Posted on August 23, 2011 by Stefan Passantino

Transparency Advocates Look to the SEC to Accomplish What Congress, The White House, and the IRS To-Date Have Not

By Stefan Passantino & Ben Keane

 

It has been almost exactly 19 months since the Supreme Court handed down its controversial decision in Citizens United v. Federal Election Commission, but the plot continues to thicken as those favoring mandatory corporate disclosure of political activities look for a non-judicial fix to the ruling. 

 

To date, the fields are littered with detritus of failed efforts at identifying a mechanism that compels corporations and wealthy individuals to disclose all exercise of their newly-recognized First Amendment freedoms. This blog has previously reported on failed efforts to mandate such disclosure in Congress, as well as the Obama White House’s proposed executive order circumventing both Congress and the Supreme Court.  To achieve these same goals, groups such as Democracy21 and the Campaign Legal Center have promoted changes to the Internal Revenue Code, while the American Bar Association has encouraged Congress to make pertinent amendments to the Lobbying Disclosure Act. 

 

Our latest contestants in this Sisyphean legal drama are a united band of like-minded law school professors looking to utilize the Securities and Exchange Commission (SEC) as a vehicle to counter the perceived negative impact of Citizens United. It appears this group has concluded that the imposing moniker “Committee on Disclosure of Corporate Political Spending” (the “Committee”) sounds more authoritative than “a united band of like-minded law school professors”. I think I agree with them on that. 

 

Under either moniker, this group has filed a petition for rulemaking with the SEC requesting draft regulations that require public companies to disclose to shareholders information regarding the use of corporate resources for political activities. The main gist of its petition – stricter SEC disclosure rules are necessary to ensure that corporate political activities are subject to the appropriate level of shareholder scrutiny in the wake of Citizen’s United. The Committee bases this conclusion on the following contentions:

 

First, it asserts that there is strong data indicating that public investors have become increasingly interested in receiving information about corporate political spending. To support this statement, the like-minded professors reference a 2006 Mason-Dixon poll indicating that 85% of shareholder respondents held that “there is a lack of transparency surrounding corporate political activity.” They also make note of a FactSet Research Systems analysis that indicates 50 out of 465 shareholder proposals appearing on public-company proxy statements in 2011 involved political spending issues.

 

Second, the Committee grounds its request in the belief that there is increasing momentum toward political spending transparency in the corporate community, as evidenced by the growing number of large public companies that have voluntarily adopted policies requiring disclosure of their political expenditures. To this point, and perhaps undercutting the urgency of their call to action, the professors highlight a study by the Center for Political Accountability indicating that nearly 60% of S&P 500 companies voluntarily provide shareholders with information regarding corporate spending on political activities.

 

Third and finally, the Committee bases its request on the idea that stricter SEC regulation of corporate political disclosure will lead to better corporate oversight and accountability mechanisms. At present, the professors assert, shareholders are unable to hold directors and officers accountable when they spend corporate funds on politics in a way that departs from the interests of the company. From the Committee’s point of view, this is due to the fact that public information regarding corporate political activity is out of the average shareholder’s reach (because it is either dispersed among too many regulatory bodies or not gathered at all). By requiring companies to disclose to one central entity (the SEC), it is the professors contention that there will be better information available to shareholders, and in turn, a subsequent improvement in corporate accountability.

 

Based upon these assertions, the Committee’s petition recommends that the SEC initiate a rulemaking project to adopt a series of regulations that mandate periodic disclosure of corporate political spending. Whether the SEC will take heed of the Committee’s request remains to be seen, but the petition itself has already begun to draw a mix of criticism and support from members of the business, legal, and academic communities.

 

For example, just a few days after the Committee’s petition was submitted, Keith Paul Bishop – the former California Commissioner of Corporations and an adjunct professor at the Chapman University School of Law – filed a response letter with the SEC refuting the professors’ contentions and requesting that no such rulemaking project be initiated by the Commission. In his response, Bishop contends that the Committee’s proposal will only add to the already extensive public disclosure burden faced by reporting companies and that it is unnecessary in light of the growing trend toward voluntary corporate disclosure. He also argues that it is not the role of the SEC to mandate corporate expenditure on public disclosure of political activity when statistics show that not even a third of 2011 proxy proposals on the subject enjoyed shareholder support.

 

In contrast, official comments filed by Mark Latham, founder of VoterMedia.org, and executives from the International Corporate Governance Network expressed strong support for the Committee’s request. Specifically, both comments revealed a common respect for the Committee’s belief that the disclosure of corporate political spending is necessary to help stave off abuse or the breach of business ethics by officers and directors.

