area known as "pay to play". The AIMR Advocacy Committee (AIMR Committee)2 offers its comments below.
Background and Summary
The SEC has proposed a new rule under the Investment Advisers Act, as well as amendments to the current recordkeeping rule to govern the practice known as "pay to play" in the investment adviser area. Specifically, new Rule 206(4)-5 would prohibit investment advisers from providing advisory services in exchange for compensation to any government client for two years after the adviser, or its partners, executive officers or solicitors, make political contributions to certain elected officials or candidates. Also proposed are amendments to existing Rule 204-2 that would require registered advisers that have government clients to maintain records of political contributions made by the adviser or any of its partners, executive officers or solicitors. Such records would be confidential and reviewed only by the Commission staff in the course of an adviser examination.
In proposing these changes, the Commission reasons that elected officials who allow political contributions to play a role in the management of public pension plan assets violate the public trust and undermine the fairness of the process by which public contracts are awarded. Advisers who seek to influence the award of an advisory contract through political contributions similarly are seen to compromise their fiduciary obligations to the plans. Concerned that Municipal Securities Rulemaking board Rule G-37, which applies to broker-dealers, has shifted the incidence of pay to play activities to the investment adviser arena, the Commission is now focusing on regulating the practices of advisers.
AIMR has long stood for market integrity through the creation and maintenance of high ethical standards in the investment industry. The AIMR Committee therefore appreciates the Commission's sensitivity to practices that are perceived to threaten investor protections, compromise fiduciary integrity or otherwise undermine the fairness of procedures by which public pension plans are run. While certain members of the AIMR Committee question the focus on advisers, rather than on the actions of the public officials who are awarding the contracts, the Committee is unwavering in its support of promoting the highest ethical standards and practices by investment advisers. The AIMR Committee does question the approach and substance of certain provisions of the Commission's pay to play proposal. These concerns are addressed below.
I. AIMR Code and Standards
Through its Code of Ethics and Standards of Professional Conduct (Code and Standards), with which all AIMR members must adhere, AIMR prohibits the types of conduct that give rise to the very activities that the Commission hopes to regulate through its Proposal. AIMR members are particularly charged with remaining aware of potential conflicts and remaining faithful to the personal and professional conduct required by the Code and Standards.
AIMR's Code and Standards require all AIMR members and candidates, at a minimum, to comply with all laws and rules of governments, governmental agencies, and self-regulatory organizations, as they carry out their professional, financial, or business activities. AIMR believes that as a matter of professional responsibility, and minimum professional conduct, each investment professional should be aware of, and comply with, laws and rules governing their conduct. Thus, in addition to other minimum standards of conduct expected, which in many cases may exceed the law, it is considered axiomatic that each investment professional comply with the law.
The commitment to high fiduciary standards is a paramount principle of the AIMR Code and Standards. In fact, the AIMR Standards of Practice Handbook directs all AIMR members who are fiduciaries for public plans to scrutinize laws and state statutes, as well as plan guidelines, to determine the extent of duty. In the absence of specific directions, the member is directed to "follow the basic tenet of fiduciary laws: loyalty, impartiality, and prudence when making decisions involving plan assets."3
AIMR's Code and Standards also stress the inherent responsibilities of industry leaders, compliance officers, and supervisors to tighten up internal compliance procedures, or suffer the inevitable consequences of losing the public trust, attracting attention from regulators, and being subject to disciplinary action. AIMR believes that investment professionals must act in a manner consistent with their obligation to deal fairly with all customers and clients when disseminating investment recommendations, disseminating material changes in prior investment advice, and in taking investment action. Only through the fair treatment of all parties will the confidence of the investing pubic be maintained.
In particular, Standard I of AIMR's Standards of Professional Conduct requires members to maintain knowledge of and comply with all applicable laws, rules and regulations of any government, government agency, or professional association governing the members' professional activities. In addition, Standard II.B requires members not to engage in any professional conduct that would adversely reflect on their honesty, trustworthiness or professional competence. Thus, AIMR members are required not only to abide by the law, but also to avoid even the appearance of impropriety.
Moreover, under the AIMR Standards, supervisors must take an active role in overseeing conduct that will not compromise the high fiduciary duties required of investment advisers. Standard III.E requires AIMR members who are supervisors to exercise reasonable means to prevent any violation of applicable statutes, regulations or provisions of the Code and Standards. All of these provisions, as well as the overriding principles established in the Code and Standards of fiduciary duty, fair dealing and impartiality provide the benchmarks for ethical conduct. It is this adherence to high ethical conduct that ultimately lies at the heart of the Commission's Proposal.
II. Specific Comments
The AIMR Committee recognizes the need to balance the protection of investors (in this case, beneficiaries of the plans being compromised by pay to play practices) against the burden on the industry. The "burden" of the current Proposal manifests in several ways.
