N.Y. Republican State Comm. v. Sec. & Exch. Comm'n

• Decision Date: 30 September 2014
• Docket Number: Civil Action No. 14–01345
• Parties: New York Republican State Committee, et al., Plaintiffs, v. Securities and Exchange Commission, Defendant.
• Court: U.S. District Court — District of Columbia

70 F.Supp.3d 362

New York Republican State Committee, et al., Plaintiffs

v.Securities and Exchange Commission, Defendant.

Civil Action No. 14–01345

United States District Court, District of Columbia.

Signed September 30, 2014

Jason B. Torchinsky, Holtzman Vogel Josefiak, PLLC, Warrenton, VA, Brian J. Field, Howard Christopher Bartolomucci, Bancroft PLLC, Washington, DC, for Plaintiffs.

Thomas Jeffrey Karr, Jeffrey A. Berger, U.S. Securities and Exchange Commission, Washington, DC, for Defendant.

MEMORANDUM OPINION

BERYL A. HOWELL, United States District Judge

The New York Republican State Committee and the Tennessee Republican Party seek declaratory and injunctive relief invalidating and enjoining the defendant, the Securities and Exchange Commission (“SEC” or “Commission”), from enforcing an SEC regulation, which was adopted over four years ago and codified at 17 C.F.R. § 275.206(4)–5 (the “Challenged Rule”). Compl. ¶ 2, ECF No. 1.¹ The Commission counters that this case “was filed in the wrong court at the wrong time by the wrong plaintiff,” Def.'s Opp'n Mot. Prelim. Inj. at 1 (“Def.'s Opp'n), ECF No. 18, and should be dismissed for lack of subject matter jurisdiction pursuant to Federal Rule of Civil Procedure 12(b)(1). Def.'s Mot. Dismiss, ECF No. 10. The Court agrees with the Commission: The plaintiffs have failed to meet their burden in establishing subject matter jurisdiction because this Court is not the proper forum for their challenge.

I. BACKGROUND

The Investment Advisers Act of 1940, 15 U.S.C. § 80b, et seq., makes it unlawful “for any investment adviser ... directly or indirectly ... to engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative.” 15 U.S.C. § 80b–6. Under the Act, the Commission has the authority to promulgate “rules and regulations ... reasonably designed to prevent such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative.” Id. § 80b–6(4). Invoking this authority in 2010, the SEC adopted the Challenged Rule, which prohibits a registered investment adviser from providing investment advisory services for compensation to a government entity within two years after making a contribution to certain officials of the government entity. See 17 C.F.R. § 275.206(4)–5. The rule targets “pay-to-play” activities, whereby investment advisers “seek to influence government officials' awards of advisory contracts by making or soliciting political contributions to those officials....” See Political Contributions by Certain Investment Advisers, 75 Fed.Reg. 41018 (July 14, 2010).

A. Adoption of the Challenged Rule

As of 2010, public pension plans totaled $2.6 trillion in assets and represented roughly one-third of all U.S. pension assets. See id. Government officials are responsible for holding and managing these assets and, in many instances, are responsible for selecting private investment advisers to manage a pension plan's portfolio of assets. Id. at 41018–19. A spate of investigations and prosecutions over the past decade revealed the reality of abusive pay-to-play activities in the selection and retention of pension plan investment advisers. Id. at 41019 nn. 18–25. For example, in New York, an investment management firm seeking to win investment business from the New York State Common Retirement Fund paid “kickbacks” to advisers of the New York State Comptroller in order to secure the business. See id. at 41019 n.18, 20 (referencing SEC v. Morris, et al., No. 09–cv–02518 (S.D.N.Y.)).

The Commission concluded, in light of this and other similar scandals, that “the selection of advisers ... has been influenced by political contributions” to the government officials responsible for selection.² 75 Fed.Reg. at 41019. The Commission identified two problems with such influence. First, distorted selection procedures increase the likelihood that less qualified investment advisers are selected (thereby resulting in lower fund performance) and that these advisers charge higher fees (thereby resulting in a higher cost to the public). Id. Second, investment advisers who “seek to influence the award of advisory contracts ... compromise their fiduciary obligations ... and defraud prospective clients.” Id. at 41022. In sum, pay-to-play practices “distort the process by which investment advisers are selected,” and therefore create “a conflict of interest between the adviser (whose interest is in being selected) and [the] prospective client (whose interest is in obtaining the best possible management service).” Id. As a result, pay-to-play practices are “inconsistent with the high standards of ethical conduct required of fiduciaries under the Advisers Act.” Id.³

Accordingly, on July 14, 2010, the SEC adopted the Challenged Rule, which seeks to limit pay-to-play activity by, among other things, prohibiting investment advisers from receiving compensation for work provided to a government entity when the investment adviser, or certain covered associates, provided a contribution to certain officials of that entity. The rule was “in the nature of [a] conflict of interest limitation[ ]” so as to regulate the fiduciary obligations of investment advisers. Id. at 41023. The Commission determined that a prophylactic rule was necessary in this instance because “pay to play practices are rarely explicit and often hard to prove.”Id. at 41022. Moreover, the Commission determined that collective action problems surrounding pay-to-play activities lessened the likelihood of a private solution as both political candidates and investment advisers have an incentive to participate in the system. Id.

