80 FR 81650 - Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of a Proposed Rule Change To Adopt FINRA Rule 2030 and FINRA Rule 4580 To Establish “Pay-To-Play” and Related Rules
SECURITIES AND EXCHANGE COMMISSION Federal Register Volume 80, Issue 250 (December 30, 2015)
Federal Register Volume 80, Issue 250 (December 30, 2015)
| Page Range | 81650-81664 | |
| FR Document | 2015-32894 |
[Federal Register Volume 80, Number 250 (Wednesday, December 30, 2015)] [Notices] [Pages 81650-81664] From the Federal Register Online [www.thefederalregister.org] [FR Doc No: 2015-32894] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-76767; File No. SR-FINRA-2015-056] Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of a Proposed Rule Change To Adopt FINRA Rule 2030 and FINRA Rule 4580 To Establish ``Pay-To-Play'' and Related Rules December 24, 2015. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act,'' ``Exchange Act'' or ``SEA'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that on December 16, 2015, Financial Industry Regulatory Authority, Inc. filed with the Securities and Exchange Commission (``SEC'' or ``Commission'') the proposed rule change as described in Items I, II, and III below, which Items have been substantially prepared by FINRA. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. --------------------------------------------------------------------------- \1\ 15 U.S.C. 78s(b)(1). \2\ 17 CFR 240.19b-4. --------------------------------------------------------------------------- I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change FINRA is proposing to adopt FINRA Rules 2030 (Engaging in Distribution and Solicitation Activities with Government Entities) \3\ and 4580 (Books and Records Requirements for Government Distribution and Solicitation Activities) to establish ``pay-to-play'' \4\ and related rules that would regulate the activities of member firms that engage in distribution or solicitation activities for compensation with government entities on behalf of investment advisers. --------------------------------------------------------------------------- \3\ FINRA published the proposed rule change as FINRA Rule 2390 in Regulatory Notice 14-50 (Nov. 2014) (``Regulatory Notice 14- 50''). FINRA has determined that the proposed rule change is more appropriately categorized under the FINRA Rule 2000 Series relating to ``Duties and Conflicts.'' \4\ ``Pay-to-play'' practices typically involve a person making cash or in-kind political contributions (or soliciting or coordinating others to make such contributions) to help finance the election campaigns of state or local officials or bond ballot initiatives as a quid pro quo for the receipt of government contracts. --------------------------------------------------------------------------- The text of the proposed rule change is available on FINRA's Web site at http://www.finra.org, at the principal office of FINRA and at the Commission's Public Reference Room. II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, FINRA included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. FINRA has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose Background & Discussion In July 2010, the SEC adopted Rule 206(4)-5 under the Investment Advisers Act of 1940 (``Advisers Act'') addressing pay-to-play practices by investment advisers (the ``SEC Pay-to-Play Rule'').\5\ The SEC Pay-to-Play Rule prohibits an investment adviser from providing advisory services for compensation to a government entity for two years after the adviser or its covered associates make a contribution to an official of the government entity, unless an exception or exemption applies. In addition, it prohibits an investment adviser from soliciting from others, or coordinating, contributions to government entity officials or payments to political parties where the adviser is providing or seeking to provide investment advisory services to a government entity. --------------------------------------------------------------------------- \5\ See Advisers Act Release No. 3043 (July 1, 2010), 75 FR 41018 (July 14, 2010) (Political Contributions by Certain Investment Advisers) (``SEC Pay-to-Play Rule Adopting Release''). See also Advisers Act Release No. 3221 (June 22, 2011), 76 FR 42950 (July 19, 2011) (Rules Implementing Amendments to the Investment Advisers Act of 1940); Advisers Act Release No. 3418 (June 8, 2012), 77 FR 35263 (June 13, 2012) (Political Contributions by Certain Investment Advisers; Ban on Third Party Solicitation; Extension of Compliance Date). --------------------------------------------------------------------------- The SEC Pay-to-Play Rule also prohibits an investment adviser and its covered associates from providing or agreeing to provide, directly or indirectly, payment to any person to solicit a government entity for investment advisory services on behalf of the investment adviser unless the person is a ``regulated person.'' A ``regulated person'' includes a member firm, provided that: (a) FINRA rules prohibit member firms from engaging in distribution or solicitation activities if political contributions have been made; and (b) the SEC finds, by order, that such rules impose substantially equivalent or more stringent restrictions on member firms than the SEC Pay-to-Play Rule imposes on investment advisers and that such rules are consistent with the objectives of the SEC Pay-to-Play Rule.\6\ The SEC stated that this SEC ban on third-party solicitations would be effective nine months after the compliance date of a final rule adopted by the SEC by which municipal advisors must register under the Exchange Act.\7\ The SEC adopted such a final rule on September 20, 2013, with a compliance date of July 1, 2014.\8\ --------------------------------------------------------------------------- \6\ See SEC Pay-to-Play Rule 206(4)-5(f)(9). A ``regulated person'' also includes SEC registered investment advisers and SEC- registered municipal advisors, subject to specified conditions. \7\ See Advisers Act Release No. 3418 (June 8, 2012), 77 FR 35263 (June 13, 2012). \8\ See Exchange Act Release No. 70462 (Sept. 20, 2013), 78 FR 67468 (Nov. 12, 2013) (Registration of Municipal Advisors). On June 25, 2015, the SEC issued notice of the compliance date for its third party solicitation ban as July 31, 2015. See Advisers Act Release No. 4129 (June 25, 2015), 80 FR 37538 (July 1, 2015). In addition, staff of the Division of Investment Management added Question I.4 to its Staff Responses to Questions About the Pay to Play Rule stating, among other things, that until the later of (i) the effective date of a FINRA pay-to-play rule or (ii) the effective date of an MSRB pay-to-play rule, the Division of Investment Management would not recommend enforcement action to the Commission against an investment adviser or its covered associates under SEC Pay-to-Play Rule 206(4)- 5(a)(2)(i) for the payment to any person to solicit a government entity for investment advisory services. See https://www.sec.gov/divisions/investment/pay-to-play-faq.htm. See also infra Effective Date, for a more detailed discussion regarding the effective date of FINRA Rules 2030 and 4580. --------------------------------------------------------------------------- [[Page 81651]] Based on this regulatory framework, FINRA is proposing a pay-to- play rule, Rule 2030, modeled on the SEC Pay-to-Play Rule that would impose substantially equivalent restrictions on member firms engaging in distribution or solicitation activities to those the SEC Pay-to-Play Rule imposes on investment advisers. FINRA is also proposing rules that would impose recordkeeping requirements on member firms in connection with political contributions.\9\ --------------------------------------------------------------------------- \9\ In connection with the adoption of the SEC Pay-to-Play Rule, the Commission also adopted recordkeeping requirements related to political contributions by investment advisers and their covered associates. See Advisers Act Rule 204-2(a)(18) and (h)(1). --------------------------------------------------------------------------- The proposed rules would establish a comprehensive regime to regulate the activities of member firms that engage in distribution or solicitation activities with government entities on behalf of investment advisers. FINRA believes that establishing requirements for member firms that are modeled on the SEC's Pay-to-Play-Rule is a more effective regulatory response to the concerns the SEC identified in the SEC Pay-to-Play Rule Adopting Release regarding third-party solicitations than an outright ban on such activity. For example, in the SEC Pay-to-Play Rule Adopting Release, the SEC stated that solicitors \10\ or ``placement agents'' \11\ have played a central role in actions that it and other authorities have brought involving pay-to- play schemes.\12\ The SEC noted that in several instances, advisers allegedly made significant payments to placement agents and other intermediaries to influence the award of advisory contracts.\13\ The SEC also acknowledged the difficulties that advisers face in monitoring or controlling the activities of their third-party solicitors.\14\ Accordingly, the proposed rules are intended to enable member firms to continue to engage in distribution and solicitation activities with government entities on behalf of investment advisers while at the same time deterring member firms from engaging in pay-to-play practices.\15\ --------------------------------------------------------------------------- \10\ ``Solicitors'' typically locate investment advisory clients on behalf of an investment adviser. See Advisers Act Release No. 2910 (Aug. 3, 2009), 74 FR 39840, 39853 n.137 (Aug. 7, 2009) (Political Contributions by Certain Investment Advisers). \11\ ``Placement agents'' typically specialize in finding investors (often institutional investors or high net worth investors) that are willing and able to invest in a private offering of securities on behalf of the issuer of such privately offered securities. See id. \12\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41037 (discussing the reasons for proposing a ban on using third parties to solicit government business). \13\ See id. \14\ See id. \15\ In response to a request from SEC staff, FINRA previously indicated its intent to prepare rules for consideration by the SEC that would prohibit its member firms from soliciting advisory business from a government entity on behalf of an adviser unless the member firms comply with requirements prohibiting pay-to-play practices. See Letter from Andrew J. Donohue, Director, Division of Investment Management, SEC, to Richard G. Ketchum, Chairman & CEO, FINRA (Dec. 18, 2009), available at http://www.sec.gov/comments/s7-18-09/s71809-252.pdf (requesting whether FINRA would consider adopting a rule preventing pay-to-play activities by registered broker-dealers acting as legitimate placement agents on behalf of investment advisers). See also Letter from Richard G. Ketchum, Chairman & CEO, FINRA, to Andrew J. Donohue, Director, Division of Investment Management, SEC (Mar. 15, 2010), available at http://www.sec.gov/comments/s7-18-09/s71809-260.pdf (stating ``[w]e believe that a regulatory scheme targeting improper pay to play practices by broker-dealers acting on behalf of investment advisers is . . . a viable solution to a ban on certain private placement agents serving a legitimate function''). --------------------------------------------------------------------------- FINRA sought comment on the proposed rule change in Regulatory Notice 14-50.\16\ As discussed further in Item II.C below, commenters were generally supportive of the proposed rule change, but also expressed some concerns. In considering the comments, FINRA has engaged in discussions with SEC staff. In addition, as discussed in Item II.B below, FINRA has engaged in an analysis of the potential economic impacts of the proposed rule change. As a result, FINRA has revised the proposed rule change as published in Regulatory Notice 14-50. In particular, as discussed in more detail in Item II.C, FINRA has determined not to propose a disclosure requirement for government distribution and solicitation activities at this time. In addition, FINRA has determined not to propose a disgorgement requirement as part of the pay-to-play rule. FINRA believes that these revisions will more closely align FINRA's proposed pay-to-play rule with the SEC Pay-to- Play Rule and help reduce cost and compliance burden concerns raised by commenters. --------------------------------------------------------------------------- \16\ See supra note 3. --------------------------------------------------------------------------- The proposed rule change, as revised in response to comments on Regulatory Notice 14-50, is set forth in further detail below. Proposed Pay-to-Play Rule A. Two-Year Time Out Proposed Rule 2030(a) would prohibit a covered member from engaging in distribution \17\ or solicitation \18\ activities for compensation with a government entity 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 an official of the government entity is made by the covered member or a covered associate (including a person who becomes a covered associate within two years after the contribution is made). As discussed in more detail below, the terms and scope of this prohibition are modeled on the SEC Pay-to-Play Rule.\19\ --------------------------------------------------------------------------- \17\ As discussed in Item II.C below, FINRA is not eliminating the term ``distribution'' from the proposed rule as suggested by some commenters. Thus, subject to the limitations discussed in Item II.C, the proposed rule would apply to covered members engaging in distribution (as well as solicitation) activities with government entities. Specifically, the proposed rule would apply to distribution activities involving unregistered pooled investment vehicles such as hedge funds, private equity funds, venture capital funds, and collective investment trusts, and registered pooled investment vehicles such as mutual funds, but only if those registered pools are an investment option of a participant-directed plan or program of a government entity. \18\ Consistent with the SEC Pay-to-Play Rule, proposed Rule 2030(g)(11) defines the term ``solicit'' to mean: ``(A) With respect to investment advisory services, to communicate, directly or indirectly, for the purpose of obtaining or retaining a client for, or referring a client to, an investment adviser; and (B) With respect to a contribution or payment, to communicate, directly or indirectly, for the purpose of obtaining or arranging a contribution or payment.'' The determination of whether a particular communication would be a solicitation would depend on the facts and circumstances relating to such communication. As a general proposition, any communication made under circumstances reasonably calculated to obtain or retain an advisory client would be considered a solicitation unless the circumstances otherwise indicate that the communication does not have the purpose of obtaining or retaining an advisory client. See also infra note 40. \19\ See SEC Pay-to-Play Rule 206(4)-5(a)(1). --------------------------------------------------------------------------- The proposed rule would not ban or limit the amount of political contributions a covered member or its covered associates could make. Instead, it would impose a two-year time out on engaging in distribution or solicitation activities for compensation with a government entity on behalf of an investment adviser after the covered member or its covered associates make a contribution to an official of the government entity. Consistent with the two-year time out in the SEC Pay-to-Play Rule, the two-year time out in the proposed rule is intended to discourage covered members from participating in pay-to- play practices by requiring a cooling-off period during which the effects of a political contribution on the selection process can be expected to dissipate. [[Page 81652]] 1. Covered Members Proposed Rule 2030(g)(4) defines a ``covered member'' to mean ``any member except when that member is engaging in activities that would cause the member to be a municipal advisor as defined in Exchange Act Section 15B(e)(4), SEA Rule 15Ba1-1(d)(1) through (4) and other rules and regulations thereunder.'' As noted above, the SEC Pay-to-Play Rule includes within its definition of ``regulated person'' SEC-registered municipal advisors, subject to specified conditions.\20\ Specifically, the SEC Pay-to-Play Rule prohibits an investment adviser from providing or agreeing to provide, directly or indirectly, payment to an SEC- registered municipal advisor unless the municipal advisor is subject to a Municipal Securities Rulemaking Board (``MSRB'') pay-to-play rule.\21\ --------------------------------------------------------------------------- \20\ See supra note 6. \21\ See SEC Pay-to-Play Rule 206(4)-5(a)(2)(i)(A) and 206(4)- 5(f)(9). --------------------------------------------------------------------------- A member firm that solicits a government entity for investment advisory services on behalf of an unaffiliated investment adviser may be required to register with the SEC as a municipal advisor as a result of such activity.\22\ Under such circumstances, MSRB rules applicable to municipal advisors, including any pay-to-play rule adopted by the MSRB, would apply to the member firm.\23\ On the other hand, if the member firm solicits a government entity on behalf of an affiliated investment adviser, such activity would not cause the firm to be a municipal advisor. Under such circumstances, the member firm would be a ``covered member'' subject to the requirements of proposed Rule 2030.\24\ --------------------------------------------------------------------------- \22\ See Exchange Act Section 15B(e)(9) and Rule 15Ba1-1(n) thereunder (defining ``solicitation of a municipal entity or obligated person'' to mean ``a direct or indirect communication with a municipal entity or obligated person made by a person, for direct or indirect compensation, on behalf of a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser . . . that does not control, is not controlled by, or is not under common control with the person undertaking such solicitation for the purpose of obtaining or retaining an engagement by a municipal entity or obligated person of a broker, dealer, municipal securities dealer, or municipal advisor for or in connection with municipal financial products, the issuance of municipal securities, or of an investment adviser to provide investment advisory services to or on behalf of a municipal entity.'') \23\ On August 18, 2014, the MSRB issued a Regulatory Notice requesting comment on draft amendments to MSRB Rule G-37, on political contributions made by brokers, dealers and municipal securities dealers and prohibitions on municipal securities business, to extend the rule to cover municipal advisors. See MSRB Regulatory Notice 2014-15 (Aug. 2014). MSRB Rule G-37 was approved by the Commission in 1994 and, since that time, has prohibited brokers, dealers and municipal securities dealers engaging in municipal securities business from participating in pay-to-play practices. See Exchange Act Release No. 33868 (Apr. 7, 1994), 59 FR 17621 (Apr. 13, 1994) (Order Approving File No. SR-MSRB-94-2). \24\ FINRA notes that a person that is registered under the Exchange Act as a broker-dealer and municipal advisor, and under the Advisers Act as an investment adviser could potentially be a ``regulated person'' for purposes of the SEC Pay-to-Play Rule. Such a regulated person would be subject to the rules that apply to the services the regulated person is performing. See also supra note 23 (noting that brokers, dealers and municipal securities dealers engaging in municipal securities business are subject to MSRB Rule G-37). --------------------------------------------------------------------------- 2. Investment Advisers The proposed rule would apply to covered members acting on behalf of any investment adviser registered (or required to be registered) with the SEC, or unregistered in reliance on the exemption available under Section 203(b)(3) of the Advisers Act for foreign private advisers, or that is an exempt reporting adviser under Advisers Act Rule 204-4(a).\25\ Thus, it would not apply to member firms acting on behalf of advisers that are registered with state securities authorities instead of the SEC, or advisers that are unregistered in reliance on exemptions other than Section 203(b)(3) of the Advisers Act. The proposed rule's definition of ``investment adviser'' is consistent with the definition of ``investment adviser'' in the SEC Pay-to-Play Rule.\26\ --------------------------------------------------------------------------- \25\ See proposed Rule 2030(g)(7). \26\ See SEC Pay-to-Play Rule 206(4)-5(a)(1). FINRA notes that, consistent with the SEC Pay-to-Play Rule, the proposed rule would not apply to state-registered investment advisers as few of these smaller firms manage public pension plans or other similar funds. See also infra note 98 and accompanying text. --------------------------------------------------------------------------- 3. Official of a Government Entity An official of a government entity would include an incumbent, candidate or successful candidate for elective office of a government entity if the office is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser or has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser.\27\ Government entities would include all state and local governments, their agencies and instrumentalities, and all public pension plans and other collective government funds, including participant-directed plans such as 403(b),\28\ 457,\29\ and 529 plans.