81 FR 60051 - Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving 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 81, Issue 169 (August 31, 2016)
Federal Register Volume 81, Issue 169 (August 31, 2016)
| Page Range | 60051-60070 | |
| FR Document | 2016-20888 |
[Federal Register Volume 81, Number 169 (Wednesday, August 31, 2016)] [Notices] [Pages 60051-60070] From the Federal Register Online [www.thefederalregister.org] [FR Doc No: 2016-20888] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-78683; File No. SR-FINRA-2015-056] Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving a Proposed Rule Change To Adopt FINRA Rule 2030 and FINRA Rule 4580 To Establish ``Pay-To-Play'' and Related Rules August 25, 2016. I. Introduction On December 16, 2015, Financial Industry Regulatory Authority, Inc. (``FINRA'') filed with the Securities and Exchange Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to adopt FINRA Rules 2030 (Engaging in Distribution and Solicitation Activities with Government Entities) and 4580 (Books and Records Requirements for Government Distribution and Solicitation Activities) to establish ``pay-to-play'' \3\ 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. Member firms serving this role--sometimes referred to as ``placement agents'' or ``solicitors'' (collectively referred to herein as ``placement agents'')--assist investment advisers with obtaining advisory business from such entities. In this context, pay-to-play has historically presented a problem, including when investment advisers retain placement agents who have made contributions to government officials who are responsible for, or can influence the outcome of, the selection process for investment advisers. When investment advisers are chosen on the basis of a placement agent's political contributions, rather than on, for example, the adviser's merit, performance, or costs, the market and selection process for advisers becomes distorted. Ultimately, pay-to-play harms investors and the public interest if government entities, including public pension plans, and their beneficiaries receive inferior services or pay higher fees. --------------------------------------------------------------------------- \1\ 15 U.S.C. 78s(b)(1). \2\ 17 CFR 240.19b-4. \3\ ``Pay-to-play practices,'' ``play-to-play arrangements'' or ``play-to-play activities,'' as referred to throughout this order, 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 proposed rule change was published for comment in the Federal Register on December 30, 2015.\4\ The Commission received ten comment letters, from nine different commenters, in response to the Notice.\5\ On February 8, 2016, FINRA extended the time period by which the Commission must approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to approve or disapprove the proposed rule change to March 29, 2016.\6\ On March 28, 2016, FINRA filed a letter with the Commission stating that it considered the comments received by the Commission in response to the Notice, and that FINRA is not intending to make changes to the proposed rule text in response to the comments.\7\ --------------------------------------------------------------------------- \4\ See Exchange Act Rel. No. 76767 (Dec. 24, 2015), 80 FR 81650 (Dec. 30, 2015) (File No. SR-FINRA-2015-056) (``Notice''). \5\ See Letters from David Keating, President, Center for Competitive Politics (``CCP''), dated Jan. 20, 2016 (``CCP Letter 1''); Clifford Kirsch and Michael Koffler, Sutherland Asbill & Brennan LLP, for the Committee of Annuity Insurers (``CAI''), dated Jan. 20, 2016 (``CAI Letter 1''); Clifford Kirsch and Michael Koffler, Sutherland Asbill & Brennan LLP, for the CAI, dated Feb. 5, 2016 (``CAI Letter 2''); David T. Bellaire, Executive Vice President and General Counsel, Financial Services Institute (``FSI''), dated Jan. 20, 2016 (``FSI Letter 1''); Tamara K. Salmon, Assistant General Counsel, Investment Company Institute (``ICI''), dated Jan. 20, 2016 (``ICI Letter''); Patrick J Moran, Esq., dated Dec. 29, 2015 (``Moran Letter''); Gary A. Sanders, Counsel and Vice President, National Association of Insurance and Financial Advisors (``NAIFA''), dated Jan. 20, 2016 (``NAIFA Letter''); Judith M. Shaw, President, North American Securities Administrators Association, Inc. (``NASAA''), dated Jan. 20, 2016 (``NASAA Letter''); Hugh D. Berkson, President, Public Investors Arbitration Bar Association (``PIABA''), dated Jan. 20, 2016 (``PIABA Letter''); and H. Christopher Bartolomucci and Brian J. Field, Bancroft PLLC, for the New York Republican State Committee and the Tennessee Republican Party (``State Parties''), dated Jan. 20, 2016 (``State Parties Letter 1''). The comment letters filed with the Commission in connection with the proposed rule change are available at: http://www.sec.gov/comments/sr-finra-2015-056/finra2015056.shtml. \6\ See Letter from Victoria Crane, Associate General Counsel, FINRA, to Lourdes Gonzalez, Assistant Chief Counsel--Sales Practices, Division of Trading and Markets, Commission, dated Feb. 8, 2016. \7\ See Letter from Victoria Crane, Associate General Counsel, FINRA, to Brent J. Fields, Secretary, Commission, dated Mar. 28, 2016 (``FINRA Response Letter 1''). --------------------------------------------------------------------------- On March 29, 2016, pursuant to delegated authority, the Commission issued an order instituting proceedings pursuant to Section 19(b)(2)(B) of the Act \8\ to determine whether to approve or disapprove the proposed rule change, [[Page 60052]] and solicited additional comment.\9\ The Commission received an additional four comments regarding the proceedings,\10\ including two letters requesting an opportunity to make an oral presentation in the proceedings.\11\ On July 6, 2016, FINRA submitted a letter responding to all comments and to the Order Instituting Proceedings.\12\ On June 21, 2016, FINRA extended the time period by which the Commission must determine whether to approve or disapprove the proposed rule change to August 26, 2016.\13\ --------------------------------------------------------------------------- \8\ 15 U.S.C. 78s(b)(2)(B). \9\ See Securities Exchange Act Release No. 77465 (Mar. 29, 2016), 81 FR 19260 (Apr. 4, 2016) (``Order Instituting Proceedings''). \10\ See Letters from David T. Bellaire, Executive Vice President and General Counsel, FSI, dated Apr. 27, 2016 (``FSI Letter 2''); Jason Torchinsky, Holtzman Vogel Josefiak Torchinsky PLLC, on behalf of the Georgia Republican Party and the State Parties, dated April 12, 2016, filed April 21, 2016 (``State Parties Letter 2''); Allen Dickerson, Legal Director, CCP, dated April 21, 2016 (``CCP Letter 2''); Allen Dickerson, Legal Director, CCP, dated April 15, 2016 (``CCP Letter 3''). \11\ See CCP Letter 2; State Parties Letter 2. The Commission denied both requests. See Letter from Brent J. Fields, Secretary, Commission, to Allen Dickerson, Legal Director, CCP dated July 11, 2016; Brent J. Fields, Secretary, Commission, to Jason Torchinsky, Holtzman Vogel Josefiak Torchinsky PLLC, on behalf the State Parties, dated July 11, 2016. \12\ See Letter from Victoria Crane, Associate General Counsel, FINRA, to Brent J. Fields, Secretary, Commission, dated July 6, 2016 (``FINRA Response Letter 2''). Both of FINRA's Responses Letters are 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. \13\ See Letter from Victoria Crane, Associate General Counsel, FINRA, to Lourdes Gonzalez, Assistant Chief Counsel--Sales Practices, Division of Trading and Markets, Commission, dated June 21, 2016. --------------------------------------------------------------------------- This order approves the rule change as proposed. Section II provides an overview of the rule and summarizes the rule as described by FINRA in its filing and as published in the Notice, Section III is a summary of the comments received and FINRA's responses, and Section IV contains the Commission's findings in approving the proposal. II. Description of the Proposed Rule Change \14\ --------------------------------------------------------------------------- \14\ The proposed rule change, as described in Item II, is excerpted, in part, from the Notice, which was substantially prepared by FINRA. See supra note 4. A more detailed description of the proposed rule change is in the Notice. --------------------------------------------------------------------------- As described more fully in the Notice, FINRA modeled proposed Rule 2030 \15\ on the Commission's Rule 206(4)-5 under the Investment Advisers Act of 1940 (``Advisers Act''), which addresses pay-to-play practices by investment advisers (the ``SEC Pay-to-Play Rule'').\16\ The SEC Pay-to-Play Rule, in part, prohibits any investment adviser covered under the rule \17\ or any of 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 such investment adviser unless such person is a ``regulated person,'' \18\ as defined under the rule, or an executive officer, general partner, managing member, or employee of the investment adviser.\19\ A ``regulated person,'' as defined in the SEC Pay-to-Play Rule, includes a registered broker-dealer, provided that: (a) FINRA rules prohibit member firms from engaging in distribution or solicitation activities if certain political contributions have been made to certain public officials; and (b) the Commission 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.\20\ --------------------------------------------------------------------------- \15\ See Notice, 80 FR at 81650-51 (citing 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'')). \16\ FINRA also published the proposed rule change in Regulatory Notice 14-50 (Nov. 2014) (``Regulatory Notice 14-50'') and sought comment on the proposal. FINRA states that commenters were generally supportive of the proposed rule change, but also expressed some concerns. As such, FINRA revised the proposed rule change as published in Regulatory Notice 14-50 in response to those comments. As described more fully in the Notice, FINRA believes that the revisions it made more closely align FINRA's proposed rule with the SEC Pay-to-Play Rule and should help reduce cost and compliance burden concerns raised by commenters. See Notice, 80 FR at 81651 n.16. \17\ The SEC Pay-to-Play Rule applies to investment advisers registered or required to be registered with the Commission, foreign private advisers that are unregistered in reliance on Section 203(b)(3) of the Advisers Act, and exempt reporting advisers as defined in Rule 204-4(a) under the Advisers Act. See 17 CFR 275.206(4)-5(a)(2). \18\ See Notice, 80 FR at 81650 n.6, 81656. See also 17 CFR 275.206(4)-5(a)(2)(i)(A). \19\ See 17 CFR 275.206(4)-5(a)(2)(i)(B) (or, in each case, a person with a similar status or function to an executive officer, general partner, or managing member of the investment adviser). \20\ See Notice, 80 FR at 81650 n.6 (citing 17 CFR 275.206(4)- 5(f)(9)). The definition of ``regulated person'' also includes SEC- registered investment advisers and SEC-registered municipal advisors, subject to specified conditions. The Commission amended the SEC Pay-to-Play Rule to add SEC-registered municipal advisors to the definition of ``regulated persons.'' See Rules Implementing Amendments to the Investment Advisers Act of 1940, Investment Advisers Act Rel. No. 3221 (June 22, 2011), 76 FR 42950 (July 19, 2011). --------------------------------------------------------------------------- In light of this regulatory framework, FINRA proposed its own pay- to-play rule to enable its member firms to continue to engage in distribution and solicitation activities for compensation with government entities on behalf of investment advisers, while subjecting its member firms to appropriate safeguards that will discourage them from engaging in pay-to-play practices.\21\ Because one of the objectives of FINRA's proposal is to satisfy the ``regulated person'' definition in the SEC Pay-to-Play Rule, the elements of and terms used in FINRA's proposal are substantially equivalent to and consistent with the objectives of the SEC Pay-to-Play Rule.\22\ As discussed below, this threshold objective precludes many of the modifications proposed by commenters given that a more permissive FINRA proposal would not meet the stringency requirements of the SEC Pay-to-Play Rule. FINRA believes that its proposed rule would establish a comprehensive regime to regulate the activities of its member firms that engage in distribution or solicitation activities with government entities on behalf of investment advisers, and would impose substantially equivalent restrictions on FINRA member firms engaging in distribution or solicitation activities to those that the SEC Pay-to-Play Rule imposes on investment advisers.\23\ --------------------------------------------------------------------------- \21\ See Notice, 80 FR at 81651, 81656. \22\ On August 25, 2016, the Commission issued a notice stating that it intends to issue an order pursuant to Section 206 of the Advisers Act and SEC Pay-to-Play Rule 206(4)-5 finding that FINRA's proposed Rule 2030 (i) imposes substantially equivalent or more stringent restrictions on broker-dealers than the SEC Pay-to-Play Rule imposes on investment advisers and (ii) is consistent with the objectives of the SEC Pay-to-Play Rule. \23\ See Notice, 80 FR at 81651, 81656. --------------------------------------------------------------------------- Furthermore, FINRA's proposed Rule 4580 would impose recordkeeping requirements on FINRA member firms in connection with its pay-to-play rule that would allow examination of member firms' books and records for compliance with Rule 2030.\24\ FINRA believes that proposed Rule 4580 is consistent with similar recordkeeping requirements imposed on investment advisers in connection with the SEC Pay-to-Play Rule.\25\ --------------------------------------------------------------------------- \24\ See id. at 81651, 81655-56. \25\ See id. at 81655 n.60 (citing Advisers Act Rule 204- 2(a)(18) and (h)(1)). --------------------------------------------------------------------------- The following is an overview of the key provisions in FINRA's proposed rules, as described by FINRA in the Notice. A. Proposed Rule 2030(a): Limitation on Distribution and Solicitation Activities Proposed Rule 2030(a) would prohibit a covered member from 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 to an official of the [[Page 60053]] 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.\26\ FINRA states that the terms and scope of the prohibitions in proposed Rule 2030(a) are modeled on the SEC Pay-to-Play Rule.\27\ According to FINRA, the two-year time-out period 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.\28\ --------------------------------------------------------------------------- \26\ See Notice, 80 FR at 81651. \27\ See id. at 81651. See also id. at 81651 n.19 (citing 17 CFR 275.206(4)-5(a)(1)). \28\ Notice, 80 FR at 81651, 81659. --------------------------------------------------------------------------- The following is an overview of some of the key terms used in FINRA's proposed Rule 2030, as discussed by FINRA in its filing and published in the Notice or as defined in proposed Rule 2030(g). 1. Covered Members The SEC Pay-to-Play Rule includes within its definition of ``regulated person'' SEC-registered municipal advisors, subject to specified conditions.\29\ 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.\30\ --------------------------------------------------------------------------- \29\ See 17 CFR 275.206(4)-5(a)(2)(i)(A) and 17 CFR 275.206(4)- 5(f)(9). \30\ See supra note 29. --------------------------------------------------------------------------- FINRA addresses the interplay between its proposed rule and the application of the MSRB's municipal advisor pay-to-play rule by exempting from the definition of ``covered member'' a member when it 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.'' \31\ FINRA states that 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.\32\ Under such circumstances, FINRA notes that the MSRB rules applicable to municipal advisors, including the pay-to-play rule adopted by the MSRB,\33\ would apply to the member firm.\34\ 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.\35\ Under such circumstances, the member firm would be a ``covered member'' subject to the requirements of proposed Rule 2030.\36\ This distinction is the result of the definitions of ``municipal advisor'' and ``solicitation of a municipal entity or obligated person'' in the Exchange Act, which only covers a person who is not affiliated with the broker, dealer, municipal securities dealer, municipal advisor, or investment adviser for whom the person is soliciting.\37\ --------------------------------------------------------------------------- \31\ Proposed Rule 2030(g)(4). See also Notice, 80 FR at 81652 (explaining that the SEC Pay-to-Play Rule includes within its definition of ``regulated person'' SEC-registered municipal advisors, subject to specified conditions, and 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 MSRB pay-to-play rule). \32\ See Notice, 80 FR at 81652. \33\ On February 17, 2016, the MSRB published a regulatory notice announcing that its pay-to-play rule was deemed approved pursuant to section 19(b)(2)(D) of the Exchange Act on February 13, 2016 and that the effective date of the rule is August 17, 2016. See Amendments to MSRB Rule G-37 on Political Contributions and Prohibitions on Municipal Securities Business and Related Amendments are Deemed Approved under the Securities Exchange Act of 1934, Regulatory Notice 2016-06, dated February 17, 2016 (the ``MSRB Regulatory Notice''), available at http://www.msrb.org/~/media/ Files/Regulatory-Notices/Announcements/2016-06.ashx?n=1. \34\ See Notice, 80 FR at 81652. \35\ See id. \36\ See id. FINRA also 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 and that such a regulated person would be subject to the rules that apply to the services the regulated person is performing. See id. at n.24. \37\ Exchange Act Section 15B(e)(4) provides that a ``municipal advisor'' includes a person that undertakes solicitation of a municipal entity or obligated person. 15 U.S.C. 78o-4(e)(4). Exchange Act Section 15B(e)(9) provides that the term ``solicitation of a municipal entity or obligated person'' means ``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 (as defined in section 202 of the Investment Advisers Act of 1940) 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.'' 15 U.S.C. 78o-4(e)(9). --------------------------------------------------------------------------- 2. Distribution Activities With respect to the triggering activities for FINRA's proposed Rule 2030(a), FINRA states that, based on the definition of ``regulated person'' in the SEC Pay-to-Play Rule,\38\ it is proposing a rule that prohibits its member firms from engaging in distribution activities (as well as solicitation activities) for compensation with government entities for two years after certain political contributions have been made to certain officials.\39\ FINRA also notes, in response to certain comments discussed below, that certain language in the SEC Pay-to-Play Rule Adopting Release further supports the inclusion of distribution activities by broker-dealers in FINRA's proposed Rule 2030.\40\ --------------------------------------------------------------------------- \38\ A ``regulated person,'' as defined in the SEC Pay-to-Play Rule, includes a FINRA member firm, provided that: (a) FINRA rules ``prohibit member firms from engaging in distribution or solicitation activities if certain political contributions have been made;'' and (b) ``[t]he Commission finds, by order, that such rules impose substantially equivalent or more stringent restrictions on broker-dealers 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].'' 17 CFR 275.206(4)-5(f)(9)(ii). \39\ See Notice, 80 FR at 81660-61 (explaining that FINRA believes its proposed rule must apply to member firms engaging in distribution activities and that FINRA did not revise the proposed rule to remove references to the term ``distribution'' as requested by comments received in response to Regulatory Notice 14-50). \40\ See Notice, 80 FR at 81660. See also id. at 81661 n.103 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298 where, according to FINRA, the Commission ``clarif[ied] under what circumstances distribution payments would violate the SEC's Pay-to- Play Rule''). --------------------------------------------------------------------------- FINRA explains that 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 because in these circumstances a member firm is not providing or seeking to provide investment advisory services to a government entity.\41\ Therefore, the proposed rule would apply to distribution activities involving unregistered pooled investment vehicles such as hedge funds, private equity funds, venture capital funds, 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.\42\ FINRA also notes that, consistent with the SEC Pay-to-Play Rule, to the extent mutual fund distribution fees are paid by the fund [[Page 60054]] using fund assets pursuant to a 12b-1 plan, such payments generally would not constitute payments by the fund's investment adviser.\43\ However, if the adviser pays for the fund's distribution out of its ``legitimate profits,'' the proposed rule would generally be implicated.\44\ --------------------------------------------------------------------------- \41\ See Notice, 80 FR at 81661 n.106 (explaining that, although the proposed rule would not apply to distribution activities relating to all registered pooled investment vehicles, pursuant to proposed Rule 2030(e) ``[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''). \42\ See id. at 81661. See also id. at 81651 n.17 and 81654 n.46. \43\ See id. at 81661 n.103. See also SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298 (discussing how broker- dealers may be compensated by advisers according to distribution arrangements and noting 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''). \44\ See Notice, 80 FR at 81661 n.103 (noting, among other things, that ``for private funds, third parties are often compensated by the investment adviser or its affiliated general partner''). 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). --------------------------------------------------------------------------- 3. Solicitation Activities FINRA states that, 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.\45\ --------------------------------------------------------------------------- \45\ Notice, 80 FR at 81651 n.18. See also id. at 81653-54 n.40. FINRA notes that, although 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 FINRA believes that 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.\46\ --------------------------------------------------------------------------- \46\ See id. at 81651 n.18. See also id. at 81653-54 n.40. --------------------------------------------------------------------------- 4. Investment Advisers Proposed Rule 2030 would apply to covered members acting on behalf of (as defined in proposed Rule 2030(g)(7)) any investment adviser registered (or required to be registered) with the Commission, 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).\47\ Thus, proposed Rule 2030 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 or Advisers Act Rule 204-4(a). The proposed rule's definition of ``investment adviser'' is consistent with the definition of ``investment adviser'' in the SEC Pay-to-Play Rule.\48\ --------------------------------------------------------------------------- \47\ See Proposed Rule 2030(g)(7). \48\ See 17 CFR 275.206(4)-5(a)(1). --------------------------------------------------------------------------- 5. Official of a Government Entity FINRA explains that an ``official'' (as defined in proposed Rule 2030(g)(8)) of a ``government entity'' (as defined in proposed Rule 2030(g)(7))--both of which FINRA states are consistent with the SEC Pay-to-Play Rule definitions--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.\49\ FINRA also notes that 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.\50\ FINRA also explains that 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), 457, and 529 plans.\51\ --------------------------------------------------------------------------- \49\ See Notice, 80 FR at 81652. \50\ See id. (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41029 (discussing the terms ``official'' and ``government entity''). \51\ See Notice, 80 FR at 81652. --------------------------------------------------------------------------- 6. Contributions Proposed Rule 2030(g)(1) defines ``contribution'' to mean any 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, and includes any payments for debts incurred in such an election or transition or inaugural expenses incurred by a successful candidate for state or local office.\52\ FINRA states that this definition is consistent with the SEC Pay-to-Play Rule.\53\ FINRA also states that it 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.\54\ FINRA further states that it 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, 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.\55\ --------------------------------------------------------------------------- \52\ See id. at 81652. \53\ See id. at 81652 n.32. See also id. at 81653. \54\ See id. at 81653 n.33 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41030). \55\ See Notice, 80 FR at 81653. --------------------------------------------------------------------------- 7. Covered Associates Proposed Rule 2030(g)(2) defines the term ``covered associates'' 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.\56\ --------------------------------------------------------------------------- \56\ Id. at 81653 n.37. FINRA states that, as also noted 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.\57\ For example, contributions by an ``executive officer of a covered member'' (as defined in proposed Rule 2030(g)(5)) would trigger the two-year ``time-out.'' \58\ FINRA also notes that whether a person is an executive officer would depend on his or her function or activities and not his or her title.\59\ In addition, FINRA states that a covered associate would include a PAC controlled by the covered member or any of its covered associates.\60\ FINRA explains that it would consider a ``covered member'' (as defined in proposed Rule 2030(g)(4)) or its covered associates to have ``control'' over a PAC if the covered member or covered [[Page 60055]] associate has the ability to direct or cause the direction of governance or operations of the PAC.\61\ --------------------------------------------------------------------------- \57\ See id. (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41031). \58\ See Notice, 80 FR at 81653. \59\ See id. \60\ See id. \61\ See id. --------------------------------------------------------------------------- B. Proposed Rule 2030(b): Prohibition on Soliciting and Coordinating Contributions Proposed Rule 2030(b) also would prohibit a covered member or covered associate from soliciting or coordinating any person or political action committee (``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.\62\ FINRA states that this provision is modeled on a similar provision in the SEC Pay-to-Play Rule \63\ and is intended to prevent covered members or covered associates from circumventing the proposed rule's two-year ``time-out'' by ``bundling,'' either by soliciting a large number of contributions by employees, or by soliciting payments to a State or local political party.\64\ --------------------------------------------------------------------------- \62\ See id. at 81653-54. See also id. at 81662. \63\ See id. at 81654 n.42 (citing 17 CFR 275.206(4)-5(a)(2)). \64\ See Notice, 80 FR at 81654. --------------------------------------------------------------------------- C. Proposed Rule 2030(c): Exceptions FINRA's proposed pay-to-play rule contains three exceptions from the proposed rule's prohibitions: (1) de minimis contributions; (2) new covered associates; and (3) certain returned contributions.\65\ FINRA states that these exceptions are modeled on similar exceptions in the SEC Pay-to-Play Rule.\66\ --------------------------------------------------------------------------- \65\ See id. \66\ See id. at n.51 (citing 17 CFR 275.206(4)-5(b)). --------------------------------------------------------------------------- 1. De Minimis Contribution Exception 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 at the time of the contributions, provided the contributions do not exceed $350 in the aggregate to any one official per election.\67\ 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.\68\ FINRA states that, consistent with the SEC Pay-to-Play Rule, under this exception, primary and general elections would be considered separate elections.\69\ FINRA also explains that this exception is based on the theory that such contributions are typically made without the intent or ability to influence the selection process of the investment adviser.\70\ --------------------------------------------------------------------------- \67\ See Notice, 80 FR at 81655. \68\ See id. \69\ See id. at 81655 n.54 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41034). \70\ See Notice, 80 FR at 81655. --------------------------------------------------------------------------- 2. Exception for Certain New Covered Associates 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. However, 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.\71\ FINRA states that this exception is consistent with the SEC Pay-to-Play Rule \72\ and is intended to balance the need for covered members to be able to make hiring decisions against 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.\73\ FINRA also provides, with respect to the ``look back'' provisions in the proposed rules generally, the following illustrations of how the ``look back'' provisions will work: If, for example, the contributions were made more than two years (or six months for new covered associates) prior to the employee becoming a covered associate, the ``time-out'' has run.\74\ According to FINRA, however, 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 applicable period has run.\75\ --------------------------------------------------------------------------- \71\ See id. \72\ See id. at 81655 n.55 (citing 17 CFR 275.206(4)-5(b)(2)). \73\ See Notice, 80 FR at 81655. \74\ See id. at 81656. \75\ See id. at 81655-56. --------------------------------------------------------------------------- 3. Exception for 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.\76\ FINRA explains that, consistent with the SEC Pay- to-Play Rule, this exception would allow a covered member to cure the consequences of an inadvertent political contribution.\77\ The proposed rule also 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, while covered members with more than 150 registered representatives would be permitted to rely on this exception no more than three times per calendar year.\78\ Furthermore, 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, which is consistent with similar provisions in the SEC Pay-to-Play Rule.\79\ --------------------------------------------------------------------------- \76\ See id. at 81655. \77\ See id. \78\ See id. FINRA notes that these limitations are consistent with similar provisions in the SEC Pay-to-Play Rule 206(4)-5(b)(3), although 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. See id. at 81655 n.59. \79\ See Notice, 80 FR at 81655. --------------------------------------------------------------------------- D. Proposed Rule 2030(d): Prohibitions as Applied to 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,\80\ 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 [[Page 60056]] investment pool directly.\81\ 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.\82\ FINRA states that proposed Rule 2030(d) is modeled on a similar prohibition in the SEC Pay-to-Play Rule 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.\83\ Therefore, according to FINRA, 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.\84\ --------------------------------------------------------------------------- \80\ See id. at 81654 n.46 (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''). \81\ See Notice, 80 FR at 81654 n.47 (FINRA notes that, 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) (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41047). \82\ See Notice, 80 FR at 81654 n.48 (FINRA states that it 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). \83\ See Notice, 80 FR at 81654 n.49 (citing 17 CFR 275.206(4)- 5(c)). \84\ See Notice, 80 FR at 81654 n.50 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044, which discusses the applicability of the SEC Pay-to-Play Rule to covered investment pools). --------------------------------------------------------------------------- As noted above, 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 because in these circumstances a member firm is not providing or seeking to provide investment advisory services to a government entity.\85\ The proposed rule would apply to distribution activities involving unregistered pooled investment vehicles such as hedge funds, private equity funds, venture capital funds, 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.