The Municipal Securities Rulemaking Board ("MSRB") has received various inquiries regarding commissions, disclosures (including delivery of disclosure materials to the MSRB) and advertisements relating to municipal fund securities, particularly in connection with sales of interests in so-called Section 529 college savings plans.[1] The nature of the commissions and other program fees that may exist with respect to municipal fund securities may differ significantly from such charges that typically may exist for traditional debt securities sold in the municipal securities market. In many cases, commissions and other fees may more closely resemble those charged in connection with investment company securities registered under the Investment Company Act of 1940 (the "Investment Company Act").[2] Although commissions and fees charged by brokers, dealers and municipal securities dealers ("dealers") effecting transactions in municipal fund securities are subject to MSRB rules, the nature and level of fees and charges collected by other parties in connection with such securities generally are not subject to regulation. However, under certain circumstances, a dealer selling municipal fund securities may be obligated to disclose to customers such fees and charges collected by other parties.

Amount of Dealer's Commissions or Service Charges

Rule G-30(b), on prices and commissions in agency transactions, prohibits dealers from selling municipal securities to a customer for a commission or service charge in excess of a fair and reasonable amount. In assessing the fairness and reasonableness of the commission or service charge, the rule permits the dealer to take into consideration all relevant factors, including the availability of the securities involved in the transaction, the expense of executing or filling the customer's order, the value of the services rendered by the dealer, and the amount of any other compensation received or to be received by the dealer in connection with the transaction. The MSRB has received inquiries as to whether the sales charge schedule set out in Rule 2830 of the National Association of Securities Dealers, Inc. ("NASD") applies to or otherwise is indicative of the levels of commissions and other fees that dealers may charge in connection with sales of municipal fund securities.

MSRB rules, not those of the NASD, apply to sales by dealers of municipal securities, including municipal fund securities. NASD Rule 2830 provides that no member firm may offer or sell shares in investment companies registered under the Investment Company Act if the sales charges are excessive. The NASD rule then sets forth various levels of aggregate sales charges to which member firms must conform, depending upon the nature of the investment company's sales charges, in order to ensure that such sales charges are not deemed excessive. The MSRB notes that the NASD derives its authority for the sales charge provisions of Rule 2830 from Section 22(b)(1) of the Investment Company Act, which expressly exempts such provisions from the limitation that Section 15A(b)(6) of the Securities Exchange Act of 1934 (the "Exchange Act") places on the NASD's ability to adopt rules that "impose any schedule or fix rates of commissions, allowances, discounts, or other fees to be charged by its members." In sharp contrast, no exemption exists from the limitations that Section 15B(b)(2)(C) of the Exchange Act places on the MSRB's ability to adopt rules that "impose any schedule or fix rates of commissions, allowances, discounts, or other fees to be charged by municipal securities brokers or municipal securities dealers."The MSRB believes that it could not, by rule or interpretation, in effect impose such a schedule for the sale of municipal fund securities.

Nonetheless, the MSRB believes that the charges permitted by the NASD under its Rule 2830 in connection with the sale of registered investment company securities may, depending upon the facts and circumstances, be a significant factor in determining whether a dealer selling municipal fund securities is charging a commission or other fee that is fair and reasonable. For example, the MSRB believes that charges for municipal fund securities transactions in excess of those permitted for comparable mutual fund shares under NASD Rule 2830 may be presumed to not meet the fair and reasonable standard under MSRB rule G-30(b), although the totality of the facts and circumstances relating to a particular transaction in municipal fund securities may rebut such presumption. Further, depending upon the specific facts and circumstances, a sales charge for a transaction in a municipal fund security that would be deemed in compliance with NASD Rule 2830 if charged in connection with a transaction in a substantially identical registered investment company security often will be in compliance with rule G-30(b).

However, the NASD schedule is not dispositive nor is it always the principal factor in determining compliance with rule G-30. The MSRB believes that the factors enunciated in rule G-30(b) and other relevant factors must be given due weight in determining whether a commission is fair and reasonable. These factors include, but are not limited to, the value of the services rendered by the dealer and the amount of any other compensation received or to be received by the dealer in connection with the transaction from other sources (such as the issuer). A dealer may not exclusively rely on the fact that its commissions fall within the NASD schedule, particularly where commission levels in the marketplace for similar municipal fund securities sold by other dealers providing similar levels of services are generally substantially lower than those charged by such dealer, taking into account any other compensation.

