Posted on July 4, 2011 by Stefan Passantino

The SEC's Newly Proposed Rules on Derivative "Swaps"

This Wednesday, the Securities and Exchange Committee (SEC) voted to propose rules that would impose certain business conduct standards on banks and other firms that deal in complex financial instruments known as “swaps.”  For the uninitiated, swaps are derivatives in which parties exchange the benefits of one financial instrument for another in order to trade the cash flow streams of the particular assets.  Swaps are typically used either to insure against market risks such as interest rate fluctuations or to make speculative investments based upon expected changes in the prices of the financial benchmarks underlying the instruments. 

This effort to regulate conduct in the derivative swap market by the SEC emerges out of the Dodd-Frank Act's comprehensive framework for monitoring over-the-counter swaps and the activities of “security-based swap dealers” and “major security-based swap participants” that engage in security-based swap transactions with counterparties (including “special entities” such as federal agencies, states and political subdivisions, employee benefit plans, governmental plans, and endowments).  The rules the SEC advanced this week would require swap dealers to disclose to their buyers the risks associated with transactions, the potential conflicts of interests involved, and the day-to-day values of their swaps, which would aid purchasers in assessing the overall worth of specific deals.  The rules would also mandate that swap dealers doing business with special entities ensure that their counterparts use independent financial advisers to assist with transactions.  Additionally, dealers would be prohibited from participating in a wide range of “pay to play” practices.

Under these new pay to play rules, securities-based swap dealers and their “covered associates” would specifically be barred from engaging in swap transactions with a “municipal entity” for a two-year period if they choose to make certain types of political contributions to officials of that municipal entity. This Proposed Rule 15Fh-6 is modeled on, and intended to complement, existing restrictions on pay to play practices under Advisers Act Rule 206(4)-5, which imposes restrictions on political contributions by investment advisers providing or seeking to provide investment advisory services to public pension plans and other government investors, and MSRB Rules G-37 and G-38, which impose such restrictions on municipal securities dealers and broker-dealers engaging or seeking to engage in the municipal securities business. The pay to play restrictions are also similar to rules the Commodity Futures Trading Commission (CFTC) recently proposed for non-securities-based swaps.

 

According to SEC Chairwoman Mary L. Schapiro, these new pay to play provisions and the other business conduct standards in the proposed rules will work to “level the playing field in the securities-based swap market by bringing needed transparency to this market and by seeking to ensure that customers in these transactions are treated fairly.” That is yet to be seen, but all five SEC commissioners nevertheless voted unanimously to propose the rules and introduce them through formal public notice. The proposed rules will remain open for public comment until August 29, at which point the SEC will take any submitted remarks under advisement and make a final vote as to their implementation.

It will be interesting to see how business leaders and public officials alike react to the SEC’s proposal during the upcoming notice and comment period. Businesses, and in particular investment firms, have had to adjust to a litany of newly proposed regulations and pay to pay rules in the wake of the passage of the Dodd-Frank Act. As such, it has left companies universally unsure as to what types of activities are permitted and prohibited in their day-to-day business. Public officials, however, have been quick to applaud any and all efforts by the federal government and its numerous business regulatory bodies to restrain “unsavory” corporate practices – practices that the SEC, MSRB, CFTC, and other entities assert have contributed to the current economic downturn and led to the misappropriation of billions upon billions of dollars in taxpayer money. Over the next few months, we shall see if both trends continue and if the movement toward increased federal regulation of business conduct and political speech persists.
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Posted on December 9, 2010 by Allix Magaziner

MSRB Takes on Pay-to-Play Again - This Time in the Muni Advisory World

The Municipal Securities Rulemaking Board (“MSRB”) is at it again. MSRB is wasting no time putting rules in place to address pay-to-play practices for the advisory community. MSRB called a special meeting to address this issue, among others, on the heels of the 2010 Dodd-Frank Act, which expanded MSRB’s jurisdiction to include the regulation of municipal advisors, in addition to dealers, which MSRB has regulated since 1975. The MSRB Board of Directors agreed to issue a request for comment on a rule that would restrict municipal advisors from engaging in or soliciting business from municipal entities when an advisor has made certain political contributions to a municipal officer responsible for awarding that business. The rule would mirror the one currently in place for dealers. MSRB officials have said the rule would not be retroactive.

