In an unusual development, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations has issued a “National Examination Risk Alert” summarizing its findings after pay-to-play compliance examinations conducted by the SEC staff.  The examinations focused on municipal securities dealers that are subject to the Municipal Securities Rulemaking Board’s pay-to-play rule, which is referred to as MSRB Rule G-37.  Rule G-37 is one of the most arcane areas of political law.  It is the sort of thing that political lawyers try to avoid at cocktail parties when asked what we do for a living.  It doesn’t have the cachet of, say, terms like “Super PAC.”  But for hundreds or even thousands of people employed by banks and other financial institutions that deal in municipal bonds, Rule G-37 is what stands in the way of their making meaningful political contributions or solicitations for the candidates of their choice. 

Rule G-37 is also important because the SEC used it as a model when it issued its much better known pay-to-play rule for investment advisers, such as hedge funds and private equity funds.  Both the SEC and the MSRB issue advice concerning pay-to-play compliance only occasionally.  The Risk Alert is especially unusual, and significant, because it provides an extremely rare view of how the SEC staff perceives and approaches the real world pay-to-play policies adopted by firms.

Here are the key points:

  • The staff notes that it “observed facts that suggest that some firms may have engaged in municipal securities business with issuers within two years of their [municipal finance professionals] making contributions other than de minimis contributions to officials of the issuers.”  This is SEC speak for:  We have found violations of Rule G-37 and we are likely to initiate enforcement actions.
  • The staff found that some firms “may have failed to file accurate and complete Form G-37s” identifying all political contributions made to covered officials.  Again, that can’t be good.  It’s another signal that enforcement actions may be brewing.  And the suggestion that publicly filed forms were inaccurate also raises the specter of the Federal False Statements Act, which is a criminal statute.
  • The staff reported that it had observed “facts that suggest that some firms examined may have failed to establish or implement adequate supervisory procedures to ensure compliance….”
  • The staff noted that many firms have adopted pre-clearance procedures under which employees must obtain approval from compliance staff before making political contributions.  Though the staff went through the motions of stating that the SEC does not require such pre-clearance procedures, the staff’s recognition that pre-clearance has become a widespread practice lends further weight to that trend.  Very interestingly, the staff also noted that some firms have adopted a “prohibition on political contributions” and have “made a determination that the jurisdictions where they operate allow such prohibitions.”  We noted just recently on this blog that such formal and implicit prohibitions are becoming more prevalent.  They present interesting issues under state labor and employment laws.  Is a ban on political contributions coercive?  Or is it a necessary measure to ensure compliance with the SEC and MSRB pay-to-play rules?

Ominously, the staff ended its report with this line:  “If you suspect or observe activity that may violate the federal securities laws or otherwise operates to harm investors, please notify us….”  We suspect pay-to-play will be a fertile field for enforcement authorities in the years ahead.  And perhaps one of those enforcement cases will be the occasion for a defendant to challenge whether the pay-to-play rules are even constitutionally enforceable.