Disclosure of Program Fees and Charges of Other Parties

MSRB rules do not explicitly require disclosure by dealers of fees and charges received by other parties to a transaction. These can include, among other things, administrative fees of the issuer, investment adviser and other parties payable from trust assets or directly by the customer. However, depending upon the facts and circumstances, certain MSRB rules may have the practical effect of requiring some level of disclosure of such fees and charges to the extent that they are material. For example, rule G-32(a)(i) generally obligates the dealer to provide an official statement to its customer in connection with sales of municipal fund securities. Although MSRB rules do not govern the content of the disclosures included by the issuer in the official statement, the MSRB believes that an official statement prepared by an issuer of municipal fund securities that is in compliance with Exchange Act Rules 10b-5 and 15c2-12 generally would provide disclosure of any fees or other charges imposed in connection with such securities that are material to investors. The MSRB further believes that, in most respects, the disclosures provided by the issuer in the official statement would provide the dealer with the type of information it is required to disclose to customers under the MSRB's fair dealing rule, rule G-17.

Advertisements

Dealer advertisements of municipal fund securities must comply with the requirements of rule G-21.[3] This rule prohibits dealers from publishing advertisements concerning municipal securities which they know or have reason to know are materially false or misleading. The MSRB has previously stated that any use of historical yields in an advertisement would be subject to this prohibition. Thus, a dealer advertisement of municipal fund securities that refers to yield typically would require a description of the nature and significance of the yield shown in the advertisement in order to assure that such advertisement is not false or misleading. Further, depending upon the facts and circumstances, a dealer may be required to disclose information regarding a fee or other charge relating to municipal fund securities that may have a material effect on such advertised yield, to the extent that such disclosure is necessary to ensure that the advertisement is not materially false or misleading with respect to such yield.

The MSRB understands that advertisements and other sales material relating to registered investment company securities are, depending upon the nature of the advertisement, subject to the requirements of Securities Act Rule 156, on investment company sales literature, Securities Act Rule 482, on advertising by an investment company as satisfying requirements of section 10, and NASD Rule 2210, on communications with the public (including IM-2210-3, on use of rankings in investment companies advertisements and sales literature), among others. The MSRB notes that both Securities Act Rule 156(a) and NASD Rule 2210(d)(1)(A) include general standards for advertisements that are substantially the same as the standard set forth in MSRB rule G-21. As a result, the MSRB believes that a dealer advertisement of municipal fund securities that would be compliant with Securities Act Rules 156 and 482 if such securities were registered investment company securities also would be in compliance with MSRB rule G-21. Further, the MSRB believes that a dealer advertisement of municipal fund securities that would be compliant with NASD Rule 2210 and IM-2210-3 if such securities were registered investment company securities also would be in compliance with MSRB rule G-21.

Submission of Official Statements to the MSRB

Dealers selling municipal fund securities are subject to the requirement under rule G-36 that they submit copies of the official statement, together with completed Form G-36(OS), to the MSRB. In some cases, a dealer that has been engaged by an issuer of municipal fund securities to serve as its primary distributor ("primary distributor") has in turn entered into relationships with one or more other dealers to provide further channels for distribution. These other dealers may include dealers that effect transactions directly with customers ("selling dealers") or dealers that provide "wholesale" distribution services but do not effect transactions directly with customers ("intermediary dealers").

The MSRB believes that, regardless of whether a formal syndicate or similar account has been formed among a primary distributor, the selling dealers and any intermediary dealers in a multi-tiered distribution system for a particular offering of municipal fund securities, the primary distributor for such offering has the responsibility set forth in rule G-36(f) to undertake all actions required under the provisions of rule G-36 and the corresponding recordkeeping requirements under rule G-8(a)(xv). These obligations include, but are not limited to, the submission of official statements (including amendments and updates) and completed Form G-36(OS) to the MSRB on a timely basis. The MSRB further believes that any selling or intermediary dealers for such offering that might be considered underwriters of the securities may rely upon the primary distributor to undertake these actions to the same extent as if they had in fact formed an underwriting syndicate as described in rule G-36(f).

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[1] Section 529 college savings plans are higher education savings plan trusts established by states under section 529(b) of the Internal Revenue Code as "qualified state tuition programs" through which individuals make investments for the purpose of accumulating savings for qualifying higher education costs of beneficiaries.

[2] Municipal fund securities are exempt from the registration and other provisions of the Investment Company Act.

