Pay to Play Law Blog 

While many spent the final days of 2018 taking a much-needed break, the Securities and Exchange Commission (SEC) was busy trumpeting its dedication to holding the regulated community accountable for violations of the federal pay-to-play laws. Just a week before Christmas, the SEC announced the assessment of a $100,000 penalty as part of an administrative settlement it reached with Ancora Advisors LLC, a Cleveland-based investment advisory firm. Ancora neither admitted nor denied the allegations detailed in the associated SEC order announcing the settlement, but the description provided by the Commission alleged violations of Rule 206(4)-5, which limits covered associates of investment advisers from making certain contributions to state and local officials with influence over the award of public contracts for the provision of investment advisory services. 

The SEC’s levied penalty in this settlement is a stark reminder that investment advisory firms must be diligent in the implementation of robust internal compliance policies that pre-screen impermissible contributions before they are made. As Ancora found out, merely having a compliance system in place that allows for post-hoc remediation of inadvertent violations is insufficient from an SEC perspective – even if identified problems are self-reported in a timely fashion.

In this particular instance, the SEC asserted that a covered associate of Ancora Advisors made over $45,000 in campaign contributions to Ohio politicians from 2013 to 2017, including former Governor John Kasich and former State Treasurer Josh Mandel. The Commission’s order also alleges that a second company official contributed $2,500 to an unidentified gubernatorial campaign in the summer of 2017. Given that Ohio’s Governor appoints members to the Ohio Board of Regents (the board overseeing the Ohio state university system), and the Governor and State Treasurer appoint members to the Board of the Ohio Public Employee Retirement System – both purported Ancora clients – the firm found itself subject to the restrictions set forth in Rule 206(4)-5. Namely, by making contributions of over $350 to covered Ohio officials, Ancora could no longer legally receive compensation for providing investment advisory services to the two public funds within the officials’ spheres of influence.

Like the vast majority of registered investment advisors, it does not appear that Ancora was blind to its potential pay-to-play risk. Quite the opposite in fact – it appears that Ancora had a fairly robust internal compliance program that led to the initial discovery of the potential violating contributions during a routine audit of political activity. Upon discovery of the problematic donations, the firm alerted the SEC and ensured that the contributions in question were returned. 

Such remedial measures and cooperation, although reasonable and appropriate, did not convince the SEC to walk away from enforcement. To the contrary, the Commission pursued its pound of monetary flesh and signaled to all advisors that merely having an internal compliance program and self-reporting any identified problems is not enough to find safe harbor. To avoid getting caught up in the pay-to-play trap, firms must employ compliance policies and procedures that prevent problematic donations before they occur. 

While only a one-off enforcement action by the SEC, the Ancora matter provides an important reminder to all in the regulated community concerning the inherent risks associated with political engagement by firm executives. Even through Ancora successfully uncovered the alleged violations through its internal regulatory compliance program and brought the matter to the SEC’s attention, the company was still slapped with a six-figure penalty and is now forced to deal with the associated public relations blowback. In 2019, it thus remains crucial for registered investment advisers and other entities subject to federal pay-to-play provisions to ensure their internal compliance programs are designed to both pre-screen political activity by key employees and educate such individuals about the potential financial and reputational consequences of certain electoral engagement.  

It may be the holiday season, but government officials never have any issue with delivering pay-to-play coal in the stockings of the regulated community.

This year’s Grinch – the DC City Council, which has for years been looking for a way to tackle the purported “pay-to-play” culture that plagues city government in the District of Columbia. While past attempts may have fallen short, increased attention because of recent polls and studies that call into question the conflict of interest policies of the city and its elected officials have lit a fire under the Council to finally take action, even if many in the business community view the action as unnecessary and incapable of reigning in the identified problems.

On Tuesday, November 20, public hearings were held to debate proposed bills related to campaign finance and pay-to-play rules. One of the bills under council review, the Campaign Finance Reform Act of 2017, written by Councilmember Charles Allen (D – Ward 6), moves to prohibit businesses which hold over $250,000 in city government contracts from being able to contribute to political campaigns. The bill would also increase authority of the Office of Campaign Finance by making it independent of the Board of Elections and requiring increased disclosure by independent expenditure committees within the City. The bill also incorporates matters of concern from previous councilmembers’ proposals and is backed by D.C. Attorney General Karl Racine.

