“Pay to Play” Developments

July 28, 2015

Based on recent announcements from the SEC and its Staff, changes may be forthcoming for advisers’ use of third-party solicitors for government entity clients.

In 2010, the US Securities and Exchange Commission (SEC) adopted Rule 206(4)-5 (commonly referred to as the “pay to play rule”) under the Investment Advisers Act. Rule 206(4)-5 (the Rule) prohibits, among other things, an SEC-registered investment adviser and certain of its officers and employees from paying a third party to solicit government entities for advisory business on behalf of the adviser if the third party is not a “regulated person.” On June 25, 2015, the SEC announced that compliance with this provision of the Rule, which had long been dormant, would be required as of July 31, 2015.[1]

There are still open questions as to how this limitation will be applied. The term “regulated person” is defined in the Rule and includes three types of SEC-registered entities: investment advisers, broker-dealers, and municipal advisors. However, to be a “regulated person,” an individual or entity must also be subject to the Rule or a substantially similar rule that has been approved by the SEC. Accordingly, before they can act as solicitors of government clients for an investment adviser, broker-dealers and municipal advisors must become subject to a comparable “pay to play” rule. Although both the Financial Industry Regulatory Authority (FINRA, which regulates broker-dealers)[2] and the Municipal Securities Regulatory Board (MSRB, which regulates municipal advisors)[3] have proposed new or amended pay to play rules that would cover broker-dealers and municipal advisors, respectively, neither has adopted such rules, and it is unclear—even if adopted—when such rules would go into effect or what other requirements would attach to broker-dealers and municipal advisors subject to them.

As a result of the SEC’s announcement, as of July 31, 2015, the only third parties that an investment adviser may pay to solicit government entity clients on its behalf are other investment advisers that are subject to Rule 206(4)-5. Nonetheless, to avoid concerns that the SEC staff would recommend enforcement action for violations of this provision of the Rule, the SEC staff updated its Pay to Play Rule FAQ to address the issue concurrently with the SEC’s announcement of the compliance date.[4] The Pay to Play Rule FAQ clarifies that until both FINRA and MSRB adopt a pay to play rule (and each rule goes into effect), the SEC staff will not recommend enforcement action under the Rule for broker-dealers and municipal advisors, respectively.

Despite the current holding pattern on enforcement action created by the FAQ guidance, the SEC’s action in this rulemaking area could prompt each of FINRA and MSRB to accelerate the implementation of its own rules. Accordingly, advisers should consider their current solicitation practices to ensure that any interaction with government entity clients is done in compliance with the Rule and to be more quickly able to implement practical policy changes if and when FINRA and MSRB rules are implemented.


If you have questions or would like more information on the issues discussed in this LawfLash, please contact any of the following Morgan Lewis lawyers:

New York
Christine Lombardo

Timothy W. Levin
John J. O’Brien
Brian London

Washington, DC
Thomas S. Harman
Steven Stone

[2] See FINRA, Political Contributions, Regulatory Notice No. 14-50 (Nov. 2014).

[3] See MSRB, Request for Comment on Drat Amendments to MSRB Rule G-37 to Extend its Provisions to Municipal Advisors, 2014-15 (Aug. 18, 2014).