\86\ --------------------------------------------------------------------------- \85\ See Notice, 80 FR at 81661. \86\ See id. --------------------------------------------------------------------------- E. Proposed Rule 2030(e): Prohibition on Indirect Contributions or Solicitations Proposed Rule 2030(e) 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.\87\ FINRA states that this provision is consistent with a similar provision in the SEC Pay-to-Play Rule \88\ 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.\89\ FINRA also notes that, consistent with guidance provided by the Commission in connection with SEC Pay-to-Play Rule 206(4)-5(d), proposed Rule 2030(e) requires a showing of intent to circumvent the rule for such persons to trigger the two-year ``time-out.'' \90\ --------------------------------------------------------------------------- \87\ See Notice, 80 FR at 81654. \88\ See id. at n.44 (citing 17 CFR 275.206(4)-5(d)). \89\ See Notice, 80 FR at 81654 n.45 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044, which discusses direct and indirect contributions or solicitations). \90\ See Notice, 80 FR at 81654. See also SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044 n.340 (explaining that like MSRB Rule G-37(d), SEC Pay-to-Play Rule 206(4)-5(d) ``requires a showing of intent to circumvent the rule for such persons to trigger the time out'') (citing Blount, 61 F.3d at 948 (``In short, according to the SEC, the rule restricts such gifts and contributions only when they are intended as end-runs around the direct contribution limitations.'')). --------------------------------------------------------------------------- F. Proposed Rule 2030(f): Exemptions Proposed Rule 2030(f) includes an exemptive provision for covered members, modeled on the exemptive provision in the SEC Pay-to-Play Rule, that would allow covered members to apply to FINRA for an exemption from the proposed rule's two-year ``time-out.'' \91\ As proposed, FINRA states that this provision would allow FINRA to exempt covered members, either conditionally or unconditionally, 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.\92\ In determining whether to grant an exemption, FINRA would take into account varying facts and circumstances, outlined in the proposed rule, that each application presents \93\ (e.g., the timing and amount of the contribution, the nature of the election, and the contributor's apparent intent or motive in making the contribution).\94\ FINRA notes that 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.\95\ --------------------------------------------------------------------------- \91\ See Notice, 80 FR at 81654-55. \92\ See id. at 81655. \93\ See id. \94\ See Order Instituting Proceedings, 81 FR at 19263. \95\ See Notice, 80 FR at 81655. --------------------------------------------------------------------------- G. Proposed Rule 4580: 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.\96\ FINRA states that this provision is consistent with similar recordkeeping requirements imposed on investment advisers in connection with the SEC Pay-to-Play Rule.\97\ The proposed rule also would require covered members to maintain a list or other record of certain specific information.\98\ FINRA states that the proposed rule would require, among other things, 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.\99\ --------------------------------------------------------------------------- \96\ See id. \97\ See id. (citing 17 CFR 275.204-2(a)(18) and (h)(1)). \98\ See Notice, 80 FR at 81655-56. \99\ See id. --------------------------------------------------------------------------- III. Summary of Comments and FINRA's Responses In response to the Notice, the Commission received ten comment letters, from nine different commenters.\100\ Six commenters generally express support for FINRA's [[Page 60057]] proposal.\101\ However, five of those commenters, while generally expressing support for the goals of the proposal, also raise certain concerns regarding various aspects of the proposal as drafted and recommended amendments to the proposal.\102\ The other three commenters did not support the proposed rule as drafted based largely on concerns involving the First Amendment to the U.S. Constitution.\103\ FINRA responded, stating that it considered the comments received by the Commission in response to the Notice, and that FINRA is not intending to make changes to the proposed rule text in response to the comments.\104\ --------------------------------------------------------------------------- \100\ See supra note 5. CAI submitted two separate comment letters in response to the Notice. See CAI Letter 1 and CAI Letter 2. \101\ See CAI Letter 1; CAI Letter 2; FSI Letter 1; ICI Letter; NAIFA Letter; NASAA Letter; and PIABA Letter. \102\ See CAI Letter 1; CAI Letter 2; FSI Letter 1; NAIFA Letter; NASAA Letter; and PIABA Letter. ICI did not raise additional concerns, but states that it is satisfied with FINRA's revisions and responses to the proposal as drafted in Regulatory Notice 14-50. See ICI Letter. \103\ See CCP Letter 1; Moran Letter; and State Parties Letter 1. Other commenters also raise certain First Amendment-related concerns. See FSI Letter 1; and CAI Letter 1. \104\ See FINRA Response Letter 1. --------------------------------------------------------------------------- The Commission received an additional four comments in response to the Order Instituting Proceedings.\105\ On July 6, 2016, FINRA submitted a letter responding to all comments and to the Order Instituting Proceedings.\106\ The comments, as well as FINRA's responses, are summarized below.\107\ --------------------------------------------------------------------------- \105\ See supra note 10. See also Memorandum from the Division of Trading and Markets regarding a May 10, 2016 conference call with representatives of CAI; Memorandum from the Division of Trading and Markets regarding a May 19, 2016 conference call with representatives of FSI. \106\ See supra note 12. \107\ The comments received in response to the Notice were summarized when the Commission instituted proceedings. See supra note 9. For further detail, the comments that the Commission received on both the Notice and the Order Instituting Proceedings are available on the Commission's Web site at http://www.sec.gov/comments/sr-finra-2015-056/finra2015056.shtml. --------------------------------------------------------------------------- A. First Amendment Comments and FINRA's Responses As noted above, five commenters either oppose the proposed rule \108\ or raise certain issues regarding the proposed rule as drafted based largely on First Amendment concerns.\109\ As a general matter, these commenters argue that FINRA's proposed rule is not narrowly tailored to serve a compelling government interest. While acknowledging that the D.C. Circuit upheld the constitutionality of a comparable MSRB pay-to-play rule in Blount v. SEC, 61 F.3d 938 (D.C. Cir. 1995), which also used analogous restrictions to discourage pay-to-play practices, these commenters believe that Supreme Court precedent has changed since Blount was decided. --------------------------------------------------------------------------- \108\ See CCP Letter 1; and State Parties Letter 1. See also CCP Letter 2; CCP Letter 3; and State Parties Letter 2. \109\ See CAI Letter 1; FSI Letter 1; FSI Letter 2; and Moran Letter. --------------------------------------------------------------------------- In response to these comments, FINRA states that the points raised by the commenters do not warrant changes to, or disapproval of, its proposed rule change.\110\ FINRA notes that the Commission has already reviewed and rejected these arguments in a nearly identical context.\111\ As FINRA explains, the State Parties filed an unsuccessful lawsuit in 2014 challenging the SEC Pay-to-Play Rule on First Amendment grounds.\112\ FINRA explains that the State Parties' comments opposing FINRA's proposed rule reiterate the arguments advanced in their suit against the Commission and, although the court of appeals decided the challenge on jurisdictional grounds, the brief that the Commission filed in the D.C. Circuit is persuasive in demonstrating that the State Parties' arguments lack merit.\113\ FINRA also notes that the SEC Pay-to-Play Rule, upon which FINRA's proposed rule change is based, was modeled on pay-to-play rules that the MSRB drafted, that the Commission approved, and that the D.C. Circuit upheld against a constitutional challenge in Blount.\114\ --------------------------------------------------------------------------- \110\ See FINRA Response Letter 2 at 3 (noting that FINRA's responses to the First Amendment arguments raised by the State Parties and CCP also address the concerns raised by CAI, FSI and Moran). A copy of FINRA Response Letter 2 is available at: https://www.sec.gov/comments/sr-finra-2015-056/finra2015056-18.pdf. \111\ See id. (citing N.Y. Republican State Comm. v. SEC, 799 F.3d 1126 (D.C. Cir. 2015) (affirming dismissal of the petition for lack of subject matter jurisdiction and also dismissing the petition as time-barred). \112\ See FINRA Response Letter 2 at 3. \113\ See id. at 3-4. \114\ See id. at 5 (citing Blount, 61 F.3d at 944). --------------------------------------------------------------------------- Furthermore, FINRA states that the proposed rule change is justified by a sufficiently important governmental interest to withstand constitutional scrutiny. For example, FINRA explains that, as in Blount, the Commission's interest in preventing fraud and in protecting market actors from ``unfair, corrupt market practices,'' are ``not only substantial, but . . . compelling.'' \115\ FINRA also notes that the Commission's interest in ``clean advisory markets is equally important.'' \116\ FINRA acknowledges the D.C. Circuit's observation in Blount that ``the link between eliminating pay-to-play practices and the Commission's goals of `perfecting the mechanism of a free and open market' and promoting `just and equitable principles of trade' is self- evident.'' \117\ In addition to noting the important interests served by its proposal, FINRA also notes that, as explained in Blount, the proposed rule change advances this government interest by seeking to halt an existing pay-to-play problem, even though, in terms of a record, ``no smoking gun is needed;'' however, ``here, the conflict of interest is apparent, the likelihood of stealth great, and the [Commission's] purpose prophylactic.'' \118\ --------------------------------------------------------------------------- \115\ See, e.g., FINRA Response Letter 2 at 5 (quoting Blount, 61 F.3d at 944). \116\ See, e.g., FINRA Response Letter 2 at 5 (quoting an observation made in Blount that the Commission's interest ``in clean bond markets'' is just as important as a legislature's interest ``in clean elections'') (quoting Blount, 61 F.3d at 944)). \117\ See, e.g., FINRA Response Letter 2 at 5 (quoting Blount, 61 F.3d at 945). \118\ See, e.g., FINRA Response Letter 2 at 6 (quoting Blount, 61 F.3d at 945). --------------------------------------------------------------------------- FINRA further believes that the proposed rule change also is ``closely drawn'' to avoid unnecessary abridgment of associational freedoms.\119\ FINRA explains that, like the pay-to-play rule upheld in Blount, its proposed rule change only ``restricts a narrow range of . . . activities for a relatively short period of time,'' and leaves available the ``vast majority of political activities.'' \120\ For example, FINRA notes that the proposal does not attempt to regulate State and local elections, nor does it impose restrictions on independent expenditures or ban political contributions, and that each of those significant avenues for political expression remains unaffected by the proposed rule change.\121\ FINRA also does not agree with arguments made by a commenter that FINRA did not consider less restrictive alternatives in drafting its proposal and that aspects of the proposal are vague or overbroad. FINRA notes that, because the Commission must find that FINRA's proposal imposes substantially equivalent or more stringent restrictions on its member firms as the SEC Pay-to-Play Rule imposes on investment advisers for FINRA members to be ``regulated persons'' under the SEC Pay-to-Play Rule, the provisions and definitions to which the commenter objects are modeled on and substantially similar to provisions in the [[Page 60058]] SEC Pay-to-Play Rule.\122\ FINRA also states that it will work with the industry and Commission to address interpretive questions and provide additional guidance, as needed, to the extent that questions arise regarding the application and scope of the provisions and terms used in the proposed rule change.\123\ --------------------------------------------------------------------------- \119\ See, e.g., FINRA Response Letter 2 at 6. \120\ See, e.g., id. (quoting Blount, 61 F.3d at 947-48). \121\ See, e.g., FINRA Response Letter 2 at 4. See also SEC Pay- to-Play Rule Adopting Release, 75 FR at 41024 n.71 (explaining that the SEC Pay-to-Play rule ``imposes no restrictions on activities such as making independent expenditures to express support for candidates, volunteering, making speeches, and other conduct''). \122\ See, e.g., FINRA Response Letter 2 at 7. \123\ See, e.g., id. --------------------------------------------------------------------------- B. Comments Regarding FINRA's Authority To Propose a Pay-to-Play Rule and FINRA's Responses Several commenters contend that FINRA does not have the authority to adopt a pay-to-play rule because only Congress or the Federal Election Commission may regulate contributions for federal elections. In response, FINRA states that the proposed rule change is consistent with the authority Congress granted a registered national securities association like FINRA under Section 15A(b)(6) of the Act to adopt rules that are designed, among other things, to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to perfect the mechanism of a free and open market and a national market system and, in general, to protect investors and the public interest.\124\ FINRA believes that the proposed rule change accomplishes the goals of Section 15A(b)(6) by, for example, allowing member firms to continue to engage in distribution or solicitation activities for compensation with governmental entities on behalf of investment advisers, while at the same time deterring member firms from engaging in pay-to-play practices.\125\ FINRA also believes that the proposed rule change is reasonably designed to address the distortion of the investment advisory market and collective action problems created by pay-to-play practices.\126\ --------------------------------------------------------------------------- \124\ See id. \125\ See id. \126\ See id. at 9. As outlined in the SEC Pay-to-Play Adopting Release, pay-to-play activities create a ``collective action'' problem in two respects. First, government officials who participate in such activities may have an incentive to continue to accept contributions to support their campaigns for fear of being disadvantaged relative to their opponents. Second, advisers may have an incentive to participate out of concern that they may be overlooked if they fail to make a contribution. See SEC Pay-to-Play Rule Adopting Release, 75 FR at 40122. --------------------------------------------------------------------------- Although FINRA acknowledges that the proposed rule's two-year ``time-out'' provision might result in fewer covered members and their covered associates making certain political contributions to certain officials, FINRA notes that if it did not adopt a pay-to-play rule, the SEC Pay-to-Play Rule would prohibit member firms from soliciting government entities for investment advisory services for compensation on behalf of investment advisers.\127\ FINRA explains that the SEC Pay- to-Play Rule provides that the rules of a self-regulatory organization (``SRO''), like FINRA, must impose ``substantially equivalent or more stringent restrictions'' on its member firms that wish to act as ``regulated persons'' as the SEC Pay-to-Play Rule imposes on investment advisers.\128\ Therefore, unless FINRA imposes sufficiently stringent restrictions, investment advisers and covered associates will be barred from providing or agreeing to provide, directly or indirectly, payment to FINRA member firms to solicit a government entity for investment advisory services on behalf of the investment adviser.\129\ FINRA believes that the proposed rule change is a more effective response to the issues addressed in the SEC Pay-to-Play Rule than a complete ban on solicitation,\130\ and notes throughout its response that the proposal imposes substantially equivalent restrictions on FINRA member firms as the SEC Pay-to-Play Rule imposes on investment advisers.\131\ --------------------------------------------------------------------------- \127\ See FINRA Response Letter 2 at 4-5. \128\ See id. at 4. \129\ See id. See also Notice, 80 FR at 81659. \130\ See FINRA Response Letter 2 at 4. \131\ See, e.g., id. at 4, 7. --------------------------------------------------------------------------- C. Variable Annuity-Related Comments and FINRA's Responses Two commenters raise concerns regarding the application of the proposed rules to variable annuities.\132\ Both of these commenters request, as a threshold matter, that FINRA confirm that Rule 2030 would not apply to variable annuities.\133\ One of these commenters requests that the proposed rule not apply to the sales of variable annuity contracts supported by a separate account that invests in mutual funds, arguing that the nature of variable annuities and the way investment options are selected does not implicate the investment advisory solicitation activities contemplated by the SEC Pay-to-Play Rule.\134\ This commenter claims that the relationship between a variable annuity contract holder and the investment adviser to a mutual fund supporting the variable annuity does not rise to a level such that it should implicate the proposed pay-to-play rule's restrictions.\135\ The other commenter claims, in support of its argument that Rule 2030 should not apply to variable annuities, that compliance with Rule 2030 would be impractical for broker-dealers selling variable annuities in the government market.\136\ This commenter also argues, for example, that a covered member selling a variable annuity, particularly where the separate account is registered as a unit investment trust, cannot fairly be seen to be engaging in solicitation activities on behalf of all of the investment advisers and sub-advisers that manage the covered investment pools available as investment options under the separate account and subaccounts.\137\ --------------------------------------------------------------------------- \132\ See CAI Letter 1 and FSI Letter 1. See also CAI Letter 2 (reflecting CAI's suggested revisions to the certain language in some of FINRA's proposed rules). \133\ See CAI Letter 1 and FSI Letter 1. \134\ See FSI Letter 1 (claiming that applying the proposed rule to variable annuities will significantly increase the compliance burden and as such may limit the options their members make available to 403(b) and 457 plans). \135\ See FSI Letter 1. \136\ See CAI Letter 1 (claiming that the dynamics and structure of variable annuities, particularly those with separate accounts registered as a unit investment trust, and the number of advisers and sub-advisers to the funds underlying sub-accounts, makes compliance with proposed Rule 2030 impractical). \137\ See id. --------------------------------------------------------------------------- This commenter also requests that proposed Rule 2030 be modified to, among other things, clarify that the distribution of a two-tiered product such as a variable annuity is not solicitation activity for an investment adviser and sub-advisers managing the funds available as investment options.\138\ Furthermore, this same commenter states that if FINRA or the Commission determines that broker-dealers selling variable annuities constitute solicitation activities for purposes of Rule 2030, that determination raises a host of interpretive questions that, in this commenter's view, would require further guidance from FINRA or the Commission.\139\ --------------------------------------------------------------------------- \138\ See id. \139\ See id. For example, CAI requests guidance on the following questions: Is the selling broker-dealer deemed to be soliciting on behalf of the adviser of each of the underlying funds or only of advisers and sub-advisers of funds underlying investment options that are selected by contract holders? If an underlying fund is managed by an adviser that uses multiple sub-advisers, is the selling firm deemed to be soliciting on behalf of all of the sub- advisers? How does the rule apply when a contract holder on his or her own allocates funds in the variable annuity to an option at a point of time (for example, five years) subsequent to the purchase of the variable annuity without any involvement of the selling firm? See id. --------------------------------------------------------------------------- In response, FINRA states that its proposed rules must impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on [[Page 60059]] investment advisers.\140\ Therefore, because the Commission did not exclude specific products from the SEC Pay-to-Play Rule, such as variable annuities, FINRA does not believe that excluding specific products from its proposed rule would satisfy the Commission's stringency requirements.\141\ FINRA notes, however, that to the extent interpretive questions arise regarding the application and scope of the provisions and terms used in its proposed rules, FINRA will work with the industry and Commission to address those interpretive questions and provide additional guidance as needed.\142\ --------------------------------------------------------------------------- \140\ See FINRA Response Letter 2 at 16. \141\ See id. \142\ See id. --------------------------------------------------------------------------- D. Comments Regarding the Scope of the Proposed Rule and FINRA's Responses Two commenters also express concern that proposed Rule 2030(d) would, in their view, re-characterize ``ordinary'' or ``customary'' distribution activities for covered investment pools as the solicitation of clients on behalf of the investment adviser to the covered investment pools.\143\ One of these commenters requests that such customary distribution activity by member firms for covered investment pools sold to government entities not be treated as solicitation activity for an investment adviser for purposes of Rule 2030 simply because an investment adviser provides advisory services to a covered investment pool that is available as an investment option.\144\ As more fully explained in the commenter's letter, the commenter claims, for example, that proposed Rule 2030(d) would recast ``traditional'' broker-dealer activity (i.e., the offer and sale of covered investment pool securities pursuant to a selling or placement agent agreement) into something it is not: The solicitation of investment advisory services on behalf of an investment adviser.\145\ This commenter also claims that the decision in Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006) and the Commission staff's interpretive position under Advisers Act Rule 206(4)-3 suggest that proposed Rule 2030(d) would be impractical.\146\ This commenter also notes that Rule 206(4)-3 puts selling firms in a contradictory position under FINRA rules and Advisers Act rules.\147\ This commenter further states that, in its view, 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.\148\ --------------------------------------------------------------------------- \143\ See CAI Letter 1 and FSI Letter 1. \144\ See CAI Letter 1. \145\ See id. \146\ See id. (claiming that ``[i]t would create significant confusion in the industry and undermine settled practices and understandings, while creating doubt as to the application of the Goldstein case and the Commission staff's guidance in the Mayer Brown no-action letter''). \147\ See id. \148\ See id. --------------------------------------------------------------------------- Similarly, another commenter expresses concern with the apparent application of proposed Rule 2030(d) to ``traditional'' brokerage sales of mutual funds and variable annuities to participant-directed government-sponsored retirement plans.\149\ As more fully explained in the commenter's letter, this commenter continues to be concerned that the provisions in proposed Rule 2030(d) go beyond that which is required under Rule 206(4)-5(a)(2)(i) and Rule 206(4)-5(c) to the detriment of investors.\150\ This same commenter also claims that mutual fund sales, as well as variable annuity sales, should be excluded, claiming that the proposed rules serve to redefine the sale of mutual funds as solicitation by a broker-dealer on behalf of an investment adviser and also conflict with the realities of conventional mutual fund selling agreements.\151\ --------------------------------------------------------------------------- \149\ See FSI Letter 1. See also FSI Letter 2 \150\ See FSI Letter 1. See also FSI Letter 2. \151\ See FSI Letter 1. See also FSI Letter 2. --------------------------------------------------------------------------- In response, FINRA explains that, in proposing FINRA Rule 2030(d), it did not intend to re-characterize broker-dealers' selling interests in variable annuities, mutual funds and private funds as soliciting an investment advisory relationship with investors who invest in those products.\152\ Rather, FINRA states that the purpose of proposed Rule 2030(d) is to clarify that the prohibition of proposed Rule 2030(a) would apply when the covered member is engaging in distribution or solicitation activities with a government entity on behalf of a covered investment pool.\153\ FINRA further explains that proposed Rule 2030(d) is modeled on a similar provision in the SEC Pay-to-Play Rule, Rule 206(4)-5(c).\154\ As such, and consistent with SEC Pay-to-Play Rule 206(4)-5(c), proposed Rule 2030(d) is 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.\155\ Finally, FINRA notes that the applicability of proposed Rule 2030(d) is for purposes of FINRA's pay-to-play rule only and, as such, would not impact or otherwise affect other FINRA rules or guidance. Therefore, FINRA has determined not to make the changes suggested by the commenters.\156\ --------------------------------------------------------------------------- \152\ See FINRA Response Letter 2 at 14. \153\ See id. \154\ See id. \155\ See id. at 15 (noting that when adopting SEC Pay-to-Play Rule 206(4)-5(c), the Commission stated that although ``an investment in a pooled investment vehicle may not involve a direct advisory relationship with a government sponsored plan [that] does not change the nature of the fraud or the harm that may be inflicted as a consequence of the adviser's pay-to-play activity'') (quoting SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044-45)). \156\ See FINRA Response Letter 2 at 15. --------------------------------------------------------------------------- E. Comments Regarding the Inclusion of Distribution Activity in the Proposed Rule and FINRA's Responses One commenter generally expresses concern that proposed Rule 2030 is unnecessarily ambiguous regarding the term ``distribution'' activities in Rule 2030(a).\157\ This commenter claims that it is unclear what distribution activities ``with'' a government entity would be prohibited, what compensation is covered by the proposed rule and who must pay it, and when a member firm might be deemed to be acting ``on behalf of'' an investment adviser.\158\ This commenter states that the ambiguity of proposed Rule 2030 may result in its misapplication in a variety of contexts, such as: Where a selling firm is affiliated with one, but not all, underlying fund advisers and none of the sub- adviser(s) to any underlying funds, or none of the underlying fund advisers, but some of the sub-advisers.\159\ --------------------------------------------------------------------------- \157\ See CAI Letter 1. \158\ See id. \159\ See id. --------------------------------------------------------------------------- This commenter also claims that, while the SEC Pay-to-Play Rule requires regulated persons to be subject to rules that prohibit them from engaging in certain distribution activities if certain political contributions have been made, SEC Pay-to-Play Rule 206(4)-5 does not mandate the use of the term ``distribution'' in describing the conduct prohibited by the proposed rule, and suggested revised rule text reflecting that assertion.\160\ The commenter believes that its suggested revisions would eliminate, among other things, the potential concern that a selling firm might violate proposed Rule 2030 unknowingly due to being deemed to be acting on behalf of investment advisers [[Page 60060]] or sub-advisers of underlying funds with which it has no relationship.\161\ --------------------------------------------------------------------------- \160\ See CAI Letter 1 and CAI Letter 2 (reflecting CAI's suggested revisions to certain language in some of FINRA's proposed rules). \161\ See CAI Letter 1 (claiming that the commenter's suggested revisions would not result in any inappropriate narrowing of the scope of Rule 2030). --------------------------------------------------------------------------- In response, FINRA states that it continues to maintain the position, outlined in the Notice, that it will not remove references to the term ``distribution.'' \162\ FINRA explains that the Notice pointed to language in the SEC Pay-to-Play Rule Adopting Release supporting the inclusion of distribution activities by broker-dealers in FINRA's proposed Rule 2030.\163\ Specifically, FINRA pointed to the Commission's discussion regarding under what circumstances distribution payments would violate the SEC's Pay-to-Play Rule.\164\ FINRA also notes that based on the Commission's definition of ``regulated person'' \165\ in the SEC's Pay-to-Play Rule, as well as the Commission's discussion regarding the treatment of distribution fees paid pursuant to a 12b-1 plan as compared to legitimate profits, FINRA believes that its proposed rule must apply to member firms engaging in distribution activities.\166\ FINRA mentioned previously, to the extent that interpretive questions arise regarding the application and scope of the provisions and terms used in the proposed rule change, FINRA will work with the industry and Commission to address the interpretive questions and provide additional guidance as needed.\167\ --------------------------------------------------------------------------- \162\ See FINRA Response Letter 2 at 12. \163\ See id. at 11-12 (citing Notice, 80 FR at 81660-61). \164\ See FINRA Response Letter 2 at 12 n.52 (citing SEC Pay-to- Play Rule Adopting Release, 75 FR at 4104 n.298). \165\ See FINRA Response Letter 2 at 12 (explaining that 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) (citing 17 CFR 275. 206(4)- 5(f)(9)(ii)(A)) (emphasis in original). \166\ See FINRA Response Letter 2 at 12 (citing Notice, 80 FR at 81660-61). \167\ See id. --------------------------------------------------------------------------- F. Comments Regarding Defined Terms Used in the Proposed Rules and FINRA's Responses Two commenters request clarification of certain defined terms used in the proposed rules.\168\ One commenter urged FINRA, or the Commission, to clarify the meaning of the term ``instrumentality'' as it is used in the definition of ``government entity.'' \169\ This commenter claims that, ``[w]ithout additional guidance, covered members will continue to struggle with whether a contribution to a given entity should be treated as a contribution to an `instrumentality' of a state or state agency, thus triggering the two-year time out. . . .'' \170\ This same commenter also asked for clarification as to whether each and every ``contribution'' (as defined in proposed Rule 2030(g)(1)) is, by definition, also a ``payment'' (as defined in proposed Rule 2030(g)(9)).\171\ --------------------------------------------------------------------------- \168\ See CAI Letter 1 and NAIFA Letter. \169\ See CAI Letter 1 (claiming that CAI's members have struggled to understand the contours of this term in the context of the SEC Pay-to-Play Rule). \170\ See id. \171\ See CAI Letter 1 (discussing Notice, 80 FR at 81654 n.41: ``Consistent with the SEC Pay-to-Play Rule, FINRA is including the broader term `payments,' as opposed to `contributions,' to deter a cover member from circumventing the proposed rule's prohibitions by coordinating indirect contributions to government officials by making payments to political parties''). --------------------------------------------------------------------------- Another commenter requests that FINRA clarify the definition of a ``covered associate'' and clarify and delineate the positions that would qualify someone as a covered ``official.'' \172\ This commenter claims that, in response to the same definition of ``covered associate'' as used in the SEC Pay-to-Play Rule, many investment advisers and broker-dealers have classified all of their representatives as covered associates regardless of whether they actually engage in the solicitation activity specified in the definition.