A final ruling on the constitutionality of the long-standing ban on contributions by federal government contractors met a significant setback last week when the D.C. Circuit remanded the case to the trial court. In an opinion issued on May 31, 2013, about two weeks after oral arguments, a three judge panel of the D.C. Circuit concluded that the case, Wagner v. Federal Election Commission, must be heard en banc by the full panel of judges of the D.C. Circuit. 

The appellate court relied on an older provision of the Federal Election Campaign Act (“FECA”), section 437h, which states that the national committee of any political party, the Federal Election Commission (“FEC”), or any voter in a Presidential election “may” file a claim that a portion of the FECA is unconstitutional in a district court, and the district court “immediately shall” certify the constitutional questions to a circuit court, which must then hear the matter en banc. Last fall, a lower federal court heard the case and upheld the contractor ban, finding that it does not violate the First and Fifth Amendment rights of government contractors and concluding in two sentences that section 437h did not require certification of the constitutional questions. 

Despite arguments from both the FEC and the plaintiffs that the three judge panel could hear the case, the court stated that section 437h is a mandatory procedure for this type of claim, based on its reading of the language, and that an en banc hearing was required. The court cited the legislative history behind the section as support for its reading, including the need to have questions about the constitutionality of FECA provisions resolved quickly by circuit courts to enable these questions to reach the Supreme Court as soon as possible.    

The court’s decision, however, will actually result in considerable delays in Wagner’s path to the Supreme Court, as it imposes a new set of procedural hurdles. The district court must first identify and certify the constitutional questions in the case, thereby sending the case back to the D.C. Circuit. Scheduling and holding additional oral arguments on the merits of the case in front of the en banc D.C. Circuit may take several weeks or even months, and the issuance of an opinion on the constitutionality of the ban could be some time after that. A possible appeal to the Supreme Court, at this point, may not be completed until after the 2014 midterm elections.


Pic1Sitting state office holders often run for federal office. As a recent decision from the FEC reminds us, it is important that resources from the state campaign not be used in the federal campaign, unless the federal campaign pays fair-market-value for those resources. Indeed, this same principle applies when other types of related organizations seek to share funds and other assets, whether that might be a 501(c)(4) and related political organization, a candidate committee and leadership PAC, or other organizations identified with a single cause or individual. Absent arms-length agreements, sharing resources can be result in a “contribution,” subject to applicable limits and source prohibitions, as well as reporting requirements.

Background of the Complaint

Josh Mandel, the Treasurer of Ohio, ran for the U.S. Senate in 2012. A complaint filed against him alleged:

1.) That his Senate campaign took over his state campaign’s website without compensation;

2.) That his state campaign impermissibly paid for travel relate to his Senate campaign; and

3.) That his Senate campaign used a state campaign email list without proper compensation.

The FEC accepted Mandel’s explanations for the first two, but deadlocked as to whether the
Pic2 state campaign properly compensated for the email list (the net result is the same: the case was closed). The FEC also rejected a fourth allegation that the State of Ohio had provided an excessive in-kind contribution to the Senate campaign.

The FEC’s analysis of these issues provides a good roadmap for how a state candidate can avoid giving his or her federal campaign impermissible contributions.

Transferring the Web Site

Mandel’s state campaign used a very logical domain: www.joshmandel.com. His Senate campaign thought it would be a good domain as well. The complaint alleged the transfer from one campaign to another was done without properly compensating the state campaign for the fair market value of the web site.


Pic3Mandel explained that in reality, the Senate Campaign hired a web development company to take over hosting and development for the site and to coordinate an arm’s length deal with the company that had been running the site for the state campaign. Payments to the new vendor were all clearly disclosed as being made by the Senate campaign. The FEC said it had no information to suggest that the transfer was done at less than fair-market-value, and accepted this arrangement.

Compliance Tip: Hiring a new company to handle the arm’s-length transaction is a good idea. If you want to keep the same web company, then you should clearly document the payment from the federal campaign to the state campaign for the web site. This cost should include the domain itself and any IP from the state campaign that the federal campaign will use (such as photos, web applications, code, etc.).

Travel

Mandel made a number of trips outside of Ohio just before announcing his Senate candidacy and paid for the travel with his state campaign funds. The total cost for this travel was about $20,000. The complaint alleged that these trips were related to “testing the waters” activities and needed to be funded from federally-permissible sources (i.e., individual contributions subject to the then-applicable limit of $2,500 per person). The complaint argued that since he made these trips just before announcing his candidacy and received contributions from these states shortly after he announced his candidacy, it was clear that the travel was related to his campaign.

