Proposed Amendments to Rule G-38 Relating to Solicitation of Municipal Securities Business to Be Filed with the Securities and Exchange Commission

INTRODUCTION

The Municipal Securities Rulemaking Board (“MSRB”) will file with the Securities and Exchange Commission (“SEC”) later this week proposed amendments to Rule G-38, on consultants.  The proposed amendments delete existing Rule G-38, on consultants, and replace it with new Rule G-38, on solicitation of municipal securities business, which prohibits brokers, dealers and municipal securities dealers (“dealers”) from paying persons who are not affiliated with the dealers for soliciting municipal securities business on their behalf.  Affiliated persons to whom payments for solicitations are permitted consist of partners, directors, officers and employees of dealers or of affiliated companies of such dealers.  The proposed amendments become effective upon approval by the SEC.

BACKGROUND

The MSRB began its current rulemaking initiative on the solicitation of municipal securities business[1] by consultants[2] early last year because of certain practices that could present challenges to maintaining the integrity of the municipal securities market.  These practices include, among other things, significant increases in recent years in the number of consultants being used, the amount these consultants are being paid and the level of reported political giving by consultants.  The MSRB has been concerned that increases in levels of compensation paid to consultants for successfully obtaining municipal securities business may be motivating consultants, who currently are not subject to the basic standards of fair practice and professionalism embodied in MSRB rules, to use more aggressive or questionable tactics in their contacts with issuers.  In addition, the MSRB has expressed concern over whether dealers are uniformly making the required disclosures to issuers and on Form G-37/G-38, and whether they are undertaking the other required duties imposed by Rule G-38, for all persons who by their actions should be considered consultants.

As has been more fully described in notices for comment published on April 5, 2004 (the “April 2004 Notice”)[3] and September 29, 2004 (the “September 2004 Notice”),[4] the MSRB believes that, as a proactive measure, it would be appropriate to apply the basic standards of fair practice and professionalism embodied in MSRB rules to all persons who solicit municipal securities business on behalf of dealers.  The application of such standards would ensure that all solicitations are undertaken in accordance with the ethical standards that govern dealer personnel.  In the April 2004 Notice, the MSRB published draft amendments to Rule G-38 that would limit payments by dealers for solicitation of municipal securities business on their behalf solely to associated persons of such dealers.  In the September 2004 Notice, the MSRB published for comment revisions to the draft amendments.  These revised draft amendments retained the prohibition on dealer payments to persons not associated with the dealer who solicit municipal securities business on behalf of such dealer but added several requirements for solicitors who are not partners, directors, officers or employees of the dealer.

After a careful and thorough review of industry comments, the MSRB has concluded that regulatory action in this area is warranted, based on the concerns previously expressed by the MSRB in the April and September 2004 Notices and continuing revelations of questionable activities involving issuer personnel, dealers, other financial services organizations, and third-party intermediaries.  Such activities have the potential to severely undermine public confidence in the municipal securities market.  The MSRB believes that the proposed amendments represent a meaningful step toward further ensuring the continued integrity of the municipal securities market.  The MSRB also believes that the benefits to the municipal securities market resulting from the proposed amendments outweigh the benefits that would accrue to permitting consultants to continue soliciting municipal securities business on behalf of dealers.

Given the limited jurisdictional reach of MSRB rules, however, a more complete response to concerns in this area requires voluntary action on the part of the unregulated parties in the municipal securities market.  The MSRB strongly encourages other industry participants – including but not limited to financial advisers, lawyers and swap participants – to take affirmative steps to ensure the integrity of their portion of the marketplace and toward severing the connection of political contributions and other payments that benefit public officials and their surrogates from the awarding of contracts relating to the municipal securities, derivative products and other financial activities of issuers.  The MSRB observes that the failure of such other parties to take meaningful steps to deter potential conflicts of interests and other possibly abusive practices may merit further consideration by the SEC or Congress.

Thus, the MSRB has determined to file the proposed amendments, described below, with the SEC.[5]  This notice also discusses supervision and certification of compliance with the new requirements of Rule G-38 relating to solicitation of municipal securities business.

SUMMARY OF PROPOSED AMENDMENTS

Summary of Proposed Amendments to Rule G-38

Prohibited Payments.   Existing Rule G-38, on consultants, is replaced in its entirety by proposed new Rule G-38, on solicitation of municipal securities business.  The proposed new rule prohibits dealers from making any direct or indirect payment to any person who is not an affiliated person of the dealer for a solicitation of municipal securities business on behalf of the dealer.

