A constitutional challenge to the SEC’s “pay to play” rule moved one step closer to resolution today, even as significant hurdles remain in an effort to strike down the rule.

The U.S. Court of Appeals for the District of Columbia Circuit heard arguments this morning on an appeal brought by two state political parties challenging federal pay-to-play restrictions. Adopted by the SEC in 2010, the challenged rule restricts political contributions and fundraising by certain individuals associated with hedge funds, private equity funds, and other registered investment advisers.

As we described in October, the district court ruled that the plaintiffs filed their case in the wrong court, leaving the court without jurisdiction to hear the challenge. In so doing, the district court gestured towards a reconsideration of existing D.C. Circuit precedent limiting jurisdiction to the Court of Appeals. Today’s arguments — before a panel comprised of three judges appointed by Democratic Presidents (Judges Tatel, Edwards, and Pillard) — addressed that preliminary question, as well as the basic question of whether the parties are the proper plaintiffs to challenge the rule.

Turning first to the question of jurisdiction, the panel seemed skeptical that the current appeal is distinguishable from similar challenges that must be brought directly in the Court of Appeals.  The state parties reiterated their view that the Investment Advisers Act allows for initial review in the district court.  But, with the court apparently reluctant to revisit its prior decisions, the parties acknowledged that their current appeal would be foreclosed should the court disagree.

Beyond this initial question, the panel explored the many barriers that may arise in future challenges to the rule.  First, even assuming the court agrees that the case may be brought in the district court, today’s panel appeared to echo the district court’s doubt regarding the parties’ standing to sue. The standing issue stems from the plaintiffs’ apparent inability to identify a registered investment adviser willing to challenge the SEC rule.

Judge Pillard expressed particular interest in the standing question, pressing the state parties to explain why they — as opposed to investment advisers directly regulated by the rule — should be allowed to challenge the rule.  Although the parties pointed to past instances in which political parties have challenged campaign finance regulations, the SEC argued that the parties have failed to demonstrate that their members have been or will be harmed by the rule.

In addition to standing issues, the panel considered other means by which an appropriate plaintiff may challenge the rule.  Because the time for a direct appeal to the Court of Appeals has passed, prospective challengers are now faced with a difficult question — either violate the rule and challenge an SEC enforcement action or navigate the difficult terrain of a pre-enforcement challenge.  With this in mind, the panel seemed to suggest that opponents of the rule are best advised to request a reconsideration of the rule before the SEC before then challenging any resulting SEC decision.  Of course, with the SEC free to withhold final action on such requests, such a challenge may not ripen for months or years.

As we have noted, the constitutionality of the SEC rule is open to question, particularly following recent Supreme Court campaign finance decisions. But depending on the outcome in this case, it may prove difficult to challenge the SEC’s rule unless a registered investment adviser, its covered employees, or a trade association representing them comes forward and is willing to serve as the plaintiff.