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Pay-to-Play – SEC Expands Scope of Rule to CABs

The SEC’s pay-to-play rule has given advisers reason to worry about potential foot faults since its adoption. As we have noted in prior posts, the rule is filled with landmines and is therefore difficult to navigate.  As was evident from the SEC’s announcement of a series of settlements of alleged pay-to-play violations in early 2017, even a small contribution without any intent to influence an election or an official can run afoul of the rule and put two years of fees and carry at risk.

Last week, the SEC issued an order that will expand the scope of the pay-to-play rule.  The SEC approved a FINRA proposal to extend the self-regulatory organization’s Rules 2030 and 4580 (its pay-to-play and associated recordkeeping rules) to a recently established category of FINRA-registered firms known as capital acquisition brokers, or CABs.

CABs are firms that focus on a more limited set of activities than full-service broker-dealers.  Generally, an entity qualifies as a CAB if it engages solely in specific capital raising or corporate advisory activities, including corporate restructurings and acting as a private fund placement agent.  However, CABs are prohibited from maintaining customer funds and cannot trade customer securities.  Firms that carry customer accounts, produce research or chaperone non-U.S. broker-dealers under Rule 15a-6 of the Exchange Act cannot register as CABs.

The SEC order subjects CABs to the pay-to-play restrictions and recordkeeping requirements already applicable to full-service broker-dealers under FINRA CAB Rules 203 and 458.  The pay-to-play rule that applies to CABs is substantially similar to the pay-to-play rule that applies to investment advisers, with minor distinctions.

As a refresher, the SEC’s pay-to-play rule generally prohibits an adviser from providing compensated advisory services to state government or retirement plan investors for two years following an impermissible contribution – in other words, no fees or carry during the two-year “time out” period.  The rule is triggered if the adviser or one of its “covered associates” makes a “contribution” to an “official” of a “government entity” unless the “contribution” falls within one of the narrow exceptions to the rule.  An adviser could also be subject to penalties if the adviser or one of its “covered associates” coordinates or solicits a “contribution” to an “official” or “payment” to a state or local political party.  The use of “quotations” here is intentional – each is a defined term within the rule that requires independent analysis by the adviser.

While the expansion of the FINRA pay-to-play rule is somewhat narrow, it serves as a useful reminder to private fund advisers to review their compliance policies, confirm that applicable recordkeeping requirements are being met, and double-down on ensuring that personnel are well-trained on the potential implications of their political activities.  With the proper procedures in place, the potential for financial and reputational harm resulting from a violation of the pay-to-play rule can be minimized.

As we have said before, a well thought out, robust, and vigilantly enforced pay-to-play policy will pay for itself.

© 2020 Proskauer Rose LLP. National Law Review, Volume VII, Number 285


About this Author

Lucy Wolf, Proskauer Law Firm, Boston, Litigation Attorney

Lucy Wolf is an associate in the Litigation Department and a member of the Private Funds Group.

Anthony M. Drenzek, Special regulatory Counsel, Proskauer Rose, Attorney, Finance Policy Lawyer
Special Regulatory Counsel

Tony is special regulatory counsel in the Corporate Department and a member of the Private Funds Group and the Private Equity & Hedge Fund Litigation team. His practice focuses on advising U.S. and offshore private fund managers on all aspects of federal, state and SRO organizational and operational compliance, with a specific emphasis on the Investment Advisers Act of 1940.

Tony assists U.S. and offshore private fund clients in registering with the SEC as investment advisers, or reporting as exempt reporting advisers, and complying with CFTC and various U.S. state registration and notice-filing requirements. He also assists on structuring fundraising transactions to comply with the U.S. offering exemptions available under Regulation D and Regulation S.


Tony proactively monitors the evolving regulatory landscape and counsels clients on practical industry approaches to compliance and how anticipated trends in agency rulemaking and staff expectations may affect their operations. He counsels clients on the establishment, implementation and evaluation of regulatory programs required under the Investment Advisers Act of 1940. In addition to compliance manuals and codes of ethics, Tony assists on the creation and maintenance of various operational-level compliance policies and procedures in areas such as investment and expense allocation policies, investment valuation procedures, cybersecurity policies, and business continuity and transition plans.

As clients’ investment management practices mature, Tony advises on the regulatory aspects of transactions involving divestments, mergers and acquisitions of investment managers and fund complexes. This includes coordinating and amending applicable regulatory filings and assuring that client consent requirements are evaluated and compliant.

As a member of the Private Equity & Hedge Fund Litigation team, Tony has advised clients on responses to inquiries and investigations from federal and state regulatory agencies on various regulatory matters, including the Investment Advisers Act’s pay-to-play and custody rule requirements.

Tony has authored and co-authored numerous articles on various regulatory matters affecting private fund sponsors, including several published in the Hedge Fund Law ReportPrivate Funds ManagementCompliance WeekVC Experts and Law360.

Prior to joining Proskauer, Tony served as an associate director of the Massachusetts Securities Division and was appointed as a Special Assistant Attorney General in the Commonwealth of Massachusetts. Between 2008 and 2013, Tony was an adjunct professor in the Law, Taxation and Financial Planning Department at Bentley University in Waltham, where he developed and taught a course focusing on application of the Securities Act of 1933 and the Securities Exchange Act of 1934.

Michael R. Hackett, Litigation Attorney, Proskauer Law Firm

Michael R. Hackett is an associate in the Litigation Department and a member of the Asset Management Litigation practice. His practice focuses on disputes and regulation involving private funds, including private equity, venture capital, hedge, real estate and private credit funds, as well as other limited partnerships, where he regularly advises funds, fund sponsors, investment advisers and institutional and individual investors.

Mike’s experience representing private fund clients runs the gamut, from control contests within advisers, to...

Joshua Newville, Proskauer Rose, regulatory enforcement attorney, industry compliance legal counsel, securities exchange commission lawyer

Joshua M. Newville is a partner in the Litigation Department in New York. His practice focuses on commercial litigation and regulatory investigations. Mr. Newville advises companies and individuals in securities litigation and compliance matters. He also focuses on internal investigations and enforcement matters. Prior to joining Proskauer, Josh was senior counsel in the U.S. Securities and Exchange Commission’s Division of Enforcement, where he investigated and prosecuted violations of the federal securities laws. Josh served in the Enforcement Division’s Asset...