February 8, 2023

Aligning pay-to-play rule 206(4)-5 compliance practices with your investment firm’s regulatory compliance program

While it would be almost too easy to treat the Securities and Exchange Commissions’ (SEC) pay-to-play rule 206(4)-5 as a special requirement implemented only during election years, that mistake can cause serious, firm-wide damages. In fact, for investment firms, establishing a compliance program which actively and regularly incorporates compliance with the SEC pay-to-play rule is essential to avoiding fines, sanctions, lockout periods, loss of revenue and a damaged reputation.

Why? Employee political contributions occur during on and off election years, making it a critical aspect of your ongoing regulatory compliance program.

In this blog, we’ll highlight how your firm can align your pay-to-play compliance with its other compliance practices, creating a compliance program which is cohesive, effective and thorough enough to mitigate your compliance risk.

Best practices to ensure your investment firm is in compliance with the pay-to-play rule

While some firms’ Code of Ethics prohibits employees from making political contributions, for those firms which allow employee political contributions, adjustments must be made to your overarching compliance program to ensure all covered employees abide by and comply with relevant pay-to-play regulations.

Here are some tactics to ensure that your investment firm remains in compliance with the pay-to-play rule:

  • Include thorough pay-to-play policies and procedures in your investment firm’s overarching compliance manual.
  • During your firm’s regular organization-wide meetings, talk about compliance, including what pay-to-play compliance looks like.
  • During regular training sessions at your firm, offer up-to-date training on the pay-to-play rule and any requirements.
  • Incorporate a political contribution preclearance process for those employees covered by the rule. This process should likely align with your employee trading preclearance requirements as well.
  • During your firm’s quarterly and or annual reviews, incorporate testing to verify all political contributions have been reported.
  • Integrate a comprehensive compliance technology which accounts for all types of employee preclearance and monitoring, including political contributions.

Firms cannot afford a pay-to-play violation. Although the fines can be steep, the cost to your firm’s reputation are often steeper. Your firm must do its due diligence to educate its covered members and avoid a pay-to-play violation.

Political contributions made by firm employees pose a significant threat to investment advisory firms. And even firms with the best compliance teams can be at risk of violating pay-to-play regulations, like the Securities and Exchange Commission’s (SEC) rule 206(4)-5, given the complexity of the rules and the myriad of regulations to which firms must comply.

Because of this, investment firms must arm themselves with the access to and support of real-time data, which can help identify potential violations and anomalies in the political donation process.

By leveraging real-time data, investment firms can quickly detect suspicious or unauthorized activities and take prompt action to prevent pay-to-play violations.

SEC Rule 206(4)-5 is arguably the most well known regulation regarding political contributions compliance or pay-to-play compliance. However, it certainly isn’t the only regulation to which firms must comply.

In fact, beyond federal regulations, firms which take part in government contracted work must contend with numerous and varied state and local regulations as well. Such regulations present unique challenges because of the various requirements within each, which should they be neglected, can cause significant financial and reputational damage.

compliance updates

For financial firms who rely on government contracted work, complying with the Securities and Exchange Commission (SEC) Pay-to-Play Rule, in addition to any other relevant political contributions compliance ruling, is essential to maintaining your contract and avoiding potential fines, sanctions, lockout periods and, ultimately, loss of revenue.

While the pay-to-play rulings do limit which campaigns your employees can contribute to, it does not completely rule out contributions across the board.

Which is where the political contribution preclearance process comes into play.