California Regulation, Proposed Statute Add to State’s Reputation for Complex, Detailed Disclosure

California is already home to some of the most complicated and searching political regulations in the country, especially in its efforts to expose “dark money” and other undisclosed political spending.  A newly-amended lobbying regulation and proposed campaign finance law will enhance that reputation.  The practical effect of each is to invite deeper scrutiny of not only the regulated entity,  but also of its donors, employees, consultants, and other affiliates, all of whom face much greater exposure under the new laws.

First, the state’s Fair Political Practices Commission recently voted to amend regulation 18616.  The amendments are specifically designed to target and expose payments for “shadow lobbying” and grassroots campaigns.  Effective July 1, if a lobbyist employer pays over $2,500 in a quarter to a person to influence lawmaking, it must disclose the recipient, amount, and purpose of those payments.  This could include payments for, among other purposes:

  • salaries for non-lobbyist employees who spend 10% or more of their time in a month lobbying or supporting lobbying;
  • directly billed lobbyist expenses;
  • government relations consulting, strategic advice, and other “shadow lobbying” legislative services;
  • grassroots campaigns;
  • advertising and media campaigns; and
  • polling and other research.

Second, the Assembly has passed, and the Senate has taken up, AB-700, the “California DISCLOSE Act.”  The Act would require many political advertisements to prominently display or announce the names of the ad sponsor’s top donors of $50,000 or more.  Adding another layer of disclosure, the bill also makes clear that efforts to hide contributions using middleman organizations or earmarked funds are impermissible — the true source of funds must be disclosed.  While the bill could be killed or amended before passage, this is a major broadening of California’s current on-advertisement disclosure laws and another blow at undisclosed funders.

UPDATE: 501(c)(4) Organizations Not Required To Provide Notice Until Treasury Issues Regulations

Under a new law, each 501(c)(4) organization will have to notify the IRS of the intent to operate as a 501(c)(4) organization; however, such notice will not be due until at least 60 days after regulations are issued implementing the notification procedures.

As reported in Inside Political Law on December 22, 2015, The Protecting Americans from Tax Hikes Act (PATH Act), added a new provision to the Internal Revenue Code that requires all newly-formed 501(c)(4) organizations to file a notice of registration with the IRS within 60 days of the organization’s formation.  The PATH Act also required certain 501(c)(4) organizations established prior to its enactment to file a notice within 180 days if they had not yet filed an exemption application (Form 1024) or annual information return (Form 990/990-EZ/990-N).

IRS Notice 2016-09 clarifies that organizations need not submit any notification until regulations are issued that implement the notification procedures.  According to Notice 2016-9,  the regulations will provide transitional rules for organizations to comply.  Once the procedure is established, section 501(c)(4) organizations that submit the required notice will receive an acknowledgment of the submission but will not receive a determination letter recognizing tax-exempt status unless a complete Form 1024 is submitted.

SEC Issues Fines for Pay-to-Play Violations That Predate Its Pay-to-Play Rule

A $12 million settlement announced last week by the Securities & Exchange Commission suggests that the SEC will aggressively pursue alleged schemes connecting political contributions to government contracts even if the political contributions do not violate its 2010 pay-to-play rule.  According to the settlement order, in 2010, the head of Public Funds at State Street Bank and Trust Company arranged to make payments, through an intermediary lobbyist, to the Ohio deputy state treasurer “in exchange for several lucrative subcustodian contracts awarded by the Office of the Treasurer of the State of Ohio.”  In addition to these cash payments, the executive also allegedly arranged for others to make at least $60,000 in political contributions to the Treasurer’s election campaign.  Based on these allegations, the SEC and State Street entered into a settlement order requiring State Street to disgorge $4 million and pay penalties of $8 million.  The conduct, the SEC alleged, “violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which prohibit fraudulent conduct in connection with the purchase or sale of securities.”

In announcing the settlement, the SEC provided more evidence that schemes connecting the award of public contracts to political contributions and fundraising are an enforcement priority: “Pay-to-play schemes are intolerable, and lobbyists and their clients should understand that the SEC will be aggressive in holding participants accountable.”  The case follows on the heels of its first major pay-to-play enforcement case in 2014.