\173\ This commenter believes that additional clarification on when an associated person of a covered member would (or would not) qualify as a ``covered associate'' would ease compliance burdens, curtail overly broad limits on legitimate political activity, and increase the consistency of procedures amongst member firms who seek to comply with both the letter and the spirit of the proposed rule.\174\ This same commenter requests additional details or guidance from the Commission with respect to this definition of ``official'' because, according to that commenter, that definition has caused, and will continue to spark confusion over exactly what offices subject the holder to be classified as an ``official'' given that the term is defined the same way in the SEC Pay-to-Play Rule.\175\ --------------------------------------------------------------------------- \172\ See NAIFA Letter. \173\ See id. \174\ See id. \175\ See id. --------------------------------------------------------------------------- In response, FINRA states that it recognizes, as did the commenters, that these terms are defined in the SEC Pay-to-Play Rule and that FINRA modeled the definitions in its proposal on those in the SEC Pay-to-Play Rule.\176\ With respect to CAI's request for clarification as to whether each and every ``contribution'' (as defined in proposed FINRA Rule 2030(g)(1)) is, by definition, also a ``payment'' (as defined in proposed FINRA Rule 2030(g)(9)), FINRA states that the definition of ``payment'' is similar to the definition of ``contribution,'' but is broader because 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).\177\ Finally, FINRA also acknowledges the concerns raised by the commenters and the requests for clarification and additional guidance from the Commission and FINRA as to certain terms.\178\ FINRA again states that to the extent that interpretive questions arise regarding the application and scope of the provisions and terms used in the proposed rule change, FINRA will work with the industry and Commission to address the interpretive questions and provide additional guidance as needed.\179\ --------------------------------------------------------------------------- \176\ See FINRA Response Letter 2 at 18. \177\ See id. at 17. \178\ See id. at 19. \179\ See id. --------------------------------------------------------------------------- G. Comments Regarding PAC Contributions and FINRA's Responses One commenter claims that statements made by FINRA in the Notice regarding the proposed rule's anti-circumvention provision, proposed Rule 2030(e), combined with statements made in Commission staff guidance concerning whether contributions through PACs would violate the SEC Pay-to-Play Rule and Section 208(d) of the Advisers Act, have the ability to chill contributions to PACs.\180\ This commenter claims, for example, that prospective contributors who simply want to donate to a PAC have been hesitant to or restricted from doing so out of fear that they may be making an indirect contribution in violation of the SEC Pay-to-Play Rule.\181\ Accordingly, this commenter requests further guidance from the Commission on the factors by which contributions to PACs would or would not trigger the anti-circumvention provision of the proposed rule.\182\ --------------------------------------------------------------------------- \180\ See NAIFA Letter. \181\ See id. \182\ See id. --------------------------------------------------------------------------- In response, FINRA again acknowledges the concerns raised by the commenter and the requests for clarification and additional guidance from the Commission and FINRA.\183\ FINRA states that, to the extent that interpretive questions arise regarding the application and scope of the provisions and terms used in the [[Page 60061]] proposed rule change, FINRA will work with the industry and Commission to address the interpretive questions and provide additional guidance as needed.\184\ --------------------------------------------------------------------------- \183\ See FINRA Response Letter 2 at 19. \184\ See id. at 18. --------------------------------------------------------------------------- Another commenter claims that it continues to believe that not all payments to political parties or PACs should have to be maintained under the books and records requirements of proposed Rule 4580.\185\ Rather, this commenter believes that only payments to political parties or PACs where the covered member or a 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.\186\ This commenter states that, while it appreciates FINRA's rationale for proposed Rule 4580, it believes the costs and burdens associated with the request far outweigh the benefits to FINRA in ensuring compliance with the rule and would lead to periodic ``fishing expeditions'' by FINRA examiners.\187\ --------------------------------------------------------------------------- \185\ See CAI Letter 1. \186\ See id. \187\ See id. --------------------------------------------------------------------------- In response, FINRA states that it disagrees with these comments and has determined to retain the recordkeeping requirements as proposed in FINRA Rule 4580.\188\ FINRA notes that, as discussed in the Notice, 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.\189\ Therefore, FINRA states that it 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.\190\ --------------------------------------------------------------------------- \188\ See FINRA Response Letter 2 at 20. \189\ See id. As FINRA explains in the Notice, a covered associate would include a PAC controlled by the covered member or any of its associates. FINRA states that it 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. See Notice, 80 FR at 81653, 81660 (noting that this position is consistent with the position taken by the SEC in connection with the SEC Pay-to-Play Rule) (citing SEC Pay-to-Play Adopting Release, 75 FR at 41032). \190\ See FINRA Response Letter 2 at 20-21. FINRA states in the Notice that the proposed recordkeeping requirements are intended to allow FINRA to examine for compliance with its proposed pay-to-play rule, and 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). See Notice, 80 FR at 81663. --------------------------------------------------------------------------- H. Comments Regarding the De Minimis Exception Under Proposed Rule 2030(c) and FINRA's Responses As discussed above, certain commenters raise concerns regarding the exception for de minimis contributions under proposed Rule 2030(c)(1) on First Amendment grounds.\191\ In addition, one commenter requests that the $350 and $150 amounts ``be raised substantially'' in both the SEC Pay-to-Play Rule and in proposed Rule 2030(c)(1), and further requests that the $350 limitation on the proposed exception for returned contributions under proposed Rule 2030(c)(3) be eliminated in both the SEC Pay-to-Play Rule and in FINRA's proposed rule.\192\ --------------------------------------------------------------------------- \191\ For a discussion of these First Amendment comments and FINRA's responses, see Section III.A, supra. \192\ See CAI Letter 1 (claiming that these contribution amounts fail to take inflation into consideration and are ``unreasonably low''). --------------------------------------------------------------------------- In response, FINRA explains that its proposed rules must impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers.\193\ Therefore, FINRA has proposed exceptions for de minimis contributions and returned contributions that are consistent with similar exceptions in the SEC Pay-to-Play Rule.\194\ FINRA does not believe that raising the limits for the de minimis exception or eliminating the limit for returned contributions would impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers.\195\ --------------------------------------------------------------------------- \193\ See FINRA Response Letter 2 at 19. \194\ See id. \195\ See id. --------------------------------------------------------------------------- I. Comments Regarding the Grandfathering of Existing Accounts and Contracts and FINRA's Responses One commenter requests that FINRA clarify the application of the proposed rule to existing government entity accounts or contracts.\196\ FSI requests that, in the event that FINRA does not amend the application of its proposed rule to covered investment pools (as requested by this same commenter), FINRA apply the proposed rule only to accounts and variable contracts opened after the effective date.\197\ --------------------------------------------------------------------------- \196\ See FSI Letter 1. \197\ See id. --------------------------------------------------------------------------- In response, FINRA explains that, as discussed above, its proposed rules must impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers.\198\ The Commission did not apply its rule only to contracts or accounts opened after the effective date of the rule.\199\ FINRA also explains in the Notice that, if the Commission approves the proposed rule change, proposed Rule 2030(a) will not be triggered by contributions made prior to the rule's effective date, and that the rule 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.\200\ FINRA states that the transition period--the time between the Commission approving the proposal and FINRA announcing the effective date of the rule--will provide member firms with time to identify their covered associates and government entity clients and to modify their supervisory systems to address new obligations under the rules.\201\ Therefore, FINRA does not believe that limiting the application of its rule in the way suggested by FSI would impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers.\202\ --------------------------------------------------------------------------- \198\ See FINRA Response Letter 2 at 16. \199\ See id. See also Notice, 80 FR at 81656. \200\ See Notice, 80 FR at 81656. \201\ See id. (``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.''). \202\ See FINRA Response Letter 2 at 16. --------------------------------------------------------------------------- J. Comments Regarding Application of the Proposed Rules to the Independent Business Model and FINRA's Responses One commenter claims that its members ``will face difficulties'' in attempting to comply with the proposed rules, and that these difficulties stem, primarily, from a requirement for independent firms to implement a rule that is premised on the notion that solicitation of clients is performed pursuant to a centralized process controlled by the management of a registered investment adviser.\203\ This same commenter claims that the ``lack of clarity'' as to the application of the SEC Pay-to-Play Rule to its members' independent business model, and the scope of government officials that trigger the requirements, has led some [[Page 60062]] firms to adopt aggressive compliance programs that prohibit political contributions.\204\ --------------------------------------------------------------------------- \203\ See FSI Letter 1 (claiming FSI believes that the SEC Pay- to-Play Rule has inadvertently captured non-corrupting activity and fears that the proposed rule may do the same). \204\ See id. (claiming that, absent clarity concerning the application of the proposed rule to the brokerage services provided to 403(b) and 457 plans, FSI's members will be faced with the choice of either adopting similarly aggressive policies or prohibiting sales to government-sponsored retirement plans). --------------------------------------------------------------------------- In response, FINRA states that, consistent with the SEC Pay-to-Play Rule, it has determined not to except from its proposed pay-to-play rule member firms engaged in the independent business model.\205\ FINRA, however, states that, to the extent that interpretive questions arise regarding the application and scope of the provisions and terms used in the proposed rule change, FINRA will work with the industry and Commission to address the interpretive questions and provide additional guidance as needed.\206\ --------------------------------------------------------------------------- \205\ See FINRA Response Letter 2 at 18. \206\ See id. --------------------------------------------------------------------------- K. Comments Requesting More Stringent Requirements in the Proposed Rules and FINRA's Responses Two commenters suggested that proposed Rule 2030 include more stringent requirements in certain respects.\207\ First, both commenters request that FINRA expand the applicability of its proposed rules to include state-registered investment advisers.\208\ More specifically, one of these commenters suggests that FINRA include state-registered investment advisers in its definition of ``investment adviser'' for the purposes of its proposed rule.\209\ Although FINRA states in the Notice that relatively few state-registered investment advisers manage public pension plans,\210\ one commenter believes that this alone does not justify permitting FINRA-member firms that do manage public pension plans, but happen to work with smaller investment advisers, to engage in pay-to-play activities with no repercussions.\211\ Another commenter claims that state-registered investment advisers now include larger firms and, therefore, it is much more likely that state-registered investment advisers will manage or advise public pension plans or similar funds.\212\ --------------------------------------------------------------------------- \207\ See NASAA Letter and PIABA Letter. \208\ See NASAA Letter and PIABA Letter. \209\ See NASAA Letter. \210\ See NASAA Letter and PIABA Letter. \211\ See PIABA Letter. Unless the commenter is discussing dually-registered intermediaries, we do not understand the commenter's reference to ``FINRA-member firms that do manage public pension plans'' as those plans are managed by investment advisers, not broker-dealers. \212\ See NASAA Letter. --------------------------------------------------------------------------- In response, FINRA states that, as discussed in the Notice,\213\ 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 to include state-registered investment advisers in its definition of ``investment adviser'' for the purposes of its proposed rule.\214\ As discussed in the Notice, FINRA explains that the Commission also declined to make a similar change to its proposed rule, stating that it was the Commission's understanding that few of these smaller firms manage public pension plans or other similar funds.\215\ --------------------------------------------------------------------------- \213\ See Notice, 80 FR at 81652 n.26 (explaining 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 id. at 81660 n.98 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41026). \214\ See FINRA Response Letter 2 at 10. \215\ See Notice, 80 FR at 81652 n.26. See also id. at 81660 n.98. --------------------------------------------------------------------------- Second, these two commenters request that FINRA include a mandatory disgorgement provision for violations of its proposed rule.\216\ These commenters state that they are disappointed that FINRA removed the mandatory disgorgement provisions from the proposal as outlined in FINRA's Regulatory Notice 14-50.\217\ These commenters believe that a mandatory disgorgement provision would act as a significant deterrent to engaging in pay-to-play schemes, and it should remain in FINRA's final rule.\218\ --------------------------------------------------------------------------- \216\ See NASAA Letter and PIABA Letter. \217\ See NASAA Letter and PIABA Letter. \218\ See NASAA Letter and PIABA Letter. --------------------------------------------------------------------------- In response, FINRA states that, after considering similar comments made in response to its Regulatory Notice 14-50, in particular, that FINRA has authority to require disgorgement of fees in enforcement actions, FINRA determined not to include a disgorgement requirement in its proposal.\219\ For those same reasons, which also are discussed in the Notice,\220\ FINRA also has determined not to revise the proposal to include a disgorgement requirement.\221\ --------------------------------------------------------------------------- \219\ See FINRA Response Letter 2 at 19-20. \220\ See Notice, 80 FR at 81662 (noting, for example, ICI's comment made in connection with Regulatory Notice 14-50 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''). \221\ See FINRA Response Letter 2 at 20. --------------------------------------------------------------------------- Finally, one commenter believes that the cooling-off period in the proposal should be at least four years.\222\ PIABA believes that the two-year cooling-off period does not adequately reduce the incentive for FINRA member firms to make political contributions to obtain pay- to-play advantages.\223\ PIABA states FINRA should start with the most comprehensive rule, and that it would welcome the deterrent effect of a four-year cooling off period.\224\ --------------------------------------------------------------------------- \222\ See PIABA Letter. \223\ See id. \224\ See id. --------------------------------------------------------------------------- FINRA declines to make PIABA's suggested change.\225\ FINRA explains that 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 period from the date of a contribution is sufficient to discourage covered members from engaging in pay-to-play practices.\226\ As FINRA explains in the Notice, 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 quid pro quo political contribution on the selection process can be expected to dissipate.\227\ --------------------------------------------------------------------------- \225\ See FINRA Response Letter 2 at 10. \226\ See id. \227\ See Notice, 80 FR at 81651. As the Commission explained, the two-year ``cooling-off period'' is not a penalty but, rather, is intended to be a period during which any effects of a quid pro quo are expected to dissipate. See SEC Pay-to-Play Adopting Release, 75 FR at 41026 n.104. --------------------------------------------------------------------------- IV. Discussion and Commission Findings After carefully considering the proposed rule change, the comments submitted, and FINRA's responses thereto, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a registered national securities association.\228\ --------------------------------------------------------------------------- \228\ In approving this proposed rule change, the Commission has considered the proposed rule change's impact on efficiency, competition, and capital formation. In this regard, the Commission considered FINRA's extensive discussion of these effects in its Notice and FINRA's response to comments on that discussion. Moreover, the Commission observes that, in response to the Commission's Notice, no commenter suggested that FINRA's analysis was incorrect or incomplete, or that the proposed rule change would have a negative effect on efficiency, competition, or capital formation. See 15 U.S.C. 78c(f). --------------------------------------------------------------------------- In particular, the Commission finds that the proposed rule change is consistent with Section 15A(b)(6) of the Act.\229\ Section 15A(b)(6), which governs registered national securities associations like FINRA, requires, among other things, that the association's rules be ``designed to prevent fraudulent and manipulative [[Page 60063]] acts and practices, to promote just and equitable principles of trade, . . . to remove impediments to and perfect the mechanism of a free and open market and a national market system and, in general, to protect investors and the public interest.'' \230\ As discussed in more detail below, we believe that FINRA's proposal is consistent with Section 15A(b)(6). FINRA's proposed rule will address the regulatory concerns that underlie, and thus support the objectives of, the SEC Pay-to-Play Rule, discussed below, by discouraging FINRA member firms and certain of their covered associates from engaging in quid pro quo corruption that may create market distortions--when, for example, an investment adviser is chosen on the basis of a placement agent's political contributions rather than the adviser's merit. Such conduct impedes a free and open market, and may harm investors and the public interest if government entities, including public pension plans, and their beneficiaries receive inferior services or pay higher fees.\231\ FINRA's proposed rule also promotes a free and open market and the protection of investors and the public interest by avoiding the outright ban on distribution and solicitation activity that would result if FINRA member firms were not ``regulated person[s]'' under the SEC Pay-to-Play Rule.\232\ The fact that FINRA's proposed rule may have implications for a small subset of political contributions made by certain covered associates to certain elected officials does not somehow eliminate FINRA's ability to adopt rules pursuant to the Act, or the Commission's authority to approve such rules under Section 19(b)(2) of the Act.\233\ --------------------------------------------------------------------------- \229\ 15 U.S.C. 78o-3(b)(6). \230\ Id. \231\ See FINRA Response Letter 2 at 8. See also Notice, 80 FR at 81651, 81656 (discussing the regulatory objectives of and statutory basis for the proposal). \232\ See FINRA Response Letter 2 at 5 (``FINRA believes that the proposed rule change is a more effective response to the issues addressed in the SEC Pay-to-Play Rule than a complete ban on solicitation.''). See also Notice, 80 FR at 81652, 81656 (discussing the regulatory objectives of and statutory basis for the proposal). \233\ While FINRA's proposed rule does not bar member firms and their covered associates from making contributions, it may affect the propensity of member firms and certain employees to make the subset of contributions that would trigger the two-year time-out. FINRA's rule does not impose a requirement that member firms publicly disclose political contributions. --------------------------------------------------------------------------- As support for the need for the proposed rule, FINRA outlined certain regulatory concerns in the Notice that also were identified by the Commission in connection with its adoption of the SEC Pay-to-Play Rule.\234\ These concerns, which also implicate the investor and public interest protections described in Section 15A(b)(6) of the Act, recognize the central role intermediaries, such as ``solicitors'' or ``placement agents,'' have played in actions that the Commission and other authorities have brought involving pay-to-play schemes.\235\ FINRA also acknowledges the Commission's observation of how investment advisers, in several instances, allegedly made significant payments to placement agents and other intermediaries to influence the award of advisory contracts.\236\ Moreover, FINRA points out the difficulties that investment advisers face in monitoring or controlling the activities of their third-party solicitors.\237\ --------------------------------------------------------------------------- \234\ See Notice, 80 FR at 81651, nn.12-14 (discussing concerns the Commission identified in the SEC Pay-to-Play Rule Adopting Release, 75 FR at 41037). \235\ See Notice, 80 FR at 81651. See also id. at nn.10-11 (explaining that ``solicitors'' typically locate investment advisory clients on behalf of an investment adviser, and that ``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) (citing Advisers Act Release No. 2910 (Aug. 3, 2009), 74 FR 39840, 39853 n.137 (Aug. 7, 2009) (Political Contributions by Certain Investment Advisers)). \236\ See Notice, 80 FR at 81651. See also e.g., SEC Pay-to-Play Adopting Release, 75 FR at 41037. \237\ See Notice, 80 FR at 81651. See also SEC Pay-to-Play Adopting Release, 75 FR at 41032 n.182, 40137 n.266 (acknowledging commenters' concerns regarding the difficulties that advisers may have when monitoring the activities of their third-party solicitors). --------------------------------------------------------------------------- As we explained in adopting the SEC Pay-to-Play Rule, public pension plans are particularly vulnerable to pay-to-play practices, and we have been particularly concerned that the engagement of placement agents who have made political contributions to key officials is viewed by investment advisers as a necessary step to securing a contract with a public pension plan.\238\ In connection with the SEC Pay-to-Play Rule, we initially proposed a complete bar on investment advisers engaging third parties to solicit government clients on their behalf because of concerns about investment advisers' use of third-party solicitors and placement agents to engage in pay-to-play activities.\239\ However, persuaded by commenters, we revised the proposed SEC Pay-to-Play Rule to permit advisers to make payments to certain ``regulated persons'' to solicit government clients on their behalf, provided that they are themselves subject to prohibitions against participating in pay-to-play practices, are subject to Commission oversight and, in the case of broker-dealers, the oversight of a registered national securities association such as FINRA.\240\ FINRA agreed and informed us that it would prepare rules for our consideration that would prohibit its members from soliciting advisory business from a government entity on behalf of an adviser unless they comply with pay-to-play restrictions.\241\ --------------------------------------------------------------------------- \238\ See SEC Pay-to-Play Adopting Release, 75 FR at 41019-20, nn.16-25 (collecting examples of SEC litigation releases as well as state and federal criminal actions with pay-to-play schemes involving placement agents among other intermediaries). See also id. at 40137, n.262 (collecting examples of state and local legislative actions undertaken to prohibit or regulate pay-to-play practices involving placement agents in response to concerns about pay-to-play activities in their jurisdictions). \239\ See id. at 41037 nn.259-68 (discussing the Commission's observations in the SEC Pay-to-Play Rule proposing release). \240\ See id. at 41041. \241\ See Notice, 80 FR at 81651 n.15 (citing a letter from Richard G. Ketchum, Chairman and Chief Executive Officer, FINRA, to Andrew J. Donohue, Director, Division of Investment Management, Commission (Mar. 15, 2010) (``Ketchum Letter''), available at http://www.sec.gov/comments/s7-18-09/s71809-260.pdf (stating that FINRA ``believe[s] 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 also notes that in developing its proposal it intended to draw closely upon all the substantive and technical elements of the Commission's rule as well as FINRA's regulatory expertise in examining and enforcing the MSRB rules, upon which the SEC Pay-to-Play Rule is based. See Ketchum Letter. See also SEC Pay-to-Play Adopting Release, 75 FR at 41042 n.317 (discussing same). --------------------------------------------------------------------------- Pay-to-play practices are harmful. They create an impediment to a free and open market by, for example, distorting the investment adviser selection process from one that is based on merit, performance and cost, to one that is influenced by a placement agent's contributions to the campaigns of government officials who are responsible for, or can influence the outcome of, selecting an investment adviser.\242\ As a result of this distortion, government entities, including pension funds, and their citizen beneficiaries may be harmed by receiving inferior services or paying higher fees.\243\ Investors and the public interest ultimately suffer, including taxpayers, residents who rely on municipal services, and the beneficiaries of public pension funds, such as firemen, police officers, teachers, and other civil [[Page 60064]] servants.\244\ Investment advisers also are harmed because their ability to participate in the market is impeded unless they are willing to engage in pay-to-play practices by, for example, hiring placement agents that make certain political contributions.\245\ --------------------------------------------------------------------------- \242\ See, e.g., SEC Pay-to-Play Adopting Release, 75 FR at 41023, 41039. \243\ SEC Pay-to-Play Adopting Release, 75 FR at 41019. \244\ SEC Pay-to-Play Adopting Release, 75 FR at 41019 (noting that the management of public pension plans ``most significantly . . . affects taxpayers and the beneficiaries of these funds, including the millions of present and future State and municipal retirees who rely on the funds for their pensions and other benefits''). \245\ See, e.g., SEC Pay-to-Play Adopting Release, 75 FR at 41023, 41039 (explaining that ``pay to play practices may hurt smaller advisers that cannot afford the required contributions. Curtailing pay to play arrangements enables advisory firms, particularly smaller advisory firms, to compete on merit, rather than their ability or willingness to make contributions''). --------------------------------------------------------------------------- The Commission also believes that the stealth in which pay-to-play practices occur and the inability of markets to properly address these practices argue strongly for rules like the SEC Pay-to-Play Rule and FINRA's proposal.\246\ Pay-to-play practices create a ``collective action'' problem in two respects: (1) Government officials who participate in such activities have an incentive to continue to accept contributions to support their campaigns for fear of being disadvantaged relative to their opponents; and (2) investment advisers have an incentive to participate out of concern that they may be overlooked if they fail to make a contribution.\247\ --------------------------------------------------------------------------- \246\ See SEC Pay-to-Play Adopting Release, 75 FR at 40122-23. See also FINRA Response Letter at 6 (noting that, as explained in Blount, ``no smoking gun is needed;'' however, ``where, as here, the conflict of interest is apparent, the likelihood of stealth great, and the [Commission's] purpose prophylactic''). \247\ See FINRA Response Letter at 9; SEC Pay-to-Play Adopting Release, 75 FR at 40122. --------------------------------------------------------------------------- We believe that application of FINRA's proposed pay-to-play rules will effectively discourage covered members and their covered associates who act as placement agents for investment advisers from participating in pay-to-play practices because their political contributions or payments will be subject to restrictions similar to those imposed on investment advisers under the SEC Pay-to-Play Rule.\248\ The Commission therefore believes that FINRA's proposed rule change will help address the concerns identified in the SEC Pay-to-Play Rule Adopting Release regarding the distortion of the investment advisory market.\249\ As a result, like the SEC Pay-to-Play rule, FINRA's proposal should help protect investors and the public interest by, among other things, reducing the costs to plans and their beneficiaries of inferior asset management services arising from adviser selection based on a placement agent's political contributions rather than prudential investment considerations.\250\ Further, in the Commission's view, FINRA's proposed rule strikes an appropriate balance in addressing these regulatory concerns by providing for FINRA member firms to be ``regulated person[s]'' under the SEC Pay-to-Play Rule.\251\ As a result, investment advisers will be able to continue to benefit from the use of placement agents in obtaining investment advisory business with government entities without political contributions distorting the process by which a government entity, such as a public pension fund, selects an adviser.\252\ The two-year time- out period imposed by the proposed rule change is not a penalty but, rather, is intended to discourage participation in pay-to-play practices by requiring a ``cooling-off period'' during which the effects of a quid pro quo political contribution on the selection process are expected to dissipate.\253\ This time-out will help promote fair competition in the market and protect public pension funds and investors by curbing fraudulent conduct resulting from pay-to-play practices.\254\ In addition, according to FINRA, the proposal can be expected to help promote competition by allowing more third-party solicitors to participate in the market for solicitation services, which in turn may reduce costs to investment advisers and improve competition for advisory services.\255\ For these reasons and as discussed throughout, the Commission finds that the proposed rule change is consistent with Section 15A(b)(6) of the Act.