\30\ --------------------------------------------------------------------------- \27\ Consistent with the SEC Pay-to-Play Rule, proposed Rule 2030(g)(8) defines an ``official'' to mean ``any person (including any election committee for the person) who was, at the time of the contribution, an incumbent, candidate or successful candidate for elective office of a government entity, if the office: (A) Is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser by a government entity; or (B) Has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser by a government entity.'' \28\ A 403(b) plan is a tax-deferred employee benefit retirement plan established under Section 403(b) of the Internal Revenue Code of 1986 (26 U.S.C. 403(b)). \29\ A 457 plan is a tax-deferred employee benefit retirement plan established under Section 457 of the Internal Revenue Code of 1986 (26 U.S.C. 457). \30\ A 529 plan is a ``qualified tuition plan'' established under Section 529 of the Internal Revenue Code of 1986 (26 U.S.C. 529). Consistent with the SEC Pay-to-Play Rule, proposed Rule 2030(g)(6) defines a ``government entity'' to mean ``any state or political subdivision of a state, including: (A) Any agency, authority or instrumentality of the state or political subdivision; (B) A pool of assets sponsored or established by the state or political subdivision or any agency, authority or instrumentality thereof, including but not limited to a ``defined benefit plan'' as defined in Section 414(j) of the Internal Revenue Code, or a state general fund; (C) A plan or program of a government entity; and (D) Officers, agents or employees of the state or political subdivision or any agency, authority or instrumentality thereof, acting in their official capacity.'' --------------------------------------------------------------------------- Thus, the two-year time out would be triggered by contributions, not only to elected officials who have legal authority to hire the adviser, but also to elected officials (such as persons with appointment authority) who can influence the hiring of the adviser. As noted in the SEC Pay-to-Play Rule Adopting Release, a person appointed by an elected official is likely to be subject to that official's influences and recommendations. It is the scope of authority of the particular office of an official, not the influence actually exercised by the individual that would determine whether the individual has influence over the awarding of an investment advisory contract under the definition.\31\ --------------------------------------------------------------------------- \31\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41029 (discussing the terms ``official'' and ``government entity''). --------------------------------------------------------------------------- 4. Contributions The proposed rule's time out provisions would be triggered by contributions made by a covered member or any of its covered associates. A contribution would include a gift, subscription, loan, advance, deposit of money, or anything of value made for the purpose of influencing the election for a federal, state or local office, including any payments for debts incurred in such an election. It would also include transition or inaugural expenses incurred by a successful candidate for state or local office.\32\ [[Page 81653]] Consistent with the SEC Pay-to-Play Rule, FINRA would not consider a donation of time by an individual to be a contribution, provided the covered member has not solicited the individual's efforts and the covered member's resources, such as office space and telephones, are not used.\33\ Similarly, FINRA would not consider a charitable donation made by a covered member to an organization that qualifies for an exemption from federal taxation under the Internal Revenue Code,\34\ or its equivalent in a foreign jurisdiction, at the request of an official of a government entity to be a contribution for purposes of the proposed rule.\35\ --------------------------------------------------------------------------- \32\ Consistent with the SEC Pay-to-Play Rule, proposed Rule 2030(g)(1) defines a ``contribution'' to mean ``any gift, subscription, loan, advance, or deposit of money or anything of value made for: (A) The purpose of influencing any election for federal, state or local office; (B) Payment of debt incurred in connection with any such election; or (C) Transition or inaugural expenses of the successful candidate for state or local office.'' \33\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41030. The SEC also noted that a covered associate's donation of his or her time generally would not be viewed as a contribution if such volunteering were to occur during non-work hours, if the covered associate were using vacation time, or if the adviser is not otherwise paying the employee's salary (e.g., an unpaid leave of absence). See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41030 n.157. FINRA would take a similar position in interpreting the proposed rule. \34\ Section 501(c)(3) of the Internal Revenue Code (26 U.S.C. 501(c)(3)) contains a list of charitable organizations that are exempt from Federal income tax. \35\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41030 (discussing the scope of the term ``contribution'' under the SEC Pay-to-Play Rule). Note, however, proposed Rule 2030(e) providing that it shall be a violation of Rule 2030 for any covered member or any of its covered associates to do anything indirectly that, if done directly, would result in a violation of the rule. --------------------------------------------------------------------------- 5. Covered Associates As stated in the SEC Pay-to-Play Rule Adopting Release, contributions made to influence the selection process are typically made not by the firm itself, but by officers and employees of the firm who have a direct economic stake in the business relationship with the government client.\36\ Accordingly, consistent with the SEC Pay-to-Play Rule, under the proposed rule, contributions by each of these persons, which the proposed rule describes as ``covered associates,'' would trigger the two-year time out.\37\ --------------------------------------------------------------------------- \36\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41031. \37\ Consistent with the SEC Pay-to-Play Rule, proposed Rule 2030(g)(2) defines a ``covered associate'' to mean: ``(A) Any general partner, managing member or executive officer of a covered member, or other individual with a similar status or function; (B) Any associated person of a covered member who engages in distribution or solicitation activities with a government entity for such covered member; (C) Any associated person of a covered member who supervises, directly or indirectly, the government entity distribution or solicitation activities of a person in subparagraph (B) above; and (D) Any political action committee controlled by a covered member or a covered associate.'' --------------------------------------------------------------------------- Contributions by an executive officer of a covered member would trigger the two-year time out. As discussed in Item II.C below, commenters requested that FINRA define the term ``executive officer'' for purposes of the proposed pay-to-play rule. Accordingly, consistent with the SEC Pay-to-Play Rule, proposed Rule 2030(g)(5) defines an ``executive officer of a covered member'' to mean: ``(A) The president; (B) Any vice president in charge of a principal business unit, division or function (such as sales, administration or finance); (C) Any other officer of the covered member who performs a policy-making function; or (D) Any other person who performs similar policy-making functions for the covered member.'' Whether a person is an executive officer would depend on his or her function or activities and not his or her title. For example, an officer who is a chief executive of a covered member but whose title does not include ``president'' would nonetheless be an executive officer for purposes of the proposed rule. In addition, a covered associate would include a political action committee, or PAC, controlled by the covered member or any of its covered associates as a PAC is often used to make political contributions.\38\ Under the proposed rule, FINRA would consider a covered member or its covered associates to have ``control'' over a PAC if the covered member or covered associate has the ability to direct or cause the direction of governance or operations of the PAC. --------------------------------------------------------------------------- \38\ See id. --------------------------------------------------------------------------- 6. ``Look Back'' Consistent with the SEC Pay-to-Play Rule, the proposed rule would attribute to a covered member contributions made by a person within two years (or, in some cases, six months) of becoming a covered associate. This ``look back'' would apply to any person who becomes a covered associate, including a current employee who has been transferred or promoted to a position covered by the proposed rule. A person would become a ``covered associate'' for purposes of the proposed rule's ``look back'' provision at the time he or she is hired or promoted to a position that meets the definition of a ``covered associate.'' Thus, when an employee becomes a covered associate, the covered member must ``look back'' in time to that employee's contributions to determine whether the time out applies to the covered member. If, for example, the contributions were made more than two years (or, pursuant to the exception described below for new covered associates, six months) prior to the employee becoming a covered associate, the time out has run. If the contribution was made less than two years (or six months, as applicable) from the time the person becomes a covered associate, the proposed rule would prohibit the covered member that hires or promotes the contributing covered associate from receiving compensation for engaging in distribution or solicitation activities on behalf of an investment adviser from the hiring or promotion date until the two-year period has run. In no case would the prohibition imposed be longer than two years from the date the covered associate made the contribution. Thus, if, for example, the covered associate becomes employed (and engages in solicitation activities) one year and six months after the contribution was made, the covered member would be subject to the proposed rule's prohibition for the remaining six months of the two-year period. This ``look back'' provision, which is consistent with the SEC Pay-to-Play Rule, is designed to prevent covered members from circumventing the rule by influencing the selection process by hiring persons who have made political contributions.\39\ --------------------------------------------------------------------------- \39\ Similarly, consistent with the SEC Pay-to-Play Rule, to prevent covered members from channeling contributions through departing employees, covered members must ``look forward'' with respect to covered associates who cease to qualify as covered associates or leave the firm. The covered associate's employer at the time of the contribution would be subject to the proposed rule's prohibition for the entire two-year period, regardless of whether the covered associate remains a covered associate or remains employed by the covered member. Thus, dismissing a covered associate would not relieve the covered member from the two-year time out. See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41033 (discussing the ``look back'' in that rule). --------------------------------------------------------------------------- B. Prohibition on Soliciting and Coordinating Contributions Proposed Rule 2030(b) would prohibit a covered member or covered associate from coordinating or soliciting \40\ any [[Page 81654]] person or PAC to make any: (1) Contribution to an official of a government entity in respect of which the covered member is engaging in, or seeking to engage in, distribution or solicitation activities on behalf of an investment adviser; or (2) payment \41\ to a political party of a state or locality of a government entity with which the covered member is engaging in, or seeking to engage in, distribution or solicitation activities on behalf of an investment adviser. This provision is modeled on a similar provision in the SEC Pay-to-Play Rule \42\ and is intended to prevent covered members or covered associates from circumventing the proposed rule's prohibition on direct contributions to certain elected officials such as by ``bundling'' a large number of small employee contributions to influence an election, or making contributions (or payments) indirectly through a state or local political party.\43\ --------------------------------------------------------------------------- \40\ Proposed Rule 2030(g)(11)(B) defines the term ``solicit'' with respect to a contribution or payment as ``to communicate, directly or indirectly, for the purpose of obtaining or arranging a contribution or payment.'' This provision is consistent with a similar provision in the SEC Pay-to-Play Rule. See SEC Pay-to-Play Rule 206(4)-5(f)(10)(ii). Consistent with the SEC Pay-to-Play Rule, whether a particular activity involves a solicitation or coordination of a contribution or payment for purposes of the proposed rule would depend on the facts and circumstances. A covered member that consents to the use of its name on fundraising literature for a candidate would be soliciting contributions for that candidate. Similarly, a covered member that sponsors a meeting or conference which features a government official as an attendee or guest speaker and which involves fundraising for the government official would be soliciting contributions for that government official. Expenses incurred by the covered member for hosting the event would be a contribution by the covered member, thereby triggering the two-year ban on the covered member receiving compensation for engaging in distribution or solicitation activities with the government entity over which that official has influence. Such expenses may include, but are not limited to, the cost of the facility, the cost of refreshments, any expenses paid for administrative staff, and the payment or reimbursement of any of the government official's expenses for the event. The de minimis exception under proposed Rule 2030(c)(1) would not be available with respect to these expenses because they would have been incurred by the firm, not by a natural person. See also SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41043 n.328, 329 (discussing the term ``solicit'' with respect to a contribution or payment). \41\ Consistent with the SEC Pay-to-Play Rule, proposed Rule 2030(g)(9) defines the term ``payment'' to mean ``any gift, subscription, loan, advance or deposit of money or anything of value.'' This definition is similar to the definition of ``contribution,'' but is broader, in the sense that it does not include limitations on the purposes for which such money is given (e.g., it does not have to be made for the purpose of influencing an election). Consistent with the SEC Pay-to-Play Rule, FINRA is including the broader term ``payments,'' as opposed to ``contributions,'' to deter a covered member from circumventing the proposed rule's prohibitions by coordinating indirect contributions to government officials by making payments to political parties. See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41043 n.331 and accompanying text (discussing a similar approach with respect to restrictions on soliciting and coordinating contributions and payments). \42\ See SEC Pay-to-Play Rule 206(4)-5(a)(2). \43\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41043 (discussing restrictions on soliciting and coordinating contributions and payments). --------------------------------------------------------------------------- In addition, as discussed in Item II.C below, in response to a request for clarification from a commenter regarding the application of this provision of the proposed rule, FINRA notes that, consistent with guidance provided by the SEC in connection with SEC Pay-to-Play Rule 206(4)-5(a)(2), a direct contribution to a political party by a covered member or its covered associates would not violate the proposed rule unless the contribution was a means for the covered member to do indirectly what the rule would prohibit if done directly (for example, if the contribution was earmarked or known to be provided for the benefit of a particular government official). C. Direct or Indirect Contributions or Solicitations Proposed Rule 2030(e) further provides that it shall be a violation of Rule 2030 for any covered member or any of its covered associates to do anything indirectly that, if done directly, would result in a violation of the rule. This provision is consistent with a similar provision in the SEC Pay-to-Play Rule \44\ and would prevent a covered member or its covered associates from funneling payments through third parties, including, for example, consultants, attorneys, family members, friends or companies affiliated with the covered member as a means to circumvent the proposed rule.\45\ In addition, as discussed in Item II.C below, in response to a request for clarification from a commenter regarding the application of this provision of the proposed rule, FINRA notes that, consistent with guidance provided by the SEC in connection with SEC Pay-to-Play Rule 206(4)-5(d), proposed Rule 2030(e) would require a showing of intent to circumvent the rule in order for such persons to trigger the two-year time out. --------------------------------------------------------------------------- \44\ See SEC Pay-to-Play Rule 206(4)-5(d). \45\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41044 (discussing direct and indirect contributions or solicitations). This provision would also cover, for example, situations in which contributions by a covered member are made, directed or funded through a third party with an expectation that, as a result of the contributions, another contribution is likely to be made by a third party to ``an official of the government entity,'' for the benefit of the covered member. Contributions made through gatekeepers thus would be considered to be made ``indirectly'' for purposes of the rule. --------------------------------------------------------------------------- D. Covered Investment Pools Proposed Rule 2030(d)(1) provides that a covered member that engages in distribution or solicitation activities with a government entity on behalf of a covered investment pool \46\ in which a government entity invests or is solicited to invest shall be treated as though the covered member was engaging in or seeking to engage in distribution or solicitation activities with the government entity on behalf of the investment adviser to the covered investment pool directly.\47\ Proposed Rule 2030(d)(2) provides that an investment adviser to a covered investment pool in which a government entity invests or is solicited to invest shall be treated as though that investment adviser were providing or seeking to provide investment advisory services directly to the government entity.\48\ --------------------------------------------------------------------------- \46\ Consistent with the SEC Pay-to-Play Rule, proposed Rule 2030(g)(3) defines a ``covered investment pool'' to mean: ``(A) Any investment company registered under the Investment Company Act that is an investment option of a plan or program of a government entity, or (B) Any company that would be an investment company under Section 3(a) of the Investment Company Act but for the exclusion provided from that definition by either Section 3(c)(1), 3(c)(7) or 3(c)(11) of that Act.'' Thus, the definition includes such unregistered pooled investment vehicles as hedge funds, private equity funds, venture capital funds, and collective investment trusts. It also includes registered pooled investment vehicles, such as mutual funds, but only if those registered pools are an investment option of a participant-directed plan or program of a government entity. \47\ Consistent with the SEC Pay-to-Play Rule, under the proposed rule, if a government entity is an investor in a covered investment pool at the time a contribution triggering a two-year time out is made, the covered member must forgo any compensation related to the assets invested or committed by the government entity in the covered investment pool. See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41047. \48\ As discussed in Item II.C below, FINRA has added proposed Rule 2030(d)(2) in response to comments on Regulatory Notice 14-50 to clarify, for purposes of the proposed rule, the relationship between an investment adviser to a covered investment pool and a government entity that invests in the covered investment pool. --------------------------------------------------------------------------- Proposed Rule 2030(d) is modeled on a similar prohibition in the SEC Pay-to-Play Rule \49\ and would apply the prohibitions of the proposed rule to situations in which an investment adviser manages assets of a government entity through a hedge fund or other type of pooled investment vehicle. Thus, the provision would extend the protection of the proposed rule to public pension plans that access the services of investment advisers through hedge funds and other types of pooled investment vehicles sponsored or advised by investment advisers as a funding vehicle or investment option in a government-sponsored plan, such as a ``529 plan.'' \50\ --------------------------------------------------------------------------- \49\ See SEC Pay-to-Play Rule 206(4)-5(c). \50\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41044 (discussing the applicability of the SEC Pay-to-Play Rule to covered investment pools). --------------------------------------------------------------------------- E. Exceptions and Exemptions As discussed in more detail below, the proposed rule contains exceptions that are modeled on similar exceptions in the SEC Pay-to- Play Rule for de minimis contributions, new covered associates and returned contributions.\51\ --------------------------------------------------------------------------- \51\ See SEC Pay-to-Play Rule 206(4)-5(b). --------------------------------------------------------------------------- In addition, proposed Rule 2030(f) includes an exemptive provision for covered members that is modeled on the [[Page 81655]] exemptive provision in the SEC Pay-to-Play Rule \52\ that would allow covered members to apply to FINRA for an exemption from the proposed rule's two-year time out. Under this provision, FINRA would be able to exempt covered members from the proposed rule's time out requirement where the covered member discovers contributions that would trigger the compensation ban after they have been made, and when imposition of the prohibition would be unnecessary to achieve the rule's intended purpose. This provision would provide covered members with an additional avenue by which to seek to cure the consequences of an inadvertent violation by the covered member or its covered associates that falls outside the limits of one of the proposed rule's exceptions. In determining whether to grant an exemption, FINRA would take into account the varying facts and circumstances that each application presents. --------------------------------------------------------------------------- \52\ See SEC Pay-to-Play Rule 206(4)-5(e). --------------------------------------------------------------------------- 1. De Minimis Contributions Proposed Rule 2030(c)(1) would except from the rule's restrictions contributions made by a covered associate who is a natural person to government entity officials for whom the covered associate was entitled to vote \53\ at the time of the contributions, provided the contributions do not exceed $350 in the aggregate to any one official per election. If the covered associate was not entitled to vote for the official at the time of the contribution, the contribution must not exceed $150 in the aggregate per election. Consistent with the SEC Pay- to-Play Rule, under both exceptions, primary and general elections would be considered separate elections.