Importantly, the conduct at issue in this case took place before the SEC pay-to-play rule was effective.  The settlement therefore suggests that even if a political contribution is not technically covered by the SEC’s specialized pay-to-play rule, it still might lead to an enforcement action under the Exchange Act’s general anti-fraud provisions.  Some of the contributions made in the State Street case, for example, were not made by “covered associates” who are subject to the SEC pay-to-play rule.  Nevertheless, the SEC apparently believed that the contribution scheme still violated general statutory and regulatory prohibitions on fraudulent conduct.  When reviewing contributions for pay-to-play compliance, compliance departments should therefore pay careful attention to the surrounding facts.  Even if the SEC pay-to-play rule technically does not apply, if facts suggest the contribution was intended to secure or retain public contracts, the contribution could still result in potentially crippling penalties.

PATH Act Requires 501(c)(4) Organizations To Provide Notice To IRS After Formation

Under recent legislation, newly-created and certain existing 501(c)(4) social welfare organizations must file a notice with the IRS.  In the past, social welfare organizations were not required to submit an application (Form 1024) to the IRS to be recognized as a tax-exempt organization but could “self-declare” exempt status, as long as the organization operated pursuant to the requirements applicable to such organizations.

The Protecting Americans from Tax Hikes Act (PATH Act), signed into law by President Obama on December 18, 2015, added a new provision to the Internal Revenue Code that requires 501(c)(4) organizations to file a notice of registration with the IRS within 60 days of the organization’s formation.

Existing organizations that have not filed a Form 1024 or annual information return (Form 990/990-EZ/990-N) on or before the date of enactment must provide the notice required within 180 days of enactment of the new law.

The IRS will have to issue the format of the notice early in 2016 so that new social welfare organizations are able to meet the deadlines.

A 501(c)(4) organization will have to provide the following to the IRS:

  • user fee
  • the name, address, and taxpayer identification number of the organization;
  • the date on which, and the state under the laws of which, the organization was organized; and
  • a statement of the purpose of the organization.

The IRS will have the authority to extend the 60-day deadline for reasonable cause.  Within 60 days after an application is submitted, the IRS must provide a letter of acknowledgement of the registration, which the organization can use to demonstrate its exempt status.  The notice and receipt are subject to the disclosure requirements, which are currently applicable to Forms 1024 and 990.

This format is similar to the Form 1023-EZ that small, charitable, 501(c)(3) organizations use to apply for recognition of tax-exempt status. Generally, the IRS makes a determination regarding a Form 1023-EZ within a month of submission.

While the filing of the notice is required of all new 501(c)(4) organizations, the option to file a more-detailed application remains for 501(c)(4) organizations that seek greater certainty regarding qualification; however, the application form used will no longer be Form 1024 but will be a new form to be issued by the IRS.

As reported in Inside Political Law on December 16, 2015, the PATH Act confirms that gift taxes do not apply to contributions to 501(c)(4), (c)(5), and (c)(6) organizations, which will provide greater certainty to donors to such organizations.

Congressional Spending Bill Shuts Down Key Goals of Campaign Finance Reform Community

A major spending bill posted late last night by Congressional leaders contains provisions shooting down two key initiatives of the campaign finance reform community. 

Stymied by a Federal Election Commission that has increasingly struggled to find consensus, campaign finance activists in recent years have turned their attention to other federal regulators, pressing those regulators to adopt their own rules governing money in politics.  Depending on your perspective, these efforts have been aimed at either bringing more transparency to elections or squelching the political speech of companies and other groups.

At the federal level, activists have long-targeted the Securities & Exchange Commission and IRS.  The proposed spending bill would put both efforts on ice.

Most significantly, the bill would bar the SEC from using appropriated funds “to finalize, issue, or implement any rule, regulation, or order regarding the disclosure of political contributions, contributions to tax exempt organizations, or dues paid to trade associations.”  An SEC rulemaking forcing public companies to disclose information about their political activities has long been a dream of the reform community.  Law professors, labor organizations, and others have organized campaigns resulting in hundreds of thousands of comments encouraging the SEC to act.  At one point a few years ago, the SEC put a potential “corporate political disclosure” rulemaking on its “Unified Agenda,” but never acted.  While the SEC has lately shown little appetite to engage in rulemaking in this area, some Members of Congress have increasingly pressured it to do so.  Today’s spending bill, if adopted, prevents the SEC from moving forward with any such rulemaking for the next fiscal year.