Mandel provided information to the FEC about the purpose of the trips (a National Association of State Treasurers meeting, a pension policy meeting, and a leadership retreat) and argued that they all involved official state business. He paid for them with state campaign funds – rather than official state funds – to avoid any question that they might be considered state political activities, as opposed to official state business. The FEC accepted this explanation, and rejected the complaint’s theory that the timing and future contributions were enough to prove he was testing the waters.

Compliance Tip: Be careful to avoid using state campaign funds to test the waters. This could include travel, polling, focus groups, or other expenses related to forming a federal campaign. Document state campaign purposes for any activities, and do not use the deliverables unless the federal campaign pays fair-market-value for them.

Email Lists

The FEC deadlocked on the issue of the email list that the state campaign provided to the
Pic4 Senate campaign. Mandel argued that he had an arm’s-length agreement that was typical for lists. First, the state campaign would provide the Senate campaign with its list. In exchange, the Senate campaign would provide the state campaign with an updated list in the future, based on names the Senate campaign acquired.

The FEC’s General Counsel accepted this arrangement as consistent with prior advisory opinions dealing with traditional mailing lists. It is not clear why two Commissioners rejected this approach, but presumably they will publish an explanation at some point.

Compliance Tip: Carefully document any list exchanges so that there is a clear record of a fair-market exchange. Given the uncertainty as to why two Commissioners do not think the email list exchange is the same as a traditional mailing list exchange, it may be prudent to seek an advisory opinion or even to make a payment for the list.

Use of State Resources

The complaint also alleged that the Senate campaign used a newsletter prepared by the Treasurer’s official office (the newsletter appeared on the official Treasurer’s website and the Senate campaign site). The complaint alleged that this newsletter was an impermissible in-kind contribution from the State of Ohio. Mandel responded that the two-page newsletter was prepared by employees on their personal time. The FEC accepted this explanation, and, because creating a two-page newsletter would not take much time, exercised its prosecutorial discretion to dismiss that allegation.

Compliance Tip: Be very careful not to use any resources from your government office for either your state or federal campaign. State law here may actually present a bigger problem than the federal law. Similarly, be cautious of state laws that may prohibit asking subordinates to do “volunteer” campaign work for you.

Don’t Forget Pay-to-Play

Finally, it is worth noting that as the Ohio Treasurer, Mr. Mandel was a covered official under the SEC’s pay-to-play rule. Therefore investment advisors doing business with Ohio (or who plan to do business with Ohio) should be careful not to allow certain executives to contribute to the federal campaign. More information about the SEC’s rule can be found here,
here, and here. Many states also have pay-to-play laws, but these do not affect federal candidates because they are preempted
by the Federal Election Campaign Act.

Compliance Tip: If you are covered by the SEC’s pay-to-play rule, provide notice of this to potential contributors so that they are not enticed into contributing in violation of the rules. If you are an investment advisor, be certain that you have all of the necessary policies and procedures in place to avoid making a prohibited contribution.

When we talk about pay-to-play, we often think about making sure that executives do not make inadvertent contributions that run afoul of a state’s pay-to-play rules and make the company ineligible for contracts. We might also think about tracking contributions from certain employees so that pay-to-play certifications are truthful and accurate. But a recent criminal indictment of a company and seven of its senior executives in New Jersey reminds us that there are also bigger issues to consider about how to build a good compliance program.

The Allegations

The indictment alleges that a major engineering firm with over $28 million in public contracts in 2011 from across New Jersey systematically tried to avoid pay-to-play disclosures and reimbursed employees for making contributions the company could not make itself. In other words, this was not just a technical violation of the rules, but rather, according to the indictment, a systematic attempt to circumvent the rules.

The indictment and related news stories allege the company and its executives:

  • Asked employees to make contributions to candidates of less than $300, to avoid disclosure thresholds.
  • Reimbursed employees for those contributions through bonuses.
  • Bundled these contributions and sent them to the candidates so they knew they were from the company.
  • Filed pay-to-play reports saying the company and its key employees covered by the disclosure law had not given contributions when they knew about the reimbursed contributions.

