Dealer Political Contributions: Ten Steps To Assure Compliance With MSRB Rule G-37

Rule G-37 was intended to protect the integrity of the public finance process by preventing so-called "pay-to-play" practices. The Rule accomplishes its mission by effectively preventing dealers and their PACs from contributing to political campaigns of issuer officials, and limiting the amounts that certain of their employees may contribute. Penalties for violating the rule can be severe. Even minor and inadvertent violations of the Rule can have potentially harsh financial consequences for a public finance group, including a two-year moratorium on important business relationships with issuers, and possible actions by securities or bank regulators involving fines and negative publicity.

This overview was prepared to provide guidance to dealers in preparing and implementing reasonable compliance procedures. The implementation of reasonable procedures is critical both to prevent potential violations and to mitigate the harm caused by inadvertent violations. This outline is based on observations and recommendations in many different contexts, including acting as an independent consultant following enforcement actions by the Securities and Exchange Commission. Although most dealers already have adequate procedures in place, they may wish to also consider the following steps towards compliance.

The MSRB rules and interpretations concerning compliance with limitations on political contributions are complex, and evolving on a continuing basis. For this reason, it is important to have at least one person within an organization who has a thorough understanding of the Rule and its requirements. This person’s specific responsibility may include:

• Developing and implementing the firm’s written compliance policies and procedures relating to Rule G-37;

• Promptly communicating any relevant changes in MSRB Rules, policies, or interpretations to appropriate persons, and revising policies and procedures, if necessary;

• Reviewing periodically the firm’s list of municipal finance professionals (MFPs) and the "Rule G-37 Watch List" (discussed below);

• Taking reasonable steps to maintain awareness of the potential problems resulting from political contributions within the dealer and among relevant communities elsewhere in the organization; and

• Serving as a point of contact for those with questions about compliance.

In large organizations, one of the primary challenges in complying with Rule G-37 can be maintaining the required list of persons who are considered "municipal finance professionals," as well as "supervisor MFPs", "non-executive MFPs", and now, "solicitor MFPs." Because the definitions are broad, debate about the persons covered under a specific definition can be a mind-numbing process. It is important, however, to begin with a good understanding of the persons who clearly fall within their scope, and then to proceed outward. Bear in mind that regardless of whether or not a particular individual or groups of individuals actually fall within the definition, once they have been placed on the dealer’s list of MFPs, in most cases it will be hard to convince regulators that their contributions are not covered by restrictions under Rule G-37. For this reason, it is important not to be broadly over-inclusive.

Carefully screen new employees and analyze any mergers or reorganizations. For Rule G-37 purposes, perhaps the most common pitfall is failing to properly screen new employees. At the time they are considered for a position, all potential MFPs should complete a political contribution form to assure that they have not made impermissible contributions over the prior two years that would taint the firm. In addition, firms should be vigilant to assure that any reorganization, merger, or change in management structure does not result in a new supervisor MFP that may have impermissible contributions. Changes in the responsibilities of senior managers within a holding company, the addition of a new person to the executive committee, or incoming directors all may present problems, and also should be monitored carefully to assure that these persons have not made contributions that will affect the firm’s dealer business.

Scheduled reviews are important to focus attention on a particular issue. We recommend that reviews occur following the filing of Form G-37 each quarter. This will permit the reviewer to determine whether all contributions were made in accordance with firm policies, including necessary approvals, and whether any of the contributions raise potential issues. In addition, the review may include an inquiry as to whether new developments have occurred within an organization, including organizational changes or the addition of new employees that may alter the group of employees subject to the Rule. The MSRB also offers guidance and modifies its rules on a regular basis, so lists and procedures must considered in light of recent rulemakings and interpretations.

In addition to quarterly reviews, we recommend that dealers consider annually a broader review of compliance procedures in this area that may include outside counsel and others within the organization. This review should be a more thorough inquiry as to the effectiveness of the program, including awareness of issues among "Watch List" personnel (discussed below), questions raised during the year, support for the program, and potential sources of compliance risks. The annual review also is an opportunity to "brain-storm" about new sources of potential risk.

