SEC Charges Private Equity Firm with Pay-to-Play Violations

For the first time since passing Rule 206(4)-5, the Securities and Exchange Commission (SEC) has charged a Philadelphia-area private equity firm with violations of the pay-to-play rule.  The case concerns contributions made to a Philadelphia mayoral candidate and to the governor of Pennsylvania. The firm –TL Ventures Inc. – has been a limited partner with the Pennsylvania State Employees’ Retirement System since 1999 and the Philadelphia Board of Pensions and Retirement since 2000. In 2011, a "covered associate" made a $2,500 campaign contribution to a Philadelphia mayoral candidate and a $2,000 campaign contribution to the governor of Pennsylvania. According to the NY Times, the contributor was a co-founder of the firm. Accordingly, the SEC found that the firm violated SEC Rule 206(4)-5, which prohibits investment advisers from providing advisory services for compensation to a government client for two years after the adviser or certain of its executives or employees (i.e. "covered associates") make a campaign contribution to a “government entity”. As a result, TL Ventures, entered into an Order Instituting Administrative and Cease-and-Desist Proceedings which requires it to pay disgorgement of $256,697, prejudgment interest of $3,197 and penalty of $35,000. A couple of points to note:

• Rule 206(4)-5 applies to investment advisers even if the government entity was already invested in the covered investment pool at the time of the contribution. As noted above, Rule 206(4)-5 was passed in 2010, ten years after the partnership began. There is no exemption for investments existing at the time of the passage of the rule.

• The firm obviously did not receive exemptive relief from the SEC (which the SEC granted in 2013 to a different investment adviser). Rule 206(4)-5(e) provides that the SEC can exempt an investment adviser from the time-out provision upon consideration of several factors including, whether the exemption is in the public interest and whether the IA:
  • before the contribution was made, adopted and implemented policies and procedures reasonably designed to prevent violations of the rule;
  • prior to or at the time of the contribution had actual knowledge of the contribution;
  • has taken all available steps to cause a return of the contribution; and
  • has taken such other remedial or preventive measures as would be appropriate under the circumstances

The latter point in particular illuminates the value of an appropriate compliance program. The critical first question? Whether employees – including co-founders of the firm – are subject to the law.