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Hedge Fund Seeks Absolution from the SEC Claiming the Potential Pay-to-Play Penalty Doesn’t Fit the Violation

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.

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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.

Hedge Fund Seeks Absolution from the SEC Claiming the Potential Pay-to-Play Penalty Doesn’t Fit the Violation

California State Treasurer Sets His Sights on Curbing Pay-to-Play in the Municipal Bond Arena

California Treasurer SealWhile 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.

California State Treasurer Sets His Sights on Curbing Pay-to-Play in the Municipal Bond Arena

Connecticut Stands Firm to Enforce Pay-to-Play Against State Party Committee

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.

Connecticut Stands Firm to Enforce Pay-to-Play Against State Party Committee

Maryland Just Can’t Help Itself When It Comes to Pay-to-Play Revisions

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.

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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.

Maryland Just Can’t Help Itself When It Comes to Pay-to-Play Revisions

FINRA Submits Final Pay-to-Play Provision for SEC Approval

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.

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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 24th 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.

 

FINRA Submits Final Pay-to-Play Provision for SEC Approval

Amicus Brief Highlights the Massive Reach and Unintended Consequences of SEC Rule 206(4)-5

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We have been following for some time the legal challenge brought by various political parties to the SEC’s pay-to-play Rule 206(4)-5.  That lawsuit, you will recall, challenges both the constitutionality and administrative jurisdiction of the SEC’s efforts to regulate campaign activity (“protected speech” by another name?) by investment advisors.  Litigation continues to press forward as the parties are set to square off again before the Court of Appeals on March 23. The latest briefing is here and our take on the appellate issues is set forth here in case you were getting popcorn and missed the action.

Now, the ongoing litigation has revealed a new plot line that this blog has written about several times: pay-to-play rules in general (and Rule 206(4)-5 specifically) have a really annoying way of converting well-intentioned policy aspirations into a morass of unintended compliance uncertainty and costs for the regulated community.  Simply stated, it is very easy to say, “Gee, it would be nice for my regulating agency to give the public confidence that government largesse isn’t handed out on the basis of who writes the biggest campaign checks.”  It is very, very hard for the appropriate regulating authority to write restrictions into law that don’t violate constitutional principles of free speech, become unconstitutionally overbroad, or otherwise create a compliance nightmare for the 99.98% of the private sector, who simply want to go about the process of doing business with the government without unknowingly finding themselves subjected to massive liability.

That tension has manifested in the thoughtful – and, quite frankly, scary – amicus brief filed by the Center for Competitive Politics on behalf of the Financial Services Institute.  In that brief, FSI notes that it is a network of independent financial advisors which are each independent broker-dealers operating entirely separately from each other as independent contractors.  Because some of these advisors are registered to provide services to pension funds and other government retirement plans, FSI member firms are subject to Rule 206(4)-5.  Makes sense, right?  Sure, until one contemplates the fact that 206(4)-5 as crafted treats all of these Mom-and-Pop advisers who happen to be performing as independent contractors under the same FSI logo are inter-related “covered associates” for pay-to-play purposes.  They are all responsible for each other’s campaign activity because the SEC chooses to treat “independent contractors” as “employees” for pay-to-play enforcement purposes (Black’s Law Dictionary having no jurisdiction over the Wisdom of the Sovereign).

Think about that.  Part-time FSI advisor Mabel in Topeka can make a political contribution that prevents Reggie in Trenton from being able to get paid under his investment advisory services contract for two years even though the two have never met (or, possibly, Reggie really pissed Mabel off with something he said at the FSI Christmas gathering in Orlando)!  What can FSI do other than what every rational, responsible, compliance-based organization would do?  It simply bans all contribution activity by all agents; regardless of the fact that the contributing agent has no intentions of ever doing business with the recipient politician.  (Amicus Brief, p. 6).

That can’t be the answer mandated by the Constitution.  It is, however, the logical response to the current morass of unintended compliance uncertainty suffered by the FSIs of the world.

Amicus Brief Highlights the Massive Reach and Unintended Consequences of SEC Rule 206(4)-5

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

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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.

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

Do SEC and MSRB Pay-to-Play Rules Scare Off Donations to Federal Candidates?

