Notice of Filing of Proposed Rule Change Relating to Amendments to Rule G-20, on Gifts and Gratuities, and Rule G-8, on Recordkeeping

On January 13, 2005, the Municipal Securities Rulemaking Board (“MSRB”) filed with the Securities and Exchange Commission (“SEC”) a proposed rule change to amend Rule G-20, on gifts and gratuities, and the related recordkeeping provisions of Rule G-8. [1]  The proposed amendments will become effective upon approval by the SEC.

SUMMARY OF PROPOSED AMENDMENTS

MSRB Rule G-20 prohibits dealers from directly or indirectly giving or permitting to be given any thing or service of value in excess of $100 per year to any person other than an employee or partner of the dealer in relation to the municipal securities activities of the recipient’s employer.  The rule provides certain exemptions from the $100 annual limit for “normal business dealings,” including (i) occasional gifts of meals or tickets to theatrical, sporting and other entertainment; (ii) sponsoring legitimate business functions that are recognized by the IRS as deductible business expenses; and (iii) gifts of reminder advertising.  However, such gifts must not be so frequent or excessive as to raise a suggestion of unethical conduct. 

MSRB Rule G-20 currently does not mandate specific requirements with respect to non-cash sales incentives, although the general fair practice principles of Rule G-17 apply. [2]  The MSRB has interpreted Rule G-17 in the context of municipal fund securities to provide that a dealer may violate the rule by engaging in marketing activities that result in a customer being treated unfairly, or by engaging in any deceptive, dishonest or unfair practice in connection with such marketing activities. [3]  Further, depending on the particular facts and circumstances, a dealer may violate Rule G-17 if it acts in a manner that is reasonably likely to induce another dealer to violate the principles of Rule G-17 or other MSRB customer protection rules. [4]  In contrast, NASD Rules 2710(i), 2820(g)(4) and 2830(l)(5) establish specific requirements with respect to the payment of non-cash compensation in connection with offerings of corporate securities, variable contracts and mutual funds.

The MSRB has determined that similar treatment across the securities markets is appropriate and would facilitate dealer understanding of, and compliance with, requirements relating to sales incentives and non-cash compensation.  Thus, the proposed amendments are intended to more fully conform Rule G-20 to NASD requirements relating to gifts and gratuities, and to add new provisions governing non-cash compensation and sales incentives in connection with municipal fund securities and other primary offerings of municipal securities, based on NASD requirements for non-cash compensation and sales incentives.  The proposed amendments would result in the following changes to Rule G-20:

•        Modify the existing provision in Rule G-20 that permits occasional gifts of meals or sports and entertainment tickets, and sponsorship of business functions outside of the $100 per year limitation by requiring that dealer personnel host (accompany) such meals, entertainment and business functions in conformity with NASD gift rule limitations, and further modify the language of the requirement to incorporate NASD language to the effect that such occasional gifts must not call into question the dealer’s ethical standards. [5] 

•        Clarify that NASD interpretations apply to comparable MSRB provisions, unless the MSRB specifically provides otherwise.

•        Incorporate definitions of “non-cash compensation,” “cash compensation” and “offeror” based on language in NASD Rules 2710, 2820 and 2830, and expand the definition of offeror to include, with respect to securities held as assets underlying municipal fund securities, any person considered an offeror under relevant NASD rules.

•        Treat non-cash sales incentives relating to municipal fund securities and other primary offerings of municipal securities (i.e., bonds and notes) in a manner similar to NASD’s treatment of non-cash sales incentives relating to mutual funds, variable contracts, and corporate debt and equity offerings, including, among other things, permitting gifts that do not exceed $100 per individual per year and are not preconditioned on achievement of a sales target; and permitting the giving and receipt of occasional gifts of meals or tickets to theatrical, sporting and other entertainment, but only if such occasional gifts are not preconditioned on achievement of a sales target.

•        Limit the circumstances under which dealers or offerors may pay or reimburse costs of training or education, based on NASD rules, including ensuring that attendance at, and payment for, such meetings is not preconditioned on achievement of a sales target; reimbursement is not applied to expenses of associated persons’ guests; and that such meetings are held at appropriate locations. [6]

•        Require that non-cash compensation arrangements include the total production and equal weighting requirements under NASD rules, which are designed to ensure that the arrangement does not favor sales of one municipal security over another. [7]

•        Amend the recordkeeping requirements in Rule G-8 to require that dealers maintain a record of non-cash compensation received in connection with a primary offering from the issuer or its advisers, the underwriter, or any of their affiliates, as well as records regarding any internal sales incentive program for municipal fund securities.

