November 1, 1999
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Release IA-1812, File No. S7-19-99, Political Contributions by Certain Investment Advisers
Dear Mr. Katz:
The Investment Counsel Association of America1 appreciates the opportunity to comment on the Securities and Exchange Commission's proposed new rule under the Investment Advisers Act of 1940 regarding political contributions by certain investment advisers, known as "pay-to-play." The proposal would prohibit investment advisers from providing advisory services for compensation to a government pension plan for two years after the adviser or any of its partners, executive officers, or solicitors make a contribution to certain elected officials or candidates related to the plan. The proposal also would require registered advisers with government clients to maintain records of political contributions made by the adviser or any of its partners, executive officers, or solicitors.
The ICAA strongly opposes any attempts by investment professionals to "buy business" through campaign contributions. We agree with SEC Chairman Arthur Levitt's public pronouncements denouncing pay-to-play practices in the securities industry, including his statement that:
Pay-to-play harms fund beneficiaries and taxpayers. It breeds cynicism of government officials, and contempt for the political process. It brings discredit on the businesses and professionals who participate in the practice. ... Competition, transparency, trust and integrity become casualties of the political process when public funds are used as a means to an end.2
Since its inception in 1937, the ICAA has promoted standards of conduct for the investment advisory profession. Over the years, many of these principles have been used by Congress and the Commission as the basis for legislation and regulations governing the conduct of investment advisers and by the U.S. Supreme Court in defining the standards of fiduciary conduct applicable to all investment advisers.3 Our current Standards of Practice emphasize that an investment adviser is a fiduciary who has the responsibility to render professional, continuous, and unbiased investment advice oriented to the investment goals of each client. Additionally, our Standards state that investment managerial personnel should be individuals of experience, ability, and integrity. We believe that campaign contributions made for the intended purpose of influencing the selection or retention of an investment adviser run counter not only to our Standards of Practice, but are contrary to an adviser's fiduciary duties. Buying business by making inappropriate political contributions has no place in our profession and these practices should be prohibited. Accordingly, the ICAA supports reasonable measures that are specifically tailored to prevent and eliminate abuses that may exist in this important area.
At the same time, we are mindful that prohibiting specified campaign contributions - without regard for the intent underlying such contributions - involves sensitive constitutional issues that should not be swept away without due regard for and consideration of an individual's right to participate fully in our political processes. One can easily imagine a range of legitimate considerations that are wholly separate from a desire to influence the selection of an adviser - including political, religious, and other personal reasons - that may compel individuals employed by investment advisory firms to make political contributions to various public officials described in the proposed rule. The proposed rule limits the rights of certain advisory personnel to make any campaign contributions, without regard for the intent underlying the contribution or even the amount of the contribution. In fact, it is somewhat puzzling that the proposed rules do not include a meaningful discussion of the countervailing constitutional rights that certainly will be compromised by adoption of the proposal, although the staff recognizes that the Commission must tailor its rules narrowly to serve a compelling government interest.4
Because of the extremely harsh penalty involved - a two-year ban on an adviser receiving compensation if there is a violation of the proposed rule - the Commission also should be mindful of the fact that investment adviser firms will err on the side of ensuring that no prohibited contributions will be made, e.g., by adopting procedures that cover employees who have any potential nexus to a public pension plan client (current or prospective) or by banning all contributions. Thus, adoption of the proposed rule may very well result in the investment adviser adopting policies and procedures that further restrict what otherwise would be lawful and appropriate contributions by investment adviser employees and their families. The bottom line is that this proposed rule requires the Commission to engage in a serious and delicate balancing act - weighing the protection of public plan clients from undue influence that may result from certain political contributions against the individual's established constitutional right to participate in the political process.
We also believe that consideration of the proposed rules should be gauged against the background and factual basis underlying the alleged need for the rules. The proposal explicitly states that it is premised upon Rule G-37, adopted by the Municipal Securities Rulemaking Board in 1994 to address pay-to-play concerns in the municipal securities area. But there are significant differences between the municipal securities industry and the investment adviser profession, as well as the facts and circumstances that led to Rule G-37 and the subject proposal. Unlike municipal dealers, investment advisers have a fiduciary relationship with each of their clients - including public pension plan clients. The investment adviser/client relationship is predicated on providing continuous, ongoing, and independent investment advice, whereas the municipal security business generally is transaction-oriented.