In addition to the above restrictions, the proposed legislation also prohibits donations from prospective municipal contractors during the formal bidding process. This restriction applies both to corporate donations and to senior executives of such corporations.

After careful consideration, the legislation passed an initial voting hurdle, with 11 of 13 City Councilmembers voting in favor. Mayor Muriel Bowser has declined to reveal her position on the legislation, although her administration has been under continued scrutiny for receiving large contributions from city vendors. Earlier in 2016, the head of D.C. Department of General Services resigned on the pretext that he was pressured by City Administrator Rashad Young to direct a contract to Fort Myer Construction, a huge campaign donor to the Mayor and other elected officials.

Later this month, the Council will revisit the legislation to take a second vote. If it passes, the bill will find itself on Mayor Bowser’s desk, with the possibility of a veto in play. We shall see. In the meantime, the Pay-to-Play Law Blog will continue to keep tabs on the progress of the bill and provide the regulated community with useful updates as they occur.

Readers of this blog know that we don’t often find ourselves discussing pay-to-play happenings emanating from the Mountain Time Zone. In 2018, however, nothing surprises the Pay-to-Play Law Blog team – not even the recent news that Montana is putting into a place an onerous, and constitutionally questionable, disclosure obligation for contractors seeking to do business with the state. The new provision – put into place via Governor Steve Bullock’s new executive order mandates that prospective state vendors in Montana publicly disclose certain organizational contributions they make to 501(c)(4) non-profit organizations. The unprecedented move was announced on June 8th by Bullock, who appears to be carving himself out a strong transparency niche among what is anticipated to be a crowded field for the 2020 Democratic presidential nomination. We’re not sure how big a niche that actually is in the electoral sense, but can’t blame a Governor for trying.

Under the new order, which goes into effect October 1, 2018 and does not apply to existing contractors, recipients of goods contracts over $50,000 and services contracts over $25,000 will be required to disclose contributions exceeding $2,500 that they have made to 501(c)(4) social welfare organizations in the two-year period prior to bid submission. These organizations, colloquially referred to as “dark money” groups by those in the transparency community, are allowed to shield their donors from public scrutiny under federal law due to their nonprofit tax status. Such organizations (like all corporations) are prohibited from making direct political contributions to federal, state and local candidates in Montana.

Since the 2010 Citizens United decision, however, such groups have been free to expend funds on independent expenditure and other election-related communications in the state, so long as such expenditures are not coordinated with Montana candidates or political committees. The connection between such independent political activities by non-profits and the appearance of improper influence over state contracting decisions seems fairly tenuous (particularly when the contributions being disclosed are not “behested” payments encouraged by public officials), but groups like the Center for American Progress are nevertheless hailing the move as a win for Montana’s citizens.

The announcement by Governor Bullock opens up what will likely be a new front in the pay-to-play disclosure battle between the regulated community and public officials. Nonprofits in jurisdictions such as California and New York are used to battling it out with state attorney generals over the limited disclosure of 501(c)(4) donor information to charitable regulators in the state, but businesses seeking and holding state contracts are generally not used to sharing such otherwise private information – particularly with the public at large. Contractors are familiar with candidate and PAC contribution disclosure in certain jurisdictions, but social welfare group donation reporting represents a whole new frontier of mandated disclosure

In just the first few weeks since the executive order’s release, it has seen supporters and detractors alike. Bullock’s backers maintain that the reporting requirement is just a good-government reform designed to ensure fair and transparent elections and contracting. Opponents, however, have highlighted the speech chilling impact of such a disclosure obligation and criticized how it undermines the reasonable expectation of privacy for donors to social welfare organizations.

As we continue through the summer and move closer to implementation of the order on October 1st, we here at Pay-to-Play Law Blog will be sure to keep the regulated community apprised of any updates or tweaks in the Treasure State. Likewise, we’ll be sure to keep everyone apprised of any jurisdictions looking to make an even bigger splash in this new pay-to-play pool after watching Montana gently dip its toe in the water.

