Recent Pay-to-Play Case Is Cautionary Tale for Advisors and Political Contributions

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In April, the Securities and Exchange Commission charged private equity firm Wayzata Investment Partners for violating the pay-to-play rule for investment advisors.

The SEC order noted that a covered associate of the firm made a $4,000 campaign contribution to a candidate for elected office in Minnesota in April 2022, and that office had influence over selecting investment advisors for a state investment board. The Minnesota State Board of Investment had been a client of Wayzata’s since 2007, and the firm continued to provide investment advisory services to the funds during the two years after the contribution, according to the SEC.

As a result, the firm paid $60,000 in penalties. SEC Commissioner Hester Peirce dissented from the enforcement action, saying it was government overreach.

“This case is yet another illustration of the overbreadth of the pay-to-play rule and another reminder of the way the rule hampers legitimate political participation,” Peirce said in a statement. “The rule allows for exemptions, but the Commission has rarely granted them. To avoid questions from Commission examiners, the easiest course is not to contribute to political campaigns. So, the cost of working for an investment adviser is that you have to give up your right to contribute to certain political campaigns.”

Yet, the rule still stands, and Wayzata’s case can provide a cautionary tale for other RIAs with associates looking to make political contributions in a hotly contested presidential election year. The election is, perhaps, even more top of mind in the wake of Trump’s conviction in the Stormy Daniels trial, which appears to have unchanged voters’ minds.

“Despite this dissent, the SEC clearly remains focused on enforcing its rule,” said Charles M. Ricciardelli, partner at Skadden, Arps, Slate, Meagher & Flom LLP and Affiliates. “In that sense, it is a cautionary tale in that it remains as important as ever to maintain vigilance in this area with properly updated policies and procedures, coupled with appropriate training and timely reminders for covered personnel.”

The Wayzata case shows that political contributions can pose compliance and reputational risks to RIAs. The firm’s assets under management declined from $644 million as of March 2023 to $376 million in its most recent Form ADV, filed in March 2024.

“We don’t know for sure whether that was Minnesota pulling out their business, or maybe it was another firm that didn’t like the reputational risk involved with them being cited by the SEC,” said Donna DiMaria, a director at Vigilant Compliance. “There’s a huge risk there because of the reputational aspect of your name being dragged through the press with enforcement and sanctions against the firm; that’s a big risk that I think most investors don’t want to have to deal with.”

Either way, this is an area firms should be focused on, as we head into the election cycle and as the volume of political contributions is expected to increase.

“If managers want to engage in business with public entities, then they’re going to have to follow the political contribution rule,” DiMaria said. “And in this market environment where we’re coming up to an election, it’s even a better time to be proactive in going out and understanding what your employees are doing in this space.”

The Rules Today

Political contributions are addressed under the SEC’s Pay-to-Play Rule, Rule 206(4)-5 of the Investment Advisers Act of 1940, which prohibits an investment advisor from collecting fees from a government entity if the advisor or certain employees have made a political contribution over specified amounts to a relevant government official. Advisors can donate $350 per election cycle for candidates they’re eligible to vote for and $150 for other candidates.

The rule includes a two-year look-back provision, where the advisor can’t take compensation from that government entity for two years after a contribution is made.

Broker/dealers and their reps are also subject to pay-to-play rules; the Financial Industry Regulatory Authority followed the SEC with its Rules 2030 and 4580, which are based on the SEC’s pay-to-play rule.

DiMaria said she recommends firms pre-clear with their compliance departments all political contributions prior to them being made.

“That way, you can see who they’re planning to make a contribution to and how much it is,” she said. “It allows you then to cross reference with areas where your business development team is working on potential new mandates and where there could be a problem coming up.

“A lot of people say, ‘Right now we’re not doing anything in that state, so there’s nothing to worry about,’ but a political contribution today carries forward and could be a potential issue in the future,” she added.

The SEC rule also states advisors need to look through the contribution to see who exactly is benefiting from it. That includes charitable donations; charitable organizations or foundations could be funneling money into political campaigns, she said.

Even firms that don’t currently work with public entities should track their advisors’ political contributions; a lot can happen in two years.

“Even our wealth management clients that don’t have any state or local business, we still have them at least report political contributions and do the review on an annual basis, so that way they at least have the information,” DiMaria said. “You just never know where your next client’s going to come from.”