Building a Compliance Program

A pay-to-play compliance program focused on pre-clearance of contributions by the company and those subject to the rules might not have stopped this kind of behavior. That is why a good pay-to-play system needs to include:

  • Broad training about the scope of pay-to-play rules, so that employees who may be asked to participate in a reimbursement effort know not to be involved.
  • An effective whistle blower process so that employees know whom to contact if they suspect something untoward.
  • Policies and procedures to prevent reimbursement of contributions, which will include the accounting staff to make certain that bonuses are paid on a regular schedule and for documented reasons and that expense reimbursements are legitimate.

Of course, preclearance of contributions for those employees subject to restrictions and/or reporting is also essential. Ultimately, the goal of the compliance system is to create a culture of compliance so that the government sales force and leadership know that they cannot use contributions to sway the contracting process.

Significant campaign finance reform legislation cleared the Maryland House of Delegates Thursday, and is now under consideration by a committee of the Maryland Senate. The Campaign Finance Reform Act of 2013 (HB 1499 and SB 1039) responds to recommendations of the recently convened Maryland Commission to Study Campaign Finance Law. The bill addresses many of the recommendations set forth in the Commission’s final report, issued in December 2012. If enacted, the changes will become effective January 1, 2015.  Highlights of the bill include:

  • Contribution and Transfer Limits. Per recipient, per election cycle contribution limits will increase from $4,000 to $6,000 per recipient, and the limit on per cycle aggregate contributions will increase from $10,000 to $24,000. Contribution and “transfer” limits will be indexed for inflation, with adjustments made at the start of every election cycle.
  • Business Entity Contributions. Two or more business entities (i.e., corporations, sole proprietorships, partnerships, LLCs, etc.) that are under common ownership or control will be treated as a single contributor for purposes of the contribution limits, closing a loophole in the current attribution rule, which applies only to corporate entities.
  • Out-of-state PACs.  Nonfederal out-of-state PACs will be subject to Maryland registration and reporting requirements.
  • Independent Expenditures and Electioneering Communications. New 48-hour registration and reporting requirements will be triggered when individuals or groups make independent expenditures (i.e., communications expressly advocating election or defeat of a candidate or ballot measure) or disbursements for electioneering communications. Donor disclosure will be expanded to require identification of any person making cumulative donations to the filer of $10,000 or more during the reporting period, regardless of whether the donations were made for the purpose of furthering independent expenditures or electioneering communications. The types of communications subject to independent expenditure and electioneering communication reporting are also broadened to include, for example, certain mass email and text blasts.
  • Pay-to-play.  The law governing disclosure of political contributions by government contractors will be refined to narrow the scope of reportable contributions and the “doing public business” threshold. Reporting will be done electronically, and reports will be made available to the public online. Contractors will be required to certify their compliance with the reporting requirements to the agencies with which they do business, and will be subject to new detailed record-keeping requirements.
  • Enforcement. The bill gives the State Board of Elections additional tools to enforce the campaign finance laws, including expanded audit authority and the authority to issue civil penalties for certain violations. The statute of limitations for prosecuting criminal violations is also extended from 2 to 3 years.

We will be tracking the bill and will supplement this post as the bill makes its way through the legislative process.

We hope you will join us for a webinar on February 27 at 1:00, called Political Law 101. We will cover all the major topics you need to be thinking about as you ramp up for lobbying the new Congress and state legislatures, host site visits and other events, and prepare for the next election cycle:

  • PACs
  • Super PACs
  • Lobbying registration and disclosure
  • Gifts to public officials and employees
  • Politics in the work place
  • Corporate policies

The full agenda and registration is here.

Last week the Commodity Futures Trading Commission (“CFTC”) issued a No-Action Letter that helps harmonize the CFTC’s pay-to-play rules for swap dealers (Regulation 23.451) with both the SEC and Municipal Securities Rulemaking Board (“MSRB”) pay-to-play regulations. The Letter also provided guidance regarding the two-year “look back” period, during which time swap dealers may be prohibited from doing business with a governmental Special Entity if a prohibited political contribution was made by the swap dealer or one of its covered associates.

Under Regulation 23.451, a swap dealer is prohibited from offering to enter into or entering into a swap or trading strategy with a governmental Special Entity if a prohibited contribution was made in the past two years. In the Letter, the CFTC clarified that this two-year “look back” period does not include any time period that precedes the date on which a swap dealer is required to register as a swap dealer with the CFTC. Thus, for an entity required to register as a swap dealer on December 31, 2012, any contributions made by it or its covered associates prior to then are not included in the “look back” period.

