Securities Regulation Daily Free speech and broker-dealer regulations are at odds in petition asking justices to remove political spending curbs
Tuesday, September 17, 2019

Free speech and broker-dealer regulations are at odds in petition asking justices to remove political spending curbs

By Mark S. Nelson, J.D.

The New York Republican State Committee wants the justices to hold that an SEC-approved FINRA rule banning certain political donations by placement agents violates the First Amendment.

The New York Republican State Committee filed a petition for certiorari asking the Supreme Court to overturn a decision by the D.C. Circuit upholding the Financial Industry Regulatory Authority, Inc.’s pay-to-play rule, which bans most political contributions by FINRA members known as placement agents who aid investment advisers to obtain business advising governmental entities. The New York Republican State Committee asserted that FINRA’s rule violates the First Amendment and/or otherwise conflicts with Supreme Court precedent, that the SEC lacked authority to approve FINRA’s rule, and that the rule itself is arbitrary and capricious. A majority on a D.C. Circuit panel upheld the rule, although one judge dissented regarding the issue of standing (New York Republican State Committee v. SEC, September 16, 2019).

FINRA Rule 2030 provides, for example, that certain broker-dealers cannot engage in distribution or solicitation activities for compensation with a government entity on behalf of an investment adviser that advises the government entity within a two-year period after making a contribution to an official of the government entity. The rule, however, contains a de minimis exception as well as exceptions for new "covered associates" and returned contributions. FINRA is authorized to grant exemptions to the rule if certain criteria are met. For purposes of the rule, "covered member" means any FINRA member other than when such member acts as a municipal adviser. "Contribution" means any gift or other item of value made for the purpose of influencing an election, payment of a debt incurred in connection with an election, or transition or inaugural expenses of a successful candidate.

First Amendment. The New York Republican State Committee argued that Rule 2030 violates the First Amendment because it runs counter to Supreme Court precedent, which it said has not permitted similar campaign finance limits to be imposed on state campaigns via federal regulation. Moreover, the organization asserted that Rule 2030 disproportionately impacts non-incumbent candidates and, in particular, Republican candidates. As an example, the organization cited the 2016 presidential election in which it said the Clinton-Kaine campaign was not limited by Rule 2030 but the Trump-Pence campaign was limited by the rule because of now-Vice President Mike Pence’s prior service as governor of Indiana.

Moreover, New York Republican State Committee argued that the D.C. Circuit shortchanged the analysis under the Supreme Court’s McCutcheon decision, which posits that quid-pro-quo corruption is the only basis for campaign finance limits. The organization also said the SEC failed to justify its rule, despite the D.C. Circuit’s having credited the SEC’s evidence. Said the organization (citations omitted):

  • The SEC, therefore, attempts to squeeze the Rule into the Supreme Court’s case law by portraying it as an effort to combat quid pro quo contributions to officials by covered members and their associates when those same members and associates act as placement agents for investment advisers seeking to obtain business from the very government entities to which the covered members and associates contributed. Such argument is doomed by its sheer implausibility where disclosed contributions within the limits established by FECA [Federal Election Campaign Act] and state laws are concerned.

With respect to the First Amendment, the D.C. Circuit majority had rejected the New York Republican State Committee’s argument for application of strict scrutiny and instead applied the "closely drawn" standard, which states that a regulation is valid if it is closely drawn to serve a sufficiently important government interest. The majority noted that the Supreme Court has stated that the prevention of corruption or of its appearance is the sole valid reason to impose political spending limits. The majority also noted that in Blount it had upheld an SEC-approved rule with similar scope and temporal curbs as Rule 2030.

Absence of SEC authority? The D.C. Circuit majority also concluded that the SEC did have Exchange Act authority to regulate against market distortions that can arise from pay-to-play activities, including regarding the public pensions at issue in the New York case. The majority grounded its decision on that court’s prior decision in Blount regarding municipal securities and otherwise distinguished the several cases cited by the New York Republican State Committee, including Galliano, which the majority said had been undermined by the Supreme Court’s decision in Pom Wonderful (the D.C. Circuit majority explained that in Pom Wonderful it was found that Food, Drug, and Cosmetic Act label rules did not bar Lanham Act claims because neither law limited the other and the laws had co-existed for 70 years). The majority concluded that the SEC had sufficiently shown instances of quid-pro-quo corruption and the tendency for an appearance of corruption regarding placement agents’ role in awarding adviser contracts.

In its petition, the New York Republican State Committee argued that Congress has reserved for itself the authority to regulate elections. The organization cites the comprehensive scope of FECA and the lack of explicit authority to regulate campaigns in the Exchange Act. According to the New York Republican State Committee, Congress has deftly shown what it seeks to regulate when it wants to do so, and the SEC should not be permitted to intrude on the campaign finance balance Congress struck in FECA by invoking its more generalized investor protection authorities.

SEC rule claimed to be arbitrary and capricious. According to the New York Republican State Committee, Rule 2030 is arbitrary and capricious because the SEC has failed to show how its rule is supported by its authority regarding "fraudulent and manipulative practices."

In the decision below, the D.C. Circuit majority concluded that the rule was not arbitrary and capricious because the SEC had responded to at least some instances of lawful contributions under FECA that nevertheless could influence government contracts to advisers. The majority further rejected the New York Republican State Committee’s assertion that the SEC had to show "rampant" quid-pro-quo corruption and again leaned heavily on its prior decision in Blount, where the majority said there was no showing of quid-pro-quo corruption.

Standing. Although standing is a threshold issue, it is addressed last here in order to emphasize the First Amendment and other bases for the New York Republican State Committee’s challenge of Rule 2030. Standing also was an issue the New York Republican State Committee won in the lower appeals court, although the D.C. Circuit opinion produced a dissent on the issue. Specifically, Judge Sentelle argued that the petition for review should have been dismissed for want of jurisdiction because the facts alleged to show injury-in-fact were too speculative or otherwise involved merely potential future injuries or were premised on the volitional acts of third parties. The dissent cited the example of one affiant who said he would, but for the rule, get donations from his contacts. The majority opinion countered that the New York Republican State Committee’s "reduced ability to raise funds" was a sufficient injury to confer standing and that the precedents cited by the dissent can be understood to mean that standing does not require "certainty."

Still, the New York Republican State Committee asserted before the Supreme Court that it has direct standing to challenge Rule 2030 because its members cannot receive political contributions under Rule 2030 in excess of the de minimis amount and the expenses it incurs to educate its members about election laws are dramatically increased because of the rule. The New York Republican State Committee also asserted associational standing on behalf of its candidates, whom it said are "covered officials" at a disadvantage versus Congressional incumbents who can receive more than the de minimis exception amount. The organization further asserted associational standing on behalf of contributors, whom it said would donate more than $350 if allowed. For both modes of associational standing, the organization cited at least one individual who would have donated more than the permitted de minimis amount.

The case is No. 19-343.

Attorneys: Jason Torchinsky (Holtzman Vogel Josefiak Torchinsky PLLC).

Companies: New York Republican State Committee; Financial Industry Regulatory Authority, Inc.

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