Effective today, March 14, 2011, the short answer is “probably not” if the fund manager has any governmental investor. Many fund managers also happen to be politically active and, for them, the new restrictions on political contributions by fund managers, which we previously summarized here, will be a huge imposition. If they also have governmental or public institutional investors (for example, many public universities have endowments that invest in a broad spectrum of categories), the rules will limit or prevent them from a broad range of political activities. For fund managers who have or are thinking about accepting investments from these “government investors,” the new political contribution rules may be very significant because they have been drafted to cast an incredibly wide net, which creates a significant risk of inadvertent violations (not actually involving any form of quid-pro-quo). For this reason, the rules are causing significant compliance concerns on the part of fund managers.
For example, here is hypothetical scenario that could be problematic under the new rules:
The above scenario seems highly unlikely to actually involve any quid-pro-quo element that the rules are intended to prevent; however, it may fall within the scope of the rules as currently drafted.
I and many other practitioners have urged the SEC to provide additional guidance on these issues so that fund managers can implement compliance programs. Until that guidance is given, we’re all stuck with an incredibly broad regulatory regime that is painful to apply (assuming there is no successful challenge to the pay to play rules on constitutional grounds, which is also possible given their breadth). This post is intended to provide some practical guidance on the potential scope of the new “pay to play rules” in reasonably plain English. (As an aside, I find the “pay to play” moniker pretty confusing so I prefer to think of them as aimed at “quid-pro-quo” or “tit for tat” arrangements.)
Summary of the Rules
Essentially, the rules say that if a fund manager or a person at a fund that has direct connections to a government investor makes a material political contribution (in excess of $150-$350) to a candidate and then the fund manager cannot accept a payment from a government investor that could be controlled or influenced by that person within 2 years of that political contribution.
Fund manager means a “covered person” in the rules, which generally includes high-level directors of a fund as well as personnel at a fund that deal directly with a government investor.
Candidate generally means an individual running for office that can control or influence, directly or indirectly, the selection of the people that make investment decisions for the government investor (including the selection of their superiors); however, state political parties and controlled political action committees (PACs) are also included.
Payment means anything of value. There is no “binding commitment” exception, meaning that, at least theoretically, payment of a VC fund capital call by a governmental investor could be an improper payment, even if pursuant to a subscription that occurred prior to a political contribution.
What About Contributions by Spouses or Immediate Family Members?
There is no direct restriction on the ability of a spouse or family member of a fund manager from making a political contribution outside of the rules. Technically, the rules do not reach their conduct; however, if the payment is being made by them in order to avoid the rules, a broad anti-avoidance rule will treat the political contribution as having been made by the fund manager directly. Essentially, the anti-avoidance rules say that you can’t make contributions directly or indirectly so planning around these restrictions is not advisable.
How to Comply
Instead of structuring around the rules, which doesn’t work per the above, better approach is to make sure there is not, in actuality, any influential relationship between the candidate and the investor. In the example chart above, that means making sure that the governor cannot control or influence hiring decisions regarding the regents or, alternatively, that the regents cannot control or influence hiring decisions regarding the university’s investment managers. If that doesn’t work, fund managers may seek an case-specific exemption from the SEC (similar to a no-action letter). The SEC has estimated that they will receive 7 such exemption requests per year but I expect that they will receive exponentially more exemption requests than that until they issue preliminary guidance discussing their intended implementation of these incredibly broad rules.