\54\ These exceptions are based on the theory that such contributions are typically made without the intent or ability to influence the selection process of the investment adviser. --------------------------------------------------------------------------- \53\ Consistent with the SEC Pay-to-Play Rule, for purposes of proposed Rule 2030(c)(1), a person would be ``entitled to vote'' for an official if the person's principal residence is in the locality in which the official seeks election. For example, if a government official is a state governor running for re-election, any covered associate who resides in that state may make a de minimis contribution to the official without causing a ban on the covered member being compensated for engaging in distribution or solicitation activities with that government entity on behalf of an investment adviser. If the government official is running for president, any covered associate in the country would be able to contribute the de minimis amount to the official's presidential campaign. See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41034 (discussing the applicability in the SEC Pay-to-Play Rule of the exception for de minimis contributions). \54\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41034. --------------------------------------------------------------------------- 2. New Covered Associates Proposed Rule 2030(c)(2) would provide an exception from the proposed rule's restrictions for covered members if a natural person made a contribution more than six months prior to becoming a covered associate of the covered member unless the covered associate engages in, or seeks to engage in, distribution or solicitation activities with a government entity on behalf of the covered member. This provision is consistent with a similar provision in the SEC Pay-to-Play Rule.\55\ As stated in the SEC Pay-to-Play Rule Adopting Release, the potential link between obtaining advisory business and contributions made by an individual prior to his or her becoming a covered associate who is uninvolved in distribution or solicitation activities is likely more attenuated than for a covered associate who engages in distribution or solicitation activities and, therefore, should be subject to a shorter look-back period.\56\ This exception is also intended to balance the need for covered members to be able to make hiring decisions with the need to protect against individuals marketing to prospective employers their connections to, or influence over, government entities the employer might be seeking as clients.\57\ --------------------------------------------------------------------------- \55\ See SEC Pay-to-Play Rule 206(4)-5(b)(2). \56\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41034 (discussing the applicability of the ``look back'' in the SEC Pay-to-Play Rule). \57\ See id. --------------------------------------------------------------------------- 3. Certain Returned Contributions Proposed Rule 2030(c)(3) would provide an exception from the proposed rule's restrictions for covered members if the restriction is due to a contribution made by a covered associate and: (1) The covered member discovered the contribution within four months of it being made; (2) the contribution was less than $350; and (3) the contribution is returned within 60 days of the discovery of the contribution by the covered member. Consistent with the SEC Pay-to-Play Rule, this exception would allow a covered member to cure the consequences of an inadvertent political contribution to an official for whom the covered associate is not entitled to vote. As the SEC stated in the SEC Pay-to-Play Rule Adopting Release, the exception is limited to the types of contributions that are less likely to raise pay-to-play concerns.\58\ The prompt return of the contribution provides an indication that the contribution would not affect a government entity official's decision to award business. The 60-day limit is designed to give contributors sufficient time to seek the contribution's return, but still require that they do so in a timely manner. In addition, the relatively small amount of the contribution, in conjunction with the other conditions of the exception, suggests that the contribution was unlikely to have been made for the purpose of influencing the selection process. Repeated triggering contributions suggest otherwise. Thus, the proposed rule would provide that covered members with 150 or fewer registered representatives would be able to rely on this exception no more than two times per calendar year. All other covered members would be permitted to rely on this exception no more than three times per calendar year. In addition, a covered member would not be able to rely on an exception more than once with respect to contributions by the same covered associate regardless of the time period. These limitations are consistent with similar provisions in the SEC Pay-to-Play Rule.\59\ --------------------------------------------------------------------------- \58\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41035. \59\ See SEC Pay-to-Play Rule 206(4)-5(b)(3). The SEC Pay-to- Play Rule includes different allowances for larger and smaller investment advisers based on the number of employees they report on Form ADV. --------------------------------------------------------------------------- Proposed Recordkeeping Requirements Proposed Rule 4580 would require covered members that engage in distribution or solicitation activities with a government entity on behalf of any investment adviser that provides or is seeking to provide investment advisory services to such government entity to maintain books and records that would allow FINRA to examine for compliance with its pay-to-play rule. This provision is consistent with similar recordkeeping requirements imposed on investment advisers in connection with the SEC Pay-to-Play Rule.\60\ The proposed rule would require covered members to maintain a list or other record of: --------------------------------------------------------------------------- \60\ See Advisers Act Rule 204-2(a)(18) and (h)(1). ---------------------------------------------------------------------------The names, titles and business and residence addresses of all covered associates; the name and business address of each investment adviser on behalf of which the covered member has engaged in distribution or solicitation activities with a government entity within the past five years (but not prior to the rule's effective date); the name and business address of all government entities with which the covered member has engaged in distribution or solicitation activities for [[Page 81656]] compensation \61\ on behalf of an investment adviser, or which are or were investors in any covered investment pool on behalf of which the covered member has engaged in distribution or solicitation activities with the government entity on behalf of the investment adviser to the covered investment pool, within the past five years (but not prior to the rule's effective date); and --------------------------------------------------------------------------- \61\ As discussed in Item II.C below, FINRA has added ``for compensation'' to proposed Rule 4580(a)(3) to clarify that, consistent with the SEC recordkeeping requirements, FINRA's proposed recordkeeping requirements would apply only to government entities that become clients. --------------------------------------------------------------------------- all direct or indirect contributions made by the covered member or any of its covered associates to an official of a government entity, or direct or indirect payments to a political party of a state or political subdivision thereof, or to a PAC. The proposed rule would require that the direct and indirect contributions or payments made by the covered member or any of its covered associates be listed in chronological order and indicate the name and title of each contributor and each recipient of the contribution or payment, as well as the amount and date of each contribution or payment, and whether the contribution was the subject of the exception for returned contributions in proposed Rule 2030. Effective Date If the Commission approves the proposed rule change, FINRA will announce the effective date of the proposed rule change in a Regulatory Notice to be published no later than 60 days following Commission approval. FINRA intends to establish an effective date that is no sooner than 180 days following publication of the Regulatory Notice announcing Commission approval of the proposed rule change, and no later than 365 days following Commission approval of the proposed rule change. This transition period will provide member firms with time to identify their covered associates and government entity clients and to modify their compliance programs to address new obligations under the rules. Proposed Rule 2030(a)'s prohibition on engaging in distribution or solicitation activities for compensation with a government entity 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 is made to the government entity, will not be triggered by contributions made prior to the effective date. Similarly, the prohibition will not apply to contributions made prior to the effective date by new covered associates to which the two years or, as applicable, six months ``look back'' applies. As of the effective date, member firms must begin to maintain books and records in compliance with proposed Rule 4580. Member firms will not be required, however, to look back for the five years prior to the effective date of the proposed rule to identify investment advisers and government entity clients in accordance with proposed Rule 4580(a)(2) and (a)(3). 2. Statutory Basis FINRA believes that the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act,\62\ which requires, among other things, that FINRA rules must be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest. --------------------------------------------------------------------------- \62\ 15 U.S.C. 78o-3(b)(6). --------------------------------------------------------------------------- FINRA believes that the proposed rule change establishes a comprehensive regime to allow member firms to continue to engage in distribution or solicitation activities for compensation with government entities on behalf of investment advisers following the compliance date for the SEC's ban on third-party solicitations while deterring member firms from engaging in pay-to-play practices. In the absence of a FINRA pay-to-play rule, covered members will be prohibited from receiving compensation for engaging in distribution and solicitation activities with government entities on behalf of investment advisers. FINRA believes that establishing a pay-to-play rule modeled on the SEC Pay-to-Play Rule is a more effective regulatory response to the concerns identified by the SEC regarding third-party solicitations than an outright ban on such activity. At the same time, FINRA believes that the proposed two-year time out will deter member firms from engaging in pay-to-play practices and, thereby, protect investors and the public interest. B. Self-Regulatory Organization's Statement on Burden on Competition FINRA does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. As discussed above, FINRA published Regulatory Notice 14-50 to request comment on the proposed rule change.\63\ Regulatory Notice 14- 50 included an analysis of the economic impacts of the proposed rule change and requested comment regarding the analysis. The assessment below includes a summary of the comments received regarding the economic impact of the proposed rule change as set forth in Regulatory Notice 14-50 as well as FINRA's responses to the comments.\64\ --------------------------------------------------------------------------- \63\ See supra note 3. \64\ All references to commenters are to comment letters as listed in Exhibit 2b and as further discussed in Item II.C of this filing. --------------------------------------------------------------------------- Economic Impact Assessment A. Need for the Rule As discussed above, the SEC Pay-to-Play Rule prohibits an investment adviser and its covered associates from providing or agreeing to provide, directly or indirectly, payment to any person to solicit a government entity for investment advisory services on behalf of the investment adviser unless the person is a ``regulated person.'' A ``regulated person'' includes a member firm, provided that: (a) FINRA rules prohibit member firms from engaging in distribution or solicitation activities if political contributions have been made; and (b) the SEC finds, by order, that such rules impose substantially equivalent or more stringent restrictions on member firms than the SEC Pay-to-Play Rule imposes on investment advisers and that such rules are consistent with the objectives of the SEC Pay-to-Play Rule. Thus, FINRA must propose its own pay-to-play rule to enable member firms to continue to engage in distribution and solicitation activities for compensation with government entities on behalf of investment advisers. B. Regulatory Objective The proposed rule change would establish a comprehensive regime to regulate the activities of member firms that engage in distribution or solicitation activities with government entities on behalf of investment advisers. FINRA aims to enable member firms to continue to engage in such activities for compensation while at the same time deterring member firms from engaging in pay-to-play practices. C. Economic Baseline The baseline used to evaluate the impact of the proposed rule change is the regulatory framework under the SEC Pay-to-Play Rule and the MSRB pay-to-play rules.\65\ In the absence of the proposed rules, some member firms currently engaging in distribution or solicitation activities with government [[Page 81657]] entities on behalf of investment advisers may not be able to receive payments from investment advisers for engaging in such activities. Since a ``regulated person'' also includes SEC-registered investment advisers and SEC-registered municipal advisors that would be subject to MSRB pay-to-play rules, member firms dually-registered with the SEC as investment advisers or municipal advisors may be able to engage in distribution or solicitation activities for compensation with government entities on behalf of investment advisers.\66\ --------------------------------------------------------------------------- \65\ See supra note 23 (discussing MSRB Rule G-37). \66\ See supra note 24 (noting that a regulated person that is registered under the Exchange Act as a broker-dealer and municipal advisor, and under the Advisers Act as an investment adviser would be subject to the rules that apply to the services the regulated person is performing). --------------------------------------------------------------------------- The member firms that would have to cease their distribution or solicitation activities for compensation with government entities on behalf of investment advisers may bear direct losses as a result of the loss of this business. In addition, the absence of a FINRA pay-to-play rule that the SEC finds by order is substantially equivalent to or more stringent than the SEC Pay-to-Play Rule may impact investment advisers and public pension plans. Specifically, without such a rule, there could be a decrease in the number of third-party solicitors which may reduce the competition in the market for solicitation services. Some investment advisers may need to search for and hire new solicitors as a result of the absence of a FINRA pay-to-play rule to continue their solicitation activities. Due to the potentially limited capacity of third-party solicitors, investment advisers may encounter difficulties in retaining solicitors or delays in solicitation services. These changes would likely increase the costs to investment advisers that rely on third-party solicitors to obtain government clients. To the extent that higher costs may reduce the number of investment advisers competing for government business, public pension plans may face more limited investment opportunities. In such an instance, there may be an opportunity cost to a government entity either as it may not invest its assets optimally, or when seeking capital due to limitations on its access to funding. D. Economic Impacts 1. Benefits The proposed rule change would enable member firms to continue to engage in distribution or solicitation activities for compensation with government entities on behalf of investment advisers within the regulatory boundaries of the proposed rule change. The proposed rule change would prevent a potentially harmful disruption in the member firms' solicitation business, and accordingly may help member firms avoid some of the likely losses associated with the absence of such a rule change. The proposed rule change may also help promote competition by allowing more third-party solicitors to participate in the market for solicitation services, which may in turn reduce costs to investment advisers and improve competition for advisory services. The proposed rule change is intended to establish a comprehensive regime to allow member firms to continue to engage in distribution or solicitation activities with government entities on behalf of investment advisers while deterring member firms from engaging in pay- to-play practices. FINRA believes the proposed rules would curb fraudulent conduct resulting from pay-to-play practices and, therefore, help promote fair competition in the market and protect public pension funds and investors. FINRA also believes the proposed rules would likely reduce the search costs of government entities and increase their ability to efficiently allocate capital, and thereby would promote capital formation. 2. Costs FINRA recognizes that covered members that engage in distribution or solicitation activities with government entities on behalf of investment advisers would incur costs to comply with the proposed rules on an initial and ongoing basis. Member firms would need to establish and maintain policies and procedures to monitor contributions the firm and its covered associates make and to ensure compliance with the proposed requirements. In addition, member firms that wish to engage in distribution or solicitation activities with government entities may face hiring constraints as a result of the two-year (or, in some cases, six months) ``look back'' provision.\67\ --------------------------------------------------------------------------- \67\ FINRA notes, however, the availability of the exemptive provision in proposed Rule 2030(f) that would allow covered members to apply to FINRA for an exemption from the proposed rule's two-year time out. --------------------------------------------------------------------------- The compliance costs would likely vary across member firms based on a number of factors such as the number of covered associates, business models of member firms and the extent to which their compliance procedures are automated, whether the covered member is (or is affiliated with) an investment adviser subject to the SEC Pay-to-Play Rule, and whether the covered member is a registered municipal securities dealer and thus subject to MSRB pay-to-play rules.\68\ A small covered member with fewer covered associates may expend fewer resources to comply with the proposed rules than a large covered member. Covered members subject to (or affiliated with entities subject to) the SEC Pay-to-Play Rule or MSRB pay-to-play rules may be able to borrow from or build upon compliance procedures already in place. For example, FINRA estimates that approximately 400 member firms are currently subject to the MSRB pay-to-play rules. --------------------------------------------------------------------------- \68\ See supra note 23 (discussing MSRB Rule G-37). --------------------------------------------------------------------------- The potential burden arising from compliance costs associated with the proposed rules can be initially gauged from the SEC's cost estimates for the SEC Pay-to-Play Rule. The SEC has estimated that investment advisers would spend between 8 and 250 hours to establish policies and procedures to comply with the SEC Pay-to-Play Rule.\69\ The SEC further estimated that ongoing compliance would require between 10 and 1,000 hours annually.\70\ The SEC estimated compliance costs for firms of different sizes. The SEC assumed that a ``smaller firm'' would have fewer than five covered associates that would be subject to the SEC Pay-to-Play Rule, a ``medium firm'' would have between five and 15 covered associates, and a ``larger firm'' would have more than 15 covered associates.\71\ The SEC estimated that the initial compliance costs associated with the SEC Pay-to-Play Rule would be approximately $2,352 per smaller firm, $29,407 per medium firm, and $58,813 per larger firm.\72\ It also estimated that the annual, ongoing compliance expenses would be approximately $2,940 per smaller firm, $117,625 per medium firm, and $235,250 per larger firm.\73\ --------------------------------------------------------------------------- \69\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41056. \70\ See id. \71\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41055. \72\ See supra note 69. \73\ See id. --------------------------------------------------------------------------- In addition, the SEC estimated the costs for investment advisers to engage outside legal services to assist in drafting policies and procedures. It estimated that 75 percent of larger advisory firms, 50 percent of medium firms, and 25 percent of smaller firms subject to the SEC Pay-to-Play Rule [[Page 81658]] would engage such services.\74\ The estimated cost included fees for approximately 8 hours of outside legal review for a smaller firm, 16 hours for a medium firm and 40 hours for a larger firm, at a rate of $400 per hour.\75\ --------------------------------------------------------------------------- \74\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41057. \75\ See id. --------------------------------------------------------------------------- The SEC estimated that the recordkeeping requirements of the SEC Pay-to-Play Rule would increase an investment adviser's burden by approximately 2 hours per year,\76\ which would cost the adviser $118 per year based on the SEC's assumption of a compliance clerk's hourly rate of $59.\77\ In addition, the SEC estimated that some small and medium firms would incur one-time start-up costs, on average, of $10,000, and larger firms would incur, on average, $100,000 to establish or enhance current systems to assist in their compliance with the recordkeeping requirements.