“We are wasting no time in seeking to implement a rule to address ‘pay-to-play’ practices in the municipal market,” said MSRB Chair Michael Bartolotta. “The MSRB already stringently regulates this area of the municipal market with rules restricting pay-to-play by municipal securities dealers, and putting similar rules in place for the advisory community is one of our top priorities.”

The Board also discussed its continued efforts to provide guidance on contributions by political action committees of companies affiliated with dealers. MSRB’s interpretive guidance takes effect on December 12, 2010. In light of such guidance, MSRB has decided not to take further action on an earlier proposal to require dealers to name PACs of their affiliated companies. Stay tuned for updates in this area.

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Posted on August 26, 2010 by Allix Magaziner

MSRB Scrutinizes PACs and the Potential for Circumvention of Rule G-37

Since 1994, the Municipal Securities Rulemaking Board (“MSRB”) has sought to eliminate pay-to-play practices in the trillion dollar municipal securities market. As a result, the muni market has adopted and refined some of the toughest rules on political contributions. The rules promulgated by the MSRB have become a model for regulation of pay-to-play, as was shown with the SEC’s reliance on the MSRB rules in connection withits pay to play rule.

The MSRB continues to strengthen its influence over the activities of municipal bond brokers and dealers. Yesterday, the MSRB filed a proposed rule change with the SEC consisting of interpretive guidance in connection with Rule G-37 and the use of political action committees (“PACs”). The MSRB said it is reviewing the pay-to-play rules because recent consolidation in the financial industry has placed bond dealers under the control of banks, bank holding companies and other companies that have PACs.

The Proposed Interpretation provides guidance on factors that may result in a PAC being treated as a dealer-controlled PAC for purposes of Rule G-37. Rule G-37 provides that certain contributions to elected officials of municipal securities issuers made by dealers, MFPs associated with dealers, and PACs controlled by dealers and their MFPs (“dealer-controlled PACs”) may result in prohibitions on the dealers from engaging in municipal securities business with such issuers for a period of two years from the date of any triggering contributions. A dealer or MFP involved in the creation of a PAC would be viewed as controlling it. The dealer must also consider whether payments made by it or its MFPs to a PAC could be viewed as an indirect contribution.

The MSRB seeks industry comment through October 29 on whether to require dealers to disclose the names of affiliated PACs to the MSRB for public scrutiny. Such information would be posted on the MSRB web site.

 
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Posted on July 7, 2010 by Allix Magaziner

Federal Pay-to-Play Rule is Here to Stay

On Wednesday, June 29, the Securities and Exchange Commission unanimously approved the final text of a new rule under the Investment Advisers Act of 1940 directed at preventing pay to play practices by investment advisers. In response to 250 comment letters, with divergent views on the issue, the Commission revised certain provisions of the rule it proposed last year but largely kept intact its initial proposal of regulations designed to ensure that investment advisors are prohibited from using campaign contributions to steer municipal investment business. Oddly enough, the Commission received no comment letters from the class of plan beneficiaries that it sought to protect with the proposed rule, although two public interest groups strongly supported the proposed revisions.

The new rule has three key elements:

1) It prohibits investment advisors from providing advisory services for compensation—either directly or through a pooled investment vehicle—for two years, if the advisor or certain of its executives or employees have made a political contribution to an elected official in a position to influence the selection of the advisor;

2) It prohibits advisory firms and certain executives and employees from soliciting or coordinating campaign contributions from others (a practice referred to as “bundling”) for any elected official in a position to influence the selection of the adviser. It also prohibits solicitation and coordination of payments to political parties in the state or locality where the adviser is seeking business; and

3) It prohibits investment advisors from paying third parties, such as placement agents, from soliciting a government client on behalf of the investment adviser, unless that third party is an SEC-registered investment advisor or broker/dealer subject to similar pay to play restrictions.