As readers of this blog know well, the avowed goal of the SEC’s pay-to-play framework is to protect the integrity of the public procurement process by preventing registered investment advisors from improperly influencing the award of state and local contracts for the management of public investment funds. On its surface, Rule 206(4)-5, which bars investment advisors from managing public investment funds in jurisdictions where their political contributions or the contributions of their “covered associates” exceed $150 per election to elected officials who directly or indirectly oversee such funds, seems well suited to this task. The problem is that many covered by these provisions – and their helpful in-house compliance officers – erroneously believe that SEC restrictions apply to contributions to ALL candidates. This is incorrect.

The language of Rule 206(4)-5 neither prohibits nor restricts investment advisors from contributing to federal candidates who presently hold no state or local office – only state “officials” from a “government entity” who have the power to directly or indirectly influence the outcome of the hiring of investment advisors (check out page 43 of the SEC’s link above if you don’t believe me). As we, and others, have pointed out previously, this rule does not apply to contributions to sitting federal candidates or to private citizens running to replace those federal candidates. Likewise, the SEC’s pay-to-play provisions place no restrictions on political donations from covered entities or individuals to state or municipal candidates who play no role in the direct or indirect oversight of public investment funds. Of course, state and local pay-to-play rules might still apply in certain circumstances – such as where a sitting state official is running for federal office, but there is no need (as a reaction to SEC pay-to-play regulations) to adopt caps that artificially restrict the ability of investment firm employees to engage in constitutionally-protected political speech.

Much the same error of interpretation can be seen in the MSRB pay-to-play context. Like their brethren in the investment advisory world, many municipal finance professionals covered by Rule G-37 erroneously believe that its provisions restrict political contributions to ALL candidates. This is simply not the case. Rule G-37’s candidate contribution provisions only restrict donations to “official(s) of any issuer” who can directly or indirectly influence the hiring of a municipal securities professional, or donations to state officials or candidates who have the authority to appoint persons with such influence. The MSRB’s regulatory framework does not prohibit contributions to federal candidates who hold no state or local office, nor does it bar contributions to private citizens turned federal candidates.

Keeping these points mind, we hope that our readers working in the investment advisory and municipal finance arenas take a moment to examine their current political contribution policies, and ensure that they successfully protect their business development interests without unnecessarily curbing otherwise legitimate and beneficial political activities. On the other hand, it could be that the SEC and MSRB pay-to-play rules are simply an inoffensive way to say “thanks, but no thanks” to your friendly neighborhood federal candidate. Can’t do anything about that…

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Do SEC and MSRB Pay-to-Play Rules Scare Off Donations to Federal Candidates?

Holiday “Gifts” from the Nation’s Capitol

A Contrasting Pair of Pay-to-Play Reprieves Emerge in the District

Just in time for the holiday season, an unexpected present from the U.S. Commodity Futures Trading Commission (CFTC) has found its way under the tree of a group that was most likely expecting to receive coal in its pay-to-play stocking. “Swap dealers”, the target of increased pay-to-play scrutiny from the CFTC over the past year, recently received the gift of thoughtful pay-to-play enforcement restraint from the Commission’s Division of Swap Dealer and Intermediary Oversight (DSIO). Meanwhile, a similar enforcement reprieve has also been given by the D.C. Council to the city’s municipal government contractors, a popular target among pay-to-play reform groups – although perhaps not for the same reason. The gifts brought to the manger might be the same, but the wisdom of the bearers … not so much.

The CFTC was the first to show its holiday spirit in the form of a no-action letter addressing the pay-to-play rules applicable to swap dealers who conduct business with certain “governmental special entities”. The CFTC pay-to-play rules in Commission Regulation 23.451, which this blog previously covered in detail, restrict a swap dealer from engaging in certain activities with a “governmental special entity” if the swap dealer (or a covered associate of the swap dealer) made or solicited contributions to an official of that governmental special entity during the two preceding years. Such rules were meant to be in regulatory harmony with similar pay-to-play provisions promulgated by the Securities and Exchange Commission (SEC) and Municipal Securities Rulemaking Board (MSRB). The DSIO, however, found them to be unnecessarily broader than their SEC and MSRB counterparts, particularly as they applied to political contributions associated with officials of federal or other non-state or non-local government agencies or instrumentalities.

