In Aprill, The Securities and Exchange Commission charged private equity firm Wayzata Investment Partners for violating the pay-to-play rule for investment advisers.
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 the selection of investment advisers for a state board investments. The Minnesota State Board of Investments had been a client of Wayzata's since 2007, and the firm continued to provide investment advisory services to the funds for two years after the contribution, according to the SEC.
As a result, the firm paid $60,000 in fines. SEC Commissioner Hester Peirce did not oppose the enforcement action, saying it was government overreach.
“This case is another illustration of the breadth of the pay-to-play rule and another reminder of how the rule impedes legitimate political participation,” Peirce said in a statement. “The rule allows for exceptions, but the Commission has rarely granted them. To avoid questions from Commission examiners, the easiest way 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.”
Still, the rule still stands, and Wayzata's case may provide a cautionary tale for other affiliated RIAs seeking to make political contributions in a hotly contested presidential election year. The election is perhaps even more top of mind after Trump's conviction in the Stormy Daniels trial, which seems to have unaltered voter minds.
“Despite this disagreement, the SEC remains clearly 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 remain vigilant in this area with properly up-to-date policies and procedures, along with appropriate training and timely reminders for staff. covered.”
The Wayzata case shows that political contributions can pose compliance and reputational risks for RIAs. The firm's assets under management fell 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 if Minnesota was pulling 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 is a huge risk 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 face.”
Either way, this is an area where firms should focus as we move 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 will have to follow the political contribution rule,” DiMaria said. “And in this market environment where we're approaching the election, it's an even better time to be proactive about going out and understanding what your employees are doing in this space.”
Rules Today
Political contributions are handled under the SEC's Pay-to-Play Rule, Rule 206(4)-5 of the Investment Advisers Act of 1940, which prohibits an investment adviser from collecting fees from a government entity if the adviser or certain employees have made a political contribution of specified amounts to a relevant government official. Councilors can donate $350 per election cycle to candidates they are eligible to vote for and $150 to other candidates.
The rule includes a two-year look-back provision, where the adviser cannot receive compensation from that government entity for two years after a contribution is made.
Broker/dealers and their representatives 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 that firms pre-clear all political contributions with their compliance departments before they are made.
“That way, you can see who they're planning to make a contribution to and how much it is,” she said. “This allows you to cross reference the areas where your business development team is working on potential new mandates and where there may be a problem.
“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 continues and could be a potential issue in the future,” he added. she.
The SEC rule also states that advisers must review the contribution to see who exactly is benefiting from it. This includes charitable donations; Charitable organizations or foundations can pour money into political campaigns, she said.
Even firms that do not currently work with public entities should follow the political contributions of their advisors; 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 they at least have the information,” DiMaria said. “You never know where your next customer is going to come from.”
Skadden's Ricciardelli said that while firms may be tempted to ban all political contributions, implementing such a blanket policy could violate labor laws.
“As a result, you basically have no choice but to pre-clear personal contributions,” he said. “Of course, then there is the question of who to pre-clear – if you set the bar too low, perhaps requiring every employee to pre-clear, you risk being overly intrusive and creating voluminous claims from individuals who are simply not covered by the rules . Of course, if you set the bar too high, you risk missing a potentially problematic contribution. Striking the right balance here is always the hardest part of building a compliance program.”
Ricciardelli said he sees many RIAs and broker/dealers who are so focused on SEC and FINRA rules that they lose track of state and local regulations.
“These rules can be more restrictive; for example, many state and local rules don't have a de minimis exemption like the SEC and FINRA rules do, so a $10 contribution can still disqualify you from an investment,” he said. “Making sure firms stay up-to-date on the myriad rules out there is essential.”
Volumes of Political Contribution
As consolidation in the wealth management space continues, broker/dealers and RIAs are getting bigger and bigger. For larger firms, that means thousands of self-reported donations in the current election cycle and hours of manual tracking and approval of political contributions.
John Van Der Wal, senior director of compliance consulting 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, US political campaigns raised nearly $8.6 billion for the 2024 House, Senate and presidential candidates. We're not yet at the finish line, but that total has already nearly surpassed the amount of the 2022 midterm elections 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 are identified and put on the ballot because they know they're going to get more turnout,” Van Der Wal said. “The key here is knowing what the reporting and clearance requirements are. And educating that you're not alone.” you; it's your family members, your spouse, and your significant other. That's where things can go wrong when there's so much volume.”
To date, the number of councilors who have made political contributions has not exceeded the previous election cycles. From January 2023 to May 15, 2024, the Federal Election Commission counted about 43,000 individual contributions from people with the job title of “financial advisor.” This compares with 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 activity tends to increase during presidential elections. The expected volume can create additional challenges and 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 contribution compliance programs. Checking the credentials, making sure the contributions were all correct, and entering them into the spreadsheets was labor intensive.
“Anytime you have a manual process, you're opening yourself up to risk because we're all human and humans make mistakes,” he said.
Access to Compliance Tools
Last year, Advisor360° created a new political contribution tool to help automate the process and reduce the number of human touch points as much as possible.
Councilors enter their political donations on a disclosure page, including contribution amounts, payment methods, contribution dates, candidate names and whether the councilor filing is eligible to vote for the person. The tool also asks if the advisor currently receives compensation from any of the listed government entities.
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 US, including political action committees. Previously, a home office would have to vet candidates themselves.
If the donation has not yet occurred and is within the firm's dollar threshold, the advisor will automatically receive pre-clearance. If it is a late detection, a completely different case is created and an alert goes straight to the home office to verify that there is no prior concern or danger.
Comply's public data monitoring platform also helps with pay-to-play compliance. The tool is powered by illumis, a data aggregator and technology provider Comply acquired in 2021. It allows firms to automatically monitor political contributions at the 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.
Although the SEC's 2024 exam priorities did not focus on pay-to-play, Comply's Van Der Wal said he has spoken to several firms that underwent an exam within the past two years, which were asked about political contributions.
“The SEC is doing a review of their officers and other directors to see what contributions they have made,” he said.