FINRA Proposes Revised Broker-Dealer Pay-to-Play Rules

Investment Management Update

Date: March 01, 2016

Key Notes:

  • Proposed rules would enable broker-dealers to act as third-party solicitors for investment advisers.
  • Proposed rules would prohibit broker-dealers from soliciting state/local government entities on behalf of an adviser for two years after a broker-dealer employee makes a contribution to a covered official/candidate of that government entity.
  • Comments due March 29, 2016.


In December 2015, the Financial Industry Regulatory Authority, Inc. (FINRA) submitted proposed Rules 2030 and 4580 to the Securities and Exchange Commission (SEC) for approval.[1] The proposed rules set forth pay-to-play restrictions and recordkeeping requirements applicable to business conducted by broker-dealers with governmental entities. The rules are intended to enable FINRA member firms to act as third-party solicitors for investment advisers (and as placement agents for investment advisers’ investment pools).

The proposed FINRA rules are intended to complement SEC Rule 206(4)-5,[2] the SEC’s existing pay-to-play rule adopted under the Investment Advisers Act (SEC Pay-to-Play Rule). Generally, pay-to-play restrictions are intended to prevent the use of campaign contributions to unduly influence government officials who are in a position to direct a government entity’s selection of an investment adviser (or investments in an investment adviser’s investment pool).[3] The SEC Pay-to-Play Rule prohibits an investment adviser from providing, or agreeing to provide, payment to any person to solicit a government entity for investment advisory services on behalf of the investment adviser unless the person is a “regulated person.” A regulated person includes a member firm, provided that:

  • FINRA rules exist that prohibit member firms from engaging in distribution or solicitation activities if the member firm (or its covered associates) has made political contributions to officials of a government entity to which the member firm directs its distribution or solicitation activities.
  • The SEC finds such rules to impose equivalent or more stringent restrictions on member firms than the SEC Pay-to-Play Rule.

FINRA intends the proposed rules to enable member firms to qualify as regulated persons, which will enable member firms to engage in distribution and solicitation activities with government entities on behalf of investment advisers, while at the same time deterring member firms from engaging in pay-to-play practices.[4]

Proposed Rule 2030
Pay-to-Play Restrictions

Proposed Rule 2030 would prohibit a covered FINRA member firm from engaging in distribution or solicitation activities with a state or local government entity for compensation on behalf of an investment adviser that provides, or is seeking to provide, investment advisory services to the government entity within two years after the covered member or a covered associate makes a covered contribution to a covered official of the government entity.[5] This restriction includes direct and indirect contributions through a controlled political action committee (PAC) or through soliciting others to make contributions.[6]

Key definitions in the proposed rule include:

  • “Covered contribution” means anything of value given to a covered official for the purpose of influencing an election, election debt retirement or transition of successful candidate inaugural expenses.[7]
  • “Covered official” means a candidate, successful candidate or incumbent of a state or local elective office who can directly or indirectly influence the government entity’s selection of an investment adviser or investment in an investment pool or has the authority to appoint an official with such capacity.[8]
  • “Covered associate”[9] means any:
    • Associated person who engages in distribution or solicitation activities with a government entity
    • Associated person who directly or indirectly supervises the government entity distribution or solicitation activities of such a solicitor
    • General partner, managing member or executive officer (the president, vice president in charge of a principal business unit, division or function, other officer or person who performs a policy-making function), or other individual with a similar policy-making status or function
  • “Investment pool”[10] means unregistered pooled investment vehicles, such as hedge funds, private equity funds, venture capital funds or collective investment trusts, and registered pooled investment vehicles, such as mutual funds, but only if those registered pools are an investment option of a government entity’s participant-directed plan or program.
Contribution Exceptions & Exemptions

Proposed Rule 2030 provides de minimis exceptions for a $350 contribution per election cycle to any one official for whom the covered associate is entitled to vote and a $150 contribution per election cycle for any other official.[11]

The proposed rule also permits FINRA members to apply to FINRA for an exemption from the two-year time-out if the firm discovers the contribution and seeks to cure the violation if imposing the time-out would be unnecessary to achieve the proposed rule’s intended protective purpose. FINRA will take facts and circumstances into account in deciding whether to grant such an exemption.[12]