[3] Rule G-21 defines advertisement as any material (other than listings of offerings) published or designed for use in the public, including electronic, media or any promotional literature designed for dissemination to the public, such as notices, circulars, reports, market letters, form letters, telemarketing scripts or reprints or excerpts of the foregoing. The term does not apply to official statements but does apply to abstracts or summaries of official statements, offering circulars and other similar documents prepared by dealers.

Differential re-offering prices. This is in response to your letter in which you ask us to provide interpretive guidance on MSRB rules G-21, G-30 and G-32 in the context of a proposed new system (the “System”) to be established by your client (the “Company”) for pricing and distribution of primary market municipal securities to retail investors. You provide a description of the System, including a discussion of incremental changes through various versions of the System. We have included below a brief summary of the MSRB’s understanding of certain key features of the System that may be relevant in responding to your questions. This should not be construed as meaning that the MSRB has “approved” the System, or even reviewed the System description which you provided, except for the limited purpose of addressing your specific questions on the three rules noted above. The MSRB expresses no views and has not considered whether the System as you describe it, or whether a broker-dealer using the System, would be in compliance with MSRB rules or other applicable law, rules or regulations, beyond the specific statements set forth herein on these three rules.

As you describe it, the System consists of an internet-based electronic primary market order matching process that will provide (1) electronic notices (“Electronic Notices”) to registered representatives at subscribing broker-dealer firms and (2) an ability to establish a range of acceptable reoffering prices for each order of primary market municipal securities. Registered representatives will provide to the System profiles (“Retail Inquiries”) that describe the features of municipal securities that the registered representative’s customers wish to purchase. The System will then automatically advise the registered representatives of the availability for purchase of a new municipal security issue that matches the Retail Inquiry by sending an Electronic Notice by fax or e-mail. The Company intends to register with the Securities and Exchange Commission as a broker-dealer prior to charging subscription fees for the services provided by the System. We understand that, for purposes of the System, a retail investor is characterized solely by the size of the order, rather than by the identity of an investor as a retail or institutional customer.

Municipal securities available for purchase through the System will be sold using a structure that establishes a range of acceptable retail reoffering prices. For each new issue, the underwriter and the issuer will establish a maximum and minimum yield and a maximum and minimum price to be entered into the System. For all Retail Inquiries that match the basic parameters of the issue (e.g., maturity, rating, state of issuer), the System will send an Electronic Notice to each registered representative that adjusts the price to include the least of the registered representative’s desired mark-up, the maximum mark-up established by the registered representative’s broker-dealer firm, or the maximum issue mark-up established by the underwriter. In the System’s initial stages, a registered representative may place an order for amounts up to $500,000 to purchase the securities upon receiving an Electronic Notice. You note that use of the System will permit sales of municipal securities of the same maturity and order size to different buyers at different prices.

You state that you believe that the business and operating plan for the System will be in compliance with all published MSRB rules and that broker-dealers subscribing to the System will not violate any MSRB rules by virtue of their use of the System. You request clarification regarding the applicability of certain provisions of rules G-21, G-30 and G-32 to broker-dealers using the System. As noted above, the MSRB cannot provide an “approval” of a proposed system or of its use by broker-dealers. We can, however, provide some guidance regarding your specific rule-related interpretive requests. Since the application of rules to particular factual situations is, by its nature, fundamentally dependent upon the specific facts and circumstances, you should be cognizant of the precise nature of our guidance and of the potential for seemingly small factual variances resulting in different conclusions regarding compliance with our rules.

Rule G-30, on Prices and Commissions

You ask us whether we view use of the System by broker-dealers to establish a range of reoffering prices (instead of a single reoffering price) as compliant with the requirement under rule G-30, on prices and commissions, that municipal securities prices be fair and reasonable. We cannot provide you with assurance that under all circumstances prices charged to customers by broker-dealers using the System will comply with rule G-30. However, the following discussion should provide some guidance in assessing whether broker-dealers using the System will be able to comply with rule G-30.

Rule G-30(a) provides that no broker-dealer shall sell municipal securities to a customer in a principal transaction except at a price that is fair and reasonable, taking into consideration all relevant factors.[1] The rule cites, as relevant factors, the best judgment of the broker-dealer as to the fair market value of the securities at the time of the transaction, the expense involved in effecting the transaction, the fact that the broker-dealer is entitled to a profit, and the total dollar amount of the transaction.[2] In addition, the MSRB has identified a number of other factors which might be relevant in determining the fairness and reasonableness of prices in municipal securities transactions. These additional factors include, but are not limited to, the availability of the security in the market, the price or yield of the security, the maturity of the security, and the nature of the professional’s business.[3] The MSRB firmly believes that the resulting yield to the customer is the most important factor in determining the fairness and reasonableness of a price in any given transaction. The MSRB previously has stated that such yield should be comparable to the yield on other securities of comparable quality, maturity, coupon rate, and block size then available in the market.

