Political Contributions — Series 53

Overview of Pay-to-Play Regulation

The municipal securities market has historically been vulnerable to a practice known as "pay-to-play" -- the notion that political contributions to state and local government officials can influence the awarding of municipal securities business. When a dealer makes contributions to officials who can influence the selection of underwriters or financial advisors, it creates an appearance of corruption that undermines public trust in the municipal market.

To address this concern, the MSRB adopted Rule G-37 in 1994, which imposes a two-year ban on municipal securities business with an issuer after a dealer or its municipal finance professionals (MFPs) make political contributions to officials of that issuer who can influence the awarding of business. The rule is prophylactic in nature, meaning it operates as a bright-line prohibition regardless of whether any actual quid pro quo is proven.

As a Municipal Securities Principal, you must understand the intricacies of Rule G-37, ensure your firm has adequate compliance procedures, and supervise the political contribution activities of your firm's MFPs and other associated persons. Violations of G-37 can result in severe consequences, including the loss of municipal securities business for two years and disciplinary sanctions by FINRA.

Pay-to-Play: The practice of making political contributions to government officials who can influence the awarding of municipal securities business, with the expectation that such contributions will result in the firm being selected for underwriting or advisory engagements.

Municipal Finance Professional (MFP): Any associated person of a dealer who is primarily engaged in municipal securities representative or principal activities, or who solicits municipal securities business, or who supervises persons engaged in these activities.

Rule G-37 Mechanics

The Two-Year Ban

The core prohibition of Rule G-37 is straightforward: a broker-dealer that has made or has had certain political contributions made on its behalf is prohibited from engaging in municipal securities business with the issuer for a period of two years after the contribution. This ban applies when:

The dealer itself makes a contribution
A municipal finance professional (MFP) of the dealer makes a contribution
A political action committee (PAC) controlled by the dealer or any of its MFPs makes a contribution

The ban applies to contributions to officials of the issuer who can influence the selection of underwriters, financial advisors, or placement agents. This includes elected officials such as governors, mayors, state treasurers, and members of city councils who have authority over the issuance of municipal securities.

Municipal Securities Business Defined

Under Rule G-37, "municipal securities business" means:

Acting as a negotiated underwriter (not a competitive underwriter)
Acting as a placement agent for a private placement of municipal securities
Acting as a financial advisor to an issuer
Providing remarketing agent services for municipal securities

A critical distinction on the Series 53 exam: Rule G-37 does NOT prohibit a firm from winning a competitive underwriting after making a political contribution. The ban only applies to negotiated business (underwriting, placement, advisory, remarketing). The rationale is that competitive business is awarded based on the lowest cost to the issuer, not on relationships, so contributions cannot influence the outcome.

Who Is a Municipal Finance Professional (MFP)?

The definition of MFP is broad and includes:

Any associated person primarily engaged in municipal securities representative activities (underwriting, trading, sales, financial advisory, research, investment advice, or any other activities involving communication with public investors)
Any associated person who solicits municipal securities business for the dealer
Any associated person who supervises persons engaged in municipal securities activities up to and including, but no higher than, the first supervisory level above the activities described above
Any person who was an MFP within the preceding two years (the look-back provision)

The MFP definition includes a two-year look-back. If a person was an MFP within the past two years but has since changed roles, their contributions during the look-back period can still trigger the ban. This means a firm must track contributions of former MFPs for two years after they leave the MFP role.

De Minimis Exceptions and Safe Harbors

The De Minimis Exception

Rule G-37 includes a de minimis exception that permits an MFP to contribute up to $250 per election to an official of an issuer for whom the MFP is entitled to vote. This means the MFP must be a registered voter in the jurisdiction where the official is running for office. The key elements are:

The maximum permitted contribution is $250 per election (primary and general elections are separate elections)
The MFP must be entitled to vote for the official receiving the contribution
If the MFP is NOT entitled to vote for the official, any contribution, regardless of amount, triggers the two-year ban
The de minimis exception applies per MFP, per official, per election

Scenario A: An MFP who lives in Springfield contributes $200 to the mayor of Springfield who is running for re-election. This is within the de minimis exception ($250 per election, and the MFP can vote for the mayor). No ban is triggered.

Scenario B: The same MFP contributes $100 to the governor of another state. Even though $100 is below $250, the MFP is not entitled to vote for this governor. The two-year ban IS triggered because the de minimis exception only applies when the MFP can vote for the official.

Scenario C: An MFP contributes $300 to a local official for whom they can vote. This exceeds the $250 de minimis threshold, so the two-year ban is triggered for the entire $300 (not just the amount over $250).