\256\ --------------------------------------------------------------------------- \248\ See Notice, 80 FR at 81651. \249\ See FINRA Response Letter at 9 (stating that ``[f]or example, the proposed rule change is reasonably designed to address the distortion of the investment advisory market and collective action problems created by pay-to-play practices''). As the Commission has explained, by addressing distortions in the process by which investment advisers are selected regarding public investments, pay-to-play rules provide important protections to public pension plans and their beneficiaries, as well as participants in other important plans or programs sponsored by government entities. See SEC Pay-to-Play Adopting Release, 75 FR at 41023, 41054. \250\ See SEC Pay-to-Play Adopting Release, 75 FR at 41039. \251\ See, e.g., FINRA Response Letter at 5 (``FINRA believes that the proposed rule change is a more effective response to the issues addressed in the SEC Pay-to-Play Rule than a complete ban on solicitation.'') See also Notice, 80 FR at 81652, 81656 (discussing the regulatory objectives of and statutory basis for the proposal). \252\ See, e.g., FINRA Response Letter 2 at 8 (``The proposed rule change accomplishes these goals by allowing member firms to continue to engage in distribution or solicitation activities for compensation with governmental entities on behalf of investment advisers, while at the same time deterring member firms from engaging in pay-to-play practices.''). \253\ See Notice, 80 FR at 81651. See also SEC Pay-to-Play Adopting Release, 75 FR at 41026 n.104. \254\ See Notice, 80 FR at 81657. \255\ See id. \256\ See 15 U.S.C. 78o-3(b)(6). --------------------------------------------------------------------------- The Commission notes that most commenters to the Notice \257\ and some of the commenters responding to the Order Instituting Proceedings \258\ generally express support for FINRA's proposal. For example, one commenter states that it is pleased that, like the SEC and the MSRB, FINRA is adopting rules to govern the activities of its members that solicit government clients on behalf of an investment adviser and also is pleased that FINRA's proposal is designed to complement, and be consistent with, the SEC's pay-to-play rule.\259\ Similarly, another commenter states that, although it requests certain revisions, it also supports FINRA's attempt to deter pay-to-play activity among covered members and supports the regulatory objectives underlying the Proposed Rules.\260\ --------------------------------------------------------------------------- \257\ See CAI Letter 1; CAI Letter 2; FSI Letter 1; ICI Letter; NAIFA Letter; NASAA Letter; and PIABA Letter. \258\ See FSI Letter 2 (claiming that the proposal creates ``compliance uncertainties'' for FSI's members, but noting that FSI ``support[s] regulatory efforts to combat pay-to-play corruption activity''). \259\ See ICI Letter. \260\ See CAI Letter 1 (recognizing ``the challenges in crafting the Proposed Rules so that they reach all of the activity sought to be eliminated without also prohibiting activity that is harmless''). --------------------------------------------------------------------------- The Commission acknowledges the concerns and questions raised by some commenters, which are outlined in further detail above in Section III. As discussed below, the Commission believes, however, that FINRA has responded to the commenters' concerns and questions in light of, among other things, the regulatory framework established by the SEC Pay-to-Play Rule, which provides that FINRA's proposed rules must impose substantially equivalent or more stringent restrictions on its members than the SEC Pay-to-Play Rule imposes on investment advisers for FINRA members to be ``regulated persons'' under the SEC Pay-to-Play Rule. A. Comments Concerning the First Amendment and Related Concerns Several commenters express the view that FINRA's proposed rule violates the First Amendment.\261\ The Commission is sensitive to the constitutional concerns raised by the commenters, but after careful consideration of their arguments, for the reasons discussed [[Page 60065]] below, concludes that FINRA's rule is consistent with the First Amendment. --------------------------------------------------------------------------- \261\ See CCP Letter 1; FSI Letter 1; FSI Letter 2; and State Parties Letter 1. See also CCP Letter 2; CCP Letter 3; Moran Letter and State Parties Letter 2. --------------------------------------------------------------------------- FINRA's rule, which focuses on covered members who serve as placement agents, tracks the SEC Pay-to-Play Rule for investment advisers, which, in turn, tracks the MSRB's pay-to-play rule, Rule G- 37, which the D.C. Circuit upheld against First Amendment challenge in 1995.\262\ The Supreme Court has issued several decisions regarding political speech since Blount was decided,\263\ and none of these decisions call into question Blount's holding that a tailored pay-to- play rule, which is nearly identical in purpose and form to FINRA's proposed rule and which also furthers an important public interest, is constitutional. Indeed, the en banc D.C. Circuit recently and unanimously upheld a broader pay-to-play restriction--a bar on all contributions to federal candidates by federal contractors--in its decision in Wagner that analyzed the post-Blount Supreme Court decisions and cited Blount with approval.\264\ Various pay-to-play restrictions imposed by other jurisdictions also have withstood First Amendment challenge in recent years.\265\ --------------------------------------------------------------------------- \262\ Blount v. SEC, 61 F.3d 938 (D.C. Cir. 1995), cert. denied, 517 U.S. 1119 (1996). One significant difference between the MSRB rule, on one hand, and the SEC's and FINRA's rules, on the other, is that the MSRB rule requires the public disclosure of political contributions whereas the SEC's and FINRA's rules do not. \263\ See, e.g., McCutcheon v. FEC, 134 S. Ct. 1434 (2014); Citizens United v. FEC, 558 U.S. 310 (2010); Davis v. FEC, 554 U.S. 724 (2008); FEC v. Wisc. Right To Life, Inc., 51 U.S. 449 (2007); Randall v. Sorrell, 548 U.S. 230 (2006); FEC v. Beaumont, 539 U.S. 146 (2003); Nixon v. Shrink Mo. Gov't PAC, 528 U.S. 377 (2000). \264\ Wagner v. FEC, 793 F.3d 1 (D.C. Cir. 2015) (en banc), cert. denied sub nom., Miller v. FEC, 136 S. Ct. 895 (2016). \265\ See, e.g., Yamada v. Snipes, 786 F.3d 1182 (9th Cir.), cert. denied, 136 S. Ct. 569 (2015); Preston v. Leake, 660 F.3d 726, 729-30, 736 (4th Cir. 2011); Ognibene v. Parkes, 671 F.3d 174, 179- 80 (2d Cir. 2011); Green Party of Connecticut v. Garfield, 616 F.3d 189, 200 (2d Cir. 2010). --------------------------------------------------------------------------- Decisions like Wagner confirm that even an outright limitation on contributions--as opposed to FINRA's rule, which may indirectly discourage contributions--is permissible if it is justified by a sufficiently important government interest and is closely drawn to avoid unnecessary abridgement of the type of political speech represented by a political contribution.\266\ We believe that FINRA's proposed rule serves a vitally important governmental interest: Discouraging a specific type of quid pro quo corruption in which political contributions made by placement agents may influence the award of investment advisory business by government entities. The Supreme Court has long held that halting quid pro quo corruption is an important government interest that justifies limitations--or outright bans--on contributions.\267\ --------------------------------------------------------------------------- \266\ Wagner, 793 F.3d at 6-8. We note that FINRA's rule is not an absolute bar on contributions, but the two-year time-out may have the effect of discouraging member firms and certain covered associates who may act as placement agents for investment advisers from making certain contributions to certain covered officials. To the extent that the commenters suggest that such an indirect limitation on contributions would be reviewed by a court under strict scrutiny, they misstate applicable Supreme Court precedent, which has maintained that limitations on contributions are reviewed under a more intermediate form of scrutiny because ``[c]ontribution limits impose a lesser restraint on political speech'' that permits ```symbolic expression of support evidence by a contribution'' but do not ```in any way infringe the contributor's freedom to discuss candidates and issues.' '' McCutcheon, 134 S. Ct. at 1444, quoting Buckley v. Valeo, 424 U.S. 1, 21 (1976). \267\ McCutcheon, 134 S. Ct. at 1452; Buckley, 424 U.S. at 27-28 (1976). --------------------------------------------------------------------------- We do not understand FINRA to be engaging in broad electoral reform or trying to clean up the electoral process. Rather, to avoid the outright ban on placement agent activity resulting from FINRA member firms not being ``regulated person[s]'' under the SEC Pay-to-Play Rule, the two-year time-out in FINRA's proposal, like the SEC Pay-to-Play Rule, discourages quid pro quos that affect government entities, including public pension funds, served by investment advisers. Quid pro quos involving placement agents, who make contributions to certain elected officials and then assist investment advisers in obtaining business from the government entities those officials serve may be: Fraudulent, run counter to just and equitable principles of trade, impede a free and open market, and harm investors and the public interest.\268\ When pay-to-play is a factor in the selection or retention of an investment adviser--when the adviser is chosen on the basis of a placement agent's political contributions rather than its merit--the most qualified adviser may not be hired, which may lead to inferior performance and payment of higher fees.\269\ Ultimately, taxpayers and fund beneficiaries suffer the harm. Moreover, pay-to-play distorts free and open markets by requiring investment advisers and their placement agents to ``play the game'' or risk being left out.\270\ In short, while FINRA's rule resembles other contribution limitations by serving a government interest in discouraging quid quo pro corruption, it is a targeted effort that should protect investors and the public by promoting the integrity of the investment advisory market. --------------------------------------------------------------------------- \268\ Blount, 61 F.3d at 944-48. See also 15 U.S.C. 78o-3(b)(6). \269\ SEC Pay-to-Play Adopting Release, 75 FR at 41022, 41053- 54. \270\ Id. at 41019, 41022, 41053. See also Blount, 61 F.3d at 945-46. --------------------------------------------------------------------------- FINRA's proposed rule advances this important governmental interest because the two-year time-out discourages pay-to-play. As explained above, pay-to-play has been and is a serious problem when placement agents assist investment advisers in obtaining advisory business from government entities.\271\ Placement agents ``played a central role in actions that [the Commission] and other authorities have brought involving pay-to-play schemes,'' and, in several instances, advisers used placement agents, who had made campaign contributions to elected officials, to influence the award of investment advisory contracts.\272\ Most notably, Alan Hevesi, the Comptroller of New York State who was responsible for investment of state pension funds, accepted campaign contributions from a placement agent and steered over $250 million in pension funds to investment advisers that had retained the placement agent.\273\ --------------------------------------------------------------------------- \271\ SEC Pay-to-Play Adopting Release, 75 FR at 41019-20. Pay- to-play that affects State and local pension funds is not limited to the investment advisory context. \272\ SEC Pay-to-Play Adopting Release, 75 FR at 41019-20, 41037. \273\ Id. at 41019-20. --------------------------------------------------------------------------- In response to these incidents, the Commission proposed a ban on the use of placement agents by investment advisers and ultimately adopted a final rule that permitted use of placement agents so long as they were ``regulated persons'' governed by the type of pay-to-play rule that FINRA has proposed here.\274\ FINRA is not alone in addressing these issues. For example, several State and local governments have barred or restricted placement agents from playing a role in the contracting process.\275\ Although the Supreme Court has never required a certain amount of past quid pro quo corruption to sustain a contribution limitation, there is more than sufficient evidence of pay-to-play practices to support FINRA's rule.\276\ --------------------------------------------------------------------------- \274\ Id. at 41037-42. \275\ Id. at 41037 n. 262. \276\ McCutcheon, 134 S. Ct. at 1445, 1458; Nixon, 528 U.S. at 390-91; Buckley, 424 U.S. at 29-30. --------------------------------------------------------------------------- The contours of FINRA's proposed rule reflect how pay-to-play practices involving placement agents affect the hiring and retention of investment advisers by State and local pension funds. One scenario implicated by FINRA's rule (and reflected in the [[Page 60066]] Hevesi matter) involves an investment adviser that seeks business from a State pension fund and retains a firm, or an individual at a firm, that has made contributions to an elected official responsible for selecting investment advisers.\277\ The elected officials who participate have no incentive to stop accepting contributions for fear of being disadvantaged relative to their opponents. Similarly neither the placement agents that make the contributions nor the investment advisers that hire the placement agents have an incentive to stop out of concern that if they abstain, their competitors will continue to engage in the practice profitably and without adverse consequences.\278\ FINRA's rule should resolve this collective-action problem by interposing a time-out that creates a disincentive to engage in pay-to-play. --------------------------------------------------------------------------- \277\ SEC Pay-to-Play Adopting Release, 75 FR at 41019-20 & nn.18-20 (citing examples). \278\ Id. at 41022, 41040, 41053. See also Blount, 61 F.3d at 945-46. Even if the public is aware of the quid pro quo relationship, there is little that can be done because the official is compromised by the receipt of the contribution, and beneficiaries of a pension fund cannot easily shift their assets out of the fund, reverse the hiring decision, or remove the official. Id. at 41027. See also id. at 41053 n.459. --------------------------------------------------------------------------- The proposed FINRA rule, like the SEC Pay-to-Play Rule that it is modeled on, is a tailored solution to a particularly pernicious form of quid pro quo corruption that affects the beneficiaries of public pension funds, such as teachers, law enforcement officers, firefighters, and other public servants, as well as the beneficiaries of other collective government funds, including participant-directed plans such as 403(b), 457 and 529 plans. The proposed FINRA rule would affect a small segment of the electorate: In general, member firms acting as placement agents for investment advisers seeking to obtain advisory business from government entities. And the proposed FINRA rule would affect only a small number of elected officials--those who are responsible for or have authority to appoint any person who is responsible for or can influence the outcome of the hiring of an investment adviser by a government entity--and has no bearing on the vast majority of elections where the elected office's scope of authority does not encompass the awarding of investment advisory contracts. Moreover, the proposed FINRA rule's de minimis exception permits some campaign contributions to be made in all instances without triggering the time-out--thus allowing ``the symbolic expression of support evidenced by a contribution''--and it does not restrict other forms of political speech, such as independent expenditures.\279\ --------------------------------------------------------------------------- \279\ McCutcheon, 134 S. Ct. at 1444, quoting Buckley, 424 U.S. at 21 (internal quotation marks omitted). --------------------------------------------------------------------------- B. Comments Regarding the Scope and Coverage of the Proposal As discussed in detail above, the commenters raise several concerns regarding the scope and coverage of the proposed rules, including with respect to: The inclusion of variable annuities and mutual funds; \280\ the inclusion of distribution activities; \281\ the application to covered investment pools; \282\ the level of the de minimis contribution exception and the returned contribution exception; \283\ the inclusion of the independent business model; \284\ and the application to existing contracts or accounts.\285\ FINRA generally responded that its proposed rules are designed to be at least as stringent as the SEC Pay-to-Play Rule so that FINRA's member firms will meet the definition of ``regulated persons'' such that they are subject to rules that impose substantially equivalent or more stringent restrictions on its members than the SEC Pay-to-Play Rule imposes on investment advisers.\286\ --------------------------------------------------------------------------- \280\ See CAI Letter 1 and FSI Letter 1. See also CAI Letter 2 (reflecting CAI's suggested revisions to certain language in some of FINRA's proposed rules). In FINRA's view, because the Commission did not exclude specific products from the SEC Pay-to-Play Rule, such as variable annuities or mutual funds, excluding specific products from its proposed rule would not satisfy the Commission's stringency requirements. See FINRA Response Letter 2 at 16. \281\ See CAI Letter 1. See also CAI Letter 2 (reflecting CAI's suggested revisions to certain language in some of FINRA's proposed rules). FINRA notes that, among other things, language in the SEC Pay-to-Play Rule Adopting Release supports the inclusion of ``distribution'' activities by broker-dealers in FINRA's proposed Rule 2030(a). See Notice, 80 FR at 81660-61 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298 where, according to FINRA, the Commission ``clarif[ied] under what circumstances distribution payments would violate the SEC's Pay-to-Play Rule''). FINRA believes that based on the Commission's definition of ``regulated person'' in the SEC's Pay-to-Play Rule, as well as the Commission's discussion regarding the treatment of distribution fees paid pursuant to a 12b-1 plan as compared to legitimate profits, its proposed rule must apply to member firms engaging in distribution activities. See FINRA Response Letter 2 at 12 (citing Notice, 80 FR at 81660-61) and FINRA Response Letter 2 at 12 n.53 (explaining that 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, and citing SEC Pay-to-Play Rule 206(4)-5(f)(9)(ii)(A)) (emphasis in original). \282\ See CAI Letter 1; FSI Letter 1; FSI Letter 2. FINRA clarifies that it is not intending in this proposal to re- characterize broker-dealers' selling interests in variable annuities, mutual funds, and private funds as soliciting an investment advisory relationship with investors who invest in those products. See FINRA Response Letter 2 at 14-15 (noting, for example, that the applicability of proposed FINRA Rule 2030(d) is for purposes of FINRA's pay-to-play rule only). FINRA also explains that FINRA Rule 2030(d) is modeled on a similar provision in the SEC Pay- to-Play Rule, Rule 206(4)-5(c) and, as such, proposed FINRA Rule 2030(d) is 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. See FINRA Response Letter 2 at 15 (noting that when adopting SEC Pay-to-Play Rule 206(4)-5(c), the Commission stated that although ``an investment in a pooled investment vehicle may not involve a direct advisory relationship with a government sponsored plan [that] does not change the nature of the fraud or the harm that may be inflicted as a consequence of the adviser's pay-to-play activity'') (quoting SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044-45). Finally, FINRA notes that the applicability of proposed FINRA Rule 2030(d) is for purposes of FINRA's pay-to-play rule only. See FINRA Response Letter 2 at 15. \283\ See CAI Letter 1. In response, FINRA explains that it has proposed exceptions for de minimis contributions and returned contributions that are consistent with similar exceptions in the SEC Pay-to-Play Rule as FINRA's proposed rules must impose substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers. FINRA does not believe that raising the limits for the de minimis exception or eliminating the limit for returned contributions would satisfy the Commission's stringency requirements set forth in the SEC Pay-to- Play Rule. \284\ See FSI Letter and FSI Letter 2. FINRA explains that the Commission did not exempt application of the rule for firms engaged in the independent business model. See FINRA Response Letter 2 at 16. As a result, in FINRA's view, excluding independent business model firms from its proposed rule would not satisfy the Commission's stringency requirements, although FINRA is willing to work with the industry and Commission to address the interpretive questions and provide additional guidance as needed. \285\ See FSI Letter 1. In response, FINRA explains that the Commission did not apply its rule only to contracts or accounts opened after the effective date of the rule; therefore, FINRA does not believe that limiting the application of its rule in the way suggested by FSI would satisfy the Commission's stringency requirements set forth in the SEC Pay-to-Play Rule. However, FINRA also explains that, if the Commission approves the proposed rule change, proposed Rule 2030(a) will not be triggered by contributions made prior to the rule's effective date, and that the rule 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. See Notice, 80 FR at 81656. \286\ See, e,g., FINRA Response Letter 2 at 4, 16. --------------------------------------------------------------------------- As noted above, the SEC Pay-to-Play Rule, in part, prohibits any investment adviser covered under the rule or any of 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 such person is a ``regulated person,'' as defined under the rule.\287\ The definition of ``regulated person'' [[Page 60067]] includes a FINRA 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 Commission 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.\288\ Thus, any changes to the proposed rules that would result in FINRA's rules not being found to impose at least substantially equivalent restrictions on its member firms and to be otherwise consistent with the objectives of the SEC Pay-to-Play Rule would result in a ban on such activity. --------------------------------------------------------------------------- \287\ See Notice, 80 FR at 81650 n.6, 81656. See also 17 CFR 275.206(4)-5(a)(2)(i)(A). \288\ See Notice, 80 FR at 81650 n.6. See also SEC Pay-to-Play Rule 206(4)-5(f)(9). The definition of ``regulated person'' also includes SEC-registered investment advisers and SEC-registered municipal advisors, subject to specified conditions. --------------------------------------------------------------------------- The Commission believes that it is appropriate and consistent with Section 15A(b)(6) of the Act for FINRA to design its proposed rules to have the same scope and provisions as the SEC Pay-to-Play Rule. If the Commission were unable to make the required stringency finding, this would result in FINRA member firms not being a ``regulated person'' under the SEC Pay-to-Play Rule and therefore prohibited from receiving compensation for engaging in distribution and solicitation activities with government entities on behalf of investment advisers.\289\ --------------------------------------------------------------------------- \289\ See Notice, 80 FR at 81650 n.6. See also id. at 81651, 81656 (discussing the regulatory objectives of and statutory basis for the proposal). --------------------------------------------------------------------------- One commenter states that the proposal is ambiguous regarding the term ``distribution'' activities in Rule 2030(a).\290\ This term in FINRA's proposed rule is taken directly from the definition of ``regulated person'' in the SEC Pay-to-Play Rule.\291\ Although the term ``distribution'' is not defined specifically in the SEC Pay-to- Play Rule, to preserve the identified benefits of the rule, the Commission interprets the term broadly in the context of the SEC Pay- to-Play Rule to mean generally engaging in any activity that is primarily intended to result in the sale of securities.\292\ In view of the Commission's prior statements regarding the term, including those contained in the SEC Pay-to-Play Rule Adopting Release,\293\ we believe the term is not ambiguous and could be applied by FINRA members for purposes of the proposed rule in a way that is consistent with the prophylactic nature of the proposal. However, we note that in connection with adopting the SEC Pay-to-Play Rule, the Commission did clarify under what circumstances distribution payments would violate the SEC's Pay-to-Play Rule.\294\ For example, the Commission explained that mutual fund distribution fees are typically paid by the fund from fund assets pursuant to a 12b-1 plan and generally would not constitute payment by the fund's adviser; therefore, such payments would not be prohibited under Rule 206(4)-5.\295\ The Commission also explained that where an adviser pays for the fund's distribution out of its ``legitimate profits,'' the rule would generally be implicated.\296\ Based on the foregoing, we believe it is appropriate for FINRA not to have specifically defined the term ``distribution'' activities for purposes of its proposal. --------------------------------------------------------------------------- \290\ See CAI Letter 1. \291\ A ``regulated person,'' as defined in the SEC Pay-to-Play Rule, includes a FINRA member firm, provided that, among other things, FINRA rules ``prohibit member firms from engaging in distribution or solicitation activities if certain political contributions have been made.'' 17 CFR 275.206(4)-5(f)(9)(ii) (emphasis added). \292\ By way of example in other contexts, the Commission has recognized that, because new distribution activities may continuously evolve in the future, it would be impracticable to develop, for example, an all-inclusive definition or list of such activities and related expenses, and declined to do so when it adopted the SEC Pay-to-Play Rule. See Bearing of Distribution Expenses by Mutual Funds, Investment Company Act Release No. 11414 (Oct. 28, 1980), 45 FR 73898, 73903 (Nov. 7, 1980) (``Rule 12b-1 Adopting Release''). See also 17 CFR.12b-1(a)(2) (explaining, in the context of registered open-end funds, that one will be deemed to be acting as a distributor of securities if they engage in ``any activity which is primarily intended to result in the sale of shares issued by such [fund], including, but not necessary limited to, the compensation of underwriters, dealers and other sales personnel, the printing and mailing of prospectuses to other than current shareholders, and the printing and mailing of sales literature''). \293\ See infra notes 294-296 and accompanying text. \294\ See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298. See also FINRA Response Letter 2 at 12 (citing Notice, 80 FR at 81660-61). \295\ See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298 (citing Rule 12b-1 Adopting Release). \296\ See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 (citing Rule 12b-1 Adopting Release). --------------------------------------------------------------------------- One commenter claims that, among other things, the ``lack of clarity as to the application of the SEC Pay-to-Play Rule to [its] members' business model, and the scope of government officials that trigger the requirements, has led some firms to adopt aggressive compliance programs that prohibit political contributions.'' \297\ As discussed above, FINRA states that, consistent with the SEC Pay-to-Play Rule, it has determined not to except from its proposed pay-to-play rule member firms that use an independent business model.\298\ We note that FINRA's rules and the federal securities laws do not distinguish so-called independent business model firms from other broker-dealer business models.\299\ Rather, although a broker-dealer may organize its operations under a variety of business models, and different business models may present unique compliance challenges, it is up to the broker-dealer to sufficiently discharge its regulatory obligations in light of the business model it has elected, and to tailor its supervisory system appropriately so that it is reasonably designed \300\ to achieve compliance with applicable federal securities laws and regulations and FINRA rules.\301\ --------------------------------------------------------------------------- \297\ See FSI Letter 1 (claiming FSI believes that the SEC Pay- to-Play Rule has inadvertently captured non-corrupting activity and it fears that the proposed rule may do the same). \298\ See FINRA Response Letter 2 at 18. \299\ While a firm may accept independent contractor status for purposes other than the federal securities laws, such treatment does not alter such person's status as a person associated with a broker or dealer or the firm's responsibility to supervise under the federal securities laws. See, e.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1572-76 (9th Cir. 1990) (en banc) (explaining that, even if a broker-dealer and registered representative contractually agree that a representative is an independent contractor, the broker-dealer is still required to supervise its representatives). \300\ See FINRA Rule 3110(a) (``Each member shall establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations and with applicable FINRA rules.'') and Exchange Act Section 15(b)(4)(E), 15 U.S.C. 78o(b)(4)(E) (authorizing the Commission to sanction a broker-dealer that ``has failed reasonably to supervise, with a view to preventing violations of'' the federal securities laws and rules and regulations thereunder). \301\ Giving guidance on its supervision rule, FINRA (then-NASD) noted that to fulfill its obligations to establish and maintain a supervisory system, a member firm must determine the types of business it conducts, how the firm is organized and operated, and the current regulatory requirements. See NASD Notice to Members 99- 45 (NASD Provides Guidance on Supervisory Responsibilities) (June 1999) (stating that this analysis will enable the member to design a supervisory system that is current and appropriately tailored to its specific attributes and structure). See also FINRA Regulatory Notice 14-10 (SEC Approves New Supervision Rules) (Mar. 2014), at 17 n.4 (discussing NASD Notice to Members 99-45). --------------------------------------------------------------------------- We also note that FINRA has committed to working with the industry and the Commission to address interpretive questions that may arise regarding the application and scope of the provisions and terms used in the proposed rule change and to provide additional guidance as needed.\302\ --------------------------------------------------------------------------- \302\ See FINRA Response Letter 2 at 18. We note that the proposed rule does contain a provision--modeled on an analogous provision in the SEC Pay-to-Play Rule--allowing member firms to apply to FINRA for an exemption, conditional or unconditional, from the proposed rule's two-year ``time-out,'' and enumerates factors for FINRA to consider in deciding whether to grant such an exemption. See Proposed Rule 2030(f). --------------------------------------------------------------------------- [[Page 60068]] C. Comments Requesting Clarification of Terms and Provisions in the Proposal Commenters asked for clarification of certain defined terms and provisions in the proposed rule, including clarification with respect to: The term ``instrumentality'' as it is used in the definition of ``government entity;'' \303\ the definition of ``covered associate'' and the positions that would qualify someone as a covered ``official;'' \304\ whether a ``contribution'' is also a ``payment;'' \305\ and the factors by which contributions to a PAC would trigger the proposed anti-circumvention rule.\306\ In response to these comments, FINRA generally acknowledges, as did the commenters, that these terms are defined in the SEC Pay-to-Play Rule and that FINRA modeled the definitions in its proposal on those in the SEC Pay-to-Play Rule.\307\ --------------------------------------------------------------------------- \303\ See CAI Letter 1. \304\ See NAIFA Letter. \305\ See CAI Letter 1. \306\ See NAIFA Letter. \307\ See FINRA Response Letter 2 at 17, 18. --------------------------------------------------------------------------- The Commission believes that FINRA's definition of ``covered associate'' in proposed Rule 2030(g) is functionally identical to the definition of the same term in the SEC Pay-to-Play Rule.