The potential ramifications of a Rule G-37-type ban for investment advisers could be extremely disruptive to the client - and ultimately to the beneficiaries of the plan - even for minor violations that have nothing to do with pay-to-play abuses. Termination of a longstanding, ongoing fiduciary relationship is a much harsher result for both client and adviser than a time-out on transactional business. Indeed, the penalty for violating the proposed rule is tantamount to a death penalty for an advisory relationship. It is extremely unlikely that a public pension plan would endure the hardships and disruptions created by a violation of the rule, go through the process of identifying and hiring a replacement adviser, and then return to the original adviser after the two-year ban ends. In all likelihood, the so-called "two-year ban" will operate as a de facto permanent ban.
We also understand that, unlike the municipal bond business where one official (often the treasurer) has significant influence over the award of a contract, the public pension process generally is more open and involves more decision-makers, including representatives of plan participants and consultants. Presumably for this reason, the Commission has decided not to extend its exception for a competitive bidding process set forth in G-37 to the investment adviser pay-to-play proposal. Because competitive bidding accounts for much of the municipal securities business, this proposal, if adopted, would apply to significantly more firms and individuals than does G-37.
The Commission should also be mindful of the fact that there is significant evidence that state and local laws and regulations are working to curb pay-to-play abuses in cases involving public pension plans, unlike the evidence that existed in the municipal securities area earlier this decade. The recent situation involving a former Connecticut state treasurer appears to be such a case.5 In fact, there is no indication that the proposed pay-to-play ban would have had any significant effect in dealing with the allegations of fraud and wrongdoing that are now being prosecuted under state law in that case. In the time since Rule G-37 was released, many state and local governments have mandated restrictions or disclosures designed to deter pay-to-play practices. According to our members, many investment advisers already have policies and procedures in place to avoid pay-to-play issues. Further, some clients request investment advisers to disclose contributions during the bidding process. Given the laws and procedures that are in place, the Commission must carefully consider whether its proposed rules are the best approach, particularly where they effectively prohibit otherwise lawful and appropriate behavior.
Indeed, these considerations make disclosure a more meaningful and appropriate approach than a two-year ban on business. A disclosure regime is more consistent with the Investment Advisers Act and other securities laws than is a prohibition. Some of our member firms believe that, in lieu of the current proposal, the Commission should consider adopting an anti-fraud rule under the Investment Advisers Act to prohibit contributions that are made with the intent to influence the selection of an investment adviser to manage the funds of a government entity. The SEC could bolster this approach by requiring advisers to disclose any political contributions to relevant officials of government clients or potential clients on a regular basis. The adviser would also be required to maintain records of certain political contributions for SEC inspection.
Finally, we trust the Commission will seriously consider whether adoption of the proposed rule will disproportionately disadvantage the investment adviser profession by imposing regulatory burdens that do not apply to other similarly situated market participants. Banks, bank holding companies, certain broker-dealers, and others enjoy an exemption from the Investment Advisers Act and thus would not be covered by the proposed rule.6 Many banks, for example, are in the business of providing discretionary investment management services to public pension plans and others, and include some of the largest advisory entities in the business. These firms compete directly with federally registered investment advisers for public pension plan business but would not be restricted by the proposed rule. Other persons who have relationships with public pension plans, including many consultants who play a significant role in the selection of investment advisers, are not regulated by the Commission and, therefore, their activities would fall outside of the proposed rule.7 In considering the subject proposal, we hope the Commission will carefully consider the fiercely competitive environment investment advisers confront. In keeping with its statutory mandate to maintain orderly markets, the Commission must ensure that a level playing field is maintained among investment advisers, their competitors, and other market participants. The Commission must avoid the imposition of burdensome regulatory requirements that solely affect the investment advisory profession, while permitting others to compete without such burdens.
Whatever approach the Commission ultimately adopts, the ICAA strongly believes that particular aspects of the current proposal must be clarified and should be more narrowly tailored to support the Commission's objectives. We therefore submit the following specific comments in an attempt to narrow the reach of the rule to areas where abuse may be more likely to exist, while continuing to serve the SEC and public interest in eliminating any impropriety or appearance of impropriety:
1. Definition of Partners, Executive Officers, and Solicitors. (Release at pp. 25-26)8
Although we recognize that the Commission has attempted to apply the rule to a limited group of persons, we respectfully submit that the proposed rule still reaches too broadly, potentially requiring investment advisory firms to maintain records and monitor the contributions of the vast majority of their employees. The proposed application of the rule to "partners, executive officers, and solicitors" should be more narrowly tailored to investment adviser personnel who are most likely to be in regular contact with existing and prospective public pension plan clients.