 

The debate over who has the better side of the argument will rage on in the coming months as the SEC weighs the proposal and determines whether to take any action. One would have to expect the Obama Administration to lend its support to the Committee’s cause in it’s typical “no fingerprints here, I don’t know what you’re talking about” approach. The response from the corporate community will undoubtedly be more mixed and more direct, but it will be interesting to see what reaction emerges from groups such as the U.S. Chamber of Commerce and The Conference Board’s newly formed Committee on Corporate Political Spending (to which, BIAS ALERT, I am an advisor). Stay tuned….
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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 February 1, 2011 by Allix Magaziner

Paper Lion Ahead for SEC's Pay-to-Play Exemption?

On March 14, the SEC's pay-to-play rule will come into effect and there is growing concern that the rule's exemption for accidental violations will result in an administrative hailstorm. The rule allows an advisor to apply to the SEC for an order exempting it from application of the two-year ban. Under such provision, the SEC can exempt advisers from the time out requirement where the adviser discovers triggering contributions after they have been made, and when imposition of the prohibition is unnecessary to achieve the rule's intended purpose. An exemption would be based on the facts and circumstances of each applicant, including the SEC's consideration of factors such as whether the adviser had a compliance program in place.

The SEC estimated that seven advisers would apply for the exemption each year, a number that several attorneys have speculated as too low given the number of investment advisers affected. On the other hand, the SEC utilized FINRA's data on exemption applications to calculate the estimate, and investment advisers have had several months to digest and prepare for the rule. Either way, whether March will come in like a lamb or a lion for the SEC is anyone's guess.

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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 August 4, 2010 by Allix Magaziner

House Financial Services Committee Seeks to Provide Rights to Shareholders in the Wake of Citizens United

In a continued effort to thwart pay-to-play practices and increase transparency of corporate involvement in the political process, the House Financial Services Committee approved the Shareholder Protection Act of 2010, H.R. 4790 by a vote of 35-28 this past Monday. The bill would require annual shareholder authorization before a public company could make certain political expenditures. A corporation would need to include in its bylaws a requirement for majority shareholder approval on political expenditures in excess of $50,000 or any expenditure that would make the total amount spent by the corporation more than $50,000. In addition, the bill would require issuers to include in annual shareholder reports a summary of all political spending that exceed $10,000, and would also would direct the Securities and Exchange Commission to issue rules requiring corporations to disclose any materials for political activities created with or purchased using company funds. Under the bill, officers and directors who authorize political expenditures without shareholder approval could be found liable for breach of fiduciary duty.

The bill was introduced by Rep. Michael Capuano (D., Mass.) who said: “If you buy into a corporation, you should have a right to say what is done with your money.” Three Democrats (Donnelly, IN; Childers, MS; and Minnick, ID) joined the Republicans in unsuccessfully voting against the bill. The committee vote occurred just days after the Senate rejected a narrower measure that would require corporations and unions to reveal the funding sources for political ads, the “DISCLOSE Act.” Both bills were aimed at mitigating the landmark Supreme Court case Citizens United vs. the Federal Election Commission, which lifted restrictions on independent expenditures by corporations. Capuano said his bill passes on to shareholders the new rights given corporations under the Supreme Court’s ruling.

A vote by the full House could not take place until September and there has been speculation that the debate could provide fodder for election-oriented talking points on free speech and corporate interests ahead of November’s mid-term elections.

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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 June 29, 2010 by Allix Magaziner

No More Delay? SEC to Discuss Pay to Play on June 30

After almost a year (and countless scandals with related enforcement actions later), it appears the SEC will issue its much loved, hated and debated pay-to-play rule. The SEC has announced the subject matter to be discussed at its open meeting on June 30, 2010: “The Commission will consider whether to adopt a new rule and related rule amendments under the Investment Advisers Act of 1940 to address ‘pay-to-play’ practices by investment advisers. The new rule is designed to prohibit advisers from seeking to influence the award of advisory contracts by public entities by making or soliciting political contributions to or for those officials who are in a position to influence the awards.”

On August 3, 2009, the SEC proposed measures at the federal level intended to eliminate, or at least curtail, “pay-to-play” practices. The proposed pay-to-play rule was published in the Federal Register on August 7, 2009, and the SEC received 250 comment letters on the proposal through October 6, 2009. As currently drafted, the prohibitions on providing investment advisory services and payments to solicit, in each case as described in the proposed rule and outlined in our prior blog entry, arise only from contributions made on or after the effective date of the rule. The current draft rule also contains a prohibition on placement agents acting as intermediaries between public pension funds and advisers. The majority of the comment letters were critical of the ban on placement agents. However, the SEC has indicated that the rule may be revised to reflect public comment. To that end, in April 2010, the SEC engaged FINRA to craft rules for registered broker-dealers when acting as a placement agent soliciting investments from government investors. Please click here for further information on this issue.  As Doug Cornelius, Chief Compliance Officer at Beacon Capital Partners has speculated: “That would make it likely that placement agents will not be banned, but merely subject to some additional regulatory requirements.”