\308\ The definition brings within the ambit of the rule--and its two-year ``time-out''--only those contributions made by employees of a member firm who, by virtue of their position or responsibilities, are best positioned to engage in pay-to-play activities as placement agents. It includes ``[a]ny general partner, managing member or executive officer of a covered member,'' any ``associated person of a covered member who engages in distribution or solicitation activities with a government entity for such covered member,'' any associated person who supervises such an employee, and any ``political action committee controlled by a covered member or a covered associate.'' FINRA's rule also adopts the Commission's definition of ``executive officer,'' which was designed to tailor the trigger for the time-out to those officers whose position is most likely to incentivize them to engage in solicitation or distribution activities--and thus most likely to incentivize them to engage in pay-to-play.\309\ --------------------------------------------------------------------------- \308\ Compare Proposed Rule 2030(g)(2), with 17 CFR 275.206(4)- 5(f)(2). \309\ At least one commenter points out that some entities have precluded all employees from making contributions as a result of the Commission's pay-to-play rule and that FINRA's rule will have the same effect. See FSI Letter 2. However, under FINRA's rule (and the SEC Pay-to-Play Rule), only certain employees' contributions will trigger the time-out and the rules on their face do not cover contributions by all employees. See SEC Pay-to-Play Rule Adopting Release, 75 FR at 40131-32. --------------------------------------------------------------------------- FINRA's definition of ``official'' also tracks the Commission's definition of that same term in the SEC Pay-to-Play Rule and, therefore, limits the rule so that a time-out is triggered only by contributions to certain officials.\310\ Under FINRA's proposed rule, the time-out for a placement agent is not triggered by a contribution to every public official running for office; it is triggered only by contributions to a 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 . . . [i]s directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser by a government entity'' or a person with authority to appoint someone whose office had the hiring responsibility.\311\ FINRA's definition, like the Commission's, is flexible enough to accommodate the myriad State and local political structures while still limiting the reach of the rule to those officials who are responsible for or have authority to appoint any person who is responsible for or can influence the outcome of the hiring of an investment adviser by a government entity.\312\ --------------------------------------------------------------------------- \310\ Compare Proposed Rule 2030(g)(8), with 17 CFR 275.206(4)- 5(f)(6). \311\ See supra note 310. \312\ If FINRA were to define ``official'' by reference to a particular title, such as ``Comptroller,'' the definition would be both over- and under- inclusive. Some officials who have hiring responsibility for investment advisers do not hold the title of ``Comptroller,'' and some officials with the title of ``Comptroller'' do not have hiring responsibility for investment advisers. Because we understand FINRA's definition to track the definition that we adopted in the SEC Pay-to-Play Rule, we note that it is the scope of authority of the office, not de facto influence, that determines whether a contribution will trigger the time-out. See SEC Pay-to-Play Adopting Release, 75 FR at 41029. --------------------------------------------------------------------------- Additionally, FINRA's definitions of ``contribution'' and ``payment'' are functionally identical to those same definitions in the SEC Pay-to-Play Rule.\313\ We note that under FINRA's rule, the time- out is not triggered by direct contributions to political parties. Therefore, a member firm will not violate the time-out if it receives compensation for solicitation and distribution activities in the wake of contributions that it or its covered associates make to a political party. Instead, FINRA's proposed rule only precludes a covered member from soliciting or coordinating payments to a political party of a State or locality of a government entity with which the covered member is engaging in distribution or solicitation activities on behalf of an investment adviser.\314\ FINRA notes in response to a commenter's request for clarification as to whether each and every ``contribution'' (as defined in proposed FINRA Rule 2030(g)(1)) is, by definition, also a ``payment'' (as defined in proposed FINRA Rule 2030(g)(9)), that the definition of ``payment'' 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).\315\ --------------------------------------------------------------------------- \313\ Compare Proposed Rules 2030(g)(8)-(9), with 17 CFR 275.206(4)-5(f)(1), 206(4)-5(f)(7). \314\ See Proposed Rule 2030(b). This aspect of the rule serves an anti-circumvention function, along with proposed Rule 2030(e), which makes it a violation of the 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.'' As FINRA notes, Rule 2030(e) precludes only intentional efforts to circumvent the time-out and a covered member would not violate the rule's prohibition on the receipt of compensation unless there is a showing that the covered member intended to evade the time-out. Thus, a contribution to a PAC--other than a PAC controlled by the covered member, which would be a ``covered associate'' for purposes of the time-out--would not trigger the time-out and the receipt of compensation in the wake of that contribution would not violate the rule unless it can be shown that the covered member or covered associate who made the contribution intended to circumvent the time- out provision. This provision, which is analogous to a provision in the Commission's Pay-to-Play Rule, precludes a member or its covered associates from, for example, funneling contributions or payments through third parties, such as attorneys, family members, or friends, to complete a pay-to-play arrangement without triggering the time-out. \315\ See FINRA Response Letter 2 at 17. --------------------------------------------------------------------------- The Commission believes that FINRA's definitions, which mirror or are functionally equivalent to similar definitions in the SEC's Pay-to- Play Rule, will help to achieve the objectives of the SEC Pay-to-Play Rule and, as described above, the requirements governing the rules of a registered national securities association.\316\ The Commission believes that it is appropriate and consistent with the Act for FINRA to encompass in its rule the same definitions and discussion regarding its pay-to-play rules as the Commission did in adopting the SEC Pay-to- Play Rule. The Commission emphasizes that FINRA has committed to working with the industry and the Commission to address interpretive questions and provide additional guidance as needed.\317\ --------------------------------------------------------------------------- \316\ See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41042- 44. \317\ There are several ways for industry members to obtain guidance from FINRA about the application of its rules. Such guidance may include FINRA's publication of Notices to Members and Regulatory Notices, as well as interpretative and exemptive letters. Although FINRA can address interpretive questions with respect to its own rules, for its member firms to satisfy the ``regulated person'' definition in the SEC Pay-to-Play Rule, the Commission must find that FINRA's pay-to-play rule (i) imposes substantially equivalent or more stringent restrictions on member firms than the SEC Pay-to-Play Rule imposes on investment advisers and (ii) that such rule is consistent with the objectives of the SEC Pay-to-Play Rule. See supra note 22 (discussing the Commission's notice of stringency findings dated August 25, 2016). Given the stringency requirements of the SEC Pay-to-Play Rule, we expect our staff to work closely with FINRA regarding interpretive questions about the application and scope of the provisions and terms used in FINRA's rule to the extent those interpretations do not otherwise require FINRA to file a proposed rule change with the Commission pursuant to Section 19(b) of the Act and the rules and regulations thereunder. --------------------------------------------------------------------------- [[Page 60069]] D. Comments Regarding the Books and Records Requirements One commenter claims that not all payments to political parties or PACs should have to be maintained under the books and records requirements of proposed Rule 4580.\318\ In response, FINRA states that it has determined to retain the recordkeeping requirements as proposed in the Notice.\319\ FINRA notes that, as discussed in the Notice, 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.\320\ FINRA states that it proposed requiring a covered member to maintain a record of all payments to political parties or PACs because such records would assist FINRA in identifying situations that might suggest an intent to circumvent the rule.\321\ --------------------------------------------------------------------------- \318\ See CAI Letter 1. \319\ See FINRA Response Letter 2 at 20-21. \320\ See id. As FINRA explains in the Notice, a covered associate would include a PAC controlled by the covered member or any of its associates. FINRA states that it 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. See Notice, 80 FR at 81653, 81660 (noting that this position is consistent with the position taken by the Commission in connection with the SEC Pay-to-Play Rule) (citing SEC Pay-to-Play Adopting Release, 75 FR at 41032). \321\ See FINRA Response Letter 2 at 20. FINRA states in the Notice that the proposed recordkeeping requirements are intended to allow FINRA to examine for compliance with its proposed pay-to-play rule, and 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). See Notice, 80 FR at 81663. --------------------------------------------------------------------------- The Commission acknowledges the comment, but agrees, as noted by FINRA, that payments to political parties or PACs can be a means for a covered member or covered associate to contribute indirectly to a government official in contravention of the proposed rule. The Commission also agrees that requiring FINRA members to maintain a record of all payments to political parties or PACs would assist FINRA in identifying situations that might suggest an intent to violate proposed Rules 2030(b) and 2030(e).\322\ The Commission therefore believes that it is appropriate and consistent with the Act for FINRA to require its members to keep records of all such payments to assist FINRA in carrying out its regulatory responsibilities to enforce compliance with the Act and with FINRA's rules.\323\ --------------------------------------------------------------------------- \322\ We note that proposed Rule 2030(e) would require a showing of intent to circumvent the rule for such persons to trigger the two-year ``time-out.'' See Notice, 80 FR at 81654. See also SEC Pay- to-Play Rule Adopting Release, 75 FR at 41044 n.340 (explaining that like MSRB Rule G-37(d), SEC Pay-to-Play Rule 206(4)-5(d) also ``requires a showing of intent to circumvent the rule for such persons to trigger the time out'') (citing Blount, 61 F.3d at 948 (``In short, according to the SEC, the rule restricts such gifts and contributions only when they are intended as end-runs around the direct contribution limitations.'')). \323\ Section 15A(b)(2) of the Act requires, among other things, that a registered national securities association, such as FINRA, has the capacity to enforce compliance by its members and persons associated with its members with the provisions of the Act, the rules and regulations thereunder, and the rules of the association. See 15 U.S.C. 78o-3(b)(2). --------------------------------------------------------------------------- E. Additional Comments Certain commenters also suggested that FINRA should include more stringent requirements in its proposed rule.\324\ Both commenters suggested that FINRA expand the applicability of its proposed rules to include state-registered investment advisers.\325\ In response, FINRA explains that 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 to include state-registered investment advisers.\326\ --------------------------------------------------------------------------- \324\ See NASAA Letter and PIABA Letter. \325\ See NASAA Letter and PIABA Letter. \326\ See FINRA Response Letter 2 at 10. --------------------------------------------------------------------------- The Commission acknowledges this comment but believes that it is appropriate for FINRA to determine to provide for the same scope of its pay-to-play rule as that of the SEC Pay-to-Play Rule. As FINRA notes, the Commission previously declined to make a similar change to the SEC Pay-to-Play Rule stating, among other things, that it was the Commission's understanding that few of these smaller state-registered firms manage public pension plans or other similar funds.\327\ --------------------------------------------------------------------------- \327\ See Notice, 80 FR at 81652 n.26, 81660 n.98. See also SEC Pay-to-Play Rule Adopting Release, 75 FR at 41026, 41060. The Commission also explained in connection with the SEC Pay-to-Play Rule that we do not have regulatory authority to oversee the activities of state-registered advisers through examination and our recordkeeping rules, nor does the Commission have authority over the states to oversee their enforcement of their rules. See SEC Pay-to- Play Rule Adopting Release, 75 FR at 41026, 41060. --------------------------------------------------------------------------- These same commenters suggest that FINRA include a mandatory disgorgement provision for violations of its proposed rule.\328\ In response, FINRA explains that it determined not to include a disgorgement requirement in its proposal because it has existing authority to require disgorgement of fees in enforcement actions.\329\ The Commission believes that it is appropriate and consistent with the Act for FINRA not to separately require mandatory disgorgement for violations of its proposed rules. --------------------------------------------------------------------------- \328\ See NASAA Letter and PIABA Letter. \329\ See FINRA Response Letter 2 at 19-20. --------------------------------------------------------------------------- Finally, one of these commenters suggests that the current two-year cooling-off period in the proposal should be at least four years.\330\ In response, FINRA states that it believes a two-year time-out from the date of a contribution is sufficient to discourage covered members from participating in pay-to-play practices by requiring a cooling-off period during which the effects of a quid pro quo political contribution on the selection process can be expected to dissipate.\331\ In addition, FINRA explains that the proposed two-year time-out is consistent with the time-out period in the SEC's Pay-to- Play Rule. The Commission believes that it is appropriate and consistent with the Act for FINRA to determine that a two-year time-out is sufficient to support the objective of the rule to deter pay-to-play activity among its covered members. The Commission notes that the same time period applies in the SEC's Pay-to-Play Rule. --------------------------------------------------------------------------- \330\ See PIABA Letter. \331\ See FINRA Response Letter 2 at 10. As the Commission explained, the two-year ``cooling-off period'' is not a penalty but, rather, is intended to be a period during which any effects of a quid pro quo are expected to dissipate. See SEC Pay-to-Play Adopting Release, 75 FR at 41026 n.104. --------------------------------------------------------------------------- The Commission recognizes these commenters suggest that the rule could have a broader scope. The Commission, however, must evaluate the proposed rule before it and approve a proposed rule if it finds that the proposed rule is consistent with the requirements of the Act and the applicable rules and regulations thereunder. As discussed above, because the rule is consistent with the Act, the Commission is required to approve the FINRA rule. [[Page 60070]] V. Conclusion Accordingly, for the reasons discussed above, the Commission finds that the proposed rule change is consistent with the Act and the rules and regulations thereunder applicable to such organization. It is therefore ordered, pursuant to Section 19(b)(2) of the Act,\332\ that the proposed rule change (SR-FINRA-2015-056) be, and hereby is, approved. --------------------------------------------------------------------------- \332\ 15 U.S.C. 78s(b)(2). By the Commission. Brent J. Fields, Secretary. [FR Doc. 2016-20888 Filed 8-30-16; 8:45 am] BILLING CODE 8011-01-P
![Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices 60051
arguments concerning the foregoing, SECURITIES AND EXCHANGE pension plans, and their beneficiaries
including whether the proposed rule COMMISSION receive inferior services or pay higher
change is consistent with the Act. fees.
[Release No. 34–78683; File No. SR–FINRA–
Comments may be submitted by any of 2015–056] The proposed rule change was
the following methods: published for comment in the Federal
Electronic Comments Self-Regulatory Organizations; Register on December 30, 2015.4 The
Financial Industry Regulatory Commission received ten comment
• Use the Commission’s Internet Authority, Inc.; Order Approving a letters, from nine different commenters,
comment form (http://www.sec.gov/ Proposed Rule Change To Adopt
rules/sro.shtml); or in response to the Notice.5 On February
FINRA Rule 2030 and FINRA Rule 4580
8, 2016, FINRA extended the time
• Send an email to rule-comments@ To Establish ‘‘Pay-To-Play’’ and
Related Rules period by which the Commission must
sec.gov. Please include File Number SR–
approve the proposed rule change,
BX–2016–047 on the subject line.
August 25, 2016. disapprove the proposed rule change, or
Paper Comments institute proceedings to determine
I. Introduction
• Send paper comments in triplicate whether to approve or disapprove the
On December 16, 2015, Financial proposed rule change to March 29,
to Secretary, Securities and Exchange Industry Regulatory Authority, Inc.
Commission, 100 F Street NE., 2016.6 On March 28, 2016, FINRA filed
(‘‘FINRA’’) filed with the Securities and
Washington, DC 20549–1090. a letter with the Commission stating that
Exchange Commission (‘‘SEC’’ or
it considered the comments received by
All submissions should refer to File ‘‘Commission’’), pursuant to Section
19(b)(1) of the Securities Exchange Act the Commission in response to the
Number SR–BX–2016–047. This file
of 1934 (‘‘Act’’ or ‘‘Exchange Act’’) 1 and Notice, and that FINRA is not intending
number should be included on the
Rule 19b–4 thereunder,2 a proposed rule to make changes to the proposed rule
subject line if email is used. To help the
Commission process and review your change to adopt FINRA Rules 2030 text in response to the comments.7
comments more efficiently, please use (Engaging in Distribution and On March 29, 2016, pursuant to
only one method. The Commission will Solicitation Activities with Government delegated authority, the Commission
post all comments on the Commission’s Entities) and 4580 (Books and Records issued an order instituting proceedings
Internet Web site (http://www.sec.gov/ Requirements for Government pursuant to Section 19(b)(2)(B) of the
rules/sro.shtml). Copies of the Distribution and Solicitation Activities) Act 8 to determine whether to approve
submission, all subsequent to establish ‘‘pay-to-play’’ 3 and related or disapprove the proposed rule change,
amendments, all written statements rules that would regulate the activities
with respect to the proposed rule of member firms that engage in 4 See Exchange Act Rel. No. 76767 (Dec. 24,
change that are filed with the distribution or solicitation activities for 2015), 80 FR 81650 (Dec. 30, 2015) (File No. SR–
Commission, and all written compensation with government entities FINRA–2015–056) (‘‘Notice’’).
communications relating to the on behalf of investment advisers. 5 See Letters from David Keating, President,
Member firms serving this role— Center for Competitive Politics (‘‘CCP’’), dated Jan.
proposed rule change between the 20, 2016 (‘‘CCP Letter 1’’); Clifford Kirsch and
Commission and any person, other than sometimes referred to as ‘‘placement
Michael Koffler, Sutherland Asbill & Brennan LLP,
those that may be withheld from the agents’’ or ‘‘solicitors’’ (collectively for the Committee of Annuity Insurers (‘‘CAI’’),
public in accordance with the referred to herein as ‘‘placement dated Jan. 20, 2016 (‘‘CAI Letter 1’’); Clifford Kirsch
provisions of 5 U.S.C. 552, will be agents’’)—assist investment advisers and Michael Koffler, Sutherland Asbill & Brennan
with obtaining advisory business from LLP, for the CAI, dated Feb. 5, 2016 (‘‘CAI Letter
available for Web site viewing and 2’’); David T. Bellaire, Executive Vice President and
printing in the Commission’s Public such entities. In this context, pay-to-
General Counsel, Financial Services Institute
Reference Room, 100 F Street NE., play has historically presented a (‘‘FSI’’), dated Jan. 20, 2016 (‘‘FSI Letter 1’’); Tamara
Washington, DC 20549, on official problem, including when investment K. Salmon, Assistant General Counsel, Investment
business days between the hours of advisers retain placement agents who Company Institute (‘‘ICI’’), dated Jan. 20, 2016 (‘‘ICI
have made contributions to government Letter’’); Patrick J Moran, Esq., dated Dec. 29, 2015
10:00 a.m. and 3:00 p.m. Copies of the (‘‘Moran Letter’’); Gary A. Sanders, Counsel and
filing also will be available for officials who are responsible for, or can Vice President, National Association of Insurance
inspection and copying at the principal influence the outcome of, the selection and Financial Advisors (‘‘NAIFA’’), dated Jan. 20,
office of the Exchange. All comments process for investment advisers. When 2016 (‘‘NAIFA Letter’’); Judith M. Shaw, President,
received will be posted without change; investment advisers are chosen on the North American Securities Administrators
basis of a placement agent’s political Association, Inc. (‘‘NASAA’’), dated Jan. 20, 2016
the Commission does not edit personal (‘‘NASAA Letter’’); Hugh D. Berkson, President,
identifying information from contributions, rather than on, for Public Investors Arbitration Bar Association
example, the adviser’s merit, (‘‘PIABA’’), dated Jan. 20, 2016 (‘‘PIABA Letter’’);
submissions. You should submit only
performance, or costs, the market and and H. Christopher Bartolomucci and Brian J. Field,
information that you wish to make Bancroft PLLC, for the New York Republican State
selection process for advisers becomes
available publicly. All submissions Committee and the Tennessee Republican Party
distorted. Ultimately, pay-to-play harms
should refer to File Number SR–BX– (‘‘State Parties’’), dated Jan. 20, 2016 (‘‘State Parties
investors and the public interest if Letter 1’’). The comment letters filed with the
2016–047 and should be submitted on
government entities, including public Commission in connection with the proposed rule
or before September 21, 2016. change are available at: http://www.sec.gov/
For the Commission, by the Division of 1 15 U.S.C. 78s(b)(1). comments/sr-finra-2015-056/finra2015056.shtml.
6 See Letter from Victoria Crane, Associate
Trading and Markets, pursuant to delegated 2 17 CFR 240.19b–4.
mstockstill on DSK3G9T082PROD with NOTICES
authority.17 3 ‘‘Pay-to-play practices,’’ ‘‘play-to-play General Counsel, FINRA, to Lourdes Gonzalez,
arrangements’’ or ‘‘play-to-play activities,’’ as Assistant Chief Counsel—Sales Practices, Division
Brent J. Fields, of Trading and Markets, Commission, dated Feb. 8,
referred to throughout this order, typically involve
Secretary. a person making cash or in-kind political 2016.
7 See Letter from Victoria Crane, Associate
[FR Doc. 2016–20961 Filed 8–30–16; 8:45 am] contributions (or soliciting or coordinating others to
make such contributions) to help finance the General Counsel, FINRA, to Brent J. Fields,
BILLING CODE 8011–01–P
election campaigns of state or local officials or bond Secretary, Commission, dated Mar. 28, 2016
ballot initiatives as a quid pro quo for the receipt (‘‘FINRA Response Letter 1’’).
17 17 CFR 200.30–3(a)(12). of government contracts. 8 15 U.S.C. 78s(b)(2)(B).
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![Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices 60053
government entity is made by the activity.32 Under such circumstances, definition of ‘‘regulated person’’ in the
covered member or a covered associate, FINRA notes that the MSRB rules SEC Pay-to-Play Rule,38 it is proposing
including a person who becomes a applicable to municipal advisors, a rule that prohibits its member firms
covered associate within two years after including the pay-to-play rule adopted from engaging in distribution activities
the contribution is made.26 FINRA states by the MSRB,33 would apply to the (as well as solicitation activities) for
that the terms and scope of the member firm.34 On the other hand, if the compensation with government entities
prohibitions in proposed Rule 2030(a) member firm solicits a government for two years after certain political
are modeled on the SEC Pay-to-Play entity on behalf of an affiliated contributions have been made to certain
Rule.27 According to FINRA, the two- investment adviser, such activity would officials.39 FINRA also notes, in
year time-out period is intended to not cause the firm to be a municipal response to certain comments discussed
discourage covered members from advisor.35 Under such circumstances, below, that certain language in the SEC
participating in pay-to-play practices by the member firm would be a ‘‘covered Pay-to-Play Rule Adopting Release
requiring a cooling-off period during member’’ subject to the requirements of further supports the inclusion of
which the effects of a political proposed Rule 2030.36 This distinction distribution activities by broker-dealers
contribution on the selection process is the result of the definitions of in FINRA’s proposed Rule 2030.40
can be expected to dissipate.28 ‘‘municipal advisor’’ and ‘‘solicitation of FINRA explains that the proposed
The following is an overview of some a municipal entity or obligated person’’ rule would not apply to distribution
of the key terms used in FINRA’s in the Exchange Act, which only covers activities related to registered
proposed Rule 2030, as discussed by a person who is not affiliated with the investment companies that are not
FINRA in its filing and published in the broker, dealer, municipal securities investment options of a government
Notice or as defined in proposed Rule dealer, municipal advisor, or investment entity’s plan or program because in
2030(g). adviser for whom the person is these circumstances a member firm is
soliciting.37 not providing or seeking to provide
1. Covered Members investment advisory services to a
2. Distribution Activities government entity.41 Therefore, the
The SEC Pay-to-Play Rule includes
within its definition of ‘‘regulated With respect to the triggering proposed rule would apply to
person’’ SEC-registered municipal activities for FINRA’s proposed Rule distribution activities involving
advisors, subject to specified 2030(a), FINRA states that, based on the unregistered pooled investment vehicles
conditions.29 Specifically, the SEC Pay- such as hedge funds, private equity
32 See Notice, 80 FR at 81652.
to-Play Rule prohibits an investment funds, venture capital funds, collective
33 On February 17, 2016, the MSRB published a
adviser from providing or agreeing to investment trusts, and registered pooled
regulatory notice announcing that its pay-to-play
provide, directly or indirectly, payment rule was deemed approved pursuant to section investment vehicles such as mutual
to an SEC-registered municipal advisor 19(b)(2)(D) of the Exchange Act on February 13, funds, but only if those registered pools
unless the municipal advisor is subject 2016 and that the effective date of the rule is August are an investment option of a
17, 2016. See Amendments to MSRB Rule G–37 on participant-directed plan or program of
to a Municipal Securities Rulemaking Political Contributions and Prohibitions on
Board (‘‘MSRB’’) pay-to-play rule.30 Municipal Securities Business and Related a government entity.42 FINRA also notes
FINRA addresses the interplay Amendments are Deemed Approved under the that, consistent with the SEC Pay-to-
between its proposed rule and the Securities Exchange Act of 1934, Regulatory Notice Play Rule, to the extent mutual fund
2016–06, dated February 17, 2016 (the ‘‘MSRB
application of the MSRB’s municipal Regulatory Notice’’), available at http://
distribution fees are paid by the fund
advisor pay-to-play rule by exempting www.msrb.org/∼/media/Files/Regulatory-Notices/
38 A ‘‘regulated person,’’ as defined in the SEC
from the definition of ‘‘covered Announcements/2016-06.ashx?n=1.
34 See Notice, 80 FR at 81652. Pay-to-Play Rule, includes a FINRA member firm,
member’’ a member when it is provided that: (a) FINRA rules ‘‘prohibit member
35 See id.
‘‘engaging in activities that would cause 36 See id. FINRA also notes that a person that is firms from engaging in distribution or solicitation
the member to be a municipal advisor registered under the Exchange Act as a broker- activities if certain political contributions have been
as defined in Exchange Act Section dealer and municipal advisor, and under the made;’’ and (b) ‘‘[t]he Commission finds, by order,
that such rules impose substantially equivalent or
15B(e)(4), SEA Rule 15Ba1–1(d)(1) Advisers Act as an investment adviser could
more stringent restrictions on broker-dealers than
through (4) and other rules and potentially be a ‘‘regulated person’’ for purposes of
the SEC Pay-to-Play Rule and that such a regulated [the SEC Pay-to-Play Rule] imposes on investment
regulations thereunder.’’ 31 FINRA states person would be subject to the rules that apply to advisers and that such rules are consistent with the
that a member firm that solicits a the services the regulated person is performing. See objectives of [the SEC Pay-to-Play Rule].’’ 17 CFR
275.206(4)–5(f)(9)(ii).
government entity for investment id. at n.24.
39 See Notice, 80 FR at 81660–61 (explaining that
37 Exchange Act Section 15B(e)(4) provides that a
advisory services on behalf of an FINRA believes its proposed rule must apply to
‘‘municipal advisor’’ includes a person that
unaffiliated investment adviser may be undertakes solicitation of a municipal entity or member firms engaging in distribution activities
required to register with the SEC as a obligated person. 15 U.S.C. 78o–4(e)(4). Exchange and that FINRA did not revise the proposed rule to
municipal advisor as a result of such Act Section 15B(e)(9) provides that the term remove references to the term ‘‘distribution’’ as
‘‘solicitation of a municipal entity or obligated requested by comments received in response to
person’’ means ‘‘a direct or indirect communication Regulatory Notice 14–50).
26 See Notice, 80 FR at 81651. 40 See Notice, 80 FR at 81660. See also id. at
27 See with a municipal entity or obligated person made
id. at 81651. See also id. at 81651 n.19 81661 n.103 (citing SEC Pay-to-Play Rule Adopting
by a person, for direct or indirect compensation, on
(citing 17 CFR 275.206(4)–5(a)(1)). Release, 75 FR at 41040 n.298 where, according to
28 Notice, 80 FR at 81651, 81659.
behalf of a broker, dealer, municipal securities
dealer, municipal advisor, or investment adviser (as FINRA, the Commission ‘‘clarif[ied] under what
29 See 17 CFR 275.206(4)–5(a)(2)(i)(A) and 17 CFR circumstances distribution payments would violate
defined in section 202 of the Investment Advisers
275.206(4)–5(f)(9). Act of 1940) that does not control, is not controlled the SEC’s Pay-to-Play Rule’’).
30 See supra note 29. 41 See Notice, 80 FR at 81661 n.106 (explaining
by, or is not under common control with the person
mstockstill on DSK3G9T082PROD with NOTICES
31 Proposed Rule 2030(g)(4). See also Notice, 80 undertaking such solicitation for the purpose of that, although the proposed rule would not apply
FR at 81652 (explaining that the SEC Pay-to-Play obtaining or retaining an engagement by a to distribution activities relating to all registered
Rule includes within its definition of ‘‘regulated municipal entity or obligated person of a broker, pooled investment vehicles, pursuant to proposed
person’’ SEC-registered municipal advisors, subject dealer, municipal securities dealer, or municipal Rule 2030(e) ‘‘[i]t shall be a violation of this Rule
to specified conditions, and prohibits an investment advisor for or in connection with municipal for any covered member or any of its covered
adviser from providing or agreeing to provide, financial products, the issuance of municipal associates to do anything indirectly that, if done
directly or indirectly, payment to an SEC-registered securities, or of an investment adviser to provide directly, would result in a violation of this Rule’’).
municipal advisor unless the municipal advisor is investment advisory services to or on behalf of a 42 See id. at 81661. See also id. at 81651 n.17 and
subject to a MSRB pay-to-play rule). municipal entity.’’ 15 U.S.C. 78o–4(e)(9). 81654 n.46.
