WASHINGTON — A lawsuit challenging the Securities and Exchange Commission's pay-to-play rules for investment advisors could have implications for the Municipal Securities Rulemaking Board's effort to write such rules for muni advisers, as well an existing MSRB rule for dealers.
The New York State Republican Committee and the Tennessee Republican Party are challenging the SEC's restrictions on the political contributions that IA firms and their employees can make to state and local officials or candidates who are in a position to influence the award of investment business, on grounds that those rules violate their Constitutional rights and overstep the commission's authority.
The SEC's rule for IAs is very similar to the MSRB's Rule G-37 for broker-dealers. Rule G-37 survived a legal test some 20 years ago, but the GOP lawsuit against the SEC has some market participants wondering if it could come under attack again just as the board prepares to revise it to include newly-regulated municipal advisors in addition to the dealers it has long governed.
G-37, adopted in 1994, prevents a dealer from engaging in muni business with an issuer within two years after it or one of its municipal finance professionals made a significant contribution to an issuer official who could influence the award of bond business. They cannot solicit contributions for an official of an issuer with which the firm is doing or is seeking to do business, and are also required to disclose contributions they make to bond ballot campaigns. MFPs can still give up to $250 per election to any candidate he or she is entitled to vote for without triggering the rule's two-year ban on business.
Soon after G-37 was adopted, it was quickly challenged in court by Alabama bond dealer William Blount, the head of Blount Parrish & Roton, Inc. who was then chairman of the Alabama Democratic Party. Blount argued, as the more recent GOP plaintiffs argue of the investment advisor restriction, that the rule violated his Constitutional right to free speech.
The U.S. Court of Appeals for the D.C. Circuit rejected that argument in August 1995 when it ruled in Blount v. SEC that G-37 was "narrowly tailored to serve a compelling government interest." The Supreme Court declined to hear Blount's appeal.
Blount pled guilty to bribery charges in 2009 and served time in federal prison.
But more recently, the Supreme Court has since issued rulings overturning restrictions on political contributions. In the 2010 Citizens United vs. Federal Election Commission case, the court held that it was unconstitutional to ban free speech by limiting independent communication, including spending by corporations, associations, and unions.
The National Association of Independent Public Finance Advisors submitted comments during the MSRB's amendments to its bond ballot contributions rules contained in G-37 last year, urging it to go further in curbing dealer gifts to bond ballot committees because of overwhelming evidence of a strong correlation between the money firms gave to the ballot initiatives and the firms being selected to underwrite the resulting bonds.
G-37 could survive a test under Citizens United's reaffirmation that regulation of corporate direct contributions, or those coordinated with a candidate, is permissible to prevent actual or perceived quid pro quo, NAIPFA said.
Nathan Howard, NAIPFA's counsel, said he continues to believe that G-37 would withstand legal scrutiny despite the possibility that it would be difficult to find evidence of systemic quid pro quo because dealer gifts to candidates have been restricted for 20 years now.
But Hardy Callcott, a partner at Sidley Austin in San Francisco, said that Citizens United and other decisions, since G-37 was tested in the Blount case, indicate a legal climate more inclined to be protective of First Amendment rights. Callcott said that another challenge to G-37 would likely be initially bound by the 1995 Blount decision, but could be more successful on appeal.
"I think it is possible that on appeal, the DC Circuit could reconsider Blount or the Supreme Court could reach a different result," he said. "I don't think it's a slam dunk for the SEC at all."
Callcott said that while it might not be easy for the MSRB to find evidence of broker dealer quid pro quo because of how long G-37 has been in place, it might be able to do so in the muni advisor realm where the rule is not yet effective. Callcott added that the SEC does appear to be sensitive to these Constitutional concerns, and that these questions could color the MSRB's approach to incorporating MAs into G-37. The board is expected to propose those amendments soon, possibly before the end of August.
Ernesto Lanza, a partner at Greenberg Traurig in Washington and a former MSRB deputy director and general counsel, admitted that the legal atmosphere has changed since 1995 but cautioned that the success of the plaintiffs challenging the SEC now may not have any direct bearing on G-37. There are notable differences in the rules, such as the fact that the SEC rule allows a $150 de minimis contribution to candidates for which the investment advisor cannot vote, whereas broker-dealers can't give anything under G-37. Though there are parallels between the two rules, a finding for the plaintiffs would not necessarily make G-37 any more or less vulnerable, Lanza said.
Dealer groups declined to comment on the lawsuit or its implications for G-37, except that the Bond Dealers of America did reiterate its support for extending the rule to cover MAs.
