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Pay to Play Law Blog

Articles, Resources, Insights on Pay to Play Regulations on the Federal and State Level

FINRA Quietly Proposes Pay-to-Play Type Rules for Its Broker-Dealer Members

Posted in SEC


By Ben Keane and Stefan Passantino

Late last week, the Financial Industry Regulatory Authority (FINRA) quietly posted a new regulatory notice proposing a series of pay-to-play type rules for its broker-dealer members that closely track the pay-to-play provisions set forth by the Securities and Exchange Commission (SEC) in Rule 206(4)-5. FINRA, the self-regulatory organization for broker-dealers, announced three specific rule proposals in its notice – Rule 2390, Rule 2271 and Rule 4580.

Proposed Rule 2390, which is clearly modeled on Rule 206(4)-5, would restrict FINRA’s member firms from engaging 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 those advisors make a disqualifying political contribution. The proposed rule would not specifically ban or limit the amount of political contributions covered FINRA members or their covered associates could make to government officials, but would instead impose a two-year time out on engaging in distribution or solicitation activities for compensation with a government entity on behalf of an investment adviser when the FINRA member or its covered associates make a disqualifying contribution.

While this type of pay-to-play framework should be familiar to those in the regulated community, what might not be so familiar are the disgorgement of profit provisions contained in proposed Rule 2390. Unlike SEC Rule 206(4)-5, the currently-announced framework of Rule 2390 would obligate covered FINRA members to disgorge any compensation or other remuneration received in association with, pertaining to, or arising out of, distribution or solicitation activities during the two-year time out period caused by a disqualifying contribution. The proposed rule would also prohibit covered FINRA members from entering into arrangements with investment advisers or government entities to recoup any such disgorged compensation at a later time period.

The remaining two proposals set forth in FINRA’s regulatory notice – Rule 2271 and Rule 4580 – deal with disclosure and recordkeeping requirements for broker-dealer members engaged in covered government distribution and solicitation activities. Specifically, proposed Rule 2271 would obligate covered FINRA members engaging in distribution and solicitation activities with a government entity to make specified disclosures to such entity regarding the identity of the investment adviser(s) being represented and the nature of the compensation arrangement associated with the representation.  Meanwhile, proposed Rule 4580 would require covered FINRA members engaging in distribution and solicitation activities with a government entity on behalf of any investment adviser to maintain specified records that could be examined by FINRA for compliance with the obligations of proposed Rules 2390 and 2271.

In conjunction with the publication of its current regulatory notice, FINRA has requested public comment from both members and non-members on all aspects of the planned provisions, including “any potential costs and burdens of the proposed rules.” For those interested in participating in the open comment process, December 15 has been set as the current response deadline. Given the likelihood of swift adoption of the proposed rules following that date, broker-dealers subject to the regulatory reach of FINRA should begin updating their compliance programs in short order.

Federal Pay-to-Play CLE Webcast – Tomorrow!

Posted in Compliance

backtoschoolCan’t get enough Pay-to-Play knowledge? Need some quick Continuing Legal Education credits before year end? You might want to check out ALI-CLE’s audio presentation on Federal “Pay-to-Play” Rules: Latest Enforcement Initiatives and Compliance Strategies tomorrow, November 18, at 12:00 – 1:30 pm Eastern Standard Time.

The “Pay-to-Play All-Stars” who will be speaking include:

S. Jane Moffat, Vice President, Government Interactions Compliance, Goldman, Sachs & Co., Salt Lake City

Leslie M. Norwood, Managing Director and Associate General Counsel, Municipal Securities Division, Securities Industry and Financial Markets

Jason Torchinsky, Holtzman Vogel Josefiak PLLC, Washington, D.C.

As well as Yours Truly.

We are going to discuss SEC Rule 206(4)5, MSRB Rule G-37, CFTC business conduct rules, anticipated developments in the law, ongoing litigation, as well as recommended compliance programs

Join us, it should be fun.

Federal District Court Rules It Does Not Have Jurisdiction To Hear Challenge to the SEC’s Pay-to-Play Law

Posted in SEC

Pay2Play(But the SEC Provides Some Helpful Guidance Anyway)

In a ruling that did not get to the merits of the substantive arguments, a federal court has ruled that it lacks jurisdiction to consider whether the SEC contravened either the US Constitution or the Federal Election Commission’s exclusive turf when it adopted its pay-to-play rule governing investment advisors. Several weeks ago, we noted the filing of this case and observed that five Justices of the US Supreme Court might be inclined to agree that First Amendment concerns warranted the overturn of the rule were they to reach the merits of that question. For now, such questions are purely academic in light of the court’s ruling that “[t]he plaintiffs have failed to meet their burden in establishing subject matter jurisdiction because this Court is not the proper forum for their challenge.” (Order. p.2)  The complaint should have been brought originally, in the opinion of the trial court, directly to the US Court of Appeals for the District of Columbia under a provision of the Investment Advisers Act which calls for all challenges of an “order” of the SEC to be brought before that court.

