Published: Wednesday, 22 Jul 2009 | 5:17 PM ET

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Federal regulators on Wednesday proposed new rules to restrain investment firms from making political donations to state or local government officials with an eye toward winning pension plan or other public business.

The Securities and Exchange Commission voted 5-0 at a public meeting to propose curbing "pay-to-play" practices by barring investment firms from providing management services for two years if they make political contributions to elected officials who could influence awarding of contracts.

In addition, investment firm executives and certain employees would be prohibited from asking another person or a political action committee to make such a contribution. The payment of fees by investment firms to so-called "placement agents" — who figure prominently in a "pay-to-play" scandal in New York state — to solicit government officials on the firms' behalf.

The SEC action addresses a practice often seen in local government that regulators say can result in investment firms winning lucrative contracts to manage millions of dollars in public employee pension plans or other government business based on their political clout, not merit. It is rarely overt and payments are often made in a way to hide the source of the money.

The practice can bring inferior services and higher transaction fees that ultimately hurt the thousands of police officers, teachers and other public employees who rely on the plans for their retirement, the regulators say. Pension plans for state and local employees represent some $2.3 trillion in assets.

"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," SEC Chairman Mary Schapiro said before the vote.

Said Commissioner Troy Paredes: "Advisers who do not pay do not get hired."

The SEC commissioners could formally adopt the proposal at some point after the 60-day public comment period. The New York pension corruption case by state Attorney General Andrew Cuomo and the SEC already has brought the indictment of two top aides to former state Comptroller Alan Hevesi. They are accused of ordering investment firms to kick back a slice of their fees as a condition of getting business.

Steven Rattner, who recently resigned his position as a key Obama administration adviser on the auto industry, has faced scrutiny in the affair. The private equity firm he led before joining the administration, the Quadrangle Group, paid more than $1 million to one of the individuals who were indicted, New York political consultant Hank Morris.

Cuomo recently has signed civil settlements with other firms that made similar payments.

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