Municipal securities dealers and municipal finance professionals should review recent interpretive guidance issued by the Municipal Securities Rulemaking Board (“MSRB”) relating to factors it considers concerning whether a political action committee (“PAC”) formed by or otherwise maintaining a relationship with an affiliate of a broker, dealer or municipal securities dealer (collectively “dealers”) is viewed as a “dealer-controlled” PAC for purposes of Rule G-37.
“Pay-to-Play” continues to be a primary focus of regulators. As noted in our July 22, 2010 Alert, the SEC recently announced new pay-to-play rules for investment advisers, which addressed Pay-to-Play practices by investment advisers and their affiliates.1 On August 25, 2010, the MSRB issued Guidance On Dealer-Affiliated Political Action Committees (the “Guidance”).2
Introduction
Rule G-37 prohibits dealers from engaging in municipal securities business with an issuer within two years after certain contributions to an official of the issuer are made by the dealer, any municipal finance professional (“MFP”) associated with the dealer, or any PACs controlled by the dealer or a MFP.3 The genesis of the Guidance appears to be the mergers in the securities industry as a result of the financial crisis. The Guidance notes that these affiliated entities have formed or maintained relationships with PACs which make contributions to issuer officials. According to the Guidance, it is these relationships that raise questions as to a) the extent the affiliated PACs may be controlled by dealers or their MFPs so that they should be considered dealer-controlled PACs for G-37 purposes; and b) the extent contributions of such affiliated PACs, even if not dealer-controlled PACs, may be used to circumvent Rule G-37 as indirect contributions for the purpose of obtaining or retaining municipal securities business.4
The Guidance illustrates factors that may result in an affiliated PAC being viewed as “controlled” by the dealer or an MFP resulting in the PAC being deemed “dealer-controlled” for purposes of Rule G-37. The Guidance provides only basic principles for making a determination of control and is not intended to be an exhaustive list of circumstances under which a PAC may be viewed as controlled.5 This statement is particularly true relating to the indicators of control that determine whether a PAC remains “dealer-controlled” for purposes of Rule G-37.
The Guidance provides that the specific facts and circumstances regarding the creation, management, operation and control of a PAC must be considered in making any determination of control with respect to the PACs.6 However, in reviewing the Guidance it is difficult to imagine the MSRB would view as permissible any scenario where a dealer or an MFP who previously created, managed, operated or controlled a PAC could claim that the PAC was no longer dealer-controlled, absent the dealer or MFP becoming “wholly disassociated” from the PAC.7 As discussed below, the Guidance increases restrictions on how dealers and MFPs can interact with affiliate PACs.
Creation of PAC
The Guidance first addresses a dealer’s or MFP’s role in the creation of a PAC in assessing whether a particular PAC is dealer-controlled. Not surprisingly, the Guidance states that if the dealer or any MFP creates the PAC, then it is viewed as a dealer-controlled PAC; simple enough. The Guidance further states that that the PAC will continue to be treated as a dealer-controlled PAC “unless and until such dealer or MFP becomes ‘wholly disassociated’ in any direct or indirect manner with the PAC.”8 The Guidance provides that any PAC created by a dealer, acting either by itself or together with other entities or individuals, is presumed to be dealer-controlled. Indeed, this presumption continues at least as long as the dealer or any MFP “retains any formal or informal role in connection with such PAC, regardless of whether such dealer or MFP has the ability to direct or cause the direction of the management or policies of the PAC.”9 The Guidance states that in effect a dealer cannot create a PAC and spin it off to an affiliate. However, the scenarios that dealers and MFPs of dealers face with affiliated PACs are much more complex. The Guidance does not provide dealers and MFPs with sufficient guidance to determine for example what, if any, informal role can exist between the dealer or MFP and the affiliated PAC without triggering G-37 obligations.
Without further clarity on this aspect of the Guidance, dealers and MFPs will continue to struggle in assessing whether any informal role is permissible without concluding that the PAC is actually dealer-controlled. Dealers also will find it challenging to develop written supervisory procedures and supervisory systems designed to address whether an affiliated PAC is deemed dealer-controlled, with Rule G-37 implications for the dealer or the MFP.
