Charles Schwab & Co., Inc.
101 Montgomery Street
San Francisco, California 94104
November 1, 1998
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File No. S7-19-99 - Political Contributions by Certain Investment Advisers
Dear Mr. Katz:
Charles Schwab & Co., Inc. ("Schwab") appreciates the opportunity to comment on the Securities and Exchange Commission's ("Commission" or "SEC") recent proposal to adopt Rule 206(4)-5 (the "Proposed Rule") under the Investment Advisers Act of 1940 (the "Advisers Act"), which is intended to eliminate "pay-to-play" practices by investment advisers.1 The Proposed Rule would prohibit an investment adviser from providing advisory services for compensation to a government client for two years after the adviser or any of its partners, executive officers or solicitors makes a contribution to certain elected officials or candidates.
Schwab supports the Commission's intended purpose for the Proposed Rule, but we believe that the Rule as currently proposed would apply too broadly and have unintended consequences. As discussed below, Schwab's recommends that the Commission narrow the Proposed Rule's scope so that its purpose can be achieved with less restrictive means. Specifically, the Proposed Rule should cover political contributions by only those solicitors that the adviser compensates to solicit government clients.
Schwab is a broker-dealer and is also a SEC registered investment adviser. Schwab serves 6.3 million active accounts with $595 billion in customer assets. Through its Schwab Institutional Services for Investment Managers enterprise, Schwab renders brokerage, custody and related services to over 5,600 independent investment advisers whose clients' accounts with Schwab total over $180 billion. Schwab is the market leader in providing these services to independent investment advisers.
Schwab offers a service called Schwab AdvisorSourceTM through which representatives in Schwab's branch offices refer interested retail investors to participating independent investment advisers. Participating advisers pay Schwab a fee in compliance with the Commission's cash solicitation rule under the Advisers Act.2 The relatively small participation fee is primarily intended to cover Schwab's costs of administering the service. It is not tied to whether the referral results in new business for the adviser. Over 400 independent advisers currently participate in AdvisorSource. Nearly all participating advisers have greater than $25 million in assets under management and are registered with the Commission under the Advisers Act. Representatives at over 300 Schwab branches currently offer AdvisorSource to Schwab customers and prospects. This year to date, Schwab has made over 23,000 referrals through the service. Assets in Schwab customer accounts managed by participating advisers as a result of AdvisorSource referrals currently total $5.3 billion. Schwab's customers are predominately retail investors. AdvisorSource is not a referral service for government entities seeking investment managers, and Schwab has not referred government entities to participating advisers. Separate from AdvisorSource, participating advisers have or are seeking government entity advisory clients.
Less Restrictive Means are Available
To Achieve the Proposed Rule's Purpose
The Proposed Rule is overly broad and would unduly burden investment advisers in ways that the Commission probably does not intend. The Commission has recognized that "investment advisers play a key role in the economic life of America today."3 Advisers can successfully play this key role only if regulation intended to protect investors is not unduly burdensome. The Commission recognized that the Proposed Rule would burden advisers and limit the ability of their associated persons to exercise their rights to participate in the political process. Thus, the Commission requested comment on the scope of the Proposed Rule's application to adviser-associated persons and the availability of less restrictive means to achieve its purpose.4 Schwab agrees that the influence of political contributions on a government entity's selection of an investment adviser may be inconsistent with investor protection. Nevertheless, we believe that the Proposed Rule can and should be better tailored to avoid undue burden on advisers.
The Proposed Rule Should Cover Only Those Solicitors
The Adviser Compensates for Soliciting Government Clients
One way in which the Proposed Rule should be narrowed is to cover political contributions by only those solicitors that the adviser compensates to solicit government clients.
The Proposed Rule's two-year ban on receiving advisory compensation from a government entity is triggered by certain political contributions not only by the adviser but also by certain persons associated with the adviser, including the adviser's solicitors.5 The Proposed Rule defines "solicitor" as "any person who, directly or indirectly, solicits any client for, or refers any client to, an investment adviser."6 The Proposed Rule therefore presumes that all non-exempt7 contributions by all solicitors are for the purpose of influencing the government entity's selection of an investment adviser. Schwab submits that this presumption is incorrect, particularly as it applies to third party solicitors.
The Proposing Release states that the Commission found that pay-to-play political contributions "were typically made by executives of the adviser or persons who solicit government clients on behalf of the adviser."8 This statement appropriately reflects the need for a sufficient nexus between the solicitor's activities and the adviser's government advisory business for the Proposed Rule to cover the solicitor's political contributions. The Commission should not restrict political contributions by persons who have no incentive to influence a government entity's selection of an adviser. Political contributions by solicitors that are not paid by the adviser to solicit government clients are not "payments to play" and should not trigger the Proposed Rule's two-year ban on the adviser.