 

Thanks to Claire McDowell for her assistance with this post.

For those of our readers with a latent East Coast bias or who have just been preoccupied with the latest political drama emanating from Washington, you may have missed the recent flurry of activity in the Bay Area that appears to be threatening the City of San Francisco’s efforts to pass a controversial ethics reform bill. The proposed Ordinance, known as the Anti-Corruption and Accountability Ordinance (ACAO), takes an aggressive tact on regulating political engagement within the City and seeks to implement a series of unique compliance obligations that venture beyond the standard approaches to eliminating pay-to-play politics.

At present, the ACAO has proven to be more of a political football than a legislative success story. The Chair of the City’s Ethics Commission recently stepped down following the Commission’s failure to approve its placement on the June primary ballot for voter consideration.  Despite this very public disappointment for backers of the measure, a motion has recently been introduced for the ACAO to be taken up for additional consideration by the Commission on April 3rd.  A similar request has been made to the San Francisco Board of Supervisors.  Given the political dynamics at play and the controversial nature of the ACAO in general, passage (or even a vote) on the ordinance next week is less than a certainty.  Some of its prospective contents, however, bear further discussion.

There are a litany of interesting regulations and restrictions included in the ACAO, including disclosure obligations related to so-called “behested payments” made on behalf of public officials and a new prohibition on certain political contributions made by entities with interests in specified land-use decisions.  But a recently inserted measure that would require large donors to state-level independent expenditure committees (Super PACs) to disclose certain personal business investments in San Francisco is catching our eyes.  This measure represents a novel disclosure mechanism obligating those wishing to politically engage through state-level Super PACs to open up their private business portfolio to public scrutiny.

The measure, sponsored by San Francisco Board of Supervisors Member Aaron Peskin, would require individuals who contribute more than $10,000 to Super PACs to disclose their financial investments of $10,000 or more in San Francisco businesses.  Such individuals would also need to report any businesses in San Francisco from which they receive compensation.   These disclosures would be required within 24 hours following the triggering contribution.

Supervisor Peskin’s proposal was met with at least some skepticism by the Ethics Commission, which questioned the constitutionality of such a disclosure obligation and the heavy regulatory burden such a provision would place on both donors and City compliance officials. Certain donors, the Commission noted, could have thousands of investments in the city, making compliance with the Peskin measure expensive and impractical.  The Commission also appeared to express some doubt as to the overall public policy value of implementing such a new requirement, which seems fairly disconnected from the stated goal of rooting out pay-to-play politics.  We here at the Pay-to-Play Law Blog would tend to agree with such skepticism.

Existing San Francisco ethics rules, which include a pay-to-play provision that prohibits contractor contributions to elected officials who have oversight responsibilities of those contracts, already seem well situated to curb the sort of unsavory political engagement elected officials and voters are most concerned about.  When paired with California’s additional disclosure requirements for entities that make contributions of $250 or more to elected officials before whom the entities have official business, it is somewhat difficult to find the added compliance value of the contemplated measure.  As our readers know well, however, that’s no true predictor of political passage in the pay-to-play context.

As April approaches, we here at Pay to Play Law Blog will continue to monitor the ACAO’s progress in San Francisco and its potential impact on pay to play compliance and political engagement within the City. Those in the regulated community with Bay Area business interests should stay tuned.

Pershing Square Capital Management has found itself in the unenviable position of having to seek absolution from the Securities and Exchange Commission for the consequences of an unintended $500 pay-to-play error by one of its former analysts, which may result in the hedge fund being forced to return millions of dollars in fees.  It has not gone unnoticed by this blog and others that the SEC has made clear it intends for the regulated community to be very, very aware of the restrictions imposed by Advisers Act Rule 206(4)-5 and has little sympathy for the potentially draconian consequences the rule can impose.  It has also not gone unnoticed by the regulated community that the penalties for failure to comply with the law can be severe – violators are debarred from receiving payment of fees (to be distinguished from being forbidden to do the work) for a period of two years from the date of the violation.

