Public confidence is critical to the long-term health of the municipal bond market, which allows state and local governments to borrow hundreds of billions of dollars each year to finance infrastructure and other public projects. But when backroom politics and campaign contributions are allowed to influence public finance decisions, that confidence is shaken.
Among the most important safeguards of municipal market integrity is a two-decades-old rule addressing pay-to-play practices – and the appearance of such practices – in the bond underwriting business. An effort by the Municipal Securities Rulemaking Board, the regulatory organization solely focused on the municipal securities market, to extend that well-established rule to the municipal advisory business now faces legal challenge.
In the early 1990s, widespread news coverage suggested it was common practice for underwriters to dangle campaign contributions when angling for bond business. It was also widely reported that municipal government officials often asked for – and even expected – campaign cash from their financial firms. These underhanded pay-to-play practices undermined market integrity and inflated costs borne by issuers, dealers and ultimately investors and taxpayers by creating artificial barriers to competition.
To address these damaging consequences, the Municipal Securities Rulemaking Board (MSRB) – with the support of leaders in the industry – took action to sever the link between the giving of political contributions and the awarding of bond underwriting business.
MSRB Rule G-37, established in 1994, bars underwriting firms from doing business with a state or local government for two years after contributing to the campaign of an elected official with the authority to influence decisions on hiring an underwriter. The first of its kind in the financial services sector, the MSRB's rule balances the First Amendment rights of individuals to contribute to political campaigns with the regulatory objective of preserving the integrity of the municipal bond market. The rule achieves this by limiting the business that can be conducted after a donation is made and not by banning political contributions outright. The rule further protects the integrity of the municipal market by requiring disclosure of political contributions by municipal securities firms, which facilitates public scrutiny of the flow of money between such firms and the elected stewards of taxpayer dollars.
The rule has survived legal challenge and was affirmed as constitutional under the First Amendment in a court ruling in 1995. Not only has the rule endured for two decades, but it has also been emulated. Numerous laws addressing the influence of political contributions on the awarding of government contracts and other financial services business are modeled on the MSRB's standard-setting rule.
On Aug. 17, Rule G-37 will be expanded to reduce the influence that political contributions may have when state or local officials decide to hire a municipal advisor to counsel them on capital-raising for infrastructure spending and other financial matters. Since the MSRB was charged with creating rules and professional qualification standards for municipal advisors with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the MSRB has intended to address the potential for pay-to-play activities on the advisory side of the municipal securities industry.
The August amendments to Rule G-37 have prompted a legal challenge that largely revisits the arguments made in the 1990s and risks bringing pay-to-play practices back in play at statehouses and city halls across the country. The MSRB is vigorously defending the rule it believes has dramatically improved the integrity of the bond underwriting business and can do the same for the municipal advisory business.
While any and all restrictions on money in politics have become a favorite target for litigation, recent opinions show the Supreme Court continues to recognize the compelling public interest in stamping out quid pro quo political corruption, and its appearance, through narrowly tailored regulations. A municipal advisor who stuffs the campaign coffers of a sitting mayor in exchange for the contract to advise on how to finance the city's new airport is a clear-cut example of corruption that undermines the integrity of the municipal securities market and can be stopped with the application of a well-proven and appropriately tailored rule.
The MSRB stands by all its rules of fair play, which have been carefully crafted to protect the integrity of the municipal bond market, and the interests of investors and taxpayers who make planning and building of municipal infrastructure possible. The MSRB will continue to work to eradicate even the appearance of the pernicious practice of pay to play and ensure that both underwriters and municipal advisors are selected on the basis of merit, not money.