United States: Pay-To-Play Laws Remain In The Spotlight: Government Contract Eligibility Hinges On Awareness And Compliance

Companies that do business with state and local governments are subject to a wide array of laws restricting their political contributions, as well as the personal political contributions of their owners, officers, and some employees. These laws are known as pay-to-play laws because they are aimed at severing the relationship — or the appearance of a relationship — between a contribution (the "pay") and the award of a government contract (the "play").

Violations of pay-to-play laws — even a single, inadvertent political contribution — can result in costly bid disqualifications, voided contracts, and damaging publicity.

In approaching compliance, government contractors should do a risk assessment that takes into account where the company does business with government agencies, whether its contracts are covered by relevant laws, and where its employees live. For many companies, pre-clearing contributions and political fundraising (which some laws also cover) and training affected personnel are essential elements of an effective compliance plan. Also, companies should adopt protocols for registration and reporting to state election boards, as there are some pay-to-play laws that impose such requirements instead of, or on top of, contribution restrictions.

Pay-to-play laws vary across jurisdictions; we have outlined the broad requirements and highlighted certain relevant updates but encourage consultation with our political law attorneys to customize a compliance plan for your particular needs.

Do pay-to-play laws apply to my business or firm?

If your business model includes contracting with federal, state, or local government bodies, you may be subject to pay-to-play laws. These laws, however, vary considerably from one jurisdiction to another. Some specialty pay-to-play laws apply only to certain types of businesses, such as state licensees, companies receiving contracts from retirement funds, redevelopment authorities, or casino operators. Some laws apply to all types of contracts, including grants and real estate leases, while others apply only to contracts awarded through a non-competitive bidding process. Most pay-to-play laws are limited to contracts or grants over a certain dollar threshold, which may apply to a single contract or a series of contracts.

While in recent years many campaign finance restrictions have been loosened, either by legislatures or the courts, pay-to-play laws have proliferated and, thus far, have been upheld by the courts. Pay-to-play laws have been adopted by approximately 20 states and dozens of major municipalities, including Los Angeles, New York, Philadelphia, and numerous cities and counties in California and New Jersey.

Which affiliated individuals and entities are covered?

Once you have determined that certain pay-to-play laws apply to your business, the next step is to identify which affiliated individuals and entities are affected. Most pay-to-play laws cover the contracting entity's officers, as well as individuals whose ownership interests are above specified levels. Other laws cover employees who represent the contractor in negotiations with government agencies, as well as their supervisors. It is also common for pay-to-play laws to contain anti-circumvention provisions by applying contribution restrictions to parent and subsidiary corporations, lobbyists, or spouses and other family members of covered owners, officers, and employees.

For companies with a multi-state footprint, an effective approach often entails compiling a list of all individuals and affiliates who are subject to at least some, if not all, applicable pay-to-play laws. With that list in place, the company can ensure that each of these individuals and entities receives training and periodic updates about the law. The company can also establish a pre-clearance system to screen political contributions and collect appropriate information about contributions from this group to help the company comply with its registration and reporting obligations.

What are the consequences of being subject to pay-to-play laws?

Prohibitions and Limitations

The most common type of pay-to-play law limits or prohibits political contributions. As described above, the entities and individuals subject to the ban or restrictions vary widely. The period of time during which contributions are restricted varies as well. Many jurisdictions, such as New Jersey and New Mexico, include a "look-back" provision, where contributions made during a specified period prior to the contract award will either disqualify the bidder from receiving the contract or require disclosure as part of the bidding process. Other jurisdictions, such as Connecticut and the city of Philadelphia, apply a contribution ban for a specified period after the contract has been fully performed or until the awarding official (the mayor, for example) has completed his or her term.

Registration and Reporting

Several states and municipalities require contractors to register their contracts and file periodic disclosure reports with the relevant election board.

While registration and reporting may be less onerous than contribution restrictions, they still impose significant regulatory burdens. For example, Maryland requires a business that receives a state or municipal contract to register with the state election board and then file semi-annual reports disclosing contributions made (and solicited) by covered individuals, including officers and directors, as well as by affiliated entities. To meet this disclosure burden, the filer's CEO or designee must either survey covered persons for reportable contributions or have a process in place that requires covered individuals to preclear their contributions through a corporate legal or compliance department.

Federal Contractors

Federal law prohibits contractors from making any contributions to officeholders or candidates for U.S. House, Senate, or President. This mainly applies to individuals, partnerships, and limited liability companies that are contractors, because all corporations are already prohibited from giving to federal candidates. The federal law, however, allows corporations that are contractors to form political action committees and solicit voluntary contributions from company executives. Partnerships, LLCs, sole proprietors, and individual contractors do not have this option, so they must be very careful about political giving.