\78\ --------------------------------------------------------------------------- \76\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41063. \77\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41061 n.541. \78\ See supra note 76. --------------------------------------------------------------------------- FINRA requested comment on the economic impacts of the proposed rule change as set forth in Regulatory Notice 14-50, including on whether the proposed rule change would impose similar compliance costs on member firms as the SEC estimated for investment advisers. Several commenters raised cost and compliance burden concerns in connection with the disclosure requirements set forth in Regulatory Notice 14-50, stating among other things, that the disclosure requirements are ``overly burdensome and create difficult compliance challenges'' \79\ and that FINRA's cost estimates in Regulatory Notice 14-50 ``do not accurately reflect the true compliance costs associated with the Proposed Rules, and particularly the costs associated with the disclosure requirements . . . .'' \80\ --------------------------------------------------------------------------- \79\ Monument Group. \80\ SIFMA. --------------------------------------------------------------------------- Monument Group stated that the vast majority of independent placement agents that would be subject to the proposed rules are small businesses, many of which are minority- or women-owned. Monument Group stated that these firms operate with focused staff and no revenues from other lines of business. Accordingly, Monument Group stated that incremental regulatory requirements that have little impact on larger firms can create significant resource and cost issues for these smaller firms. Specifically, Monument Group stated that the disclosure requirements would place significant and unique burdens on independent third-party private fund placement agents. Another commenter, 3PM, stated that the proposed rule change would add a new and significant burden on small firms in terms of the disclosure and recordkeeping requirements. 3PM also stated that not only would small firms be impacted by cost, but also by their limited personnel resources who would have to take on additional responsibilities to comply with the proposed rule change. Monument Group requested that FINRA consider the already existing state, municipal and local lobbying registration, disclosure and reporting requirements and pay-to-play regimes in calculating the cost and competitive impact of the proposed rule change. Monument Group stated that the proposed rule change disproportionately affects FINRA- registered placement agents (as compared with other broker-dealers) and has the largest economic and anti-competitive effect on small independent firms. As discussed above and in more detail in Item II.C below, after considering the comments, FINRA has determined not to propose a disclosure requirement for government distribution and solicitation activities at this time. FINRA believes that this determination will reduce substantially the cost and compliance burden concerns raised by commenters regarding the proposed rule change. FINRA however may consider a disclosure requirement for government distribution and solicitation activities as part of a future rulemaking and would consider the economic impact of any such revised proposed disclosure requirement as part of that rulemaking. Although FINRA has determined to retain a recordkeeping requirement, FINRA notes that, in response to commenter concerns to Regulatory Notice 14-50 regarding the significant costs associated with maintaining lists of unsuccessful solicitations,\81\ FINRA has modified the proposed rule such that covered members would only be required to maintain lists of government entities that become clients.\82\ --------------------------------------------------------------------------- \81\ See, e.g., 3PM. \82\ See proposed Rule 4580(a)(3). --------------------------------------------------------------------------- Since the scope of the proposed rule after the modifications is substantially equivalent to the SEC Pay-to-Play Rule, FINRA believes that the SEC's cost estimates serve as a reasonable reference for the potential compliance costs on member firms. In response to the question on the costs of engaging outside legal services to assist in drafting policies and procedures to comply with the proposed rule, 3PM estimated that the majority of member firms would spend between $1,500 and $2,500 or approximately five to 10 hours of a professional consultant's time. In addition, 3PM estimated that a member firm would exert approximately 10 to 20 additional hours of compliance oversight in connection with the proposed rule each year. These estimates are slightly lower than the SEC's estimates discussed above. The proposed rule is not expected to have competitive effects among member firms engaging in distribution or solicitation activities, since all member firms will be subject to the same prohibitions. Moreover, because the restrictions imposed by the proposed rule are substantially equivalent to the restrictions imposed by the SEC Pay-to-Play Rule, the proposed rule is not expected to create an uneven playing field between member firms and investment advisers. There may be a potential impact on the competition between member firms and municipal advisors depending on the differences between the proposed rule and the finalized MSRB rules regulating similar activities of municipal advisors.\83\ --------------------------------------------------------------------------- \83\ See supra note 23. --------------------------------------------------------------------------- E. Regulatory Alternatives Since the SEC requires that FINRA impose ``substantially equivalent or more stringent restrictions'' on member firms that wish to act as ``regulated persons'' than the SEC Pay-to-Play Rule imposes on investment advisers, FINRA believes it is appropriate (and achieves the right balance between the costs and benefits) to model the proposed rule change on the SEC Pay-to-Play Rule rather than impose a regulatory alternative, including a more stringent regulatory alternative, on such member firms. C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others In November 2014, FINRA published the proposed rule change for comment in Regulatory Notice 14-50. FINRA received 10 comment letters in response to Regulatory Notice 14-50. A copy of Regulatory Notice 14- 50 is attached as Exhibit 2a to the proposed rule change that was filed with the Commission. A list of the comment letters received in response to Regulatory Notice 14-50 is attached as Exhibit 2b.\84\ Copies of the [[Page 81659]] comment letters received in response to Regulatory Notice 14-50 are attached as Exhibit 2c. --------------------------------------------------------------------------- \84\ All references to commenters are to the comment letters as listed in Exhibit 2b to the proposed rule change. --------------------------------------------------------------------------- Most commenters expressed appreciation or support for FINRA's decision to propose a pay-to-play rule, noting the potential disruption of an SEC ban on third party solicitations if FINRA were not to propose and adopt a pay-to-play rule. The commenters raised, however, a number of concerns with the proposed pay-to-play rule, as well as the related proposed disclosure and recordkeeping requirements. A summary of the comments and FINRA's responses are discussed below.\85\ --------------------------------------------------------------------------- \85\ Comments that speak to the economic impacts of the proposed rule change are addressed in Item II.B above. --------------------------------------------------------------------------- First Amendment Concerns CCP expressed First Amendment concerns with the proposed rule change. Among other things, CCP raised vagueness and over-breadth concerns with a number of the provisions in the proposed rule change,\86\ and asserted that the prohibition on soliciting and coordinating contributions is a ``grave infringement of the basic `right to associate for the purpose of speaking.' '' --------------------------------------------------------------------------- \86\ See CCP (discussing, among other things, the proposed definitions of the terms ``official of a government entity,'' ``solicit'' and ``contribution,'' as well as the provision prohibiting any covered member or any of its covered associates from doing anything indirectly that, if done directly, would result in a violation of the proposed pay-to-play rule). --------------------------------------------------------------------------- In light of CCP raising these constitutional concerns, FINRA notes that the proposed pay-to-play rule does not impose any restrictions on making independent expenditures, ban political contributions, or attempt to regulate State and local elections. FINRA acknowledges that the two-year time out provision may affect the propensity of covered members and their covered associates to make political contributions.\87\ As discussed in Regulatory Notice 14-50 and as recognized by CCP, however, establishing requirements to regulate the activities of member firms that engage in distribution or solicitation activities with government entities on behalf of investment advisers is a more effective response to the requirements of the SEC Pay-to-Play Rule than an outright ban on such activity. If FINRA were not to have a pay-to-play rule, the result would be a ban on member firms soliciting government entities for investment advisory services for compensation on behalf of investment advisers. --------------------------------------------------------------------------- \87\ CCP requested that FINRA state explicitly whether the proposed rule would permit contributions in support of independent expenditures. FINRA notes that, consistent with the SEC Pay-to-Play Rule, the proposed rule would not in any way impinge on a wide range of expressive conduct in connection with elections. For example, the rule would not impose any restrictions on activities such as making independent expenditures to express support for candidates, volunteering, making speeches, and other conduct. See also SEC Pay- to-Play Rule Adopting Release, 75 FR 41018, 41024 (discussing independent expenditures). --------------------------------------------------------------------------- Moreover, for an investment adviser and its covered associates to provide or agree to provide, directly or indirectly, payment to a member firm to solicit a government entity for investment advisory services on behalf of the investment adviser, the SEC must find that FINRA's pay-to-play rule imposes substantially equivalent or more stringent restrictions on member firms than the SEC Pay-to-Play Rule imposes on investment advisers and that FINRA's rule is consistent with the objectives of the SEC Pay-to-Play Rule. CCP suggested alternative approaches to the proposed pay-to-play rule that it argued would be ``less restrictive,'' but FINRA does not believe that CCP's suggested less restrictive alternatives would meet the SEC's requirements. Accordingly, FINRA has crafted its proposal such that it is substantially similar to the SEC's Pay-to-Play Rule.\88\ --------------------------------------------------------------------------- \88\ In addition, FINRA notes that, to the extent there are interpretive questions regarding the application and scope of the provisions and terms used in its pay-to-play rule, FINRA will work with the industry to understand the interpretive questions and provide additional guidance where warranted. --------------------------------------------------------------------------- FINRA notes that the SEC modeled the SEC Pay-to-Play Rule on similarly designed MSRB Rule G-37, which the United States Court of Appeals for the District of Columbia Circuit upheld against a First Amendment challenge in Blount v. SEC.\89\ As stated in the SEC Pay-to- Play Rule Adopting Release, the Blount opinion served as an important guidepost in helping the SEC shape the SEC Pay-to-Play Rule.\90\ Similar to MSRB Rule G-37 and the SEC Pay-to-Play Rule, FINRA believes it has closely drawn its proposal to accomplish the goal of preventing quid pro quo arrangements while avoiding unnecessary burdens on the protected speech and associational rights of covered members and their covered associates. This analysis is further supported by the Court of Appeals for the District of Columbia Circuit's recent unanimous en banc decision in Wagner v. FEC, which relied on Blount to uphold against a First Amendment challenge a law barring campaign contributions by federal contractors.\91\ As detailed below, the proposed rule is closely drawn in terms of the conduct it prohibits, the persons who are subject to its restrictions, and the circumstances in which it is triggered. --------------------------------------------------------------------------- \89\ 61 F.3d 938 (D.C. Cir. 1995), cert. denied, 517 U.S. 1119 (1996). \90\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41023. \91\ Wagner v. FEC, No. 13-5162, 2015 U.S. App LEXIS 11625 (D.C. Cir. July 7, 2015). --------------------------------------------------------------------------- Proposed Pay-to-Play Rule A. Two-Year Time Out Consistent with Regulatory Notice 14-50, proposed Rule 2030(a) would impose a two-year time out on engaging in distribution or solicitation activities for compensation with a government entity on behalf of an investment adviser after the covered member or its covered associates make a contribution to an official of the government entity. NASAA stated that member firms should be prohibited from engaging in distribution or solicitation activities on behalf of an investment adviser directed at any government entity for a period of four years following any qualifying contribution by the member firm. In addition, NASAA stated that if a member firm has engaged in solicitation or distribution activities with a government entity on behalf of an investment adviser, the member firm should be prohibited from making any qualifying contributions to that government entity for a period of four years following the conclusion of the solicitation or distribution activities. FINRA has declined to make NASAA's suggested changes. The proposed two-year time out is consistent with the time-out period in the SEC's Pay-to-Play Rule, and FINRA believes that a two-year time out from the date of a contribution is sufficient to discourage covered members from engaging in pay-to-play practices. 1. Government Entity Government entities would include all state and local governments, their agencies and instrumentalities, and all public pension plans and other collective government funds, including participant-directed plans such as 403(b),\92\ 457,\93\ and 529 \94\ plans. CAI urged FINRA or the SEC to provide additional guidance as to the criteria for determining whether an entity is an ``instrumentality'' under the proposed rule. CAI noted that its members have struggled to understand the contours of this term in the context of the SEC Pay-to-Play Rule. As stated in Regulatory Notice 14-50 and above, the definition of a ``government entity'' is consistent with the definition of that term in the SEC Pay- to-Play Rule. The SEC has not provided additional guidance regarding [[Page 81660]] the meaning of the term ``instrumentality'' in connection with its Pay- to-Play Rule. Thus, at this time, FINRA declines to provide additional guidance as part of the proposed rule. FINRA recognizes, however, the concerns raised by CAI and will continue to discuss with the industry interpretive questions relating to the proposed rule change. --------------------------------------------------------------------------- \92\ See supra note 28. \93\ See supra note 29. \94\ See supra note 30. --------------------------------------------------------------------------- 2. Solicitation Consistent with Regulatory Notice 14-50, the proposed pay-to-play rule defines the term ``solicit'' to mean, with respect to investment advisory services, ``to communicate, directly or indirectly, for the purpose of obtaining or retaining a client for, or referring a client to, an investment adviser'' and, with respect to a contribution or payment, ``to communicate, directly or indirectly, for the purpose of obtaining or arranging a contribution or payment.'' \95\ CAI sought confirmation that the proposed rule would not apply when a covered member communicates with a third party and has no intent to obtain a client for, or refer a client to, an investment adviser (in the context of investment advisory services) and there is no intent to obtain or arrange a contribution or payment (in the context of contributions to officials of government entities and payments to political parties). --------------------------------------------------------------------------- \95\ Proposed Rule 2030(g)(11). --------------------------------------------------------------------------- As stated in Regulatory Notice 14-50 and above, the determination of whether a particular communication is a solicitation for investment advisory services or a contribution or payment would be dependent upon the specific facts and circumstances relating to such communication. As a general proposition, if there is no intent to obtain a client for, or refer a client to, an investment adviser (in the context of investment advisory services) or to obtain or arrange a contribution or payment (in the context of contributions to officials of government entities and payments to political parties), FINRA would not consider the communication to be a solicitation.\96\ --------------------------------------------------------------------------- \96\ See supra notes 18 and 40. --------------------------------------------------------------------------- 3. Investment Advisers The proposed pay-to-play rule would apply to covered members acting on behalf of any investment adviser registered (or required to be registered) with the SEC, or unregistered in reliance on the exemption available under Section 203(b)(3) of the Advisers Act for foreign private advisers, or that is an exempt reporting adviser under Advisers Act Rule 204-4(a).\97\ NASAA and 3PM suggested that FINRA expand the definition of ``investment adviser'' to include state-registered investment advisers, stating, among other things, that it would further reduce the disruptions created by pay-to-play schemes. To remain consistent with the SEC Pay-to-Play Rule, FINRA has determined not to expand the scope of the proposed rule as suggested by commenters. FINRA notes that the SEC declined to make a similar change to its proposed rule, stating that it is their understanding that few of these smaller firms manage public pension plans or other similar funds.\98\ --------------------------------------------------------------------------- \97\ See proposed Rule 2030(g)(7). \98\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41026. --------------------------------------------------------------------------- 4. Covered Associates/Executive Officers A ``covered associate'' includes any general partner, managing member or executive officer of a covered member, or other individual with a similar status or function.\99\ SIFMA requested that FINRA define the term ``executive officer'' for purposes of the proposed rule. Consistent with the SEC Pay-to-Play Rule and for purposes of the FINRA pay-to-play rule only, FINRA has added proposed Rule 2030(g)(5) to define an ``executive officer of a covered member'' to mean: ``(A) The president; (B) Any vice president in charge of a principal business unit, division or function (such as sales, administration or finance); (C) Any other officer of the covered member who performs a policy- making function; or (D) Any other person who performs similar policy- making functions for the covered member.'' --------------------------------------------------------------------------- \99\ See supra note 37 (defining the term ``covered associate''). --------------------------------------------------------------------------- A covered associate also would include a PAC controlled by the covered member or any of its covered associates. FSI asserted that the restrictions on PAC contributions, and the definition of ``control'' with respect to covered associates are vague and potentially over- broad. For example, FSI stated that ``[i]t is unclear whether an employee or executive of a member firm that holds a position on a PAC board of directors or other advisory committee would have `control' of the PAC under the Proposed Rules. It would also cover PACs that are not connected to the employee or executive's member firm.'' As stated in Regulatory Notice 14-50 and above, FINRA would consider a covered member or its covered associates to have ``control'' over a PAC if the covered member or covered associate has the ability to direct or cause the direction of governance or operations of the PAC. This position is consistent with the position taken by the SEC in connection with the SEC Pay-to-Play Rule.\100\ --------------------------------------------------------------------------- \100\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41032 (discussing PACs). --------------------------------------------------------------------------- 5. Distribution a. Inclusion of Distribution Activities Consistent with Regulatory Notice 14-50, proposed Rule 2030(a) would impose a two-year time out on engaging in distribution or solicitation activities for compensation with a government entity on behalf of an investment adviser after the covered member or its covered associates makes a contribution to an official of the government entity. Some commenters questioned the meaning of the term ``distribution'' in the context of the proposed rule. For example, SIFMA stated that it is their understanding ``that the phrase `distribution and solicitation,' as used in the SEC Pay-to-Play Rule, is interpreted to mean `the solicitation of investment advisory services.' '' CAI stated that ``[s]ince the term `distribution' has no meaning in the context of an investment adviser and is inconsistent with the personal nature of the services provided by investment advisers, [it] strongly recommends that FINRA eliminate each and every reference to the word `distribution' throughout the Notice and the Proposed Rules. . . . [I]t is not clear what activity the term `distribution' is meant to cover that is not captured by the term `solicitation.' '' The SEC Pay-to-Play Rule prohibits an investment adviser and its covered associates from providing or agreeing to provide, directly or indirectly, payment to any person to solicit a government entity for investment advisory services on behalf of the investment adviser unless the person is a ``regulated person.'' \101\ The SEC Pay-to-Play Rule defines a ``regulated person'' to include a member firm, provided that FINRA rules prohibit member firms from engaging in distribution or solicitation activities if political contributions have been made.