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![60054 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices
using fund assets pursuant to a 12b-1 exempt reporting adviser under SEC Pay-to-Play Rule.53 FINRA also
plan, such payments generally would Advisers Act Rule 204–4(a).47 Thus, states that it would not consider a
not constitute payments by the fund’s proposed Rule 2030 would not apply to donation of time by an individual to be
investment adviser.43 However, if the member firms acting on behalf of a contribution, provided the covered
adviser pays for the fund’s distribution advisers that are registered with state member has not solicited the
out of its ‘‘legitimate profits,’’ the securities authorities instead of the SEC, individual’s efforts and the covered
proposed rule would generally be or advisers that are unregistered in member’s resources, such as office space
implicated.44 reliance on exemptions other than and telephones, are not used.54 FINRA
Section 203(b)(3) of the Advisers Act or further states that it would not consider
3. Solicitation Activities Advisers Act Rule 204–4(a). The a charitable donation made by a covered
FINRA states that, consistent with the proposed rule’s definition of member to an organization that qualifies
SEC Pay-to-Play Rule, proposed Rule ‘‘investment adviser’’ is consistent with for an exemption from federal taxation
2030(g)(11) defines the term ‘‘solicit’’ to the definition of ‘‘investment adviser’’ under the Internal Revenue Code, or its
mean: in the SEC Pay-to-Play Rule.48 equivalent in a foreign jurisdiction, at
(A) With respect to investment advisory the request of an official of a
5. Official of a Government Entity
services, to communicate, directly or government entity to be a contribution
indirectly, for the purpose of obtaining or FINRA explains that an ‘‘official’’ (as for purposes of the proposed rule.55
retaining a client for, or referring a client to, defined in proposed Rule 2030(g)(8)) of
an investment adviser; and (B) With respect a ‘‘government entity’’ (as defined in 7. Covered Associates
to a contribution or payment, to proposed Rule 2030(g)(7))—both of Proposed Rule 2030(g)(2) defines the
communicate, directly or indirectly, for the which FINRA states are consistent with term ‘‘covered associates’’ to mean:
purpose of obtaining or arranging a the SEC Pay-to-Play Rule definitions—
contribution or payment.45 (A) Any general partner, managing member
would include an incumbent, candidate or executive officer of a covered member, or
FINRA notes that, although the or successful candidate for elective other individual with a similar status or
determination of whether a particular office of a government entity if the office function; (B) Any associated person of a
communication would be a solicitation is directly or indirectly responsible for, covered member who engages in distribution
would depend on the facts and or can influence the outcome of, the or solicitation activities with a government
circumstances relating to such hiring of an investment adviser or has entity for such covered member; (C) Any
associated person of a covered member who
communication, as a general authority to appoint any person who is supervises, directly or indirectly, the
proposition FINRA believes that any directly or indirectly responsible for, or government entity distribution or solicitation
communication made under can influence the outcome of, the hiring activities of a person in subparagraph (B)
circumstances reasonably calculated to of an investment adviser.49 FINRA also above; and (D) Any political action
obtain or retain an advisory client notes that it is the scope of authority of committee controlled by a covered member
would be considered a solicitation the particular office of an official, not or a covered associate.56
unless the circumstances otherwise the influence actually exercised by the FINRA states that, as also noted in the
indicate that the communication does individual, that would determine SEC Pay-to-Play Rule Adopting Release,
not have the purpose of obtaining or whether the individual has influence contributions made to influence the
retaining an advisory client.46 over the awarding of an investment selection process are typically made not
advisory contract under the definition.50 by the firm itself, but by officers and
4. Investment Advisers FINRA also explains that government employees of the firm who have a direct
Proposed Rule 2030 would apply to entities would include all state and economic stake in the business
covered members acting on behalf of (as local governments, their agencies and relationship with the government
defined in proposed Rule 2030(g)(7)) instrumentalities, and all public client.57 For example, contributions by
any investment adviser registered (or pension plans and other collective an ‘‘executive officer of a covered
required to be registered) with the government funds, including member’’ (as defined in proposed Rule
Commission, or unregistered in reliance participant-directed plans such as 2030(g)(5)) would trigger the two-year
on the exemption available under 403(b), 457, and 529 plans.51 ‘‘time-out.’’ 58 FINRA also notes that
Section 203(b)(3) of the Advisers Act for whether a person is an executive officer
6. Contributions
foreign private advisers, or that is an would depend on his or her function or
Proposed Rule 2030(g)(1) defines activities and not his or her title.59 In
43 See id. at 81661 n.103. See also SEC Pay-to- ‘‘contribution’’ to mean any gift, addition, FINRA states that a covered
Play Rule Adopting Release, 75 FR at 41040 n.298 subscription, loan, advance, deposit of associate would include a PAC
(discussing how broker-dealers may be money, or anything of value made for
compensated by advisers according to distribution controlled by the covered member or
arrangements and noting that ‘‘[m]utual fund the purpose of influencing the election any of its covered associates.60 FINRA
distribution fees are typically paid by the fund for a federal, state or local office, and explains that it would consider a
pursuant to a 12b-1 plan, and therefore generally includes any payments for debts ‘‘covered member’’ (as defined in
would not constitute payment by the fund’s adviser. incurred in such an election or
As a result, such payments would not be prohibited proposed Rule 2030(g)(4)) or its covered
[under the SEC Pay-to-Play Rule] by its terms’’). transition or inaugural expenses associates to have ‘‘control’’ over a PAC
44 See Notice, 80 FR at 81661 n.103 (noting, incurred by a successful candidate for if the covered member or covered
among other things, that ‘‘for private funds, third state or local office.52 FINRA states that
parties are often compensated by the investment this definition is consistent with the 53 See id. at 81652 n.32. See also id. at 81653.
adviser or its affiliated general partner’’). For a
mstockstill on DSK3G9T082PROD with NOTICES
54 See id. at 81653 n.33 (citing SEC Pay-to-Play
discussion of a mutual fund adviser’s ability to use
‘‘legitimate profits’’ for fund distribution, see
47 See Proposed Rule 2030(g)(7). Rule Adopting Release, 75 FR at 41030).
48 See 55 See Notice, 80 FR at 81653.
Investment Company Act of 1940 Release No. 11414 17 CFR 275.206(4)–5(a)(1).
49 See Notice, 80 FR at 81652. 56 Id. at 81653 n.37.
(Oct. 28, 1980), 45 FR 73898 (Nov. 7, 1980) (Bearing
57 See id. (citing SEC Pay-to-Play Rule Adopting
of Distribution Expenses by Mutual Funds). 50 See id. (citing SEC Pay-to-Play Rule Adopting
45 Notice, 80 FR at 81651 n.18. See also id. at Release, 75 FR at 41029 (discussing the terms Release, 75 FR at 41031).
81653–54 n.40. ‘‘official’’ and ‘‘government entity’’). 58 See Notice, 80 FR at 81653.
46 See id. at 81651 n.18. See also id. at 81653– 51 See Notice, 80 FR at 81652. 59 See id.
54 n.40. 52 See id. at 81652. 60 See id.
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![Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices 60057
proposal.101 However, five of those Blount v. SEC, 61 F.3d 938 (D.C. Cir. observation in Blount that ‘‘the link
commenters, while generally expressing 1995), which also used analogous between eliminating pay-to-play
support for the goals of the proposal, restrictions to discourage pay-to-play practices and the Commission’s goals of
also raise certain concerns regarding practices, these commenters believe that ‘perfecting the mechanism of a free and
various aspects of the proposal as Supreme Court precedent has changed open market’ and promoting ‘just and
drafted and recommended amendments since Blount was decided. equitable principles of trade’ is self-
to the proposal.102 The other three In response to these comments, evident.’’ 117 In addition to noting the
commenters did not support the FINRA states that the points raised by important interests served by its
proposed rule as drafted based largely the commenters do not warrant changes proposal, FINRA also notes that, as
on concerns involving the First to, or disapproval of, its proposed rule explained in Blount, the proposed rule
Amendment to the U.S. Constitution.103 change.110 FINRA notes that the change advances this government
FINRA responded, stating that it Commission has already reviewed and interest by seeking to halt an existing
considered the comments received by rejected these arguments in a nearly pay-to-play problem, even though, in
the Commission in response to the identical context.111 As FINRA explains, terms of a record, ‘‘no smoking gun is
Notice, and that FINRA is not intending the State Parties filed an unsuccessful needed;’’ however, ‘‘here, the conflict of
to make changes to the proposed rule lawsuit in 2014 challenging the SEC interest is apparent, the likelihood of
text in response to the comments.104 Pay-to-Play Rule on First Amendment
The Commission received an stealth great, and the [Commission’s]
grounds.112 FINRA explains that the purpose prophylactic.’’ 118
additional four comments in response to State Parties’ comments opposing
the Order Instituting Proceedings.105 On FINRA’s proposed rule reiterate the FINRA further believes that the
July 6, 2016, FINRA submitted a letter arguments advanced in their suit against proposed rule change also is ‘‘closely
responding to all comments and to the the Commission and, although the court drawn’’ to avoid unnecessary
Order Instituting Proceedings.106 The of appeals decided the challenge on abridgment of associational freedoms.119
comments, as well as FINRA’s jurisdictional grounds, the brief that the FINRA explains that, like the pay-to-
responses, are summarized below.107 Commission filed in the D.C. Circuit is play rule upheld in Blount, its proposed
A. First Amendment Comments and persuasive in demonstrating that the rule change only ‘‘restricts a narrow
FINRA’s Responses State Parties’ arguments lack merit.113 range of . . . activities for a relatively
FINRA also notes that the SEC Pay-to- short period of time,’’ and leaves
As noted above, five commenters Play Rule, upon which FINRA’s available the ‘‘vast majority of political
either oppose the proposed rule 108 or proposed rule change is based, was activities.’’ 120 For example, FINRA
raise certain issues regarding the notes that the proposal does not attempt
modeled on pay-to-play rules that the
proposed rule as drafted based largely to regulate State and local elections, nor
MSRB drafted, that the Commission
on First Amendment concerns.109 As a
approved, and that the D.C. Circuit does it impose restrictions on
general matter, these commenters argue
upheld against a constitutional independent expenditures or ban
that FINRA’s proposed rule is not
challenge in Blount.114 political contributions, and that each of
narrowly tailored to serve a compelling Furthermore, FINRA states that the
government interest. While those significant avenues for political
proposed rule change is justified by a expression remains unaffected by the
acknowledging that the D.C. Circuit
sufficiently important governmental proposed rule change.121 FINRA also
upheld the constitutionality of a
interest to withstand constitutional does not agree with arguments made by
comparable MSRB pay-to-play rule in
scrutiny. For example, FINRA explains a commenter that FINRA did not
101 See CAI Letter 1; CAI Letter 2; FSI Letter 1;
that, as in Blount, the Commission’s consider less restrictive alternatives in
ICI Letter; NAIFA Letter; NASAA Letter; and PIABA interest in preventing fraud and in drafting its proposal and that aspects of
Letter. protecting market actors from ‘‘unfair, the proposal are vague or overbroad.
102 See CAI Letter 1; CAI Letter 2; FSI Letter 1;
corrupt market practices,’’ are ‘‘not only FINRA notes that, because the
NAIFA Letter; NASAA Letter; and PIABA Letter. ICI substantial, but . . . compelling.’’ 115
did not raise additional concerns, but states that it Commission must find that FINRA’s
is satisfied with FINRA’s revisions and responses to FINRA also notes that the Commission’s proposal imposes substantially
the proposal as drafted in Regulatory Notice 14–50. interest in ‘‘clean advisory markets is equivalent or more stringent restrictions
See ICI Letter. equally important.’’ 116 FINRA on its member firms as the SEC Pay-to-
103 See CCP Letter 1; Moran Letter; and State
acknowledges the D.C. Circuit’s Play Rule imposes on investment
Parties Letter 1. Other commenters also raise certain
First Amendment-related concerns. See FSI Letter
110 See FINRA Response Letter 2 at 3 (noting that
advisers for FINRA members to be
1; and CAI Letter 1. ‘‘regulated persons’’ under the SEC Pay-
104 See FINRA Response Letter 1. FINRA’s responses to the First Amendment
105 See supra note 10. See also Memorandum arguments raised by the State Parties and CCP also to-Play Rule, the provisions and
from the Division of Trading and Markets regarding
address the concerns raised by CAI, FSI and definitions to which the commenter
Moran). A copy of FINRA Response Letter 2 is objects are modeled on and
a May 10, 2016 conference call with representatives
available at: https://www.sec.gov/comments/sr-
of CAI; Memorandum from the Division of Trading substantially similar to provisions in the
and Markets regarding a May 19, 2016 conference finra-2015-056/finra2015056-18.pdf.
111 See id. (citing N.Y. Republican State Comm.
call with representatives of FSI.
106 See supra note 12. v. SEC, 799 F.3d 1126 (D.C. Cir. 2015) (affirming 117 See, e.g., FINRA Response Letter 2 at 5
107 The comments received in response to the
dismissal of the petition for lack of subject matter (quoting Blount, 61 F.3d at 945).
jurisdiction and also dismissing the petition as 118 See, e.g., FINRA Response Letter 2 at 6
Notice were summarized when the Commission
time-barred). (quoting Blount, 61 F.3d at 945).
instituted proceedings. See supra note 9. For further 112 See FINRA Response Letter 2 at 3. 119 See, e.g., FINRA Response Letter 2 at 6.
detail, the comments that the Commission received
mstockstill on DSK3G9T082PROD with NOTICES
113 See id. at 3–4.
on both the Notice and the Order Instituting 120 See, e.g., id. (quoting Blount, 61 F.3d at 947–
114 See id. at 5 (citing Blount, 61 F.3d at 944).
Proceedings are available on the Commission’s Web 48).
site at http://www.sec.gov/comments/sr-finra-2015- 115 See, e.g., FINRA Response Letter 2 at 5 121 See, e.g., FINRA Response Letter 2 at 4. See
056/finra2015056.shtml. (quoting Blount, 61 F.3d at 944). also SEC Pay-to-Play Rule Adopting Release, 75 FR
108 See CCP Letter 1; and State Parties Letter 1. 116 See, e.g., FINRA Response Letter 2 at 5 at 41024 n.71 (explaining that the SEC Pay-to-Play
See also CCP Letter 2; CCP Letter 3; and State (quoting an observation made in Blount that the rule ‘‘imposes no restrictions on activities such as
Parties Letter 2. Commission’s interest ‘‘in clean bond markets’’ is making independent expenditures to express
109 See CAI Letter 1; FSI Letter 1; FSI Letter 2; and just as important as a legislature’s interest ‘‘in clean support for candidates, volunteering, making
Moran Letter. elections’’) (quoting Blount, 61 F.3d at 944)). speeches, and other conduct’’).
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![Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices 60059
investment advisers.140 Therefore, 206(4)–3 puts selling firms in a advisers.155 Finally, FINRA notes that
because the Commission did not contradictory position under FINRA the applicability of proposed Rule
exclude specific products from the SEC rules and Advisers Act rules.147 This 2030(d) is for purposes of FINRA’s pay-
Pay-to-Play Rule, such as variable commenter further states that, in its to-play rule only and, as such, would
annuities, FINRA does not believe that view, a broker-dealer that offers and not impact or otherwise affect other
excluding specific products from its sells interests in a mutual fund or FINRA rules or guidance. Therefore,
proposed rule would satisfy the private fund cannot be characterized as FINRA has determined not to make the
Commission’s stringency soliciting on behalf of the investment changes suggested by the
requirements.141 FINRA notes, however, adviser to a covered investment pool.148 commenters.156
that to the extent interpretive questions Similarly, another commenter E. Comments Regarding the Inclusion of
arise regarding the application and expresses concern with the apparent Distribution Activity in the Proposed
scope of the provisions and terms used application of proposed Rule 2030(d) to Rule and FINRA’s Responses
in its proposed rules, FINRA will work ‘‘traditional’’ brokerage sales of mutual
with the industry and Commission to One commenter generally expresses
funds and variable annuities to
address those interpretive questions and concern that proposed Rule 2030 is
participant-directed government-
provide additional guidance as unnecessarily ambiguous regarding the
sponsored retirement plans.149 As more term ‘‘distribution’’ activities in Rule
needed.142
fully explained in the commenter’s 2030(a).157 This commenter claims that
D. Comments Regarding the Scope of letter, this commenter continues to be it is unclear what distribution activities
the Proposed Rule and FINRA’s concerned that the provisions in ‘‘with’’ a government entity would be
Responses proposed Rule 2030(d) go beyond that prohibited, what compensation is
Two commenters also express which is required under Rule 206(4)– covered by the proposed rule and who
concern that proposed Rule 2030(d) 5(a)(2)(i) and Rule 206(4)–5(c) to the must pay it, and when a member firm
would, in their view, re-characterize detriment of investors.150 This same might be deemed to be acting ‘‘on behalf
‘‘ordinary’’ or ‘‘customary’’ distribution commenter also claims that mutual fund of’’ an investment adviser.158 This
activities for covered investment pools sales, as well as variable annuity sales, commenter states that the ambiguity of
as the solicitation of clients on behalf of should be excluded, claiming that the proposed Rule 2030 may result in its
the investment adviser to the covered proposed rules serve to redefine the sale misapplication in a variety of contexts,
investment pools.143 One of these of mutual funds as solicitation by a such as: Where a selling firm is
commenters requests that such broker-dealer on behalf of an investment affiliated with one, but not all,
customary distribution activity by adviser and also conflict with the underlying fund advisers and none of
member firms for covered investment realities of conventional mutual fund the sub-adviser(s) to any underlying
pools sold to government entities not be selling agreements.151 funds, or none of the underlying fund
treated as solicitation activity for an In response, FINRA explains that, in advisers, but some of the sub-
investment adviser for purposes of Rule proposing FINRA Rule 2030(d), it did advisers.159
2030 simply because an investment not intend to re-characterize broker- This commenter also claims that,
adviser provides advisory services to a dealers’ selling interests in variable while the SEC Pay-to-Play Rule requires
covered investment pool that is annuities, mutual funds and private regulated persons to be subject to rules
available as an investment option.144 As funds as soliciting an investment that prohibit them from engaging in
more fully explained in the advisory relationship with investors certain distribution activities if certain
commenter’s letter, the commenter who invest in those products.152 Rather, political contributions have been made,
claims, for example, that proposed Rule FINRA states that the purpose of SEC Pay-to-Play Rule 206(4)–5 does not
2030(d) would recast ‘‘traditional’’ proposed Rule 2030(d) is to clarify that mandate the use of the term
broker-dealer activity (i.e., the offer and the prohibition of proposed Rule ‘‘distribution’’ in describing the conduct
sale of covered investment pool 2030(a) would apply when the covered prohibited by the proposed rule, and
securities pursuant to a selling or member is engaging in distribution or suggested revised rule text reflecting
placement agent agreement) into solicitation activities with a government that assertion.160 The commenter
something it is not: The solicitation of entity on behalf of a covered investment believes that its suggested revisions
investment advisory services on behalf pool.153 FINRA further explains that would eliminate, among other things,
of an investment adviser.145 This proposed Rule 2030(d) is modeled on a the potential concern that a selling firm
commenter also claims that the decision similar provision in the SEC Pay-to-Play might violate proposed Rule 2030
in Goldstein v. SEC, 451 F.3d 873 (D.C. Rule, Rule 206(4)–5(c).154 As such, and unknowingly due to being deemed to be
Cir. 2006) and the Commission staff’s consistent with SEC Pay-to-Play Rule acting on behalf of investment advisers
interpretive position under Advisers Act 206(4)–5(c), proposed Rule 2030(d) is
Rule 206(4)–3 suggest that proposed intended to extend the protections of 155 See id. at 15 (noting that when adopting SEC
Rule 2030(d) would be impractical.146 the proposed rule to government entities Pay-to-Play Rule 206(4)–5(c), the Commission
that access the services of investment stated that although ‘‘an investment in a pooled
This commenter also notes that Rule investment vehicle may not involve a direct
advisers through hedge funds and other advisory relationship with a government sponsored
140 See FINRA Response Letter 2 at 16. types of pooled investment vehicles plan [that] does not change the nature of the fraud
141 See id. sponsored or advised by investment or the harm that may be inflicted as a consequence
142 See id. of the adviser’s pay-to-play activity’’) (quoting SEC
mstockstill on DSK3G9T082PROD with NOTICES
143 See CAI Letter 1 and FSI Letter 1. Pay-to-Play Rule Adopting Release, 75 FR at 41044–
147 See id.
144 See CAI Letter 1. 45)).
148 See id. 156 See FINRA Response Letter 2 at 15.
145 See id.
149 See FSI Letter 1. See also FSI Letter 2 157 See CAI Letter 1.
146 See id. (claiming that ‘‘[i]t would create
150 See FSI Letter 1. See also FSI Letter 2. 158 See id.
significant confusion in the industry and 151 See FSI Letter 1. See also FSI Letter 2. 159 See id.
undermine settled practices and understandings,
152 See FINRA Response Letter 2 at 14.
while creating doubt as to the application of the 160 See CAI Letter 1 and CAI Letter 2 (reflecting
153 See id.
Goldstein case and the Commission staff’s guidance CAI’s suggested revisions to certain language in
in the Mayer Brown no-action letter’’). 154 See id. some of FINRA’s proposed rules).
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![60060 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices
or sub-advisers of underlying funds additional guidance, covered members ‘‘contribution’’ (as defined in proposed
with which it has no relationship.161 will continue to struggle with whether FINRA Rule 2030(g)(1)) is, by definition,
In response, FINRA states that it a contribution to a given entity should also a ‘‘payment’’ (as defined in
continues to maintain the position, be treated as a contribution to an proposed FINRA Rule 2030(g)(9)),
outlined in the Notice, that it will not ‘instrumentality’ of a state or state FINRA states that the definition of
remove references to the term agency, thus triggering the two-year ‘‘payment’’ is similar to the definition of
‘‘distribution.’’ 162 FINRA explains that time out. . . .’’ 170 This same ‘‘contribution,’’ but is broader because it
the Notice pointed to language in the commenter also asked for clarification does not include limitations on the
SEC Pay-to-Play Rule Adopting Release as to whether each and every purposes for which such money is given
supporting the inclusion of distribution ‘‘contribution’’ (as defined in proposed (e.g., it does not have to be made for the
activities by broker-dealers in FINRA’s Rule 2030(g)(1)) is, by definition, also a purpose of influencing an election).177
proposed Rule 2030.163 Specifically, ‘‘payment’’ (as defined in proposed Rule Finally, FINRA also acknowledges the
FINRA pointed to the Commission’s 2030(g)(9)).171 concerns raised by the commenters and
discussion regarding under what Another commenter requests that the requests for clarification and
circumstances distribution payments FINRA clarify the definition of a additional guidance from the
would violate the SEC’s Pay-to-Play ‘‘covered associate’’ and clarify and Commission and FINRA as to certain
Rule.164 FINRA also notes that based on delineate the positions that would terms.178 FINRA again states that to the
the Commission’s definition of qualify someone as a covered extent that interpretive questions arise
‘‘regulated person’’ 165 in the SEC’s Pay- ‘‘official.’’ 172 This commenter claims regarding the application and scope of
to-Play Rule, as well as the that, in response to the same definition the provisions and terms used in the
Commission’s discussion regarding the of ‘‘covered associate’’ as used in the proposed rule change, FINRA will work
treatment of distribution fees paid SEC Pay-to-Play Rule, many investment with the industry and Commission to
pursuant to a 12b–1 plan as compared advisers and broker-dealers have address the interpretive questions and
to legitimate profits, FINRA believes classified all of their representatives as provide additional guidance as
that its proposed rule must apply to covered associates regardless of whether needed.179
member firms engaging in distribution they actually engage in the solicitation
activities.166 FINRA mentioned activity specified in the definition.173 G. Comments Regarding PAC
previously, to the extent that This commenter believes that additional Contributions and FINRA’s Responses
interpretive questions arise regarding clarification on when an associated One commenter claims that
the application and scope of the person of a covered member would (or statements made by FINRA in the
provisions and terms used in the would not) qualify as a ‘‘covered Notice regarding the proposed rule’s
proposed rule change, FINRA will work associate’’ would ease compliance anti-circumvention provision, proposed
with the industry and Commission to burdens, curtail overly broad limits on Rule 2030(e), combined with statements
address the interpretive questions and legitimate political activity, and made in Commission staff guidance
provide additional guidance as increase the consistency of procedures concerning whether contributions
needed.167 amongst member firms who seek to through PACs would violate the SEC
comply with both the letter and the Pay-to-Play Rule and Section 208(d) of
F. Comments Regarding Defined Terms
spirit of the proposed rule.174 This same the Advisers Act, have the ability to
Used in the Proposed Rules and
commenter requests additional details chill contributions to PACs.180 This
FINRA’s Responses
or guidance from the Commission with commenter claims, for example, that
Two commenters request clarification respect to this definition of ‘‘official’’ prospective contributors who simply
of certain defined terms used in the because, according to that commenter,
proposed rules.168 One commenter want to donate to a PAC have been
that definition has caused, and will hesitant to or restricted from doing so
urged FINRA, or the Commission, to continue to spark confusion over exactly
clarify the meaning of the term out of fear that they may be making an
what offices subject the holder to be indirect contribution in violation of the
‘‘instrumentality’’ as it is used in the classified as an ‘‘official’’ given that the
definition of ‘‘government entity.’’ 169 SEC Pay-to-Play Rule.181 Accordingly,
term is defined the same way in the SEC this commenter requests further
This commenter claims that, ‘‘[w]ithout Pay-to-Play Rule.175 guidance from the Commission on the
In response, FINRA states that it
factors by which contributions to PACs
161 See CAI Letter 1 (claiming that the
recognizes, as did the commenters, that
commenter’s suggested revisions would not result would or would not trigger the anti-
these terms are defined in the SEC Pay-
in any inappropriate narrowing of the scope of Rule circumvention provision of the
2030). to-Play Rule and that FINRA modeled
162 See FINRA Response Letter 2 at 12. the definitions in its proposal on those proposed rule.182
163 See id. at 11–12 (citing Notice, 80 FR at in the SEC Pay-to-Play Rule.176 With In response, FINRA again
81660–61). respect to CAI’s request for clarification acknowledges the concerns raised by
164 See FINRA Response Letter 2 at 12 n.52 (citing
as to whether each and every the commenter and the requests for
SEC Pay-to-Play Rule Adopting Release, 75 FR at clarification and additional guidance
4104 n.298). from the Commission and FINRA.183
170 See id.
165 See FINRA Response Letter 2 at 12 (explaining
that the SEC Pay-to-Play Rule defines a ‘‘regulated
171 See CAI Letter 1 (discussing Notice, 80 FR at FINRA states that, to the extent that
person’’ to include a member firm, provided that 81654 n.41: ‘‘Consistent with the SEC Pay-to-Play interpretive questions arise regarding
FINRA rules prohibit member firms from engaging Rule, FINRA is including the broader term the application and scope of the
in distribution or solicitation activities if political ‘payments,’ as opposed to ‘contributions,’ to deter
provisions and terms used in the
mstockstill on DSK3G9T082PROD with NOTICES
contributions have been made) (citing 17 CFR 275. a cover member from circumventing the proposed
206(4)–5(f)(9)(ii)(A)) (emphasis in original). rule’s prohibitions by coordinating indirect
177 See id. at 17.
166 See FINRA Response Letter 2 at 12 (citing contributions to government officials by making
payments to political parties’’). 178 See id. at 19.