Partners. The definition of "partners" is too broad in the context of limited partnerships, in which most limited partners have little or no involvement in the operations of the adviser and may have a relatively insignificant investment in the adviser. A more appropriate definition would simply apply to "general partners." Alternatively, the definition could apply only to partners with a significant ownership interest (e.g.,10 %) in the adviser and who have a functional role in the operations of the adviser. Moreover, it is unclear whether the Commission means to include "shareholders" in the definition of "partners." If so, the Commission should explicitly state that shareholders are covered and limit the definition to 10% shareholders who have a functional role in the operations of the adviser.9
Executive Officers. We believe the definition of "executive officer" in the proposed rule requires further clarification. For example, the term "vice president" in some firms could encompass dozens of individuals, including persons who have no significant relationship or nexus to public pension plan clients. Other persons covered by the rule - such as any person "who performs...policy-making functions for the investment adviser" - may in fact have little or no contact with existing or prospective government clients. Moreover, certain terms in the proposed definition (e.g., "principal function" and "policy-making function") are somewhat unclear and could result in inconsistent interpretation and uncertainty. We therefore propose defining executive officer to mean "the president, CEO, or any officer in charge of a principal business unit or division related to portfolio management, client relations, sales, or marketing." This definition includes the types of personnel more likely to be involved with existing or prospective public pension plan clients. It would exclude officers in charge of administrative, accounting, technical, or legal units, who are unlikely to solicit such clients.
Solicitors. The proposed definition of "solicitor" is susceptible to broad and varying interpretations and should be clarified and narrowed.10 For example, "solicitor" may be interpreted to include a portfolio manager who makes just one presentation at one meeting with one client. It appears to include any employee who even once refers a client to the employee's firm or affiliated adviser for no additional compensation.11 The purpose of the rule would be served by more narrowly defining "solicitor" as "any employee whose primary function includes soliciting or referring clients to an investment adviser." This definition principally would apply to an adviser's marketing personnel, on whom the SEC should focus its concerns.
The release states that the proposed rule applies to third-party solicitors. It is very difficult to monitor and enforce rules regarding independent third parties. We strongly believe that it is quite harsh to hold an investment adviser fully accountable for the actions of third parties over whom the adviser has minimal control. To ensure absolute compliance with the proposed rule, a firm may even have to try to ban contributions by each and every person who does business with the firm. We understand the reasons underlying the Commission's inclusion of third-party solicitors in its definition of "solicitor": the Commission does not have direct statutory authority over third-party solicitors, yet third-party solicitors may have a financial incentive to pay-to-play and investment advisers may benefit from such payments.
The Commission's proposal, however, is not workable. Logistically, adviser firms will find it burdensome - if not impossible - to monitor continuously and keep detailed records regarding third parties. Further, as the Commission recognized in the proposed exemption provision, it is unfair and unproductive to ban firms from participating in a client relationship when the firm did not know of, or play any role in, a third party's contribution. If the firm instructs a third party to make a contribution to obtain business, the firm already would be culpable under proposed rule 206(4)-5(a)(2) for soliciting a contribution and may be subject to the two-year ban on compensation for making an "indirect" contribution.
We believe it is unnecessary to include third-party solicitors in the rule at all, because any abuse would be covered by proposed rule 206(4)-5(a)(2). However, we also propose the following alternative, consistent with the structure of the Advisers Act. Third-party solicitors currently are governed by Rule 206(4)-3, the cash solicitation rule. We suggest that the Commission amend Rule 206(4)-3 to require a solicitor who is a natural person to disclose in writing to the adviser and government entity client or prospective client any contributions the solicitor has made to an official of the government entity within the past two years.12 The solicitor should also certify that he or she will make no contributions in the future to any official of that government entity. The disclosure should be made in the separate written disclosure document mandated by Rule 206(4)-3(b), which the adviser is required to maintain under Section 204-2(a)(15) of the Advisers Act. The SEC inspection staff would have full access to these disclosure documents.
2. Definition of "Official of Government Entity"
Because the consequences of violating proposed Rule 206(4)-5 are so draconian, it is crucial that investment advisers have a very clear understanding of who is and who is not an "official" of a "government entity." The proposed definition of "official" is vague and could be quite broad.13 Under the proposal, an investment adviser must decide on its own whether an office is "directly or indirectly responsible for, or can influence the outcome of, the use of an investment adviser by a government entity" or an office with the authority to appoint such a person. Government entities are not required to assist investment advisers by providing a list of officials covered by the rule. Because the definition is tied to an "office" rather than a particular "official" and includes persons who can appoint such officials, investment advisers cannot simply assume that the person with whom they are in contact is the relevant "official." Relevant officials could be many layers removed from the plan. Quite possibly, an adviser might have to hire a law firm for an opinion on the vagaries of local law before the adviser can even begin to think about contacting a potential client. Alternatively, an adviser could ban all contributions to all state and local officials nationwide for all covered employees - an outcome that would have obvious unfortunate implications on the ability of employees to participate fully in the political system and an outcome which we presume the Commission does not intend.
