Amendments Filed to Rule G-37 Concerning the Exemption Process and the Definition of Municipal Finance Professional

The additional factors will help to clarify facts and circumstances relevant to exemptive requests and will facilitate the review of such requests by the appropriate regulatory agency. To further clarify and facilitate this process, the MSRB also is withdrawing certain Rule G-37 Qs and As previously published concerning when an exemption may or may not be appropriate. This action is necessary in order to clarify that the regulatory agencies have discretion in administering the exemption process. The proposed amendments will assist the regulatory agencies in exercising their discretion in a manner that will fulfill the purposes of Rule G-37.

One commentator on the draft amendments stated that the MSRB should require the regulatory agencies to consider the proportionality of the penalty to the ban on business. Another commentator stated that exemptive relief should be available only to those dealers that discover problematic contributions prior to a third party discovering them. The MSRB determined not to add more factors to the rule than those proposed. Also, while self-discovery of problematic contributions is a factor, the Board believes it should not be a conclusive one against the dealer. A failure to self-discover does not mean that a dealer has willfully violated the rule.

Adoption of an Automatic Exemption Provision

The proposed amendments provide for an automatic exemption from a dealer’s ban on business in certain limited instances. This provision sets out procedures that would permit dealers to execute two such exemptions per 12-month period for contributions made by an MFP of $250 or less if the dealer discovers the contribution within four months of the date of such contribution and the contributor obtains a return of the contribution within 60 calendar days of the date of discovery of such contribution by the dealer. A dealer would not be permitted to execute more than one automatic exemption relating to contributions by the same MFP. The automatic exemption would not be available for contributions made by a dealer, a dealer-controlled PAC or MFP-controlled PAC. Finally, dealers would be required to report the exemption on Form G-37/G-38 and to maintain records of such exemptions pursuant to Rule G-8, on books and records. A dealer would be banned from municipal securities business until the contribution was returned.

The MSRB believes that a limited automatic exemption provision will provide a measure of relief to the industry without compromising the purposes of Rule G-37. In addition, it will relieve some of the regulatory agencies’ burden of administering the exemption process by removing from this process certain routine cases involving small contributions. The MSRB notes that the time periods proposed are reasonable and will encourage dealers to discover contributions that could give rise to a ban on business in a timely manner (e.g., in preparation for the filing of quarterly Forms G-37/G-38) and to seek quick refunds of these contributions. The automatic exemption will, for example, allow dealers who wish to hire as an MFP someone who previously gave a small contribution to an issuer official to lift the ban on business with that issuer after meeting the requirements of the new provision. Also, a dealer could lift the ban on business if an MFP contributes to an issuer official for whom he or she is not entitled to vote without knowing that his or her firm does business with that issuer. The MSRB determined to limit the number of exemptions, as well as the dollar amount involved, to ensure that the automatic exemption provision could only be used in limited circumstances and not as an avenue for circumvention of the rule.

Certain commentators asked that the amount of contributions available for an automatic exemption be higher (e.g., $1000), certain timeframes be revised or the requirement for the return of the contribution be deleted. The MSRB did revise the draft amendments to require the contributor to obtain a return of the contribution within 60 calendar days of the date of discovery of such contribution by the dealer, rather than requiring the contributor to make a written refund request within 30 days of discovery of the contribution and obtain a refund within 30 days thereafter. The MSRB determined that the remaining requirements as proposed are appropriate.

Definition of Municipal Finance Professional

MFPs Primarily Engaged in Municipal Securities Representative Activities

The proposed amendments revise the definition of MFP to exempt retail sales representatives. While there may be limited instances in which retail sales persons make contributions to obtain municipal securities business for dealers, the MSRB believes that these instances do not outweigh the compliance burden of determining which of these persons are included in the rule. In addition, any retail sales representative who solicits municipal securities business would remain covered under the rule as an MFP.

One commentator opposed the proposal because of the possible use of registered representatives to obtain municipal securities business but the MSRB determined to retain the exemption.

