When the history of the Securities & Exchange Commission’s pay-to-play rule is written, 2014 could be the inflection point. Developments this year suggest two dramatically different paths for the rule in the years to come: either the rule will unravel from court challenges or it will become an increasingly prominent enforcement weapon in the SEC’s arsenal.
In August, two state Republican party committees sued the SEC, alleging that that the pay-to-play rule unlawfully restricted the ability of Republicans in those states to contribute to some federal candidates and unlawfully limited the ability of some federal Republican candidates to receive contributions to which they were otherwise entitled. The complaint alleged that the pay-to-play rule exceeded the SEC’s authority under the Adviser’s Act, conflicted with the Federal Election Campaign Act, and violated the First Amendment of the United States Constitution. In September, a federal district court in Washington, D.C. dismissed the case on procedural grounds, arguing that it had been filed in the wrong court and expressed skepticism as to whether the political parties had standing to bring the lawsuit in the first place. That case is now on appeal before the federal appeals court in Washington, D.C. Despite the setback, if litigation is ultimately successful, the constitutionally dubious rule would be dealt a major blow.
At around the same time the state parties were attempting to chip away at the rule, the SEC was ramping up enforcement. In June, the SEC hit a Philadelphia-area private equity firm with a major penalty in the first case involving alleged violations of the pay-to-play rule. In that enforcement action, two political contributions from an employee of the private equity firm totaling less than $5,000 helped lead to an order requiring the firm to pay a $35,000 penalty and disgorge almost $260,000 in profits, plus interest. The immediate aftermath of the case was even more significant because it became clear that the SEC is ramping up enforcement in this area. In the press release that accompanied the SEC’s order, the director of the SEC’s Enforcement Division stated: “We will use all available enforcement tools to ensure that public pension funds are protected from any potential corrupting influences. … [W]e will hold investment advisers strictly liable for pay-to-play violations.” And, a few days later, the director told Dow Jones & Company: “Our concern is that [these types of violations] could be prevalent, but it’s hard to say how prevalent. We are actively looking for it. We rely on tips and whistleblowers, and we do our own surveillance.”
With pressure mounting to find cases to justify the draconian rule in the face of court challenge, it is clear that the SEC is making a real effort to flush out pay-to-play enforcement cases. It has a number of tools at its disposal to do this including soliciting tips from whistleblowers, its own surveillance and data analysis using publicly available campaign finance reports, and inspections of existing investment advisers. Because these matters fall at the intersection of election and securities laws, Covington’s cross-disciplinary team of political and SEC lawyers is uniquely situated to help clients navigate pay-to-play enforcement matters and investigations to a successful resolution.