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Posted on March 23, 2010 by Allix Magaziner

SEC Warns Firms on Muni Pay-to-Play Rules

As we previously reported, the Securities and Exchange Commission (SEC) has given notice that it intends to take a very active role with respect to pay-to-play issues in the securities markets. On March 18, 2010, the SEC issued a report warning firms that municipal securities rules prohibiting pay-to-play apply to affiliated financial professionals, not just a firm’s employees. In the report the Commission made it clear that an executive who supervises the activities of a broker, dealer or municipal securities dealer is not exempt from the MSRB’s pay-to-play rule just because he or she may be outside the firm’s corporate governance structure.

The pay-to-play rule at issue is MSRB Rule G-37, which generally prohibits firms from underwriting municipal bonds for an issuer for two years after a municipal finance professional (MFP) involved with that firm makes a campaign contribution to an elected official of that municipality. The Commission clarified that an executive may be deemed an MFP if he or she is not part of a broker-dealer, but oversees the broker-dealer from the vantage of a holding company.

The SEC report was issued in connection with an Enforcement Division inquiry into whether JP Morgan Securities Inc. (JPMSI) violated MSRB Rule G-37. JPMSI underwrote municipal bonds issued by the state of California within two years after the Vice Chairman of JPMSI’s parent bank holding company, JP Morgan Chase & Co., Inc. (JP Morgan Chase), who also led JP Morgan Chase’s investment banking business, gave a $1,000 contribution to the Treasurer of the State of California. As quoted from the report: “On September 10, 2002, the Vice Chairman forwarded an invitation for the California Treasurer’s New York fundraising event to JP Morgan Chase’s executive committee and to its Vice President for Government Relations with a handwritten note stating that the California Treasurer is an important client and soliciting their help in raising $10,000 for the event.” Although the Vice Chairman of JP Morgan Chase was not a director, officer or employee of JPMSI, the Commission found he nevertheless was an MFP associated with JPMSI because he functionally supervised JPMSI and served on the executive committee that oversaw JPMSI.

One commentator observed of the JPMSI investigation: “That is exactly the sort of behavior that the SEC wants to prohibit with MSRB Rule G-37 and its proposed pay to play rule.” The SEC merely said its report should serve as a “warning” about mixing political donations and state banking business.

The SEC report serves to remind the financial community that placing an executive who supervises the activities of a broker, dealer or municipal securities dealer outside of the corporate governance structure of such broker, dealer or municipal securities dealer does not prevent the application of MSRB Rule G-37 to that individual’s conduct. “Firms cannot rely solely upon…organizational charts in determining whether a person is subject to those rules,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. The SEC will look to the activities, not merely the title, of an associated person in determining whether the person is subject to the pay-to-play restrictions. A key takeaway from this report is that pay-to-play remains a key focus of the SEC and the SEC is continuing to increase its involvement with respect to pay-to-play issues.
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Posted on February 19, 2010 by Allix Magaziner

The SEC Considers Exemptions for Pay-to-Play Proposal on Registered Broker-Dealers

As we previously reported in our blog entry  “SEC Bans Third Party Solicitations of Municipal Investors,”  the investment industry has been in an uproar over the SEC’s proposed ban on the use of third party intermediaries (such as placement agents registered as broker-dealers with the SEC) by advisors in the government arena. In what appears to be a response to numerous comment letters the SEC received urging alternatives to the outright ban, the SEC is contemplating exemptions to its pay-to-play proposal. As reported in Reuters, “the agency appears to be willing to allow broker-dealers to act as legitimate placement agents if the Financial Industry Regulatory Authority (FINRA) the broker-dealer watchdog, implements strict pay-to-play rules.”

In a December letter to FINRA, an SEC official was quoted as saying “It occurs to us that an exception to the ban for registered broker-dealers acting as legitimate placement agents might be feasible if FINRA were to implement rules that would prohibit pay-to-play activities by those persons.” Herb Perone, a spokesman for FINRA acknowledged that FINRA had received letters from the SEC and that the proposal was under discussion.

The SEC proposal must be put to a final commission vote before the proposal becomes a rule. The SEC is still evaluating public comments and has not yet made a final recommendation to the commission.