(In an interesting window into the byzantine, Through the Looking Glass logic that infects the minds of lawyers everywhere, the trial court then goes on to reject the parties’ argument that that “Rule 206(4)-5 isn’t an ‘order’, Your Honor, its, ummm, a ‘rule’” on the ground that standing precedent allows the court to interchange the terms as needed and that “[w]hat appears to be an affirmative grant of appellate jurisdiction to review agency rules becomes, in reality, an affirmative revocation of jurisdiction to review all agency rules not otherwise enumerated in the direct review statute.” (Op. p. 18). Huh?)

Logical gymnastics aside, one kernel of helpful guidance has arisen from this judicial leg wrestling match. The SEC has conceded that state legislators are not necessarily “covered officials” for purposes of application of the pay-to-play rules.

Rule 206(4)-5 prohibits investment advisors from receiving compensation for providing their services to government pension plan clients when those advisors (or certain covered executives) have made campaign contributions above minimal thresholds to “covered officials” who have the ability to influence the award of public investment advisory contracts. The complaint filed by the parties noted that New York State Senator Lee Zeldin is a member of the New York State Senate and arguably a “covered public official” because he is “charged with confirming members of the New York Board of Regents, which sets guidelines and standards for managing certain state endowments.” (Complaint, para. 44). Similarly, the plaintiffs alleged, “[t]he Tennessee Republican Party has state officials currently seeking federal office who are covered by this rule, which restricts Plaintiff Tennessee Republican Party’s ability to fundraise.” (Id. para. 44).

In an important concession, the SEC has confirmed that merely having the power to confirm members of the board which selects investment advisors is not akin to “the ability to influence the award of public investment advisory contracts”. The Commission expressly admitted as such in oral argument and that position in writing here at pages 6-9 and here on page 17.  The court’s order references that concession/clarification in footnote 6 of its opinion (or should I say, the court’s “rule”, the two terms are interchangeable these days, you know).


MSRB Looks to Extend Pay-to-Play Regulation to Municipal Advisors

Posted in SEC


This week, the Municipal Securities Rulemaking Board (MSRB) requested public comment on draft amendments it is proposing to its rules regulating pay-to-play practices. Here, the MSRB is proposing a revision to Rule G-37 so as to extend its reach to municipal advisors. The regulated community knew this revision was coming last May but now we get a chance to examine the actual proposal, contemplate its policy implications, and place our bets on the outcome of inevitable judicial review.

As anticipated, the proposed changes would extend Rule G-37′s regulation of  contribution activity by municipal securities dealers (the folks who initiate the principal sales of bonds) to municipal advisors (the folks who help local governments decide how and when to issue bonds and then how to invest the proceeds). I say “as anticipated” because the Dodd Frank Wall Street Reform and Consumer Protection Act extended MSRB’s jurisdiction to permit the regulation of municipal advisors way back in 2010. Power may abhor a vacuum, but that is nothing compared to the contempt a regulating agency has for new authority unaccompanied by a Notice of Proposed Rulemaking.

Snark aside, MSRB’s proposed revisions are not, on their face, earth shattering. If Rule G-37 prevents broker-dealers from engaging in municipal business within two years of making campaign contributions to issuers, it stands to reason that municipal advisors should share their fate. That is especially true when one considers that some municipal advisors are also registered broker-dealers (and thus already subject to Rule G-37) while others are not.  What is not obvious to all is whether the United States Supreme Court will agree that anyone can be forced to abide by such restrictions consistent with the First Amendment.  That is less apparent.

Back in May, MSRB Board Chair Daniel Heimowitz was quoted as saying that these revisions are necessary to prevent the “appearance of corruption” manifest in municipal advisor contribution activity. In what is surely not a coincidence, that language is echoed by MSRB Executive Director Lynnette Kelly in the MSRB’s official press rollout of the proposed changes this week:

“Addressing corruption, or the appearance of corruption, in the awarding of municipal advisory business is a fundamental goal of the MSRB’s comprehensive regulatory framework for municipal advisors,” said MSRB Executive Director Lynnette Kelly. “Applying our well-established dealer pay-to-play rule to municipal advisors will help ensure that all regulated municipal market entities and professionals are held to the same high standards of integrity.”