The MSRB intends generally that the provisions of Rule G-20 be read consistently with the analogous NASD provisions, unless the MSRB specifically indicates otherwise.  Thus, relevant NASD interpretations would be presumed to apply to the comparable MSRB provision, subject to the MSRB’s right to make distinctions when necessary and appropriate in the context of municipal fund securities and other primary offerings of municipal securities.

DISCUSSION OF INDUSTRY COMMENTS

            In June 2004, the MSRB requested comment on draft amendments to Rule G-20, and the related recordkeeping provisions of Rule G-8, that would:

•       Treat non-cash sales incentives relating to municipal fund securities and other primary offerings of municipal securities (i.e., bonds and notes) in a manner similar to NASD’s treatment of non-cash sales incentives relating to mutual funds and corporate debt and equity offerings.

•      Modify the existing provision in MSRB Rule G-20 that permits occasional gifts of meals or sports and entertainment tickets, and sponsorship of business functions outside of the $100 per year limitation by requiring that dealer personnel host (accompany) such meals, entertainment and business functions.

•      Amend the recordkeeping requirements in Rule G-8 to require that dealers maintain a record of non-cash compensation received in connection with a primary offering from the issuer or its advisers, the underwriter, or any of their affiliates, as well as records regarding any internal sales incentive program for municipal fund securities. [8]

In response to the draft amendments, the MSRB received comment letters from NASD, Investment Company Institute (“ICI”), Morgan Keegan, and Bernardi Securities.  Three of the commentators (NASD, ICI and Morgan Keegan) expressed general support for the draft amendments, and one commentator (Bernardi Securities) opposed one aspect of the draft amendments.  Two of the commentators (NASD and ICI) suggested that the MSRB make certain revisions, discussed below. 

The MSRB believes that a number of the commentators’ concerns and suggestions have merit and, accordingly, revised the amendments to (1) incorporate NASD rule language where possible; (2) clarify that NASD interpretations would apply to comparable MSRB provisions, unless the MSRB specifically provides otherwise; and (3) expand the definition of offeror to include, with respect to securities held as assets underlying municipal fund securities, any person considered an offeror under relevant NASD rules.

Consistency between NASD and MSRB Rules.  NASD and ICI supported the MSRB’s proposal to make Rule G-20 consistent with NASD’s rules.  ICI stated that a “uniform system of regulation between the MSRB and the NASD reduces the potential that persons subject to both regimes will face conflicting regulatory requirements and facilitates compliance efforts.  Moreover, inasmuch as the NASD is charged with inspecting securities firms for compliance with the rules of the MSRB, providing uniformity between MSRB’s rules and those of the NASD . . . should facilitate the NASD’s ability to conduct such inspections.”  NASD suggested that the MSRB, “whenever possible, use precisely the same language as Rule 2830, and clarify that…[NASD’s] interpretation of that rule would similarly apply to the interpretation of the Rule G-20 amendments.”

The MSRB agrees that, whenever possible, incorporating identical language between comparable provisions of MSRB and NASD rules would facilitate dealer understanding of and compliance with such provisions, as well as facilitate the inspection and enforcement thereof.  The MSRB has, therefore, incorporated NASD language in the proposed amendments to Rule G-20, including those provisions relating to the requirement that dealers host meals, tickets to events and the like; technical language on gifts that call into question the dealer’s ethical standards; non-cash compensation arrangements, including payment or reimbursement for education and training meetings; and the definitions of “non-cash compensation, “cash compensation,” and “offeror.” 

NASD interpretations.  NASD asked the MSRB to clarify whether NASD’s interpretation of the exception for training and education meetings, as set forth in its Summer 2000 Regulatory and Compliance Alert, would apply to the training and education meeting exception in the draft amendments. [9]  The MSRB agrees that this interpretation should apply to the similar provisions of amended Rule G-20.

As noted above, the MSRB intends generally that the provisions of Rule G-20 be read consistently with the analogous NASD provisions, unless the MSRB specifically indicates otherwise.  Thus, relevant NASD interpretations would be presumed to apply to the comparable MSRB provision, subject to the MSRB’s right to make distinctions when necessary and appropriate in the context of municipal fund securities and other primary offerings of municipal securities.