Finally, the rule contains a catch-all, “don’t let the lawyers find a loophole” provision, which prohibits acts done indirectly, which if done directly, would result in a violation of the rule (such as old favorites like funneling contributions through an investment adviser’s attorneys, spouses or affiliated companies).

JUSTIFIED BY PAST ABUSES

The Commission justified its approval of the new rule by referencing the perceived past success of MSRB rule G-37: “Our years of experience with MSRB rule G-37 suggests that the ‘strong medicine’ provided by that rule has both significantly curbed participation in pay to play and provides a reasonable cooling off period to mitigate the effect of a political contribution.” The Commission further rationalized the need for a tough federal rule based on its belief that neither “codes of ethics [nor] compliance procedures alone would be adequate to stop pay to play practices, particularly when the advisor or senior officers of the advisor are involved...” Under the rule, investment advisers remain obligated to adopt policies and procedures designed to prevent violation of the rule. The Commission affirmed “that an adviser’s implementation of a strong compliance program will reduce the likelihood, and therefore costs, of inadvertent violations.”

ANTICIPATING A FIRST AMENDMENT LEGAL CHALLENGE?

In the discussion portion of the rule, the Commission addressed comment letters and also tackled First Amendment concerns, explaining that the new rule is closely drawn to accomplish the goal of preventing quid pro quo arrangements while avoiding unnecessary burdens on the protected speech and association rights of investment advisers. The Commission pointed out “…the rule imposes no restrictions on activities such as making independent expenditures to express support for candidates, volunteering, making speeches, and other conduct.” The Commission distinguished the recent Citizens United Case, by stating: “Citizens United deals with certain independent expenditures (rather than contributions to candidates), which are not implicated by our rule.”

 

PLACEMENT AGENTS ARE NOT BANNED BUT SUBJECT TO FINRA REGULATION

The Commission, persuaded by comment letters, retreated from an outright ban on investment advisers hiring so-called placement agents. As outlined above, the regulations approved allow advisors to continue hiring placement agents provided those agents are registered with the SEC or the Financial Industry Regulatory Authority (FINRA) and subject to pay-to-play restrictions. The restriction on investment advisers using unregistered placement agents will not take effect for one year, in part to give FINRA, which has experience enforcing the MSRB rules, time to propose such rules. Andrew Donohue, who heads the SEC division of investment management, said that the FINRA regulations will be “at least as stringent” as his agency’s rules. Nevertheless, SEC Chairwoman Mary Schapiro warned in an open meeting Wednesday that if the SEC finds any signs of abuse of the new rule, it may still consider an outright ban. “If the Commission determines that third-party placement agents continue to inappropriately influence the selection of investment advisers for government clients even under our enhanced rule, I expect we would consider the imposition of a full ban,” said Schapiro.

SOME CONTRIBUTIONS PERMITTED - BUT HAVE AN ACCEPTED PAY TO PLAY COMPLIANCE PROGRAM IN PLACE

The Commission also attempted to temper the rule by providing certain exceptions to the prohibition on contributions. Contributions of $350 or less per election per candidate can be ignored “de minimus” if the contributor is entitled to vote for the recipient and contributions of $150 or less per election per candidate are permitted even if the contributor is not entitled to vote for the candidate. In addition, an adviser may apply to the Commission for an order exempting it from the two-year compensation ban. The SEC emphasized that a key factor in determining whether to exempt a firm in circumstances in which a violation occurs will be whether the firm has adopted and implemented an adequate pay to play compliance program.  As the Commission noted: “While we have designed the rule to reduce its impact, investment advisers are best positioned to protect these clients by developing and enforcing robust compliance programs designed to prevent contributions from triggering the two-year time out.”

The effective date of the new rule will be 60 days after it is published in the Federal Register. As noted above, investment advisers may no longer use third parties to solicit government business except in compliance with the rule on one year after the Effective Date. Advisers may need to continue to provide advice for a reasonable period of time during which a client can seek to obtain advisory services from others. While some commentators urged the Commission to allow advisers to continue to receive fees during the two year time out for services provided pursuant to existing contracts, the Commission responded: “Allowing contracts acquired as a result of political contributions to continue uninterrupted would eviscerate the rule.”

