With the 2016 election around the corner, fund managers who wish to engage in the political process must be careful to comply with the federal, state, local, and even fund-specific "pay-to-play" rules that govern their political giving. These laws and regulations impose limits or even outright bans on political contributions by fund managers, their PACs, subsidiaries, directors, officers, and employees involved in soliciting business from government entities.
Pay-to-play laws vary widely, creating a compliance challenge for companies doing business in multiple jurisdictions. Beyond the variation and complexity, pay-to-play laws stand apart from other campaign finance laws because penalties can strike at the bottom line. In addition to civil and criminal penalties, violators can find their bids disqualified and contracts voided. If an adviser or one of its employees – or sometimes even a spouse of an employee – inadvertently runs afoul of these regulations, they face potentially significant penalties, such as a multi-year ban on future business, disgorgement of earned fees, or the voiding of contracts.
Scope of Federal, State, and Local Regulations
In response to scandals involving awards of contracts to companies that were politically active, the Securities and Exchange Commission (SEC) and other financial regulators have issued pay-to-play rules that restrict contributions to state and local candidates and public officials, including federal candidates who are currently state officeholders:
- SEC Pay-to-Play Rule. Rule 206(4)-5, promulgated under the Investment Advisers Act of 1940, limits political involvement by investment advisers that manage money on behalf of public pension funds. Subject to certain exceptions, an adviser may not receive compensation for providing advisory services to a government entity for a two-year period after the adviser or one of its covered associates makes a political contribution to a public official of a government entity who is or will be in a position to influence the award of advisory business.
- Municipal Securities Rulemaking Board (MSRB). Rule G-37 restricts campaign contributions for those who underwrite municipal bonds. Municipal securities dealers are barred from receiving state and local business for two years if the dealer or its affiliated individuals make certain political contributions.
- Financial Industry Regulatory Authority (FINRA). Proposed Rule 2030(a) would affect broker-dealers that engage in certain distribution and solicitation activities on behalf of investment advisers. If approved, the Rule would impose a two-year ban on earning compensation for distribution or solicitation engagements with a government entity on behalf of an investment adviser if a covered employee of the broker-dealer makes a disqualifying contribution.
These rules also prohibit using third-party entities as conduits to circumvent contribution restrictions. Therefore, fund managers should inquire how and where a contribution recipient spends its money, with an eye to whether the recipient supports state or local candidates or parties. For example, national party committees, federal leadership PACs, and outside organizations have wide latitude to contribute to state parties and candidates for office, and may trigger a pay-to-play violation for the fund manager.
In addition to federal regulations, individual states and municipalities have promulgated their own laws, which can overlap with, or differ significantly from, the federal rules. Key aspects of these laws, which can differ by jurisdiction, include:
- Nature of the Law: Some jurisdictions prohibit or limit contributions by contractors, while others impose reporting obligations.
- Contracting Threshold: Some laws affect virtually all contracts; others affect only those that are sole-source or no-bid, or that exceed a certain value.
- Scope: Some jurisdictions limit pay-to-play rules to the entity with the contract, others extend coverage to parent and subsidiary companies, and some extend the rules even further to include directors, executives, employees, and family members.
- Contribution Limits: Each rule has its own contribution thresholds—either for when the law requires disclosure or as a limit on the amount that may be contributed before contracts are prohibited.
- Remedy: In some jurisdictions, violating a pay-to-play law results in a fine or penalty. In others, the remedy is rescission of an ongoing contract or ineligibility for future contracts.
Practical Considerations and Avoiding Pitfalls
In-Kind Contributions. Federal, state, and local pay-to-play rules may be violated by a range of activity that goes well beyond contributing money to a candidate. An "in-kind" contribution made, solicited, or coordinated by a covered fund manager may be deemed a contribution to the official or candidate for public office; violations may result from employees soliciting contributions, hosting a non-fundraiser "meet and greet" for a candidate, or volunteering their time.
Keep Optics in Mind. The fact that a political contribution does not run afoul of pay-to-play rules does not mean that it is advisable. Fund managers should consider how a political contribution appears, particularly its timing. If an elected official is about to vote or has just voted on a matter impacting the company or the private equity fund industry at large, a fund manager should be cautious about making a contribution at that time.
Gift Rules. Fund managers must keep in mind that there are also federal, state, and local regulations involving gifts to elected officials. Fund managers must be extremely cautious about providing gifts to elected officials, including buying meals or paying for travel.
Implement a Compliance Plan. Overlapping and sometimes contradictory pay-to-play regulations present a minefield of potential liability. The implementation of a detailed compliance plan is one of the most important actions an adviser can take to prevent a pay-to-play violation. Employees should be trained on pay-to-play issues, and both political and charitable contributions should be cleared before a check is mailed or a contribution is made. Employees should also seek approval before they agree to solicit contributions or fundraise on behalf of a candidate or political entity.