Attorneys & Counselors at law

SECURITIES AND EXCHANGE COMMISSION PLAYS CAMPAIGN FINANCE WATCHDOG

February 10, 2012

While the courts are de-regulating campaign finance, other branches of government are searching for ways to clamp down.  At the national level, the Securities and Exchange Commission has targeted individuals and entities that provide investment advisory services to government pension systems.  Effective March 14, 2011, Rule 206(4)-5 adopted by the SEC in June 2010 makes it unlawful:

  • for an investment adviser
  • to receive compensation for providing advisory services to a government entity for a two-year period
  • after the adviser or any of its covered associates
  • makes or solicits a political contribution
  • to a public official of a government entity or candidate for such office who is or will be in a position to influence the award of advisory business.

The SEC likes to characterize this as a “two-year time out” instead of a prohibition, but it certainly operates as a ban on a substantial number of campaign contributions at the state and local levels.

Players subject to this new rule have struggled to develop and implement internal compliance procedures for a couple of reasons.  First, it is not always clear how long the tentacles of the rule are with respect to what elected officials qualify as “public officials of a government entity.”  Where an elected official has direct appointment authority to select board members of public pension systems, the application of the rule is apparent.  But when the appointment requires subsequent “consent” or confirmation by an additional layer of government, such as a state senate or local city council, does compliance with Rule 206(4)-5 prohibit contributions to members of and candidates for the entire governing body?  A conservative approach, given the significant consequences imposed for making a prohibited contribution, dictate that such contributions should be avoided.

Second, members of trade associations that sponsor political action committees are struggling to determine whether their contributions to these PACs, many of which have existed for decades, are permitted under Rule 206(4)-5.  Both the trade associations and their members have been making changes over the last year to accommodate the rule.  Relying on limited SEC advice and MSRB interpretations related to a similar rule, some of the accommodations appear contradictory – on the one hand, regulated entities are advised that they should not participate on the boards of such PACs, should not receive PAC board agendas or minutes, should not be privy to the PAC’s past or planned contributions to candidates, and should observe other similar firewall procedures.  On the other hand, when responding to a nonspecific solicitation for a contribution to a PAC, advisors are instructed to inquire how any funds received from the advisor or its covered associates will be used, to ensure that they will not be used to contribute to a candidate that the advisor or covered associate could not contribute to directly.  Further, advisors are warned that so-called “pre-emptive instructions” stating that a contribution to a PAC is not to be used for the benefit specified candidates is not sufficient to meet an investment advisor’s obligations with regard to ensuring that such contributions are not being made to circumvent the requirements of Rule 206(4)-5.  However, pre-emptive instructions, in conjunction with other supervisory procedures such as a firewall from covered associates participating in PAC decision making and transmittal of information about a PAC’s activities, and internal pre-approval procedures for contributions contemplated by covered associates, should be sufficient to protect an investment advisor from violations of the Rule while allowing investment advisors to financially support PACs sponsored by a trade association of which the advisor is a member.

Going forward, watch for the Securities and Exchange Commission to be a major player in regulating campaign activities.  Last year, the SEC allowed a shareholder proposal (which was ultimately defeated) that would have required an annual shareholder advisory vote on Home Depot’s electioneering contributions and communications.  Campaign reform groups have encouraged the SEC to mandate disclosure of campaign spending to shareholders and to give shareholders a role in pre-approving corporate campaign spending.  Given recent court decisions peeling away a number of restrictions on corporate political activities, federal and state regulatory bodies are likely to be the next battleground.