According to Pershing Square’s application for exemption from 206(4)-5’s penalty provisions, which was filed with the SEC in September but only made public this week,  a single Pershing Square analyst made a single $500 contribution to a Massachusetts candidate for governor in excess of the $150 limit proscribed by 206(4)-5.  As the law makes clear, it did not matter that Pershing Square employs a robust compliance program and that the analyst’s contribution was made in violation of firm policy and apparently without the knowledge of Pershing Square’s Chief Compliance Officer.  It did not matter that the analyst never spoke with the state fund or its representatives.  It did not matter that the analyst was arguably not sufficiently senior to fit the definition of a “covered associate”.   It did not matter that the recipient of the funds was the sister of family friend who the donor never spoke with.  It did not matter that the candidate did not even receive sufficient votes to get on the ballot and it did not matter that the contribution was returned.  All that matters under the regulation is that Pershing Square is one of many funds managing the Massachusetts  Pension Reserves Investment Fund and that one of its lower-level investment analysts donated to a candidate seeking election to an office (governor) that has the power to appoint members of the state pension fund who, in turn, would have the power to select those firms hired to manage the fund’s money.

From the somewhat-biased perspective of an adviser to those seeking to comply with the myriad of pay-to-play rules at the federal, state and local levels, Pershing’s application for an exemption would appear well-founded and the relief sought appropriate.  Past experience, however, has made clear that the Commission has historically viewed the virtues of its enforcement mission as superior to the unintended consequences borne by those who, quite frankly, appear to have done as much as a large operation could possibly do to enforce internal compliance with pay-to-play requirements.  One needs look no further than the SEC’s response to another unfortunate Massachusetts political contribution by a former Goldman Sachs investment banker to discern where the Commission’s sympathies are likely to lie.

As stated by Pershing Square in its application for exemption from 206(4)-5’s penalty provisions, the rule “can be violated as a result of circumstances wholly unrelated to the harm the Rule was designed to prevent. . . . Despite the best efforts of an adviser, an employee’s unintentional violation of the adviser’s internal policies could cause the adviser to suffer a financial loss many thousands of times greater than the value of a contribution that the adviser would have never approved in the first place.”

As of yet, the SEC has declined to comment.  Gulp.

While it’s easy for mainstream news outlets to get caught up in the mid-summer drama of Vice-Presidential selections, national political party conventions, and the geopolitical repercussions of Brexit, we remain focused on sharing updates on the real hot button issues of 2016 – like municipal bond pay-to-play. Don’t worry… you can thank us after you get back from your summer vacations and tune back into the reality of regulatory creep.  (“You want us on that wall.  You NEED us on that wall!”)

As many in the regulated community were enjoying some well-earned time away from the office last week, California State Treasurer John Chiang was hard at work in Sacramento announcing new policies aimed at curbing the ability of municipal bond counsels, underwriters, and financial advisors to participate in local bond election campaigns.  These policies are part of a new enforcement initiative launched July 27 that requires municipal finance firms seeking California state business to certify that they will no longer make contributions to local bond election campaigns.

As detailed in Treasurer Chiang’s letter to law firms, underwriters and financial advisors currently in the California state bond pool, continued participation in the underwriter pool will now be contingent upon the making of “an affirmative statement that the firm, or any officer, director, partner, co-partner, shareholder, owner, or employee of the firm, will not make any cash or in-kind service contributions … to promote or facilitate any bond or ballot measure in California.”  Additionally, access to the underwriter pool will also be premised on a concurrent certification by covered entities and officials that they will not provide “bond campaign services” in connection with California municipal bond campaigns or ballot measures.

This second certification will effectively prevent municipal bond attorneys, underwriters and financial advisors from performing or facilitating any of the following activities in conjunction with local bond campaigns or ballot measures: fundraising; public opinion polling; election strategy and management; volunteer organization; get-out-the-vote services; development of campaign literature; or the production of advocacy materials.  Certain exceptions to these prohibitions will apply, but the Treasurer’s Office is clearly looking to take an aggressive stance against any and all behaviors that it views as pay-to-play tactics designed to engender favoritism in the issuance of bond packages approved by local California voters.

