Pay-to-Play Rules & Compliance Best Practices

Organizations must always comply with the U.S. Securities and Exchange Commission’s pay-to-play rules. The Investment Advisers Act of 1940, specifically Rule 206(4)-5, dictates the rules and regulations for political contributions, as well as what needs to be done to comply.

It’s extremely important for all firms to comply with these strict rules because the penalties for violations can be quite expensive. Violators can be fined hefty amounts and even prohibited from making political contributions for a certain period of time. What’s more, political contributions as low as $150 could trigger a violation of the pay-to-play rule. That’s why it’s so important to have compliance best practices in place. Here’s what you need to know.

Aristotle offers the most comprehensive, up-to-date, and accurate political contributions database in the market to help your organization track contributions and remain in compliance with Pay-to-Play rules. Learn More

What is the Rule?

SEC Rule206(4)-5 is in place to protect against political contributions that could unduly influence the decision of a politician and/or government entity. The pay-to-play rule can be triggered any time an organization(or an employee of an organization) makes a political contribution to a government official who could allocate or manage money for a client that is a government entity.

According to the rules, a contribution made to a political party or a PAC that solicits funds to support a government official are treated as a contribution made directly to that official. Beyond direct contributions, volunteering on behalf of a political party or PAC, or donating the use of property for an event, could trigger the SEC’s pay-to-play rules as well.

With this rule, the SEC is seeking to prohibit any quid-pro-quo arrangement. In other words, the rule is intended to prevent a political contribution being made in exchange for preferential treatment on a contract, service, or legislative effort.

Who Does the Rule Apply to?

SEC Rule206(4)-5 prohibits any person considered a “covered advisor” from providing a paid advisory service to any government entity for two years after the adviser or any associates does one of the following:

  • Makes a political contribution to any official from that government entity
  • Solicited or coordinated political contributions to any official from that government entity

The pay-to-play rules categorize a “covered advisor” in one of three buckets:

  1. An executive officer, managing member and/or general partner of an organization
  2. An employee who, on behalf of an investment adviser, solicits any government entity; or a person who indirectly or directly supervises that employee
  3. A PAC that’s controlled by any investment adviser or by any person outlined in numbers one and two

The SEC further defines an official who receives a contribution as any person who either held office for a government entity or was a candidate for such a position at the time the contribution was made.

The office in question also must either:

  • Be able to influence the outcome or be indirectly or directly responsible for the decision to hire investment advisers to the government entity
  • Have the authority to hire someone to perform number one

This means that both successful and unsuccessful candidates for a government position can be considered an official as defined by the SEC pay-to-pay rules.

Pay-to-Play Compliance Best Practices

To ensure your firm is compliant with the pay-to-pay rules, it’s essential to create some best practices for monitoring all government relationships and political contributions:

Educate Your Staff

The first step is to ensure that you and your employees or members understand the pay-to-play rules as they apply to your situation. It’s possible that not every aspect of the rules applies to your organization, but some may. Know also that the SEC’s rules relate to federal government entities, and there may be local and state rules that apply as well.

Keep in mind that the rules apply to all your employees or members. As such, make sure people in your organization are thoroughly aware of the rules, how to be compliant with them and the penalties for not doing so.

Define Clear Policies

Create policies that ensure your organization adheres to the rules. While your policies must obviously meet the minimums of the rules, it’s a good idea to go a step further. By having policies in place that are stricter than the law, you’ll ensure there are no questions or gray areas.

Equip Your Team

Give your employees the tools they need to be compliant. Communicating the rules is great, but it’s only one part of the equation. They need all support and tools an organization can provide.

Use cutting-edge technologies to automate the monitoring of activities at your firm that could be subject to the pay-to-play rules. Compliance can be very time consuming for your employees—and inefficient if done manually. An automated software system can help employees track and manage political contributions with ease.

Test & Monitor Processes

Finally, it’s important to run tests to measure your firm’s compliance. You can verify political contributions by cross-referencing donations and employee names through political contribution databases. Conducting reviews periodically of this information will help you identify contributions that could apply to the rules.

Depending on the risk of your organization, you could choose to run these compliance tests annually, bi-annually, quarterly or even more frequent.

Aristotle Can Help You Remain Compliant

Having a solid compliance plan in place that adheres to best practices will ensure you avoid violating the SEC’s pay-to-play rules. Even so, remaining compliant is no simple task. Many financial organizations seek assistance with Pay-to-Play compliance and pre-clearance for their employees. Aristotle provides P2P services to many of the largest financial institutions in the country. Our federal, state, and local databases from public records provide organizations with all the information they need to ensure compliance and avoid unnecessary risk.

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