Automatic Exemption Process

Rule G-37 provides an automatic exemption process (sometimes called the "return of contribution" exemption) if certain conditions are met:

The contribution was made by an MFP (not by the dealer itself)
The contribution does not exceed $250
The contributor obtains a return of the contribution within four months of learning it was made (or should have been discovered through reasonable procedures)
The dealer must have had procedures in place reasonably designed to discover and prevent violations

This automatic exemption provides a safety valve for inadvertent violations but requires the firm to have robust compliance procedures in place. The MSRB has also provided for a broader exemption process that allows dealers to request an exemption from the MSRB for contributions that do not trigger the policy concerns underlying the rule.

The Look-Back Provision

When a new MFP joins a dealer, the firm must consider contributions made by that person during the two years preceding their becoming an MFP at the firm. If the new MFP made a contribution during the look-back period that would have triggered a ban, the dealer is prohibited from engaging in municipal securities business with the relevant issuer for the remainder of the two-year ban period.

This look-back provision means that firms must conduct thorough due diligence on the political contribution history of any person being hired or promoted into an MFP role. Many firms require new MFPs to complete a political contributions questionnaire covering the prior two years.

Scenario	Ban Triggered?	Reason
MFP gives $250 to official they can vote for	No	Within de minimis exception
MFP gives $100 to official they cannot vote for	Yes (2 years)	De minimis requires voting entitlement
MFP gives $300 to official they can vote for	Yes (2 years)	Exceeds $250 de minimis limit
Dealer PAC gives $500 to issuer official	Yes (2 years)	Dealer-controlled PAC contributions are covered
New hire made contribution 18 months ago (pre-hire)	Yes (6 months remaining)	Two-year look-back applies

Reporting and Supervisory Obligations

Quarterly Reporting to MSRB

Under Rule G-37, dealers must file quarterly reports with the MSRB disclosing:

All contributions to officials of issuers made by the dealer, its MFPs, and its dealer-controlled PACs
All payments made to political parties of states and localities where the dealer engages in municipal securities business
All municipal securities business engaged in during the quarter

These reports are publicly available on the MSRB's EMMA system, providing transparency about the relationship between political contributions and municipal securities business. Reports must be filed within 30 calendar days after the end of each calendar quarter (January, April, July, and October). Even if a dealer has nothing to report, it must file a report indicating "nothing to report."

Principal Supervisory Responsibilities

The Municipal Securities Principal must implement comprehensive procedures to ensure compliance with Rule G-37:

Identification of MFPs: Maintain a current list of all MFPs, including those who have been MFPs within the past two years
Pre-Clearance Procedures: Many firms require MFPs to obtain pre-clearance before making any political contribution
Contribution Monitoring: Systems to track and monitor political contributions by MFPs, their spouses, and dealer-controlled PACs
New Hire Due Diligence: Questionnaires and verification procedures for persons being hired or promoted into MFP roles
Training and Education: Regular training for MFPs on the requirements and restrictions of Rule G-37
Quarterly Reporting: Procedures to ensure accurate and timely filing of quarterly reports with the MSRB
Record Retention: Maintaining records of all contributions, reports, and compliance procedures

Rule G-37 is strict but predictable. The principal must build systems to prevent violations rather than react to them. The most effective approach combines pre-clearance requirements, ongoing monitoring, new-hire due diligence, and regular training. A single improper contribution of any amount by an MFP to an official they cannot vote for can cost the firm two years of business with that issuer.

Prohibition on Soliciting and Bundling

Rule G-37 also prohibits dealers and MFPs from soliciting or coordinating contributions to officials of issuers with which the dealer is engaged in or seeking municipal securities business. This anti-bundling provision prevents dealers from circumventing the direct contribution limits by organizing fundraising events or soliciting contributions from third parties on behalf of issuer officials.

Additionally, dealers may not make payments to state or local political parties in states where they engage in municipal securities business if the purpose is to circumvent the contribution restrictions. This provision prevents the use of political parties as conduits for indirect contributions to issuer officials.

Remember G-37 with "2-250-V": 2-year ban, $250 de minimis, and must be able to Vote for the official. If you can't vote, even $1 triggers the ban. If you can vote, up to $250 per election is safe.

Check Your Understanding

Test your knowledge of political contribution rules. Select the best answer for each question.

1. Under Rule G-37, the ban on municipal securities business after a prohibited contribution lasts:

2. An MFP who lives in City A contributes $150 to the treasurer of City B. What is the result?

3. Rule G-37 prohibits a firm from engaging in which type of underwriting after a prohibited contribution?

4. The G-37 look-back provision applies for how long when a new MFP joins a firm?

5. How frequently must dealers file political contribution reports with the MSRB?