Category: Government Contracting

Another Pay-to-Play Case

There are few among us who think the high cost of getting elected and fundraising that it requires is good for American politics. The SEC took a moral high ground and passed Rule 206(4)-5. That rule effectively prohibits investment managers from making political contributions to politicians who control pension money, other than small token amounts. The SEC brought another pay-to-play case last week for egregious behavior. State Street was charged with funneling campaign contributions to a state treasury official.

Politician: Holding Out a Stack of Money

When I first saw this case I thought it would be a Rule 206(4)-5 case since State Street is a big money manager. In this circumstance, the relationship was a custodial relationship and outside the Advisers Act.

The deputy treasurer of a state pension fund arranged for illicit political contributions and improper payoffs through a fundraiser/lobbyist for State Street.

According to the SEC’s complaint against the fundraiser/lobbyist, Robert Crowe, he met the state official’s demand for campaign contributions by illegally filtering cash through his personal bank account and reimbursing individuals for contributions made in their own names. Crowe made additional illicit campaign contributions in response to the official’s threats that State Street would lose the business.

The State Street employee who headed it’s public funds group was also charged for participating in the pay-to-play scheme. According to the complaint against Vincent DeBaggis, he arranged for payments through a strawman as lobbying services, knowing that a large portion of that fee would be going to the state official. The lobbying agreement called for a success fee if the state pension funds became clients of State Street. DeBaggis’ conduct was in violation of State Street’s Standard of Conduct.

“Pension fund contracts cannot be obtained on the basis of illicit political contributions and improper payoffs,” said Andrew J. Ceresney, Director of the SEC’s Enforcement Division. “DeBaggis corruptly influenced the steering of pension fund custody contracts to State Street through bribes and campaign donations.”

The state official, Amer Ahmad, has already been convicted of misconduct and is currently in federal prison.

This case was more egregious than the first case the SEC brought against a Philadelphia firm for making a $2000 contribution, with no showing that it was designed to buy influence.

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Pay to Play Rule In Effect on July 31

The Securities and Exchange Commission announced the compliance date for the ban on third-party solicitation pursuant to the Pay-to-Play rule: July 31, 2015. Rule 206(4)-5 prohibits an investment adviser from providing compensated services to a government entity, following a political contribution to certain officials of that entity.

pay to play.

Rule 206(4)-5 became effective on September 13, 2010 and the compliance date for the third-party solicitor ban was set to September 13, 2011.

The third-party solicitation ban, prohibits an investment adviser from paying a third-party to solicit advisory business from any government entity, on behalf of the adviser, unless the third party is a regulated entity:

  • Registered Investment Adviser;
  • Registered Broker-Dealer; or
  • Certain Registered Municipal Advisers.

When the Commission added municipal advisors to the definition of regulated person, the Commission also extended the third-party solicitor ban’s compliance date to June 13, 2012. However, at the time the final municipal advisor registration rule was not in effect. So, the SEC extended the third-party solicitor ban’s compliance date from June 13, 2012 to nine months after the compliance date of the final rule. That date is now set at July 31, 2015.

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$250 Could Cost a Firm $6.1 Million

compliance politics and money

A T. Rowe Price vice president made a $250 contribution to the campaign of Scott Walker for governor of Wisconsin in a recall election. That small donation could have cost T. Rowe Price $6.1 million in fees. The SEC’s Rule 206(4)-5 once again shows it scary side to advisers. Fortunately, the Securities and Exchange Commission granted some relief.

T. Rowe Price Associates, Inc. and T. Rowe Price International Ltd, affiliated SEC registered advisers, have over $60 billion in assets under management. Amidst that, T. Rowe Price manages some money for the Wisconsin state public pension plan.

Governor Walker appoint some of the members to the board of trustees. That makes the Wisconsin Governor an “Official” under Rule 206(4)-5.

Unfortunately, the vice president failed to pre-clear the February 2012 contribution with his compliance group and sent in the donation. He does not live in Wisconsin and is not entitled to vote for that Official’s office. So his donation is limited to $150 under Rule 206(4)-5.

T. Rowe Price discovered the errant contribution in March 2014 while developing a testing program that includes searches of public websites for contributions made by employees.

The SEC ruling is a good result for the firm, but shows how out of proportion the SEC rule is for potential harm.

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Lawsuit Against SEC’s Political Contribution Rule

USDC for DC Meade_and_Prettyman_Courthouse

The New York Republican State Committee and the Tennessee Republican Party brought suit against the Securities and Exchange Commission challenging its political contributions rule for investment advisers, . The complaint seeks an injunction against the enforcement of the rule’s political contribution restrictions on contributions to federal candidates.

