What Public Safety Plans Should Know About SEC Enforcement Of Its Pay To Play Rule

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1 What Public Safety Plans Should Know About SEC Enforcement Of Its Pay To Play Rule Suzanne M. Dugan Luke Bierman Ray Sarola Cohen Milstein Sellers & Toll, PLLC Washington, DC ۰New York ۰Philadelphia ۰Chicago

2 The SEC Recently Concluded its First Enforcement Action for Violations of its Pay to Play Rule On June 20, 2014 the SEC announced the conclusion of an enforcement action against a private equity firm, TL Ventures, for violating its Pay to Play Rule. An associate of TL Ventures made political contributions to public officials who were in a position to influence the selection of investment advisers for public pension funds. The firm was required to pay nearly $300,000 in disgorgement and penalties. 2

3 Background: Pay to Play Scandals In recent years, as pension fund AUM grew and investment managers sought advantages in the race to collect fees for managing public dollars, there were a rash of scandals where money was funneled from investment managers to politicians. CT, IL, NY, CA, NM 3

4 Harms Caused By Pay to Play Practices Selection of managers not based solely on merit Higher fees Loss of public confidence in decisionmaking process 4

5 Harms Caused By Pay to Play Practices Reputational damage Ethics investigations Regulatory enforcement actions Criminal convictions 5

6 Rule 206(4)-5: The SEC s Pay to Play Rule It shall be unlawful: For any investment adviser registered (or required to be registered) with the Commission, or unregistered in reliance on the exemption available under section 203(b)(3) of the Advisers Act (15 U.S.C. 80b-3(b)(3)) to provide investment advisory services for compensation to a government entity within two years after a contribution to an official of the government entity is made by the investment adviser or any covered associate of the investment adviser. Rule 206(4)-5(a)(1) 6

7 To Whom Does The Rule Apply? Rule is under the SEC s Investment Advisers Act authority it applies to investment advisers that provide services to government funds Applies to: firms and covered associates, including current and former employees Who provide or want to provide services to certain government funds (incl. DB and DC plans) 7

8 What Does The Rule Prohibit? Prohibits receipt of advisory fees within two years of a triggering contribution. No requirement to prove quid pro quo What contributions trigger the Rule? $350 (voting) and $150 (non-voting) per election limits To officials or candidates for an office that can influence the hiring of an investment adviser or can appoint a person with such influence 8

9 What Does the Rule Prohibit? (Continued) Receipt of compensation for advisory services for two years after triggering contribution Can be difficult to quantify amount of compensation earned over particular time periods for certain types of managers (2 and 20, ex.). 9

10 What Else Does the Rule Prohibit? (Slide 3) Anything done indirectly that would constitute a violation if done directly. Rule 206(4)-5(d) 10

11 What Are The Remedies For A Violation? Adviser must continue to provide services, without compensation, for reasonable time Disgorgement of compensation during two years after triggering contribution Exception for returned contributions under limited circumstances 11

12 Case Study: TL Ventures Chronology 1999: Pennsylvania SERS invests in TL Ventures IV 2000: Philadelphia and Pennsylvania SERS invest in TL Ventures V April 2011: Covered associate contributes $2500 to candidate for Philadelphia Mayor Nov. 2011: Covered associate contributes $2000 to candidate for PA Governor June 2014: SEC Cease-and-Desist Order 12

13 TL Ventures: Relevant Facts The Investments Private equity funds illiquid, lockups Were in wind-down at time of contributions The Political Contributions Made by a single individual more than 10 years after initial investments The Candidates For Governor and Mayor, who appoint a minority of the pension fund trustees 13

14 TL Ventures: Enforcement Results Disgorgement: over $250,000 Other penalties and interest SEC Order: public censure, reputational impact 14

15 Lessons and Implications Pension trustees and staff must be knowledgeable of Rule and how to use it to protect fund assets and decisionmaking. Pay to Play Rule applies and compliance should be monitored throughout duration of investment SEC resources are limited one action announced since 2010 means you can t rely on SEC enforcement 15

16 Best Practices (or So What Can I Do? ) Education Board Policies Initial Due Diligence/Representations Periodic/Ongoing Monitoring Treatment of past violations Consider Addressing Remedies in Management Agreements What will occur in case of violation timing and how compensation will be measured 16

17 Final Thoughts Rule is important tool to prevent undue influence on pension investment decisionmaking and protect fund assets from suboptimal investments and fees. Pension Trustees and Staff are first line of defense. Far better to prevent violations than rely on enforcement actions to remedy them. 17

18 Questions (and maybe Answers) Ask Away 18

19 Contact Information: Suzanne M. Dugan Cohen Milstein Sellers & Toll, PLLC Luke Bierman Cohen Milstein Sellers & Toll, PLLC Ray Sarola Cohen Milstein Sellers & Toll, PLLC 19