Penalties

Violations of pay-to-play laws may result in disqualified bids, canceled contracts, and even debarment. Because pay-to-play law provisions are frequently memorialized in government contracts, non-compliance can also put your company in material breach of contract.

In some cases, pay-to-play law violations can involve criminal charges against both a company and its executives or dovetail with bribery or other corruption charges.

Companies may also face civil penalties — ranging from $50 per day for late filings to $5,000 per violation — for more severe violations, such as making a prohibited contribution. Most jurisdictions provide for higher penalties if a violation is found to be knowing and willful.

Approaching Compliance

An effective compliance program can dramatically reduce the risks posed by pay-to-play laws. This starts with a review of where the company is doing or seeking business, and where covered personnel are located. From there, companies should do a risk assessment, which might range from analyzing a single jurisdiction or business unit to a company-wide legal audit, depending on the scope of your governmental contracts and other business.

A process for pre-clearing contributions should be implemented, along with a protocol for registration and ongoing reporting. Most compliance programs also include annual training and periodic reminders to covered personnel. (Some pay-to-play laws specify the type of written notice required.)

Additionally, we recommend a periodic review of campaign contribution databases. Under some pay-to-play laws, if an unlawful contribution is identified and refunded within a prescribed period, no penalties will be imposed.

Recent Developments

Montana Adopts Broad Disclosure Requirements

Pursuant to an executive order signed by Governor Steve Bullock in late 2018, prospective contractors must now not only disclose contributions to state candidates and political parties, but must also publicly report expenditures made to any entity, including a 501(c)(4) organization, that pays for electioneering communications in Montana or makes contributions, transfers, or expenditures to another entity that pays for electioneering communications in Montana. The requirements, which are intended to capture spending on so-called "dark money" ads, represent a new frontier in contractor disclosure requirements.

Vermont Establishes Pay-to-Play Regime

The Vermont legislature enacted pay-to-play restrictions which became effective in December of 2018. The law applies to certain sole-source contracts and prohibits contractors and prospective contractors from making contributions to an official responsible for awarding the contract. The restrictions extend to spouses, individuals with controlling interest in a business entity contractor, an entity's CEO or equivalent, and employees with substantive responsibilities related to the negation of the contract. A prohibited contribution results in the termination of the contract.

The District of Columbia Implements Pay-to-Play

As we've mentioned, the District of Columbia recently adopted pay-to-play restrictions which prohibit a contractor from making contributions to the official responsible for awarding its contract, as well as any PAC or constituent-service program affiliated with that official and any candidates for that covered office. Senior officers of the contracting entity are also covered by the prohibition. Violations of the law can result in the termination of existing contracts, a four-year disqualification from seeking future contracts (including extensions of existing contracts), civil penalties, and being included on a publicly available list of violators.

San Francisco, California Puts Pay-to-Play on the Ballot

In November 2019, voters will have an opportunity to vote on amendments to the city's campaign finance rules, including a more restrictive approach to contractors. The ballot initiative would prohibit contributions by any individual with a "financial interest" in a land-use matter pending before the City Boards or Commissions to a member of the Board of Supervisors, the Mayor, or the City Attorney or candidates for such offices. The prohibition covers any entity or individual with an ownership interest of at least $5 million in the land use matter and officers and directors of such entities, as well as developers of projects with an estimated construction cost of at least $5 million that is the subject of a pending land use matter. The prohibition would begin at the commencement of the matter and end 12 months from the date that the applicable Board or Commission issues a final decision or any appeals to another City agency from the decision have been resolved.

A Note About Financial Services Pay-To-Play Laws

Many financial service companies contract with states or municipalities to manage public pension or retirement funds or provide other financial services. As a consequence, these companies are covered by the state and local pay-to-play laws discussed above. But that is not the end of the story. Financial service companies may also be subject to federal pay-to-play regulations that can result in a two-year ban on compensated business if a political contribution is made by the company or its affiliates to an incumbent or candidate who has direct or indirect authority over the decision to hire the company. These include:

  • Securities Exchange Commission Rule 206(4)-5, regulating registered investment advisers;
  • Municipal Securities Rulemaking Board Rule G-37, regulating broker-dealers that underwrite municipal securities and municipal advisors;
  • Financial Industry Regulatory Authority Rule 2030, regulating broker-dealers that solicit government investors for affiliated or third-party investment advisers (e.g., placement agents); and
  • Commodity Futures Trading Commission Regulation 23.451, regulating swap dealers.

Companies and firms subject to these federal pay-to-play regulations should consider some of the same compliance measures discussed above, such as pre-clearance of contributions, training, and monitoring public contribution databases. Also, protocols should be established to screen new hires and promoted employees. These laws also impose significant recordkeeping requirements.

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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