The first attack on the rule is that Federal Election Campaign Act gave the Federal Election Commission exclusive jurisdiction over federal campaigns. I don’t know enough about that law to opine on that argument.

The second attack is that the rule exceeds the SEC’s statutory authority. They look to the release for Rule 206(4)-5 and the SEC’s own statement that the rule may prohibit acts that are not themselves fraudulent. The problem is that the SEC is confusing payments to state officials as a quid pro quo for business with legal campaign contributions.

As for expertise, the parties point out that the SEC has no specialized knowledge of campaign finance or elections.

The third attack is that the rule violates the First Amendment to the US Constitution. One focal point of the argument is that the rule distorts the ability to give to candidates running for the same office. I pointed this out in the 2012 Republican presidential primaries. Contributions were limited to Rick Perry, but none of the other candidates.

Although some of the arguments could be used to take down the entire rule, the parties are only seeking to exclude it from application to federal candidates. In my view that would be an improvement. It would make it a much clearer rule. The only published relief under the rule was when the Ohio State Treasurer was running for US Senate. The employee thought the rule did not apply to federal candidates.

I don’t like the political contributions rule. It takes innocent, legal behavior, with no fraudulent intent, and turns it into a regulatory violation. Campaign finance is a problem, but the SEC rule does little to help the problem.

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Meade and Prettyman Courthouse by AgnosticPreachersKid
CC BY-SA 3.0

SEC Charges Private Equity Firm With Pay-to-Play Violations

compliance politics and money

The SEC has brought its first case under the pay-to-play rule for registered investment advisers. It’s just as horrible as I thought it would be.

The Securities and Exchange Commission enacted Rule 206(4)-5 to address pay-to-play abuses involving campaign contributions made by registered investment advisers and their key employees. The concern was contributions to government officials who are in a position to influence the selection of advisers to manage government client assets, including public pension assets. The SEC perceived that there is a culture of making contributions in exchange for investment.

TL Ventures sponsored private equity funds. The Pennsylvania State Employees’ Retirement System is an investor in two funds. The City of Philadelphia Board of Pensions and Retirement is an investor in one fund. The commitments were made in 1999 and 2000. As a limited partner in the fund, neither government pension fund had the right to withdraw its contribution or to make a bigger contribution.

In 2011, a covered associate of TL Ventures made a $2500 campaign contribution to the Mayor of Philadelphia. The Mayor appoints three of the nine members of the City of Philadelphia Board of Pensions and Retirement. Therefore the Mayor has indirect influence over the investment decisions and contributions are subject to Rule 206(4)-5.

In 2011, a covered associate of TL Ventures made a $2000 contribution to the Governor of Pennsylvania. The Governor appoints six of the eleven members of the board of the Pennsylvania State Employees’ Retirement System. Therefore the Governor has indirect influence over the investment decisions and contributions are subject to Rule 206(4)-5.

In this case, the dollar amounts are not huge. In the current race for Governor, Ed Rendell and Bob Casey have together spent $31.5 million. The violation in this case was $2500. I assume the Covered Associate lived in Pennsylvania. Therefore the cap under Rule 206(4)-5 was $350.

The contributions were made more than 10 years after the investment decision was made. There is no statement of malice or bad intent by TL Ventures. But Rule 206(4)-5 does not require a showing of quid pro quo or actual intent to influence an elected official or candidate. You make a contribution; you violate the rule.

The SEC action also includes a charge of failing to register with the SEC. TL Ventures tried to structure its business to avoid registration. TL Ventures managed venture capital funds and therefore was able to be an exempt reporting adviser. Its affiliate, Penn Mezzanine, had less than $150 million under management and therefore would be subject to state registration, not SEC registration. The SEC has stated that it will treat two or more affiliated advisers that are separate legal entities but are operationally integrated as a single adviser. The SEC found that the operations of the two were integrated. Therefore, the firm should have registered with the SEC.

The firm ended up paying a disgorgement of $256,697. I assume that translates to the two years worth of fees that TL Ventures collected from the government pension funds.

The amounts are relatively small. The firm was not currently soliciting the government pension funds for business. There is no finding of malice or egregious behavior.

Good luck going to sleep tonight.

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California’s Public Disclosure of Private Fund Investments

top secret

One of the challenges with having a government pension plan investor is the potential disclosure obligations under the states’ sunshine laws. A similar problem exists with Securities and Exchange Commission. The SEC is subject to the Freedom of Information Act and exam information is potentially subject to some level of disclosure.