We suggest that "official" be defined as a person who is directly involved in selecting the investment adviser. Moreover, we believe it is unfair and unduly burdensome for each investment adviser to try and ascertain all officials to whom the rule may apply. To this end, we strongly urge the SEC to coordinate with state and local organizations to compile a single list of "officials" on which all investment advisers may rely for purposes of the rule. At a minimum, the Commission should publish publicly a list of state "officials" and indicate those officials who are also candidates for federal office.
3. Definition of "Contribution"
The Commission proposes to define "contribution" as "any gift, subscription, loan, advance, or deposit of money or anything of value made for the purpose of influencing any election...payment of debt incurred in connection with any such election; or ... transition or inaugural expenses...."14 On its face, the proposal seems to apply only to election-related payments or gifts and would not apply to ordinary and usual business entertainment, such as meals, sporting events, theater tickets and similar items "of value," which are not otherwise prohibited or restricted under state or local law. It is our understanding that these types of gratuities generally are not made for the purpose of influencing an election and do not relate to debt, transitional, or inaugural expenses. Additionally, the consequences of making an inadvertent mistake in the burdensome process of policing meals, tickets, and related items would be disproportionately severe. Therefore, we respectfully request that the final rule confirm our understanding of the definition of "contribution" in this regard.15
Similarly, many officials of clients or prospective clients solicit investment advisers and their employees to make a wide array of contributions involving a charity. We assume these types of contributions in response to a solicitation are not covered by the proposed rule. If our understanding is incorrect, we would appreciate clarification in the final rule release.16 Finally, we would appreciate confirmation that a covered employee's volunteer time for a political campaign is not a "contribution," unless employer resources (such as providing office space for the campaign) are used.17
4. De Minimis Exception (Release at pp. 26-27)
The ICAA respectfully requests that the de minimis exception be revised to permit an employee to make contributions of $1,000 or less to any candidate, not merely those for whom the employee could vote, if registered.18 In today's economy, the reality is that $1,000 for any candidate is not going to buy a contract or an opportunity to be considered for a contract - it would not even buy a seat at the table. Increasing the exception to $1,000, however, would permit citizens to feel they are participating more fully in determining the quality of life in their communities.19 In many cases, an investment adviser employee lives in one voting district and works in another. These individuals often take a great interest in their workplace location and they should have the freedom to participate fully in supporting officials who will make decisions affecting them.20
Further, limiting contributions to candidates for whom an employee can vote is inconsistent with the national goals of various legitimate groups or PACs, which sometimes name particular government officials in their contribution materials. For example, certain groups solicit contributions earmarked for specific female or minority candidates around the country or specific candidates who believe in particular platforms. In our democracy, no one should be prohibited from expressing support for these causes through contributions; as it is, even a $250 limit would significantly limit the ability of individuals to make a meaningful statement of support for particular candidates for legitimate reasons. For example, if the proposed rules were in effect today, Republicans who would like to be considered for public pension plan business in Texas or New York would not be permitted to provide any meaningful support to George W. Bush or Mayor Rudolph Giuliani. Democrats wishing to support Hilary Clinton, however, could proceed unfettered. Clearly, the rule would hamper candidates for federal office who are currently state or local officials, while effectively benefiting candidates who already hold a federal office.
Finally, we understand that certain Federal Election Commission officials have expressed concern that the SEC's proposal may conflict with the Federal Election Campaign Act of 1971 (FECA).21 Increasing the de minimis to $1,000 would make the SEC's rules more consistent with FECA, which in 1974 established a $1,000 limit on individual contributions.22
5. The "Look Back" Requirement (Release at pp. 27-28)
The look-back proposal presents a number of difficulties. Firms will have to question potential job applicants regarding their specific contributions and require new hires to sign a representation regarding such contributions. Currently, this query is not made of most candidates in the investment advisory profession and would inhibit advisers' competition for talent and the ability of advisory personnel to change jobs. Moreover, advisers have every reason to be concerned about potential liability in questioning applicants regarding their political contributions; such questions may elicit information from these individuals about their political, religious, sexual orientation, racial, or other views or affiliations.23 In essence, this provision is an invitation to lawsuits by job applicants, whether legitimate or not.
