SEC Proposes to Rescind Pay-to-Play Rule for Investment Advisers

The US Securities and Exchange Commission proposed to do away completely with its “pay-to-play” rule under the Investment Advisers Act of 1940, citing unintended consequences over the rule’s 16-year history and the presence of existing principles-based regulations to sufficiently address pay-to-play risks.

On September 3, 2026, the US Securities and Exchange Commission (SEC) voted to propose the full rescission of Rule 206(4)-5 (the Rule) under the Investment Advisers Act of 1940 (Advisers Act), which restricts political contributions by investment advisers that seek to manage assets of state and local governments, as well as the Rule’s related recordkeeping provisions (the Proposal).

The SEC acknowledges in the Proposal that the steep penalties for “foot-faults” under the Rule caused many advisers to opt for blanket prohibitions on political donations, representing a hindrance to adviser personnel’s constitutional right to political speech. The SEC also notes that the Rule may have resulted in obstacles to adviser hiring and promotion of qualified individuals and a smaller field of competition for public investment mandates, potentially resulting in less favorable investment terms for pensions.

The Proposal reflects the SEC’s view that preventing fraud would be best served by a principles-based approach that allows advisers to tailor their compliance policies and procedures and codes of ethics to suit their respective pay-to-play risk profiles under the existing framework of the Advisers Act. The Proposal is subject to public comment, which will remain open for 60 days following the publication of the Proposal in the Federal Register.

BACKGROUND AND HISTORY

Adoption of the Rule

The SEC adopted the Rule in 2010 to prevent investment advisers from using political contributions to influence governmental officials responsible for the hiring of investment advisers, otherwise known as pay-to-play practices.

Under the Rule, if an adviser or a “covered associate” of the adviser makes a contribution to an official of a government entity, or a candidate for such office, whose office is in a position to influence the government entity’s selection of an investment adviser, the adviser generally is prohibited from receiving compensation for providing advisory services to that entity for two years thereafter, known as a “time-out” period.

The Rule also prohibits an adviser from paying a third party to solicit government entities for advisory business unless the solicitor is a “regulated person” as defined in the Rule or falls within certain specified categories of persons associated with the adviser. In addition, the Rule restricts an adviser and its covered associates from soliciting or coordinating certain political contributions and payments. The Rule provides certain exceptions, including for de minimis contributions and certain returned contributions.

Challenges Since Adoption

Since the Rule’s adoption, the SEC has observed numerous challenges associated with its complexity. Market participants have described the Rule as burdensome and difficult to apply, noting that it effectively creates a de facto strict liability standard. Among the Rule’s unintended consequences, the SEC highlighted the following:

• Blanket contribution bans: Some advisers have prohibited all political contributions by the adviser and its employees rather than attempting to parse the Rule’s intricate requirements, chilling political speech protected by the First Amendment.
• Hiring and promotion difficulties: The Rule’s lookback provisions may prevent advisers from hiring or promoting qualified individuals into covered associate roles due to political contributions those individuals made before assuming such roles, even contributions that present no material pay-to-play risk.
• Disproportionate penalties: The two-year compensation ban can be triggered by contributions of as little as $150, and the de minimis thresholds have not been updated for inflation since 2010, making them significantly lower than federal campaign finance contribution limits.
• Interpretive difficulties: Advisers face challenges identifying applicable “officials” and “covered associates” due to the breadth and ambiguity of those definitions.

THE PROPOSED RECISSION

The SEC proposes to rescind the Rule in its entirety, taking the position that the Rule’s goals may be better achieved through a principles-based approach. The SEC notes that pay-to-play practices are already prohibited by the antifraud provisions of the Advisers Act, specifically Sections 206 (1), (2), and (4). The SEC underscores this position by observing that before the Rule’s adoption, the SEC brought several enforcement actions under the antifraud provisions of the Advisers Act, effectively targeting pay-to-play schemes.

The SEC identified several existing regulatory requirements it views as sufficient to address pay-to-play risks:

• Compliance rule (Rule 206(4)-7 under the Advisers Act): Registered advisers are required to adopt and implement written policies and procedures reasonably designed to prevent fraudulent practices, including pay-to-play practices. The compliance rule requires annual review of those policies’ adequacy and effectiveness. The SEC notes that this principles-based requirement allows advisers to tailor their policies and procedures to address pay-to-play risks presented by their particular businesses.
• Code of ethics rule (Rule 204A-1 under the Advisers Act): Registered advisers must adopt a code of ethics setting forth standards of business conduct reflecting the adviser's fiduciary obligations. The SEC notes that an adviser’s code of ethics can address political contributions and other conduct presenting pay-to-play risks.
• State, local, and other federal laws: Existing state, local, and federal laws independently impose criminal and civil penalties for public sector corruption, bribery, and fraudulent quid pro quo schemes.