Look Back and Look Forward Provisions

Since Rule G-37 prohibits a dealer from engaging in municipal securities business within two years of certain contributions made by MFPs, a dealer must perform a two-year “look back” of its MFPs’ contributions in order to make a determination on whether it is subject to any prohibitions on municipal securities business. Dealers have informed the MSRB that this look back has precluded them from hiring individuals who had made contributions, even though the contributions (which may have been relatively small) were made at a time when the individuals had no reason to be familiar with Rule G-37. In addition, some dealers have noted how the look back has affected individuals with regard to in-firm transfers and promotions.

Once an individual is designated as an MFP by a dealer, he or she retains this designation for two years after the last activity or position which gave rise to the designation. This “look forward” provision has created compliance problems for some dealers in trying to track the contributions of individuals who have left their MFP positions and transferred to other areas in the firms.

The proposed amendments produce the following results:

• MFPs primarily engaged in municipal securities representative activities: The two-year look back is retained, and the look forward is reduced to one year.
• Solicitor MFPs: The two-year look back is retained, but limited only to contributions to officials of the issuer solicited, and the look forward is reduced to one year.
• Supervisor and management-level MFPs: The look back and look forward are eliminated.

Thus, the two-year look back is retained for those MFPs who are primarily engaged in municipal securities representative activities and for those who solicit municipal securities business while the two year look forward is reduced to one year for these individuals. The look back and look forward are eliminated for supervisor and management-level MFPs.[6] The MSRB believes that supervisors and management-level MFPs should remain subject to the rule while they hold their supervisory positions; however, the potential link between obtaining municipal securities business and contributions made by an individual prior to becoming an MFP solely by reason of taking on a new supervisory or management position is tenuous and therefore should not be subject to the rule. The MSRB notes that most supervisors in the municipal securities department will still be covered by the two-year look back because such individuals are “primarily engaged” in municipal securities representative activities.

In addition, many dealers over the years have raised concerns about bringing non-MFPs to meetings with issuers to solicit municipal securities business (e.g., an individual with expertise in asset-backed securities may be asked to attend a meeting with an issuer that is considering a securitization of tobacco settlement revenue or delinquent tax receipts) because the prior contributions of these individuals could result in a ban on business, even if made to issuers other than those solicited. Dealers believe that such a result is unreasonable given that the contribution by the solicitor MFP to another issuer’s official would have no impact on the underwriter selection process of the issuer that he or she is soliciting. Accordingly, the proposed amendments limit the look back for solicitor MFPs (i.e., persons not primarily engaged in municipal securities representative activities) only to contributions to officials of the issuer solicited. Once these solicitors become MFPs, all of their subsequent contributions to any issuer official still will be covered by the rule.

Certain commentators asked that the look back and look forward provisions be deleted for all MFPs or at least reduced to six months. Certain commentators also opposed the reduced look back for solicitors. The MSRB retained the time frames contained in the draft amendments because it believes these timeframes are appropriate.

Other Issues

Commentators raised other issues concerning Rule G-37 that were not related to the draft amendments. They included increasing the de minimis contribution amount, deleting the “entitled to vote” requirement, requiring disclosure of bank PAC and bank holding company PAC contributions, constitutional issues, issues concerning contributions to ballot referenda and the deletion of the two-year ban on municipal securities business after contributions to issuer officials are made. The MSRB carefully considered all of these issues but determined not to make any other revisions to Rule G-37 at this time. The MSRB is reviewing the issue of ballot referenda to determine whether any further action in this area is warranted.

September 26, 2002

TEXT OF PROPOSED AMENDMENTS[7]

Rule G-37. Political Contributions and Prohibitions on Municipal Securities Business

(a) No change.

(b)(i) No broker, dealer or municipal securities dealer shall engage in municipal securities business with an issuer within two years after any contribution to an official of such issuer made by: (A) the broker, dealer or municipal securities dealer; (B) any municipal finance professional associated with such broker, dealer or municipal securities dealer; or (C) any political action committee controlled by the broker, dealer or municipal securities dealer or by any municipal finance professional; provided, however, that this section shall not prohibit the broker, dealer or municipal securities dealer from engaging in municipal securities business with an issuer if the only contributions made by the persons and entities noted above to officials of such issuer within the previous two years were made by municipal finance professionals to officials of such issuer for whom the municipal finance professionals were entitled to vote and which contributions, in total, were not in excess of $250 by any municipal finance professional to each official of such issuer, per election.