We propose that the Commission eliminate the look-back provision. Eliminating the provision will in no way compromise the Commission's goals. Officials of relevant government entities are unlikely to "credit" to an advisory firm a contribution previously made by a newly hired employee (as much as two years earlier). Moreover, this provision "punishes" the advisory firm for contributions the individual made while employed at a prior firm. We are aware of no evidence that this type of conduct has occurred. In any event, we believe the "no solicitation" and "directly or indirectly" provisions of the pay-to-play proposal adequately address any illicit contributions made by employees departing a firm.
Should the Commission choose to retain the look-back provision, we respectfully submit that the time period be limited to six months and that the Commission obtain from Congress some liability protection for advisory firms for asking employees and potential employees specific questions about their history of political contributions.
6. The SEC's Authority to Grant Exemptions (Release at pp. 31-32)
Because the proposed sanctions are so severe, the exemption process established by the Commission is a crucial element of the proposal. First and foremost, the exemption process must provide for a prompt response. This is simply a matter of fundamental fairness. Delays in the exemptive process will harm the adviser, the plan, and beneficiaries of the plan. We therefore suggest requiring a response to an exemptive application within 30 days. To achieve this result, we suggest that the Commission delegate to its staff authority to grant exemptions. Because of the potential for a significant number of innocent or inadvertent problems, we strongly believe that the rule should provide that an application not acted upon within 30 days would be automatically granted.24
Second, because of the severity of the sanctions, the Commission should set forth specific criteria, which, if established, would result in the automatic issuance of an exemption. For example, an automatic exemption should issue if the applicant can establish that the contribution was made inadvertently or without the intent, purpose, or actual effect of influencing the selection or consideration of the adviser.25 Similarly, if employees or solicitors of the adviser who communicate with the government client had no knowledge of a contribution made by an employee who has no contact with the client, an exemption should issue.
Third, the Commission should factor in the differences between the municipal bond business and the investment adviser profession in fashioning exemptions. The municipal bond business is transaction-based. Forced termination of an ongoing fiduciary relationship is a much harsher result for both client and adviser than a ban on a transactional business. For example, particular types of advisers may fill a specific niche of expertise required by a client. Whether or not a contribution has been made, in many circumstances the adviser chosen by the client may indeed be the most qualified candidate and the selection may be in the best interests of plan beneficiaries. A forced change could result in additional costs - as well as a change in performance and risk - for beneficiaries of government plans.
Fourth, the text of the release states that the Commission "would apply these exemptive provisions with sufficient flexibility to avoid consequences disproportionate to the violation while accomplishing the remedial purpose of the rule."26 We strongly support this goal, including the proportionality concept. Firms should not be subject to forfeiture of significant revenues or important relationships because of an inadvertent error by one of many employees.27 We assume that the phrase "conditionally or unconditionally" in the proposed exemption language permits the Commission, through its staff, to impose alternate remedies to a two-year ban on business when it appears that a remedy is justified yet a ban is too severe under the circumstances.28
Finally, the Commission should make provision for an application for exemption made in advance of the contribution for legitimate reasons. For example, an advisory employee, otherwise subject to the rule, may wish to make a contribution outside the de minimis to an official for religious reasons. That employee should be able to obtain advance reassurance from the Commission that such contribution would not result in a ban for the firm. Similarly, some investment advisers are currently supporting (both financially and otherwise) legislative proposals that would result in increased government-related investment advisory opportunities, such as IRS Code §529 college savings plans. Having successfully supported such legislation, firms should not then be banned from responding to subsequent RFPs for these plans.29
7. Termination of Advisory Contracts Under Proposed Two-Year Ban (Release at p. 23)
Under the current proposal, an adviser and its client appear to have three options when a violation of the rule occurs: (1) the adviser could immediately resign from an account by giving the requisite notice (and not charge fees for the notice period); (2) the adviser could continue to manage plan assets for no compensation for any time period up to two years per an agreement with the client; or (3) the adviser could continue to manage plan assets while applying for an exemption from the SEC.30
Virtually all advisory contracts provide a time period for termination. For example, the ICAA's specimen advisory contract provides: "This agreement may be terminated at any time upon __ days' prior written notice by either party." The blank is a term to be negotiated by the parties at the outset of the relationship. By contract, both the government client and the adviser mutually agree to a time period for termination. We believe that leaving the time period to contractual negotiation provides the most flexibility for an adviser and its client. However, government clients often negotiate lengthy periods for termination so that they have significant time to select a new adviser. We therefore strongly recommend that the rule permit compensation to be paid during the time period between notice of termination and until termination or until the client finds a successor adviser. The penalty of losing a significant client - which we believe will be a permanent loss of business in most cases - is harsh enough without imposing the additional penalty of uncompensated work for termination periods of up to 180 days under some contracts. Our recommendation would not only benefit the adviser but also the client, who may have legitimate concerns about the adviser's motivation to perform during the period between notice and actual termination. Significantly, the MSRB does not prohibit the receipt of compensation in analogous situations under Rule G-37.31
8. The Proposed Recordkeeping Requirements (Release at pp. 33-34)
The ICAA understands the Commission's need to review records maintained by advisers to prevent pay-to-play practices by their covered employees. We submit, however, that the proposed record-keeping requirements should be more narrowly tailored to meet the Commission's objectives.