Notice, 80 FR at 81660–61).
172 See NAIFA Letter. 179 See id.
167 See id.
173 See id. 180 See NAIFA Letter.
168 See CAI Letter 1 and NAIFA Letter.
169 See CAI Letter 1 (claiming that CAI’s members 174 See id. 181 See id.
175 See id. 182 See id.
have struggled to understand the contours of this
term in the context of the SEC Pay-to-Play Rule). 176 See FINRA Response Letter 2 at 18. 183 See FINRA Response Letter 2 at 19.
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acts and practices, to promote just and SEC Pay-to-Play Rule.234 These to-play activities.239 However,
equitable principles of trade, . . . to concerns, which also implicate the persuaded by commenters, we revised
remove impediments to and perfect the investor and public interest protections the proposed SEC Pay-to-Play Rule to
mechanism of a free and open market described in Section 15A(b)(6) of the permit advisers to make payments to
and a national market system and, in Act, recognize the central role certain ‘‘regulated persons’’ to solicit
general, to protect investors and the intermediaries, such as ‘‘solicitors’’ or government clients on their behalf,
public interest.’’ 230 As discussed in ‘‘placement agents,’’ have played in provided that they are themselves
more detail below, we believe that actions that the Commission and other subject to prohibitions against
FINRA’s proposal is consistent with authorities have brought involving pay- participating in pay-to-play practices,
Section 15A(b)(6). FINRA’s proposed to-play schemes.235 FINRA also
are subject to Commission oversight
rule will address the regulatory acknowledges the Commission’s
and, in the case of broker-dealers, the
concerns that underlie, and thus observation of how investment advisers,
in several instances, allegedly made oversight of a registered national
support the objectives of, the SEC Pay- securities association such as FINRA.240
to-Play Rule, discussed below, by significant payments to placement
agents and other intermediaries to FINRA agreed and informed us that it
discouraging FINRA member firms and would prepare rules for our
certain of their covered associates from influence the award of advisory
contracts.236 Moreover, FINRA points consideration that would prohibit its
engaging in quid pro quo corruption
out the difficulties that investment members from soliciting advisory
that may create market distortions—
advisers face in monitoring or business from a government entity on
when, for example, an investment
controlling the activities of their third- behalf of an adviser unless they comply
adviser is chosen on the basis of a
placement agent’s political party solicitors.237 with pay-to-play restrictions.241
As we explained in adopting the SEC Pay-to-play practices are harmful.
contributions rather than the adviser’s
Pay-to-Play Rule, public pension plans They create an impediment to a free and
merit. Such conduct impedes a free and
are particularly vulnerable to pay-to-
open market, and may harm investors open market by, for example, distorting
play practices, and we have been
and the public interest if government the investment adviser selection process
particularly concerned that the
entities, including public pension plans, engagement of placement agents who from one that is based on merit,
and their beneficiaries receive inferior have made political contributions to key performance and cost, to one that is
services or pay higher fees.231 FINRA’s officials is viewed by investment influenced by a placement agent’s
proposed rule also promotes a free and advisers as a necessary step to securing contributions to the campaigns of
open market and the protection of a contract with a public pension government officials who are
investors and the public interest by plan.238 In connection with the SEC responsible for, or can influence the
avoiding the outright ban on Pay-to-Play Rule, we initially proposed outcome of, selecting an investment
distribution and solicitation activity that a complete bar on investment advisers adviser.242 As a result of this distortion,
would result if FINRA member firms engaging third parties to solicit government entities, including pension
were not ‘‘regulated person[s]’’ under government clients on their behalf funds, and their citizen beneficiaries
the SEC Pay-to-Play Rule.232 The fact because of concerns about investment may be harmed by receiving inferior
that FINRA’s proposed rule may have advisers’ use of third-party solicitors services or paying higher fees.243
implications for a small subset of and placement agents to engage in pay- Investors and the public interest
political contributions made by certain
ultimately suffer, including taxpayers,
covered associates to certain elected 234 See Notice, 80 FR at 81651, nn.12–14
residents who rely on municipal
officials does not somehow eliminate (discussing concerns the Commission identified in
FINRA’s ability to adopt rules pursuant the SEC Pay-to-Play Rule Adopting Release, 75 FR services, and the beneficiaries of public
to the Act, or the Commission’s at 41037). pension funds, such as firemen, police
authority to approve such rules under
235 See Notice, 80 FR at 81651. See also id. at officers, teachers, and other civil
nn.10–11 (explaining that ‘‘solicitors’’ typically
Section 19(b)(2) of the Act.233 locate investment advisory clients on behalf of an 239 See id. at 41037 nn.259–68 (discussing the
As support for the need for the investment adviser, and that ‘‘placement agents’’
typically specialize in finding investors, often Commission’s observations in the SEC Pay-to-Play
proposed rule, FINRA outlined certain institutional investors or high net worth investors, Rule proposing release).
regulatory concerns in the Notice that that are willing and able to invest in a private 240 See id. at 41041.
also were identified by the Commission offering of securities on behalf of the issuer of such 241 See Notice, 80 FR at 81651 n.15 (citing a letter
in connection with its adoption of the privately offered securities) (citing Advisers Act from Richard G. Ketchum, Chairman and Chief
Release No. 2910 (Aug. 3, 2009), 74 FR 39840, Executive Officer, FINRA, to Andrew J. Donohue,
39853 n.137 (Aug. 7, 2009) (Political Contributions Director, Division of Investment Management,
230 Id. by Certain Investment Advisers)). Commission (Mar. 15, 2010) (‘‘Ketchum Letter’’),
231 See FINRA Response Letter 2 at 8. See also 236 See Notice, 80 FR at 81651. See also e.g., SEC available at http://www.sec.gov/comments/s7-18-
Notice, 80 FR at 81651, 81656 (discussing the Pay-to-Play Adopting Release, 75 FR at 41037. 09/s71809-260.pdf (stating that FINRA ‘‘believe[s]
regulatory objectives of and statutory basis for the 237 See Notice, 80 FR at 81651. See also SEC Pay- that a regulatory scheme targeting improper pay to
proposal). to-Play Adopting Release, 75 FR at 41032 n.182, play practices by broker-dealers acting on behalf of
232 See FINRA Response Letter 2 at 5 (‘‘FINRA 40137 n.266 (acknowledging commenters’ concerns investment advisers is . . . a viable solution to a
believes that the proposed rule change is a more regarding the difficulties that advisers may have ban on certain private placement agents serving a
effective response to the issues addressed in the when monitoring the activities of their third-party legitimate function’’)). FINRA also notes that in
SEC Pay-to-Play Rule than a complete ban on solicitors). developing its proposal it intended to draw closely
solicitation.’’). See also Notice, 80 FR at 81652, 238 See SEC Pay-to-Play Adopting Release, 75 FR upon all the substantive and technical elements of
81656 (discussing the regulatory objectives of and at 41019–20, nn.16–25 (collecting examples of SEC the Commission’s rule as well as FINRA’s
mstockstill on DSK3G9T082PROD with NOTICES
statutory basis for the proposal). litigation releases as well as state and federal regulatory expertise in examining and enforcing the
233 While FINRA’s proposed rule does not bar criminal actions with pay-to-play schemes MSRB rules, upon which the SEC Pay-to-Play Rule
member firms and their covered associates from involving placement agents among other is based. See Ketchum Letter. See also SEC Pay-to-
making contributions, it may affect the propensity intermediaries). See also id. at 40137, n.262 Play Adopting Release, 75 FR at 41042 n.317
of member firms and certain employees to make the (collecting examples of state and local legislative (discussing same).
242 See, e.g., SEC Pay-to-Play Adopting Release,
subset of contributions that would trigger the two- actions undertaken to prohibit or regulate pay-to-
year time-out. FINRA’s rule does not impose a play practices involving placement agents in 75 FR at 41023, 41039.
requirement that member firms publicly disclose response to concerns about pay-to-play activities in 243 SEC Pay-to-Play Adopting Release, 75 FR at
political contributions. their jurisdictions). 41019.
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![60064 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices
servants.244 Investment advisers also are result, like the SEC Pay-to-Play rule, these reasons and as discussed
harmed because their ability to FINRA’s proposal should help protect throughout, the Commission finds that
participate in the market is impeded investors and the public interest by, the proposed rule change is consistent
unless they are willing to engage in pay- among other things, reducing the costs with Section 15A(b)(6) of the Act.256
to-play practices by, for example, hiring to plans and their beneficiaries of The Commission notes that most
placement agents that make certain inferior asset management services commenters to the Notice 257 and some
political contributions.245 arising from adviser selection based on of the commenters responding to the
The Commission also believes that the a placement agent’s political Order Instituting Proceedings 258
stealth in which pay-to-play practices contributions rather than prudential generally express support for FINRA’s
occur and the inability of markets to investment considerations.250 Further, proposal. For example, one commenter
properly address these practices argue in the Commission’s view, FINRA’s states that it is pleased that, like the SEC
strongly for rules like the SEC Pay-to- proposed rule strikes an appropriate and the MSRB, FINRA is adopting rules
Play Rule and FINRA’s proposal.246 Pay- balance in addressing these regulatory to govern the activities of its members
to-play practices create a ‘‘collective concerns by providing for FINRA that solicit government clients on behalf
action’’ problem in two respects: (1) member firms to be ‘‘regulated of an investment adviser and also is
Government officials who participate in person[s]’’ under the SEC Pay-to-Play pleased that FINRA’s proposal is
such activities have an incentive to Rule.251 As a result, investment advisers designed to complement, and be
continue to accept contributions to will be able to continue to benefit from consistent with, the SEC’s pay-to-play
support their campaigns for fear of being the use of placement agents in obtaining rule.259 Similarly, another commenter
disadvantaged relative to their investment advisory business with states that, although it requests certain
opponents; and (2) investment advisers government entities without political revisions, it also supports FINRA’s
have an incentive to participate out of contributions distorting the process by attempt to deter pay-to-play activity
concern that they may be overlooked if which a government entity, such as a among covered members and supports
they fail to make a contribution.247 public pension fund, selects an the regulatory objectives underlying the
We believe that application of adviser.252 The two-year time-out period Proposed Rules.260
FINRA’s proposed pay-to-play rules will imposed by the proposed rule change is The Commission acknowledges the
effectively discourage covered members not a penalty but, rather, is intended to concerns and questions raised by some
and their covered associates who act as discourage participation in pay-to-play commenters, which are outlined in
placement agents for investment practices by requiring a ‘‘cooling-off further detail above in Section III. As
advisers from participating in pay-to- period’’ during which the effects of a discussed below, the Commission
play practices because their political quid pro quo political contribution on believes, however, that FINRA has
contributions or payments will be the selection process are expected to responded to the commenters’ concerns
subject to restrictions similar to those dissipate.253 This time-out will help and questions in light of, among other
imposed on investment advisers under promote fair competition in the market things, the regulatory framework
the SEC Pay-to-Play Rule.248 The and protect public pension funds and established by the SEC Pay-to-Play Rule,
Commission therefore believes that investors by curbing fraudulent conduct which provides that FINRA’s proposed
FINRA’s proposed rule change will help resulting from pay-to-play practices.254 rules must impose substantially
address the concerns identified in the In addition, according to FINRA, the equivalent or more stringent restrictions
SEC Pay-to-Play Rule Adopting Release proposal can be expected to help on its members than the SEC Pay-to-
regarding the distortion of the promote competition by allowing more Play Rule imposes on investment
investment advisory market.249 As a third-party solicitors to participate in advisers for FINRA members to be
the market for solicitation services, ‘‘regulated persons’’ under the SEC Pay-
244 SEC Pay-to-Play Adopting Release, 75 FR at which in turn may reduce costs to to-Play Rule.
41019 (noting that the management of public investment advisers and improve
pension plans ‘‘most significantly . . . affects
competition for advisory services.255 For A. Comments Concerning the First
taxpayers and the beneficiaries of these funds, Amendment and Related Concerns
including the millions of present and future State
and municipal retirees who rely on the funds for advisers are selected regarding public investments, Several commenters express the view
their pensions and other benefits’’). pay-to-play rules provide important protections to that FINRA’s proposed rule violates the
245 See, e.g., SEC Pay-to-Play Adopting Release, public pension plans and their beneficiaries, as well
as participants in other important plans or programs First Amendment.261 The Commission
75 FR at 41023, 41039 (explaining that ‘‘pay to play
practices may hurt smaller advisers that cannot sponsored by government entities. See SEC Pay-to- is sensitive to the constitutional
afford the required contributions. Curtailing pay to Play Adopting Release, 75 FR at 41023, 41054. concerns raised by the commenters, but
250 See SEC Pay-to-Play Adopting Release, 75 FR
play arrangements enables advisory firms, after careful consideration of their
particularly smaller advisory firms, to compete on at 41039.
arguments, for the reasons discussed
merit, rather than their ability or willingness to 251 See, e.g., FINRA Response Letter at 5 (‘‘FINRA
make contributions’’). believes that the proposed rule change is a more
256 See 15 U.S.C. 78o–3(b)(6).
246 See SEC Pay-to-Play Adopting Release, 75 FR effective response to the issues addressed in the
at 40122–23. See also FINRA Response Letter at 6 SEC Pay-to-Play Rule than a complete ban on 257 See CAI Letter 1; CAI Letter 2; FSI Letter 1;
(noting that, as explained in Blount, ‘‘no smoking solicitation.’’) See also Notice, 80 FR at 81652, ICI Letter; NAIFA Letter; NASAA Letter; and PIABA
gun is needed;’’ however, ‘‘where, as here, the 81656 (discussing the regulatory objectives of and Letter.
conflict of interest is apparent, the likelihood of statutory basis for the proposal). 258 See FSI Letter 2 (claiming that the proposal
stealth great, and the [Commission’s] purpose 252 See, e.g., FINRA Response Letter 2 at 8 (‘‘The creates ‘‘compliance uncertainties’’ for FSI’s
prophylactic’’). proposed rule change accomplishes these goals by members, but noting that FSI ‘‘support[s] regulatory
247 See FINRA Response Letter at 9; SEC Pay-to- allowing member firms to continue to engage in efforts to combat pay-to-play corruption activity’’).
mstockstill on DSK3G9T082PROD with NOTICES
Play Adopting Release, 75 FR at 40122. distribution or solicitation activities for 259 See ICI Letter.
248 See Notice, 80 FR at 81651. compensation with governmental entities on behalf 260 See CAI Letter 1 (recognizing ‘‘the challenges
249 See FINRA Response Letter at 9 (stating that of investment advisers, while at the same time in crafting the Proposed Rules so that they reach all
‘‘[f]or example, the proposed rule change is deterring member firms from engaging in pay-to- of the activity sought to be eliminated without also
reasonably designed to address the distortion of the play practices.’’). prohibiting activity that is harmless’’).
253 See Notice, 80 FR at 81651. See also SEC Pay-
investment advisory market and collective action 261 See CCP Letter 1; FSI Letter 1; FSI Letter 2;
problems created by pay-to-play practices’’). As the to-Play Adopting Release, 75 FR at 41026 n.104. and State Parties Letter 1. See also CCP Letter 2;
254 See Notice, 80 FR at 81657.
Commission has explained, by addressing CCP Letter 3; Moran Letter and State Parties Letter
distortions in the process by which investment 255 See id. 2.
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![Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices 60065
below, concludes that FINRA’s rule is FINRA’s proposed rule serves a vitally a government interest in discouraging
consistent with the First Amendment. important governmental interest: quid quo pro corruption, it is a targeted
FINRA’s rule, which focuses on Discouraging a specific type of quid pro effort that should protect investors and
covered members who serve as quo corruption in which political the public by promoting the integrity of
placement agents, tracks the SEC Pay-to- contributions made by placement agents the investment advisory market.
Play Rule for investment advisers, may influence the award of investment FINRA’s proposed rule advances this
which, in turn, tracks the MSRB’s pay- advisory business by government important governmental interest
to-play rule, Rule G–37, which the D.C. entities. The Supreme Court has long because the two-year time-out
Circuit upheld against First Amendment held that halting quid pro quo discourages pay-to-play. As explained
challenge in 1995.262 The Supreme corruption is an important government above, pay-to-play has been and is a
Court has issued several decisions interest that justifies limitations—or serious problem when placement agents
regarding political speech since Blount outright bans—on contributions.267 assist investment advisers in obtaining
was decided,263 and none of these We do not understand FINRA to be advisory business from government
decisions call into question Blount’s engaging in broad electoral reform or entities.271 Placement agents ‘‘played a
holding that a tailored pay-to-play rule, trying to clean up the electoral process. central role in actions that [the
which is nearly identical in purpose and Rather, to avoid the outright ban on Commission] and other authorities have
form to FINRA’s proposed rule and placement agent activity resulting from brought involving pay-to-play
which also furthers an important public FINRA member firms not being schemes,’’ and, in several instances,
interest, is constitutional. Indeed, the en ‘‘regulated person[s]’’ under the SEC advisers used placement agents, who
banc D.C. Circuit recently and Pay-to-Play Rule, the two-year time-out had made campaign contributions to
unanimously upheld a broader pay-to- in FINRA’s proposal, like the SEC Pay- elected officials, to influence the award
play restriction—a bar on all to-Play Rule, discourages quid pro quos of investment advisory contracts.272
contributions to federal candidates by that affect government entities, Most notably, Alan Hevesi, the
federal contractors—in its decision in including public pension funds, served Comptroller of New York State who was
Wagner that analyzed the post-Blount by investment advisers. Quid pro quos responsible for investment of state
Supreme Court decisions and cited involving placement agents, who make pension funds, accepted campaign
Blount with approval.264 Various pay- contributions to certain elected officials contributions from a placement agent
to-play restrictions imposed by other and then assist investment advisers in and steered over $250 million in
jurisdictions also have withstood First obtaining business from the government pension funds to investment advisers
Amendment challenge in recent entities those officials serve may be: that had retained the placement
years.265 Fraudulent, run counter to just and agent.273
Decisions like Wagner confirm that equitable principles of trade, impede a In response to these incidents, the
even an outright limitation on free and open market, and harm Commission proposed a ban on the use
contributions—as opposed to FINRA’s investors and the public interest.268 of placement agents by investment
rule, which may indirectly discourage When pay-to-play is a factor in the advisers and ultimately adopted a final
contributions—is permissible if it is selection or retention of an investment rule that permitted use of placement
justified by a sufficiently important adviser—when the adviser is chosen on agents so long as they were ‘‘regulated
government interest and is closely the basis of a placement agent’s political persons’’ governed by the type of pay-
drawn to avoid unnecessary contributions rather than its merit—the to-play rule that FINRA has proposed
abridgement of the type of political most qualified adviser may not be hired, here.274 FINRA is not alone in
speech represented by a political which may lead to inferior performance addressing these issues. For example,
contribution.266 We believe that and payment of higher fees.269 several State and local governments
Ultimately, taxpayers and fund have barred or restricted placement
262 Blount v. SEC, 61 F.3d 938 (D.C. Cir. 1995),
beneficiaries suffer the harm. Moreover, agents from playing a role in the
cert. denied, 517 U.S. 1119 (1996). One significant pay-to-play distorts free and open contracting process.275 Although the
difference between the MSRB rule, on one hand,
and the SEC’s and FINRA’s rules, on the other, is markets by requiring investment Supreme Court has never required a
that the MSRB rule requires the public disclosure advisers and their placement agents to certain amount of past quid pro quo
of political contributions whereas the SEC’s and ‘‘play the game’’ or risk being left out.270 corruption to sustain a contribution
FINRA’s rules do not. In short, while FINRA’s rule resembles limitation, there is more than sufficient
263 See, e.g., McCutcheon v. FEC, 134 S. Ct. 1434
other contribution limitations by serving evidence of pay-to-play practices to
(2014); Citizens United v. FEC, 558 U.S. 310 (2010);
Davis v. FEC, 554 U.S. 724 (2008); FEC v. Wisc. support FINRA’s rule.276
Right To Life, Inc., 51 U.S. 449 (2007); Randall v. indirect limitation on contributions would be The contours of FINRA’s proposed
Sorrell, 548 U.S. 230 (2006); FEC v. Beaumont, 539 reviewed by a court under strict scrutiny, they rule reflect how pay-to-play practices
U.S. 146 (2003); Nixon v. Shrink Mo. Gov’t PAC, misstate applicable Supreme Court precedent,
which has maintained that limitations on
involving placement agents affect the
528 U.S. 377 (2000).
264 Wagner v. FEC, 793 F.3d 1 (D.C. Cir. 2015) (en contributions are reviewed under a more hiring and retention of investment
banc), cert. denied sub nom., Miller v. FEC, 136 S. intermediate form of scrutiny because advisers by State and local pension
Ct. 895 (2016). ‘‘[c]ontribution limits impose a lesser restraint on funds. One scenario implicated by
political speech’’ that permits ‘‘‘symbolic
265 See, e.g., Yamada v. Snipes, 786 F.3d 1182
expression of support evidence by a contribution’’
FINRA’s rule (and reflected in the
(9th Cir.), cert. denied, 136 S. Ct. 569 (2015);
Preston v. Leake, 660 F.3d 726, 729–30, 736 (4th but do not ‘‘‘in any way infringe the contributor’s
271 SEC Pay-to-Play Adopting Release, 75 FR at
Cir. 2011); Ognibene v. Parkes, 671 F.3d 174, 179– freedom to discuss candidates and issues.’ ’’
McCutcheon, 134 S. Ct. at 1444, quoting Buckley v. 41019–20. Pay-to-play that affects State and local
80 (2d Cir. 2011); Green Party of Connecticut v.
mstockstill on DSK3G9T082PROD with NOTICES
Valeo, 424 U.S. 1, 21 (1976). pension funds is not limited to the investment
Garfield, 616 F.3d 189, 200 (2d Cir. 2010).
266 Wagner, 793 F.3d at 6–8. We note that
267 McCutcheon, 134 S. Ct. at 1452; Buckley, 424 advisory context.
272 SEC Pay-to-Play Adopting Release, 75 FR at
FINRA’s rule is not an absolute bar on U.S. at 27–28 (1976).
268 Blount, 61 F.3d at 944–48. See also 15 U.S.C. 41019–20, 41037.
contributions, but the two-year time-out may have 273 Id. at 41019–20.
the effect of discouraging member firms and certain 78o–3(b)(6).
269 SEC Pay-to-Play Adopting Release, 75 FR at 274 Id. at 41037–42.
covered associates who may act as placement agents
for investment advisers from making certain 41022, 41053–54. 275 Id. at 41037 n. 262.
contributions to certain covered officials. To the 270 Id. at 41019, 41022, 41053. See also Blount, 61 276 McCutcheon, 134 S. Ct. at 1445, 1458; Nixon,
extent that the commenters suggest that such an F.3d at 945–46. 528 U.S. at 390–91; Buckley, 424 U.S. at 29–30.
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Hevesi matter) involves an investment political speech, such as independent contribution exception and the returned
adviser that seeks business from a State expenditures.279 contribution exception; 283 the inclusion
pension fund and retains a firm, or an of the independent business model; 284
B. Comments Regarding the Scope and
individual at a firm, that has made and the application to existing contracts
Coverage of the Proposal
contributions to an elected official or accounts.285 FINRA generally
responsible for selecting investment As discussed in detail above, the responded that its proposed rules are
advisers.277 The elected officials who commenters raise several concerns designed to be at least as stringent as the
participate have no incentive to stop regarding the scope and coverage of the SEC Pay-to-Play Rule so that FINRA’s
accepting contributions for fear of being proposed rules, including with respect member firms will meet the definition
disadvantaged relative to their to: The inclusion of variable annuities of ‘‘regulated persons’’ such that they
opponents. Similarly neither the and mutual funds; 280 the inclusion of are subject to rules that impose
placement agents that make the distribution activities; 281 the substantially equivalent or more
contributions nor the investment application to covered investment stringent restrictions on its members
advisers that hire the placement agents pools; 282 the level of the de minimis than the SEC Pay-to-Play Rule imposes
have an incentive to stop out of concern on investment advisers.286
that if they abstain, their competitors
279 McCutcheon, 134 S. Ct. at 1444, quoting
As noted above, the SEC Pay-to-Play
Buckley, 424 U.S. at 21 (internal quotation marks Rule, in part, prohibits any investment
will continue to engage in the practice omitted).
profitably and without adverse 280 See CAI Letter 1 and FSI Letter 1. See also CAI adviser covered under the rule or any of
consequences.278 FINRA’s rule should Letter 2 (reflecting CAI’s suggested revisions to its covered associates from providing or
resolve this collective-action problem by certain language in some of FINRA’s proposed agreeing to provide, directly or
rules). In FINRA’s view, because the Commission indirectly, payment to any person to
interposing a time-out that creates a did not exclude specific products from the SEC Pay-
disincentive to engage in pay-to-play. to-Play Rule, such as variable annuities or mutual solicit a government entity for
The proposed FINRA rule, like the funds, excluding specific products from its investment advisory services on behalf
SEC Pay-to-Play Rule that it is modeled proposed rule would not satisfy the Commission’s of the investment adviser unless such
stringency requirements. See FINRA Response person is a ‘‘regulated person,’’ as
on, is a tailored solution to a Letter 2 at 16.
particularly pernicious form of quid pro 281 See CAI Letter 1. See also CAI Letter 2
defined under the rule.287 The
quo corruption that affects the (reflecting CAI’s suggested revisions to certain definition of ‘‘regulated person’’
beneficiaries of public pension funds, language in some of FINRA’s proposed rules).
