Purchase of new issue from issuer. This is in response to your letter in which you ask whether Board rule G-17, on fair dealing, or any other rule, regulation or federal law, requires an underwriter to purchase a bond issue from a municipal securities issuer at a “fair price.”

Rule G-17 states that, in the conduct of its municipal securities business, each broker, dealer and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice. Thus, the rule requires dealers to deal fairly with issuers in connection with the underwriting of their municipal securities.  Whether or not an underwriter has dealt fairly with an issuer is dependent upon the facts and circumstances of an underwriting and cannot be addressed simply by virtue of the price of the issue. For example, in a competitive underwriting where an issuer reserves the right to reject all bids, a dealer submits a bid at a net interest cost it believes will enable it to successfully market the issue to investors. One could not view a dealer as having violated rule G-17 just because it did not submit a bid that the issuer considers fair. On the other hand, when a dealer is negotiating the underwriting of municipal securities, a dealer has an obligation to negotiate in good faith with the issuer. If the dealer represents to the issuer that it is providing the best market price available on this issue, and this is not the case, the dealer may violate rule G-17. Also, if the dealer knows the issuer is unsophisticated or otherwise depending on the dealer as its sole source of market information, the dealer’s duty under rule G-17 is to ensure that the issuer is treated fairly, specifically in light of the relationship of reliance that exists between the issuer and the underwriter. MSRB interpretation of December 1, 1997.

Recently, dealers have raised questions regarding how the prohibition on municipal securities business in rule G-37, on political contributions and prohibitions on municipal securities business, applies to certain situations. Rule G-37 prohibits any dealer from engaging in municipal securities business with an issuer within two years after any contribution to an official of such issuer made by: (i) the dealer; (ii) any municipal finance professional associated with such dealer; or (iii) any political action committee controlled by the dealer or any municipal finance professional.[1] If a municipal finance professional makes a political contribution to an issuer official for whom he is not entitled to vote, the dealer is prohibited from engaging in municipal securities business with that issuer for two years. The Board has been asked whether the prohibition on municipal securities business extends to certain services provided under contractual agreements with an issuer that pre-date the contribution. The Board is issuing the following interpretation of the prohibition on municipal securities business pursuant to rule G-37.

"New" Municipal Securities Business

 A dealer subject to a prohibition on municipal securities business with an issuer may not enter into any new contractual obligations with that issuer for municipal securities business.[2] The Board adopted rule G-37 in an effort to sever any connection between the making of political contributions and the awarding of municipal securities business. The Board believes that the problems associated with political contributions––including the practice known as "pay-to-play"––undermine investor confidence in the municipal securities market, which confidence is crucial to the long-term health of the market, both in terms of liquidity and capital-raising ability.

Pre-Existing Issue-Specific Contractual Undertakings

The Board believes that it is consistent with the intent of rule G-37 that a dealer subject to a prohibition on municipal securities business with an issuer be allowed to continue to execute certain issue-specific contractual obligations in effect prior to the date of the contribution that caused the prohibition. For example, if a bond purchase agreement was signed prior to the date of the contribution, a dealer may continue to perform its services as an underwriter on the issue. Also, if an issue-specific agreement for financial advisory services was in effect prior to the date of the contribution, the dealer may continue in its role as financial advisor for that issue. In the same manner, a dealer may act as remarketing agent or placement agent for an issue and also may continue to underwrite a commercial paper program as long as the contract to perform these services was in effect prior to the date of the contribution. Subject to the limitations noted below, these activities are not considered new municipal securities business and thus can be performed by dealers under a prohibition on municipal securities business with the issuer.

Dealers also have asked questions regarding certain terms in contracts to provide on-going municipal securities business that allow for additional services or compensation. For example, a dealer may have an agreement to provide remarketing services for a municipal securities issue, the terms of which allow the issuer to change the "mode" of the outstanding bonds from variable to a fixed rate of interest or from Rule 2a-7 eligible to non-Rule 2a-7 eligible. [3] Generally, the per bond fee increases if the dealer sells fixed rate municipal securities or non-money market fund securities. Also, an agreement to underwrite a commercial paper program may include terms for increasing the size of the program. While the per bond fee probably does not increase if more commercial paper is underwritten, the amount of money paid to the dealer does increase. The Board views the provisions in existing contracts that allow for changes in the services provided by the dealer or compensation paid by the issuer as new municipal securities business and, therefore, rule G-37 precludes a dealer subject to a prohibition on municipal securities business from performing such additional functions or receiving additional compensation.

Non-Issue Specific Contractual Undertakings

Dealers also at times enter into long-term contracts with issuers for municipal securities business, e.g., a five-year financial advisory agreement. If a contribution is given after such a non-issue-specific contract is entered into that results in a prohibition on municipal securities business, the Board believes the dealer should not be allowed to continue with the municipal securities business, subject to an orderly transition to another entity to perform such business. This transition should be as short a period of time as possible and is intended to give the issuer the opportunity to receive the benefit of the work already provided by the dealer and to find a replacement to complete the work, as needed.