While the addition of a few basic certification statements may seem minor to the untrained eye, requiring affirmative statements such as these will also almost certainly heighten the compliance risk borne by the regulated community.  After all, the “inadvertent non-compliance” defense is dramatically more difficult to assert, and a “false statement” indictment is dramatically more easy to obtain, when affirmative certifications are a compliance obligation.

The launch of this new initiative was met with strong support from members of the local government community, including the California Association of County Treasurers and Tax Collectors, and by transparency advocacy organizations such as California Forward and Common Cause.  Those entities and individuals caught in the regulatory crosshairs of the Treasurer’s new policies, however, undoubtedly have a more cynical view of their adoption.  This is particularly the case given the fact that the initiative targets forms of political engagement that are already highly-limited by Municipal Securities Rulemaking Board Rule G-37, and was introduced at a time when Treasurer Chiang is launching his candidacy for California Governor.  Coincidence?  They think not.

Regardless of timing, the restrictions put in place by this new enforcement initiative require entities in the current California state bond pool to comply by August 31, 2016 or risk suspension from participation.  Those entities and individuals seeking to gain entry into the current pool will also face similar certification requirements as of that date.  So, a small public service announcement to those of our readers in either category – be sure to get your Golden State pay-to-play house in order before summer comes to an end.

In announcing a $325,000 settlement with the Connecticut Democratic State Central Committee, the State Elections Enforcement Commission (“SEEC”) has made clear that it will not tolerate efforts to circumvent the state’s pay-to-play laws.  At issue was the state party’s solicitation of state contractor money into the party’s federal account and subsequent use of those funds to finance mailers in support of Governor Dannel Malloy’s re-election campaign.  The agency, which oversees enforcement of Connecticut’s pay-to-play law (Ct. Gen. Stat. 9-612), had earlier chosen to offer a friendly warning not to use federal political party accounts to circumvent the state’s pay-to-play regulatory scheme.  As we have previously noted, Connecticut takes some degree of pride in its restrictive pay-to-play statute, and in the fact that the statute’s constitutionality was upheld in federal court.  Connecticut is one of those states which will debar a state contractor or prospective state contractor from future business for a full year if it, or its employees, directors, spouses, or children, engage in impermissible contribution activity.

You can thus imagine that the SEEC was none too amused to read news reports back in 2014 highlighting Connecticut Governor Malloy’s prowess in raising funds in $10,000 chunks from state contractors for the Connecticut Democratic Party’s federal account.  (PRO TIP: If you are going to “launder” state contractor funds through your federal account, don’t issue press releases airing your dirty laundry).  Thus, on February 11, 2014, the SEEC convened a special meeting for the purpose of issuing an unsolicited advisory opinion “clarify[ing] and publish[ing] advice on the use of money and assets of the federal account in Connecticut elections”.  Mostly, however, the SEEC used the opportunity to clarify that “[o]f most concern is the fact that much of the reported fundraising has involved Connecticut state contractors, who are prohibited from making contributions to party committees registered with the SEEC,” and to make clear everyone understands that federal “funds that are generally prohibited from being used in Connecticut elections are not, in fact, used to make expenditures in Connecticut elections.”

When the state party failed to acquiesce and acknowledge the SEEC’s inherent wisdom, the Commission filed suit in state court asserting the long-standing principles of administrative law and common law sovereignty referred to by legal scholars as the “Doctrine of Can You Hear Me Now?”

While Connecticut Republicans expressed dismay that the Democratic Party will not have to abandon its argument that federal campaign finance laws “Trump” the Connecticut statute and were able to characterize their payment of $325,000 as “voluntary”, the fact remains that SEEC executive director Michael Brandi was able to state that the penalty was “probably in the range of multiple times what the commission has ever issued in the past” and that to his recollection the previous high-water mark for such a “voluntary” payment was $20,000.

Ultimately, the solution set forth in the proposed settlement agreement involves the common use of separate “Compliance Accounts” within the state party’s federal account.  The fix is relatively simple but one which allows state regulators to ensure their guidance is being heard.

