The Top Three Political Law Risks for Hedge Funds, Private Equity Funds, and Investment Firms

Perhaps no industry faces more scrutiny and regulation of its political activities than the financial services industry.   Even though these rules are often not intuitive, failure to comply with them can result in big penalties, loss of business, and debilitating reputational consequences.  In this advisory, we describe three sometimes overlooked political law related risks for hedge funds, private equity funds and other investment firms: (i) ensuring that covered employees and others affiliated with the investment firm do not make political contributions that result in “pay-to-play” problems for the firm; (ii) identifying when investor relations activities trigger state or local lobbying registration requirements; and (iii) conducting political law due diligence on prospective investments and portfolio companies.  For each risk area, we outline steps and policies firms can adopt to avoid these common compliance traps.

California Legislature Passes “California DISCLOSE Act,” a Complex but Clarifying Update to the State’s Political Advertising Disclosure Rules

Over the weekend, the California legislature passed AB249, the California DISCLOSE Act, a controversial set of campaign finance disclosure rules that have been years in the making.  The law now awaits Gov. Jerry Brown’s approval.  The law’s proponents have argued that it is necessary in order to provide voters with complete information about the sponsors of advertising.  Its opponents have called prior versions of the bill confusing.  Regardless, assuming the law is not vetoed, it will make some key changes to the California Political Reform Act of which anyone active in California political advertising and campaign finance should be aware.

First, the law requires that almost all advertising carry some form of “paid for by” statement, though it does so in a complicated manner.  Under the prior law, it was not entirely clear where and how sponsorship information was to be disclosed, especially where electronic advertising was concerned.  Under the DISCLOSE Act, depending on the type of electronic advertising, it usually must include sponsorship information, in the form of a link that reads, “Who funded this ad?,” a direct link to sponsor information, or include the sponsor information in the ad itself.  The law also establishes special rules for disclosures in social media, text messaging, standard websites, and other electronic communications.  The law maintains the exceptions to disclosure for communications from an organization to its members, and for communications where including the disclosure might be difficult because of the item on which the communication appears or because of technological limitations.  However, these various rules are spread across numerous provisions of the Political Reform Act — tracing the requirements through the law is a time-consuming task.

Second, in what will probably be the change most noticeable to the public, the law would make the on-advertisement disclosure of an ad’s sponsor and top donors much more prominent for ballot measure ads and candidate ads funded by outside groups.  While much of this information is required already, it has often been buried in fine print and made hard to read by using all uppercase letters.  Under the new law, these advertisements generally must include the names of those three persons who have each contributed the most to the sponsoring committee in an amount over $50,000 in the prior year (if there are any such contributors), as well as the “paid for by” information.  On television and other video ads, sponsor and donor names must appear in a black box, usually taking up 1/3 of the screen for at least five seconds at the start or finish of the ad, with each name on its own line, using standard capitalization.  Large donors to ballot measures and outside committees supporting candidates should consider that their names would be prominently placed on the recipient’s advertising.

Third, the law expands and clarifies the state’s rules for reporting earmarked contributions, with the goal of preventing committees from burying their donors under layers of organizations, though there is a key loophole here.  Under the DISCLOSE Act, if contributions are given to one committee formed to support a candidate or ballot measure and earmarked for that candidate or ballot measure, and the recipient gives them to a second committee formed to support that candidate or measure, the second committee must report as the donor not the first committee but the original source of the earmarked money.  The apparent goal behind this requirement is best illustrated by example.  Assume a trade group solicits contributions to a committee named “Businesses Against Prop 1,” and ABC Corp. and The Smith Co. each contribute over $50,000, knowing the money will then go to the broader “No on 1” committee.  Under the old rules, the donor disclosed on “No on 1” ads may have been “Businesses Against Prop 1.”  Under the DISCLOSE Act, the ad may need to display “ABC Corp.” and “The Smith Co.”  However, there is also a new loophole built into the law for earmarked contributions in the form of dues or assessments to a membership organization or its sponsored committee by its members that are earmarked but are less than $500/year per donor.

This is only a sampling of the changes the DISCLOSE Act makes to the state’s disclosure system — the reality is that the changes are too detailed and complex to be captured in a single blog post.  The main takeaway for any organization planning to contribute to, or place advertisements in, California elections moving forward should carefully consider the changes in the law, and think about consulting with counsel on how those changes might impact their activity.

Unless vetoed, these changes take effect on January 1, 2018, in time for the November 2018 election that will feature an open gubernatorial race as well as legislative races and ballot measures.

