The Financial Industry Regulatory Authority (“FINRA”) recently filed its revised pay-to-play rules proposal with the Securities Exchange Commission (“SEC”). Investment advisers have been awaiting FINRA’s pay-to-play rules ever since the SEC announced last year that it would not recommend enforcement action against an investment adviser or its associated persons for the payment to a third party for the solicitation of a government entity for investment advisory services until either FINRA or the Municipal Securities Rulemaking Board (“MSRB”) had adopted its own pay-to-pay rules for broker-dealers.
Pay-to-play activities involve the practice of making cash or in kind contributions, or soliciting others to make those contributions, to state or local officials or other government entities as an incentive for the receipt of government contracts. Pursuant to Rule 206(4)-5, investment advisers are prohibited from providing a government entity with investment advisory services for compensation within two years of contributing monetarily to that government entity. In addition, and of particular interest here, under Rule 206(4)-5 investment advisers may not provide payment to any third party to solicit a government entity for investment advisory services on behalf of the investment adviser unless that third party is a registered investment adviser, a registered broker-dealer, or a registered municipal adviser.
FINRA’s originally proposed pay-to-play rules were modeled on Rule 206(4)-5, differing in that it contained disclosure requirements which would require written disclosures to government entities stating that the registered broker-dealer was engaged in solicitation or distribution activities on behalf of the investment adviser. The disclosure would have to describe the nature of the affiliation between the adviser and registered member and the type of compensation received, among other details, and would have to be updated within ten days of any changes. In addition, if the member firm violated the proposed role it would be required to disgorge any compensation received as a result of its solicitation activities.
In response to comment letters received, FINRA revised its proposed pay-to-play rules to be more in line with the Investment Advisers Act and Rule 206(4)-5. The recently filed version it is still largely modeled on Rule 206(4)-5, although notably it no longer contains the disclosure or disgorgement requirements. Proposed FINRA Rule 2030 prohibits member firms from soliciting a government entity for compensation on behalf of an investment adviser that provides or is seeking to provide investment advisory services to such government entity within two years after a contribution to the government entity is made. There are also various recordkeeping requirements that member firms must follow pursuant to proposed FINRA Rule 4580.
While FINRA modified its proposed rule to remove the disclosure or disgorgement requirements, it did note in its rule filing that it maintains the ability to require a disgorgement of fees in enforcement actions. In addition, FINRA stated that it would continue to consider whether a disclosure rule was appropriate. Now that the proposed rule has been filed with the SEC, the SEC will either approve or disapprove the proposed rule change or institute proceedings to determine whether the proposed rule change should be disapproved. If it is approved, investment advisers will be expected to comply with the third-party solicitor provision of Rule 206(4)-5.
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