The 2024 U.S. Presidential election is grabbing the headlines right now. However, 469 other federal elections, 13 gubernatorial elections, and countless contests at the state and local levels will be decided in November. With so many candidates and campaigns, the risk of pay-to-play and political donation rule violations, even unintentional ones, is high.
Pay-to-play compliance and the tracking of political contributions and donations is a concern for firms of all sizes. Managing political contributions and donations is top of mind during crucial election years, but it should remain a perennial priority for compliance teams. Firms need to have policies and procedures in place to identify violations of pay-to-play potential conflicts of interest around political contributions and donations—and avoid the fines and reputational damage that those conflicts can bring.
Expect another year of robust contributions
The 2020 elections saw record levels of political contributions. And although the 2023-2024 election cycle shows a different overall breakdown compared to the 2019-2020 cycle, with variations in candidate fundraising, party contributions, and PAC activity, the overall amount raised in this cycle to date is tracking closely with the last election. Through June of 2023, $1.07 billion in total was raised, as outlined in the Statistical Summary of Six-Month Campaign Activity of the 2023-2024 Election Cycle, as compared to $1.08 billion as noted in the Statistical Summary of Six-Month Campaign Activity of the 2019-2020 Election Cycle.
Pay-to-Play Compliance Key in Record Breaking Election Cycle
Remind employees of their obligations
With so many donations received so far—and much more to be raised in the upcoming months—firms should fully expect that their employees are among the political donors.
Is your firm aware of the impact of any political contributions that your employees are making? And are your employees aware of the rules they are beholden to?
In the run-up to the election, now is the time to remind employees about firm policies and expectations regarding political contributions and donations if they haven’t been reminded already. What types of contributions are permitted, and which ones are restricted? If an employee wants to make a donation, what exactly do they need to do to adhere to firm policy and regulatory requirements? Policies and procedures should be comprehensive, actionable, and backed up by an audit trail.
This is also a good time for organizations to review their code of conduct and practices to ensure that training, compliance monitoring, attestation, and reporting on political contributions and donations—and all potential conflicts of interest—are on point.
Regulators are watching and enforcement can be strict
Pay-to-play and political contribution regulations are in place to prevent conflicts of interest and ensure that investment advisers are selected based on merit rather than political contributions. Relevant regulations include SEC Rule 206 (4)-5, FINRA Rules 2030 & 4580, MSRB Rule G-37 and CFTC Regulation 23.451.
It’s also important to note that candidates themselves are also held to political contribution limits, including limits on cash, anonymous, and in-kind contributions.
SEC Commissioner Hester M. Pierce refers to the Pay-to-Play rule as “an exceedingly blunt instrument.” In a 2022 enforcement sweep, the SEC fined four investment advisers for violations of pay-to-play compliance rules. A common thread across the cases involved covered associates donating to a campaign for a candidate running for elected office where the investment advisers had established advisory relationships with relevant before the contributions were made. Pierce points out that there was little evidence of “quid pro quid” or undue influence in any of the actions.
In all four cases, contributions were $1000 or less. One of the violations was for a donation of only $400--only $50 over the $350 per candidate, per election exemption. In one of the cases, the associate was not covered by the rule when the contribution was made but fell under the provision of the two-year look-back requirement.
Recent exemptions granted by the SEC underscore the significance of strong compliance policies and quick corrective action in case of a potential violation. In 2023, the SEC granted two firms exceptions because they were able to identify potential violations of the pay-to-play rule within their organizations, demonstrate robust and effective compliance policies, and take prompt corrective action.
In another SEC action, a firm's policies were not correctly followed due to oversights and assumptions. In this case, the firm took significant action to address the situation, including replacing the CCO, updating political donation policy, adding quarterly certifications, installing upgraded software, and updating the firm's compliance manual. In this action, even given the scope of the reforms, the SEC imposed an annual independent compliance review.
Implement robust controls including donor verification reporting
Recent actions highlight the significant risk of violations of pay-to-pay and political donations compliance rules. Even if the infractions were minimal and inadvertent, the penalties can still be steep. Firms must have systems to manage political donation compliance and provide a defensible audit trail for regulators, auditors, and the board.
The article Pay-to-Play Tips and Reminders from the Investors Advisors Association reinforces the need for robust controls. According to the IAA, the core elements of an effective pay-to-pay and political conation compliance program include:
- Mandatory pre-clearance of donations
- Education and training
- Reminder of policy
- Robust reporting
- Compliance testing and oversight
The article also notes that electronic communications reviews can uncover undisclosed or problematic contributions.
Running periodic spot checks or relying on employees to self-report donations is time-consuming and ineffective. Compliance teams need access to comprehensive political donation data and solid tracking systems in place to satisfy regulatory requirements and must be able to identify prohibited contributions easily.
Gifts and entertainment are closely related concerns
Restrictions on gifts and entertainment and potential lobbyist registration requirements are also significant areas of compliance concern. The giving and receiving of gifts and entertainment may be perceived as a conflict of interest.
Firms need to have policies and procedures in place to identify potential conflicts of interest in these areas and around political donations—and avoid the fines and reputational damage that those conflicts can bring.
Financial Services Firms Suspend or Review Political Contributions
A perennial compliance challenge
While an eventful election year makes the impact of political contributions and donations top of mind, pay-to-play and donation compliance is an ongoing concern for firms of all sizes. Relevant donor data needs to be tracked at the federal, state, and local levels, and state and local rules differ across jurisdictions. Hence, managing pay-to-play compliance is also an ongoing challenge for many firms.
MCO’s Political Contributions and Donations solution provides access to updated donation data across federal, state, and local jurisdictions, enabling the verification of employee contributions against an outside source. Compliance teams can quickly and efficiently configure customized rules and run reporting to manage and monitor political contributions and pay-to-play compliance/
MCO’s Gifts, Entertainment and Hospitality solution monitors and manages employee gifts, meals, entertainment, travel and hospitality activities. Compliance teams can easily document and address potential conflicts of interest with a comprehensive solution that automates the submission and approval process for gifts and entertainment, allowing firms to reduce compliance risk.
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