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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

SEC Pumps the Breaks on the Adoption of FINRA’s Proposed Pay-to-Play Rule

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.

Slow Road Picture

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.

SEC Pumps the Breaks on the Adoption of FINRA’s Proposed Pay-to-Play Rule

Enforcing Pay-to-Play Violations

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I recently had an interesting dialogue with a city attorney in a pay-to-pay state about a new and – from the perspective of candidates everywhere – concerning state trend in pay-to-pay enforcement: mandatory candidate reimbursements.   States and local jurisdictions are taking a hard look at revising their statutes to add language that requires the recipient of violating contributions to provide a refund under penalty of law and further imposes an additional  penalty upon that elected official for failing to do so.

Most provisions, such as in the granddaddy state of New Jersey, mirror their rules on relatively standard provisions developed by at the state level that puts the burden on the donor to “seek and receive reimbursement” when trying to cure.  Saddle River New Jersey’s pay-to-play law represents a good example of such a law.  Clearly, these laws as drafted require the return of the donation by the recipient, but they do not expressly mandate that the recipient “shall” or “must” return the requested donation under penalty of law.  For the recipient of those precious funds – the local politician – that is a very, very important distinction with a difference.

Similarly, many state and local provisions have “curing” language which follows the SEC’s federal regulation of investment advisors, Rule 206(4)-5, which mandates that the “contributor must obtain a return of the contribution”.  While that language requires more effort than a simple request of the refund, it does not expressly place a dictate upon the official to return the money upon penalty of law.

This is not to say that such laws are unprecedented or that the momentum is not headed in that way.  The City of Houston’s statute provides:

It shall be unlawful for any contractor to contribute or offer any contribution to a candidate, or for any candidate to solicit or accept any contribution from a contractor during a contract award period. In the event that a candidate unknowingly accepts a contribution in contravention of the foregoing provision, it shall be the duty of the candidate to return the contribution within ten days after he becomes aware of the violation.  Sec. 18-36(a) (emphasis added).

Similarly, Albuquerque’s City Charter provides:

Ban on Contributions from Business Entities and City Contractors. No candidate shall accept a contribution in support of the candidate’s campaign from any corporation, limited liability company, firm, partnership, joint stock company or similar business entity or any agent making a contribution on behalf of such a business entity. No candidate shall accept a contribution in support of the candidate’s campaign from any person, other than a City employee, who at the time of the contribution is in a contractual relationship with the City to provide goods or services to the City. The remedy for an unknowing violation of this subsection shall be the return of the contribution.  A.C. Art. XIII §4(f) (emphasis added).

Such laws clearly represent the directional trend in pay-to-play enforcement.  It is hard to dispute the facial appeal of any law transferring compliance obligations upon both the donor and the recipient of such funds.  More enforcement and deterrence is always better than less, right?  Possibly, possibly not.   If this blog has shown anything over the years, pay-to-play enforcement is filled with the potential for unintended consequences and such consequences abound if the recipient of such funds cannot be shown to know of the violation occasioned by the contribution and willfully refuses to refund.  As one who represents candidates as well as donors, it is clear that in even the smallest of races, the candidate herself is not always aware of contributions and certainly does not always know the business interests of the donors.  The potential for political shenanigans abounds if one were inclined to set an incumbent up.

Enforcing Pay-to-Play Violations

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

MSRB Formally Proposes Rule Extending Pay-to-Play to Municipal Advisors

MSRB

After much deliberation, the Municipal Securities Rulemaking Board (MSRB) has filed proposed pay-to-play rules revising Rule G-37 so as to extend its reach to all municipal advisors, including those acting as third-party solicitors. The regulated community has known this revision was coming for several years but now we get a chance to see what the MSRB thought of our public comments this year (Spoiler Alert: Not much – it’s pretty much the same rule proposed back in 2010 when Dodd Frank extended MSRB jurisdiction to permit regulation of municipal advisors).

Government regulators, it would appear, do not share the same affinity for last minute plot twists and “I didn’t see that coming” reversals of fortune as the rest of us. If you are a member of the regulated community – and not a blog author looking for breaking news – that is probably a good thing. Here, predictability has resulted in a much anticipated extension of the existing G-37 pay-to-play rule for dealers (the folks who initiate the principal sales of bonds) to include a prohibition against municipal advisors (the folks who help local governments decide how and when to issue bonds and then how to invest the proceeds) from engaging in their craft for two years if certain political contributions have been made to officials of those entities who can influence the award of business.