\102\ Thus, the SEC Pay-to-Play Rule requires FINRA to have a rule that prohibits member firms from engaging in distribution (as well as solicitation) activities if political contributions have been made. --------------------------------------------------------------------------- \101\ See SEC Pay-to-Play Rule 206(4)-5(a)(2). \102\ See SEC Pay-to-Play Rule 206(4)-5(f)(9)(ii)(A). --------------------------------------------------------------------------- Language in the SEC Pay-to-Play Rule Adopting Release further supports the inclusion of distribution activities by broker-dealers in a FINRA pay-to-play rule. For example, when discussing comments related to its proposed ban on using third parties to solicit government business, the SEC addressed [[Page 81661]] commenters' concerns that the provision would interfere with traditional distribution arrangements of mutual funds and private funds by broker-dealers, by clarifying under what circumstances distribution payments would violate the SEC's Pay-to-Play Rule.\103\ --------------------------------------------------------------------------- \103\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41040 n.298 (stating that ``[m]utual fund distribution fees are typically paid by the fund pursuant to a 12b-1 plan, and therefore generally would not constitute payment by the fund's adviser. As a result, such payments would not be prohibited [under the SEC Pay-to- Play Rule] by its terms. Where an adviser pays for the fund's distribution out of its `legitimate profits,' however, the rule would generally be implicated. . . . For private funds, third parties are often compensated by the adviser or its affiliated general partner and, therefore, those payments are subject to the rule.'') --------------------------------------------------------------------------- Based on the SEC's definition of ``regulated person'' as well as its discussion regarding the treatment of distribution fees paid pursuant to a 12b-1 plan, FINRA believes its proposed rule must apply to member firms engaging in distribution activities. Accordingly, FINRA has not revised the proposed rule to remove references to the term ``distribution.'' \104\ --------------------------------------------------------------------------- \104\ In addition, FINRA notes that many of the concerns raised by commenters in connection with including distribution activities in the proposed rule related to the additional burden associated with the proposed disclosure requirements and such activities. As discussed further below, FINRA has determined not to propose a disclosure rule relating to government distribution and solicitation activities. --------------------------------------------------------------------------- b. Scope of Distribution Activities ICI requested confirmation that, with respect to mutual funds, the proposed rule would be triggered only when a member firm solicits a government entity to include a mutual fund in a government entity's plan or program and not when the member is selling mutual fund shares to a government entity. FSI asked for clarification with respect to the treatment of traditional brokerage activities by a financial advisor as ``distribution or solicitation activities'' in the context of government entity plans. As discussed above, the proposed pay-to-play rule would apply to distribution activities by covered members. FINRA notes, however, that based on the definition of a ``covered investment pool,'' the proposed rule would not apply to distribution activities related to registered investment companies that are not investment options of a government entity's plan or program.\105\ Thus, the proposed rule would apply to distribution activities involving unregistered pooled investment vehicles such as hedge funds, private equity funds, venture capital funds, and collective investment trusts, and registered pooled investment vehicles such as mutual funds, but only if those registered pools are an investment option of a participant-directed plan or program of a government entity.\106\ --------------------------------------------------------------------------- \105\ Proposed Rule 2030(g)(3) defines a ``covered investment pool'' to mean: ``(A) Any investment company registered under the Investment Company Act that is an investment option of a plan or program of a government entity, or (B) Any company that would be an investment company under Section 3(a) of the Investment Company Act but for the exclusion provided from that definition by either Section 3(c)(1), 3(c)(7) or 3(c)(11) of that Act.'' \106\ Although the proposed rule would not apply to distribution activities relating to all registered pooled investment vehicles, FINRA notes the language of proposed Rule 2030(e) that ``[i]t shall be a violation of this Rule for any covered member or any of its covered associates to do anything indirectly that, if done directly, would result in a violation of this Rule.'' --------------------------------------------------------------------------- CAI requested clarification that ``compensation'' in the context of covered investment pools does not include conventional compensation arrangements for the distribution of mutual funds, variable annuity contracts and other securities included within the definition of ``covered investment pool.'' Consistent with the SEC Pay-to-Play Rule, to the extent the mutual fund distribution fees are paid by the fund pursuant to a 12b-1 plan, such payments would not be prohibited under the proposed rule as they would not constitute payments by the fund's investment adviser. If, however, the adviser pays for the fund's distribution out of its ``legitimate profits,'' the proposed rule would generally be implicated.\107\ For private funds, third parties are often compensated by the investment adviser or its affiliated general partner. Thus, such payments would be subject to the proposed rule. In addition, FINRA notes that structuring such a payment to come from the private fund for purposes of evading the rule would violate the rule.\108\ --------------------------------------------------------------------------- \107\ For a discussion of a mutual fund adviser's ability to use ``legitimate profits'' for fund distribution, see Investment Company Act of 1940 Release No. 11414 (Oct. 28, 1980), 45 FR 73898 (Nov. 7, 1980) (Bearing of Distribution Expenses by Mutual Funds) (explaining, in the context of the prohibition on the indirect use of fund assets for distribution, unless pursuant to a 12b-1 plan, ``[h]owever, under the rule there is no indirect use of fund assets if an adviser makes distribution related payments out of its own resources. . . . Profits which are legitimate or not excessive are simply those which are derived from an advisory contract which does not result in a breach of fiduciary duty under section 36 of the [Investment Company] Act.''). \108\ See also SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41040 n.298 and accompanying text. CAI also asked FINRA to consider afresh the SEC's position in its Pay-to-Play Rule that payments originating with an investment adviser should be treated as a payment for solicitation, regardless of the purpose or context for the payment. As discussed above, for purposes of the proposed rule, FINRA is taking a position consistent with the SEC's position in its Pay-to-Play Rule. --------------------------------------------------------------------------- B. Prohibitions as Applied to Covered Investment Pools 1. General In Regulatory Notice 14-50, proposed Rule 2390(e) (now proposed as Rule 2030(d)) provided that a covered member that engages in distribution or solicitation activities with a government entity on behalf of an investment adviser to a covered investment pool in which a government entity invests or is solicited to invest shall be treated as though the covered member was engaging in or seeking to engage in distribution or solicitation activities with the government entity on behalf of the investment adviser directly. CAI raised concerns regarding the application of the prohibitions of the proposed rule to covered investment pools stating, among other things, ``that a broker- dealer that offers and sells interests in a mutual fund or private fund cannot be characterized as soliciting on behalf of the investment adviser to a covered investment pool.'' CAI reasoned that ``[t]here is no basis for this notion given the [SEC] staff's interpretation in the Mayer Brown no-action letter and the Goldstein case . . ., as well as the lack of any relationship between the selling firm and the investment adviser.'' \109\ --------------------------------------------------------------------------- \109\ See Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006) and Mayer Brown LLP, SEC No-Action Letter (``Mayer Brown letter''), available at https://www.sec.gov/divisions/investment/noaction/2008/mayerbrown072808-206.htm#P15_323. In Goldstein, the court held that the SEC's ``Hedge Fund Rule,'' which would have given the SEC greater oversight over hedge funds, was invalid because it was arbitrary and in conflict with the purpose of the underlying statute in which the new rule was included. The court concluded that hedge fund investors are not clients of fund advisers for the purpose of the Adviser's Act registration requirement. In the Mayer Brown letter, SEC staff stated that Rule 206(4)-3 generally does not apply to a registered investment adviser's cash payment to a person solely to compensate that person for soliciting investors or prospective investors for, or referring investors or prospective investors to, an investment pool managed by the adviser. The letter distinguishes between a person referring other persons to the adviser where the adviser manages only investment pools and is not seeking to enter into advisory relationships with these other persons (but rather the other persons will be investors or prospective investors in one or more of the investment pools managed by the adviser), versus referring other persons as prospective advisory clients. The letter notes that whether the rule applies will depend on the facts and circumstances. --------------------------------------------------------------------------- After considering CAI's concerns, FINRA has modified the language of the proposed rule to recognize the relationship between the selling member and the covered investment [[Page 81662]] pool, but also to clarify that for purposes of the proposed rule, a covered member engaging in distribution or solicitation activities on behalf of a covered investment pool in which a government entity invests or is solicited to invest shall be treated as though the covered member was engaging in, or seeking to engage in, distribution or solicitation activities with the government entity on behalf of the investment adviser to the covered investment pool directly.\110\ --------------------------------------------------------------------------- \110\ See proposed Rule 2030(d). --------------------------------------------------------------------------- As stated in Regulatory Notice 14-50, proposed Rule 2390(e) (now proposed as Rule 2030(d)) was modeled on a similar provision in the SEC Pay-to-Play Rule, Rule 206(4)-5(c),\111\ and was intended to extend the protections of the proposed rule to government entities that access the services of investment advisers through hedge funds and other types of pooled investment vehicles sponsored or advised by investment advisers.\112\ As noted by CAI, however, FINRA recognizes that without a provision corresponding more closely to SEC Pay-to-Play Rule 206(4)- 5(c), there is nothing in the proposed rule that deems an investment adviser to a covered investment pool to have a direct investment advisory relationship with government entities investing in the pool. CAI noted that: ``Without such a provision, proposed rule 2390(e) would not apply the two year time out restriction in proposed rule 2390(a) to advisers to [covered investment pools]. This is because proposed Rule 2390(a) would only apply where an investment adviser `provides or is seeking to provide investment advisory services to such government entity.' '' --------------------------------------------------------------------------- \111\ SEC Pay-to-Play Rule 206(4)-5(c) provides that ``an investment adviser to a covered investment pool in which a government entity invests or is solicited to invest shall be treated as though that investment adviser were providing or seeking to provide investment advisory services directly to the government entity.'' \112\ In adopting this provision, the SEC noted a commenter's questioning of its authority to apply the rule in the context of covered investment pools in light of the opinion of the Court of Appeals for the District of Columbia Circuit in the Goldstein case. See supra note 109. The SEC concluded, however, that it has authority to adopt rules proscribing fraudulent conduct that is potentially harmful to investors in pooled investment vehicles pursuant to Section 206(4) of the Advisers Act and, therefore, adopted SEC Pay-to-Play Rule 206(4)-5(c) as proposed. See SEC Pay- to-Play Rule Adopting Release, 75 FR 41018, 41045 n.355. --------------------------------------------------------------------------- Accordingly, FINRA has modified the proposed rule to include proposed Rule 2030(d)(2) that provides that for purposes of the proposed rule ``an investment adviser to a covered investment pool in which a government entity invests or is solicited to invest shall be treated as though that investment adviser were providing or seeking to provide investment advisory services directly to the government entity.'' 2. Two-Tiered Investment Products CAI sought confirmation from FINRA that the proposed pay-to-play rule would not apply in the context of two-tiered investment products, such as variable annuities. CAI asserted, among other things, that ``[o]rdinarily, there is no investment adviser providing investment advisory services to the separate account supporting the variable annuity contract, although there are investment advisers providing investment advisory services to the underlying mutual funds or unregistered investment pools.'' CAI requested clarification that a covered member selling two-tiered investment products is not engaging in solicitation activities on behalf of the investment adviser and sub- advisers managing the underlying funds. FINRA notes that the SEC did not exclude specific products from the SEC Pay-to-Play Rule and, therefore, FINRA has determined not to exclude specific products from its proposed rule. C. Disgorgement In Regulatory Notice 14-50, FINRA proposed a ``disgorgement'' provision that, among other things, would have required that the covered member pay, in the order listed, any compensation or other remuneration received by the covered member pertaining to, or arising from, distribution or solicitation activities during the two-year time out to: (A) A covered investment pool in which the government entity was solicited to invest, as applicable; (B) the government entity; (C) any appropriate entity designated in writing by the government entity if the government entity or covered investment pool cannot receive such payments; or (D) the FINRA Investor Education Foundation, if the government entity or covered investment pool cannot receive such payments and the government entity cannot or does not designate in writing any other appropriate entity. NASAA expressed support for FINRA's inclusion of a disgorgement provision for violations of the proposed rule. Most commenters, however, opposed the requirement.\113\ SIFMA stated that ``[w]hile disgorgement is the almost universal remedy for violations of various pay-to-play rules, . . . making application of the remedy mandatory could have the deleterious effect of dissuading covered members from voluntary disgorgement of fees where such members discover pay-to-play violations themselves.'' ICI stated that ``including disgorgement as a penalty is not necessary given that the SEC and FINRA both have full authority to require disgorgement of fees, and indeed, disgorgement has been the penalty universally applied (along with additional penalties) in enforcement actions under existing pay-to-play rules, such as MSRB Rule G-37 and SEC Rule 206(4)-5.'' --------------------------------------------------------------------------- \113\ See, e.g., SIFMA, CAI and ICI. --------------------------------------------------------------------------- After considering the comments and, in particular, that FINRA has authority to require disgorgement of fees in enforcement actions, FINRA has determined not to include a disgorgement requirement in the proposed rule. D. Prohibition on Soliciting and Coordinating Contributions Consistent with Regulatory Notice 14-50, proposed Rule 2030(b) would prohibit a covered member or covered associate from coordinating or soliciting any person or PAC to make any: (1) Contribution to an official of a government entity in respect of which the covered member is engaging in, or seeking to engage in, distribution or solicitation activities on behalf of an investment adviser; or (2) payment to a political party of a state or locality of a government entity with which the covered member is engaging in, or seeking to engage in, distribution or solicitation activities on behalf of an investment adviser. As stated in Regulatory Notice 14-50 and above, this provision is modeled on a similar provision in the SEC Pay-to-Play Rule.\114\ --------------------------------------------------------------------------- \114\ See SEC Pay-to-Play Rule 206(4)-5(a)(2). --------------------------------------------------------------------------- CAI sought confirmation that the proposed prohibition on soliciting and coordinating contributions would not apply when a contribution is made to a political action committee, political party or other third party, where there is no knowledge or indication of how such contribution will be used. Similar to guidance provided in the context of SEC Pay-to-Play Rule 206(4)-5(a)(2), FINRA notes that a direct contribution to a political party by a covered member or its covered associates would not violate the proposed rule unless the contribution was a means for the covered member to do indirectly what the rule would prohibit if done directly (for example, if the contribution was earmarked or known to be provided for the benefit of a particular government official).\115\ --------------------------------------------------------------------------- \115\ See also SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41044 n.337. --------------------------------------------------------------------------- [[Page 81663]] E. Direct or Indirect Contributions or Solicitations Consistent with Regulatory Notice 14-50, proposed Rule 2030(e) provides that it shall be a violation of the proposed pay-to-play rule for any covered member or any of its covered associates to do anything indirectly that, if done directly, would result in a violation of the rule. CAI requested that FINRA incorporate a knowledge and support requirement into this provision of the proposed rule so that it would be violated only if a covered member has direct knowledge of, and takes measures to aid and support, activities undertaken by its affiliates. As stated in Regulatory Notice 14-50 and above, this provision is modeled on SEC Pay-to-Play Rule 206(4)-5(d). Consistent with guidance provided by the SEC in connection with that provision, FINRA has clarified that it would require a showing of intent to circumvent the rule for a covered member or its covered associates funneling payments through a third party to trigger the two-year time out.\116\ --------------------------------------------------------------------------- \116\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41044 n.340. --------------------------------------------------------------------------- F. Exceptions In Regulatory Notice 14-50, FINRA included exceptions to the prohibition in the proposed pay-to-play rule for de minimis contributions and returned contributions. CAI and CCP stated that they believe that the $350 and $150 de minimis contribution limits are unreasonably low. CAI stated that it believes the $350 amount for returned contributions is unnecessary because ``[i]f the contribution is returned as is required under the exception, then no harm will result as both the contributor and contributee are placed in the same position they would have been in had no contribution been made.'' FINRA has determined not to modify the proposed exceptions. As stated in Regulatory Notice 14-50 and above, the exceptions are modeled on similar exceptions in the SEC Pay-to-Play Rule for de minimis contributions and returned contributions.\117\ Moreover, FINRA believes that it is necessary to keep the amounts at the levels as proposed in Regulatory Notice 14-50 to meet the requirement in the SEC Pay-to-Play Rule that the restrictions in FINRA's rule must be substantially equivalent to, or more stringent than, the restrictions in the SEC Pay- to-Play Rule. --------------------------------------------------------------------------- \117\ See SEC Pay-to-Play Rule 206(4)-5(b). --------------------------------------------------------------------------- Proposed Recordkeeping Requirements A. Unsuccessful Solicitations Proposed Rule 4580 would require covered members that engage in distribution or solicitation activities with a government entity on behalf of any investment adviser that provides or is seeking to provide investment advisory services to such government entity to maintain books and records that would allow FINRA to examine for compliance with its proposed pay-to-play rule. SIFMA requested that FINRA not extend the recordkeeping requirements to unsuccessful solicitations where the covered member does not receive compensation because maintaining such records would impose significant costs on covered members with little corresponding benefit. \118\ --------------------------------------------------------------------------- \118\ See also CAI, 3PM and FSI (requesting that FINRA not apply the proposed recordkeeping requirements to unsuccessful solicitations of government entities). --------------------------------------------------------------------------- FINRA intends that the recordkeeping requirements of proposed Rule 4580 be consistent with similar recordkeeping requirements imposed on investment advisers in connection with the SEC Pay-to-Play Rule.\119\ The SEC does not require investment advisers to maintain lists of government entities that do not become clients.