Definitions of Affiliated Person and Affiliated Company.   An affiliated person of a dealer is defined as any partner, director, officer or employee of the dealer or of an affiliated company.  An affiliated company of a dealer is an entity that controls, is controlled by or is under common control with the dealer and whose activities are not limited solely to the solicitation of municipal securities business.  Thus, a dealer affiliate whose activities consist only of soliciting municipal securities business and that undertakes no other bona fide activities with respect to the dealer or with respect to any other affiliated company of the dealer does not qualify as an affiliated company for purposes of new Rule G-38.[6]

Definition of Solicitation.   Solicitation is defined as a direct or indirect communication with an issuer for the purpose of obtaining or retaining municipal securities business.[7]

Transitional Payments and New Form G-38t.   Notwithstanding the foregoing, dealers are permitted to make payments to non-affiliated persons for solicitations of municipal securities business if such payments are made with respect solely to solicitation activities undertaken by such persons on or prior to the date of SEC approval of the amendments.  Such payments are permitted only if (A) the dealer had been selected by the issuer on or prior to the approval date of the proposed amendments to engage in such municipal securities business;[8] (B) the consultant has not solicited municipal securities business from any issuer on behalf of the dealer at any time after the approval date; and (C) the dealer submits to the MSRB, by the last day of the month following the end of each calendar quarter during which payments to the consultant are made or remain pending, new Form G-38t.[9]  The dealer must provide on Form G-38t the same types of disclosures currently required to be made with respect to consultants under existing Rule G-38.[10]  The MSRB will make public copies of all Forms G-38t it receives on its web site at www.msrb.org.  The use of Form G-37/G-38 will be discontinued on the date of SEC approval of the amendments.  All information submitted to the MSRB with respect to consultants on or after the date of SEC approval must be submitted on Form G-38t rather than old Form G-37/G-38, even if a payment required to be reported to the MSRB has been made to the consultant prior to such date of approval.

The MSRB expects that dealers will terminate their contractual obligations with and remit final payments to consultants promptly following approval of the amendments by the SEC.  The MSRB will ask the applicable enforcement agencies to review Forms G-38t and the circumstances of continuing payments to consultants in order to ensure that such payments are not being made in an attempt to circumvent the intent of the new rule provisions.

Summary of Proposed Amendments to Rule G-37 and Forms G-37/G-38 and G-37x

Rule G-37 is amended to (i) delete references and provisions relating to consultant information provided under Rule G-38, (ii) reflect that those associated persons who solicit municipal securities business and thereby are municipal finance professionals include affiliated persons under Rule G-38, (iii) add a reference to the definition of solicitation under new Rule G-38, (iv) reflect the renaming of Form G-37/G-38 as Form G-37, and (v) make section headings consistent throughout the rule.  Form G-37/G-38 is renamed as Form G-37, and Section IV and the consultant attachment to the form are deleted.[11]  In addition, Form G-37x is amended to delete references to the reporting of consultant information.

Summary of Proposed Amendments to Rule G-8

Rule G-8, on recordkeeping, is amended to require dealers to retain copies of any submitted Forms G-38t and records of their submission to the MSRB, as well as to reflect the historical nature of the records that dealers must retain with respect to the deleted consultant provisions of existing Rule G-38.

SUPERVISION AND CERTIFICATION OF COMPLIANCE WITH REQUIREMENTS RELATING TO SOLICITATION OF MUNICIPAL SECURITIES BUSINESS

Rule G-27 obligates dealers to adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance with MSRB rules.  Therefore, dealers will need to adopt, maintain and enforce such procedures to ensure compliance with the new provisions of Rule G-38. Compliance with this supervisory obligation under Rule G-27 with respect to the new provisions of Rule G-38 will require dealers to take the necessary steps to ensure that payments are not directly or indirectly being paid to any person other than an affiliated person of the dealer in exchange for such person’s solicitation of municipal securities business on the dealer’s behalf.  This entails, among other things, understanding the true nature of the services provided by non-affiliated persons for which payments may be made.  Furthermore, under section (e) of Rule G-27, all dealers are required to review, at least on an annual basis, their supervisory system and written supervisory procedures to determine whether they are adequate and up-to-date, and all dealers are required to ensure that they are in compliance with their supervisory obligations.

