Under the rule, if an investment adviser or certain employees of an advisory firm contribute to a politician with influence over hiring, they cannot be paid by the pension fund for two years.
Investment advisers who manage public pensions and other types of government investment funds will be limited in making political contributions to officials who choose fund advisers.
In a unanimous vote Wednesday, the Securities and Exchange Commission adopted a regulation designed to curtail so-called “pay to play” schemes in which advisers try to curry favor with politicians by donating to their campaigns.
Under the rule, if an investment adviser or certain employees of an advisory firm contribute to a politician with influence over hiring, they cannot be paid by the pension fund for two years. Advisers would be prohibited from bundling donations from other people or political action committees for the officeholder or a party.
The rule bars advisers and their colleagues from paying a solicitor or placement agent to seek government business unless the third party is a registered investment adviser or broker-dealer. In addition, the regulation stops indirect political contributions from an adviser's spouse, lawyer or affiliated companies.
The new rule, which is modeled after those applying to municipal securities, becomes effective 60 days after its publication in the Federal Register.
Compliance with the rule's provisions generally will be required within six months of the effective date. Compliance with the third-party ban and those provisions applicable to advisers and registered investment companies subject to the rule will be required one year after the effective date.
The Financial Industry Regulatory Authority Inc. is drawing up a similar regulation for broker-dealers. SEC staff said that Finra should complete its work within a year.
SEC Chairman Mary Schapiro said pay-to-play arrangements “reward political connections rather than management skill” and foster fraud and corruption.
“The cost of this practice is borne by retired teachers, firefighters and other government employees relying on expected pension benefits, or by parents and students counting on a state-sponsored college savings account,” Ms. Schapiro said. “And, ultimately, this cost can be borne by taxpayers, who may have to make up shortfalls when vested obligations cannot be met.”
Ms. Schapiro cited a recent case the SEC brought against the New York State Common Retirement Fund over alleged kickbacks connected to investments. Similar actions have been filed in California, New York, New Mexico, Illinois, Ohio, Connecticut and Florida.
The new regulation will require investment advisory firms to put "very rigid compliance procedures in place," said Edward Pittman, who is of counsel at Dechert LLP in Washington.
Even with those controls, the new regulation is likely to be difficult to police with the advent of online political fundraising, which was perfected by then-Sen. Barack Obama, D-Illinois, in his 2008 presential campaign. Those tactics also are being used at the state and local level, where officials may have influence over public funds.
For instance, investment advisers who do business with New York City may be limited in their ability to contribute to Mayor Michael Bloomberg under the new rule. The compliance office of the advisory firm will have to keep track of some employees who donate to mayoral races.
"The danger is that someone goes online and makes a credit card payment on Michael Bloomberg's Web site — and no one in the organization sees it," Mr. Pittman said. "It's a tremendous compliance challenge to figure out who should be subject to the limits on political contributions."
Government investment funds are growing exponentially. Public pensions total $2.6 trillion in assets, comprising one third of the U.S. pension market. There is nearly $100 billion in Section 529 college savings plans.
The final rule was designed to avoid completely barring third-party placement agents and to preserve the right of investment advisers to participate in the political system, according to SEC staff members.
Advisers would be allowed to contribute $350 per election — primary and general — to politicians and political challengers connected to adviser selection if the adviser is entitled to vote for the candidate. The limit is $150 if the adviser cannot vote for the candidate.
Advisers can continue to contribute up to $2,300 per election to candidates who are running for offices that don't oversee public funds, as permitted under federal election law.
“The rule is appropriately sensitive to First Amendment concerns,” said SEC Commissioner Kathleen Casey.