(ii) For an individual designated as a municipal finance professional solely pursuant to subparagraphs (C), (D) or (E) of paragraph (g)(iv) of this rule, the provisions of paragraph (b)(i) shall apply only to contributions made during such time as the individual is a municipal finance professional.

(iii) For an individual designated as a municipal finance professional solely pursuant to subparagraph (B) of paragraph (g)(iv) of this rule, the provisions of paragraph (b)(i) shall apply to contributions made by such individual to officials of an issuer prior to becoming a municipal finance professional only if such individual solicits municipal securities business from such issuer.

(c) through (d) No change.

(e)(i) Except as otherwise provided in paragraph (e)(ii), each broker, dealer or municipal securities dealer shall, by the last day of the month following the end of each calendar quarter (these dates correspond to January 31, April 30, July 31 and October 31) send to the Board by certified or registered mail, or some other equally prompt means that provides a record of sending, two copies of Form G-37/G-38 setting forth, in the prescribed format, the following information:

(ii) through (iii) No change.

(f) No change.

(g) Definitions. (i) through (iii) No change.

(h) No change.

(i) A registered securities association with respect to a broker, dealer or municipal securities dealer who is a member of such association, or the appropriate regulatory agency as defined in Section 3(a)(34) of the Act with respect to any other broker, dealer or municipal securities dealer, upon application, may exempt, conditionally or unconditionally, a broker, dealer or municipal securities dealer who is prohibited from engaging in municipal securities business with an issuer pursuant to section (b) of this rule from such prohibition. In determining whether to grant such exemption, the registered securities association or appropriate regulatory agency shall consider, among other factors [whether]:

(j) Automatic Exemptions.

*  *  *  *  *

Rule G-8: Books and Records to be Made by Brokers, Dealers and Municipal Securities Dealers

(a) Description of Books and Records Required to be Made. Except as otherwise specifically indicated in this rule, every broker, dealer and municipal securities dealer shall make and keep current the following books and records, to the extent applicable to the business of such broker, dealer or municipal securities dealer:

* * * * * *

FORM G-37/G-38

Name of dealer: ________________________________________________________

Report period: _________________________________________________________

I. CONTRIBUTIONS made to issuer officials (list by state)

II. PAYMENTS made to political parties of states or political subdivisions (list by state)

III. ISSUERS with which dealer has engaged in municipal securities business (list by state)

IV. CONSULTANTS

* * * * *

RULE G-37 QUESTIONS & ANSWERS TO BE WITHDRAWN [8]

May 24, 1994 (Q&A #12)

[Q: A dealer may discover that a "disgruntled" municipal finance professional made a contribution to an issuer official deliberately to prohibit the dealer from engaging in municipal securities business with the issuer. Is there a procedure in place whereby the dealer can seek an exemption from the prohibition on municipal securities business in such circumstances?]

[A: The Board recognizes that there may be limited circumstances in which a dealer should be able to request an exemption from the prohibition on business. Thus, the Board has filed with the SEC an amendment to rule G-37 that allows bank regulatory authorities (the Office of the Comptroller of the Currency, Federal Reserve Board and Federal Deposit Insurance Corporation), upon application by a dealer, to grant such exemption, conditionally or unconditionally, in certain circumstances. See the rule filing, SR-MSRB-94-5, for more information about this procedure.]

June 15, 1995 (Q&A #4)

[Q: Rule G-37(i) provides a procedure whereby dealers may request that the NASD or the appropriate regulatory agency (i.e., federal bank regulatory authorities) grant an exemption from the rule’s two-year ban on municipal securities business with an issuer which resulted from political contributions made to officials of that issuer by the dealer, a PAC controlled by the dealer, or a municipal finance professional. If a municipal finance professional made a contribution to an issuer official which triggered the ban, what factors would be relevant to the dealer’s decision to request an exemption from that ban, and to the NASD or appropriate regulatory agency in determining whether the exemption should be granted?]

