SEC Cracks Down on ‘Pay to Play’

November 3, 2009 Updated: November 3, 2009

WASHINGTON—The Securities and Exchange Commission (SEC) proposed to curtail “pay to play” practices used by investment advisers seeking to manage money for state and local government pension plans.

The SEC’s new proposal seeks to prevent advisers from making political contributions or payments to influence their selection by politicians.

“In the public pension and government plan world, ‘pay to play’ refers to an often unspoken, but well-understood arrangement,” said SEC Chairman Mary Schapiro in a speech at an SEC open meeting this month.

“It's an arrangement whereby investment advisers who make political contributions and related payments to key officials are then rewarded with, or afforded the opportunity to compete for, contracts to manage public pension plans and other government accounts.”

The concern is that public pension plans as a whole have grown to around $2.2 trillion, about 33 percent of the country’s pension funds in total. That amount represents a very large fish for unscrupulous investment advisers.

The SEC found that if the fund trustees appointed to select the investment advisers took contributions from advisers, the process could be undermined by foul play. “Pay to play practices can result in public plans and their beneficiaries receiving sub-par advisory services at inflated prices,” Schapiro said in a recent statement.

“Our proposal would significantly curtail the corrupting and distortive influence of pay to play practices,” Schapiro said, referring to future selection processes under consideration by the SEC.

If adopted, SEC’s new proposal would not be limited to just the advisers, but would also prohibit specific executives and employees “from paying a third party.” Elected officials and those running for office with responsibility in pension or other government funds would be prohibited from accepting or soliciting political funds. Lastly, funds may not be channeled through third parties, including attorneys, family members, or any related company.

The SEC believes that it can’t guard against all efforts to influence the election process as clandestine actions often are difficult to uncover. However, its rules will address an issue that has dogged the process for some time.

Public Opinion Matters

Many experts in public service and academia submitted their views on the matter to the SEC.

R. Dean Kenderdine, executive director at the Maryland State Retirement and Pension System said he was “dismayed” at the changes and that “this matter may result in unintended hardships being placed upon public pension funds” and that it “would result in increased costs to the investment firms.”

Kenderdine believes that the proposed rule would curtail competition and not be in the best interest of the public.

Cornell law professors are in general in support of the proposed rule according to William A. Jacobson, Esq., professor at Cornell Law School. Jacobson believes that the new rules would level the playing field for smaller investment advisory firms.

Financial Adviser 101

Financial advisers are a dime a dozen, but understanding a little of the rules governing those we entrust with our pension and other funds goes a long way. Pension fund administrators should also actively engage in the debate to better recognize if trustees truly work on behalf of the fund or for those greasing their pockets.

Investment advisers are not financial planners in the truest sense, but its gets murky when an investment adviser fills both roles. Advisers must have trust, fiduciary responsibility, and transparency.

Investment advisers should be experts in investing to best assist their clients for a fee. Financial planners, on the other hand, don’t actively manage their clients’ funds, but teach their clients to stay within their means and prepare them for eventual retirement.

Investment advisers who administer more than $25 million in assets have to register with the SEC. Those who manage $25 million or less must register with state securities regulators where the investment advisers have their primary business location.