Prospective Clients. The proposed rule, in effect, requires firms to keep an ongoing, continuously updated list of prospective government clients.32 We oppose this proposed provision because we do not see why the required information is necessary. The remedy of a two-year ban on receiving compensation simply does not fit a situation where the adviser fails to obtain the client's business. If an advisory firm is not selected for business, that firm has caused no harm to the plan or its beneficiaries. If an adviser is acting inappropriately, that conduct will be recorded when the adviser is actually chosen by a client. If the firm is never chosen, it certainly will determine that its contribution activities are for naught and will not continue them. Further, it is logistically unclear how a firm should compile this list. Should all letters that are sent to prospective clients be copied immediately to the compliance officer? Should all RFPs received be sent to the compliance officer? Must each solicitor maintain a log of phone calls made to prospective clients and update the compliance officer daily? The burden of continuously compiling this list would be significant, with little or no benefit to the Commission or the public.33
Indirect Contributions. As proposed, the rule would require each firm to maintain records of all "direct or indirect" contributions made to "an official, a political party of a State or political subdivision thereof, or a political action committee."34 How is a firm to determine what is an "indirect" contribution?35 That determination appears to require a state-of-mind assessment by an employer. The Commission's release states that spouses are not covered by the rule unless they are used to indirectly make a contribution. We strongly agree that spouses should not be covered consistent with a narrowly tailored rule. Spouses should be permitted to continue to participate in the political and civic life of their communities. However, the Commission should provide clearer guidance to firms and employees on this subject. We therefore propose that the Commission clarify the "indirect" provision by stating that it refers to contributions made with the intent, purpose, or effect of influencing an official of a government entity.36
For similar reasons, the Commission also should make clear that an investment adviser may rely on self-reporting or certifications by covered employees, who could be asked to list their contributions and certify that they have not made any indirect contributions. The adviser should not have to conduct continuous expansive, invasive (and expensive) investigations of a covered employee, as well as the employee's friends and family. Indeed, we suggest that the Commission rephrase the provision to require the investment adviser to keep annual reports submitted by covered personnel (similar to the annual reports now required by the personal trading rule under the Investment Company Act).
Political Action Committees. We do not understand why investment advisers are required to keep records regarding contributions made to a "political party" or "political action committee." The proposed rule prohibits contributions to an "official of a government entity." The Commission itself has stated that "[c]ontributions to political parties would not trigger the proposed rule's prohibitions, unless the contribution is earmarked or known to be provided to an official."37 We assume, and the Commission should clarify, that the same statement applies to political action committees or similar organizations. If contributions to a party or PAC do not trigger the rule's prohibitions, there is no compelling need to maintain records of such contributions. Any contribution made to a party or PAC for the purpose of obtaining business from a certain official would be covered by the requirement to report indirect contributions and by the Commission's statement that the contribution must not be earmarked for a particular official.
Payments. Although the prohibitions of the rule apply only to "contributions," the record-keeping provisions apply to either "contributions or payments." Unlike the definition of "contribution," the term "payment" is not limited to situations involving an attempt to influence elections.38 It is unclear why the Commission needs records of payments that are unrelated to elections if they do not violate the rule. And, as discussed above, if the term "payment" includes ordinary and usual business entertainment expenses that are not otherwise prohibited, these record-keeping requirements will be very burdensome and difficult to follow. Moreover, such an interpretation would render completely erroneous the Commission's assumption that the proposal involves "no substantial additional burdens" in addition to records internally required for compliance with the rule.39 We therefore request that the Commission strike the word "payment" from the proposed amendments to Rule 204-2.
Total Ban on Employee Contributions. Advisory firms may attempt to avoid the burdens imposed by the record-keeping requirements and the possible imposition of the "death penalty" for violations of the rule by simply banning all employees or all covered employees from making political contributions. If an investment adviser wishes to take this path, it should be permitted simply to obtain a signed statement each year from each covered employee certifying that he/she has complied with the ban. This annual certification should be permitted in lieu of the records required by Rule 204-2(l)(1)(ii)-(iv) and (2).