The financial industry remains in the early stages of evaluating the impact this new federal pay to play rule will have on its activities. One thing we all know for certain, federal regulation of pay to play is here to stay.
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Posted on December 15, 2009 by Pay-to-Play Blogger

MSRB Files Rule Change with SEC

As we highlighted in our November 11, 2009 blog post, in June the Municipal Securities Rulemaking Board (“MSRB”) announced plans to file a rule change with the SEC to revise Rule G-37. The MSRB created Rule G-37 in 1994 to prevent municipal securities dealers from being awarded business based on political contributions. The rule prohibits dealers from engaging in municipal securities business with issuers for two years if they make certain contributions to the political campaigns of officials of such issuers. The proposed revision to Rule G-37 would require municipal securities dealers, their muni professionals, and political action committees to disclose the political contributions they make to bond ballot election campaigns. On December 4, 2009, the MSRB filed with the SEC amendments to Rule G-37 and Rule G-8. Rule G-8 pertains to books and records to be made by brokers, dealers, and municipal securities dealers. Below please find a link to the text of the proposed rule changes. The SEC must approve the rules before they would become effective.

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Posted on September 16, 2009 by Pay-to-Play Blogger

SEC Boots Kickbacks at Federal Level

Amid the storm of pay-to-play scandals and as pay-to-play has become an increasingly hot-button state issue, the Securities Exchange Commission (the “SEC”) stepped in on August 3, 2009 to propose measures at the federal level intended to eliminate or at least curtail “pay-to-play” practices. The measures are aimed to regulate the practice of money managers making political contributions or hidden payments in hopes of winning business from government officials and conversely government officials soliciting political contributions by guaranteeing an award of business. Although the SEC has initiated fraud cases in the past related to kickbacks in pay-to-play schemes, the proposed rules seek to comprehensively address the growth of the government pension plan market and the alleged evils related to its expansion.

According to SEC Chairman Mary Schapiro, “Pay to play practices can result in public plans and their beneficiaries receiving sub-par advisory services at inflated prices. Our proposal would significantly curtail the corrupting and distortive influence of pay to play practices.” As one commentator has stated “so Shapiro is trying to be proactive, reducing…the near occasions of sin.” The rule is intended to help ensure advisory contracts are awarded on professional competence and not political influence. However, as SEC Commissioner Luis Aguilar has cautioned, pay-to-play conduct “is incredibly hard to police.”

The new rule, which revisits a 1999 SEC proposal that was not finalized in part due to monitoring concerns, would prohibit an investment adviser from providing advisory services for compensation to a government client for two years after the adviser makes a contribution to certain elected officials or candidates. Like the 1999 SEC proposal, the proposed rule is modeled on rules G-37 and G-38 of the Municipal Securities Rulemaking Board (“MSRB”), which address pay to play practices in the municipal securities markets. The SEC has couched the rule as a two-year “time out” on conducting compensated advisory business with a government client after a contribution is made and not as a limitation or outright ban of political contributions.

The proposal would also forbid an adviser from providing or agreeing to provide, directly or indirectly, payment to any third party for a solicitation of advisory business from any government entity on behalf of such adviser. Additionally, it would prevent an adviser from soliciting from others, or coordinating, contributions to certain elected officials or candidates or payments to political parties where the adviser is seeking government business. New recordkeeping requirements that would require a registered adviser to maintain certain records of the political contributions made by the adviser are also proposed.

The implications of the proposed measures could be wide ranging. For example, the new recordkeeping rules may have the unintended effect of causing non-U.S. advisers to private pools not to accept investments from U.S. government entities in order to avoid onerous record keeping requirements. In addition, commentators have speculated that the proposed ban on the use of third parties (like placement agents) would make it difficult for smaller and newer funds to develop business because such funds would not have existing contacts with the managers of public pools of capital. The uneven playing field for small funds in turn could limit the investment choices of pension plan officials, who may not have the time and resources to evaluate potential investment opportunities. The SEC seeks comments to address these and other possible pitfalls associated with its proposal.

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