Definition of “offeror.”  NASD suggested that the draft definition of “offeror,” which includes the issuer’s service providers in connection with the marketing and maintenance of its municipal fund securities, also should include the investment adviser to the underlying funds.  Similarly, ICI recommended expanding the draft definition of “offeror” to include the issuer of any investment product into which the assets of a municipal fund security are invested, as well as any investment adviser, fund administrator, underwriter, or affiliated person of such entities with respect to such underlying investments.  The MSRB agrees, and revised the proposed rule language to reflect this change, with minor adjustments to more fully conform to municipal fund securities and other primary offerings of municipal securities.

Applicability of basic gift limitation to municipal fund securities.  ICI suggested that the MSRB limit the provisions that would be applicable to municipal fund securities to those set forth in draft subsection (d) of Rule G-20.  ICI noted that the draft amendments would result in there being two provisions governing “de minimis” gifts, and two provisions governing gifts of meals or tickets.  ICI stated that this is unnecessary and will create confusion.  It recommended that subsections (a) and (b) be revised to exclude the offer and sale of municipal fund securities, and that such offers and sales be subject solely to subsection (d).  The MSRB does not agree with this suggestion; the two provisions are intended to apply in different contexts.  Rule G-20(a) applies to gifts and gratuities in relation to the municipal securities activities of the employer of the recipient.  Rule G-20(d) applies to non-cash compensation in connection with the sale and distribution of a primary offering of municipal securities.  The MSRB believes that both provisions are important and both should apply to municipal fund securities as well as to other primary offerings of municipal securities.  The MSRB observes that dealers selling mutual fund shares also are currently subject to both NASD Rule 3060 and NASD Rule 2830(l)(5).

Records of de minimis gifts.  ICI recommended that the MSRB revise the draft recordkeeping requirement in Rule G-8 regarding non-cash compensation to conform to NASD Rule 2830, on investment company securities.  ICI stated that the NASD rule does not require dealers to keep records of de minimis gifts (i.e., those under $100 per year) or occasional meals or tickets to theatrical and sporting events.  ICI suggested that the MSRB similarly exclude these items from the recordkeeping requirements of Rule G-8 “based on the conclusion that these de minimis items do not raise regulatory concerns and, therefore, the burden of making and keeping such records would exceed any benefits of requiring them.”  ICI further noted that this revision would provide uniformity between MSRB and NASD recordkeeping requirements.  The MSRB does not agree with this recommendation.  The provisions in NASD Rule 3060, on influencing or rewarding employees of others, require firms to keep a separate record of all payments or gratuities in any amount.  The MSRB believes that a recordkeeping requirement for de minimis gifts is necessary for both the dealer and the appropriate regulatory agency to determine whether a rule violation has occurred.

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Questions concerning this notice should be directed to Ernesto A. Lanza, Senior Associate General Counsel, or Jill C. Finder, Assistant General Counsel, at 703-797-6600.

January 13, 2005

TEXT OF AMENDMENTS [10]

Rule G-20 – Gifts, [and] Gratuities and Non-Cash Compensation.

(a) General Limitation on Value of Gifts and Gratuities.  No broker, dealer or municipal securities dealer shall, directly or indirectly, give or permit to be given any thing or service of value, including gratuities, in excess of $100 per year to a person other than an employee or partner of such broker, dealer or municipal securities dealer, if such payments or services are in relation to the municipal securities activities of the employer of the recipient of the payment or service.  For purposes of this rule the term “employer” shall include a principal for whom the recipient of a payment or service is acting as agent or representative.

(b) Normal Business Dealings.  Notwithstanding the foregoing, the provisions of section (a) of this rule shall not be deemed to prohibit occasional gifts of meals or tickets to theatrical, sporting, and other entertainments hosted by the broker, dealer or municipal securities dealer; the sponsoring by the broker, dealer or municipal securities dealer of legitimate business functions that are recognized by the Internal Revenue Service as deductible business expenses; or gifts of reminder advertising; provided, that such gifts shall not be so frequent or so [expensive] extensive as to raise [a suggestion of conduct inconsistent with high standards of professional ethics in the municipal securities industry] any question of propriety.

(c) No change.