Activist efforts to press the IRS to issue a rulemaking that could narrowly define 501(c)(4) social welfare organizations would also now be on hold.  Critics have maintained that these tax-exempt groups are flooding the airwaves with election advertising without disclosing their donors.  Accordingly, they have demanded that the IRS issue rules defining when these so-called “dark money” groups can legitimately claim social welfare status and when they must become section 527 political organizations that must disclose their donors.  In 2013, the IRS proposed a rule tackling this issue.  After intense criticism from many sides, the IRS pulled the regulation back.  We have heard rumblings that the IRS was getting closer to proposing a new rule, but the spending bill would appear to put a stop to that, at least during fiscal year 2016.  The bill also confirms that gift taxes would not apply to contributions to 501(c)(4) and (c)(6) organizations, which will provide greater certainty to donors to such organizations.

In the case of the SEC and IRS rulemaking, the spending bill applies only to the use of appropriated funds in fiscal year 2016.  Campaign finance reform groups will likely attempt to resurrect these reform initiatives after that.  But, at least for now, these reform efforts appear to be on life support.

 

SEC Fines Should Prompt Firms Engaged in Political Intelligence To Revisit Insider Trading Policies

In a rare move, the Securities & Exchange Commission has assessed penalties against a political intelligence firm for failing to adopt adequate policies to prevent the flow of inside governmental information to the firm’s clients.  The enforcement action is particularly noteworthy because all the factual allegations took place in 2010, before Congress passed the STOCK Act which, as we have noted, clarified that the insider trading rules applied to inside government information.

The enforcement action involved Marwood Group Research, LLC, a political intelligence firm, registered broker-dealer and state registered investment adviser that provides “research notes” to hedge funds and other financial industry clients addressing likely outcomes of future government actions.  To compile these research notes, its analysts would sometimes receive information from government officials which presented a substantial risk of being material and non-public.  The order states that Marwood sometimes conveyed this information to clients via the “research notes” and in other calls and meetings. 

Marwood had written policies prohibiting the dissemination of material, non-public information and requiring information be brought to the attention of the Chief Compliance Officer if there was any doubt as to whether it was material and nonpublic.  “Material nonpublic information” was expressly defined to include information about “any pending but not yet publicly proposed or approved action by a regulatory or other government agency.”  Research notes were required to be reviewed beforehand by the company’s compliance department for possible inappropriate dissemination of material nonpublic information.

Nevertheless, the SEC indicated that these policies and procedures were inadequate as they were not reasonably designed to prevent the misuse of material, non-public information given the nature of Marwood’s business.  It was not enough for the policy to require compliance department review of the research notes.  Rather, the SEC suggested that the policy must “expressly require the compliance department to be advised as to the source of the information included in the research note or about communications with government sources, if any.”  The failure to require the compliance department to be apprised of this back-up information, the SEC concluded, resulted in a violation of the Exchange Act and Advisers Act as Marwood’s policies and procedures did not adequately address the risk its employees would obtain and disseminate material, non-public information from government officials.

As a result, the SEC ordered Marwood to retain an independent consultant to conduct a review of the company’s enforcement of its policies related to the obtaining or use of material non-public information, to submit the report to the SEC, and to adopt any recommendations.  It also slapped Marwood with a $375,000 civil fine. 

Based on this enforcement action, hedge funds, political intelligence firms and other financial industry participants would be well-advised to take a close look at their insider trading policies to ensure they adequately capture the risks associated with their business, and that those policies are being complied with on a firm-wide basis.  As underscored in the order, a firm’s policies and procedures may be insufficient if the compliance department is not apprised of the sources for predictions conveyed to clients or relied upon to make investment decisions, or provided with additional information to ensure that the CCO or other gatekeeper has a sufficient appreciation for the facts to determine whether the information received from the government source is material and non-public.

