Political groups appeal SEC pay-to-play rule

A federal limit on political contributions by money managers doing business with public pension funds is working so well that some political groups are continuing to challenge it in court.

After being rebuffed Oct. 1 in U.S. District Court on procedural grounds, Republican state committees in New York and Tennessee asked a federal appeals court in Washington Oct. 6 to expedite the case and to overturn the Securities and Exchange Commission's pay-to-play rule, arguing it is both unconstitutional and that it gives an unfair advantage to federal candidates, who do not have the same constraints.

For money managers, the rule also is providing an easy way to rebuff requests for political contributions.

“There was a lot of pressure for them to say yes,” said Lawrence Manson Jr., chairman and CEO of NexTier Capital Solutions LLC, Chicago, a consultant to institutional investors and money managers on reducing business risk. “Being able to say no is a comfortable place to be. I think they all are worried that they're going to trip, and ... would like to have their lives easier.”

There is plenty to trip over.

SEC Rule 206(4)-5 joins other pay-to-play bans enacted by the Commodity Futures Trading Commission to deal with derivatives and by the Municipal Securities Rulemaking Board to control corruption among brokers/dealers in municipal securities. MSRB officials now are working on a rule for advisers to the issuers of municipal bonds to complement a similar SEC rule that became effective this July. The latest actions are part of a larger effort by Congress and regulators to increase transparency and campaign contribution limits, particularly in municipal finance.

The SEC's pay-to-play rule, which became effective in 2011, prohibits investment advisers from taking compensation for services provided to a government client or through a pooled investment vehicle if anyone from the firm makes political contributions to someone who could influence the awarding of the advisory contract. Managers eligible to vote for a candidate may contribute up to $350 per election while others may give up to $150. Anything above those limits triggers a two-year ban on getting paid for the services, but the investment firm is also prohibited from severing the relationship.

The rule also prohibits money managers and their covered associates from coordinating or soliciting any person or political action committee to make any payment to a political party, or doing anything to circumvent the rule.

The impact of the rule took many by surprise June 20 when SEC officials announced their first pay-to-play enforcement action against TL Ventures Inc., a Wayne, Pa., private equity firm that agreed to settle without admitting or denying the charges and to return $256,697 in advisory fees to the $27 billion Pennsylvania State Employees' Retirement System, Harrisburg, and the $4.5 billion Philadelphia Board of Pensions and Retirement, after someone with a TL Ventures affiliate, Penn Mezzanine Partners Management LP, made campaign contributions to candidates for governor and mayor in 2011. The fact that TL Ventures' relationship with the pension funds pre-dated the political contribution didn't matter.

For political candidates, the rule's impact is being felt in this election season as money managers shy from making contributions, or even request refunds of their contributions.

“It is much, much more difficult for candidates to raise money from this community,” said Stefan Passantino, a partner in the Washington law firm McKenna Long & Aldridge LLP who specializes in political law. “Money managers are already in a highly regulated area and are not looking to getting close to any lines. It's far easier for a compliance person simply to impose a no contributions rule.”

State political candidates and parties are at a particular disadvantage to their federal counterparts now that the Supreme Court lifted aggregate spending limits in its 2014 McCutcheon vs. FEC decision, said Jason Torchinsky, one of the lawyers for the plaintiffs seeking to have the SEC pay-to-play rule overturned in New York State Republican State Committee and Tennessee Republican Party vs. Securities and Exchange Commission. “Now, the money is not going to go to state parties, and (the state parties) can't solicit,” he said. “State candidates are covered officials (under the SEC rule), and their opponents may not be.”

The main argument in the case now before the U.S. Court of Appeals for the District of Columbia is whether the SEC rule violates First Amendment free speech rights by subjecting money managers to political contribution limits more stringent than federal limits. It is an argument that could likely wind up before the Supreme Court, observers say. “The rationale that the justices used to overturn the limits in McCutcheon is the very same rationale that they would use here,” said Mr. Passantino.

The SEC's two-year ban on such activity is particularly frustrating, said Mr. Torchinsky, because a state candidate could run for federal office or vice versa, and in the process jeopardize a money manager's contribution given in good faith.

“They're asking you to have a crystal ball and to look two years into the future,” said Mr. Torchinsky with the law firm Holtzman Vogel Josefiak PLLC in Warrenton, Va.

While a court decision will come too late for this campaign season, “there's going to be continuing calls on numerous fronts for more clarity — either additional guidance, judicially imposed clarity or something else,” said Mr. Passantino, who advises political candidates and donors on pay-to-play compliance. “We hope to create significantly more clarity for the regulated community on which candidates are covered under the restrictions by both the SEC and the MSRB. That will be a huge benefit to the regulated community. They want to be able to engage with government without fear of being singled out.”

In the meantime, investment firms and their public pension fund clients need to pay attention, said Suzanne Dugan, who leads the ethics and fiduciary counseling practice at Cohen Milstein Sellers & Toll PLLC in Washington and consults with several public pension systems. The SEC rule “is an effective and necessary way to prohibit what were very real abuses. It ensures that investment decisions are being made in participants' best interests. We see it working every day, and public pension funds are the first line of defense.”