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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 November 11, 2009 by Pay-to-Play Blogger

The SEC Has Been Busy With Pay-to-Play Compliance and Expects You To Be As Well

The Securities and Exchange Commission (SEC) has given notice that it intends to take a very active role with respect to pay-to-play issues in the securities markets and has put the regulated community on notice that it expects private corporate compliance training to be well under way as well.

As we have recently reported, the SEC has announced its intentions to take a significantly more aggressive regulatory posture with regard to the confluence of campaign contributions and public investing. Just last week, the House Financial Services Committee saw to it that the SEC has the tools for the job when it voted to double the SEC’s budget and awarded the Commission significantly greater regulatory powers.

The Municipal Securities Rulemaking Board (“MSRB”) has also gotten into the act by recently announcing plans to file a rule change with the SEC to revise Rule G-37 to prohibit dealers from engaging in municipal securities business with issuers for two years if they make certain contributions to the political campaigns of officials of 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.

Meanwhile, in a case which should get the attention of compliance officers everywhere, the SEC has recently notified Southwest Securities Inc. that it plans to recommend “administrative and cease-and-desist proceedings” against the company based, in part, on the company’s failure to conduct compliance training for its financial services staff. In that case, the SEC initiated the action as a result of the company’s alleged use of political donations to win municipal bank work. Southwest’s (now former) employee at the center of the allegations maintained that he only unintentionally exceeded the MSRB cap of $250 donation per election and that the SEC was “more concerned about Southwest Securities and their lack of compliance training of their bankers.” According to FINRA records, Southwest said the employee had failed to report political contributions as required by MSRB and the employee, in turn, faulted the company for failing to adequately inform him of the MSRB rules.

In another, very significant action, the SEC announced last week that banking powerhouse JPMorgan has entered into a multi-million dollar settlement with the agency over allegations that company employees made unlawful payments to friends of county officials. Under the settlement JPMorgan agreed to cancel interest-rate swap contracts between it and Jefferson County, Alabama, pay $75 million in civil fines and payments, and forfeit $647 million in claimed termination fees under the swap contracts.

The allegations giving rise to liabilities in excess of $722 million for JP Morgan ultimately arose from allegations concerning the actions of just two (now former) managing directors of JPMorgan. “The transactions were complex but the scheme was simple,” SEC Enforcement Director Robert Khuzami said in a statement. “Senior JP Morgan bankers made unlawful payments to win business and earn fees.”

These federal enforcement developments highlight the importance of instituting a proper compliance training program. Firms should review and revise policies, practices, and procedures to stay current on the most recent versions of the rules and regulations promulgated by the SEC and MSRB. The SEC has put the regulated community on notice that failure to implement proper compliance policies and train employees adequately can have significant negative consequences. By undertaking the effort to develop a comprehensive compliance program before problems arise, companies can better protect themselves from potential liability and its related, potentially catastrophic, costs and expenses. 

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Posted on October 22, 2009 by Pay-to-Play Blogger

New Mexico Chief Investment Officer Resigns after Investigation

The pay-to-play probe related to U.S. public pension systems led by New York Attorney General Andrew Cuomo, the U.S. Securities and Exchange Commission and the Justice Department has claimed another victim. Bloomberg reports today that New Mexico's chief investment officer has resigned after being drawn into the nationwide investigation.

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Posted on October 21, 2009 by Pay-to-Play Blogger

Blue Ribbon Panel Proposal

Amid the continued debate over the SEC’s proposed pay-to-play rules there are some proponents who argue that oversight of pay-to-play practices must reach beyond the agency’s current recommendations. So even while many commentators oppose the rules on grounds that they sweep too broadly and impair competition, (click here to read comment letters) the former head of the SEC, Arthur Levitt, has declared that President Barack Obama should empower a “blue ribbon” panel to investigate pay-to-play practices of public pension funds.

The call for a probe into the public pension fund practices comes at a time when certain pension funds are examining their own investment processes and making positive changes, such as the California Public Employees’ Retirement System. However, the general concern among regulators and funds is that choices about who should invest public monies are influenced by factors like money and politics rather than an investment manager’s merits and cannot be subject to self-regulation. Levitt said in an interview on Bloomberg Television that public pension fund boards should not make investment decisions, but should cede such power to a professional staff.

The SEC’s proposed rules are meant to address those concerns. The SEC proposal is modeled on the rules proposed by the agency in 1999, when Levitt was chairman. Levitt has explained, “We had a lot of pressure [against the proposal in 1999].” The pressure came from Congress, Levitt said. “When you talk about campaign contributions, Congress gets very sensitive. They feel that’s one step away from their own activities.” Levitt’s panel would go beyond the SEC proposal and would investigate the public officials who sit on boards of state pension funds, highlight conflicts and recommend “best practices.”

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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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