Nancy and Stephen Einhorn host a dinner at their home in 2005. Credit: Milwaukee Journal Sentinel

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Conservative Milwaukee financier Stephen Einhorn and his wife, Nancy, donated $25,000 to Gov. Scott Walker a month before Einhorn's firm won a contract to manage $1 million of taxpayer money, potentially triggering federal "pay-to-play" conflict of interest rules.

Einhorn's Capital Midwest and two other companies were chosen by the Wisconsin Housing and Economic Development Authority from a field of six applicants to invest $7 million of federal money in state businesses, particularly those in low-income communities. After an inquiry by the Milwaukee Journal Sentinel about the two $12,500 contributions from the Einhorns, a WHEDA official said the agency is holding off on releasing the money to Capital Midwest until the firm resolves questions about the federal rule.

"They've got to get this answered before anybody's comfortable making any kind of final release," said John Hogan, WHEDA chief operating officer.

Hogan said WHEDA kept the selection process free from political influence. His comments were echoed by others who sought the money - including those from firms that didn't win. But some of the fund managers also said they had explicit policies in place to prevent political donations from creating a real or perceived conflict of interest.

A spokeswoman at a Chicago public relations firm representing Einhorn said that he and his fund had done nothing improper.

WHEDA committed the money to the newly created Capital Midwest Wisconsin Fund II. That fund "does not charge management or incentive fees and is designed and structured to be compliant with the (U.S. Securities and Exchange Commission) 'pay-for-play' rules that prohibit such fees," Einhorn spokeswoman Tracey Mendrek said. "Neither the . . . fund nor Stephen Einhorn anticipate earning any such fees on any state funded investment in the future."

Einhorn recently drew criticism from liberals and civil rights groups when he paid for dozens of anonymous billboards in the Milwaukee area and two Ohio cities warning residents of the penalties for committing voter fraud. The critics felt the billboards were aimed at discouraging voting by minorities in low-income neighborhoods. Einhorn and his wife said they considered the signs a public service "because voter fraud undermines our democratic process."

'Pay-to-play' rule

The Einhorns' contributions to Walker could trigger a rule enacted in 2010 by the SEC, the federal agency that regulates financial firms. That's because Walker effectively appoints the executive director of WHEDA as well as eight of the 12 members of the board of the quasi-governmental authority. The rule could prevent Einhorn from collecting compensation on the $1 million for two years after the contributions were made. U.S. Treasury Department conflict of interest rules might also apply.

The "pay-to-play" rule is the first far-reaching effort by the SEC to limit outside investment managers' ability to steer business their way through campaign contributions. The rule could apply in this case and the matter should be looked at further, said Robert Hockett, a professor of financial law at Cornell University in Ithaca, N.Y.

"I can't think off the top of my head of any strong arguments why this (rule) would not be at least applicable here, even if not actually violated," Hockett said.

Hockett said he would need to know more details about how Einhorn might benefit financially from the deal.

"It definitely raises a yellow flag, maybe not the red flag, but certainly a yellow flag," Hockett said.

The situation underscores the kinds of entanglements that could arise under a state venture capital program that Walker and lawmakers hope to pass next year. Some fund managers said that they competed for the funds from WHEDA in part because they saw the process as a dry run for later state venture capital deals.

Walker's official spokeswoman Jocelyn Webster and his campaign spokesman Tom Evenson said that neither the administration nor the campaign was aware that Einhorn was seeking state business around the time the contributions were made.

Webster said the award process had been open to the public, competitive and free from all political influence, adding that no political appointees had sat on WHEDA's award committee.

"There's no wrongdoing on our part at all," Webster said. " . . . We've gone back and reviewed this and are very comfortable with how we handled it and how WHEDA managed it."

Evenson said that it was up to donors to use "their personal judgment" when doing business with the state.

When aware of a donor with potential state business, "the campaign's policy is to say, 'Thank you but we'd rather not have you donate to the campaign because of the potential conflict,' " Evenson said.

The SEC rule says it is unlawful for investment managers to provide advice 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."