* * *

The Board recognizes that there is a great variety in the terms of agreements regarding municipal securities business and that the interpretation noted above may not adequately deal with all such agreements. Thus, the Board is seeking comment on how a prohibition on municipal securities business pursuant to rule G-37 affects contracts for municipal securities business entered into with issuers prior to the date of the contribution triggering the prohibition on business. In particular, the Board is seeking comment on other examples whereby a dealer may be contractually obligated to perform certain activities after the date of the triggering contribution. If other examples are provided, the Board would like comments on how these situations should be addressed pursuant to rule G-37.

Based upon the comments received on this notice, the Board may issue additional interpretations or amend the language of rule G-37. 

[1] The only exception to rule G-37’s absolute prohibition on municipal securities business is for certain contributions made to issuer officials by municipal finance professionals. Contributions by such persons to officials of issuers do not invoke application of the prohibition on business if (i) the municipal finance professional is entitled to vote for such official and (ii) contributions by such municipal finance professional do not exceed, in total, $250 to each official, per election.

[2] The term "municipal securities business" is defined in the rule to encompass certain activities of dealers, such as acting as negotiated underwriters (as managing underwriter or as syndicate member), financial advisors, placement agents and negotiated remarketing agents. The rule does not prohibit dealers from engaging in business awarded on a competitive bid basis.

[3] SEC Rule 2a-7 under the Investment Company Act of 1940 defines eligible securities for inclusion in money market funds

Financial advisor to conduit borrower.  This is in response to your letter concerning rule G-37, on political contributions and prohibitions on municipal securities business. You state that your firm served as financial advisor to the underlying borrower, not the governmental issuer, for a certain issue of municipal securities. You ask whether you are required to report this financial advisory activity on Form G-37/G-38.

Rule G-37(g)(vii) defines the term "municipal securities business" to include "the provision of financial advisory or consultant services to or on behalf of an issuer with respect to a primary offering of municipal securities in which the dealer was chosen to provide such services on other than a competitive bid basis." If the financial advisory services your firm provided were to the underlying borrower and not "to or on behalf of an issuer,"[1] then your firm was not engaging in "municipal securities business" and these financial advisory services are not required to be reported on Form G-37/G-38.  MSRB interpretation of January 23, 1997.
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[1] Rule G-37(g)(ii) defines "issuer" as the governmental issuer specified in section 3(a)(29) of the Securities Exchange Act.

Fairness opinions. This is in response to your letter concerning the retention of your firm by issuers to render a fairness opinion on the pricing associated with certain negotiated issues of general obligation municipal securities issued by [state deleted] governmental units. You ask whether the rendering of these fairness opinions on the pricing of municipal securities issues is a financial advisory activity which must be disclosed on Form G-37/G-38 as municipal securities business.

Rule G-23, on activities of financial advisors, states in paragraph (b) that a financial advisory relationship shall be deemed to exist when

a broker, dealer, or municipal securities dealer renders or enters into an agreement to render financial advisory or consultant services to or on behalf of an issuer with respect to a new issue or issues of municipal securities, including advice with respect to the structure, timing, terms and other similar matters concerning such issue or issues, for a fee or other compensation or in expectation of such compensation for the rendering of such services. [Emphasis added]

Thus, the activity your firm performs on behalf of issuers of municipal securities pursuant to an agreement (i.e. , rendering advice with respect to the terms of a new issue) establishes that a financial advisory relationship exists between your firm and these issuers.

Rule G-37, on political contributions and prohibitions on municipal securities business, requires dealers to report municipal securities business to the Board on Form G-37/G-38. The definition of "municipal securities business" contained in rule G-37(g)(viii) includes

the provision of financial advisory or consultant services to or on behalf of an issuer with respect to a primary offering of municipal securities in which the dealer was chosen to provide such services on other than a competitive bid basis.

Pursuant to the information contained in your letter, your firm should submit a Form G-37/G-38 during each quarter in which the firm reaches an agreement to provide the financial advisory services you described. If your firm has an on-going financial advisory arrangement with an issuer, your firm would need to list each new issue in which your firm acted as financial advisor during the quarter in which the new issue settled. I have enclosed for your information a copy of the Rule G-37 and Rule G-38 Handbook which includes instructions for completing and filing Form G-37/G-38. MSRB interpretation of January 10, 1997.

Separately identifiable department or division of a bank. This will acknowledge receipt of your letter of November 12, 1975, in which you request, on behalf of the Dealer Bank Association, an interpretative opinion with respect to the rule of the Municipal Securities Rulemaking Board (the "Board") defining the term "separately identifiable department or division of a bank," as used in section 3(a)(30) of the Securities Exchange Act of 1934, as amended (the "Act"). Such rule was originally numbered rule 4 of the Board and became effective on October 15, 1975. The rule is presently numbered rule G-1 of the Board.