 

Thanksgiving Treat: Executive Branch Gift Rules in for Rewrite

As the nation looks forward to giving thanks with family and friends, the Office of Government Ethics (OGE) will be proposing revisions to regulations that specify when employees of the federal executive branch must say, “No, thanks.” These changes are only proposals at this time and have not yet taken effect. Many of the changes are intended to make the rules more readable, but there are a number of important revisions, including:

  • Written authorization required for all widely attended gatherings (WAGs). The WAG rule allows for free attendance at certain events and is one of the most commonly used exceptions to the gift rules. OGE’s proposal would require written authorization for all WAGs, not just when the person extending the invitation has interests that could be substantially affected by the employee. The OGE believes “certain technologies . . . such as the Internet and mobile devices” make this change practicable, and the authorization would not need to be detailed.
  • A new provision discourages acceptance of permissible gifts. OGE added a new provision designed to encourage government employees to consider whether, even if a gift is permissible, acceptance of the gift could negatively “affect the perceived integrity of the employee or the credibility and legitimacy of the agency’s programs.” The new provision includes a number of factors to consider in making this judgment call, such as whether those with views different from the donor are also provided access to the government.
  • Alcohol is not a “modest item of food or refreshment.” A new example would clarify that the exclusion to the definition of “gift” for “modest items of food and refreshment” does not allow for the acceptance of alcoholic beverages.
  • Store gift cards of $20 or less are ok; prepaid cards are not. A rule that permits employees to accept gifts of $20 or less would be clarified to allow for gift cards to a particular store (the OGE example discusses a gift card “to a national coffee chain”). Cards without such restrictions, such as prepaid debit cards, are still prohibited as the functional equivalent of cash.
  • Receptions Hosted by Former Employer. The changes would allow a government employee to attend receptions hosted by a former employer, if the government employee is not given special treatment.
  • Unsolicited informational materials are ok; approval required if they exceed $100. Recognizing that some informational material, such as books, may be useful but expensive, the OGE would allow unsolicited informational material of up to $100 in value; if the value exceeds $100, approval would be required. Entertainment and art are not allowed.
  • “Free attendance” could include meals outside a group context. The OGE recognized that, when employees present at an event, a meal is often held just with the presenters. This revision would allow government employees to participate in those meals.

Comments on the proposed rule must be submitted within 60 days of the publication of the rule in the Federal Register—which is expected to occur on November 27.

FEC Provides Some Answers To Candidates and Super PACs

Last week the Federal Election Commission (FEC) took incremental steps toward defining the rules for those considering becoming a candidate and how candidates interact with Super PACs. FEC AO 2015-09 (Senate Majority PAC and House Majority PAC).  As expected, the agency could not reach consensus on most of the legal issues raised, but it did provide some marginally useful guidance, much of it a reaffirmation of its existing regulations and prior decisional law.

Here are the most salient things the agency said.

  • Individuals who are “testing the waters” to decide if they should run for federal office must still comply with the FEC’s rules requiring the use of federally permissible funds. This seems to preclude “testing the waters” Super PACs or 501(c)(4) organizations.
  • You become a “candidate” when you decide that you are going to run. It is this personal decision, and not the formal filing of papers with the FEC, that makes you a “candidate.”
  • There is no limit to how long you can think about running. You can “test the waters” for months or years, so long as you remain truly undecided about whether to run.
  • “I meant what I said and I said what I meant.” D. Seuss, Horton Hatches the Egg. If you publicly tell people you are running, the FEC will assume you mean it.
  • Telling the press the date you will announce your candidacy is good evidence you have decided to run.
  • Individuals who are “agents” of a candidate’s campaign for fundraising purposes can also raise money for multicandidate Super PACs, so long as they don’t do so on behalf of the candidate. The FEC could not agree on whether the same rule would apply to “agents” who fundraise for single candidate Super PACs.
  • Potentially the most significant part of the opinion was a sanctioning of “small room” fundraising events for Super PACs. There is no minimum number of attendees necessary for an event to qualify under the FEC’s rules for when a federal candidate or officeholder can attend an event — including a Super PAC fundraising event — where non-federal funds are raised.

The Commission could not find consensus on the more weighty issues presented, including the role of a potential candidate in setting up a Super PAC that would support her or his campaign, a potential candidate sharing strategic information with a Super PAC, whether there is a dollar threshold for how much a potential candidate can raise while still remaining undecided about whether to run, and whether a potential candidate’s coordination with a Super PAC taints that Super PAC’s spending after the person announces his or her candidacy. On these important questions, the agency could provide no guidance on how the law should apply.