The emphasis on cross-selling and brand awareness in many organizations also can create situations in which competitors may be quick to alert regulators of the possibility for indirect contributions. For this reason, we recommend that firms maintain a "Rule G-37 Watch List" of all individuals within the organization, including parents and affiliates, who have regular contact with municipal officials, to assure that they receive educational training, are familiar with the possible limitations on their activities under Rule G-37, and are provided with a source to answer questions before problems occur.

Any "Watch List" should be realistic, and take into account issues including daily business interactions among employees, so that they reflect the way an organization operates. In some organizations, this may include regional and local bank managers, trust, treasury, or asset managers, or persons who call on municipalities to manage their non-public finance banking business, or may make available resources for politically- related activities. Other groups that also may be targeted for education include the accounting departments, marketing departments, and human resources departments, which should be familiar with Rule G-37-related policies and trained to raise questions related to screening of new hires and political expense reimbursements.

Since proscribed activity may encompass use of a firm’s facilities for solicitations of contributions, attendance at political events, and use of the firm’s name, it is important that all personnel be aware of the possible problems that can occur from such activities. In integrated organizations, such as banks and other larger financial firms, it is particularly important to explain these limitations to individuals who are not familiar with the public finance industry. Often, this can be covered in general policies relating to political contributions and other activities, but limitations should also be reviewed by the municipal compliance officer.

One practice that has led to SEC enforcement action in the past is joint sales calls. Cross-marketing and the use of introductions designed to generate business is a cultural behavior fostered in many large organizations. This culture may be supported by compensation systems that directly or indirectly reward referrals for all business, including public finance work. However, problems may arise when the introduction between the issuer official and the public finance department occurs as a result of efforts by a member of the organization who has made political contributions to the official. A policy, similar to that set forth below, may be adopted and communicated to MFPs and all Watch List employees on a regular basis. For example:

Third-party firms (e.g., consultants, law firms, finders, and lobbyists) who work with an organization also may be a source of potential troubles, since they may seek to enhance their perceived value by using relationships within issuer communities to make introductions that could lead to municipal finance business. Any quid pro quo relationships involving political contributions should be prohibited. A dealer may attempt to prevent potential problems with any consultants that it retains directly by adding provisions to the consulting agreement that prohibit such conduct. In larger, more diverse organizations, this may need to be an area of regular discussion and education.

PAC procedures should be formalized to assure that in addition to other screens, senior officials in the legal, compliance, and public finance departments approve any contributions in order to avoid potential problems. Firms need to be conscious that the MSRB has expressed concern that contributions to PACs and top tier political organizations, federal, state, and local parties, may be used as an indirect means of filtering monies to issuer officials. For this reason, firms must inquire about how PAC funds will be used by a political party, and whether a significant portion of any contributions may be directed to a particular issuer official’s campaign. With respect to holding company and affiliate PACs, they also may employ two-way "information barriers" to assure that MFPs do not have access to PAC records, except with the approval of the Legal or Compliance Departments, and only on a "need-to-know" basis. Members of those PAC committees also should not make contributions based on knowledge of the dealer’s clients or business objectives. When PAC funds are contributed largely by MFPs, compliance officials should be alert to any business incentive that would not be allowed.

Political contribution request forms. All political contributions made by MFPs should be approved, including contributions to political parties and PACs. MFPs should be discouraged from making contributions prior to obtaining approval, and each MFP should take personal responsibility for assuring that appropriate approvals are obtained. This has been a persistent problem with assistants inadequately trained or absent at the time that contributions are made.

In addition to monitoring the amount of contributions so that they do not exceed $250, there should be some inquiry to assure that employees are eligible to vote in the race for which the contribution is made. We also recommend that forms include a representation that the contributor was not solicited by a member of the organization to make the contribution. Finally, those responsible for processing employee expenses should be trained and alert to MFPs and non-MFPs seeking reimbursement for attending dinners and other politically-related functions.

Actions by any number of persons within an integrated organization may have a significant effect on compliance with Rule G-37. The broader audience for any communications, the manner of education or training, and the strength of the message, all require strategic consideration.