Time will tell, but it is not at all clear that the MSRB’s articulated “appearance of corruption” justification will impress our current Supreme Court which expressly announced in McCutcheon v. FEC that the “appearance of corruption” rationale behind limitations on political speech is precisely the kind of thing that won’t withstand First Amendment scrutiny. It is clear that MSRB is aware of McCutcheon and has undertaken steps to conform with the holding.  MSRB’s proposed amendments require an actual link between a ban on municipal securities business “and a contribution made to an official with the ability to influence the awarding of that type of business.” The proposed new rules similarly require a link between a ban on municipal advisory business and a contribution made to an official with the ability to influence the awarding of that type of business. For reasons we discussed in connection with the TL Ventures case, these are significant concessions.

Let’s leave it here with the MSRB proposed regulations for now:  Logical? Clearly. Sound and acceptable public policy? Probably. Constitutional in the eyes of Chief Justice Roberts and Justices Thomas, Alito, Scalia, and Kennedy?  I gotta say, the early line is 3:2 against.

Your comments to the MSRB proposal are due October 1, 2014.

State Party Committees Challenge Constitutionality of SEC Pay-to-Play Rule 206(4)-5

Posted in SEC

moneyp2pAnd so it begins…

On Friday, the New York and Tennessee state Republican parties, led by the very able Jason Torchinsky, filed a complaint in District of Columbia federal court challenging both the constitutionality and administrative propriety of the SEC’s pay-to-play rule governing investment advisors; Rule 206(4)-5. This is a serious challenge that we all will be well served to follow carefully.

First, the basics: SEC Rule 206(4)-5 regulates the political activities of investment advisors in a way that others are not regulated. Specifically, SEC regulations prohibit investment advisors from receiving compensation for providing their services to government pension plan clients when those advisors (or certain covered executives) have made campaign contributions above minimal thresholds to candidates (or parties) and when those politicians have the ability to influence the award of public investment advisory contracts. (The SEC rule doesn’t prevent the advisor from being forced to honor its contractual obligations, mind you, just from getting paid to do the work!)

The Rule has gotten a great deal of attention and has caused considerable consternation for candidates trying to raise money from a favorite contribution target: bankers. (Remember the famous line attributed to noted bank robber Willie Sutton when asked why he robbed banks?  “Because that’s where the money is!”  The same holds true for politicians and bankers.)

Recently, this blog noted the SEC’s first-ever enforcement action against TL Ventures for violation of this rule. We noted with alarm both the breadth of the regulatory landscape staked out by the SEC as well as the apparent constitutional hurdles to such regulation in light of the United States Supreme Court’s First Amendment analysis underlying McCutcheon v. FEC. Now, it appears, we are going to get a chance to see this analysis tested.

Enter the Tennessee and New York Republican parties, which see Rule 206(4)-5 as a challenge to the ability of its members to raise or make campaign contributions. Interestingly, the New York and Tennessee complaint highlights the plight of New York State Senator Lee Zeldin, who is the New York Republican Party’s nominee to represent the Empire State’s First Congressional District. As a State Senator, Mr. Zeldin confirms members of the New York Board of Regents and is thus potentially a “covered official” not permitted to accept funds from investment advisors or permit the party to fundraise for him (Complaint, ¶ 44).

The complaint challenges the SEC on several grounds. First, the plaintiffs allege that the power to regulate federal campaign activity lies exclusively with the Federal Election Commission. (Those guffaws you hear right now are coming from the many folks trying in vain to convince the hopelessly partisan and deadlocked Commission to “regulate” ANYTHING these days). Second, the complaint alleges that the Rule, singling out as it does a lone class of donors to limit contribution activity, is both arbitrary and capricious. (Ah, were it that easy to overturn government regulation!). Third, and most interesting, is the First Amendment challenge predicated on McCutcheon for the reasons discussed here at length.  The Supreme Court clearly regards campaign activity as “speech”, restricted only to the extent absolutely necessary to prevent direct, quid pro quo corruption. The SEC clearly believes it has the power to regulate contributions by companies like TL Ventures without a need to show intent or quid pro quo corruption.

The plaintiffs are represented by capable and tenacious counsel. With respect to the Constitutional challenges, a strong case can be made that five Justices of the current Supreme Court will agree. Pull up a chair, grab some popcorn, and let’s settle in to watch a good old fashioned tussle.