Recordkeeping Amendments

The Proposal would amend Rule 204-2 under the Advisers Act to eliminate paragraph (a)(18), which requires registered advisers to make and keep certain records in connection with the Rule, including records of covered associates, government entity clients, contributions to officials, and payments to regulated persons. Advisers would, however, continue to be required to maintain copies of their compliance policies and procedures, codes of ethics, and records of written agreements with clients.

Impact on Adviser Practices

If the Rule is rescinded, some advisers may choose to update their compliance policies and procedures to replace prescriptive requirements with more tailored approaches reflecting their specific pay-to-play risks. Others may choose to maintain their existing policies as a component of their compliance framework. The SEC notes that advisers who continue to provide or seek to provide services to government entities would still need to assess their pay-to-play risks and maintain reasonably designed policies and procedures pursuant to Rule 206(4)-7 under the Advisers Act.

Importantly, rescission of the Rule would not eliminate other pay-to-play restrictions that may apply to advisers or persons they use to solicit government entities. As the SEC notes, advisers may still face restrictions under the following:

• Municipal Securities Rulemaking Board (MSRB) Rule G-37, which imposes political contribution and related restrictions on certain brokers, dealers, municipal securities dealers, and municipal advisors
• Financial Industry Regulatory Authority (FINRA) Rule 2030, which imposes pay-to-play restrictions on FINRA member firms that engage in distribution or solicitation activities for investment advisers
• Rule 15Fh-6 under the Securities Exchange Act of 1934, as amended (Exchange Act), which imposes pay-to-play restrictions on security-based swap dealers

These requirements may remain applicable, for example, where an adviser is dually registered as an investment adviser and broker-dealer or municipal advisor, or where an adviser uses a person subject to one of these regimes to solicit government entities. Accordingly, if the proposed rescission is adopted, advisers considering changes to their pay-to-play policies would need to assess whether these or other applicable federal, state, local, or self-regulatory requirements continue to restrict their political contribution or solicitation activities.

Alternatives Considered

The SEC considered several alternatives to full rescission:

• New policies and procedures requirements: The SEC considered combining rescission with a new rule specifically requiring advisers to adopt pay-to-play-specific compliance policies with prescribed features. The SEC concluded this approach could cause advisers to anchor their compliance programs to the prescribed provisions rather than tailor their compliance programs to their particular pay-to-play risks.
• Amending the existing rule: The SEC also considered amending specific provisions of the Rule such as raising the de minimis threshold to $3,500, reducing the two-year time-out period, narrowing key definitions, or expanding the exemptive process. The SEC concluded this approach would produce smaller cost reductions and would not address the fundamental challenges of applying uniform definitions across diverse state and local government structures.
• Size-based exemptions: The SEC considered exempting smaller advisers from the Rule but expressed concern that doing so could create greater incentives for such advisers to engage in pay-to-play practices and potentially encourage regulatory arbitrage.

LOOKING AHEAD

If adopted, the rescission would represent a significant shift from the SEC’s prescriptive approach to pay-to-play practices toward a principles-based framework that gives advisers greater flexibility to tailor their compliance programs to their particular business models and risk profiles. The rescission would not, however, eliminate advisers’ obligations to address pay-to-play risks under the antifraud and fiduciary provisions of the Advisers Act and their other applicable regulatory obligations.

Advisers that provide or seek to provide advisory services to state and local government entities should consider how the proposed rescission could affect their existing compliance frameworks, including whether current political contribution restrictions, preclearance requirements, employee training, monitoring, and other controls should be retained or modified. Any such review should account for other applicable pay-to-play requirements that would remain in effect, including MSRB Rule G-37, FINRA Rule 2030, Exchange Act Rule 15Fh-6, and applicable state and local requirements.

The Proposal remains subject to public comment, and the SEC could modify its approach before adopting the proposed rescission. Advisers should therefore monitor the rulemaking process and continue to comply with the Rule unless and until its rescission becomes effective.