The Guidance provides similar presumptions when a PAC is created by any person who later becomes an MFP. In that case, the PAC is presumed to be dealer-controlled for as long as the person retains any formal or informal role in connection with the PAC, regardless of whether the person has the ability to direct or cause the direction of the management or policies of the PAC.10 The Guidance states that this presumption continues as long as the person associated with the dealer has the ability to direct or cause the direction of the management or policies of the PAC. Specifically, the Guidance states that “if the person creating the PAC, or any other associated person with the ability to direct or cause the direction of the management or policies of such PAC, is or later becomes an MFP, such PAC would be deemed an MFP-controlled PAC.”11
Management, Funding and Control of PAC
The Guidance also cites that another important factor beyond creating and maintaining an association with a PAC includes the dealer’s or MFP’s ability to direct or cause the direction of the management or policies of a PAC.12 To this end, the Guidance clarifies that, even where the dealer or MFP has the ability to, alone or in conjunction with other entities or individuals, direct or cause the direction of the management or the policies of the PAC, the PAC will be presumptively deemed a “dealer-controlled” PAC. As a result, a PAC can be viewed as controlled by multiple dealers if the control of the PAC is shared among dealers.13
The level of funding by the dealer, its MFPs or other persons also may be considerations in determining whether a PAC is presumptively dealer-controlled. The Guidance makes clear that even in the absence of other indicia of control, a PAC which receives a majority of its funding from a single dealer or MFP is “conclusively presumed” to be controlled by that dealer or MFP.14 Although the Guidance points to the size or frequency of contributions made by other contributors not affiliated in any way with the dealer as another factor to be considered, there is no bright line test. The Guidance suggests that only where a small number of voluntary contributions made by a limited number of employees of the dealer would the MSRB not automatically consider this to raise the presumption of “dealer-control.”15 Even in that context, the automatic presumption would not be overcome unless “the collective contributions by the dealer or its employees is not significant as compared to the total funding of the affiliated PAC, subject to consideration of the other relevant facts and circumstances.”16 Although this example provides some insight, there is no bright line test that dealers or MFPs can apply.17
Dealers and MFPs are cautioned that dealer or MFP control may be presumed in instances where the dealer or its MFPs leverage the contribution activities of affiliated PACs in soliciting municipal securities business. Depending upon the circumstances, references to contributions made by an affiliated PAC during solicitations of municipal securities business could serve as evidence of control so that the PAC could be viewed as dealer-controlled. Indeed, the Guidance states that “[s]uch control could be found even in circumstances where the dealer or its MFPs have not made contributions to the affiliated PAC.”18 As a result, dealers should have adequate written procedures and policies to prevent references to contributions made by an affiliated PAC during solicitations of municipal securities business.
Rebutting the Presumptions
Although the Guidance provides a number of examples of “presumptive” control of a PAC by a dealer or MFP, it also suggests that certain considerations may assist a dealer or MFP in rebutting the presumptions. These considerations include whether the dealer or person creating the PAC:
Again, it appears MSRB intends to substantially limit any role by the dealer or MFP in the affiliated PAC and it is only in very limited and discrete instances that a dealer or MFP can rebut the presumptions to demonstrate that the PAC is not dealer-controlled.
Indirect Contributions
In the past, MSRB also has issued interpretive guidance relating to indirect contributions, and this Guidance reaffirms prior guidance on that topic.19 Even in instances where an affiliated PAC is determined not to be dealer-controlled, dealers must assess whether payments made by the dealer or its MFPs to an affiliated PAC could be viewed as an indirect contribution subject to Rule G-37.20 Rule G-37(d) provides that no broker, dealer or municipal securities dealer or any municipal finance professional shall, directly or indirectly, through or by any other person or means, do any act which would result in a violation of sections (b) or (c) of the rule. Section (b) relates to the ban on business and Section (c) relates to the prohibition on soliciting and coordinating contributions.21
Prior MSRB guidance on indirect contributions provides that contributions to a non-dealer-associated PAC that is soliciting funds to support a limited number of issuer officials might result in a prohibition on municipal securities business.22 The MSRB also informed dealers that they should make inquiries of a non-dealer-associated PAC that is soliciting contributions to ensure that contributions to the PAC would not be treated as an indirect contribution.23
Past MSRB guidance has addressed supervisory procedures that dealers should have in place in connection with payments to a non-dealer-associated PAC or a political party to avoid indirect violations of Rule G-37(d).24 That prior guidance states that each dealer must adopt, maintain and enforce written supervisory procedures designed to monitor whether either the dealer or its MFPs are using payments to political parties or non-dealer-controlled PACs to contribute indirectly to an issuer official.25 To provide further guidance, the MSRB informed dealers that they might establish procedures requiring that, prior to any contribution to a PAC, the dealer make due diligence inquiries regarding the intended use of contribution, the motive for the contribution and whether it was solicited.26 They also suggested that dealers could establish certain information barriers between any affiliated PACs and the dealer and its MFPs.27 In instances where dealers have established information barriers, the guidance stated that the dealers should review their information barriers to ensure that the affiliated entities’ contributions, payments or PAC disbursements are neither influenced by the dealer or its MFPs, nor communicated to the dealers and the MFPs. As an alternative, the dealer can establish written supervisory procedures that prohibit the dealer or MFP from providing information to issuer personnel regarding affiliated PAC contributions.