Avid followers of the Pay to Play Law Blog know how active the State of Maryland has been over the past few years with regard to the amendment and revision of its pay-to-play framework for those contracting with or otherwise doing business with state and local governments.  In 2014, we saw a new pay-to-play regime implemented that instituted an array of new filing obligations, contribution reporting requirements, and enhanced record retention and certification obligations for Maryland government contractors.  Then, in 2015, state legislators followed up with a collection of amendments to the new regime that closed unintended disclosure loopholes and shifted the semi-annual reporting calendar to the May and November schedule that now applies to covered contractors across the Old Line State.  A few months after those legislative changes, the State Board of Elections (“SBOE”) joined the party with the promulgation of an array of regulations clarifying how the rapidly evolving pay-to-play regime would be administered and enforced moving forward.

Fast forward to 2016 and the regulated community probably feels like it’s having deja vu all over again.  During this year’s General Assembly session, lawmakers in Annapolis once again took it upon themselves to pass legislative amendments tweaking their beloved pay to play framework.  The changes, which are relatively minor in comparison to last spring’s modifications, codify an interpretive rule proposed by the SBOE last year that sought to broaden the political contribution disclosure obligations of covered contractors who have politically-active business affiliates.

Under the existing regulatory regime codified in state law, pay-to-play filers are required to report the political donations of their subsidiaries provided such affiliates are “doing business with” Maryland state or local government and 30% or more owned or controlled by the covered contractor.  The 2016 amendments, however, broaden the scope of potential affiliate disclosure.  The recent legislative revisions, which were signed into law by Governor Larry Hogan in late April and go into effect on October 1 of this year, clarify that covered contractors should disclose the donations of all politically-active subsidiaries (which are 30% owned or controlled) regardless of whether or not such affiliates do business with state or local governments in Maryland.  An express exemption to this disclosure obligation was provided for a very narrow group of subsidiaries that are affiliated with publicly-traded, bank holding companies and that are not doing public business in Maryland.  The legislative changes will, however, require that most covered contractors disclosure the political contributions of their affiliated subsidiaries.

A few short days after these legislative changes were signed into law, the SBOE followed the General Assembly’s lead in preening over Maryland’s “precious” pay-to-play framework.  The Board, in a Notice of Proposed Action published in the State Register, recommended changes to several of its current regulatory provisions governing the disclosure of political contribution activity by covered state and local government contractors.  First, as one might expect, the proposed regulations seek to align current SBOE rules with this year’s legislative changes regarding the attribution of contributions by the subsidiaries of covered government contractors.  Perhaps more interestingly, however, the proposed rules also seek to alter the current timing of the “initial” pay to play disclosure filings required of new Maryland contractors and to clarify how entities doing business in the state can comply with the “CEO reporting obligations” concerning disclosable political contributions.

As those in the regulated community know well, Maryland’s current regulations require specific state and local government contractors to file with the SBOE an initial registration statement (highlighting specific contract information) and a statement of reportable political contributions (covering the two years prior to the contract) within one business day of the contract’s award.  The Board’s new proposal advocates for an extension of the filing window for the registration from one business day to fifteen business days after the contract’s award.  The proposed rules also request that the time frame for submitting the political contribution disclosure report be extended to fifteen business days after the registration statement is filed.

In addition to these administrative changes, the Board’s newly-proposed rules seek to clarify how covered government contractors can meet their CEO-reporting requirements under existing law.  Under current law, the officers, directors and partners of covered contractors are required to report disclosable political contributions to the CEOs of their entities as part of the state disclosure requirements.  Such CEOs are also obligated to notify all reporting individuals with their entities (and reporting subsidiaries) that Maryland law requires public disclosure of their contributions.  To ease the administrative burdens associated with the incoming notification process, the SBOE’s proposed rules would permit a designee of the CEO to collect contribution information on behalf of a reporting entity provided such collection is completed within five business days of the close of the applicable reporting period.  In regard to the outgoing notification process, the proposed rules would allow CEOs to avoid their obligation to warn all reporting individuals about their reporting requirements under state law if the disclosing entity implements a legal pre-clearance framework and a written compliance policy that is annually reviewed by such donors.