But the state level equivalents of FOIA are worded a bit differently. You also have the situation where the state’s pension fund is an investor. So the performance of an investment is somewhat relevant to the public, since public tax dollars are at work.

A recent ruling came out of California. That case involves the efforts by a news publication to obtain individual private fund information for investments made by the Regents of the University of California. Reuters made the request under the California Public Records Act, Gov. Code, § 6250 et seq. The Regents refused to provide the information. Reuters sued.

The Superior Court ruled in favor of Reuters and found that the Regents were required to use “objectively reasonable efforts” to obtain individual fund information for the Regents’ current investments even though the Regents had not prepared, owned, used, or retained this fund information.

The First District Court of Appeal reversed in Regents of the University of California v Superior Court, (Cal. App. 1st Dist. Dec. 19, 2013).  The Court held that

unless a writing is related “to the conduct of the public’s business” and is “prepared, owned, used, or retained by” a public entity, it is not a public record under the Public Records Act, and its disclosure would not be governed by the Act.

Clearly, the private fund information is related to the public’s business because tax dollars are being invested.

The decision made in Coalition of University Employees v. The Regents of the University of California (Super. Ct. Alameda County, 2003, No. RG03-089302) (the CUE Case) made it clear that private fund reporting on investments by the Regents is subject to California’s Public Records Act. That case involved a request for the internal rate of return for 94 separate private fund investments.

As a result, some of the fund managers stopped reporting to the Regents.

Subsequently, the Public Records Act was amended and California Government Code Section 6254.26 carves out specific pieces of information about private funds. Although the fund documents, meeting materials and financial statements are not part of the public record, fund return information is still within the bounds of disclosure.

Some of the Regents’ fund managers provided minimal information because they did not want it disclosed to the public. In the discussion, the Court makes it clear that it is not ruling on whether it is proper for private fund managers to withhold the information or whether the Regents should continue to do business with private fund managers who withhold information because of the sunshine law.

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New York City “Pay-to-Play” Law is Upheld

The U.S. Court of Appeals for the Second Circuit upheld a New York City “pay-to-play” law against various constitutional challenges: Ognibene v. Parkes. The Pay to play law is in Local Law 34 and it:

  1. Lowers the caps applicable to campaign contributions from parties that have “business dealings” with New York City
    • to $400 (otherwise $4,950 applies to contributors not within the purview of the Law) for candidates for city-wide offices,
    • to $320 (otherwise $3,850) for candidates for borough offices, and
    • to $250 (otherwise $2,750) for candidates for city council,
  2. Prohibits public matching for contributions from the Affected Persons, and
  3. extends a ban on contributions from corporations to apply to partnerships, LLCs, and LLPs.

“Business dealings” include, among other things, “contracts for investment of pension funds” and transactions with “lobbyists”.

The plaintiffs in Ognibeneh include Republican Party members, the New York State Conservative Party, lobbyists, and other business interests. They challenged the Law as a violation of the First Amendment, the Fourteenth Amendment, and the Voting Rights Act. They lost in the district court and made this appeal. In affirming the district court’s decision, the Second Circuit considered whether the aforementioned provisions of the Law were “closely drawn to address a sufficiently important state interest” and found that each was sufficiently closely-drawn.

The Second Circuit agreed with the district court that the “doing business” contribution limits are “closely drawn” because combating corruption and the public perception of corruption is a sufficiently important justification for placing limits on donations to a candidate. The court draws a distinction from restrictions on independent corporate campaign expenditures which were struck down in Citizens United as overly burdensome limitations on speech.

The court was not persuaded that actual “evidence of recent scandals” was needed to justify the contribution limits. “[T]o require evidence of actual scandals for contribution limits would conflate the interest in preventing actual corruption with the separate interest in preventing apparent corruption.” Finding “no doubt that the threat of corruption or its appearance is heightened when contributors have business dealings with the City” and citing studies by the City Council on the issue, the court held that it is “reasonable and appropriate” to place additional limitations on contributions by Affected Persons.

The court drew another distinguish between the Green Party case in Connecticut and this law. The Connecticut law challenged in Green Party put in place a total ban on contributions, as opposed to mere limits.  However, “if the appearance of corruption is particularly strong due to recent scandals, therefore, a ban may be appropriate.”

Of course, pay-to-play laws are not unique to New York City. The SEC’s Rule 206(4)-5 enacted a similar limit on campaign contributions. Anyone challenging the SEC rule would have to look at this case and realize the SEC rule would like stand up to court scrutiny.