The CFTC also eliminated disparities between its pay-to-play rule, on the one hand, and the SEC and MSRB pay-to-play rules on the other, regarding which state and local officials are subject to the contribution ban. Regulation 23.451 prohibits swap dealers and their covered associates from making political contributions to government officials (or soliciting contributions to those same officials) of a “governmental Special Entity” and/or “government plans,” as defined in Section 3 of the Employee Retirement Income Security Act of 1974 (“ERISA”). This definition includes federal officials as well as state and local officials. Because most swap dealers are subject to all three rules, this change should help simplify compliance.

The landmark Supreme Court ruling in the Citizens United case paved the way for explosive growth in political spending during the 2012 election cycle.  However, for government contractors and their principals, a growing number of “pay-to-play” laws restrict political contributions and fundraising, and can result in severe penalties, including the loss of contracts. Venable has just issued an alert addressing recent developments with pay-to-play laws and identifying key steps for staying in compliance.

On November 2, 2012, the District Court for the District of Columbia, two days after oral argument, upheld the long-standing ban on political contributions from federal government contractors. In Wagner v. Federal Election Commission, three independent contractors with various federal agencies argued that the ban on federal contractor contributions in section 441c of the Federal Election Campaign Act (“FECA”) violated their First and Fifth Amendment rights.

The ruling keeps federal contractors outside the bounds of the Supreme Court’s decision in Citizens United. Unlike other corporations, federal contractors may not make contributions, either directly or in-kind, to independent expenditure-only committees, commonly known as Super PACs. In addition, while officers and employees of federal contractors are free to make personal political contributions, and to establish and donate to federal PACs, an individual who IS the federal contractor may not make contributions to federal candidates, national political parties or federal Super PACs.

Background

The challenged FECA section prohibits any person who (a) enters into any contract with the United States for “personal services, or the furnishing of any materials, supplies, or equipment . . . or for selling any land or building [where] payment for the performance . . . is to be made in whole or in part from funds appropriated by the Congress” (b) from making or soliciting a contribution to “any political party, committee, or candidate for public office or to any person for any political purpose or use.” Section 441c is thus a federal-level “pay-to-play” ban: it seeks to guard against federal contractors using political donations to help secure more business. The plaintiffs in Wagner have limited duration consulting contracts with federal agencies. All want to make contributions to federal races during the current election cycle but are subject to the ban.

Analysis

First Amendment Claim

While political contributions are protected by the First Amendment, here the court concluded that preventing corruption is a sufficiently important government interest to justify the ban. The court noted that section 441c was originally passed in the 1940s in response to federal contractors being required to buy campaign books at higher prices to obtain government business. The court also pointed to more recent examples, such as a 2005 Connecticut contractor contribution ban passed after the governor awarded over $100 million in state contracts to a large donor.

The plaintiffs argued that the ban is too broad, as it applies to persons at low risk for corruption, including those who do not receive their contracts through a bidding process. The court, however, held that Congress has considerable flexibility in deciding how to address corruption given the importance of the government interest in preventing it.

Equal Protection Claim

The plaintiffs argued that section 441c violates their rights under the Equal Protection clause of the Fifth Amendment because they are treated more harshly with respect to political contributions than are federal employees and the officers, directors, shareholders, and employees of corporations that contract with the government.

Applying an “intermediate” standard of scrutiny, the court found that government contractors are different from federal employees and from corporate government contractors in significant ways that justify the ban. Federal contractors are reasonably treated differently but not necessarily more harshly than federal employees, who may (generally) make contributions, but not solicit them. The plaintiffs also argued that section 441c unfairly penalizes holders of personal services contracts.  Corporate federal contractors are subject to the 441c ban, but directors, officers, employees, and shareholders are not. Corporate contractors may also form political action committees (“PACs”). The court found that employees, stockholders, directors, officers, and corporate PACs that make contributions are acting as individuals or as different entities, and thus it is acceptable to treat them differently.

Impacts of Wagner and Effects on Contributions to Super PACs

Following Wagner, the 441c ban still applies to all funds under the dominion and control of the individual government contractor, not just to payments received from the government.