\120\ Accordingly, FINRA has added the term ``for compensation'' to proposed Rule 4580(a)(3) to clarify that the proposed Rule would not apply to unsuccessful solicitations. --------------------------------------------------------------------------- \119\ See Advisers Act Rule 204-2(a)(18) and (h)(1). \120\ See SEC Pay-to-Play Rule Adopting Release, 75 FR 41018, 41050. --------------------------------------------------------------------------- B. Indirect Contributions Consistent with Regulatory Notice 14-50, proposed Rule 4580(a)(4) would require a covered member to maintain books and records of all direct and indirect contributions made by the covered member or any of its covered associates to an official of a government entity, or direct or indirect payments to a political party of a state or political subdivision thereof or to a PAC. 3PM requested that FINRA eliminate the requirement to maintain a list of indirect contributions, arguing that ``requiring firms to . . . track and monitor indirect contributions could become extremely time consuming and costly for firms.'' CAI asserted that not all payments to political parties or PACs should have to be maintained. Instead, CAI stated that only payments to political parties or PACs where the covered member or covered associate: (i) Directs the political party or PAC to make a contribution to an official of a government entity which the covered member is soliciting on behalf of an investment adviser, or (ii) knows that the political party or PAC is going to make a contribution to an official of a government entity which the covered member is soliciting on behalf of an investment adviser, should have to be maintained. As stated in the Regulatory Notice and above, the proposed recordkeeping requirements are intended to allow FINRA to examine for compliance with its proposed pay-to-play rule. Thus, the reference to indirect contributions in proposed Rule 4580(a)(4) is intended to include records of contributions or payments a covered member solicits or coordinates another person or PAC to make under proposed Rule 2030(b) (Prohibition on Soliciting and Coordinating Contributions).\121\ In addition, payments to political parties or PACs can be a means for a covered member or covered associate to funnel contributions to a government official without directly contributing. Thus, FINRA is proposing to require a covered member to maintain a record of all payments to political parties or PACs as such records would assist FINRA in identifying situations that might suggest an intent to circumvent the rule.\122\ --------------------------------------------------------------------------- \121\ This interpretation is consistent with the SEC's interpretation of a similar provision in Advisers Act Rule 204- 2(a)(18)(i). \122\ ICI stated that if FINRA applies the requirements of proposed Rule 4580(a)(4) to a member firm holding an omnibus account on behalf of another broker-dealer that solicited a government entity, and the omnibus dealer is unaware of the broker-dealer's solicitation activities, the omnibus dealer will likely be unable to maintain records required by proposed Rule 4580. As a potential way in which to address this concern, ICI referenced an SEC staff no- action relief letter that addresses a similar concern regarding the recordkeeping requirements related to the SEC Pay-to-Play Rule. See ICI referencing Investment Company Institute, SEC No-Action Letter dated September 12, 2011, available at http://www.sec.gov/divisions/investment/noaction/2011/ici091211-204-incoming.pdf. FINRA recognizes the concern raised by ICI and will address interpretive questions as needed regarding the application of the proposed recordkeeping requirements to covered members holding omnibus accounts on behalf of other broker-dealers that engage in distribution or solicitation activities with government entities. --------------------------------------------------------------------------- Proposed Disclosure Requirements In Regulatory Notice 14-50, FINRA proposed Rule 2271 to require a covered member engaging in distribution or solicitation activities for compensation with a government entity on behalf of one or more investment advisers to make specified disclosures to the government entity regarding each investment adviser. Several commenters raised concerns regarding the proposed disclosure requirements.\123\ For [[Page 81664]] example, commenters raised concerns regarding the scope and timing of the disclosure requirements \124\ and that the requirements would be duplicative of existing federal and state investor protection-related disclosure requirements.\125\ In addition, commenters raised concerns regarding the costs and compliance burdens associated with the proposed disclosure requirements.\126\ --------------------------------------------------------------------------- \123\ See, e.g., SIFMA, Monument Group, ICI, IAA, FSI, CAI and 3PM. \124\ See, e.g., SIFMA, Monument Group, ICI, IAA, CAI and 3PM. \125\ See, e.g., SIFMA, Monument Group and FSI. \126\ See, e.g., SIFMA, Monument Group and 3PM. --------------------------------------------------------------------------- After considering the comments, FINRA has determined not to propose a disclosure rule at this time. FINRA will continue to consider whether such a rule would be appropriate. If FINRA determines to propose a disclosure rule at a later date, it would do so pursuant to FINRA's notice and comment rulemaking process. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 45 days of the date of publication of this notice in the Federal Register or within such longer period (i) as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will: (A) By order approve or disapprove such proposed rule change, or (B) institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or Send an email to rule-comments@sec.gov. Please include File Number SR-FINRA-2015-056 on the subject line. Paper Comments Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090. All submissions should refer to File Number SR-FINRA-2015-056. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of such filing also will be available for inspection and copying at the principal office of FINRA. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-FINRA-2015-056 and should be submitted on or before January 20, 2016. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.\127\ --------------------------------------------------------------------------- \127\ 17 CFR 200.30-3(a)(12). --------------------------------------------------------------------------- Brent J. Fields, Secretary. [FR Doc. 2015-32894 Filed 12-29-15; 8:45 am] BILLING CODE 8011-01-P
![81650 Federal Register / Vol. 80, No. 250 / Wednesday, December 30, 2015 / Notices
wireless equipment installed on towers Commission is publishing this notice to The SEC Pay-to-Play Rule prohibits an
and buildings near the data center. The solicit comments on the proposed rule investment adviser from providing
Exchange represents, based on the change from interested persons. advisory services for compensation to a
information available to it, that the government entity for two years after the
I. Self-Regulatory Organization’s
proposed wireless connection would adviser or its covered associates make a
Statement of the Terms of Substance of
provide data at the same or similar contribution to an official of the
the Proposed Rule Change government entity, unless an exception
speed, and at the same or similar cost,
as existing wireless networks, thereby FINRA is proposing to adopt FINRA or exemption applies. In addition, it
enhancing competition.19 The Exchange Rules 2030 (Engaging in Distribution prohibits an investment adviser from
also notes that the proposed wireless and Solicitation Activities with soliciting from others, or coordinating,
connection would compete not just with Government Entities) 3 and 4580 (Books contributions to government entity
other wireless connections, but also and Records Requirements for officials or payments to political parties
with fiber optic networks, which may be Government Distribution and where the adviser is providing or
more attractive to some Users as they Solicitation Activities) to establish seeking to provide investment advisory
are more reliable and less susceptible to ‘‘pay-to-play’’ 4 and related rules that services to a government entity.
weather conditions. For these reasons, would regulate the activities of member The SEC Pay-to-Play Rule also
the Commission does not believe that firms that engage in distribution or prohibits an investment adviser and its
the proposed rule change imposes a solicitation activities for compensation covered associates from providing or
burden on competition not necessary or with government entities on behalf of agreeing to provide, directly or
appropriate in furtherance of the investment advisers. indirectly, payment to any person to
purposes of the Act. The text of the proposed rule change solicit a government entity for
is available on FINRA’s Web site at investment advisory services on behalf
IV. Conclusion http://www.finra.org, at the principal of the investment adviser unless the
It is therefore ordered, pursuant to office of FINRA and at the person is a ‘‘regulated person.’’ A
Section 19(b)(2) of the Act,20 that the Commission’s Public Reference Room. ‘‘regulated person’’ includes a member
proposed rule change (SR–NYSEMKT– firm, provided that: (a) FINRA rules
II. Self-Regulatory Organization’s prohibit member firms from engaging in
2015–85) be, and it hereby is, approved. Statement of the Purpose of, and
For the Commission, by the Division of
distribution or solicitation activities if
Statutory Basis for, the Proposed Rule political contributions have been made;
Trading and Markets, pursuant to delegated Change
authority.21 and (b) the SEC finds, by order, that
Brent J. Fields,
In its filing with the Commission, such rules impose substantially
FINRA included statements concerning equivalent or more stringent restrictions
Secretary.
the purpose of and basis for the on member firms than the SEC Pay-to-
[FR Doc. 2015–32811 Filed 12–29–15; 8:45 am]
proposed rule change and discussed any Play Rule imposes on investment
BILLING CODE 8011–01–P
comments it received on the proposed advisers and that such rules are
rule change. The text of these statements consistent with the objectives of the SEC
may be examined at the places specified Pay-to-Play Rule.6 The SEC stated that
SECURITIES AND EXCHANGE
in Item IV below. FINRA has prepared this SEC ban on third-party solicitations
COMMISSION
summaries, set forth in sections A, B, would be effective nine months after the
[Release No. 34–76767; File No. SR–FINRA– and C below, of the most significant compliance date of a final rule adopted
2015–056] aspects of such statements. by the SEC by which municipal advisors
must register under the Exchange Act.7
Self-Regulatory Organizations; A. Self-Regulatory Organization’s The SEC adopted such a final rule on
Financial Industry Regulatory Statement of the Purpose of, and September 20, 2013, with a compliance
Authority, Inc.; Notice of Filing of a Statutory Basis for, the Proposed Rule date of July 1, 2014.8
Proposed Rule Change To Adopt Change
FINRA Rule 2030 and FINRA Rule 4580 1. Purpose also Advisers Act Release No. 3221 (June 22, 2011),
To Establish ‘‘Pay-To-Play’’ and 76 FR 42950 (July 19, 2011) (Rules Implementing
Related Rules Background & Discussion Amendments to the Investment Advisers Act of
1940); Advisers Act Release No. 3418 (June 8,
In July 2010, the SEC adopted Rule 2012), 77 FR 35263 (June 13, 2012) (Political
December 24, 2015.
206(4)–5 under the Investment Advisers Contributions by Certain Investment Advisers; Ban
Pursuant to Section 19(b)(1) of the Act of 1940 (‘‘Advisers Act’’) addressing on Third Party Solicitation; Extension of
Securities Exchange Act of 1934 (‘‘Act,’’ pay-to-play practices by investment Compliance Date).
‘‘Exchange Act’’ or ‘‘SEA’’) 1 and Rule advisers (the ‘‘SEC Pay-to-Play Rule’’).5
6 See SEC Pay-to-Play Rule 206(4)–5(f)(9). A
19b–4 thereunder,2 notice is hereby ‘‘regulated person’’ also includes SEC registered
investment advisers and SEC-registered municipal
given that on December 16, 2015, 3 FINRA published the proposed rule change as advisors, subject to specified conditions.
Financial Industry Regulatory FINRA Rule 2390 in Regulatory Notice 14–50 (Nov. 7 See Advisers Act Release No. 3418 (June 8,
Authority, Inc. filed with the Securities 2014) (‘‘Regulatory Notice 14–50’’). FINRA has 2012), 77 FR 35263 (June 13, 2012).
and Exchange Commission (‘‘SEC’’ or determined that the proposed rule change is more 8 See Exchange Act Release No. 70462 (Sept. 20,
appropriately categorized under the FINRA Rule 2013), 78 FR 67468 (Nov. 12, 2013) (Registration of
‘‘Commission’’) the proposed rule 2000 Series relating to ‘‘Duties and Conflicts.’’ Municipal Advisors). On June 25, 2015, the SEC
change as described in Items I, II, and 4 ‘‘Pay-to-play’’ practices typically involve a
issued notice of the compliance date for its third
III below, which Items have been person making cash or in-kind political party solicitation ban as July 31, 2015. See Advisers
mstockstill on DSK4VPTVN1PROD with NOTICES
substantially prepared by FINRA. The contributions (or soliciting or coordinating others to Act Release No. 4129 (June 25, 2015), 80 FR 37538
make such contributions) to help finance the (July 1, 2015). In addition, staff of the Division of
19 See
election campaigns of state or local officials or bond Investment Management added Question I.4 to its
supra notes 12 and 13 and accompanying ballot initiatives as a quid pro quo for the receipt Staff Responses to Questions About the Pay to Play
text. of government contracts.
20 15
Rule stating, among other things, that until the later
U.S.C. 78s(b)(2). 5 See Advisers Act Release No. 3043 (July 1, of (i) the effective date of a FINRA pay-to-play rule
21 17 CFR 200.30–3(a)(12). 2010), 75 FR 41018 (July 14, 2010) (Political or (ii) the effective date of an MSRB pay-to-play
1 15 U.S.C. 78s(b)(1).
Contributions by Certain Investment Advisers) rule, the Division of Investment Management would
2 17 CFR 240.19b–4. (‘‘SEC Pay-to-Play Rule Adopting Release’’). See not recommend enforcement action to the
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![Federal Register / Vol. 80, No. 250 / Wednesday, December 30, 2015 / Notices 81651
Based on this regulatory framework, proposed rules are intended to enable distribution 17 or solicitation 18 activities
FINRA is proposing a pay-to-play rule, member firms to continue to engage in for compensation with a government
Rule 2030, modeled on the SEC Pay-to- distribution and solicitation activities entity on behalf of an investment
Play Rule that would impose with government entities on behalf of adviser that provides or is seeking to
substantially equivalent restrictions on investment advisers while at the same provide investment advisory services to
member firms engaging in distribution time deterring member firms from such government entity within two
or solicitation activities to those the SEC engaging in pay-to-play practices.15 years after a contribution to an official
Pay-to-Play Rule imposes on investment of the government entity is made by the
FINRA sought comment on the
advisers. FINRA is also proposing rules covered member or a covered associate
proposed rule change in Regulatory
that would impose recordkeeping (including a person who becomes a
requirements on member firms in Notice 14–50.16 As discussed further in
Item II.C below, commenters were covered associate within two years after
connection with political the contribution is made). As discussed
contributions.9 generally supportive of the proposed
rule change, but also expressed some in more detail below, the terms and
The proposed rules would establish a
comprehensive regime to regulate the concerns. In considering the comments, scope of this prohibition are modeled on
activities of member firms that engage in FINRA has engaged in discussions with the SEC Pay-to-Play Rule.19
distribution or solicitation activities SEC staff. In addition, as discussed in The proposed rule would not ban or
with government entities on behalf of Item II.B below, FINRA has engaged in limit the amount of political
investment advisers. FINRA believes an analysis of the potential economic contributions a covered member or its
that establishing requirements for impacts of the proposed rule change. As covered associates could make. Instead,
member firms that are modeled on the a result, FINRA has revised the it would impose a two-year time out on
SEC’s Pay-to-Play-Rule is a more proposed rule change as published in engaging in distribution or solicitation
effective regulatory response to the Regulatory Notice 14–50. In particular, activities for compensation with a
concerns the SEC identified in the SEC as discussed in more detail in Item II.C, government entity on behalf of an
Pay-to-Play Rule Adopting Release FINRA has determined not to propose a investment adviser after the covered
regarding third-party solicitations than disclosure requirement for government member or its covered associates make
an outright ban on such activity. For distribution and solicitation activities at a contribution to an official of the
example, in the SEC Pay-to-Play Rule this time. In addition, FINRA has government entity. Consistent with the
Adopting Release, the SEC stated that determined not to propose a two-year time out in the SEC Pay-to-
solicitors 10 or ‘‘placement agents’’ 11 disgorgement requirement as part of the Play Rule, the two-year time out in the
have played a central role in actions that pay-to-play rule. FINRA believes that proposed rule is intended to discourage
it and other authorities have brought these revisions will more closely align covered members from participating in
involving pay-to-play schemes.12 The FINRA’s proposed pay-to-play rule with pay-to-play practices by requiring a
SEC noted that in several instances, the SEC Pay-to-Play Rule and help cooling-off period during which the
advisers allegedly made significant reduce cost and compliance burden effects of a political contribution on the
payments to placement agents and other concerns raised by commenters. selection process can be expected to
intermediaries to influence the award of
The proposed rule change, as revised dissipate.
advisory contracts.13 The SEC also
acknowledged the difficulties that in response to comments on Regulatory
advisers face in monitoring or Notice 14–50, is set forth in further 17 As discussed in Item II.C below, FINRA is not
detail below. eliminating the term ‘‘distribution’’ from the
controlling the activities of their third- proposed rule as suggested by some commenters.
party solicitors.14 Accordingly, the Proposed Pay-to-Play Rule Thus, subject to the limitations discussed in Item
II.C, the proposed rule would apply to covered
Commission against an investment adviser or its A. Two-Year Time Out members engaging in distribution (as well as
covered associates under SEC Pay-to-Play Rule solicitation) activities with government entities.
206(4)–5(a)(2)(i) for the payment to any person to Proposed Rule 2030(a) would prohibit Specifically, the proposed rule would apply to
solicit a government entity for investment advisory distribution activities involving unregistered pooled
a covered member from engaging in investment vehicles such as hedge funds, private
services. See https://www.sec.gov/divisions/
investment/pay-to-play-faq.htm. See also infra equity funds, venture capital funds, and collective
Effective Date, for a more detailed discussion 15 In response to a request from SEC staff, FINRA investment trusts, and registered pooled investment
regarding the effective date of FINRA Rules 2030 previously indicated its intent to prepare rules for vehicles such as mutual funds, but only if those
and 4580. consideration by the SEC that would prohibit its registered pools are an investment option of a
9 In connection with the adoption of the SEC Pay- member firms from soliciting advisory business participant-directed plan or program of a
to-Play Rule, the Commission also adopted from a government entity on behalf of an adviser government entity.
recordkeeping requirements related to political unless the member firms comply with requirements 18 Consistent with the SEC Pay-to-Play Rule,
contributions by investment advisers and their prohibiting pay-to-play practices. See Letter from proposed Rule 2030(g)(11) defines the term
covered associates. See Advisers Act Rule 204– Andrew J. Donohue, Director, Division of ‘‘solicit’’ to mean: ‘‘(A) With respect to investment
2(a)(18) and (h)(1). Investment Management, SEC, to Richard G. advisory services, to communicate, directly or
10 ‘‘Solicitors’’ typically locate investment Ketchum, Chairman & CEO, FINRA (Dec. 18, 2009), indirectly, for the purpose of obtaining or retaining
advisory clients on behalf of an investment adviser. available at http://www.sec.gov/comments/s7-18- a client for, or referring a client to, an investment
See Advisers Act Release No. 2910 (Aug. 3, 2009), 09/s71809-252.pdf (requesting whether FINRA adviser; and (B) With respect to a contribution or
74 FR 39840, 39853 n.137 (Aug. 7, 2009) (Political would consider adopting a rule preventing pay-to- payment, to communicate, directly or indirectly, for
Contributions by Certain Investment Advisers). play activities by registered broker-dealers acting as the purpose of obtaining or arranging a contribution
11 ‘‘Placement agents’’ typically specialize in legitimate placement agents on behalf of investment or payment.’’ The determination of whether a
finding investors (often institutional investors or advisers). See also Letter from Richard G. Ketchum, particular communication would be a solicitation
high net worth investors) that are willing and able Chairman & CEO, FINRA, to Andrew J. Donohue, would depend on the facts and circumstances
mstockstill on DSK4VPTVN1PROD with NOTICES
to invest in a private offering of securities on behalf Director, Division of Investment Management, SEC relating to such communication. As a general
of the issuer of such privately offered securities. See (Mar. 15, 2010), available at http://www.sec.gov/ proposition, any communication made under
id. comments/s7-18-09/s71809-260.pdf (stating ‘‘[w]e circumstances reasonably calculated to obtain or
12 See SEC Pay-to-Play Rule Adopting Release, 75 believe that a regulatory scheme targeting improper retain an advisory client would be considered a
FR 41018, 41037 (discussing the reasons for pay to play practices by broker-dealers acting on solicitation unless the circumstances otherwise
proposing a ban on using third parties to solicit behalf of investment advisers is . . . a viable indicate that the communication does not have the
government business). solution to a ban on certain private placement purpose of obtaining or retaining an advisory client.