9. A Transition Period (Release at p. 34)
The ICAA respectfully submits that some investment advisory firms will need a significant amount of time to develop internal procedures to comply with the proposed rule. In order to ensure that (1) procedures are in place, (2) appropriate personnel have been hired and trained, (3) all relevant employees have been informed properly of the rule and procedures, and (4) any necessary legal opinions have been obtained, we propose a transition period of 180 days.
* * * *
The ICAA opposes any practice by which investment professionals try to gain access to business through political contributions. We commend the Commission for attempting to eradicate pay-to-play practices in the financial services industry. The ICAA stands ready to assist the Commission in any way needed to craft an effective rule that is tailored to eliminate pay-to-play practices without unnecessarily infringing on free speech rights or imposing unnecessary burdens on the investment advisory profession.
We truly appreciate your consideration of our comments and trust that you will not hesitate to contact us if we may provide additional information regarding these or any other issues.
David G. Tittsworth
cc: The Honorable Arthur Levitt
The Honorable Isaac C. Hunt, Jr.
The Honorable Norman S. Johnson
The Honorable Paul R. Carey
The Honorable Laura Unger
Paul F. Roye, Esq.
Robert E. Plaze, Esq.
|1||The ICAA is a national not-for-profit association that exclusively represents federally registered investment adviser firms. Founded in 1937, our membership consists of about 250 investment advisory firms that collectively manage funds in excess of $2 trillion for a wide variety of institutional and individual clients. For further information, please see www.icaa.org.|
|2||Remarks by Chairman Arthur Levitt, In the Best Interests of Beneficiaries: Trust and Public Funds, at the 1999 Annual Meeting of the Council of Institutional Investors (March 30, 1999).|
|3||See SEC v. Capital Gains Research Bureau, 375 U.S. 180, 190 (1963).|
|4||See Blount v. Securities and Exchange Commission, 61 F.3d 938, 943 (D.C. Cir. 1995).|
|5||See, e.g., The New York Times, Ex-Treasurer in Connecticut Pleads Guilty (Sept. 24, 1999).|
|6||See, e.g., Section 202(a)(11), Investment Advisers Act of 1940. For example, the Commission's binders of "evidence" related to this proposal contain numerous mentions of an entity that may be exempt from registration as a subsidiary of a bank. In addition, this rule does not address pay-to-play practices by custodians, brokers, and other regulated entities or vendors that provide public pension plans with services other than discretionary asset management.|
|7||See "Paying to Play" Pensions & Investments, May 17, 1999: "The Securities and Exchange Commission, in proposing to ban pay-to-play at public pension funds, missed tackling a huge related issue. It also should look at the power of consultants and the subtle pay-to-play they generate in the investment management community through money managers buying services from them."|
|8||Where the Commission has requested comment on a specific subject, we have referenced the release page number in the subject heading. See Political Contributions by Certain Investment Advisers, 64 Fed. Reg. at 46822 (August 27, 1999), Release No. IA-1812 (August 4, 1999) ("Release").|
|9||We assume that by including the term "partners" in the proposal, the Commission does not intend to impose requirements related to control persons or affiliates or their employees. Accord Release at p. 26 (stating that contributions by employees of control persons or affiliates do not trigger the rule's prohibitions).|
|10||The proposed rule defines solicitor as "any person who, directly or indirectly, solicits any client for, or refers any client to, an investment adviser." (emphasis added). Release p. 40.|
|11||Although the Commission's proposed definition is the same as that used in the cash solicitation rule (Rule 206(4)-3), the purpose of the cash solicitation rule is very different from the purpose of the pay-to-play proposal. In the Rule 206(4)-3 context, the "solicitor" definition is of no consequence unless there is an arrangement for cash compensation in exchange for the referral/solicitation. Even where cash is involved, an employee (as opposed to third party) solicitor need only identify himself/herself to the prospective client (which, even without the rule, would be done by any firm's marketing department). Thus, although it seems on the surface beneficial to use consistent definitions, the "solicitor" definition in Rule 206(4)-3 should not apply and is not relevant to a context in which no additional compensation is involved.|
|12||We suggest that the rules apply to natural person solicitors because some firms retain solicitors that constitute a large corporate entity, such as a full-service broker-dealer firm. Under the current proposal, it is ambiguous whether a contribution made by one employee of a huge brokerage firm could disqualify an investment adviser to whom the brokerage firm referred a government client - a result we believe the Commission did not intend. A rule that applied to entities may similarly discourage internal referrals among affiliated entities, perhaps another unintended result of the proposal.|
