Legal Alert: SEC Proposes Rescission Of Investment Adviser Pay-to-Play Rule
Quick Summary
The SEC has proposed eliminating the Pay-to-Play Rule, which for over 15 years has restricted political contributions by investment adviser personnel and penalized firms whose employees donate to officials with influence over public pension investments. The SEC says the rule is overly broad and burdensome, and estimates rescission would save advisers roughly $416 million annually in compliance costs. Until any final rule takes effect, advisers should continue complying with the current requirements. Read on for the full breakdown. Just weeks before the U.S. midterm elections, as compliance officers routinely remind employees of the restrictions on political contributions under Rule 206(4)-5, the SEC proposed rescinding the rule altogether on Thursday, September 3, 2026.[1]
If adopted, the proposal could make 2026 the last election cycle in which such reminders are necessary.
Adopted in 2010 just three weeks before President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the rule on political contributions, popularly known as the “Pay-to-Play Rule,” essentially limited the ability of investment advisory personnel to make certain political contributions to politicians who may influence investment decisions by state and local government plans and, in some cases, public universities.
Notably, as later amended to reflect the new exemptions regime created by the Dodd-Frank Act, the Pay-to-Play Rule currently applies not only to registered investment advisers (“RIAs”) but to foreign private advisers (“FPAs”) and exempt reporting advisers (“ERAs”) as well, including those exempt advisers relying on either the venture capital fund adviser exemption or the private fund adviser exemption.
While the Pay-to-Play Rule doesn’t flatly prohibit political contributions, it instead imposes a two-year prohibition on receiving compensation for providing investment advisory services to a government entity following certain contributions to an official who can influence the entity’s investment decisions. In the private fund context, that prohibition can implicate both management fees and carried interest.
For example, if a fund sponsor’s employee made a covered donation to a candidate for governor in California, the adviser may be prohibited from receiving management fees or carried interest from state pension plans that make investments in that sponsor’s investment funds for the following two years, a significant reduction in potential advisory compensation.
As such, many advisers (registered and exempt alike) developed extensive compliance programs to monitor the political contributions of personnel. If the rule is rescinded as proposed, those prescriptive compliance regimes would no longer be required by the Pay-to-Play Rule.
While the rule is designed to target state and local governmental plans, candidates for federal office can also be captured by the rule. For example, contributions to the Republican presidential ticket in 2016 could have implicated the rule because vice-presidential candidate Mike Pence was then governor of Indiana, thereby complicating compensation from Indiana state and local plans.
Supporters of the rule say that its bright-line prohibitions have eliminated the quid pro quo aspects that the SEC targeted in adopting the rule. Critics of the Pay-to-Play Rule argue that it is overbroad, that existing fraud remedies are sufficient to handle abuses, and that it effectively chills political speech. Indeed, in a statement on the proposal to rescind the rule, SEC chair Paul Atkins made many of those arguments:
However, since its adoption, it has proven only to be needlessly penalizing, burdensome, and complex to implement, and misaligned with the SEC’s mandate.
After more than 15 years of experience administering the rule, it is clear that it is overly prescriptive and has produced a host of unintended consequences. Beyond operational implementation challenges, it has imposed serious penalties for small, often impulsive donations to candidates in both parties, and routinely punishes and handicaps advisory firms for an employee making a donation even before joining the business.
Furthermore, advisers’ implementation of the rule has effectively resulted in the suppression of political speech…. Such practice discourages full participation in the electoral process through contributions to candidates. People should not have to choose between their political speech rights and a job in a particular industry.
Background
Rule 206(4)-5 was adopted in 2010 as a result of several scandals involving kickbacks from fund sponsors to officials who could influence the selection of investment advisers by state and local pension plans, though the SEC had long been concerned about the issue. As implemented, the Pay-to-Play rule is designed to remove the connection between political contributions to officials who may be able to influence decision-making with respect to government and public pension investment advisory business.
The rule provides that no adviser may 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 (including a person who becomes a covered associate within two years after the contribution is made).
Furthermore, no adviser may provide (or agree to provide), directly or indirectly, payment to any person to solicit a government entity for investment advisory services on behalf of such adviser unless such person is (A) a regulated person (such as another RIA, a registered broker-dealer or a registered municipal advisor) or (B) an executive officer, general partner, managing member (or, in each case, a person with a similar status or function), or employee of the investment adviser.
Similar rules exist prohibiting the same compensation and solicitation in respect of political action committees (“PACs”).
As such, the Pay-to-Play Rule imposes significant limits on personnel of fund sponsors who donate to campaigns and payments to placement agents who solicit state and local governmental entities.
The Pay-to-Play Rule provides a de minimis exception for natural persons:
- up to $350 to any one official, per election, for whom the person was entitled to vote at the time of the contribution; or
- up to $150 to any one official, per election, for whom the person was not entitled to vote at the time of the contributions.