13 See id. agents serving a legitimate function’’). See also infra note 40.
14 See id. 16 See supra note 3. 19 See SEC Pay-to-Play Rule 206(4)–5(a)(1).
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![81660 Federal Register / Vol. 80, No. 250 / Wednesday, December 30, 2015 / Notices
the meaning of the term and 3PM suggested that FINRA expand This position is consistent with the
‘‘instrumentality’’ in connection with its the definition of ‘‘investment adviser’’ position taken by the SEC in connection
Pay-to-Play Rule. Thus, at this time, to include state-registered investment with the SEC Pay-to-Play Rule.100
FINRA declines to provide additional advisers, stating, among other things,
5. Distribution
guidance as part of the proposed rule. that it would further reduce the
FINRA recognizes, however, the disruptions created by pay-to-play a. Inclusion of Distribution Activities
concerns raised by CAI and will schemes. To remain consistent with the Consistent with Regulatory Notice 14–
continue to discuss with the industry SEC Pay-to-Play Rule, FINRA has 50, proposed Rule 2030(a) would
interpretive questions relating to the determined not to expand the scope of impose a two-year time out on engaging
proposed rule change. the proposed rule as suggested by in distribution or solicitation activities
2. Solicitation commenters. FINRA notes that the SEC for compensation with a government
declined to make a similar change to its entity on behalf of an investment
Consistent with Regulatory Notice 14– proposed rule, stating that it is their adviser after the covered member or its
50, the proposed pay-to-play rule understanding that few of these smaller covered associates makes a contribution
defines the term ‘‘solicit’’ to mean, with firms manage public pension plans or to an official of the government entity.
respect to investment advisory services, other similar funds.98 Some commenters questioned the
‘‘to communicate, directly or indirectly, meaning of the term ‘‘distribution’’ in
for the purpose of obtaining or retaining 4. Covered Associates/Executive
the context of the proposed rule. For
a client for, or referring a client to, an Officers
example, SIFMA stated that it is their
investment adviser’’ and, with respect to A ‘‘covered associate’’ includes any understanding ‘‘that the phrase
a contribution or payment, ‘‘to general partner, managing member or ‘distribution and solicitation,’ as used in
communicate, directly or indirectly, for executive officer of a covered member, the SEC Pay-to-Play Rule, is interpreted
the purpose of obtaining or arranging a or other individual with a similar status to mean ‘the solicitation of investment
contribution or payment.’’ 95 CAI sought or function.99 SIFMA requested that advisory services.’ ’’ CAI stated that
confirmation that the proposed rule FINRA define the term ‘‘executive ‘‘[s]ince the term ‘distribution’ has no
would not apply when a covered officer’’ for purposes of the proposed meaning in the context of an investment
member communicates with a third rule. Consistent with the SEC Pay-to- adviser and is inconsistent with the
party and has no intent to obtain a client Play Rule and for purposes of the personal nature of the services provided
for, or refer a client to, an investment FINRA pay-to-play rule only, FINRA has by investment advisers, [it] strongly
adviser (in the context of investment added proposed Rule 2030(g)(5) to recommends that FINRA eliminate each
advisory services) and there is no intent define an ‘‘executive officer of a covered and every reference to the word
to obtain or arrange a contribution or member’’ to mean: ‘‘(A) The president; ‘distribution’ throughout the Notice and
payment (in the context of contributions (B) Any vice president in charge of a the Proposed Rules. . . . [I]t is not clear
to officials of government entities and principal business unit, division or what activity the term ‘distribution’ is
payments to political parties). function (such as sales, administration meant to cover that is not captured by
As stated in Regulatory Notice 14–50 or finance); (C) Any other officer of the the term ‘solicitation.’ ’’
and above, the determination of whether covered member who performs a policy- The SEC Pay-to-Play Rule prohibits an
a particular communication is a making function; or (D) Any other investment adviser and its covered
solicitation for investment advisory person who performs similar policy- associates from providing or agreeing to
services or a contribution or payment making functions for the covered provide, directly or indirectly, payment
would be dependent upon the specific member.’’ to any person to solicit a government
facts and circumstances relating to such A covered associate also would entity for investment advisory services
communication. As a general include a PAC controlled by the covered on behalf of the investment adviser
proposition, if there is no intent to member or any of its covered associates. unless the person is a ‘‘regulated
obtain a client for, or refer a client to, FSI asserted that the restrictions on PAC person.’’ 101 The SEC Pay-to-Play Rule
an investment adviser (in the context of contributions, and the definition of defines a ‘‘regulated person’’ to include
investment advisory services) or to ‘‘control’’ with respect to covered a member firm, provided that FINRA
obtain or arrange a contribution or associates are vague and potentially rules prohibit member firms from
payment (in the context of contributions over-broad. For example, FSI stated that engaging in distribution or solicitation
to officials of government entities and ‘‘[i]t is unclear whether an employee or activities if political contributions have
payments to political parties), FINRA executive of a member firm that holds been made.102 Thus, the SEC Pay-to-
would not consider the communication a position on a PAC board of directors Play Rule requires FINRA to have a rule
to be a solicitation.96 or other advisory committee would have that prohibits member firms from
3. Investment Advisers ‘control’ of the PAC under the Proposed engaging in distribution (as well as
Rules. It would also cover PACs that are solicitation) activities if political
The proposed pay-to-play rule would not connected to the employee or contributions have been made.
apply to covered members acting on executive’s member firm.’’ As stated in Language in the SEC Pay-to-Play Rule
behalf of any investment adviser Regulatory Notice 14–50 and above, Adopting Release further supports the
registered (or required to be registered) FINRA would consider a covered inclusion of distribution activities by
with the SEC, or unregistered in reliance member or its covered associates to have broker-dealers in a FINRA pay-to-play
on the exemption available under ‘‘control’’ over a PAC if the covered rule. For example, when discussing
mstockstill on DSK4VPTVN1PROD with NOTICES
Section 203(b)(3) of the Advisers Act for member or covered associate has the comments related to its proposed ban on
foreign private advisers, or that is an ability to direct or cause the direction of using third parties to solicit government
exempt reporting adviser under governance or operations of the PAC. business, the SEC addressed
Advisers Act Rule 204–4(a).97 NASAA
98 See SEC Pay-to-Play Rule Adopting Release, 75 100 See SEC Pay-to-Play Rule Adopting Release,
95 Proposed Rule 2030(g)(11). 75 FR 41018, 41032 (discussing PACs).
FR 41018, 41026.
96 See supra notes 18 and 40. 99 See supra note 37 (defining the term ‘‘covered 101 See SEC Pay-to-Play Rule 206(4)–5(a)(2).
97 See proposed Rule 2030(g)(7). associate’’). 102 See SEC Pay-to-Play Rule 206(4)–5(f)(9)(ii)(A).
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![Federal Register / Vol. 80, No. 250 / Wednesday, December 30, 2015 / Notices 81661
commenters’ concerns that the proposed rule would apply to B. Prohibitions as Applied to Covered
provision would interfere with distribution activities involving Investment Pools
traditional distribution arrangements of unregistered pooled investment vehicles
1. General
mutual funds and private funds by such as hedge funds, private equity
broker-dealers, by clarifying under what funds, venture capital funds, and In Regulatory Notice 14–50, proposed
circumstances distribution payments collective investment trusts, and Rule 2390(e) (now proposed as Rule
would violate the SEC’s Pay-to-Play registered pooled investment vehicles 2030(d)) provided that a covered
Rule.103 such as mutual funds, but only if those member that engages in distribution or
Based on the SEC’s definition of registered pools are an investment solicitation activities with a government
‘‘regulated person’’ as well as its option of a participant-directed plan or entity on behalf of an investment
discussion regarding the treatment of program of a government entity.106 adviser to a covered investment pool in
distribution fees paid pursuant to a 12b– CAI requested clarification that which a government entity invests or is
1 plan, FINRA believes its proposed rule ‘‘compensation’’ in the context of solicited to invest shall be treated as
must apply to member firms engaging in covered investment pools does not though the covered member was
distribution activities. Accordingly, include conventional compensation engaging in or seeking to engage in
FINRA has not revised the proposed arrangements for the distribution of distribution or solicitation activities
rule to remove references to the term mutual funds, variable annuity contracts with the government entity on behalf of
‘‘distribution.’’ 104 and other securities included within the the investment adviser directly. CAI
definition of ‘‘covered investment raised concerns regarding the
b. Scope of Distribution Activities application of the prohibitions of the
pool.’’ Consistent with the SEC Pay-to-
ICI requested confirmation that, with Play Rule, to the extent the mutual fund proposed rule to covered investment
respect to mutual funds, the proposed distribution fees are paid by the fund pools stating, among other things, ‘‘that
rule would be triggered only when a pursuant to a 12b–1 plan, such a broker-dealer that offers and sells
member firm solicits a government payments would not be prohibited interests in a mutual fund or private
entity to include a mutual fund in a under the proposed rule as they would fund cannot be characterized as
government entity’s plan or program not constitute payments by the fund’s soliciting on behalf of the investment
and not when the member is selling investment adviser. If, however, the adviser to a covered investment pool.’’
mutual fund shares to a government adviser pays for the fund’s distribution CAI reasoned that ‘‘[t]here is no basis for
entity. FSI asked for clarification with out of its ‘‘legitimate profits,’’ the this notion given the [SEC] staff’s
respect to the treatment of traditional proposed rule would generally be interpretation in the Mayer Brown no-
brokerage activities by a financial implicated.107 For private funds, third action letter and the Goldstein
advisor as ‘‘distribution or solicitation parties are often compensated by the case . . ., as well as the lack of any
activities’’ in the context of government investment adviser or its affiliated relationship between the selling firm
entity plans. general partner. Thus, such payments and the investment adviser.’’ 109
As discussed above, the proposed would be subject to the proposed rule. After considering CAI’s concerns,
pay-to-play rule would apply to In addition, FINRA notes that FINRA has modified the language of the
distribution activities by covered structuring such a payment to come proposed rule to recognize the
members. FINRA notes, however, that from the private fund for purposes of relationship between the selling
based on the definition of a ‘‘covered evading the rule would violate the member and the covered investment
investment pool,’’ the proposed rule rule.108
would not apply to distribution solicitation, regardless of the purpose or context for
the payment. As discussed above, for purposes of
activities related to registered under Section 3(a) of the Investment Company Act
the proposed rule, FINRA is taking a position
investment companies that are not but for the exclusion provided from that definition
consistent with the SEC’s position in its Pay-to-Play
by either Section 3(c)(1), 3(c)(7) or 3(c)(11) of that
investment options of a government Act.’’
Rule.
entity’s plan or program.105 Thus, the 106 Although the proposed rule would not apply
109 See Goldstein v. SEC, 451 F.3d 873 (D.C. Cir.
2006) and Mayer Brown LLP, SEC No-Action Letter
to distribution activities relating to all registered
103 See SEC Pay-to-Play Rule Adopting Release,
(‘‘Mayer Brown letter’’), available at https://
pooled investment vehicles, FINRA notes the
www.sec.gov/divisions/investment/noaction/2008/
75 FR 41018, 41040 n.298 (stating that ‘‘[m]utual language of proposed Rule 2030(e) that ‘‘[i]t shall mayerbrown072808-206.htm#P15_323. In
fund distribution fees are typically paid by the fund be a violation of this Rule for any covered member Goldstein, the court held that the SEC’s ‘‘Hedge
pursuant to a 12b–1 plan, and therefore generally or any of its covered associates to do anything Fund Rule,’’ which would have given the SEC
would not constitute payment by the fund’s adviser. indirectly that, if done directly, would result in a greater oversight over hedge funds, was invalid
As a result, such payments would not be prohibited violation of this Rule.’’ because it was arbitrary and in conflict with the
[under the SEC Pay-to-Play Rule] by its terms. 107 For a discussion of a mutual fund adviser’s
purpose of the underlying statute in which the new
Where an adviser pays for the fund’s distribution ability to use ‘‘legitimate profits’’ for fund rule was included. The court concluded that hedge
out of its ‘legitimate profits,’ however, the rule distribution, see Investment Company Act of 1940 fund investors are not clients of fund advisers for
would generally be implicated. . . . For private Release No. 11414 (Oct. 28, 1980), 45 FR 73898 the purpose of the Adviser’s Act registration
funds, third parties are often compensated by the (Nov. 7, 1980) (Bearing of Distribution Expenses by requirement.
adviser or its affiliated general partner and, Mutual Funds) (explaining, in the context of the In the Mayer Brown letter, SEC staff stated that
therefore, those payments are subject to the rule.’’) prohibition on the indirect use of fund assets for Rule 206(4)–3 generally does not apply to a
104 In addition, FINRA notes that many of the distribution, unless pursuant to a 12b–1 plan, registered investment adviser’s cash payment to a
concerns raised by commenters in connection with ‘‘[h]owever, under the rule there is no indirect use person solely to compensate that person for
including distribution activities in the proposed of fund assets if an adviser makes distribution soliciting investors or prospective investors for, or
rule related to the additional burden associated related payments out of its own resources. . . . referring investors or prospective investors to, an
with the proposed disclosure requirements and Profits which are legitimate or not excessive are investment pool managed by the adviser. The letter
such activities. As discussed further below, FINRA simply those which are derived from an advisory
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distinguishes between a person referring other
has determined not to propose a disclosure rule contract which does not result in a breach of persons to the adviser where the adviser manages
relating to government distribution and solicitation fiduciary duty under section 36 of the [Investment only investment pools and is not seeking to enter
activities. Company] Act.’’). into advisory relationships with these other persons
105 Proposed Rule 2030(g)(3) defines a ‘‘covered 108 See also SEC Pay-to-Play Rule Adopting (but rather the other persons will be investors or
investment pool’’ to mean: ‘‘(A) Any investment Release, 75 FR 41018, 41040 n.298 and prospective investors in one or more of the
company registered under the Investment Company accompanying text. CAI also asked FINRA to investment pools managed by the adviser), versus
Act that is an investment option of a plan or consider afresh the SEC’s position in its Pay-to-Play referring other persons as prospective advisory
program of a government entity, or (B) Any Rule that payments originating with an investment clients. The letter notes that whether the rule
company that would be an investment company adviser should be treated as a payment for applies will depend on the facts and circumstances.
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![81662 Federal Register / Vol. 80, No. 250 / Wednesday, December 30, 2015 / Notices
pool, but also to clarify that for purposes seeking to provide investment advisory where such members discover pay-to-
of the proposed rule, a covered member services directly to the government play violations themselves.’’ ICI stated
engaging in distribution or solicitation entity.’’ that ‘‘including disgorgement as a
activities on behalf of a covered penalty is not necessary given that the
2. Two-Tiered Investment Products
investment pool in which a government SEC and FINRA both have full authority
entity invests or is solicited to invest CAI sought confirmation from FINRA to require disgorgement of fees, and
shall be treated as though the covered that the proposed pay-to-play rule indeed, disgorgement has been the
member was engaging in, or seeking to would not apply in the context of two- penalty universally applied (along with
engage in, distribution or solicitation tiered investment products, such as additional penalties) in enforcement
activities with the government entity on variable annuities. CAI asserted, among actions under existing pay-to-play rules,
behalf of the investment adviser to the other things, that ‘‘[o]rdinarily, there is such as MSRB Rule G–37 and SEC Rule
covered investment pool directly.110 no investment adviser providing 206(4)–5.’’
