Pay-To-Play Rule: Exempt Reporting Advisers Must Monitor Political Contributions

Philip A. Dunlap of BoyarMiller

The U.S. Securities and Exchange Commission (SEC) amended Rule 206(4)-5 of the Investment Advisers Act, otherwise known as the “Pay-to-Play” Rule, so that it applies to exempt reporting advisers also. Exempt reporting advisers are those who (i) advise solely venture capital funds or (ii) advise solely private funds having less than $150 million aggregate assets under management. Rule 206(4)-5 provides the following prohibitions:

  1. a ban on an adviser receiving compensation for services provided to a government entity for a two-year period after a political contribution has been made by the adviser or any of its “covered associates” to officials of such entity;
  2. a ban on an adviser using third-party solicitors who are not registered broker-dealers or registered investment advisers subject to the pay-to-play restrictions; and
  3. a ban on an adviser or any of its “covered associates” attempting to solicit or coordinate other persons or PACs to make political contributions to certain officials of a government entity to which the adviser is attempting to provide advisory services.

Under Rule 206(4)-5, a “covered associate” includes (i) any partner, managing member or executive officer, (ii) any employee who solicits a government entity for the adviser and (iii) any PAC controlled by the adviser or a covered associate.

An “official” includes incumbents, candidates or successful candidates for elected office of a governmental entity if such office can directly or indirectly influence the outcome of the hiring of an investment adviser by a government entity.

The prohibition on receiving compensation for two years applies whether or not the adviser has actual knowledge of the contribution that triggered the two-year “time-out”. However, as a fiduciary to its clients, the adviser may be required to continue providing advisory services during any “time-out” period.

Rule 206(4)-5 also contains a “look back” provision pursuant to which advisers must look back in time to ascertain if covered associates have made prohibited contributions. Any contributions made by a person within two (2) years of becoming a covered associate (if the covered associate solicits clients) and six (6) months if the covered associate does not solicit clients, will be attributed to the adviser. As a result, the adviser will be subject to a “time-out” for the remainder of the applicable period (2 years or 6 months) that such person is a covered associate of the adviser. Because of this provision, advisers should carefully consider the past actions of its covered associates (and potential covered associates) to determine if any “time-out” applies to the covered associate and would be attributed to the adviser.

Thankfully, the SEC has provided an exception to the prohibited contributions. A natural person covered associate may contribute (i) up to $350 to an official per election (primary and general elections are considered separate elections) if the covered associate was entitled to vote for such official at the time of the contribution and (ii) up to $150 if the covered associate was not entitled to vote for such official at the time of the contribution.

Furthermore, if a “time-out” period is triggered because such covered associate was not entitled to vote for the official at the time of the contribution, the adviser may cure such inadvertent contribution if (i) the contribution was $350 or less, (ii) the adviser discovers the contribution within four (4) months of the date of the contribution and (iii) ensures the return of the triggering contribution within sixty (60) days of discovering the triggering contribution.

As a result of the revisions to Rule 206(4)-5, it is especially important in this election year for advisers to (i) ensure that its employees are aware of the prohibitions on political contributions, (ii) conduct proper due diligence on previous political contributions of existing covered associates and potential new hires that would be covered associates and (iii) engage a compliance officer to develop internal policies for political contributions, monitoring of employee’s political activity and contact with placement agents or other third- party solicitors.

The final adoption of Rule 206(4)-5 can be found at:

Philip A. Dunlap, Associate,

I joined BoyarMiller's Business Group in April 2011. My practice primarily consists of corporate, private equity and private securities transactions as well as serving as outside general counsel in a variety of matters including mergers and acquisitions, financing, employment agreements and raising capital through private offerings. I have represented hedge funds, private equity funds, venture capital funds and real estate funds in their formation, operation and compliance in multiple jurisdictions.

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Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Boyar Miller. This work reflects the law at the time of writing.