United States: New Pay-to-Play Rules And Recent Enforcement Actions

Regulators and lawmakers across the United States have put forward new pay-to-play rules to further limit campaign contributions by companies and individuals that do business with or lobby the government. Those new rules take effect later in 2017 and through early 2019. Regulators have also brought several new enforcement actions during the first quarter of this year under existing pay-to-play rules and ethics laws.

This roundup summarizes:

  • 2017 enforcement actions by the Securities and Exchange Commission (SEC) under Investment Advisers Act Rule 206(4)-5
  • New Financial Industry Regulatory Authority (FINRA) pay-to-play rules for placement agents
  • New NYC pay-to-play rules to limit nonprofit donations
  • 2017 enforcement actions by the Chicago Board of Ethics
  • New San Francisco campaign contribution limits for lobbyists

SEC Takes Enforcement Actions against Investment Advisers under Pay-to-Play Rule – The SEC announced sanctions against 10 investment advisory firms in January 2017 for violations of Investment Advisers Act Rule 206(4)-5. The SEC alleges that each of the firms violated the rule by accepting advisory fees from a public pension system fund within two years after the firm or one of its covered associates made a political contribution to a government official with influence over that pension system or to a candidate for such an office. The firms each agreed to pay fines of up to $100,000 and are subject to cease-and-desist orders.

The sanctions demonstrate how seriously the SEC views enforcement of the rule. Most of the political contributions that triggered the sanctions were relatively small, with many around $500. In several cases, the contributor sought a prompt refund of the contribution. Many of the recipient government officials had only attenuated involvement with the pension system (such as a governor who appoints a small number of pension board members). Many of the pension systems at issue invested in closed-end funds years earlier, and no new investment was under consideration. Some of the investment advisors voluntarily disclosed the contribution and sought discretionary relief from the SEC, as contemplated by the rule, but the request for relief was denied.

The sanctions demonstrate the importance of preventative compliance even for relatively small political contributions. A prompt attempt to unwind a contribution—even within 24 hours—appears unpersuasive.

SEC and FINRA Prepare for New Pay-to-Play Rules for Placement Agents – Last year the SEC approved new FINRA rules that limit political contributions by member firms engaged in distribution or solicitation activities on behalf of investment advisers involving public pension systems and other government funds. The new FINRA rules are scheduled to take effect on August 20, 2017. The new FINRA rules complement the extension of Municipal Securities Rulemaking Board (MSRB) Rule G-37 to municipal advisers last year.

The new FINRA rules, Rules 2030 and 4580, are modeled on Investment Advisers Act Rule 206(4)-5. Rule 2030 prohibits a FINRA member firm from engaging in distribution or solicitation activities for compensation with a government fund on behalf of an investment adviser within two years after the firm or one of its covered associates makes a political contribution to a government official with influence over the government fund or to a candidate for such an office. Like the SEC rule, a firm's "covered associates" include its general partner, managing member or executives with similar functions; persons who are engaged in distribution or solicitation activities with government funds and their supervisors; and political action committees controlled by the firm or a covered associate. The rule allows limited de minimis contributions and also prohibits soliciting or coordinating contributions that are otherwise restricted by the rule. Rule 4580 imposes certain recordkeeping requirements pertaining to the activities regulated by Rule 2030.

FINRA and its member firms are preparing for the rules to take effect on August 20. Contributions made prior to the effective date will not trigger Rule 2030's prohibition. As of the effective date, member firms must begin to maintain books and records as required by Rule 4580.

The SEC's pay-to-play rule prohibits investment advisers from paying a third party, including an affiliate entity, to solicit government entities for investment advisory services unless that party is a registered investment adviser subject to the SEC's pay-to-play rule, a municipal adviser subject to MSRB Rule G-37 or a registered broker-dealer complying with FINRA's new pay-to-play rules. The effectiveness of this prohibition had been delayed until the municipal adviser and broker-dealer pay-to-play rules were made effective.

NYC Enacts New Pay-to-Play Rules; Investigation into Mayor's Fundraising Ends – New York City enacted a series of campaign finance and ethics reforms at the end of 2016 intended to further restrict donations by city contractors, lobbyists and others to candidates for city offices and nonprofit organizations controlled by city officials. The reforms came in response to allegations that the current mayor, Bill de Blasio, was raising substantial funds from persons who do business with the city, directed through a nonprofit advocacy organization he supported.

The new reforms limit contributions to nonprofit organizations controlled by an elected city official or his or her staff to $400 per year. The limit applies to entities and persons doing business with the city, including city contractors, city pension system fund managers and lobbyists, as well as certain of their senior executives and owners and their domestic partners, spouses and children. Nonprofit organizations subject to the limit are required to obtain written submissions from donors to identify whether each donor is subject to the contribution limit. The new limits take effect on January 1, 2018, and certain enforcement provisions come into effect on January 1, 2019.

On March 16, 2017, after an investigation of whether Mayor de Blasio took favorable action for donors to his nonprofit advocacy organization, the Campaign for One New York, federal and local prosecutors announced that they would not bring criminal charges against the mayor or his staff in connection with their fundraising activities. Many of the donors did business with the city and, consequently, were subject to city pay-to-play limits. However, those donors were allowed to make significant donations to the Campaign for One New York.

Chicago Board of Ethics Steps Up Enforcement Actions – The Chicago Board of Ethics recently took action to further restrict gifts to city officials. The board also took enforcement action in connection with lobbyist reporting requirements.

The board last month issued a statement prohibiting city officials from accepting an offer from the Chicago White Sox for complimentary tickets to the opening game of the season. The statement follows an opinion issued last year that barred city officials from accepting Chicago Cubs playoff baseball tickets at face value (which was less than market value) unless they attended the game in a ceremonial capacity, as the market value of the ticket would exceed the city's gift ban limit of $50.

The board also stepped up enforcement actions in connection with lobbyist reporting requirements. The board alleged that certain registered lobbyists had not disclosed lobbying activity after communications with Chicago Mayor Rahm Emanuel and his staff were made publicly available in response to a Freedom of Information Act request.

The City of Chicago's lobbyist ordinance is expansive. The ordinance covers communications with any city official or employee, not just elected officials, on legislative and administrative matters. The ordinance requires registered lobbyists to report detailed information about their lobbying activity, including the compensation received from each client, the agency lobbied, the action involved, and any expenditures, gifts and political contributions made.

New San Francisco Pay-to-Play Rules Take Effect in 2018 – Voters in San Francisco approved a referendum in November 2016, Proposition T, to prohibit political contributions and bundling by registered lobbyists. The referendum also prohibits most gifts by lobbyists to local officials. The new rules will take effect on January 1, 2018.

Investment fund managers and their marketing staff and placement agents should take particular note of the new prohibitions. California law requires placement agents, who can include certain in-house staff, to register as lobbyists with the state or local government when marketing to public pension systems in California. Persons registered as lobbyists become subject to all rules applicable to lobbyists, including pay-to-play political contribution limits.

Originally published on April 18, 2017

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