[A: In determining whether to grant such an exemption, rule G-37(i) requires the NASD or the appropriate regulatory agency to consider, among other factors, whether (i) such exemption is consistent with the public interest, the protection of investors and the purposes of rule G-37; and (ii) such dealer (A) prior to the time the contribution(s) which resulted in such prohibition was made, had developed and instituted procedures reasonably designed to ensure compliance with the rule; (B) prior to or at the time the contribution(s) which resulted in such prohibition was made, had no actual knowledge of the contribution(s); (C) has taken all available steps to cause the person or persons involved in making the contribution(s) which resulted in such prohibition to obtain a return of the contribution(s); and (D) has taken such other remedial or preventive measures as may be appropriate under the circumstances.

In reviewing the facts and circumstances presented by the dealer, as well as the factors set forth above, the NASD or the appropriate regulatory agency will consider whether, prior to the time the contribution was made, the dealer had developed and instituted procedures reasonably designed to ensure compliance with the rule. Such procedures are required by rule G-27 on supervision. Effective compliance procedures are essential because rule G-37 requires the dealer to have information regarding each contribution made by the dealer, dealer-controlled PACs and municipal finance professionals so that the dealer can determine where and with whom it may or may not engage in municipal securities business. In addition, for disclosure purposes, the dealer must maintain information on executive officers’ contributions and payments to political parties, as well as consultant hiring practices. Moreover, because of the "directly and indirectly" provision in rule G-37(d), as well as the no solicitation and no bundling provisions in section (c) of the rule, the dealer must ensure that those persons and entities subject to the rule are not causing the dealer to be in violation thereof. In this regard, the Board wishes to remind dealers that they are responsible for determining which of their employees, supervisors (e.g., branch managers), and management personnel (e.g., members of the dealer’s executive or management committee or similarly situated officials) are "municipal finance professionals." In addition to those persons and entities covered by the rule, the dealer must ensure that other persons and entities hired to assist in municipal securities activities (e.g., consultants) are not being directed to make contributions, or otherwise being used as conduits, in violation of the rule. In reviewing a request for exemption, the NASD or the appropriate regulatory agency also will consider whether the dealer has taken all available steps to obtain a return of the contribution. The return of the contribution, while important, is only one of the factors to be considered, and is not dispositive of whether an exemption should be granted.

Finally, the NASD or appropriate regulatory agency will consider whether the dealer has taken remedial or preventive measures as may be appropriate under the circumstances. Thus, dealers should provide information on any changes to compliance procedures and/or personnel action taken to address the particular situation which resulted in the prohibition so that such problems do not recur. For additional guidance on the exemption provision, please refer to Q&A number 2 in the August 1994 issue of MSRB Reports (Vol. 14, No. 4).

The Board previously provided two examples in which exemptions may be appropriate. The first example described a situation in which a disgruntled municipal finance professional made a contribution purposely to injure the dealer, its management or employees. The second example involved a municipal finance professional who was eligible to vote for a particular issuer official and who made a number of small contributions during an election cycle (e.g., over four years) which, when consolidated, amounted to slightly over the $250 de minimis exemption (e.g., $255).

The Board believes that the following situations are not sufficient to justify the granting of an exemption from a ban on business: (1) a contribution was made by a municipal finance professional which subjected the dealer to the two-year ban on business, but the municipal finance professional was not aware of rule G-37 or any of its particular provisions; (2) the dealer or a municipal finance professional did not know that the recipient of a particular contribution was an "official of an issuer"; and (3) at the time the contribution was made, an associated person did not know that he was a "municipal finance professional" by virtue of his supervisory capacity, by being primarily engaged in municipal securities representative activities, or by virtue of any of the other activities listed in the rule’s definition of municipal finance professional.