In your letter you pose a series of questions concerning rule G-1, as follows: 

1. A bank has an operations department that performs processing and clearance activities, and maintains records, with respect to the bank's underwriting, trading and sales of municipal securities, as well as with respect to certain other bank activities. Can this bank have a "separately identifiable department or division" as defined in rule G-1?
2. In a bank with numerous branches, an employee or officer in a branch will on occasion accept or solicit an order from a customer for municipal securities. Does this preclude a finding that the bank has a "separately identifiable department or division"?
3. Mr. X is a senior vice president of a bank. He is not a director. Mr. X's only relationship to the bank's municipal securities dealer activities is that he is a member of a management committee within the bank that determines the amount of the bank's funds that will be made available for the bank's municipal securities dealer activities, as well as for other bank activities. The bank has a separately identifiable department or division that otherwise meets the requirements of rule G-1. Is Mr. X a person who must be designated by the board of directors of the bank under rule G-1(a)(1)?
4. A bank has a corporate trust department that, among other things, serves as paying agent for certain municipal securities and performs clearing functions in municipal securities, in addition to the processing and clearance activities performed in connection with the bank's underwriting, trading and sales of municipal securities. Are the persons in the bank's corporate trust department who engage solely in activities that do not relate to the underwriting, trading and sales of municipal securities by the bank performing municipal securities dealer activities?

With respect to question (1) above, paragraph (d) of rule G-1 contemplates that the municipal securities dealer activities of a bank, as such activities are defined in paragraph (b) of the rule, may be conducted in more than one organizational or operational unit of the bank, for example, underwriting, trading and sales activities in the bond department, and processing and clearance activities in the operations department of the bank. Under the rule, all such units can be aggregated to constitute a separately identifiable department or division within the meaning of section 3(a)(30) of the Act, provided that each such unit is identifiable and under the direct supervision of an officer designated by the board of directors of the bank as responsible for the day-to-day conduct of the bank's municipal securities dealer activities. The officer so designated need not be the same for all such units. For example, the senior officer of the bank's bond department may be designated as responsible for the municipal securities dealer activities conducted by that department, while the senior officer of the bank's operations department may be designated as responsible for the municipal securities dealer activities conducted by that department. In addition, the records of each such unit relating to municipal securities dealer activities must be separately maintained or separately extractable so as to permit independent examination of such records and enforcement of applicable provisions of the Act, the rules and regulations of the Commission thereunder and the rules of the Board. Finally, each such unit comprising the separately identifiable department or division may be engaged in activities other than those relating to municipal securities dealer activities. For example, the bond department may also engage in activities relating to United States government obligations, while the operations department may perform processing and clearance functions for departments of the bank other than the bond department.

With respect to question (2) above, paragraph (d) of rule G-1 also contemplates that the municipal securities dealer activities of a bank may be conducted at more than one geographic location. However, in order for such a bank to have a separately identifiable department or division, the branch employees who accept or solicit orders for municipal securities must, with respect to acceptance or solicitation of such orders, be affiliated with one of the identifiable units of the bank comprising such department or division and must, with respect to acceptance or solicitation of such orders, be responsible to an officer designated by the board of directors of the bank as responsible for the day-to-day conduct of the bank's municipal securities dealer activities. Further, the bank's records relating to the transactions effected by such branch employees must meet the criteria of paragraph (a) of rule G-1 with respect to separate maintenance and accessibility.

With respect to question (3) above, paragraph (c) of rule G-1 recognizes that senior officers of a bank may make determinations affecting bank policy as a whole which have an indirect effect on the municipal securities dealer activities of the bank. For example, determinations with respect to the deployment of the bank's funds may affect the size of the bank's inventory of municipal securities or volume of underwriting. Ordinarily such determinations would not directly relate to the day-to-day conduct of the bank's municipal securities dealer activities and senior officers making such determinations need not be designated by the board of directors of the bank as responsible for the conduct of such activities. However, if the determinations of senior officers have a direct and immediate impact on the day-to-day conduct of the bank's municipal securities dealer activities, whether by reason of the scope of such determinations, the frequency with which such determinations are made, or by reason of other factors, such officers may be considered to be directly engaged in the conduct of the bank's municipal securities dealer activities and required to be designated by the board of directors of the bank as responsible for the day-to-day conduct of such activities.

With respect to question (4) above, the regulatory focus of section 15B(b)(2)(H) of the Act is on the dealer activities of a bank. Accordingly, subparagraph (b)(2) of rule G-1 was intended to relate to such dealer activities, and not to describe other activities of the bank which might involve municipal securities. Employees of a bank's corporate trust department who perform clearance and other functions with respect to municipal securities, but which do not relate to the underwriting, trading and sales activities of the bank, do not perform municipal securities dealer activities within the meaning of rule G-1.

This opinion is rendered on behalf of the Board, pursuant to authority delegated by the Board. Copies of this opinion are being sent to the Securities and Exchange Commission, the bank regulatory agencies and the National Association of Securities Dealers, Inc. MSRB interpretation of November 17, 1975.