On the corporate side, a government contractor may still create a federal PAC, and its directors, officers, employees, and shareholders may make contributions  to the PAC and directly to federal candidate campaigns and other political committees. But if the federal contractor is an individual, such individual may not make contributions in connection with federal elections. Moreover, the FEC’s position, confirmed in this case, is that while Citizens United permits corporations to make independent expenditures in support of or in opposition to candidates, the ruling does not apply to corporate federal contractors because of section 441c. This means that a corporate government
contractor, while it can still form its own PAC:

  • Cannot donate to a PAC that makes only independent expenditures (i.e., a super PAC). In Wagner, the court noted that there is “substantial doubt” about whether this position is constitutional after Citizens United and SpeechNow.org v. Federal Election Commission.  However, the FEC’s position is that federal contractor contributions to super PACs are prohibited.
  • Must avoid in-kind contributions to Super PACs (and Super PACs must be careful not to accept such contributions). This means, for example, that a federal contractor should not allow use of its office space, employees or other resources (such as a mailing list) by a federal candidate committee, political party or even a Super PAC.
  • Must still be careful to comply with state and local “pay-to-play” laws. This case addresses only contributions made by federal government contractors to federal candidates and PACs, and national political parties. As a separate matter, many states and localities restrict or prohibit political contributions by government contractors and their principals, or require such persons and entities to file public reports disclosing their political contributions.

Prominent Wall Street firm Goldman Sachs will pay almost $12 million to settle charges that one of its investment bankers made undisclosed campaign contributions to a state official responsible for awarding government contracts.

The case is the first SEC action for pay-to-play violations based on “in-kind” – meaning, non-cash – contributions to a political campaign. In the settlement order, the SEC charges that Goldman vice president, Neil M.M. Morrison, sought lucrative government contracts from the State of Massachusetts while at the same time doing political campaign work out of Goldman’s offices for state treasurer, Timothy P. Cahill. The SEC alleges that Morrison’s activities included fundraising, writing speeches, talking with reporters, and approving personnel decisions for the campaign. The Goldman executive also allegedly made cash payments to a third party, who then contributed to Cahill’s campaign.

The SEC order faults Goldman for failing to properly monitor the investment banker’s activities.  Goldman Sachs entered into the settlement without admitting or denying liability. Morrison did not settle.

This is the second major announcement from the SEC this month concerning pay-to-play practices. A couple of weeks ago, the SEC issued a “Risk Alert” urging municipal securities dealers to institute training, pre-clearance procedures for political contributions, and other compliance measures to prevent unlawful intervention in campaigns.

More broadly, the Goldman settlement serves as a potent reminder that political activity by employees – even personal political activity – can present substantial risks to employers doing business with state and local government. Using company staff and resources in connection with fundraising and directing contributions through third-parties may also violate federal and state campaign finance laws, even if the employer is not a contractor.

Last week the SEC’s Office of Compliance Inspections and Examinations issued a National Examination Risk Alert for brokers, dealers and municipal securities dealers regarding compliance with Municipal Securities Rulemaking Board (MSRB) Rule G-37. The Risk Alert noted that recent SEC examiners have observed practices that raise concerns whether firms are adequately complying with all of their obligations under the MSRB’s “pay-to-play” rules.

Although this Risk Alert specifically relates to brokers, dealers and municipal securities dealers subject to MRSB rules, it should be noted that investment advisers are subject to similar “pay-to-play” restrictions under SEC Rule 206(4)-5.

Concerns identified by examiners include:

  • Compliance with the Rule’s ban on doing business with a municipal issuer within two years of a political contribution to officials of the issuer by any of the firm’s municipal finance professionals;
  • Possible recordkeeping violations;
  • Failure to file accurate and complete required forms with regulators regarding political contributions; and
  • Inadequate supervision.

The Risk Alert goes on to note several practices certain firms are engaging in to minimize the potential for violations of the Rule. These practices include:

  • Training professionals on the requirements of the MSRB’s “pay-to-play” regulations;
  • Requiring firm employees to certify on an annual or other periodic basis that they understand all requirements regarding political contributions;
  • Having the firm actively search for political contributions made by employees to detect contributions that might violate the contribution restrictions; and
  • Pre-clearing political contributions by firm employees and, in some cases, family members.

That the SEC highlighted these practices suggests that the agency will expect a similar approach to compliance by investment advisors. At the same time, as we discussed in another recent post, certain practices encouraged by the SEC may be at odds with protections afforded by state employment laws.

In sum, risks are high for firms subject to pay-to-play rules, with a careful approach to compliance the best protection.