Will President Obama’s New Overtime Regulations Shrink Corporate Restricted Classes?

Corporate PAC managers may soon find that the universe of employees who receive corporate PAC solicitations has unexpectedly shrunk.  In July 2015, the Department of Labor proposed new regulations that would dramatically increase the number of workers entitled to overtime wages.  The Department of Labor estimates that, under the new regulations, approximately 5 million new white collar workers could receive overtime pay.  Currently, salaried employees are not entitled to overtime pay if they perform certain duties and are paid at least $455 per week (the equivalent of $23,600 annually).  Under the proposed regulations, the duties test would remain the same but the salary threshold would increase to $921 per week/$47,892 annually.  This salary threshold would also be adjusted year-to-year, pegged at the 40th percentile of weekly earnings of full-time salaried workers.

In practice, because the FEC regulations and Fair Labor Standards Act regulations overlap to a degree, some companies take a shortcut in their legal analysis and solicit PAC contributions only from employees not entitled to overtime pay and refuse to solicit those entitled to overtime pay.  Thus, when the number of employees entitled to receive overtime pay increases, the universe of employees solicited by these corporate PACs may fall.

Legally, however, these regulations should not require companies to reduce the size of their restricted class.  While the FEC regulations look to Fair Labor Standards Act regulations for guidance in determining whether an individual’s duties place that individual in the restricted class, the FLSA’s salary cut-off on overtime payments is not relevant to this analysis.  Nonetheless, these new rules may present corporate PACs with a good opportunity to conduct a more thorough “restricted class review” to confirm that solicited employees all fall within the restricted class and to determine whether others may also be solicited.

California Approves Strict Rules on Super PAC Coordination

California has existing regulations that define when expenditures by outside groups, including super PACs, are coordinated with candidates and become illegal contributions to those campaigns.  These rules create a presumption of coordination under certain circumstances.  Yesterday, the Fair Political Practices Commission (“FPPC”) approved revisions to its rules on independent expenditures and coordination that expand the situations where a presumption of coordination exists.

The changes adopted by the FPPC mirror activities that have been the subject of debate and controversy at the federal level.  California, like many states, is moving forward with efforts to tighten the rules on super PAC expenditures.

The following list describes the primary ways that California changed its rules regarding “presumed coordination.”  If the facts show that these situations exist, the candidate and outside groups have the burden of proving that illegal coordination did not occur.

  • Republication.  While republication of campaign materials was already presumed to be coordination in California, the revised rules add “video footage” to the list of campaign materials in this rule.  This may be an attempt to prevent super PACs from using “b-roll” footage filmed by candidates, which has become a common practice.
  • Fundraising.  If a candidate solicits funds for or appears as a speaker at a fundraiser for a super PAC primarily formed to support that candidate, expenditures made by the super PAC are now presumed to be coordinated with the candidate.  At the federal level, the Federal Election Commission has approved candidates appearing at super PAC fundraisers, with certain restrictions on how much they can solicit for the super PAC, without raising coordination concerns.  California now takes a much more restrictive approach on fundraising activities by candidates and super PACs.
  • Former Staff.  There is now a presumption of coordination if the group making an expenditure is “established, run, or staffed in a leadership role” by an individual who previously worked for a candidate in a senior role during the current campaign.  The “current campaign” extends from one year before the primary in which the candidate is running through the general election.
  • Candidate’s Family.  Like former staff, expenditures made by groups “established, run, staffed in a leadership role” by a member of the candidate’s immediate family are presumed to be coordinated with the candidate.  In addition, and somewhat surprisingly, expenditures made by groups that are principally funded by a member of the candidate’s immediate family are presumed to be coordinated expenditures.

It is important to note that this is not the full scope of what amounts to coordination under California’s broad rules, only what the new rules add to the list of presumptions.  Also, this activity does not mean that coordination necessarily exists, but if challenged, the candidate and outside group will need to spend their time and resources to prove that coordination did not occur.

As noted above, state regulators are steadily imposing stricter rules on super PACs than what is found at the federal level.  It is important to know the state rules on coordination before engaging in activities in that state and to avoid the temptation to think that what is commonplace at the federal level will be permissible in state elections.

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