The SEC’s twisty argument to toss pay-to-play muni bond rule challenge

July 28, 2016

(Reuters) – Last December, Congress wanted to make sure that the Securities and Exchange Commission would keep its nose out of campaign finance reform. As you know, there’s been considerable debate in recent years about whether the SEC should require corporations to disclose their political spending. The agency hasn’t shown much eagerness to do so, but in the Appropriations Act of 2016 (which was actually passed in December 2015), the House and Senate seemed to take the issue out of the SEC’s control. The law barred the commission from using SEC funds to “finalize, issue or implement any rule, regulation or order regarding the disclosure of political contributions.”

Now the SEC is arguing that the very law intended to block the commission from meddling with campaign finance shields the commission against litigation by three state Republican parties attempting to challenge new rules restricting contributions by private advisors to municipal bond issuers. The SEC’s motion to dismiss a challenge at the 6th U.S. Circuit Court to the new rules has left the Tennessee, Georgia and New York Republican parties fairly sputtering with indignation.

“The SEC turns the Appropriations Act language on its head, asserting that the Act required the SEC to do precisely what it was barred from doing,” the state parties’ lawyers at Bancroft wrote in a brief filed Wednesday.

Here’s the gist of the SEC’s wonderfully ironic argument. In 2010’s Dodd-Frank financial reform law, Congress imposed a time limit for the commission’s review of new rules proposed by self-regulating bodies, including the Municipal Securities Rulemaking Board, which oversees muni bond lawyers and financial advisers. The Dodd-Frank provision says the SEC has 45 days to issue an order approving or rejecting the proposal, or else instituting a review process. If the SEC takes no action within the 45-day time frame, the law says, the proposed new regulation “shall be deemed to have been approved by the commission.”

Two days before President Obama signed the Appropriations Act into law, the municipal securities board submitted notice that it wanted to tighten its regulation of the practice known as pay-to-play, in which private firms hoping to be hired for bond-related work contribute to the campaigns of elected officials who dole out those assignments. In the rules proposed last December, the board called for muni bond dealers and advisers to report their political contributions every quarter. It also proposed that advisors be barred for two years from doing work for public officials they have contributed to or raised money for.

The SEC published a notice of the board’s proposal but did not institute a review or issue an order accepting or rejecting the proposal. So under the Dodd-Frank 45-day provision, the board’s regulation was “deemed approved” in February.

The Tennessee, Georgia and New York Republicans went to the 6th and 11th Circuits to challenge the new rules. Their cases were consolidated in the 6th Circuit, where state parties are arguing that the tightened pay-to-play rules are unconstitutional under the First Amendment because they force muni bond advisors and dealers “to choose between exercising their constitutional right to support candidates through political contributions and continuing to provide advisory and dealer services,” Tennessee’s petition said. “A municipal advisor or dealer (and its employees) may only do the latter by forgoing the former.”

Ordinarily, federal appellate courts have jurisdiction over suits involving federal agency rulemaking. But the SEC’s motion to dismiss this case contends there was no rulemaking. Because the muni bond board’s new pay-to-play regulations took effect under Dodd-Frank’s default provision, the agency never issued a final order on the new restrictions – the threshold, according to the SEC, for a challenge to an agency rule. And why didn’t the SEC issue an order? Because, according to the SEC, Congress handcuffed the agency when it drafted the Appropriations Act signed into law right before the muni bond board suggested new regulations.

“The commission did not act because Congress precluded it from using appropriated funds to finalize, issue, or implement an order regarding the disclosure of political contributions, and the MSRB’s rule requires the disclosure of certain political contributions,” the SEC said in its brief, which was first covered by the Bond Buyer. Moreover, according to the SEC, the same Appropriations Act precludes the agency from using its resources to defend the muni board rules!

Pretty ingenious, don’t you think? But as you would expect, the state parties say there is a fundamental flaw in the SEC’s reasoning. According to the brief they filed Wednesday, the provision on campaign finance and the SEC in last December’s Appropriations Act required the commission to reject the muni bond board’s rule-tightening – not to allow it to become a regulation by default. “The SEC offers no support for its radical position that the Exchange Act allows the (muni bond board) to enact rules free from either SEC or judicial review,” the brief said. “The SEC offers no evidence that Congress wanted to create a loophole that allows the SEC to turn proposed rules by (self-regulating boards) into unreviewable law.”

The SEC contends it is backed by 2007 precedent from the D.C. Circuit in Sprint Nextel v. FCC. The state Republican parties counter that the D.C. Circuit never endorsed the proposition that the SEC “can implement unreviewable rules.” In fact, according to the parties, the SEC’s dismissal argument raises a new constitutional issue under the non-delegation doctrine because the commission effectively abdicated its rulemaking authority and empowered the self-regulating board.

The SEC asked the appeals court to stay merits briefing until it resolves the jurisdictional question the commission raised in its motion to dismiss. Otherwise, the state parties’ brief of the merits of its challenge is due at the end of August.

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