We meet today to consider a proposal that would significantly curtail the corrupting and distortive influence of pay to play practices, including, among other things, campaign contributions made to influence the selection of investment advisers to manage public pension plans and similar government investment accounts.
In the public pension and government plan world, "pay to play" refers to an often unspoken, but well-understood arrangement. It's an arrangement whereby investment advisers who make political contributions and related payments to key officials are then rewarded with, or afforded the opportunity to compete for, contracts to manage public pension plans and other government accounts. There should be no place for such practices in an investment advisory industry comprised of fiduciaries that are subject to high standards of ethical conduct.
Pay to play practices can result in public plans and their beneficiaries receiving sub-par advisory services — at inflated prices. It is important, therefore, that we address adviser pay to play practices for public plans and their beneficiaries and participants, who are relying on advisers to manage their future retirement benefits and education funds, and for taxpayers, who in some cases fund the services advisers provide. In the end, the selection of investment advisers to manage public plans should be based on merit and the best interests of the plans and their beneficiaries, not the payment of kickbacks or political favors.
In 1999, the Commission considered a proposal to curb adviser pay to play practices modeled on MSRB Rule G37 that applies to underwriters of municipal bonds. In the ten years since, we have seen a number of criminal and regulatory actions that suggest the need to act to finally address these practices.
And, importantly, the scope of government plans, and thus the potential harm that can result from pay to play practices, has grown. Public pension plans alone hold more than $2.2 trillion of assets and represent one-third of all U.S. pension assets.
Additionally, state-sponsored plans that enable families to invest money for college and other types of higher education, commonly known as "529 plans," hold more than $104 billion in assets. These plans were in their infancy when the Commission last took up this issue in 1999.
In light of the potential for fraud, and the substantial size and increased scope and importance of the government plan market, it is time for the Commission to act to prevent adviser pay to play practices.
In taking these steps today, I think we can help to level the playing field for all advisers, both large and small, so that they can compete for government contracts based on investment skill and quality of service, not based on political contributions and inappropriate, under-the-table payments.
The core of today's proposals would prohibit an investment adviser who makes a political contribution to an elected official in a position to influence the selection of the adviser from providing advisory services for compensation for a period of two years. The adviser also would be prohibited from soliciting contributions for such officials. The rules would apply to the investment adviser as well as certain executives and employees of the adviser. Additionally, the rules would apply to political incumbents as well as candidates for a position that can influence the selection of an adviser.
The proposals also would prohibit an adviser and certain of its executives and employees from paying a third party, such as a solicitor or placement agent, to solicit a government client on behalf of the investment adviser. The proposals, however, would not preclude a state or local government from hiring a third party to assist with the selection of an investment adviser.
Finally, and very importantly, the proposals would prohibit an adviser and certain of its executives and employees from doing indirectly acts that would violate the rules if done directly. This provision would prevent advisers from circumventing the rule by directing or funding contributions through third parties, such as attorneys, family members or companies affiliated with the adviser.
The rule's provisions generally would apply to advisers of pooled investment vehicles, such as mutual funds, that often are used as investment vehicles in 529 college investment plans and similar government plans.
While the SEC can and has brought fraud cases related to kickbacks in adviser pay to play schemes, we are concerned there may be broader efforts and monetary payments being made to influence the selection of advisers to manage government plans. These payments have a distortive influence on the adviser selection process.
However, proving a direct quid pro quo or intent to influence in a specific case often is not possible, particularly since these practices may be done in a manner that is intentionally difficult to detect. As a result, the prophylactic rules we are considering today would address specific circumstances where monetary payments may inappropriately be used to influence the selection of an investment adviser.
I look forward to hearing more about these proposals from Division of Investment Management Director, Buddy Donohue. Before we do that, however, I would like to thank those who have worked long and hard to prepare the recommendation before us today: Buddy, Donohue, Bob Plaze, Sarah Bessin, Dan Kahl, Matt Goldin and Melissa Roverts from the Division of Investment Management; Amy Edwards and Chuck Dale from the Office of Economic Analysis; and Meridith Mitchell, Jeff Singdahlsen, Lori Price, David Fredrickson, Cathy Ahn, Sharon Zamore and Mark Pennington in the Office of General Counsel.