The Proposing Release notes that the definition of solicitor is intended to cover employees "who play a role in obtaining government clients..."9 If the adviser's own employees who play no role in obtaining government clients are not covered by the Proposed Rule, then neither should the adviser's solicitors who do not solicit government clients. We believe that the Proposing Release reflects the Commission's intent for the Proposed Rule to cover only those adviser associated persons whose jobs are sufficiently related to the adviser's government business to raise the potential for pay-to-play contributions. The definition of solicitor should be revised to reflect this intent.
The definition as currently drafted fails to limit the Rule's coverage to persons with an incentive to make pay-to-play contributions. As defined, a solicitor is "any" person who solicits or refers "any" client.10 Schwab suggests that the definition of "solicitor" be revised to read as follows:
Any person compensated directly by an investment adviser for soliciting government entity clients for, or referring government entity clients to, the investment adviser.
In addition to being inconsistent with the Commission's apparent intent, coverage by the Proposed Rule of solicitors who do not solicit government clients would needlessly impose significant burdens on advisers and their solicitors. In order to avoid triggering the two-year ban on an adviser, the adviser's solicitors would need to know, and the adviser would therefore need to disclose to its solicitors, the identities of all of the adviser's current and prospective government clients. Conversely, the solicitor would need to disclose to the adviser the recipients and amounts of all of its political contributions to officials of government entities. In fact, in addition to the Proposed Rule, the Commission has also proposed amendments to the books and records rule under the Advisers Act11 that would require the adviser to keep records of those contributions.12 Where the solicitation arrangement between the adviser and the solicitor does not relate to government clients, application of the Proposed Rule's two-year ban and the exchange and recordkeeping of government client and prospect lists and political contribution lists required to comply with the Proposed Rule would be irrelevant.
For example, as a large corporate citizen headquartered in the City of San Francisco, from time to time Schwab makes political contributions to San Francisco elected officials and candidates. Schwab is not engaged by any adviser to, and does not solicit the City of San Francisco for or refer it to any investment adviser, through its AdvisorSource service or otherwise. There may be, however, advisers participating in AdvisorSource (for whom Schwab is therefore a solicitor) who have or are seeking the City of San Francisco as an advisory client. Under the Proposed Rule, Schwab's contributions would trigger the Rule's two-year ban on those advisers' receipt of compensation for their services to the City of San Francisco. This is despite the fact that the business relationship between Schwab and the adviser has nothing to do with either Schwab's or the adviser's separate relationships with the City of San Francisco and its officials.
Advisers to whom Schwab makes referrals have no reason related to their business arrangement with Schwab to tell Schwab who their government clients and prospects are, and Schwab has no desire to know. Conversely, Schwab has no reason to tell the advisers the government officials and candidates to whom Schwab contributes, and the advisers have no desire to know. Narrowing the Proposed Rule's definition of solicitor to comport with the Commission's apparent intended scope of the Rule would eliminate this undue burden that the Proposed Rule would otherwise impose.
The Commission should use less restrictive means to achieve its objective of eliminating investment adviser "pay-to play" practices. The Commission can do this by narrowing the Proposed Rule to cover political contributions by only those solicitors that the adviser compensates to solicit government clients. This would not compromise the Proposed Rule's effect on investment adviser pay-to-play practices. It would address the undue burden that the Proposed Rule will otherwise impose on investment advisers.
CHARLES SCHWAB & CO., INC.
David E. Riggs
Vice President and
Senior Corporate Counsel
cc: Paul F. Roye
Director, Division of Investment Management
1 SEC Release No. IA-1812; File No. S7-19-99 (August 4, 1999)(the "Proposing Release").
2 Rule 206(4)-3.
3 SEC Release No. IA-1728, IC-23293; File No. S7-20-98, Investment Adviser Year 2000 Reports (June 30, 1998) at p. 2.
4 See Proposing Release, II. Discussion, 1. "Pay-to-Play" Restrictions, at p. 7 Indeed, under Blount v. SEC, 61 F. 3d 938 (D.C. Cir. 1995), the Commission is required to adopt the least restrictive alternative necessary to achieve its purpose.
5 Proposed Rule 206(4)-5(a)(1)(ii).
6 Proposed Rule 206(4)-5(e)(6).
7 See Proposed Rule 206(4)-5(b), which provides a de minimis exception for an adviser's associated persons' contributions of $250 or less to elected officials or candidates for which the contributor is entitled to vote.
8 See Proposing Release, II. 1., at p. 7 (emphasis supplied).
9 See Proposing Release, II. 1., at p. 7.
10 See Proposing Release text accompanying Note 83.
11 Rule 204-2.
12 See proposed Rule 204-2(l).