Dealers are reminded of the recent adoption by NASD of its Rule 3013 and IM-3013, on annual certification of compliance and supervisory processes.[12]  The NASD rule and interpretive material require that NASD member firms designate a chief compliance officer (“CCO”) and have the chief executive officer or equivalent officer (“CEO”) certify annually that the firm has in place processes to establish, maintain, review, test and modify written compliance policies and written supervisory procedures reasonably designed to achieve compliance with, among other things, applicable MSRB rules.  This certification must include statements that the firm has in place certain compliance processes and the CEO has conducted one or more meetings with the CCO in the preceding 12 months to discuss the processes.  Such meetings must include a discussion of the firm’s compliance efforts to date and identify and address significant compliance problems.  The compliance processes required by NASD must be evidenced in a report that is provided to the firm’s board of directors and audit committee.  Such report should include the manner and frequency in which the processes are administered, as well as identification of the officers and supervisors who have responsibility for such administration.

Although NASD makes clear that supervisors with business line responsibility remain accountable for the discharge of a firm’s compliance policies and written supervisory procedures, the CEO will be responsible for the veracity of his or her certification as to having processes in place to establish, maintain, review, test and modify the firm’s written compliance and supervisory policies and procedures.  NASD also makes clear the importance of firms adopting policies and procedures that are effective as to both the scope of, and the achievement of compliance with, applicable MSRB rules.  The MSRB expects that, once the proposed amendments have been approved by the SEC, dealers will expeditiously put into place effective policies and procedures under Rule G-27 relating to the new provisions of Rule G-38 so as to ensure both the achievement of compliance with such provisions and the accuracy of the required CEO certification with respect to the policies and procedures established for Rule G-38.

DISCUSSION OF COMMENTS ON THE SEPTEMBER 2004 NOTICE

In the September 2004 Notice, the MSRB proposed revised draft amendments to Rule G-38 that would have prohibited a dealer from making payments for the solicitation of municipal securities business on its behalf to any person who is not an associated person of the dealer.  The revised draft amendments would have imposed additional obligations on dealers with respect to any solicitor who is not a partner, director, officer or employee.  These obligations would have included the entering into of a contractual agreement, the subjecting of such solicitors to MSRB rules (including but not limited to Rule G-37) with respect to their solicitation activities, and the disclosure of arrangements relating to such solicitors.

The MSRB received comments from 19 commentators.[13]  Several commentators express general support for the revised draft amendments, although some state that the requirements should extend beyond the dealer community and another states that consultants should be fully banned.  Most commentators oppose the revised draft amendments and argue in favor of an alternative approach that would allow consultants to continue to solicit subject to certain contractually imposed standards of fair practice and professionalism.  Other commentators state that the existing disclosure provisions of Rule G-38 work well and should not be changed.  Some of the commentators that oppose the revised draft amendments argue that the associated person concept in the proposal is unworkable and that supervision of outside solicitors for compliance with MSRB rules would be problematic.[14]

As discussed above, the MSRB believes that regulatory action in this area is fully warranted and would help ensure continued public confidence in the municipal securities market.  The existing consultant disclosure requirements under current Rule G-38 have assisted the MSRB in determining that action is necessary in this area but cannot serve as a substitute for such action.  Furthermore, although the suggested contractual alternative to the MSRB proposal might provide some incremental improvement in the regulation of solicitation of municipal securities business over the existing rule, the MSRB believes that its concerns dictate that the MSRB take significantly more decisive action that ensures that dealers are fully responsible for solicitation activities undertaken for their benefit.   The MSRB believes that the proposed amendments to be filed with the SEC represent a meaningful step toward further ensuring the continued integrity of the municipal securities market and invites the unregulated parties in the municipal finance arena to join in the MSRB’s efforts in support of a fair system of public sector financing.

March 15, 2005

* * * * *

TEXT OF PROPOSED AMENDMENTS [15]

Rule G-38.  Solicitation of Municipal Securities Business Consultants

[The existing language of Rule G-38 would be deleted in its entirety and replaced by the following rule language:]

(a) Prohibited Payments.  Subject to section (c) of this rule, no broker, dealer or municipal securities dealer may provide or agree to provide, directly or indirectly, payment to any person who is not an affiliated person of the broker, dealer or municipal securities dealer for a solicitation of municipal securities business on behalf of such broker, dealer or municipal securities dealer.

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

(i) The term “solicitation” means a direct or indirect communication by any person with an issuer for the purpose of obtaining or retaining municipal securities business.

(ii) The term “affiliated person of the broker, dealer or municipal securities dealer” means any person who is a partner, director, officer or employee of the broker, dealer or municipal securities dealer (or, in the case of a bank dealer, any person occupying a similar status or performing similar functions for the bank dealer) or of an affiliated company of the broker, dealer or municipal securities dealer.

