RIA Compliance Blog
As we recently highlighted, the Securities and Exchange Commission took enforcement action against three registered investment advisers for violating the pay-to-play rule applicable to advisers under the Investment Advisers Act. Broker-dealers should be aware that in 2017 the Financial Industry Regulatory Authority announced the approval of modifications to two rules – Rules 203 and 458, imposing similar prohibitions and limitations on capital acquisition brokers (“CABs”). A CAB is a FINRA member firm that participates in a restricted amount of activities, such as “advising companies on capital raising and corporate restructuring, and acting as placement agents for sales of unregistered securities to institutional investors under limited conditions.” The rules will implement “’pay-to-play’ and related recordkeeping rules to the activities of member firms that have elected to be governed by the CAB Rules.” The new rules went into effect on December 6, 2017.
Pay-to-play rules have been commonplace in the financial industry for a number of years. In 2010, the SEC implemented Rule 206(4)-5, also known as the “Pay-to-Play Rule,” under the Investment Advisers Act of 1940. Under the Pay-to-Play Rule, investment advisers are forbidden, in part, from giving or agreeing to give payment to any person to offer investment advisory services to a government entity unless that person is a “regulated person.” FINRA members firms are regulated persons under the conditions that FINRA rules do not allow member firms to participate in distribution or solicitation activities if the firm or its employees have made political contributions, and the SEC determines, by order, that the FINRA rules implement sufficiently equal or stricter limitations on member firms than the Pay-to-Play Rule does on investment advisers. The FINRA rules must also be compatible with the Pay-to-Play Rule’s principles.
In August 2016, the SEC greenlit FINRA Rules 2030 and 4580 to implement a regulatory framework to monitor the conduct of member firms that participate in distribution or solicitation activities with government entities pursuant to agreements with investment advisers. Rule 2030 provides guidelines for member firms who participate in such activities. Rule 4580 provides that member firms who participate in such activities must maintain books and records pertaining to these activities. These rules provide a way for member firms to participate in distribution and solicitation activities with government entities without violating the Pay-to-Play Rule. These rules went into effect on August 20, 2017. However, they have no direct application to CABs.
The CAB Rules, which became effective on April 14, 2017, require CABs to comply with certain FINRA rules. However, they do not explicitly state that CABs are required to comply with FINRA Rules 2030 and 4580. In response, FINRA proposed and eventually adopted two new rules, Rules 203 and 458, which clarify that CABs are obligated to comply with Rules 2030 and 4580. Rule 203 requires CABs to comply with Rule 2030, while Rule 458 requires CABs to comply with Rule 4580.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.