SEC Pay-to-Play Rule Set to Expand to Capital Acquisition Brokers

The universe of those covered by the SEC’s pay-to-play restrictions is expanding. If a newly proposed SEC rule is adopted as expected, pay-to-play restrictions will now extend to cover the recently created class of broker-dealers called Capital Acquisition Brokers (“CABs”).  In this advisory, we discuss the background on the proposed rule and its implications for CABs themselves and for investment advisers that retain CABs to solicit business from government entities.

Avoiding State and Local Lobbying Compliance Violations

Corporate legal and compliance departments are usually well aware of the laws regulating lobbying the federal government. Recent news reports, however, indicate that companies have more trouble with state and local lobbying laws. A few features of state and local lobbying make it a tricky blind spot. This increases the risk of failing to properly register or file lobbying reports, or of running afoul of restrictions imposed on lobbyists. In this alert, we outline the questions that can help avoid these headline-grabbing violations.

MSRB Pay-to-Play Challenge Stymied by Sixth Circuit over Standing

Over the past few years, a few state political party committees have relentlessly sought to block or overturn pay-to-play laws overseen by the Securities and Exchange Commission (SEC). Yesterday, the Sixth Circuit delivered another defeat to an ongoing effort to challenge federal pay-to-play laws.

Last year, we noted that the Municipal Securities Rulemaking Board (MSRB) had drafted an amendment to its pay-to-play rule, Rule G-37, expanding their scope. Not long after our article, the Tennessee Republican Party, the Georgia Republican Party, and the New York Republican State Committee filed petitions to review the final rule adopting the MSRB’s amendments.

The Sixth Circuit dismissed this latest challenge for lack of standing. The result is not entirely surprising in that the petitioners faced a high hurdle: because they challenged the amendments to the MSRB’s rule, but not Rule G-37 itself, they were required to focus on activity restricted specifically due to the amendments and not the preexisting rule.

Essentially, the Court determined that the parties had not identified any particular person who could have made a contribution under the preexisting MSRB rule and would do so now but for the 2016 amendments. Similarly, the parties were unable to show that their fundraising efforts faced greater challenge post-amendment than under the old rule.

This opinion should not be seen as an endorsement of the substance of the pay-to-play rules. Rather, as with the an earlier challenge to the SEC’s rule, yesterday’s opinion from the Sixth Circuit emphasizes the importance of ensuring that the right people file their challenge in the right place at the right time.

Kentucky Raises Contribution Limits in July, Adjusts Reporting

Starting this month, nearly all of Kentucky’s campaign contribution limits increase, excepting contributions that remain either unlimited in amount or prohibited.

Perhaps the most substantial change is the establishment of building fund accounts for political party executive committees, which may now accept unlimited funds from corporations. Also of note is the elimination of an aggregate $10,000 or 50%-of-total-contributions limit on how much a candidate or slate of candidates may accept from certain committees, which would have the practical effect of allowing parties to direct more funding into contested races.

Limits are raised to $5,000 annually to any executive committee or caucus campaign committee (up $2,500 over the prior limit); to $2,000 per election for candidates and slates (+$1,000/election); and to $2,000 annually for permanent committees and contributing organizations (+$500/year). The latter two limits would be adjusted every other year. Limits on cash and anonymous contributions would also be raised to $100 from $50.

Other changes include increased thresholds for campaign finance reporting and modified reporting dates. The Kentucky Registry of Election Finance prepared a helpful summary of the changes.

Kentucky’s new campaign finance law follows a trend we have observed over the past ten years. As contributions to outside groups that are permitted to receive unlimited funds have surged, campaign resources have shifted away from candidates and parties and toward outside groups.  One response to this dynamic has been a push to raise contribution limits to candidates and parties. As discussed during the legislative debate, Kentucky’s new law does just that.  Expect more states to follow suit.

U.S. House Considering Major Change to Trade Association PAC Fundraising Rules

The U.S. House Committee on Appropriations is considering a major change to the way trade associations are allowed to raise money into their political action committees (PACs).  Currently, if a trade association wants to solicit money from its member companies’ employees, it must first get advance approval from the company, and each company can authorize only one trade association to solicit its employees for any calendar year.  The current draft of the Financial Services and General Government Appropriations bill, which provides funding for the Federal Election Commission (FEC), includes a rider that would prohibit the FEC from using any of the appropriated funds to enforce these trade association PAC fundraising rules.  In another piece of welcome news for trade associations, the bill would also prohibit the Securities and Exchange Commission (SEC) from requiring public disclosure of companies’ trade association dues payments, a provision which was also successfully included in last year’s appropriations bill by agreement with the White House.