“It’s About to Get Real Up in Here”

Posted in California, CalPERS


Former CalPERS CEO to Plead Guilty in Pay-to-Play Case

Last week we highlighted the case of TL Ventures to warn of the large enforcement claim staked by the SEC in connection with Rule 206(4)-5 of the Advisers Act. Not to be outdone by a sister regulator, the Justice Department has now announced that Federico R. Buenrostro Jr., the former CEO of the California Public Employees’ Retirement System, is expected to plead guilty for his involvement in the CalPERs “pay-to-play” scheme. When one considers that TL Ventures was required to disgorge their fees – and that the firm associated with former CalPERS board member Mr. Villalobos’ firm brought in $14 million in connection with the alleged scam, the regulated community needs to see the threat and recognize that this is likely not all a coincidence.

SEC Starts Hitting the Private Sector Hard for Pay-to-Play Violations

Posted in SEC

Stay Alert

By Stefan Passantino

For the first time ever, the SEC has brought a pay-to-play case against an investment advisor for making political contributions. Previously, and with the requisite lack of subtlety and fanfare you have come to expect from this blog, we highlighted the SEC’s massive consent judgment against Goldman Sachs over a series of “in kind” contributions by one of its bankers. What makes this case equally noteworthy in the wake of the Goldman precedent is not only the fact that the SEC is signaling that its enforcement efforts will not be tempered either by a lack of intent to influence and investment decisions, but that such efforts will also not be deterred even by a lack of opportunity to influence those decisions.

The investment community needs to take note and heed these warnings immediately. TL Ventures gives us all 285,000 reasons to do so.

As spelled out in greater detail in a recent, articulate, insightful, and well-crafted law firm client alert, in April 2011, a “covered associate” of TL Ventures made contributions to the campaign of a candidate for Mayor of Philadelphia and the Governor of Pennsylvania. The Mayor of Philadelphia appoints three of the nine members of the Philadelphia Retirement Board and the Governor of Pennsylvania appoints six of the eleven members of the board of the Pennsylvania SERS. The SEC charged TL Ventures with pay-to-play violations under Rule 206(4)-5 of the Advisers Act because the contributions triggered the two-year “time out” from receiving advisory fees from the Philadelphia Retirement Board and SERS. As was the case with Goldman, TL Ventures agreed to settle the matter without admitting or denying the allegations, disgorging its fees of over $250,000, and paying a penalty of $35,000.

For the uninitiated, Rule 206(4)-5 generally prohibits investment advisors from providing advisory services for compensation to a government entity for two years after the adviser or certain of its executives or employees make political contributions above specified thresholds to an elected official or candidate for political office if the office is “directly or indirectly responsible for, or can influence that government entity’s selection of the adviser.”

It is a significant question whether the facts alleged in this matter represent the type of case that was envisioned when the pay-to-play rules were adopted, and whether this is the type of case that combats what the SEC described as a significant problem of influence in the management of public funds. Absent from the SEC’s allegations was any assertion that TL Ventures or the covered associate at issue attempted to influence an investment decision of either the Philadelphia Board or SERS. Indeed, the SEC went out of its way in its consent order to declare that “Rule 206(4)-5 does not require a showing of quid pro quo or actual intent to influence an elected official or candidate.”

Of particular relevance here, TL Ventures did not appear even to have an opportunity to influence an investment decision. The SEC alleged that both SERS and the Philadelphia Board were investors in the funds prior to the political contribution and that the funds were in wind down mode, and that both SERS and the Philadelphia Board were already committed to TL Venture funds until the funds officially wound down. Additionally, there was no allegation that TL Ventures marketed any additional funds for investments during the two-year period after the covered associate at issue made the prohibited political contributions. Thus, the political donations in question could not have had any effect on any investment decision because there was simply no investment decision to be made.

In addition to being a bit scary and a large neon flashing compliance alert for the regulated community, one has to wonder whether the SEC’s enforcement action against TL Ventures and its pay-to-play rules are constitutional under the Supreme Court’s recent decision in McCutcheon v. Federal Election Commission, 572 U.S.__(2013).  Readers of this blog will recall that in McCutcheon, the Supreme Court found that aggregate political contribution limits violated the First Amendment because the  regulation of political speech must be limited to targeting instances of “quid pro quo” corruption or its appearance. No such concern was found by the Court in the aggregate campaign contribution limit context. Coincidentally, the existence or appearance of quid pro quo corruption is precisely the standard the SEC has gone out of its way to assert is NOT required to allege a Rule 206(4)-5 violation. In turn, one has to wonder how the Roberts Court would view the SEC’s attempted application of a strict liability standard for Rule 206(4)-5 violations that involve absolutely no opportunity to influence an actual investment decision.

Contractor Contribution Bans Post McCutcheon – “Um, Hans, There Appear to be More Cracks in the Dike!”