The Board is strongly of the view that exemptions should be granted only in limited circumstances. If a significant number of exemptions are granted by the regulatory agencies, then the Board may reexamine the propriety of the exemption provision.]

June 29, 1998 (Q&A #1 (partial withdrawal), 2 and 3)

1. Q:A person is associated with a dealer in a non-municipal finance professional capacity and makes a political contribution to an official of an issuer for whom such person is not entitled to vote. Less than two years after such person made the contribution, the dealer merges with another dealer and, solely as a result of the merger, that person becomes a municipal finance professional of the surviving dealer. Would the surviving dealer be prohibited from engaging in municipal securities business with that issuer?

A: Yes. Rule G-37 would prohibit the surviving dealer from engaging in municipal securities business with the issuer for two years from the date the contribution was made. Of course, the surviving dealer’s prohibition on business would only begin when the person who made the contribution becomes a municipal finance professional of the surviving dealer.

The Board notes, however, that rule G-37 was not intended to prevent mergers in the municipal securities industry or, once a merger is consummated, to seriously hinder the surviving dealer’s municipal securities business if the merger was not an attempt to circumvent the letter or spirit of rule G-37. [Thus, the Board believes that it would be appropriate for the NASD or the appropriate regulatory agency (i.e., federal bank regulatory authorities) to grant conditional or unconditional exemptions from bans on municipal securities business arising from such mergers if the NASD or the appropriate regulatory agency determines that, pursuant to rule G-37(i), the exemption is consistent with the public interest, the protection of investors and the purposes of the rule, as well as any other factors set forth in the rule or any other factors deemed relevant by the NASD or the appropriate regulatory agency.]

[2. Q: The Board has previously provided two examples in which exemptions from a ban on municipal securities business may be appropriate under rule G-37(i). Are these the only situations in which the NASD or the appropriate regulatory agency may provide an exemption under rule G-37(i)?]

[A: No. The two examples noted in Q&A number 4 (June 15, 1995), MSRB Reports, Vol. 15, No. 2 (July 1995) at 3-4, MSRB Manual (CCH) & 3681, were not meant to be the only instances in which exemptions might appropriately be given. Because of the varying factual situations that arise with each exemptive request, the Board believes that the NASD and the appropriate regulatory agencies should review such other factual situations presented by dealers in exemptive requests pursuant to the requirements in rule G-37(i) and, based on the facts, either approve or reject the request. Rule G-37(i) allows the NASD and the appropriate regulatory agencies to grant exemptions from the ban on business "conditionally or unconditionally" and, if the NASD or the appropriate regulatory agency believes it would be appropriate to shorten the ban on business or limit its scope, it is authorized to do so as long as the requirements of rule G-37(i) are met.]

[3. Q: The Board has previously described three situations which it believes are not sufficient to justify the granting of an exemption from a ban on municipal securities business under rule G-37(i). Does this mean that the NASD or the appropriate regulatory agency may never provide an exemption under rule G-37(i) if any of these situations exist?]

[A: No. The Board’s intent in describing these three scenarios in Q&A number 4 (June 15, 1995), MSRB Reports, Vol. 15, No. 2 (July 1995) at 3-4, MSRB Manual (CCH) & 3681, was to note that none of these situations was sufficient, in and of itself, to justify the granting of an exemption from a ban on municipal securities business. However, any such scenario in combination with other facts and circumstances deemed relevant by the NASD or the appropriate regulatory agency (including, but not limited to, the factors set forth in rule G-37(i)) could, in the judgment of the NASD or the appropriate regulatory agency, be sufficient to justify a conditional or unconditional exemption from the ban.

The Board also notes that none of the three situations previously cited as insufficient to justify an exemption involved a contribution made prior to an individual becoming a municipal finance professional. Thus, for example, where a non-de minimis contribution was made by a person who later becomes a municipal finance professional (whether by reason of a merger, as a newly hired associated person, as an existing associated person becoming involved in municipal securities activities, or otherwise), neither the NASD nor any appropriate regulatory agency is constrained from granting a conditional or unconditional exemption if, in its judgment, such exemption is consistent with rule G-37(i).]