Any effective compliance program needs to have support from senior management in an integrated organization. In most larger organizations, the dealer will need to rely upon support from others with only tenuous relationships to public finance in order to assure necessary procedures are in place. The endorsement of senior managers, or "high-level persons," will be necessary to access information and develop policies in departments or divisions outside the supervision of the dealer. For example, part of a strategic analysis may require an examination of who may put the organization’s name on invitations for political events, sponsor an event, or provide access to the firm’s facilities or resources "of value" for political functions. References to municipal finance capabilities in general marketing materials also must be monitored. In addition, compensation formulas for personnel outside the Public Finance Department should be reviewed to assure that affiliates do not receive compensation for referrals, unless specifically approved.

An essential element of any G-37 compliance program is employee awareness. Firms should have a formal Rule G-37 awareness program to regularly communicate the Rule G-37 limitations to employees of the firm, as well as senior affiliate personnel and persons on the "Rule G-37 Watch List" who have frequent contact with issuer officials. For "Watch List" employees, Rule G-37 training can be incorporated into a firm’s broader ethics training program stressing organizational values, and as part of discussions concerning gifts and entertainment of public officials. Within the dealer itself, Rule G-37 training should be a regular part of annual firm educational training.

As part of the Rule G-37 awareness program, firms should remind MFPs and "Watch List" employees that schemes to indirectly make contributions for the purposes of gaining public finance business is inconsistent with the firm’s values and is prohibited. Competitors are keen to note and refer to such indirect contributions, which also may lead to Rule G-37 violations. As stressed earlier, contributions by consultants, including attorneys, and family members can be subject to scrutiny, and also can result in a violation of the Rule if they are orchestrated by the MFP to influence the issuer official for the purpose of generating public finance business.

The strength of the message and support for compliance within the organization is critical. An e-mail from the chief compliance officer of an affiliate broker-dealer will not command the attention in most organizations that would be afforded the same message from a senior officer or the firm’s General Counsel. Involvement of senior management of the organization is necessary to assure that broad constituencies are familiar with the firm’s policies. Some organizations also require that their employees periodically affirm that they understand the firm’s policies relating to Rule G-37 and political contributions, and are in compliance.

Firms should encourage questions regarding political contributions and compliance with Rule G-37. Aspects of the Rule are complex, and in many instances there may be no clear answer to a particular question. However, raising issues often can prevent potential problems. Generally, a contact person will be part of the compliance staff of the dealer or legal department. However, a single point of contact for all questions relating to political contributions, gifts, and entertainment of public officials, and use of organization facilities, may be appropriate for larger institutions.

Even when an impermissible contribution has been made, all may not be lost. There may or may not have been a violation of Rule G-37. Because the NASD has authority to grant exemptions for firms where problematic contributions have occurred, it is important that employees be encouraged to come forward as soon as possible so the firm can attempt to remediate any potential violation.* In order to encourage reporting of actual or suspected problems, employees should have the ability to communicate confidentially and have assurance that any reports will be seriously considered.

Once the firm determines that an impermissible contribution has been made, or violation of Rule G-37 has occurred, it should attempt to learn of the scope of the problem and the nature of its involvement (e.g., whether the action was inadvertent), and implement steps to prevent future occurrences. If there has been a violation of the firm’s policies by an employee, depending on the nature of the actions, it should consider appropriate punitive measures, which may include a letter of censure or warning, or dismissal. In some instances, Rule G-37 problems may reflect a larger problem that could include additional civil or criminal violations. Depending upon the circumstances, the firm also should consider discussing with counsel how best to approach regulators. Particularly if a violation of the Rule has not yet occurred, it may wish to request an exemption from the NASD.

In instances in which exemptions have been granted by the NASD, the firms involved have demonstrated that they had reasonable procedures in place at the time of the improper contribution, or other action, and that they had taken remedial action to prevent further problems. Remedial measures cited by the NASD in the past have included retaining outside counsel to review current procedures; advising relevant investment bankers and affected issuers that the firm is imposing a self-ban on further solicitations until and unless an exemption is obtained from the NASD; removing the contributor from oversight on the relevant account and denying him or her any compensation associated with the account (including indirect compensation); barring that person from making further contributions; implementing "firewalls" to assure that the person has no contact with the public finance department and the issuers; seeking a refund from the issuer official; and contacting the NASD to report the violation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.