Posted in District of Columbia


As predicted, the United States Supreme Court’s analysis in McCutcheon v. FEC threatens once again to topple the constitutional underpinnings supporting contractor bans on contributions.

This time, the crack in the dike in dire need of young Hans Brinker’s able finger appears in the D.C. Circuit where the court – sitting en bancannounced today in Wagner v. FEC that it will hear oral argument in September on First Amendment challenges to the long-standing prohibition against federal contractor contributions in connection with federal elections.

It is difficult to see how this law (2 USC 441c) survives Justice Roberts’ analysis in McCutcheon. As noted political law academic Rick Hasen sagely (and succinctly) observes on his blog, “[t]his will be a tough case for the government after McCutcheon, and potentially a big decision.”  He is correct, of course. This might be the case that cracks the pay-to-play dike and floods us all with contractor contributions.

See you in September. Russell Crowe and I will be out back working on our boat.

MSRB Announces Pay-to-Play Rules are Coming for Municipal Advisors

Posted in First Amendment, SEC


The Municipal Securities Rulemaking Board (“MSRB”) announced this week that it has decided to propose amendments to existing pay-to-play rules governing broker dealers (Rule G-37) to have them also cover municipal advisors. Basically, a “municipal advisor” is simply a technical way to describe a financial advisor who provides her services to local municipalities which have shown themselves to date to be in dire need of quality financial advice. (Seriously, read this last link – it alone is worth the price of your subscription to this blog).

Regular followers of this blog (there’s gotta’ be one right?) will recall that Rule G-37 is designed to prevent broker-dealers from engaging in municipal business within two years of making campaign contributions to issuers. Interestingly, MSRB Board Chair Daniel Heimowitz was quoted after the Board’s quarterly meeting as saying that the need for this curb on campaign activity is the “appearance of corruption” manifest in municipal advisor contribution activity:

For two decades, MSRB Rule G-37 has played a central role in curbing the use of, and the appearance of the use of, political contributions to secure municipal securities business,” . . . “Extending these provisions to municipal advisors will help prevent quid pro quo political corruption, or the appearance of such corruption, in public contracting for both dealers and municipal advisors.

This rationale is noteworthy, of course, because the United States Supreme Court just announced in McCutcheon v. FEC that the “appearance of corruption” rationale behind limitations on political speech is precisely the kind of thing that won’t withstand first amendment scrutiny.

Public comment on the proposed revisions should be offered within a month. I’m guessing Chief Justice Roberts will wait until later to offer public comment.


Federal Judge Notes the Implications of McCutcheon in Striking New York’s Limits on Contributions to SuperPACs

Posted in First Amendment, New York


Our last post analyzed the clear implications of the US Supreme Court’s reasoning in McCutcheon v. FEC to pay-to-play laws everywhere. Now, it would appear, at least one federal judge in New York has reluctantly, but decisively, relied upon that same reasoning to strike New York State’s contribution limits for SuperPACs. In that case, New York Progress and Protection PAC v. James Walsh, Judge Crotty opined that he was compelled to “apply the Supreme Court’s binding decisions” notwithstanding the Court’s “concern” over the “misguided” result:

“Our Supreme Court has made clear that only certain contribution limits comport with the First Amendment. Since contributing money is a form of speech, preventing quid pro quo corruption or its appearance is the only governmental interest strong enough to justify restrictions on political speech. Citizens United v. FEC, 558 U.S. 310, 357-61 (2010). More recently in McCutcheon, the Court concluded that “the possibility that an individual who spends large sums may garner influence over or access to elected officials or political parties . . . does not give rise to such quid pro quo corruption.” Id. at 1438. In effect, it is only direct bribery—not influence—that the Court views as crossing the line into quid pro quo corruption. The Court agrees with Justice Breyer. He said that, “[t]his critically important definition of ‘corruption’ is inconsistent with the Court’s prior case law.” McCutcheon, 134 S. Ct. at 1466 (Breyer, J., dissenting). But this Court is bound to apply this definition “no matter how misguided . . . [the Court] may think it to be.” Hutto v. Davis, 454 U.S. 370, 375 (1982).”

It is only a matter of time before this same analysis is applied to state pay-to-play laws. When that happens, one can anticipate that several such laws will fail to withstand the scrutiny.

Editor’s Note: If you did not catch Peter Overby’s thoughtful reflection on the 20th anniversary of federal pay-to-play laws on NPR, it is worth listening to.

Editor’s Note to the Editor’s Note: Be aware, the first editor uses the adjective “thoughtful” as a euphemism for “it’s really cool that NPR referred to the blog on ‘All Things Considered’.”