(d) Non-Cash Compensation in Connection with Primary Offerings.  In connection with the sale and distribution of a primary offering of municipal securities, no broker, dealer or municipal securities dealer, or any associated person thereof, shall directly or indirectly accept or make payments or offers of payments of any non-cash compensation.  Notwithstanding the provisions of section (a) of this rule, the following non-cash compensation arrangements are permitted:

(i) gifts that do not exceed $100 per individual per year and are not preconditioned on achievement of a sales target;

(ii) occasional gifts of meals or tickets to theatrical, sporting, and other entertainments; provided that such gifts are not so frequent or so extensive as to raise any question of propriety and are not preconditioned on achievement of a sales target;

(iii) payment or reimbursement by offerors in connection with meetings held by an offeror or by a broker, dealer or municipal securities dealer for the purpose of training or education of associated persons of a broker, dealer or municipal securities dealer, provided that:

(A) associated persons obtain the prior approval of the broker, dealer or municipal securities dealer to attend the meeting and attendance is not preconditioned by the broker, dealer or municipal securities dealer on achievement of a sales target or any other incentives pursuant to a non-cash compensation arrangement permitted by paragraph (d)(iv);

(B) the location is appropriate to the purpose of the meeting, which shall mean an office of the offeror or the broker, dealer or municipal securities dealer, a facility located in the vicinity of such office, a regional location with respect to regional meetings, or a location at which a significant asset, if any, being financed or refinanced in the primary offering is located;

(C) the payment or reimbursement is not applied to the expenses of guests of the associated person; and

(D) the payment or reimbursement is not preconditioned by the offeror on achievement of a sales target or any other non-cash compensation arrangement permitted by paragraph (d)(iv).

(iv) non-cash compensation arrangements between a broker, dealer or municipal securities dealer and its associated persons, or a company that controls the broker, dealer or municipal securities dealer and the associated persons of the broker, dealer or municipal securities dealer, provided that:

(A) the non-cash compensation arrangement is based on the total production of associated persons with respect to all municipal securities within respective product types distributed by the broker, dealer or municipal securities dealer;

(B) the non-cash compensation arrangement requires that the credit received for each municipal security within a municipal security product type is equally weighted; and

(C) no entity that is not an associated person of the broker, dealer or municipal securities dealer participates directly or indirectly in the organization of a permissible non-cash compensation arrangement.

(v) contributions by any person other than the broker, dealer or municipal securities dealer to a non-cash compensation arrangement between a broker, dealer or municipal securities dealer and its associated persons, provided that the arrangement meets the criteria in paragraph (d)(iv). 

(e) Definitions.  For purposes of this rule, the following terms have the following meanings: 

(i)         The term “non-cash compensation” shall mean any form of compensation received in connection with the sale and distribution of municipal securities that is not cash compensation, including but not limited to merchandise, gifts and prizes, travel expenses, meals and lodging.

(ii)        The term “cash compensation” shall mean any discount, concession, fee, service fee, commission, asset-based sales charge, loan, override or cash employee benefit received in connection with the sale and distribution of municipal securities.

(iii)       The term “offeror” shall mean, with respect to a primary offering of municipal securities, the issuer, any adviser to the issuer (including but not limited to the issuer’s financial adviser, bond or other legal counsel, or investment or program manager in connection with the primary offering), the underwriter of the primary offering, or any person controlling, controlled by, or under common control with any of the foregoing; provided, however, that, with respect to a primary offering of municipal fund securities, “offeror” shall also include any person considered an “offeror” under NASD Rule 2710, NASD Rule 2820 or NASD Rule 2830 in connection with any securities held as assets of or underlying such municipal fund securities.

(iv)       The term “primary offering” shall mean a primary offering defined in Securities Exchange Act Rule 15c2-12(f)(7).

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

(a)(i) – (xvi) No change.

(xvii)  Records Concerning Compliance with Rule G-20.  Each broker, dealer and municipal securities dealer shall maintain:

(A) [(i)] a separate record of any gift or gratuity referred to in Rule G-20(a); [and]

(B) [(ii)] all agreements referred to in Rule G-20(c) and all compensation paid as a result of those agreements; and[.]

(C) records of all non-cash compensation referred to in Rule G-20(d).  The records shall include the name of the person or entity making the payment, the names of the associated persons receiving the payments (if applicable), and the nature (including the location of meetings described in Rule G-20(d)(iii), if applicable) and value of non-cash compensation received.

 (xviii) – (xxii)  No change.

(b)-(g)  No change.

 

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