The Commission explicitly modeled the Challenged Rule on Rule G–37, adopted by the Municipal Securities Rulemaking Board in 1994, and approved by the SEC, which imposed a “two-year timeout” for municipal securities dealers who contributed to an official of a municipal securities bond issuer. See id. at 41020 ; see also 59 Fed.Reg. 17621 (April 13, 1994). During a “two-year timeout,” a municipal securities dealer is barred from engaging in municipal securities business with an issuer if the dealer, or certain related parties, previously contributed to certain officials of such issuer.⁴ The Commission believed that Rule G–37 “significantly curbed pay to play practices in the municipal securities market.” 75 Fed.Reg. at 41020. Additionally, the Commission borrowed Rule G–37's timeout approach because the D.C. Circuit had previously upheld Rule G–37 against a First Amendment challenge, see Blount v. SEC, 61 F.3d 938 (D.C.Cir.1995). 75 Fed.Reg. at 41023 (“[T]he Blount opinion has served as an important guidepost in helping us shape our rule.”).

B. Requirements of the Challenged Rule

The Challenged Rule makes it unlawful “for any investment adviser registered ... with the Commission ... to provide investment advisory services for compensation to a government entity within two years after a contribution to an official of the government entity is made by the investment adviser or any covered associate of the investment adviser....” 17 C.F.R. § 275.206(4)–5. Other provisions in the same Challenged Rule seek to prevent circumvention of this primary prohibition. Specifically, in addition to being unable to make the contribution directly, an investment adviser may not: (1) coordinate and solicit contributions to an official of a government entity to which the adviser provides or seeks to provide services or to a state political party where the adviser seeks to provide services, id. § 275.206(4)–5(a)(2)(ii) ; (2) pay third parties to solicit government entities unless those third parties are “regulated person[s]”, see id. § 275.206(4)–5(a)(2)(i) ; or (3) do “anything indirectly which, if done directly, would” violate the rule, id. § 275.206(4)–5(d). The rule provides several exceptions, including a “de minimis exception,” which permits contributions by covered associates to candidates of up to $350 (if the covered associate is eligible to vote for the candidate) or $150 (if the covered associate is ineligible to vote for the candidate). Id. § 275.206(4)–5(b)(1). The Commission was urged to adopt higher contribution limits, but declined because “[t]he $1,000 amount suggested by some commenters strikes us as a rather large contribution that could influence the hiring decision[.]” 75 Fed.Reg. at 41035.

Additional regulations, which were also initially targeted for invalidation by the plaintiffs in their Complaint, require investment advisers to “make and keep true, accurate and current ... books and records” relating to their business, including political contributions by certain employees to a government official, entity, state political party, or political action committee, 17 C.F.R. § 275.204–2(a)(18)(i)(C), and restrict the ability of investment advisers to retain certain solicitors to assist in solicitation activities, id. § 275.206(4)–3.

C. The Plaintiffs' Legal Challenge

The plaintiffs, the New York Republican State Committee and the Tennessee Republican Party, have state and local officeholders running, or considering running, for federal office. See Declaration of Jason Weingartner ¶¶ 7–8, Pls.' Mem. Prelim. Inj., Ex. A. ECF No. 7–2 (“Weingartner Decl.”); Declaration of Frederick Brent Leatherwood ¶¶ 7–8, Pls.' Mem. Prelim. Inj., Ex. B., ECF No. 7–3 (“Leatherwood Decl.”). The New York Republican State Committee asserts that the Challenged Rule harms one if its members, State Senator Lee Zeldin, a candidate for the U.S. House of Representatives. Weingartner Decl. ¶ 7. As part of the plaintiffs' operations, the plaintiffs have encountered “potential donors who have declined to contribute” to certain federal candidates or have otherwise “limited their contributions to certain candidates” because of the Challenged Rule. Weingartner Decl. ¶ 10; Leatherwood Decl. ¶ 10. Likewise, “donors and potential donors” have either limited or refrained from making contributions to the state party...