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No Good Deed Goes Unpunished: The SEC’s Recent $100K Penalty For Inadvertent and Self-Reported Pay-to-Play Violations Is A Not So Subtle Reminder of the Need for Compliance Vigilance

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.  

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No Good Deed Goes Unpunished: The SEC’s Recent $100K Penalty For Inadvertent and Self-Reported Pay-to-Play Violations Is A Not So Subtle Reminder of the Need for Compliance Vigilance

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

PL blog

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