(iii) The term “affiliated company of the broker, dealer or municipal securities dealer” means any entity directly or indirectly controlling, controlled by, or under common control with the broker, dealer or municipal securities dealer whose activities with respect to the broker, dealer or municipal securities dealer or with respect to any other affiliated company of the broker, dealer or municipal securities dealer are not limited solely to the solicitation of municipal securities business.

(iv) The terms “issuer,” “municipal securities business” and “payment” shall have the meanings set forth in Rule G-37(g).

(c) Transitional Payments. 

(i) A broker, dealer or municipal securities dealer may make payments to a person other than an affiliated person of the broker, dealer or municipal securities dealer for a solicitation of municipal securities business on behalf of such broker, dealer or municipal securities dealer if such payment is made with respect solely to solicitation activities undertaken by such person on or prior to the effective date of this rule pursuant to a Consultant Agreement under former Rule G-38, but only if:

(A) the broker, dealer or municipal securities dealer had been selected by the issuer on or prior to the effective date of this rule to engage in such municipal securities business;

(B) such person has not solicited municipal securities business from any issuer on behalf of the broker, dealer or municipal securities dealer at any time after the effective date of this rule; and

(C) the broker, dealer or municipal securities dealer sends to the Board, by the last day of the month following the end of each calendar quarter during which payments to such person are made or remain pending, Form G-38t, setting forth, in the prescribed format, the information with respect to such person required to be disclosed to the Board pursuant to section (e) of former Rule G-38.  The broker, dealer or municipal securities dealer shall send two copies of Form G-38t to the Board by certified or registered mail, or some other equally prompt means that provides a record of sending.  The Board shall make public a copy of each Form G-38t received from any broker, dealer or municipal securities dealer.

(ii) For purposes of this section (c), the term “effective date of this rule” means [insert date of SEC approval of proposed rule change] and the term “former Rule G-38” means Rule G-38 of the Board in effect on the day prior to the effective date of this rule.

                                                                       * * * * *

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

(a) No change.

(b) Ban on Municipal Securities Business.  No change.

(c) Prohibition on Soliciting and Coordinating Contributions.  No change.

(d) Circumvention of Rule.  No change.

(e) Required Disclosure to Board.

(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 Form G-37/G-38 setting forth, in the prescribed format, the following information:

(A)-(B) No change.

(C) any information required to be included on Form G-37/G-38 for such calendar quarter pursuant to paragraph (e)(iii);

(D) any information required to be disclosed pursuant to section (e) of rule G-38;

(D) (E) such other identifying information required by Form G-37/G-38; and

(E) (F) No change.

The Board shall make public a copy of each Form G-37/G-38 received from any broker, dealer or municipal securities dealer.

(ii)(A) No broker, dealer or municipal securities dealer shall be required to send Form G-37/G-38 to the Board for any calendar quarter in which either:

(A) (1) such broker, dealer or municipal securities dealer has no information that is required to be reported pursuant to clauses (A) through (C) (D) of paragraph (e)(i) for such calendar quarter; or

(B) (2) subject to clause (B) of this paragraph (e)(ii), such broker, dealer or municipal securities dealer has not engaged in municipal securities business, but only if such broker, dealer or municipal securities dealer:

(1) (a) No change.

(2) (b) has sent to the Board completed Form G-37x setting forth, in the prescribed format, (a) (i) a certification to the effect that such broker, dealer or municipal securities dealer did not engage in municipal securities business during the eight consecutive calendar quarters immediately preceding the date of such certification, (b) (ii) certain acknowledgements as are set forth in said Form G-37x regarding the obligations of such broker, dealer or municipal securities dealer in connection with Forms G-37/G-38 and G-37x under this paragraph (e)(ii) and rule G-8(a)(xvi), and (c) (iii) such other identifying information required by Form G-37x; provided that, if a broker, dealer or municipal securities dealer has engaged in municipal securities business subsequent to the submission of Form G-37x to the Board, such broker, dealer or municipal securities dealer shall be required to submit a new Form G-37x to the Board in order to again qualify for an exemption under this subclause (B) (A)(2).  The Board shall make public a copy of each Form G-37x received from any broker, dealer or municipal securities dealer.

(B) If for any calendar quarter a broker, dealer or municipal securities dealer has met the requirements of clause (A)(2) of this paragraph (e)(ii) but has information that is required to be reported pursuant to clause (D) of paragraph (e)(i), then such broker, dealer or municipal securities dealer shall be required to send Form G-37/G-38 to the Board for such quarter setting forth only such information as is required to be reported pursuant to clauses (D) and (E) of paragraph (e)(i).