These proposed rules and regulations are open for public comment with the SBOE until May 30, 2016.  As the comment period comes to a conclusion and final provisions are adopted, Pay to Play Law Blog will be sure to closely monitor any relevant changes to help the regulated community stay abreast of the latest on Maryland pay-to-play law.

We’ve all been there before – charging headlong down the interstate at a few (or more than a few) miles per hour over the speed limit, when we suddenly come upon a speed trap conveniently tucked into a service road in the highway median.  The natural reaction – pump the breaks, keep it at the limit for the next half mile or so, and hope upon hope that you are not the unlucky one singled out for the traffic stop and corresponding ticket.   Sometimes you escape unscathed…. sometimes you don’t.

Well, who says federal regulators aren’t just like the rest of us.  On Tuesday, in our nation’s capital, the Securities and Exchange Commission (SEC) did its best interstate speed trap impression when it announced that it would delay the adoption of the pay-to-play regulatory proposal submitted by the Financial Industry Regulatory Authority (FINRA) in late December of 2015 so as to allow further comment on the potential impact of the provisions.  The delay itself is likely a surprise to many of our loyal readers – after all, it’s not often that our blog gets the chance to cover regulators (federal or otherwise) who decide to slow the push toward stricter pay-to-play and transparency regulations .  In all likelihood, however, most members of FINRA and others in the regulated community see the SEC’s action as nothing more than a pump of the bureaucratic breaks as the Commission navigates its way past some constitutional speed traps and on its way back up to high-speed regulation.

For those who haven’t followed our recent coverage of this issue (here and here), FINRA first proposed a set of pay-to-play provisions way back in 2014 that, although modeled on SEC Rule 206(4)-5, included unique compensation disgorgement and disclosure elements that drew a slew of negative public comments from many in the regulated community.  In light of those objections, FINRA reconsidered the structure of its initial proposal and submitted a new framework to the SEC late last December for review, approval and adoption.

The main component of the proposed regulatory structure – Rule 2030(a) – again borrowed from SEC Rule 206(4)-5 and sought to restrict the ability of FINRA member firms to engage in distribution or solicitation activities on behalf of registered investment advisers that provide or seek to provide investment advisory services to government entities if “covered employees” of the broker-dealers make prohibited political contributions.  The submitted rule, like other federal pay-to-play regulations already in effect, would not specifically ban or limit the amount of political contributions covered FINRA members and their covered associates can make to government officials.  Rather, Rule 2030(a) seeks to impose a two-year “time out” on the earning of compensation for distribution or solicitation engagements with a government entity on behalf of an investment adviser when a FINRA member or its covered associate makes a disqualifying contribution.

So, if FINRA’s new pay-to-play proposal merely tracks the provisions already in place against registered investment advisors under current SEC rules, why did the Commission even bother to pump the breaks at all on its approval?  Well, many in the regulated community believe that the delay is a direct result of the SEC’s concern about the constitutional “speed trap” the Commission has once again run into in the pay-to-play context.  As we here at Pay to Play Law Blog have highlighted with some frequency these past few years, recent First Amendment jurisprudence coming out of the federal courts has (in many people’s eyes) begun to erode much of the constitutional justification for pay-to-play rules that restrict political speech for the sake of regulating the appearance of corruption rather than actual quid pro quo corruption.

The SEC first tangled with such a free-speech “speed trap” in litigation with the New York and Tennessee Republican Parties, who sought declaratory and injunctive relief invalidating and enjoining the Commission from enforcing Rule 206(4)-5.  Although the Commission was able to escape this pay-to-play constitutional challenge without being pulled over and ticketed – due to the dismissal of the suit at the District Court level and affirmation of that decision by the D.C. Circuit – it nevertheless made the regulators stand up and become slightly more defensive drivers when cruising down the regulatory highway.  The Commission’s reaction to the present FINRA proposal makes this readily apparent.