Although this Guidance serves as an important reminder of the dealer’s requirements to address indirect contributions made by the dealer, its MFPs and others, it does little to offer additional ways a dealer can monitor compliance with Rule G-37(d). Indeed, given the apparent concern at the outset of this Guidance that the MSRB remains concerned that individuals and firms subject to Rule G-37 may seek ways around the rule, a reaffirmation of prior Guidance provides little insight on what steps dealers can take to avoid violations of Rule G-37.
Conclusion
The ever-increasing scrutiny by regulators of political contributions and activities by dealers, MFPs and other persons involved in the municipal securities business serves as a stark reminder that firms must remain vigilant in enforcing their policies and procedures in this area. Indeed, this Guidance, as well as prior guidance issued by the MSRB strongly suggests that there are only very limited exceptions to when a presumption of a dealer’s, MFP’s or other person’s control will be presumed. As such, in light of this Guidance, dealers should revisit their written supervisory policies and procedures to address the issue of control in the context of dealer-controlled PACs, affiliated PACs and indirect contributions.
Please direct questions to any of the listed lawyers or to any other Bingham lawyer with whom you ordinarily work on related matters:
Amy Kroll, Partner, Broker-Dealer Group
amy.kroll@bingham.com, 202.373.6118
David Boch, Partner, Broker-Dealer Group
david.boch@bingham.com, 617.951.8485
Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area
roger.joseph@bingham.com, 617.951.8247
Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area
edwin.smith@bingham.com, 617.951.8615
Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area
timothy.burke@bingham.com, 617.951.8620
1See SEC Unanimously Passes “Pay-to-Play” Rule for Investment Advisors, Bingham.com (July 22, 2010).
2See MSRB Notice 2010-30 (August 25, 2010) (the “Notice”). In addition to publishing the Guidance, the MSRB seeks comment on whether to require dealers to disclose the names of affiliated PACs to the MSRB for public scrutiny. The MSRB has requested that the Proposed Interpretive Guidance become effective 60 days after approval by the SEC and comments on it should be directed to the SEC. Comments on the Notice should be directed to the MSRB and are due on October 29, 2010.
3MSRB Rule G-37.
4Guidance, p 1.
5Guidance, p. 2.
6Id.
7Id.
8Id.
9Id.
10Id.
11Guidance, p. 2. The Guidance states that “[h]owever, a PAC created by an individual acting in his or her formal capacity as an officer, employee, director or other representative of a dealer, regardless of whether such individual is an MFP, would be deemed a dealer-controlled PAC rather than a PAC controlled by the individual.” See Guidance, fn 7.
12Guidance, p. 2.
13Guidance, pp. 2-3.
14Guidance, p. 3.
15Id.
16Id.
17Id.
18Id. See also Guidance, fn. 9 citing Rule G-37 Question & Answer No. III.7 (September 22, 2005) for a discussion of indirect contributions through affiliated PACs.
19Rule G-37 Question & Answer No. III.4 and 5 (August 6, 1996), Rule G-37 Question & Answer No. III.7 (September 22, 2005), and Rule G-37 Interpretive Letter — Supervisory procedures relating to indirect contributions conference accounts and 527 organizations (December 21, 2006).
20Guidance, p. 3.
21Guidance, fn 3.
22Guidance, p. 3, citing fn 10 (Rule G-37 Question & Answer No. III.4 (August 6, 1996).
23Guidance, p. 3, citing fn 11 (Rule G-37 Question & Answer No. III.5 (August 6, 1996).
24Guidance, p. 4, fn 12 citing Rule G-27 (c).
25Guidance, p. 4, fn 13 citing Rule G-37 Question & Answer No. III.7 (September 22, 2005).
26Guidance, p. 4.
27Guidance, p. 4, fn 14.
This article was originally published by Bingham McCutchen LLP.