The SEC has not yet made it clear how the agency intends to enforce the rule, but a number of investment firms adopted policy changes, said Stefan Passantino, an attorney at the Washington, D.C., law firm of McKenna Long & Aldridge who oversees the "Pay to Play Law Blog."

Some firms have banned employees from making any political contributions at the state level, while others require employees to clear contributions in advance, Passantino said.

Five of eight Wisconsin-based fund companies contacted by the Journal Sentinel said they have policies that limit political contributions. Three did not have such policies, but said they do no government business.

Capital Midwest is receiving no management fee from WHEDA, but the firm can take as much as 3.6% in expense reimbursements, according to a copy of the agreement provided by the firm. The agreement also says WHEDA is to receive 6% annual interest on the investment, though the agency risks losing the money if the fund is not successful. Einhorn would appear to be entitled to any profits on top of that. The agreement does not appear to specify whether Capital Midwest must make equity or debt investments in companies, or whether there are limits on the amount of interest it could collect on loans.

Hockett, of Cornell University, said that in situations involving investment companies and advisers who act on their behalf, federal regulators have interpreted the term compensation broadly. Other financial benefits for Einhorn, besides a management fee, might trigger the rules, Hockett added.

GOP supporters

Since December 2009, Einhorn and his wife have given $47,750 to Walker, including donations of $12,500 from each spouse to Walker on Nov. 22, 2011, according to an analysis of their state and federal political contributions by the Wisconsin Democracy Campaign and the Journal Sentinel.

At the time of the November 2011 donations, recall petitions were being circulated against Walker. That triggered an unusual clause in state law allowing unlimited donations to the governor, rather than the usual $10,000 limit per contributor during a four-year campaign cycle.

Since 1996, the Einhorns have also given tens of thousands of dollars to other Republican candidates at the state and federal level.

The two other managers chosen by WHEDA are receiving more than Capital Midwest. NEW Capital Management Inc. received a $2 million commitment and Generation Growth Capital received a $4 million commitment.

NEW Capital Management president and general partner Charles Goff gave a total of $300 in two donations to Walker since the SEC rule went into effect Sept. 30, 2010. That allows Goff to fall within an exemption to the SEC rule that allows up to $350 in donations to a candidate during an election cycle if the contributor can vote for the candidate. It also follows the rules of NEW Capital's conflict of interest policy, Goff said.

Generation Growth Capital Fund II has not yet finalized its agreement with WHEDA. The fund is managed by Cory Nettles, a former state commerce secretary under then-Democratic Gov. Jim Doyle. Between 2001 and 2010, Nettles and his wife gave more than $28,000 to Democrats, including Doyle and Walker opponent Tom Barrett.

But Nettles said he hasn't contributed to state candidates since the SEC conflict of interest rules went into effect to avoid triggering the rules in situations such as this one.

"It is because of those rules that none of us make contributions" in cases of potential investments, he said.

Nettles praised the process used by WHEDA to award the investment contracts.

"I know when things happen as a nod and wink. There was no hint of that. It was a nonpartisan process," Nettles said.

Officials at the three losing firms agreed. Teresa Esser of Silicon Pastures, Byron Frenz of CW Technologies LLC and Clay Norrbom, managing director of Global Infrastructure Asset Management, all said that they believed the process had been fair.

Along with the similarly named fund created for the WHEDA investment, Capital Midwest manages the $40 million Capital Midwest Fund II. That larger fund received $15 million of its capital from David Einhorn, according to a recent New York Times article. David Einhorn, Stephen's son, is a well-known New York hedge fund manager who is known for his ability to move markets when his Greenlight Capital bets against a stock. He was ranked 41st on Fortune's list of the most important businesspeople in the U.S. in 2012, and in February was ordered to pay an $11 million fine for insider trading.

WHEDA started the Wisconsin Equity Investment Fund program with $7 million of $22.4 million that the state received from the U.S. Treasury Department's State Small Business Credit initiative. Spokesmen for the SEC and U.S. Treasury declined to comment.