Just months after concluding its litigation battle with the GOP state parties, the SEC received a flurry of well-reasoned comments from groups (including the NY and TN GOP, the Center for Competitive Politics, and others) opposing the FINRA proposal on similar constitutional grounds to what the Commission faced in the Rule 206(4)-5 suit.  Seeing this same free-speech “speed trap” appearing again on the horizon, the SEC thoughtfully withheld its rubber stamp for the FINRA proposal and decided to pump the breaks on its regulatory activity until a more thorough rulemaking could be conducted.  Depending on the outcome of that process, which will permit the submission of additional written comments and the presentation of oral testimony on the FINRA proposals, the delay could be a full blown traffic stop for the SEC, or nothing more than an obligatory slowdown by the Commission as it makes its way past the radar gun.

Those in the regulated community who question the constitutionality of the FINRA provisions (and the analogous SEC rules), see this delay as a key opportunity to reign in the Commission and its approach to federal pay-to-play provisions.  Others, however, simply see the delay as a postponement of the inevitable – a move by the SEC that simply allows it to get its ducks in a row regarding the FINRA provisions and insulate itself against any future legal challenges.  Only time will tell which part of the regulated community is correct, but we here at Pay to Play Law Blog will be right here to keep our readers apprised of the next steps in this ongoing saga.

When the average American looks back on the close of another holiday season, they think about all the longstanding traditions that were renewed yet again – the family gatherings, the holiday parties, the celebrations of faith, and the resolutions for self improvement.  When we here at the Pay-to-Play Law Blog look back on the end of the holiday season, we gaze warmly back at the Federal Register and determine which of our favorite regulatory agencies left a surprise under the tree for our loyal readers.  We know, we know… we’re the Ebenezer Scrooge of legal blogs.

 

One of this year’s regulatory gift givers is a repeat holiday patron – the Financial Industry Regulatory Authority (FINRA) – that preliminarily proposed an initial suite of pay-to-play provisions in late 2014.  Those provisions, although modeled closely on Securities and Exchange Commission (SEC) Rule 206(4)-5, included unique compensation disgorgement and disclosure elements that drew the attention of many in the regulated community.  After consideration of the public comments surrounding those elements and the regulatory proposals as a whole, FINRA reconsidered the structure of its initial provisions and submitted the newly framed Rule 2030(a) and Rule 4580 to the SEC on December 24^th for adoption.

From a pay-to-play perspective, Rule 2030(a) is where the rubber meets the road.  If formally enacted, Rule 2030(a) would effectively restrict the ability of FINRA member firms to engage in distribution or solicitation activities on behalf of registered investment advisers that provide or seek to provide investment advisory services to government entities if “covered employees” of the broker-dealers make prohibited political contributions.  The proposal, like Rule 206(4)-5 and other federal pay-to-play rules, would not specifically ban or limit the amount of political contributions covered FINRA members and their covered associates can make to government officials.  Rather, Rule 2030(a) seeks to impose a two-year “time out” on the earning of compensation for distribution or solicitation engagements with a government entity on behalf of an investment adviser when a FINRA member or its covered associate makes a disqualifying contribution.

For the purposes of the newly-proposed rule, a disqualifying contribution is defined as any political donation made to an official of a government entity that is valued at an aggregate value of more than $350 in an election year or more than $150 in a non-election.  In the case of an inadvertent or mistaken contribution above these levels, Rule 2030(a) permits a broker-dealer to cure the potential pay-to-play violation without penalty so long as a refund of the donation is received within a four-month period of the initial contribution.

With the publication of the proposed rules in the Federal Register on December 30th, the regulated community now has just over two weeks left in the 21-day comment period to respond to the SEC with pertinent observations and concerns about both Rule 2030(a) and Rule 4580 (which represents a formal recitation of FINRA’s new recordkeeping requirements for broker-dealer members).  For those of our readers who are interested in participating in the open comment process, submissions must be made on or before January 20, 2016 and may be filed online at https://www.sec.gov/cgi-bin/ruling-comments.

Following the completion of the formal notice and comment process and finalization of the provisions by the SEC, both FINRA rules should be put into effect in short order – likely during the second half of 2016 or early 2017.  Broker-dealers looking to engage politically during the 2016 election cycle should take heed, monitor the situation accordingly, and ensure their compliance and recordkeeping systems are fully up-to-date.  And we here at Pay-to-Play Law Blog will be sure to keep the regulated community posted on any future developments or changes.