A Compilation of Enforcement and Non-Enforcement Actions

28 August 2009 Publication
Author(s): Peter D. Fetzer

Legal News: Investment Management Update

Non-Enforcement Matters

Proposed SEC Rule Intended to Curb Advisers’ Pay to Play Practices
The SEC recently proposed a new rule (Rule) to curb so-called “pay to play” practices by investment advisers seeking business from public pension and other governmental plans. The Rule’s intent is to prevent investment advisers from donating to politicians in an effort to influence politicians in selecting an adviser to manage government-held investments. In her statement before the SEC, Chair Mary Schapiro described the SEC’s concern in this area as follows: More than $2.3 trillion is invested in government pension plans and government-sponsored 529 plans. Government officials often seek outside investment advisers to help make investment decisions for those plans. In turn, the investment advisers are paid based on the assets under management. There have been several recent cases of investment advisers making substantial campaign “donations” to government officials who could, if elected, directly or indirectly influence which investment adviser is selected to manage the assets under those government plans.

The proposed Rule would become Rule 206(4)-5 to the Investment Advisers Act of 1940 and is basically a modified version of a rule proposed by the SEC in 1999. The proposed Rule consists of three restrictions:

  1. Investment advisers would be barred from performing paid advisory services for two years if they or certain of their executives and employees made contributions of greater than $250 to an officeholder or a candidate who, if elected, would be able to influence the selection of an investment adviser
  2. Investment advisers and certain of their executives and employees are likewise barred from making or soliciting contributions through other persons or political action committees to elected officials or political parties that could influence the selection of an investment adviser
  3. Investment advisers and certain of their executives and employees are barred from paying a third party such as a solicitor or placement agent to solicit government clients for the adviser


The SEC has already received dozens of comments, only half-way through its comment period. Most of the comments compliment the SEC’s intentions and recognize the problem, real or perceived, that exists. Some believe the rule is too harsh. A two-year ban on advisory activities effectively would require an investment adviser to “start over.” Others deride the harsh consequences, given that advisers might unintentionally violate the proposed Rule through an unauthorized contribution or solicitation by an employee. Intent to influence politicians is not an element of the proposed Rule.

Moreover, the proposal raises federal constitutional issues, namely in the realm of free speech and states’ rights. Some object to the proposed Rule, saying that it will have a chilling effect on constitutionally protected free speech, particularly that fundamental free speech associated with political activity. Others note that the federal de minimus limit of $250 will apply with unequal force in Vermont (where campaign costs are comparatively low) and California’s East Bay (where campaign costs are comparatively high). Some comments suggest that states, rather than the federal government, are in a better position to determine what constitutes a de minimum donation in their jurisdiction.

However, the most common complaint in the comments to the proposed Rule is that the third regulation listed above (the ban on paying third-party solicitors or placement agents) would disproportionately impact small, medium, and emerging investment advisers. Some advisers warn that only large investment advisers will be able to afford in-house marketing agents and would, therefore, have a much easier time convincing government officials to hire them.

Comments to this proposed Rule are due September 18, 2009.

SEC Reopens Comment Period on Short Sale Rule
The SEC reopened the period to receive further comments related to restrictions on short sales. In our April newsletter (http://www.foley.com/publications/pub_detail.aspx?pubid=5973), we outlined five different approaches the SEC was considering in reinstating its short selling restrictions. The SEC elected not to include all five approaches in its proposal when it submitted to the public the proposed Rule for comment. Now, the SEC is looking for comments on the modified uptick rule, one of the approaches the SEC did not initially include in its proposed Rule.

Under the modified uptick rule (or as some have called it, the “alternative uptick rule”), short selling is barred only when the price is set at an amount greater than the existing best-available national bid. The SEC acknowledges that this approach is more restrictive than its other options. However, the modified uptick rule also will be easier for the SEC to implement.

The comment period will close September 16, 2009.

Enforcement Matters

SEC Charges Adviser for Overstating Asset Value
The SEC recently brought charges against Brantley Capital Management (Brantley), an investment adviser, and two of its executives. According to the SEC’s complaint, Brantley substantially overstated the value of debt equity and debt investments in two failing companies that comprised more than 50 percent of the investment capital of Brantley Capital Corp. In using an overvalued asset amount, the adviser was able to collect more fees than it would have been entitled to if the assets had been valued fairly.

The SEC settled charges with one of the executives of Brantley, who agreed to pay $50,000 in penalties. However, the adviser and the other charged executive are poised to defend their actions. Attorneys for the remaining defendants have not publicly stated their grounds for a defense.

Bankruptcy Trustee Drops One-Third of Suits Against Defrauded Investors
In a controversial move earlier this year, a U.S. Bankruptcy Trustee sued nearly 700 individuals and businesses in an effort to recoup some of the losses generated from boy band producer Lou Pearlman’s $300 million Ponzi scheme. Recently, the Trustee has agreed to drop 232 of those “clawback” suits.

Many of the would-be defendants in the clawback suits were victims themselves, having lost a large portion of their principal investment in Pearlman’s Ponzi scheme. The clawback suits that remain allegedly target at least some investors who profited from the Ponzi scheme before it was uncovered. Negotiations are ongoing between the Trustee and attorneys representing that class of investors.

Mr. Pearlman is currently serving a 25-year prison sentence for his fraud conviction.


Legal News: Investment Management Update is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. If you have any questions about this update or would like to discuss these topics further, please contact your Foley attorney or the following:


Terry D. Nelson
Madison, Wisconsin

Joseph D. Shumow
Madison, Wisconsin

Peter D. Fetzer
Milwaukee, Wisconsin