The proposed rule applies a “look-back” whereby political contributions made by a person who becomes a covered associate in the two years prior to his or her obtaining that position are attributed to the member firm to measure the time-out period. However, the look-back period is only six months for certain new associates who are not directly involved in distribution or solicitation activities.[13]

Proposed Rule 4580

Proposed Rule 4580 requires a covered member firm to maintain various records including:

  • Covered associate name, title, and business and home addresses.
  • Investment adviser name and address if the covered FINRA member has engaged in successful distribution or solicitation activities with a government entity within the past five years.
  • Name and address of the government entity with which the covered FINRA member has engaged in successful distribution or solicitation activities for compensation on behalf of an investment adviser, or which is or was an investor in any covered investment pool for which the covered FINRA member has engaged in distribution or solicitation activities on behalf of the investment adviser, within the past five years.
  • Direct or indirect contributions the covered FINRA member or any of its covered associates made to an official of a government entity, or direct or indirect payments made to a political party of a state or political subdivision thereof, or to a PAC.
Revisions to 2014 Proposed Rules

In response to comment letters from various market participants, FINRA made certain notable changes to previously proposed versions of the rules:[14]

  • Eliminated a disclosure requirement that would have required notice to the government entity in writing at the time of an initial distribution or solicitation of compensation to be paid and the relationship with the investment adviser.
  • Eliminated disgorgement of compensation obtained in violation of the rules.
  • Eliminated records retention requirement when related to unsuccessful solicitation or distribution activities when compensation is contingent upon success.
Expected Effective Dates

The proposal is subject to the SEC’s public comment and approval process. FINRA has requested that the SEC respond to its proposal by March 29, 2016. If the SEC approves, FINRA will announce the effective date of the proposed rule change in a Regulatory Notice to be published no later than 60 days following SEC approval. FINRA intends to establish an effective date that is no sooner than 180 days following publication of the Regulatory Notice and no later than 365 days following SEC approval.[15] This transition period will provide member firms with time to identify their covered associates and government entity clients and to modify their compliance programs to address new obligations under the rules.

The prohibition on engaging in distribution or solicitation activities with a state or local government entity for compensation on behalf of an investment adviser that provides, or is seeking to provide, investment advisory services to the government entity within two years after a contribution is made to the government entity, will not be triggered by contributions made prior to the effective date. Similarly, the prohibition will not apply to contributions made prior to the effective date by new covered associates to which the two-year or, as applicable, six-month look-back applies.

FOR MORE INFORMATION

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[2] 17 CFR 206(4)-5.

[3] Release at, e.g., 9-10.

[4] Release at 7.

[5] Release at 9, describing Rule 2030(a).

[6] Release at 15-16, describing Rule 2030(g)(2).

[7] Rule 2030(g)(1).

[8] Rule 2030(g)(8).

[9] Proposed Rule 2030(g)(2) defines a covered associate to also include any political action committee controlled by a covered member or covered associate.

[10] Release at 9, 20-21. Rule 2030(g)(3), defining a covered investment pool to mean: (a) any investment company registered under the Investment Company Act that is an investment option of a plan or program of a government entity, or (b) any company that would be an investment company under Section 3(a) of the Investment Company Act but for the exclusion provided from that definition by either Section 3(c)(1), 3(c)(7) or 3(c)(11) of that act.

[11] Rule 2030(c)(1).

[12] Rule 2030(f).

[13] Rule 2030(c)(2).

[14] Release at 8, 37-38. The 2014 version of proposed Rule 4580 required, among other things, that a covered FINRA member keep records of the names and addresses of all government entities with which it engaged in solicitation or distribution activities on behalf of an investment adviser. As submitted, current proposed Rule 4580 limits this requirement to such solicitation and distribution activities engaged in “for compensation.” In the release, FINRA states that this change is meant to clarify that recordkeeping would not apply to unsuccessful solicitations. However, based on the plain language of proposed Rule 4580, this recordkeeping requirement could be read to cover an unsuccessful solicitation undertaken on retainer or in connection with another compensation arrangement that is not contingent upon success.

[15] Release at 4, 86.