The rule also prohibits doing indirectly what an adviser or covered associate could not do directly, which can capture contributions nominally made through a spouse or other third party on the covered associate’s behalf. The concept of “contribution” is broadly defined as well, including not only cash, but gifts, loans, or anything of value. That breadth includes the purchase of campaign merchandise, which is generally deemed a contribution under federal law.
Moreover, “official” is also broadly defined under the rule as any incumbent, candidate or successful candidate for elective office of a government entity if the office “is directly or indirectly responsible for, or can influence the outcome of” or “has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of” the hiring of an investment adviser by a government entity. So while a governor may not typically have any role in the investment decisions that a state’s pension plan makes, his or her powers are typically sufficiently broad to implicate contributions to a gubernatorial campaign.
The rule governs all “government entities,” meaning any US state or political subdivision of a US state (such as a city or county), including:
- any agency, authority, or instrumentality of the State or political subdivision;
- a pool of assets sponsored or established by the US state or political subdivision or any agency, authority or instrumentality thereof, including, but not limited to a “defined benefit plan”;
- a plan or program of a government entity; and
- officers, agents, or employees of the State or political subdivision or any agency, authority or instrumentality thereof, acting in their official capacity
While many SEC rules governing RIA personnel apply to “supervised persons,” the Pay-to-Play Rule instead applies to “covered associates.” Although many covered associates will also be supervised persons, the definition can reach certain persons outside the adviser, including personnel of an affiliate who directly or indirectly supervise an adviser employee who solicits government entities:
- any general partner, managing member or executive officer, or other individual with a similar status or function;
- any employee who solicits a government entity for the investment adviser and any person who supervises, directly or indirectly, such employee; and
- any PAC controlled by the investment adviser or by any person described above.
The rule was initially adopted under Section 206 of the U.S. Investment Advisers Act of 1940 (the “Advisers Act”), which generally prohibits fraud by advisers and is a key anchor of Advisers Act enforcement.
Proposal
The proposal to rescind the Pay-to-Play Rule in full is perhaps most surprising in its breadth. The SEC considered whether the problems that the Pay-to-Play Rule addresses could be solved through other means, including higher de minimis amounts, narrower definitions and different timing considerations. Instead, the SEC has proposed rescinding the rule in its entirety and removing the corresponding provisions of Rule 204-2 (the “Books and Records Rule” that mandates certain RIA recordkeeping). In so doing, the SEC is arguing that the rule’s bright-line approach to corruption is too blunt an instrument. The SEC notes that other aspects of Section 206(1), (2) and (4) can be applied to advisers who engage in quid pro quo activity to exchange political contributions for later preferential treatment by state and local investment plans.
The SEC estimates that rescission would result in approximately $416 million in annual compliance cost savings, including estimated annual savings of approximately $323,000 for larger advisers. Many advisers have implemented complex reporting regimes whereby all firm employees, consultants, and other “covered associates” must pre-clear their (and their spouses’) political contributions prior to making them. Other firms simply impose a blanket prohibition on political contributions altogether.
In rescinding Rule 206(4)-5, the SEC instead points to Rule 206(4)-7 as the proper regulatory remedy, which requires that RIAs implement written policies and procedures, arguing that rescinding the Pay-to-Play Rule would not rescind the obligation of RIAs to have policies and procedures designed to prevent fraudulent pay-to-play practices. As such, rescission of the rule would not necessarily mean the end of RIA political contributions policies in some cases. Some firms (especially those with an investor base that includes many public pension plans) may choose to retain preclearance reporting or other controls, even if the SEC proposal is adopted.
Notably, ERAs and FPAs are not subject to Rule 206(4)-7, so the regulatory burden on those exempt advisers would fall even more dramatically, though all advisers (registered or exempt) remain subject to the broad anti-fraud provisions of Section 206.
The SEC also notes that the rule can complicate hiring decisions for investment advisers because of the rule’s lookback. In hiring a professional who made a prior contribution, an investment adviser might be prevented from earning compensation due to a decision made by an individual before he or she was even associated with the investment adviser. The SEC also argues that the rule may hurt public pensions by limiting competition by effectively prohibiting some investment firms from competing for those plans’ fees and potential carried interest.
Conclusion
Advisers, especially as the 2026 midterm elections approach, should continue to comply fully with the Pay-to-Play Rule. Nonetheless, the SEC’s proposed action, if adopted, would fundamentally change political-contribution compliance for investment advisers.
ERAs and FPAs would no longer be subject to a prescriptive SEC pay-to-play compliance regime, while RIAs would move from the Pay-to-Play Rule’s current bright-line restrictions toward a principles-based approach under Rule 206(4)-7, tailored to the particular pay-to-play risks presented by their businesses.
Shulman Rogers regularly represents both registered investment advisers and exempt reporting advisers in connection with Advisers Act compliance, including investor qualifications and other client requirements, including disclosure, custody, marketing, and other regulatory requirements. We continue to monitor developments under the Advisers Act and all securities laws and SEC rulemaking.
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The contents of this Alert are for informational purposes only and do not constitute legal advice. If you have any questions about this Alert, please contact the Shulman Rogers attorney with whom you regularly work.
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