As such, the DSIO issued its November no-action letter to provide swap dealers and their covered associates with relief from having to unnecessarily “expend significant resources to update their current policies and procedures to ensure compliance with Regulation 23.451’s prohibition” on contributions not otherwise covered by the SEC and/or MSRB rules. In its letter, the DSIO officially stated that “the Division will not recommend that the [CFTC] take an enforcement action against any [swap dealer] or covered associate of any [swap dealer] for failure to be fully compliant with Regulation 23.451” with respect to contributions not generally subject to restriction by the SEC and/or MSRB pay-to-play rules.

By implementing this limitation, the DSIO appears to be making an effort to provide swap dealers with clarity regarding the scope of the CFTC’s pay-to-play provisions and likewise to harmonize such regulatory requirements with the statutory directives of the Dodd-Frank Act and other federal law. In this sense, the CFTC reprieve is both well meaning and a sensible policy decision. The reprieve offered by the D.C. Council, however, appears to be more the product of bureaucracy and delay than sensibility.

As such, on the other end of the naughty/nice list, we have the D.C. Council’s foot dragging on pay-to-play reform. As detailed in the pages of this blog over the course of the past year, various elected officials in the District of Columbia have been “hard at work” pushing comprehensive ethics and pay-to-play reform proposals in front of the D.C. Council. Back in March, Councilman Tommy Wells introduced a piece of legislation containing a collection of pay-to-play reforms for the District that had been previously ignored by the Council in 2011. Similarly, in September of this year, Mayor Vincent Gray presented his own proposal, drafted by D.C. Attorney General Irvin Nathan, which would seriously restrict the ability of major Washington vendors to make political contributions to any District official or candidate involved in influencing the award of a contract or grant by the municipal government.  Shortly thereafter, Councilman Jack Evans also introduced his own “pay-to-play” proposal that seeks to entirely remove the D.C. Council from the municipal contract-approval process.

Despite the sound and fury associated with the introduction of these reform efforts, the council has yet to produce any results. In fact, none of these proposals has moved an inch in the D.C. Council’s legislative process, leaving many reform advocates wondering whether the push toward campaign finance and pay-to-play reform in the District is more about politicians seeking to score public relations points and less about serious legislative changes. As the Editorial Board of The Washington Post put it earlier this week:

            “[The fact] that the council didn’t have the time [to move forward on campaign finance and pay-to-play reform] – the excuse offered for inaction – speaks to a distressing lack of urgency in addressing this critical issue. Even more worrisome, it suggests a reluctance among those who benefit from the slack regulation of political dollars to fix a system that has helped perpetuate the District’s ‘pay-to-play’ culture.”

The excuse being referenced by the Post is a recent statement by D.C. Council Chairman Phil Mendelson indicating that no legislative progress will be made on campaign finance reform before the end of the Council’s yearly session. Similar comments have also been made by Councilwoman Muriel Bowser, the Chairwoman of the Government Operations Committee, who claimed that “most members [of the Council] … don’t want to rush” with regard to reform efforts. Can kicking at its best.

Long story short… don’t expect pay-to-play changes in the District any time soon. Nevertheless, should the D.C. Council decide to take action in the new year, Pay-to-Play Law Blog will be right here keeping our readers up to date.

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Holiday “Gifts” from the Nation’s Capitol

Taking Stock of The STOCK Act. . . . Wither “Political Intelligence”?

Proponents of ethics reform and increased political transparency in Washington don’t often see reform proposals pass through Congress by overwhelming margins, and rarely does anyone bemoan an excess of “political intelligence” in Washington, but that’s exactly what happened on Capitol Hill this past week. While the reform community can’t quite be sure what version of reform will survive the ongoing tug of war between the U.S. Senate and U.S. House of Representatives, it is clear that those trading on “inside political knowledge” are clearly in the transparency crosshairs.

If you are a consultant, a lobbyist, a law firm, or simply a person with inside knowledge of how Washington thinks, this post pertains to you (but you already know that, of course).

Two relevant reform proposals emerged in the wake of growing public outrage generated by CBS’ “Sixty Minutes” and other reports highlighting the ability of elected officials and their staff to trade on otherwise “non-public” information for personal investment gains. Near universal public outrage is about the only catalyst for Congressional action these days but, despite bipartisan grass-roots calls for reform, no singular solution is ever presented by Congress…. Instead, as many might have predicted, Congress produced two competing visions of what problems need to be addressed and how to go about it.