As stated in Regulatory Notice 14–50, investment advisory services to the
After considering the comments and,
proposed Rule 2390(e) (now proposed separate account supporting the variable
in particular, that FINRA has authority
as Rule 2030(d)) was modeled on a annuity contract, although there are
to require disgorgement of fees in
similar provision in the SEC Pay-to-Play investment advisers providing
enforcement actions, FINRA has
Rule, Rule 206(4)–5(c),111 and was investment advisory services to the
determined not to include a
intended to extend the protections of underlying mutual funds or
disgorgement requirement in the
the proposed rule to government entities unregistered investment pools.’’ CAI
proposed rule.
that access the services of investment requested clarification that a covered
advisers through hedge funds and other member selling two-tiered investment D. Prohibition on Soliciting and
types of pooled investment vehicles products is not engaging in solicitation Coordinating Contributions
sponsored or advised by investment activities on behalf of the investment
adviser and sub-advisers managing the Consistent with Regulatory Notice 14–
advisers.112 As noted by CAI, however,
underlying funds. FINRA notes that the 50, proposed Rule 2030(b) would
FINRA recognizes that without a
provision corresponding more closely to SEC did not exclude specific products prohibit a covered member or covered
SEC Pay-to-Play Rule 206(4)–5(c), there from the SEC Pay-to-Play Rule and, associate from coordinating or soliciting
is nothing in the proposed rule that therefore, FINRA has determined not to any person or PAC to make any: (1)
deems an investment adviser to a exclude specific products from its Contribution to an official of a
covered investment pool to have a direct proposed rule. government entity in respect of which
investment advisory relationship with the covered member is engaging in, or
C. Disgorgement seeking to engage in, distribution or
government entities investing in the
pool. CAI noted that: ‘‘Without such a In Regulatory Notice 14–50, FINRA solicitation activities on behalf of an
provision, proposed rule 2390(e) would proposed a ‘‘disgorgement’’ provision investment adviser; or (2) payment to a
not apply the two year time out that, among other things, would have political party of a state or locality of a
restriction in proposed rule 2390(a) to required that the covered member pay, government entity with which the
advisers to [covered investment pools]. in the order listed, any compensation or covered member is engaging in, or
This is because proposed Rule 2390(a) other remuneration received by the seeking to engage in, distribution or
would only apply where an investment covered member pertaining to, or arising solicitation activities on behalf of an
adviser ‘provides or is seeking to from, distribution or solicitation investment adviser. As stated in
provide investment advisory services to activities during the two-year time out Regulatory Notice 14–50 and above, this
such government entity.’ ’’ to: (A) A covered investment pool in provision is modeled on a similar
Accordingly, FINRA has modified the which the government entity was provision in the SEC Pay-to-Play
proposed rule to include proposed Rule solicited to invest, as applicable; (B) the Rule.114
2030(d)(2) that provides that for government entity; (C) any appropriate CAI sought confirmation that the
purposes of the proposed rule ‘‘an entity designated in writing by the proposed prohibition on soliciting and
investment adviser to a covered government entity if the government coordinating contributions would not
investment pool in which a government entity or covered investment pool apply when a contribution is made to a
entity invests or is solicited to invest cannot receive such payments; or (D) political action committee, political
shall be treated as though that the FINRA Investor Education party or other third party, where there
investment adviser were providing or Foundation, if the government entity or is no knowledge or indication of how
covered investment pool cannot receive such contribution will be used. Similar
110 See proposed Rule 2030(d). such payments and the government to guidance provided in the context of
111 SEC Pay-to-Play Rule 206(4)–5(c) provides that entity cannot or does not designate in SEC Pay-to-Play Rule 206(4)–5(a)(2),
‘‘an investment adviser to a covered investment
pool in which a government entity invests or is
writing any other appropriate entity. FINRA notes that a direct contribution
solicited to invest shall be treated as though that NASAA expressed support for to a political party by a covered member
investment adviser were providing or seeking to FINRA’s inclusion of a disgorgement or its covered associates would not
provide investment advisory services directly to the provision for violations of the proposed violate the proposed rule unless the
government entity.’’
112 In adopting this provision, the SEC noted a
rule. Most commenters, however, contribution was a means for the
commenter’s questioning of its authority to apply opposed the requirement.113 SIFMA covered member to do indirectly what
the rule in the context of covered investment pools stated that ‘‘[w]hile disgorgement is the the rule would prohibit if done directly
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in light of the opinion of the Court of Appeals for almost universal remedy for violations (for example, if the contribution was
the District of Columbia Circuit in the Goldstein
case. See supra note 109. The SEC concluded,
of various pay-to-play rules, . . . earmarked or known to be provided for
however, that it has authority to adopt rules making application of the remedy the benefit of a particular government
proscribing fraudulent conduct that is potentially mandatory could have the deleterious official).115
harmful to investors in pooled investment vehicles effect of dissuading covered members
pursuant to Section 206(4) of the Advisers Act and,
therefore, adopted SEC Pay-to-Play Rule 206(4)–5(c)
from voluntary disgorgement of fees 114 See SEC Pay-to-Play Rule 206(4)–5(a)(2).
as proposed. See SEC Pay-to-Play Rule Adopting 115 See also SEC Pay-to-Play Rule Adopting
Release, 75 FR 41018, 41045 n.355. 113 See, e.g., SIFMA, CAI and ICI. Release, 75 FR 41018, 41044 n.337.
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![Federal Register / Vol. 80, No. 250 / Wednesday, December 30, 2015 / Notices 81663
E. Direct or Indirect Contributions or Proposed Recordkeeping Requirements investment adviser, or (ii) knows that
Solicitations A. Unsuccessful Solicitations the political party or PAC is going to
make a contribution to an official of a
Consistent with Regulatory Notice 14– Proposed Rule 4580 would require government entity which the covered
50, proposed Rule 2030(e) provides that covered members that engage in member is soliciting on behalf of an
it shall be a violation of the proposed distribution or solicitation activities investment adviser, should have to be
pay-to-play rule for any covered with a government entity on behalf of maintained.
member or any of its covered associates any investment adviser that provides or
As stated in the Regulatory Notice and
to do anything indirectly that, if done is seeking to provide investment
advisory services to such government above, the proposed recordkeeping
directly, would result in a violation of requirements are intended to allow
the rule. CAI requested that FINRA entity to maintain books and records
that would allow FINRA to examine for FINRA to examine for compliance with
incorporate a knowledge and support its proposed pay-to-play rule. Thus, the
compliance with its proposed pay-to-
requirement into this provision of the reference to indirect contributions in
play rule. SIFMA requested that FINRA
proposed rule so that it would be not extend the recordkeeping proposed Rule 4580(a)(4) is intended to
violated only if a covered member has requirements to unsuccessful include records of contributions or
direct knowledge of, and takes measures solicitations where the covered member payments a covered member solicits or
to aid and support, activities undertaken does not receive compensation because coordinates another person or PAC to
by its affiliates. As stated in Regulatory maintaining such records would impose make under proposed Rule 2030(b)
Notice 14–50 and above, this provision significant costs on covered members (Prohibition on Soliciting and
is modeled on SEC Pay-to-Play Rule with little corresponding benefit. 118 Coordinating Contributions).121 In
206(4)–5(d). Consistent with guidance FINRA intends that the recordkeeping addition, payments to political parties
provided by the SEC in connection with requirements of proposed Rule 4580 be or PACs can be a means for a covered
that provision, FINRA has clarified that consistent with similar recordkeeping member or covered associate to funnel
it would require a showing of intent to requirements imposed on investment contributions to a government official
circumvent the rule for a covered advisers in connection with the SEC without directly contributing. Thus,
member or its covered associates Pay-to-Play Rule.119 The SEC does not FINRA is proposing to require a covered
require investment advisers to maintain member to maintain a record of all
funneling payments through a third
lists of government entities that do not payments to political parties or PACs as
party to trigger the two-year time out.116
become clients.120 Accordingly, FINRA such records would assist FINRA in
F. Exceptions has added the term ‘‘for compensation’’ identifying situations that might suggest
to proposed Rule 4580(a)(3) to clarify an intent to circumvent the rule.122
In Regulatory Notice 14–50, FINRA that the proposed Rule would not apply
included exceptions to the prohibition Proposed Disclosure Requirements
to unsuccessful solicitations.
in the proposed pay-to-play rule for de In Regulatory Notice 14–50, FINRA
minimis contributions and returned B. Indirect Contributions proposed Rule 2271 to require a covered
contributions. CAI and CCP stated that Consistent with Regulatory Notice 14– member engaging in distribution or
they believe that the $350 and $150 de 50, proposed Rule 4580(a)(4) would solicitation activities for compensation
minimis contribution limits are require a covered member to maintain with a government entity on behalf of
unreasonably low. CAI stated that it books and records of all direct and one or more investment advisers to
believes the $350 amount for returned indirect contributions made by the make specified disclosures to the
contributions is unnecessary because covered member or any of its covered government entity regarding each
‘‘[i]f the contribution is returned as is associates to an official of a government investment adviser. Several commenters
required under the exception, then no entity, or direct or indirect payments to raised concerns regarding the proposed
harm will result as both the contributor a political party of a state or political disclosure requirements.123 For
and contributee are placed in the same subdivision thereof or to a PAC. 3PM
position they would have been in had requested that FINRA eliminate the 121 This interpretation is consistent with the
no contribution been made.’’ requirement to maintain a list of SEC’s interpretation of a similar provision in
indirect contributions, arguing that Advisers Act Rule 204–2(a)(18)(i).
FINRA has determined not to modify ‘‘requiring firms to . . . track and
122 ICI stated that if FINRA applies the
the proposed exceptions. As stated in requirements of proposed Rule 4580(a)(4) to a
monitor indirect contributions could member firm holding an omnibus account on behalf
Regulatory Notice 14–50 and above, the become extremely time consuming and of another broker-dealer that solicited a government
exceptions are modeled on similar costly for firms.’’ CAI asserted that not entity, and the omnibus dealer is unaware of the
exceptions in the SEC Pay-to-Play Rule broker-dealer’s solicitation activities, the omnibus
all payments to political parties or PACs dealer will likely be unable to maintain records
for de minimis contributions and should have to be maintained. Instead, required by proposed Rule 4580. As a potential way
returned contributions.117 Moreover, CAI stated that only payments to in which to address this concern, ICI referenced an
FINRA believes that it is necessary to political parties or PACs where the SEC staff no-action relief letter that addresses a
keep the amounts at the levels as similar concern regarding the recordkeeping
covered member or covered associate: (i) requirements related to the SEC Pay-to-Play Rule.
proposed in Regulatory Notice 14–50 to Directs the political party or PAC to See ICI referencing Investment Company Institute,
meet the requirement in the SEC Pay-to- make a contribution to an official of a SEC No-Action Letter dated September 12, 2011,
Play Rule that the restrictions in government entity which the covered available at http://www.sec.gov/divisions/
investment/noaction/2011/ici091211–204-
mstockstill on DSK4VPTVN1PROD with NOTICES
FINRA’s rule must be substantially member is soliciting on behalf of an incoming.pdf. FINRA recognizes the concern raised
equivalent to, or more stringent than, by ICI and will address interpretive questions as
118 See also CAI, 3PM and FSI (requesting that
the restrictions in the SEC Pay-to-Play needed regarding the application of the proposed
FINRA not apply the proposed recordkeeping recordkeeping requirements to covered members
Rule. requirements to unsuccessful solicitations of holding omnibus accounts on behalf of other
government entities). broker-dealers that engage in distribution or
116 See SEC Pay-to-Play Rule Adopting Release, 119 See Advisers Act Rule 204–2(a)(18) and (h)(1). solicitation activities with government entities.
75 FR 41018, 41044 n.340. 120 See SEC Pay-to-Play Rule Adopting Release, 123 See, e.g., SIFMA, Monument Group, ICI, IAA,
117 See SEC Pay-to-Play Rule 206(4)–5(b). 75 FR 41018, 41050. FSI, CAI and 3PM.
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![81664 Federal Register / Vol. 80, No. 250 / Wednesday, December 30, 2015 / Notices
example, commenters raised concerns number should be included on the its practical utility; ways to enhance its
regarding the scope and timing of the subject line if email is used. To help the quality, utility, and clarity; and ways to
disclosure requirements 124 and that the Commission process and review your minimize burden on respondents,
requirements would be duplicative of comments more efficiently, please use including the use of automated
existing federal and state investor only one method. The Commission will collection techniques or other forms of
protection-related disclosure post all comments on the Commission’s information technology. Mail, email, or
requirements.125 In addition, Internet Web site (http://www.sec.gov/ fax your comments and
commenters raised concerns regarding rules/sro.shtml). Copies of the recommendations on the information
the costs and compliance burdens submission, all subsequent collection(s) to the OMB Desk Officer
associated with the proposed disclosure amendments, all written statements and SSA Reports Clearance Officer at
requirements.126 with respect to the proposed rule the following addresses or fax numbers.
After considering the comments, change that are filed with the (OMB), Office of Management and
FINRA has determined not to propose a Commission, and all written Budget, Attn: Desk Officer for SSA,
disclosure rule at this time. FINRA will communications relating to the Fax: 202–395–6974, Email address:
continue to consider whether such a proposed rule change between the OIRA_Submission@omb.eop.gov.
rule would be appropriate. If FINRA Commission and any person, other than (SSA), Social Security Administration,
determines to propose a disclosure rule those that may be withheld from the OLCA, Attn: Reports Clearance
at a later date, it would do so pursuant public in accordance with the Director, 3100 West High Rise, 6401
to FINRA’s notice and comment provisions of 5 U.S.C. 552, will be Security Blvd., Baltimore, MD 21235,
rulemaking process. available for Web site viewing and Fax: 410–966–2830, Email address:
printing in the Commission’s Public OR.Reports.Clearance@ssa.gov.
III. Date of Effectiveness of the
Reference Room, 100 F Street, NE., Or you may submit your comments
Proposed Rule Change and Timing for
Washington, DC 20549, on official online through www.regulations.gov,
Commission Action
business days between the hours of referencing Docket ID Number [SSA–
Within 45 days of the date of 10:00 a.m. and 3:00 p.m. Copies of such 2015–0079].
publication of this notice in the Federal filing also will be available for I. The information collections below
Register or within such longer period (i) inspection and copying at the principal are pending at SSA. SSA will submit
as the Commission may designate up to office of FINRA. All comments received them to OMB within 60 days from the
90 days of such date if it finds such will be posted without change; the date of this notice. To be sure we
longer period to be appropriate and Commission does not edit personal consider your comments, we must
publishes its reasons for so finding or identifying information from receive them no later than February 29,
(ii) as to which the self-regulatory submissions. You should submit only 2016. Individuals can obtain copies of
organization consents, the Commission information that you wish to make the collection instruments by writing to
will: available publicly. All submissions the above email address.
(A) By order approve or disapprove should refer to File Number SR–FINRA– 1. Internet Direct Deposit
such proposed rule change, or 2015–056 and should be submitted on Application—31 CFR 210—0960–0634.
(B) institute proceedings to determine or before January 20, 2016. SSA requires all applicants and
whether the proposed rule change recipients of Social Security Old Age,
For the Commission, by the Division of
should be disapproved. Trading and Markets, pursuant to delegated Survivors, and Disability Insurance
IV. Solicitation of Comments authority.127 (OASDI) benefits, or Supplemental
Brent J. Fields, Security Income payments to receive
Interested persons are invited to
Secretary. these benefits and payments via direct
submit written data, views and
[FR Doc. 2015–32894 Filed 12–29–15; 8:45 am] deposit at a financial institution. SSA
arguments concerning the foregoing,
receives Direct Deposit/Electronic
including whether the proposed rule BILLING CODE 8011–01–P
Funds Transfer (DD/EFT) enrollment
change is consistent with the Act.
information from OASDI beneficiaries
Comments may be submitted by any of
SOCIAL SECURITY ADMINISTRATION and SSI recipients to facilitate DD/EFT
the following methods:
of their funds with their chosen
Electronic Comments [Docket No: SSA–2015–0079] financial institution. We also use this
• Use the Commission’s Internet information when an enrolled
Agency Information Collection individual wishes to change their DD/
comment form (http://www.sec.gov/ Activities: Proposed Request and
rules/sro.shtml); or EFT information. For the convenience of
Comment Request the respondents, we collect this
• Send an email to rule-comments@
sec.gov. Please include File Number SR– The Social Security Administration information through several modalities,
FINRA–2015–056 on the subject line. (SSA) publishes a list of information including an Internet application, in-
collection packages requiring clearance office or telephone interviews, and our
Paper Comments by the Office of Management and automated telephone system. In
• Send paper comments in triplicate Budget (OMB) in compliance with addition to using the direct deposit
to Secretary, Securities and Exchange Public Law 104–13, the Paperwork information to enable DD/EFT of funds
Commission, 100 F Street NE., Reduction Act of 1995, effective October to the recipient’s chosen financial
mstockstill on DSK4VPTVN1PROD with NOTICES
Washington, DC 20549–1090. 1, 1995. This notice includes revisions institution, we also use the information
and an extension of OMB-approved through our Direct Deposit Fraud
All submissions should refer to File
information collections. Indicator to ensure the correct recipient
Number SR–FINRA–2015–056. This file
SSA is soliciting comments on the receives the funds. Respondents are
124 See, e.g., SIFMA, Monument Group, ICI, IAA, accuracy of the agency’s burden OASDI beneficiaries and SSI recipients
CAI and 3PM. estimate; the need for the information; requesting that we enroll them in the
125 See, e.g., SIFMA, Monument Group and FSI. Direct Deposit program or change their
126 See, e.g., SIFMA, Monument Group and 3PM. 127 17 CFR 200.30–3(a)(12). direct deposit banking information.
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Document Created: 2015-12-30 03:15:48
Document Modified: 2015-12-30 03:15:48
| Category | Regulatory Information | |
| Collection | Federal Register | |
| sudoc Class | AE 2.7: GS 4.107: AE 2.106: | |
| Publisher | Office of the Federal Register, National Archives and Records Administration | |
| Section | Notices | |
| FR Citation | 80 FR 81650 |
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