FINRA notes that, among other things, language in inflicted as a consequence of the adviser’s pay-to-
such as teachers, law enforcement the SEC Pay-to-Play Rule Adopting Release play activity’’) (quoting SEC Pay-to-Play Rule
officers, firefighters, and other public supports the inclusion of ‘‘distribution’’ activities Adopting Release, 75 FR at 41044–45). Finally,
servants, as well as the beneficiaries of by broker-dealers in FINRA’s proposed Rule FINRA notes that the applicability of proposed
2030(a). See Notice, 80 FR at 81660–61 (citing SEC FINRA Rule 2030(d) is for purposes of FINRA’s pay-
other collective government funds, Pay-to-Play Rule Adopting Release, 75 FR at 41040 to-play rule only. See FINRA Response Letter 2 at
including participant-directed plans n.298 where, according to FINRA, the Commission 15.
such as 403(b), 457 and 529 plans. The ‘‘clarif[ied] under what circumstances distribution 283 See CAI Letter 1. In response, FINRA explains
proposed FINRA rule would affect a payments would violate the SEC’s Pay-to-Play that it has proposed exceptions for de minimis
Rule’’). FINRA believes that based on the contributions and returned contributions that are
small segment of the electorate: In Commission’s definition of ‘‘regulated person’’ in consistent with similar exceptions in the SEC Pay-
general, member firms acting as the SEC’s Pay-to-Play Rule, as well as the to-Play Rule as FINRA’s proposed rules must
placement agents for investment Commission’s discussion regarding the treatment of impose substantially equivalent or more stringent
advisers seeking to obtain advisory distribution fees paid pursuant to a 12b–1 plan as restrictions on member firms as the SEC Pay-to-Play
compared to legitimate profits, its proposed rule Rule imposes on investment advisers. FINRA does
business from government entities. And must apply to member firms engaging in not believe that raising the limits for the de minimis
the proposed FINRA rule would affect distribution activities. See FINRA Response Letter exception or eliminating the limit for returned
only a small number of elected 2 at 12 (citing Notice, 80 FR at 81660–61) and contributions would satisfy the Commission’s
officials—those who are responsible for FINRA Response Letter 2 at 12 n.53 (explaining that stringency requirements set forth in the SEC Pay-
the SEC Pay-to-Play Rule defines a ‘‘regulated to-Play Rule.
or have authority to appoint any person person’’ to include a member firm, provided that 284 See FSI Letter and FSI Letter 2. FINRA
who is responsible for or can influence FINRA rules prohibit member firms from engaging
explains that the Commission did not exempt
the outcome of the hiring of an in distribution or solicitation activities if political
application of the rule for firms engaged in the
investment adviser by a government contributions have been made, and citing SEC Pay-
independent business model. See FINRA Response
to-Play Rule 206(4)–5(f)(9)(ii)(A)) (emphasis in
entity—and has no bearing on the vast original). Letter 2 at 16. As a result, in FINRA’s view,
majority of elections where the elected 282 See CAI Letter 1; FSI Letter 1; FSI Letter 2.
excluding independent business model firms from
its proposed rule would not satisfy the
office’s scope of authority does not FINRA clarifies that it is not intending in this
Commission’s stringency requirements, although
encompass the awarding of investment proposal to re-characterize broker-dealers’ selling
FINRA is willing to work with the industry and
interests in variable annuities, mutual funds, and
advisory contracts. Moreover, the private funds as soliciting an investment advisory
Commission to address the interpretive questions
proposed FINRA rule’s de minimis and provide additional guidance as needed.
relationship with investors who invest in those 285 See FSI Letter 1. In response, FINRA explains
exception permits some campaign products. See FINRA Response Letter 2 at 14–15
that the Commission did not apply its rule only to
contributions to be made in all instances (noting, for example, that the applicability of
proposed FINRA Rule 2030(d) is for purposes of contracts or accounts opened after the effective date
without triggering the time-out—thus FINRA’s pay-to-play rule only). FINRA also of the rule; therefore, FINRA does not believe that
allowing ‘‘the symbolic expression of explains that FINRA Rule 2030(d) is modeled on a limiting the application of its rule in the way
similar provision in the SEC Pay-to-Play Rule, Rule suggested by FSI would satisfy the Commission’s
support evidenced by a contribution’’— stringency requirements set forth in the SEC Pay-
206(4)–5(c) and, as such, proposed FINRA Rule
and it does not restrict other forms of 2030(d) is intended to extend the protections of the to-Play Rule. However, FINRA also explains that, if
proposed rule to government entities that access the the Commission approves the proposed rule
277 SEC Pay-to-Play Adopting Release, 75 FR at
services of investment advisers through hedge change, proposed Rule 2030(a) will not be triggered
mstockstill on DSK3G9T082PROD with NOTICES
41019–20 & nn.18–20 (citing examples). funds and other types of pooled investment by contributions made prior to the rule’s effective
278 Id. at 41022, 41040, 41053. See also Blount, 61 vehicles sponsored or advised by investment date, and that the rule will not apply to
F.3d at 945–46. Even if the public is aware of the advisers. See FINRA Response Letter 2 at 15 (noting contributions made prior to the effective date by
quid pro quo relationship, there is little that can be that when adopting SEC Pay-to-Play Rule 206(4)– new covered associates to which the two years or,
done because the official is compromised by the 5(c), the Commission stated that although ‘‘an as applicable, six months ‘‘look back’’ applies. See
receipt of the contribution, and beneficiaries of a investment in a pooled investment vehicle may not Notice, 80 FR at 81656.
286 See, e,g., FINRA Response Letter 2 at 4, 16.
pension fund cannot easily shift their assets out of involve a direct advisory relationship with a
the fund, reverse the hiring decision, or remove the government sponsored plan [that] does not change 287 See Notice, 80 FR at 81650 n.6, 81656. See
official. Id. at 41027. See also id. at 41053 n.459. the nature of the fraud or the harm that may be also 17 CFR 275.206(4)–5(a)(2)(i)(A).
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![Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices 60067
includes a FINRA member firm, Commission’s prior statements consistent with the SEC Pay-to-Play
provided that: (a) FINRA rules prohibit regarding the term, including those Rule, it has determined not to except
member firms from engaging in contained in the SEC Pay-to-Play Rule from its proposed pay-to-play rule
distribution or solicitation activities if Adopting Release,293 we believe the member firms that use an independent
political contributions have been made; term is not ambiguous and could be business model.298 We note that
and (b) the Commission finds, by order, applied by FINRA members for FINRA’s rules and the federal securities
that such rules impose substantially purposes of the proposed rule in a way laws do not distinguish so-called
equivalent or more stringent restrictions that is consistent with the prophylactic independent business model firms from
on member firms than the SEC Pay-to- nature of the proposal. However, we other broker-dealer business models.299
Play Rule imposes on investment note that in connection with adopting Rather, although a broker-dealer may
advisers and that such rules are the SEC Pay-to-Play Rule, the organize its operations under a variety
consistent with the objectives of the SEC Commission did clarify under what of business models, and different
Pay-to-Play Rule.288 Thus, any changes circumstances distribution payments business models may present unique
to the proposed rules that would result would violate the SEC’s Pay-to-Play compliance challenges, it is up to the
in FINRA’s rules not being found to Rule.294 For example, the Commission broker-dealer to sufficiently discharge
impose at least substantially equivalent explained that mutual fund distribution its regulatory obligations in light of the
restrictions on its member firms and to fees are typically paid by the fund from business model it has elected, and to
be otherwise consistent with the fund assets pursuant to a 12b–1 plan tailor its supervisory system
objectives of the SEC Pay-to-Play Rule and generally would not constitute appropriately so that it is reasonably
would result in a ban on such activity. payment by the fund’s adviser; designed 300 to achieve compliance with
The Commission believes that it is therefore, such payments would not be applicable federal securities laws and
appropriate and consistent with Section prohibited under Rule 206(4)–5.295 The regulations and FINRA rules.301
15A(b)(6) of the Act for FINRA to design Commission also explained that where We also note that FINRA has
its proposed rules to have the same an adviser pays for the fund’s committed to working with the industry
scope and provisions as the SEC Pay-to- distribution out of its ‘‘legitimate and the Commission to address
Play Rule. If the Commission were profits,’’ the rule would generally be interpretive questions that may arise
unable to make the required stringency implicated.296 Based on the foregoing, regarding the application and scope of
finding, this would result in FINRA we believe it is appropriate for FINRA the provisions and terms used in the
member firms not being a ‘‘regulated not to have specifically defined the term proposed rule change and to provide
person’’ under the SEC Pay-to-Play Rule ‘‘distribution’’ activities for purposes of additional guidance as needed.302
and therefore prohibited from receiving its proposal.
compensation for engaging in One commenter claims that, among 298 See FINRA Response Letter 2 at 18.
distribution and solicitation activities other things, the ‘‘lack of clarity as to
299 While a firm may accept independent
with government entities on behalf of contractor status for purposes other than the federal
the application of the SEC Pay-to-Play securities laws, such treatment does not alter such
investment advisers.289 Rule to [its] members’ business model, person’s status as a person associated with a broker
One commenter states that the and the scope of government officials or dealer or the firm’s responsibility to supervise
proposal is ambiguous regarding the that trigger the requirements, has led under the federal securities laws. See, e.g.,
term ‘‘distribution’’ activities in Rule Hollinger v. Titan Capital Corp., 914 F.2d 1564,
some firms to adopt aggressive 1572–76 (9th Cir. 1990) (en banc) (explaining that,
2030(a).290 This term in FINRA’s compliance programs that prohibit even if a broker-dealer and registered representative
proposed rule is taken directly from the political contributions.’’ 297 As contractually agree that a representative is an
definition of ‘‘regulated person’’ in the discussed above, FINRA states that, independent contractor, the broker-dealer is still
SEC Pay-to-Play Rule.291 Although the required to supervise its representatives).
300 See FINRA Rule 3110(a) (‘‘Each member shall
term ‘‘distribution’’ is not defined example, an all-inclusive definition or list of such establish and maintain a system to supervise the
specifically in the SEC Pay-to-Play Rule, activities and related expenses, and declined to do activities of each associated person that is
to preserve the identified benefits of the so when it adopted the SEC Pay-to-Play Rule. See reasonably designed to achieve compliance with
Bearing of Distribution Expenses by Mutual Funds,
rule, the Commission interprets the term Investment Company Act Release No. 11414 (Oct.
applicable securities laws and regulations and with
broadly in the context of the SEC Pay- applicable FINRA rules.’’) and Exchange Act
28, 1980), 45 FR 73898, 73903 (Nov. 7, 1980) (‘‘Rule Section 15(b)(4)(E), 15 U.S.C. 78o(b)(4)(E)
to-Play Rule to mean generally engaging 12b–1 Adopting Release’’). See also 17 CFR.12b– (authorizing the Commission to sanction a broker-
in any activity that is primarily 1(a)(2) (explaining, in the context of registered dealer that ‘‘has failed reasonably to supervise, with
open-end funds, that one will be deemed to be
intended to result in the sale of acting as a distributor of securities if they engage
a view to preventing violations of’’ the federal
securities.292 In view of the securities laws and rules and regulations
in ‘‘any activity which is primarily intended to thereunder).
result in the sale of shares issued by such [fund], 301 Giving guidance on its supervision rule,
288 See Notice, 80 FR at 81650 n.6. See also SEC including, but not necessary limited to, the
FINRA (then-NASD) noted that to fulfill its
Pay-to-Play Rule 206(4)–5(f)(9). The definition of compensation of underwriters, dealers and other
obligations to establish and maintain a supervisory
‘‘regulated person’’ also includes SEC-registered sales personnel, the printing and mailing of
system, a member firm must determine the types of
investment advisers and SEC-registered municipal prospectuses to other than current shareholders,
business it conducts, how the firm is organized and
advisors, subject to specified conditions. and the printing and mailing of sales literature’’).
293 See infra notes 294–296 and accompanying
operated, and the current regulatory requirements.
289 See Notice, 80 FR at 81650 n.6. See also id.
See NASD Notice to Members 99–45 (NASD
at 81651, 81656 (discussing the regulatory text. Provides Guidance on Supervisory Responsibilities)
objectives of and statutory basis for the proposal). 294 See SEC Pay-to-Play Rule Adopting Release,
(June 1999) (stating that this analysis will enable
290 See CAI Letter 1. 75 FR at 41040 n.298. See also FINRA Response the member to design a supervisory system that is
291 A ‘‘regulated person,’’ as defined in the SEC Letter 2 at 12 (citing Notice, 80 FR at 81660–61). current and appropriately tailored to its specific
295 See SEC Pay-to-Play Rule Adopting Release,
Pay-to-Play Rule, includes a FINRA member firm, attributes and structure). See also FINRA
mstockstill on DSK3G9T082PROD with NOTICES
provided that, among other things, FINRA rules 75 FR at 41040 n.298 (citing Rule 12b–1 Adopting Regulatory Notice 14–10 (SEC Approves New
‘‘prohibit member firms from engaging in Release). Supervision Rules) (Mar. 2014), at 17 n.4
distribution or solicitation activities if certain 296 See SEC Pay-to-Play Rule Adopting Release, (discussing NASD Notice to Members 99–45).
political contributions have been made.’’ 17 CFR 75 FR at 41040 (citing Rule 12b–1 Adopting 302 See FINRA Response Letter 2 at 18. We note
275.206(4)–5(f)(9)(ii) (emphasis added). Release). that the proposed rule does contain a provision—
292 By way of example in other contexts, the 297 See FSI Letter 1 (claiming FSI believes that the modeled on an analogous provision in the SEC Pay-
Commission has recognized that, because new SEC Pay-to-Play Rule has inadvertently captured to-Play Rule—allowing member firms to apply to
distribution activities may continuously evolve in non-corrupting activity and it fears that the FINRA for an exemption, conditional or
the future, it would be impracticable to develop, for proposed rule may do the same). Continued
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![60068 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices
C. Comments Requesting Clarification of FINRA’s definition of ‘‘official’’ also soliciting or coordinating payments to a
Terms and Provisions in the Proposal tracks the Commission’s definition of political party of a State or locality of a
Commenters asked for clarification of that same term in the SEC Pay-to-Play government entity with which the
certain defined terms and provisions in Rule and, therefore, limits the rule so covered member is engaging in
the proposed rule, including that a time-out is triggered only by distribution or solicitation activities on
contributions to certain officials.310 behalf of an investment adviser.314
clarification with respect to: The term
Under FINRA’s proposed rule, the time- FINRA notes in response to a
‘‘instrumentality’’ as it is used in the
out for a placement agent is not commenter’s request for clarification as
definition of ‘‘government entity;’’ 303
triggered by a contribution to every to whether each and every
the definition of ‘‘covered associate’’
public official running for office; it is ‘‘contribution’’ (as defined in proposed
and the positions that would qualify
triggered only by contributions to a FINRA Rule 2030(g)(1)) is, by definition,
someone as a covered ‘‘official;’’ 304
person ‘‘who was, at the time of the also a ‘‘payment’’ (as defined in
whether a ‘‘contribution’’ is also a
contribution, an incumbent, candidate proposed FINRA Rule 2030(g)(9)), that
‘‘payment;’’ 305 and the factors by which
or successful candidate for elective the definition of ‘‘payment’’ is similar to
contributions to a PAC would trigger the
office of a government entity, if the the definition of ‘‘contribution,’’ but is
proposed anti-circumvention rule.306 In
office . . . [i]s directly or indirectly broader in the sense that it does not
response to these comments, FINRA responsible for, or can influence the include limitations on the purposes for
generally acknowledges, as did the outcome of, the hiring of an investment which such money is given (e.g., it does
commenters, that these terms are adviser by a government entity’’ or a not have to be made for the purpose of
defined in the SEC Pay-to-Play Rule and person with authority to appoint influencing an election).315
that FINRA modeled the definitions in someone whose office had the hiring The Commission believes that
its proposal on those in the SEC Pay-to- responsibility.311 FINRA’s definition, FINRA’s definitions, which mirror or
Play Rule.307 like the Commission’s, is flexible are functionally equivalent to similar
The Commission believes that enough to accommodate the myriad definitions in the SEC’s Pay-to-Play
FINRA’s definition of ‘‘covered State and local political structures while Rule, will help to achieve the objectives
associate’’ in proposed Rule 2030(g) is still limiting the reach of the rule to of the SEC Pay-to-Play Rule and, as
functionally identical to the definition those officials who are responsible for or described above, the requirements
of the same term in the SEC Pay-to-Play have authority to appoint any person governing the rules of a registered
Rule.308 The definition brings within who is responsible for or can influence national securities association.316 The
the ambit of the rule—and its two-year the outcome of the hiring of an Commission believes that it is
‘‘time-out’’—only those contributions investment adviser by a government appropriate and consistent with the Act
made by employees of a member firm entity.312 for FINRA to encompass in its rule the
who, by virtue of their position or Additionally, FINRA’s definitions of same definitions and discussion
responsibilities, are best positioned to ‘‘contribution’’ and ‘‘payment’’ are regarding its pay-to-play rules as the
engage in pay-to-play activities as functionally identical to those same Commission did in adopting the SEC
placement agents. It includes ‘‘[a]ny definitions in the SEC Pay-to-Play Pay-to-Play Rule. The Commission
general partner, managing member or Rule.313 We note that under FINRA’s emphasizes that FINRA has committed
executive officer of a covered member,’’ rule, the time-out is not triggered by to working with the industry and the
any ‘‘associated person of a covered direct contributions to political parties. Commission to address interpretive
member who engages in distribution or Therefore, a member firm will not questions and provide additional
solicitation activities with a government violate the time-out if it receives guidance as needed.317
entity for such covered member,’’ any compensation for solicitation and
associated person who supervises such distribution activities in the wake of 314 See Proposed Rule 2030(b). This aspect of the
an employee, and any ‘‘political action contributions that it or its covered rule serves an anti-circumvention function, along
committee controlled by a covered with proposed Rule 2030(e), which makes it a
associates make to a political party. violation of the rule ‘‘for any covered member or
member or a covered associate.’’ Instead, FINRA’s proposed rule only any of its covered associates to do anything
FINRA’s rule also adopts the precludes a covered member from indirectly that, if done directly, would result in a
Commission’s definition of ‘‘executive violation of this Rule.’’ As FINRA notes, Rule
2030(e) precludes only intentional efforts to
officer,’’ which was designed to tailor same effect. See FSI Letter 2. However, under circumvent the time-out and a covered member
the trigger for the time-out to those FINRA’s rule (and the SEC Pay-to-Play Rule), only would not violate the rule’s prohibition on the
officers whose position is most likely to certain employees’ contributions will trigger the receipt of compensation unless there is a showing
time-out and the rules on their face do not cover that the covered member intended to evade the
incentivize them to engage in contributions by all employees. See SEC Pay-to-Play time-out. Thus, a contribution to a PAC—other than
solicitation or distribution activities— Rule Adopting Release, 75 FR at 40131–32. a PAC controlled by the covered member, which
and thus most likely to incentivize them 310 Compare Proposed Rule 2030(g)(8), with 17 would be a ‘‘covered associate’’ for purposes of the
to engage in pay-to-play.309 CFR 275.206(4)–5(f)(6). time-out—would not trigger the time-out and the
311 See supra note 310. receipt of compensation in the wake of that
312 If FINRA were to define ‘‘official’’ by reference contribution would not violate the rule unless it can
unconditional, from the proposed rule’s two-year
to a particular title, such as ‘‘Comptroller,’’ the be shown that the covered member or covered
‘‘time-out,’’ and enumerates factors for FINRA to
definition would be both over- and under- associate who made the contribution intended to
consider in deciding whether to grant such an
inclusive. Some officials who have hiring circumvent the time-out provision. This provision,
exemption. See Proposed Rule 2030(f).
303 See CAI Letter 1. responsibility for investment advisers do not hold which is analogous to a provision in the
the title of ‘‘Comptroller,’’ and some officials with Commission’s Pay-to-Play Rule, precludes a
304 See NAIFA Letter.
the title of ‘‘Comptroller’’ do not have hiring member or its covered associates from, for example,
mstockstill on DSK3G9T082PROD with NOTICES
305 See CAI Letter 1.
responsibility for investment advisers. Because we funneling contributions or payments through third
306 See NAIFA Letter. parties, such as attorneys, family members, or
understand FINRA’s definition to track the
307 See FINRA Response Letter 2 at 17, 18.
definition that we adopted in the SEC Pay-to-Play friends, to complete a pay-to-play arrangement
308 Compare Proposed Rule 2030(g)(2), with 17 Rule, we note that it is the scope of authority of the without triggering the time-out.
315 See FINRA Response Letter 2 at 17.
CFR 275.206(4)–5(f)(2). office, not de facto influence, that determines
309 At least one commenter points out that some whether a contribution will trigger the time-out. See 316 See SEC Pay-to-Play Rule Adopting Release,
entities have precluded all employees from making SEC Pay-to-Play Adopting Release, 75 FR at 41029. 75 FR at 41042–44.
contributions as a result of the Commission’s pay- 313 Compare Proposed Rules 2030(g)(8)–(9), with 317 There are several ways for industry members
to-play rule and that FINRA’s rule will have the 17 CFR 275.206(4)–5(f)(1), 206(4)–5(f)(7). to obtain guidance from FINRA about the
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![60070 Federal Register / Vol. 81, No. 169 / Wednesday, August 31, 2016 / Notices
V. Conclusion Exchange also proposes to make business day and is not a Wednesday in
Accordingly, for the reasons corresponding changes to Rule 16.1, which Quarterly Options Series expire
discussed above, the Commission finds entitled ‘‘Definitions.’’ (‘‘Wednesday SPY Expirations’’).6 The
The text of the proposed rule change proposed Wednesday SPY Expiration
that the proposed rule change is
is available at the Exchange’s Web site series will be similar to the current
consistent with the Act and the rules
at www.batstrading.com, at the Short Term Option Series, with certain
and regulations thereunder applicable to
principal office of the Exchange, and at exceptions, as explained in greater
such organization.
the Commission’s Public Reference detail below. The Exchange notes that
It is therefore ordered, pursuant to
Room. having Wednesday expirations is not a
Section 19(b)(2) of the Act,332 that the
II. Self-Regulatory Organization’s novel proposal. Specifically, the
proposed rule change (SR–FINRA–
Statement of the Purpose of, and Chicago Board Options Exchange,
2015–056) be, and hereby is, approved.
Statutory Basis for, the Proposed Rule Incorporated (‘‘CBOE’’) recently
By the Commission. received approval to list Wednesday
Change
Brent J. Fields, expirations for broad-based indexes.7
Secretary. In its filing with the Commission, the In regards to Wednesday SPY
[FR Doc. 2016–20888 Filed 8–30–16; 8:45 am]
Exchange included statements Expirations, the Exchange is proposing
concerning the purpose of and basis for to remove the current restriction
BILLING CODE 8011–01–P
the proposed rule change and discussed preventing it from listing Short Term
any comments it received on the Option Series that expire in the same
SECURITIES AND EXCHANGE proposed rule change. The text of these week in which monthly option series in
COMMISSION statements may be examined at the the same class expire. Specifically, the
places specified in Item IV below. The Exchange will be allowed to list
[Release No. 34–78696; File No. SR– Exchange has prepared summaries, set Wednesday SPY Expirations in the same
BatsEDGX–2016–50] forth in Sections A, B, and C below, of week in which monthly option series in
the most significant parts of such SPY expire. The current restriction to
Self-Regulatory Organizations; Bats
statements. prohibit the expiration of monthly and
EDGX Exchange, Inc.; Notice of Filing
and Immediate Effectiveness of A. Self-Regulatory Organization’s Short Term Option Series from expiring
Proposed Rule Change To Amend Rule Statement of the Purpose of, and on the same trading day is reasonable to
19.6, Series of Options Contracts Open Statutory Basis for, the Proposed Rule avoid investor confusion. This
for Trading, To Allow Wednesday Change confusion will not apply with
Expirations for SPY Options Wednesday SPY Expirations and
1. Purpose standard monthly options because they
August 26, 2016. The purpose of the proposed rule will not expire on the same trading day,
Pursuant to Section 19(b)(1) of the change is to harmonize the Exchange’s as standard monthly options do not
Securities Exchange Act of 1934 rules with the rules governing Short expire on Wednesdays. Additionally, it
(‘‘Act’’),1 and Rule 19b–4 thereunder,2 Term Options Series programs of other would lead to investor confusion if
notice is hereby given that, on August options exchanges. Specifically, the Wednesday SPY Expirations were not
25, 2016, Bats EDGX Exchange, Inc. (the Exchange proposes to amend Rule 19.6, listed for one week every month because
‘‘Exchange’’ or ‘‘EDGX’’) filed with the entitled ‘‘Series of Options Contracts there was a monthly SPY expiration on
Securities and Exchange Commission Open for Trading,’’ related to the STOS the Friday of that week.
(‘‘Commission’’) the proposed rule Program to allow Wednesday Under the proposed Wednesday SPY
change as described in Items I and II expirations for SPY options. The Expirations, the Exchange may list up to
below, which Items have been prepared Exchange also proposes to make certain five consecutive Wednesday SPY
by the Exchange. The Exchange has corresponding changes to 16.1, entitled Expirations at one time. The Exchange
designated this proposal as a ‘‘non- ‘‘Definitions.’’ The proposed rule may have no more than a total of five
controversial’’ proposed rule change change is based on the recent approval Wednesday SPY Expirations listed. This
pursuant to Section 19(b)(3)(A) of the of a filing submitted by the BOX is the same listing procedure as Short
Act 3 and Rule 19b–4(f)(6) thereunder,4 Options Exchange LLC (‘‘BOX’’).5 Term Option Series that expire on
which renders it effective upon filing Currently, under the STOS Program, Fridays. The Exchange is also proposing
with the Commission. The Commission the Exchange may open for trading on to clarify that the five series limit in the
is publishing this notice to solicit any Thursday or Friday that is a current Short Term Option Series
comments on the proposed rule change business day series of options on that Program Rule will not include any
from interested persons. class that expire on each of the next five Wednesday SPY Expirations.8 This
Fridays, provided that such Friday is means, under the proposal, the
I. Self-Regulatory Organization’s not a Friday in which monthly options Exchange would be allowed to list five
Statement of the Terms of Substance of series or Quarterly Options Series expire Short Term Option Series expirations
the Proposed Rule Change (‘‘Short Term Option Series’’). The for SPY expiring on Friday under the
The Exchange filed a proposal to Exchange is now proposing to amend its current rule and five Wednesday SPY
amend Rule 19.6, entitled ‘‘Series of rule to permit the listing of options Expirations. The interval between strike
Options Contracts Open for Trading,’’ expiring on Wednesdays. Specifically, prices for the proposed Wednesday SPY
related to the Short Term Option Series the Exchange is proposing that it may Expirations will be the same as those for
the current Short Term Option Series.
mstockstill on DSK3G9T082PROD with NOTICES
(‘‘STOS’’) Program to allow Wednesday open for trading on any Tuesday or
expirations for SPY options. The Wednesday that is a business day, series
6 See proposed paragraph (g) of Interpretation and
of options on the SPDR S&P 500 ETF
Policy .05 to Rule 19.6.
332 15U.S.C. 78s(b)(2). Trust (‘‘SPY’’) to expire on any 7 See Securities Exchange Act Release No. 76909
1 15 U.S.C. 78s(b)(1). Wednesday of the month that is a (January 14, 2016), 81 FR 3512 (January 21, 2016)
2 17 CFR 240.19b–4.
(SR–CBOE–2015–106).
3 15 U.S.C. 78s(b)(3)(A). 5 See Securities and Exchange Act Release No. 8 See proposed changes to Interpretation and
4 17 CFR 240.19b–4(f)(6). 78668 (August 24, 2016) (SR–BOX–2016–28). Policy .05 to Rule 19.6.
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Document Created: 2018-02-02 12:14:52
Document Modified: 2018-02-02 12:14:52
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| sudoc Class | AE 2.7: GS 4.107: AE 2.106: | |
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