The Senate set forth its vision last Thursday when it passed the Stop Trading on Congressional Knowledge (“STOCK”) Act of 2012 in a lopsided, 96-3 roll call vote. In addition to tackling the fundamental problem not so subtly referenced in its title, the STOCK Act seeks to implement a number of aggressive ethics rules and revisions to the Lobbying Disclosure Act aimed at further restricting legislative and executive branch conflicts of interest and mandating more transparency in the area of non-lobbyist political consulting.

Most significantly for “Establishment Washington”, included within the Senate proposal’s ban on “insider trading” is a controversial obligation that all “political intelligence” consultants register and disclose their activities as if they were federal lobbyists, and a contentious legislative fix to the poorly-written “honest services fraud” statute that was recently-deemed unconstitutional by the U.S. Supreme Court in contexts outside of bribery and kickback schemes.

The language of the Senate bill would reach individuals and entities who engage in “political intelligence contacts” for the purpose of obtaining information from officials of the executive and legislative branches of government “for use in analyzing securities or commodities markets, or in informing investment decisions.” Any organization employing or retaining an individual who engages in one such contact would be required to register and report in the same fashion as if they were a lobbyist-registrant under the Lobbying Disclosure Act (LDA).  As such, they would be subject to the same quarterly and semi-annual disclosure requirements that lobbyist-registrants currently meet.

On a quarterly basis, via a Form LD-2, “political intelligence” registrants would need to disclose the “issue areas” their organizations are discussing, the legislative body or federal agencies they are contacting, the employee(s)/consultant(s) that engage in such contacts, and the total expenses incurred with regard to the intelligence-gathering activities. On a semi-annual basis, via a Form LD-203, political intelligence registrants would also need to disclose political contributions and contributions to events honoring or recognizing covered executive or legislative branch officials. Such contribution reports would be required of both individual consultants and their employing organizations, effectively opening up a new segment of the Washington political class to public scrutiny of its campaign and non-campaign donations. Certain limited exemptions to these disclosure requirements do exist under the Senate version of the bill, but they are not nearly as broad as those carved out under the LDA for current lobbyist-registrants.

Reform and transparency are all well and good, but these requirements proved too much for the House (and legions of the suddenly activated “political intelligencia”) to accept.

Yesterday morning, the House followed the Senate’s lead by passing its own amended version of the STOCK Act by a similarly enormous voting margin – 417 to 2 to be exact – but without the requirement that non-lobbyist “political intelligence” consultants register and report their activities. Likewise, the House version of the bill refrains from amending the honest services fraud statute to allow for its use in non-bribery and non-kickback scenarios.

House Majority Leader Eric Cantor (R-VA) articulated the House rationale when he commented that the Senate’s disclosure requirements were something “outside of what we do” and that they were not part of the original purpose of the STOCK Act legislation. Also criticized was the “vagueness” of the political intelligence provisions as pertains to anything that happens in Washington.

Thus, in as sure an effort towards “assisted suicide” as Congress has in its arsenal these days, the amended House STOCK Act calls for a federal study of the “political intelligence” industry for the purpose of making future legislative recommendations and additionally prohibits lawmakers from receiving access to initial public offerings of stock. THAT always results in action, right?

Looking to the future, many believe that the political intelligence requirements of the Senate’s STOCK Act are yet another reformulation of recent efforts attempting to compel increased disclosure, and thus disincentivize, political spending by corporations and wealthy individuals. This blog has discussed similar efforts by the SEC, Congress, the ABA, and the Obama Administration in the past. And as such, it is easy to understand the negative reaction that has come from these House Members and many on K Street. Particularly when coupled with the drastic effect the expansion of registration and reporting requirements would have on business activities in and around Washington, D.C moving forward.

In the end, it will be interesting to see whether the overarching goal of banning “insider trading” by Members of Congress and congressional staff becomes collateral damage in the battle over establishing political intelligence registration and reporting requirements. Stranger things have happened on Capitol Hill. Anyone selling information or access in Washington needs to be closely watching Congress in the coming weeks to see how this tug of war ends.

But you already know that.

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Taking Stock of The STOCK Act. . . . Wither “Political Intelligence”?