Similarly, as is the rule for dealers, the proposed rule also requires municipal advisors to disclose their political contributions to municipal entity officials and bond ballot campaigns for posting on the MSRB’s Electronic Municipal Market Access website (affectionately referred to as the “Go Tell EMMA®” Provision).

Interestingly, however, the proposed rule appears not to extend the $250 “de minimis” contribution exception to municipal advisor firms.

One thing is clear, the good folks at the MSRB have not spent the last two years thinking of new ways to describe their rule to the press. As we reported in August of 2014:

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.”

This week, MSRB Executive Director Kelly decided to switch things up by issuing a press release sayingFor more than 20 years, the MSRB’s pay-to-play rule for dealers has served as a model for other regulations to address public corruption, or the appearance of corruption. Applying this proven model to municipal advisors will ensure that all regulated municipal finance professionals are held to the same high standards of integrity.”

Candidly, this is a rule that makes sense – especially when one considers that under the existing rule, some municipal advisors are also registered broker-dealers (and thus already subject to Rule G-37) while others are not. The MSRB deals with this “multiple hat” phenomenon by “cross banning” such individuals who make a contribution to an official who can influence either the selection of advisors or dealers from future business on either side of the fence. On the other hand, professionals who make a contribution to an official who has influence over one type of business only burn their firm by subjecting it a ban on that business line and not the other. They should, of course, expect to be banned from the entire firm Christmas party nonetheless.

What is not obvious to all is whether the United States Supreme Court will agree that the MSRB’s articulated “appearance of corruption” justification for the proposed rule 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 presents a First Amendment challenge.

MSRB Formally Proposes Rule Extending Pay-to-Play to Municipal Advisors

SEC Promotes Pay-to-Play Compliance with a Friendly Reminder – and a Wells Notice

With a friendly reminder and notice of an investigation, the Securities and Exchange Commission has reminded us all, yet again, that it is moving forward with pay-to-play enforcement whether the regulated community is ready or not. This is a theme that has played out for some time now as the SEC has done a good job of signaling their punches. The Commission is, however, starting to throw punches.cops

On the “Good Cop” side of promoting pay-to-play compliance, the SEC issued a friendly reminder yesterday that the compliance date for Rule 206(4)-5’s prohibition against investment advisers and their covered associates from providing payments to unregulated third-parties to solicit advisory business from any government entity is almost upon us (July 31, 2015).

As a bit of a history lesson, Rule 206(4)-5 became effective way back in September 13, 2010 and included the third-party solicitor ban. At that time, the SEC set the compliance date for that ban to September of 2011 but later added municipal advisors to the definition of “regulated persons”. Because of this, the Commission also extended the third-party solicitor ban’s compliance date to June 13, 2012. In the absence of a final municipal advisor registration rule, the Commission then extended the third-party solicitor ban’s compliance date from June 13, 2012 to nine months after the compliance date of the final rule. When the final rule was released with a final registration date of October 31, 2014 (see Section V), the compliance date for everyone, including municipal advisors, to comply with the third-party solicitor ban was known to be July 31, 2015.

In short, this compliance date is absolutely not a surprise to the regulated community but rather reflects execution on a regulatory scheme the SEC has been telegraphing for some time now. It is still a nice gesture to send out a reminder, however.

On the other side of the coin, it has recently been reported that SEC staff has made clear, via a “Wells” notice that it intends to ask the Commission for authorization to initiate a civil inquiry into allegations that State Street Corporation improperly used third party consultants and lobbyists (and possibly campaign contributions) to influence a public bidding process. This little tidbit was contained within State Street’s Form 8-K filing of June 18, 2015 which read:

On June 18, 2015, State Street Corporation announced that the enforcement staff of the U.S. Securities and Exchange Commission has provided it with a “Wells” notice. The notice relates to a previously disclosed SEC investigation into our solicitation of asset servicing business for public retirement plans and, specifically, our relationships with particular clients in two states during a period ending in 2011. As previously reported, the investigation includes our use of consultants and lobbyists and, in at least one instance, political contributions by one of our consultants during and after a public bidding process. The Wells notice informs State Street that the SEC staff intends to ask the Commission for permission to bring a civil enforcement action that would allege violations of the securities laws (i.e., Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder). The issuance of a Wells notice provides State Street with the opportunity to make a submission to the Commission in response to the SEC staff’s position. State Street intends to submit such a response.

Some are more motivated by the misfortunes of others than friendly reminders from our public servants. Either way, the SEC is signaling, yet again, that painful pay-to-play enforcement is here to stay.

SEC Promotes Pay-to-Play Compliance with a Friendly Reminder – and a Wells Notice

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

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

FINRA

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

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

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).

 

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

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

MSRB

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.

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