The AIMR Committee believes the proposed scope of the rules does not achieve the appropriate "level playing field." As proposed, Rule 206(4)-5 would apply to advisers that register with the SEC, including those with fewer than fifteen clients during the last 12 months. It generally would not apply to smaller, state-registered advisers. While, as a practical matter, the majority of advisers to public funds may be those registered with the SEC, the AIMR Committee favors an approach that treats all in this role similarly. The AIMR Committee therefore urges a uniform application of pay to play regulations to all advisers, whether state or SEC-registered.
Impracticality of Compliance
In addition, there are substantial concerns about the feasibility of complying with certain provisions of the Proposal. In particular, the AIMR Committee believes that the compliance requirements of the "look-back provision" impose an unreasonable burden on investment advisers.
The proposed rule would prohibit advisers from providing advice for compensation to a government entity within two years after a contribution to an official of a government entity has been made by (a) the adviser, (b) any of its partners, executive officers or solicitors or (c) any political action committee controlled by the adviser or by any of its partners, executive officers or solicitors. Contributions made by the partner, executive officer or solicitor would also be attributed to any other adviser that employs or engages the person who made the contribution within two years after the contribution was made. This "look-back" provision would require that an adviser determine whether it is subject to restrictions when employing or engaging a partner, executive officer or solicitor.
The AIMR Committee believes that this provision is not only overly restrictive, but sets a level of monitoring and administrative recordkeeping that would be difficult to achieve. For example, would a firm's compliance obligations under the Rule be met by simply questioning a newly-employed person as to prior contributions? What would be required to verify the accuracy of the information? Would the new employer be required to confer with, and obtain documentation for a two-year period, from prior employers?
The AIMR Committee believes the objectives of the Commission's Proposal can be met without the administrative burden that would be imposed by the look-back provision. If the Commission determines to retain the proposed look-back provision, the AIMR Committee asks that it provide explicit guidance as to its parameters.
The AIMR Committee agrees that groups such as spouses, control persons and affiliates should not fall within the ambit of this requirement. However, even the inclusion of "solicitors" in this group to be monitored under the look-back provision poses an enforceability problem. Given that solicitor is defined, for purposes of the Proposal, to include those who indirectly solicit any client for an adviser, creation of a tracking system to capture this information would impose an unreasonable burden on advisers. The AIMR Committee thus suggests that solicitors, as defined, be deleted from the applicable scope of the look-back provision.
Similarly, "executive officers," which would be covered by the provision, would include "other persons who perform a policy-making function for the adviser." While this tracks the language in the Advisers Act of 1940, the AIMR Committee believes extending this to the look-back requirement could go well beyond the intentions of the Proposal. The Committee urges the Commission to narrowly define the scope of "executive officer" in this case and to provide explicit examples of those that would be deemed to hold a policy-making position under the Rule. Again, the AIMR Committee
urges the Commission to formulate a construction that avoids imposing an unreasonable burden on the adviser's information gathering and recordkeeping systems.
Monitoring and Recordkeeping
In its Proposal, the Commission requests suggestions for alternative means for enforcing the new rule. In response, the AIMR Committee suggests that the Commission consider a monitoring and recordkeeping system based on "negative reporting." Recognizing the discomfort certain employees may have in revealing the focus of their campaign contributions, the Committee believes that the Commission can accomplish its purpose in stemming pay to play practices by asking employees to confirm that they have not made contributions to certain candidates or officials, rather than listing all contributions that they have made.
Under this approach, a firm would circulate on a routine basis, a list of all public clients, as well as public entities that are being solicited by the firm. All those subject to the rule would have to confirm that they had not made political contributions (in excess of the mandated limit) to officials (or candidates) in those jurisdictions, except as
disclosed. This system would allow employers to effectively screen pay to play practices and establish an effective recordkeeping system, without unnecessarily compromising privacy issues.
The AIMR Committee appreciates the opportunity to comment on this rule proposal. If we can provide additional information, or answer any questions, please do not hesitate to contact Deborah Lamb at 404-724-4233 or Linda Rittenhouse at 804-951-5333.
Deborah A. Lamb and Linda L. Rittenhouse
Chair, AIMR Advocacy Committee and AIMR Vice President and Associate General Counsel
cc: AIMR Advocacy Distribution List
1 The Association for Investment Management and Research is a global, nonprofit organization of over 39,000 investment professionals from 91 countries. Through its headquarters in the U.S. and 89 Member Societies and Member Chapters throughout the world, AIMR provides global leadership in investment education, professional standards, and advocacy programs.
2 The Advocacy Advisory Committee coordinates the priorities of AIMR's Advocacy committees and reviews major new regulatory, legislative, and other developments affecting AIMR's global membership.
3 Topical Study: Fiduciary Duty, AIMR Standards of Practice Handbook (8th ed.) 1999.