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Image is New York City celebrating the surrender of Japan. They threw anything and kissed anybody in Times Square., 08/14/1945 from the US National Archives

PCAOB is Fixed – May Take Other Agencies Down (or get Fixed)

In the Free Enterprise vs. PCAOB decision, the Supreme Court found that a double layer of limitation of firing for cause is unconstitutional. You can’t have an agency where the officers are only removable for cause under another federal agency whose members are only removable for cause. One level of protected tenure is acceptable, but two is not.

In his dissent, Justice Breyer argued that PCAOB is not the only agency that had two level of protected tenure. He goes on to name names. He identifies four other appointments that have more than one level of protection.

Federal Labor Relations Authority: Foreign Service Labor Relations Board
“The Chairperson [of the FLRA, who also chairs the Board] may remove any other Board member . . . for corruption, neglect of duty, malfeasance, or demonstrated incapacity to perform his or her functions . . . .” 22 U. S. C. §4106(e)

General Services Administration: Civilian Board of Contract Appeals
“Members of the Civilian Board shall be subject to removal in the same manner as administrative law judges, [i.e., ‘only for good cause established and determined by the Merit Systems Protection Board.’] ” 41 U. S. C. §438(b)(2)

Postal Service: Inspector General
“The Inspector General may at any time be removed upon the written concurrence of at least 7 Governors, but only for cause.” 39 U. S. C. §202(e)(3)

Social Security Administration: Office of the Chief Actuary
“The Chief Actuary may be removed only for cause.” 42 U. S. C. §902(c)(1)

I think Justice Breyer just removed tenure from these positions.  In reading the PCAOB decision, I don’t think these positions are unconstitutional. Merely, they have lost their tenure and can now be removed at-will by the independent boards that appoint them.

School Official Disciplined for Misuse of LexisNexis

The Massachusetts State Ethics Commission fined Mark Rivera, the former Lawrence School Department Urban Affairs Liaison and Special Assistant to the School Superintendent, for misuse of his access rights to LexisNexis.

The Lawrence School Department purchased access to the LexisNexis database so Rivera could obtain contact information for parents no longer living in the district, and contact parents and students regarding attendance issues. However, Rivera misused his School Department access to conduct “hundreds of searches of non-public information on individuals, including state and local elected officials, professional athletes and Hollywood celebrities….”

Massachusetts General Law chapter 268a §23(b)(2) prohibits a public official from using their official position to “to secure for himself or others unwarranted privileges or exemptions which are of substantial value and which are not properly available to similarly situated individuals.”

Rivera used his official position to gain access to the database for private purposes.

Running database checks on Lawrence police Chief John Romero, David Ortiz, Johnny Damon, Michael Chiklis and Hugh Laurie cost Rivera $5,000.

This is not the only trouble for Rivera. He was also indicted on seven counts of larceny and was forced to resign in April. His boss, suspended Lawrence Superintendent Wilfredo Laboy, was recently indicted for fraud, embezzlement and possession of alcohol on school premises.

The Lawrence Public Schools system is among the poorest districts in Massachusetts. Almost 83 percent of its student body is classified as economically disadvantage.

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FINRA and Placement Agents

Will FINRA step in to prevent a ban on placement agents working with government investors?

You may remember that last August, the SEC published a proposed rule that would create a prohibition on paying a third party, such as a placement agent, to solicit a government client on behalf of the investment adviser: IA-2910. The rule has generated lots of comments. The intent of the proposed rule is to prevent “pay-to-play” scandals. A noble and worthy goal.

The SEC seems to be softening its position on the placement agent ban. In a December 18 letter, the SEC asked FINRA if they would interested in crafting some rules for registered broker-dealers in dealing with government investors. Legitimate placement agents (such as FINRA-registered broker-dealers) “could be subject to separate regulations that might restrict their ability to engage in pay to play activities on behalf of their investment adviser clients.”

It took three months, but FINRA responded to the SEC with a “yes“.

“I am delighted to state that we are in a position to promulgate such a rule. We believe that the FINRA proposal should impose regulatory requirements on member broker-dealer placement agents as rigorous and as expansive as would be imposed by the SEC on investment advisers. We believe that a regulatory scheme targeting improper pay to play practices by broker-dealers acting on behalf of investment advisers is both a viable solution to a ban on certain private placement agents serving a legitimate function.”

It sounds like SEC is getting closer on making a decision about its pay to play rule. Perhaps the FINRA rule will make it easier to deal with.

In the interest of disclosure, my company uses placement agents in its dealings with investors, including government investors.

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