|13||Proposed Rule 206(4)-5(e)(4).|
|14||Proposed Rule 206(4)-5(e)(1).|
|15||Accord MSRB Rule G-37 and Rule G-38 Handbook at 10, confirming that such gratuities are not covered by the rule.|
|16||Id. (MSRB confirms that charitable donations are not covered).|
|17||Id. at 9, 13 (MSRB confirms same).|
|18||We strongly urge the Commission to permit individuals to make some contribution to candidates for whom they are not eligible to vote, even if the Commission should decide upon a different de minimis amount than the $1,000 we suggest.|
|19||We understand that $250 is the de minimis amount under Rule G-37. We submit, however, that such amount was established more than five years ago, when $250 presumably was a more meaningful contribution. We also understand that the more extensive record of abuses in the municipal securities industry may have led the Commission to impose a relatively low de minimis amount.|
|20||For example, employees and owners of businesses in Baltimore City may reside in Baltimore County or other locations. Such employees and business owners, however, may care deeply about issues affecting Baltimore City, where they work daily. Similar issues are raised when Maryland and Virginia residents would like to contribute meaningfully to their workplace environments in Washington, D.C.|
|21||See, e.g., SEC "Play-to-Pay" [sic] Rules: Its Impact with Respect to FECA, Memorandum to The Federal Election Commission from Lawrence M. Noble, General Counsel, et al. (Sept. 20, 1999).|
|22||See id. p. 2. Indeed, some have suggested that the proposed rule may encourage use of "soft money," which some political participants would like to discourage.|
|23||See, e.g., District of Columbia Human Rights Act of 1977, Title 1, Chapter 25, Subchapter II, Section 1-2512 (prohibiting employment discrimination based on, among other classes, race, color, religion, gender, sexual orientation, or political affiliation) (emphasis added).|
|24||Cf. General Instructions for Preparing and Filing Form ADV-W ("a notice to withdraw from registration ... shall become effective on the 60th day after the filing thereof" unless the SEC has begun proceedings before then).|
|25||For example, we understand that there may be private investment companies with respect to which the adviser does not know who the beneficiaries are; only the sponsor or distributor of the fund may know whether a public pension plan is one of the beneficiaries. This is an area in which consideration of intent (or lack thereof) should result in an exemption. Note that in private investment company cases, the adviser would not be able to resign from the relationship; instead the client would have to withdraw its investment in the fund. The SEC exemption process may be able to identify a more logistically suitable sanction in such cases if it finds there was an intent to influence the selection process.|
|26||Release at 32.|
|27||Indeed, loss of a very significant public pension plan client could result in layoffs or other cutbacks. Further, investment advisers are concerned that these severe consequences would be triggered, for example, where a disgruntled employee spends just $1 on a contribution to an official for whom he is not registered to vote.|
|28||We are aware of, and strongly oppose, the MSRB's statement that certain inadvertent mistakes are not grounds for an exemption under any circumstances, such as failure to recognize that an individual is an "official" consistent with the Board's interpretation of that term. See MSRB Rule G-37 Handbook at 17.|
|29||See, e.g., State-College-Savings Plans Go National, Tax Legislation Broadens Market, Wall Street Journal, C1 (Sept. 23, 1999).|
|30||See Release at p. 32 n.101.|
|31||MSRB Interpretation of Prohibition on Municipal Securities Business Pursuant to Rule G-37 (February 21, 1997).|
|32||Proposed Rule 204-2(l)(1)(ii).|
|33||If the Commission nevertheless decides to retain this requirement, we strongly recommend that it require the list to be updated on an annual, not a continuous, basis and include only those clients to which a formal, written proposal has been made.|
|34||Proposed Rule 204-2(l)(1)(iv).|
|35||Some have suggested (incorrectly we believe) that contributions made using a check from a joint checking account where both names appear on the check should be considered "indirect" contributions. This suggestion is contrary to the MSRB's comment that where a covered employee and another person sign a check drawn on a joint account, only 50% of the contribution is attributable to the employee. MSRB G-37 Handbook at 17.|
|36||See Release at p. 26, which states: "Contributions by other employees of the adviser or other persons (such as spouses, control persons and affiliates) would not otherwise trigger the rule's prohibitions unless the adviser ... used the person to indirectly make a contribution." At a minimum, the phrase "with the intent, purpose, or effect of influencing an official of a government entity" should be added at the end of that sentence.|
|37||Release at p. 25 n.81.|
|38||Proposed Rule 204-2(l)(3)(ii).|
|39||Release at p. 34.|