WASHINGTON — Investment advisers may face tough compliance issues in the wake of the Securities and Exchange Commission's unanimous adoption last week of rules designed to prevent IAs from making political contributions to elected officials to obtain business from state and local pension funds, investment pools and college-savings accounts.

Under the new IA rules, which are modeled on the Municipal Securities Rulemaking Board's Rule G-37 for broker-dealers, an investment adviser would be barred for two years from receiving compensation for providing advisory services to a state or local government if it or certain of its executives or employees makes significant political contributions to elected officials in a position to influence the selection of advisers.

Edward Pittman, a lawyer at Dechert LLP and former SEC attorney, said the IA rules "are really going to pose some difficult compliance issues" for investment advisers, perhaps more so than Rule G-37 posed for muni broker-dealers because IAs have broader-based businesses that include many nongovernmental clients.

The SEC rules would prohibit an IA and certain of its executives or employees from "bundling," soliciting or coordinating campaign contributions from others to give to either elected officials who could influence their selection or political parties in the areas in which the IA is seeking to provide services.

In addition, the rules would prohibit an IA from paying a so-called third-party IA or broker-dealer from soliciting business on its behalf if the third party is not regulated or subject to pay-to-play restrictions. The Financial Industry Regulatory Authority is expected to write rules containing pay-to-play restrictions for broker-dealer placement agents.

The SEC backed off an earlier proposal banning IAs from using third-party placement agents altogether, after many of the more than 250 commentators complained the ban would be too harsh. But SEC Chairman Mary Schapiro said, "If the commission determines that third-party placement agents continue to inappropriately influence the selection of investment advisers for government clients — even under our enhanced rules — I expect that we would consider the imposition of a full ban on the use of these third parties."

Schapiro said that "pay-to-play distorts municipal investment priorities as well as the process by which investment managers are selected." She added: "It can mean that public plans and their beneficiaries receive subpar adviser performance at a premium price."

The rules designed to prevent IAs from engaging in pay-to-play practices will become effective within 60 days of being published in the Federal Register and generally will have to be complied with six months after that.

The development comes 10 years after the SEC first considered a version of the rules at the urging of former chairman Arthur Levitt. Those initial rules were scrapped after they angered Phil Gramm, the Texas Republican who was Senate Banking Committee chairman at that time.

But since then, Schapiro noted, public pension plans have grown to represent one-third of all U.S. pension assets, with more than $2.6 trillion in assets under management, and college-savings plans hold $100 billion in assets. In addition the SEC and other authorities have brought civil or criminal cases involving allegations of IA pay-to-play practices in California, New York, New Mexico, Illinois, Ohio, Connecticut and Florida, she said.

SEC officials at the meeting to vote on the issue cited the commission's new enforcement unit on municipal securities and public pension funds for playing a key role in the development of the rules. The group's leaders, Elaine Greenberg and Mark Zehner, have had experience with pay-to-play cases in the municipal securities market.

The rules do contain two de minimis exceptions in contrast to Rule G-37's one, leading Pittman, who had been involved in muni reforms at the SEC, to ask whether the MSRB will consider changing its rule to mirror the new SEC rule for investment advisers.

Under G-37, municipal finance professionals who contribute $250 or less to a state or local official for whom they can vote would not trigger the rule's two-year ban on negotiated municipal securities business for their firms.

The new SEC rule, however, would allow investment advisers to avoid the two-year ban on receiving compensation for services if they contribute up to $350 to an elected official for whom they could vote, or $150 to any elected official.

"Now that the SEC has this new rule out, is the MSRB going to have to go out and amend Rule G-37 to add a $150 exception?" asked Pittman, who suggested the SEC put two exceptions in the IA rule to narrowly tailor it and avoid a challenge to its constitutionality. Rule G-37 survived a constitutional challenge from an Alabama broker-dealer soon after it was put into effect in 1994. But Pittman points out that was 16 years ago.

Asked about the issue, MSRB executive director Lynnette Hotchkiss said last week that the board is aware of the SEC's new rule and will discuss it, if it needs to, at its next meeting later this month.

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