The practical effect of this provision would be that the FEC could not enforce the existing restrictions on trade association PAC fundraising at all during fiscal year 2018 (October 1, 2017 through September 30, 2018).  If this provision were not enforced, this could have a major impact on trade association PAC fundraising.  The dual restrictions of 30118(b)(4)(D) can severely limit a trade association’s ability to raise money for its PAC.  Currently, if a trade association wants to solicit a member company’s employees, it must first convince the company to allow the solicitation, but the FEC’s rules severely limit what the trade association can say when making the request.  Most companies are members of more than one trade association, but can currently only approve one of those associations’ PAC solicitations.  Thus, companies must choose between supporting the PAC of a large business-wide trade association (like the Chamber of Commerce or National Association of Manufacturers), or a more industry-specific trade association.  With these burdens lifted, trade associations will be able to solicit funds freely from the executives, administrative staff, and stockholders of all of their member companies, plus those individuals’ families.  This should come as welcome news to trade associations, but will be less exciting to member company executives who could face an onslaught of new solicitations.

However, this all comes with two major caveats.  First, the bill does not eliminate the solicitation rule.  Instead, it essentially prohibits enforcement of the rule for FY2018.  If the FY2019 appropriations bill does not contain the same restriction as this FY2018 bill, then the FEC presumably could resume enforcement of violations, including violations that occurred in FY2018.  Second, even if the FEC is barred from enforcing this prohibition, the Department of Justice might theoretically be able to, acting independently, bring criminal charges for knowing and willful violations.

Therefore, even if this provision remains in the final bill, it would be prudent to seek advice of counsel before making a solicitation that violates the fundraising restrictions.  The bill passed through subcommittee markup on Thursday with no changes.

The same bill also includes other political and election law provisions, including elimination of the Election Assistance Commission, which provides guidance on election best practices; restrictions on the IRS’ ability to enforce the rule against religious organization political activity; a prohibition on any IRS rulemaking that would regulate the political activity of 501(c)(4) social welfare organizations; and a prohibition on any SEC requirement that companies disclose their political contributions or trade association dues.

Rep. Gowdy Plans Deeper Oversight

The new chairman of the House Committee on Oversight and Government Reform, Representative Trey Gowdy (R-S.C.), outlined his plans for the Committee last week.  As we expected, Mr. Gowdy said that he would pursue more methodical investigations.  Noting that hearings are “an inefficient way to gather facts,” Mr. Gowdy said that the Committee would pursue investigations outside of the public spotlight and then use hearings to present the Committee’s findings.

This shift in focus could have significant implications for private sector companies and executives that are investigated by the Committee.

First, more methodical investigations usually mean more extensive document requests, including discovery of electronic records such as internal company e-mails.  It may also mean that the Committee will conduct more interviews and depositions, or request that targets give sworn, written answers to detailed interrogatory requests.  These investigative tools and techniques are the same methods that are used by criminal prosecutors.  Mr. Gowdy, of course, is a former federal and state prosecutor.

Second, if the Committee conducts most of its investigation before proceeding to a hearing, hearings could be harder for company witnesses.  Mr. Gowdy is a strong questioner, and he is at his strongest when confronting witnesses about past statements.  If the Committee develops a detailed record of past statements, such as historical e-mails or deposition testimony taken in the context of the investigation, the hearings may look a lot like courtroom cross-examinations.

We previously noted that the Committee has sometimes been criticized for flitting from topic to topic, conducting a large number of relatively high level investigations.  For the targets of these investigations, the high-profile hearings are a significant challenge to be sure, but the legal and public relations risks are relatively contained.  Longer and deeper investigations carry significantly more risks to companies facing investigations by Mr. Gowdy and the Committee.

Efforts to End Super PACs Moving Forward, Face Uphill Climb

Last summer there was much ado about the two parallel efforts of a “Dream Team” of attorneys to “end Super PACs.”  Their goal was to get the Supreme Court to overturn the decision  of the D.C. Circuit in SpeechNow v. FEC, and similar decisions in other circuits, which led to the creation of Super PACs.  Those efforts have continued to move forward, with developments on both fronts last week.  However, intervening events have made it increasingly unlikely that the group will achieve its goal via either approach.