Skadden’s Ricciardelli said while firms may be tempted to prohibit all political contributions, implementing such a sweeping policy could violate labor laws.

“As a result, you essentially have no choice but to pre-clear personal contributions,” he said. “Of course, then the question becomes who to pre-clear—if you set the line too low, perhaps requiring every employee to pre-clear, you may risk being overly intrusive and creating voluminous requests by individuals who simply aren’t covered by the rules. Of course, if you set the line too high, you risk missing a potentially problematic contribution. Striking the right balance here is always the hardest part of establishing a compliance program.”  

Ricciardelli said he sees many RIAs and broker/dealers who are so focused on the SEC and FINRA rules that they lose track of state and local regulations.

“Those rules may be more restrictive; for example, many state and local rules do not have a de minimis exemption as the SEC and FINRA rules do, so a $10 contribution could still disqualify you from an investment,” he said. “Making sure firms stay up-to-date on the myriad rules that are out there is essential.”

Political Contribution Volumes

As consolidation in the wealth management space continues, broker/dealers and RIAs alike are becoming ever larger. For the biggest firms, that means thousands of self-reported donations in the current election cycle and hours of manually tracking and approving political contributions.

John Van Der Wal, senior director of compliance advisory at Comply, a software provider in the compliance space, said this election cycle is expected to generate more donations than previous ones.

According to USAFacts data, between January 2023 and April 2024, U.S. political campaigns collected around $8.6 billion for the 2024 House, Senate and presidential candidates. We’re not at the finish line yet, but that total has already nearly surpassed the 2022 midterm election haul of $9.3 billion, according to OpenSecrets.

“During a presidential election cycle, more people come out of the woods and vote with their dollars. More issues get identified and placed on the ballot because they know they’re going to have greater turnout,” Van Der Wal said. “The key here is knowing what the requirements are for reporting and preclearance. And educating that it’s not just you; it’s members of your household, your spouse, your domestic partner, and your significant other. That’s where things can go wrong when there’s this much volume.”

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To date, the number of advisors making political contributions has not exceeded past election cycles. From January 2023 through May 15, 2024, the Federal Election Commission tallied about 43,000 individual contributions from people with the job title “financial advisor.” That compares to about 53,000 contributions for the same period of the 2022 election and 56,000 for the 2020 presidential election.

Steven Niedzwiadek, product manager for compliance at Advisor360°, a wealth management software provider, said there tends to be increased activity during presidential elections. The expected volume can create challenges and additional strains on compliance departments.

Niedzwiadek said that in past cycles, some of his clients had as many as two people whose full-time jobs were to run political contributions compliance programs. Verifying the attestations, making sure the contributions were all accurate, and entering them in the spreadsheet was labor intensive.

“Anytime you have a manual process, you are opening yourself up to risk because we’re all human, and humans make errors,” he said.

Accessing Compliance Tools

Last year, Advisor360° rolled out a new political contributions tool to help automate the process and reduce the number of human touchpoints as much as possible.

Advisors input their political donations into a disclosure page, including contribution amounts, payment methods, contribution dates, candidate names and whether the advisor filing is eligible to vote for the person. The tool also asks whether the advisor currently receives compensation from any of the government entities listed.

Advisor360’s tool integrates with Ballotpedia’s election database and automatically populates with the name of every candidate in every race in every jurisdiction in the U.S., including political action committees. Previously a home office would have to verify candidates on their own.

If the donation has yet to occur and is within the firm’s dollar threshold, the advisor will automatically receive pre-clearance. If it’s a late disclosure, a completely different case gets created, and an alert goes straight to the home office to verify there’s no concern or upfront risk.

Comply’s public data monitoring platform also helps with pay-to-play compliance. The tool is powered by illumis, a data aggregator and tech provider Comply acquired in 2021. It allows firms to automatically monitor political contributions on a federal, state and local level. The tool also features alerts, workflow tools and filters to remove false positives. It also has integrated pre-clearance and certification functions.

Even though the SEC’s 2024 examination priorities did not focus on pay-to-play, Comply’s Van Der Wal said he’s spoken to some firms who underwent an exam within the last two years who were asked about political contributions.

“The SEC is doing a review of their officers and other principals to see what contributions they have done,” he said.

https://www.wealthmanagement.com/regulation-compliance/recent-pay-play-case-cautionary-tale-advisors-and-political-contributions

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