Why Republican State Committees Say Revised Rule G-37 Is Unconstitutional

WASHINGTON – Three state Republican parties are challenging the constitutionality of a revised Municipal Securities Rulemaking Board rule designed to prevent municipal advisors as well as dealers from engaging in pay-to-play practices. The revised rule was approved by the Securities and Exchange Commission in February.

The state parties have asked two federal appeals courts to set aside and vacate the revisions to MSRB Rule G-37, which has applied to dealers since 1994 and would take effect for municipal advisors beginning on Aug. 17.

Under the revised rule, municipal advisors, like dealers, will be barred from engaging in negotiated municipal business with an issuer for two years if the firm, one of its professionals, or a political action committee that is controlled by the firm or an associated professional, makes significant contributions to an issuer official who can influence the award of bond business. However, the revised rule allows a municipal finance professional (MFP) or a municipal advisor professional (MAP) to give a de minimis contribution of up to $250 to any candidate for whom he or she can vote for without triggering the two-year ban.

Two of the groups challenging the revised rule, the Georgia Republican Party and the New York Republican State Committee, filed a petition against the MSRB and SEC on April 13 in the U.S. Court of Appeals for the Eleventh Circuit in Atlanta. The court's jurisdiction covers Georgia, Alabama, and Florida.

The Tennessee Republican Party, which is represented by the same lawyers as the other two state Republican groups, filed an identical challenge on April 12 in the U.S. Court of Appeals for the Sixth Circuit in Cincinnati. That court's jurisdiction is Tennessee, Kentucky, Michigan, and Ohio.

Christopher Bartolomucci, a partner with the law firm Bancroft here, Edmund LaCour Jr., an associate with the same firm, and Jason Torchinsky, a partner at Virginia-based Holtzman Vogel Josefiak Torchinsky, are representing the Republican organizations.

The groups are asking the courts to hold that the revised rule exceeds the statutory authority of the SEC and MSRB, is arbitrary and capricious, violates the First Amendment on free speech, and should be set aside and vacated. They are also asking the courts to enjoin the commission and MSRB from implementing the rule's requirements.

SEC officials declined to comment on the case.

The MSRB told The Bond Buyer on Wednesday that it "considers [the revised rule] to be a vital measure in promoting the integrity of the $3.7 trillion municipal securities market."

"The amendments to Rule G-37 extend the longstanding pay-to-play rule for municipal securities dealers to municipal advisors, including those acting as third-party solicitors," the board said. "If the courts consider the matter, the MSRB intends to vigorously defend the policies it believes should be in place to address quid pro quo corruption, and the appearance of this type of corruption."

Bartolomucci, LaCour, and Torchinsky are alleging the amended rule is "doomed three times over." "The MSRB political contribution rule … violates the First Amendment by forcing municipal advisors or dealers (and their employees) to choose between exercising their constitutional right to support candidates through political contributions and continuing to provide advisory and dealer services," the lawyers wrote. "A municipal advisor or dealer (and its employees) may only do the latter by forgoing the former."

The Supreme Court only allows this type of constitutional infringement if it is done to prevent quid pro quo corruption, according to the lawyers. Rule G-37 fails to satisfy that standard, they added, because, according to the 2014 Supreme Court ruling in McCutcheon v. FEC, spending money on an election that is not in connection with efforts to control the officeholder's actions does not qualify as quid pro quo corruption.

The lawyers also argue in their complaints that Congress did not empower the SEC, let alone the MSRB, to regulate political contributions when it granted generic authority to establish rules "designed to prevent fraudulent and manipulative acts and practices." Campaign finance regulation has instead long been "the exclusive province" of Congress and the Federal Election Commission, they said.

Rule G-37 was challenged after the SEC first approved it for dealers in 1994. Alabama bond dealer William Blount filed suit against the SEC and MSRB in the U.S. Court of Appeals for the District of Columbia, arguing the rule violated his constitutional right to free speech. The D.C. appellate court rejected that argument in 1995, ruling G-37 was "narrowly tailored to serve a compelling government interest." The Supreme Court declined to take up Blount's appeal of that ruling.

The Republican groups from New York and Tennessee that are currently opposing G-37 previously also unsuccessfully challenged an SEC-approved pay-to-play rule covering investment advisors. The U.S. Court of Appeals for the District of Columbia dismissed that lawsuit in August 2015 on a technicality, finding the two groups missed the 60-day deadline to challenge the rule after it went into effect.

Bartolomucci, LaCour, and Torchinsky made clear in their complaints over G-37 that the petitions were submitted within the 60-day period after the SEC's approval. They also reminded the court that their clients voiced their concerns about the rule in comment letters submitted to the SEC before the commission made its decision.

More recently, SEC attorneys have moved to have the cases transferred to different courts. They are asking that the petition brought in the Eleventh Circuit be transferred to the Sixth Circuit because the filings in the two courts are identical and the Sixth Circuit filing came a day earlier. Legally, that means the Eleventh Circuit cases belong in the Sixth Circuit court where proceedings were first instituted, the SEC said.

The MSRB's lawyer, Joseph Guerra, a co-leader of Sidley Austin's Supreme Court and appellate practice, is also asking that the petition already filed in the Sixth Circuit be transferred to the D.C. Circuit because it "would serve the convenience of the parties and the interest of justice in this matter" as counsel representing the MSRB, SEC, and the three petitioners are all located in the D.C. and Virginia area.

The lawyers for the three Republican committees have opposed the motions to transfer their suits.

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