The first approach flows through the Federal Election Commission (“FEC”).  The attorneys filed a complaint alleging that various donors and Super PACs had made or received contributions in excess of the pre-SpeechNow limits on PAC contributions.  However, the FEC has officially recognized since 2010 that SpeechNow makes those limits unenforceable against Super PACs.  Press reports indicate that the FEC dismissed the Dream Team complaint based on SpeechNow.  Last week the complainants announced their plans to sue the FEC over the decision, on the grounds that it was arbitrary, capricious, and contrary to law.  The complainants hope to take this case to Supreme Court.  Among various challenges that have always faced the effort, however, there is one glaring new one:  the confirmation of Justice Neil Gorsuch.  His elevation (instead of Merrick Garland or another Democratic nominee) makes it less likely that the Court would reject the holding in SpeechNow and abolish Super PACs.

In the parallel effort, an aligned nonprofit has been working hard to pass an ordinance in St. Petersburg, Florida that would abolish Super PAC activity in that city.  Last week, the ordinance passed a preliminary vote of the city council 5-3.  This sets up a final vote in July to pass the ordinance.  Having passed once already, it seems likely the ordinance will become law.  The city is expecting an immediate lawsuit challenging the ordinance.  That lawsuit would theoretically head to the Supreme Court by way of the 11th Circuit, which, unlike many other of the federal appellate courts, has not decided on this SpeechNow issue before.  A decision upholding the ordinance would create a circuit split and potentially entice Supreme Court action.  However, in the time since the ordinance was first introduced, the 11th Circuit reached a decision in Alabama Democratic Conference v. Broussard that appears to acknowledge that SpeechNow was rightly decided, though it does not directly address the issue.  See Ala. Dem. Conf. v. Broussard, 838 F.3d 1057 (11th Cir. 2016), cert. denied sub nom. Ala. Dem. Conf. v. Marshall, No. 16-832, 2017 WL 1427593 (Apr. 24, 2017).  This makes a circuit split unlikely, reducing the chances that the Supreme Court would take up the issue via this path.  Even if the 11th Circuit upholds the ordinance, the Supreme Court would still likely strike it down as unconstitutional.

Will the FEC Declare War on Russia?

Noting that we are at an “all hands on deck” moment for our democracy, FEC Commissioner Ellen Weintraub circulated to the Commission yesterday a document citing former Vice President Dick Cheney for the proposition that the United States is now at war with Russia, and that “[e]very part of our government that has jurisdiction over [reported Russian attempts to affect the 2016 presidential election] must exercise every scrap of its jurisdiction as fully as it can.”  She calls on the FEC to “find out the facts of what happened during the 2016 Presidential election, and move firmly and swiftly to fix any problems we might find.”  As with any declaration of war, this one comes with a Churchillian reference to the FEC’s “finest hour,” and an insistence that this struggle must not be a partisan one, citing Senator Mitch McConnell for the proposition that we need strong action against Russia.

Despite what some may feel is overheated rhetoric, Commissioner Weintraub presents some quite sensible proposals about what the agency might do to ensure the integrity of our electoral system.  While her list also includes proposals that some commissioners are certain to view as unsupported by the current factual record, it would be better if the commissioners were able to focus on the points where they agreed, rather than disagreed.

Specifically, Commissioner Weintraub outlines six actions she will ask her fellow commissioners to support, including:

  • Having the Justice Department, Treasury and similar agencies brief the FEC to get it up to speed on the problem;
  • Ensure the FEC’s enforcement teams are fully staffed and form interagency task forces if the problem proves too big;
  • Assure the public that the FEC’s data is safe;
  • Begin a rulemaking to adopt a test that will treat more corporations as foreign nationals, barred from participating in American politics;
  • Hold hearings on whether more rulemakings might be necessary; and
  • Give Congress guidance on which pending legislation it should pass and if new bills are needed.

If the Republicans on the FEC can look beyond the overheated rhetoric, and identify reasonable steps the agency could take, progress could be made.  There is no doubt the FEC should ensure its legal team is adequately staffed, and if particular expertise is lacking, seek it out in other agencies.  If the Russians made efforts to hack the FEC’s computer system, an assurance as to the quality of the agency’s defenses would be welcome.  And if the FEC had a more reliable source of information on the threat we face than the public reports in Time and The Intercept, that would be a good thing.

But there are certainly proposals that will not meet with majority support, and with that comes a significant risk that Thursday’s meeting is a repeat of past performances at the FEC, where one side accuses the other of being indifferent to the imminent threat of lawlessness, and the other accuses its opponents of stripping citizens of their liberties.  It would be unfortunate, for the issue at hand is a significant one, and both sides have something meaningful to say about how to make improvements to the agency’s handling of it.