UK: Pay-to-Play: Proposed MSRB Guidance Regarding PACs Under Rule G-37

Last Updated: 23 September 2010
Article by Edward L. Pittman


The Municipal Securities Rulemaking Board ("MSRB") recently filed with the Securities and Exchange Commission ("SEC") proposed guidance ("Proposed Guidance") regarding affiliated Political Action Committees ("PACs") for purposes of the pay-to-play limitations imposed on municipal securities dealers under MSRB rule G-37 ("Rule G-37").1 Much of the Proposed Guidance consolidates MSRB policy statements regarding PACs that were previously approved by the SEC. While the Proposed Guidance is aimed at municipal securities dealers, if approved by the SEC it will likely serve as precedent for similar limitations imposed on investment advisers by Rule 206(4)-5 under the Investment Advisers Act of 1940 ("Rule 206(4)-5").2

Overview of Restrictions on PAC Activity

Rule G-37 limits the ability of municipal securities dealers, as well as their municipal

finance professionals ("MFPs"),3 to seek business from government entities if they have made political contributions to an elected official that has the ability to influence the decisions of the government entity. Similar limits on political contributions apply to affiliated and unaffiliated PACs if they are considered to be "controlled" by the municipal securities dealer or any of its MFPs. The use of PACs to make indirect contributions is prohibited.

The Proposed Guidance is directed primarily at PACs of affiliated entities (e.g., bank holding companies and insurance holding companies). While it also applies to unaffiliated PACs, the Proposed Guidance will be of particular interest to compliance officers and counsel to inte-grated holding companies that may have PACs.

Controlled PACs

In the context of defining a "controlled PAC," the longstanding interpretation of the MSRB has been that "control" is "the ability to direct or cause the direction of the management or the policies of a PAC."4 In the Proposed Guidance, however, the MSRB suggests that this standard is not determinative. It proposes, for the first time, additional, non-exclusive, principles for making a determination about whether a PAC may be viewed as "controlled" by either the dealer or its MFPs.

Creation of the PAC

According to the Proposed Guidance, if a dealer or an MFP, either alone or with others, has a formal or informal role in creating the PAC, it would continue to be viewed as a "controlled PAC" unless the dealer or the MFP becomes wholly disassociated with the PAC—regardless of whether that dealer or MFP has the ability to direct or cause the direction of the management or policies of the PAC.

Management and Funding of the PAC

The Proposed Guidance also states that "control" does not have to be exclusive or majority control, and that multiple dealers may be considered to "control" a single PAC. "Strong indicators" of whether or not the PAC is "controlled" would include:

  • The power, alone or in conjunction with similarly powered entities, to cause the direction of the management and policies of the PAC;
  • The level of funding provided by dealers and their MFPs to a PAC. The MSRB states that "a PAC that receives a majority of its funding from a single dealer (including the collective contri-butions of its MFPs and employees) or a single MFP is conclusively presumed to be controlled by such dealer or MFP, regardless of the lack of any of the other indicia of control described in this notice"; and
  • Size or frequency of contributions by a dealer or MFP, viewed in light of the size and frequency of contributions made by other contributors not affiliated in any way with the dealer or MFP.

Mitigating Factors

Conversely, the MSRB suggests mitigating factors that would indicate that a PAC is not under the control of the dealer or an MFP. Specifically, the Proposed Guidance states that control of a PAC will not be presumed if either the dealer or an MFP:

(i) participates with a broad-based group of other entities and/or individuals in creating the PAC, (ii) at no time undertakes any direct or indirect role (and, in the case of a dealer, no person associated with the dealer undertakes any direct or indirect role) in leading the creation of the PAC or in directing or causing the direc-tion of the management or the policies of the PAC, and/or (iii) provides funding for such PAC (and, in the case of a dealer, its associated persons collectively provide funding for such PAC) that is not substantially greater than the typical funding levels of other participants in the PAC who do not undertake a direct or indirect role in leading the creation of the PAC or in directing or causing the direction of the management or the policies of the PAC.

Indirect Contributions Through PACs: Supervisory Procedures

Due Diligence Regarding Contributions to PACs

The Proposed Guidance restates the MSRB's policy regarding due diligence in connection with contri-butions made to PACs by the dealer and its MFPs. In essence, the MSRB summarizes prior guidance stating that contributions to a PAC which supports a limited number of candidates might be viewed as an indirect contribution to those candidates. For this reason, as part of their pre-clearance procedures, dealers should make inquiries to determine which candidates are supported by an unaffiliated PAC.

The Proposed Guidance also references the MSRB's prior policy statements indicating that dealers should have supervisory procedures in place reasonably designed to ensure that neither the dealer nor its MFPs are using payments to political parties or non-dealer controlled PACs to make indirect contributions. The Proposed Guidance suggests that these procedures might include undertaking certain due diligence inquiries regarding: the intended use of the contribution, the motive for making the contribution, and whether the contribution was solicited.

Information Barriers Between Affiliated PACs and Dealers

The Proposed Guidance also repeats earlier MSRB policy statements about leveraging contributions made by affiliated PACs. The MSRB reaffirms its position that dealers should consider establishing information barriers between any affiliated PACs and the dealer (and its MFPs) to assure that PAC contributions are not improperly influenced, and that information regarding past or anticipated contributions by the PAC cannot be leveraged by the dealers or their MFPs. The MSRB notes that potential information barriers include:

i) a prohibition on the dealer or MFP from recommending, nominating, appointing or approving the management of affiliated PACs; ii) a prohibition on sharing the affiliated PAC's meeting agenda, meeting schedule, or meeting minutes; iii) a prohibition on identification of prior affiliated PAC contributions, planned PAC contributions or anticipated PAC contributions; iv) a prohibition on directly providing or coordinating information about prior negotiated municipal securities businesses, solicited municipal securities business, and planned solicitations of municipal securities business; and v) other such information barriers as the firm deems appropriate to monitor conflicting interest and prevent abuses effectively.


The MSRB's Proposed Guidance on PACs must be approved by the SEC in order to become effective. The formal comment period on the filing expires on September 30, 2010.

Whether or not the MSRB's Proposed Guidance is approved by the SEC, many of the principles already have been set forth in prior MSRB statement and will be familiar to dealers. For investment advisers that will be subject to Advisers Act Rule 206(4)-5, the MSRB's Proposed Guidance provides a good benchmark, suggesting how the SEC and its staff may interpret similar provisions in that rule which relate to PAC activity.


1 Securities Exchange Act Release No. 62718 (August 13, 2010).

2 Rule 206(4)-5, which was adopted by the SEC this summer, is patterned directly on MSRB Rule G-37. In many instances in the adopting release for Rule 206(4)-5, the SEC has referred to MSRB statements concerning Rule G-37 to provide guidance as to how similar terms in Rule 206(4)-5 will be interpreted. See Advisers Act Release No. 3043 (July 1, 2010).

3 Under Rule 206(4)-5, similar persons are defined as "Covered Associates."

4 MSRB Question and Answer No. IV. 24 (May 24, 1994). Under Rule 206(4)-5, "control" is defined by the SEC in the release adopting the rule as "the ability to direct or cause the direction of the governance or operations of the PAC."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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