(iii) If a broker, dealer or municipal securities dealer engages in municipal securities business during any calendar quarter after not having reported on Form G-37/G-38 the information described in clause (A) of paragraph (e)(i) for one or more contributions or payments during the two-year period preceding such calendar quarter solely as a result of clause (B) (A)(2) of paragraph (e)(ii), such broker, dealer or municipal securities dealer shall include on Form G-37/G-38 for such calendar quarter all such information (including year and calendar quarter of such contributions or payments) not so reported during such two-year period.

(iv) A broker, dealer or municipal securities dealer that submits Form G-37/G-38 or Form G-37x to the Board shall either:

(A) No change.

(B) submit an electronic version of such form to the Board in such format and manner specified in the current Instructions for Forms G-37/G-38 and Form G-37x.

(f) Voluntary Disclosure to Board.  No change.

(g) Definitions.

(i)-(iii) No change.

(iv) The term “municipal finance professional” means:

(A) No change.

(B) any associated person (including but not limited to any affiliated person of the broker, dealer or municipal securities dealer, as defined in rule G-38) who solicits municipal securities business, as defined in paragraph (vii);

(C)-(E) No change.

Each person designated by the broker, dealer or municipal securities dealer as a municipal finance professional pursuant to rule G-8(a)(xvi) is deemed to be a municipal finance professional.  Each person designated a municipal finance professional shall retain this designation for one year after the last activity or position which gave rise to the designation.

(v)-(viii) No change.

(ix) Except as used in section (c), the term “solicit” means the taking of any action that would constitute a solicitation as defined in rule G-38(b)(i).

(h) Operative Date.  No change.

(i) Application for Exemption.  No change.

(j) No change.

                                                                       * * * * *

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:

(i)-(xv) No change.

(xvi) Records Concerning Political Contributions and Prohibitions on Municipal Securities Business Pursuant to Rule G-37. Records reflecting:

(A)-(G) No change.

(H) Brokers, dealers and municipal securities dealers shall maintain copies of the Forms G-37/G-38 and G-37x sent to the Board along with the certified or registered mail receipt or other record of sending such forms to the Board.

(I)-(J) No change.

(K) No broker, dealer or municipal securities dealer shall be subject to the requirements of this paragraph (a)(xvi) during any period that such broker, dealer or municipal securities dealer has qualified for and invoked the exemption set forth in clause (B) (A)(2) of paragraph (e)(ii) of rule G-37; provided, however, that such broker, dealer or municipal securities dealer shall remain obligated to comply with clause (H) of this paragraph (a)(xvi) during such period of exemption.  At such time as a broker, dealer or municipal securities dealer that has been exempted by this clause (K) from the requirements of this paragraph (a)(xvi) engages in any municipal securities business, all requirements of this paragraph (a)(xvi) covering the periods of time set forth herein (beginning with the then current calendar year and the two preceding calendar years) shall become applicable to such broker, dealer or municipal securities dealer.

(xvii) No change.

(xviii) Records Concerning Consultants Pursuant to Former Rule G-38.  Each broker, dealer and municipal securities dealer shall maintain:

(A) No change.

(B) a copy of each Consultant Agreement referred to in former rule G-38(b);

(C)-(D) No change.

(E) a listing of issuers and a record of disclosures made to such issuers, pursuant to former rule G-38(d), concerning each consultant used by the broker, dealer or municipal securities dealer to obtain or retain municipal securities business with each such issuer;

(F)  records of each reportable political contribution (as defined in former rule G-38(a)(vi)), which records shall include:

(1)-(3) No change.

(G) records of each reportable political party payment (as defined in former rule G-38(a)(vii)), which records shall include:

(1)-(3) No change.

(H) records indicating, if applicable, that a consultant made no reportable political contributions (as defined in former rule G-38(a)(vi)) or no reportable political party payments (as defined in former rule G-38(a)(vii));

(I) a statement, if applicable, that a consultant failed to provide any report of information to the dealer concerning reportable political contributions or reportable political party payments; and

(J) the date of termination of any consultant arrangement.; and

(K) copies of the Forms G-38t sent to the Board along with the certified or registered mail receipt or other record of sending such forms to the Board.

For purposes of this clause (xviii), the term “former rule G-38” shall have the meaning set forth in Rule G-38(c)(ii).

(xix)-(xxii) No change.

(b)-(g) No change.

                                                                       * * * * *

 

CLICK HERE FOR NEW FORM G-38t AND AMENDED FORMS G-37 AND G-37x 

 

---