Although a comparative yield assessment is the most important factor in determining whether a transaction price is fair and reasonable, rule G-30 states that other facts and circumstances of a specific transaction may also enter into the final determination of whether the transaction price is fair and reasonable. Thus, rule G-30 clearly contemplates the possibility that, depending upon the facts and circumstances of two contemporaneous transactions in identical securities, both transactions may be priced in compliance with rule G-30 even though the prices are not identical. It is not possible to state a specific percentage of variance between prices on contemporaneous transactions that would create a presumption of a violation of rule G-30 with respect to the higher priced transaction since a number of different factors may be relevant to the individual transactions.[4] However, the degree to which price variances may occur without raising the presumption of a rule G-30 violation generally would parallel the level of variance in the relevant factors under rule G-30 from transaction to transaction in the same security. For example, a large difference in the par value of two transactions could potentially justify a larger price difference than would a small difference in the par value of the two transactions.

The MSRB has stated that, although rule G-30 does not specifically mention new issue offering prices which may be set by the syndicate or the issuer, compliance with rule G-30 in this context also is determined by whether the price of a municipal security is fair and reasonable, taking into account all relevant factors.[5] As noted above, a comparative yield assessment is the most important factor in determining the fairness and reasonableness of a transaction price. Although it is the ultimate responsibility of the broker-dealer effecting a transaction with a customer to ensure that the price is in compliance with rule G-30, the issuer and underwriter may help broker-dealers using the System to avoid possible violations of rule G-30 by carefully reviewing the ranges of yields and prices entered by the underwriter into the System to ensure that the net yield to customers[6] would be comparable to that of similar securities regardless of where within the established ranges a transaction is executed by a broker-dealer using the System.

Rule G-32, on Disclosures in Connection with New Issues

You provide us with a sample of proposed language to be included in the official statement for new issue municipal securities to be sold using the System. This language indicates the lowest price at which any of the securities in the new issue are offered and also indicates a range of maximum prices at which the securities are offered based on various lot sizes of the securities sold in a particular transaction. The language further states that, subject to the practices of each broker-dealer firm in the selling group, investors may have purchased the securities at prices lower than those shown in the range of maximum prices included in the official statement. Finally, the language provides a specific dollar amount representing the total compensation paid to the underwriter as representative of the selling group. You ask us whether inclusion of such language in the official statement by issuers using the System complies with rule G-32.

Rule G-32(a)(ii) provides that, in connection with new issue municipal securities purchased by the underwriter in a negotiated sale, any broker-dealer selling such securities to a customer must deliver to the customer by no later than settlement information regarding, among other things, the underwriting spread and the initial offering price for each maturity in the issue, including maturities that are not reoffered.[7] The MSRB has stated that the obligation to disclose the underwriting spread requires that the broker-dealer disclose the difference between the initial offering price of the new issue and the amount paid by the underwriter to the issuer, expressed either in dollars or points per bond.[8] The MSRB has prohibited broker-dealers from merely disclosing to customers the offering prices and amount paid to the issuer and describing how the underwriting spread can be calculated from these figures.[9] The MSRB has stated that initial offering prices may be expressed either in terms of dollar price or yield.[10]

The MSRB recognizes that disclosure of initial offering prices and underwriting spread is more complicated in circumstances where securities of the same maturity may be offered at a number of different prices, as compared to the typical situation where each maturity is stated to be offered at a single price. The MSRB believes that, under these circumstances, the initial offering prices and underwriting spread may be expressed as a range of values.

In expressing the initial offering prices as a range of values, broker-dealers must ensure that the prices at which the securities are initially offered to customers will fall within the expressed range. At the same time, the MSRB believes that the disclosure of a range of prices must not be misleading to customers. For example, a range that implies that a market may exist at prices where in fact no transactions are likely to occur could be misleading. In addition, a range that includes prices that are not fair and reasonable for purposes of rule G-30 could mislead customers with regard to what would in fact constitute a fair and reasonable price. These and other practices arising in connection with the disclosure of a range of initial offering prices could constitute violations of rule G-17[11] and would not satisfy the disclosure obligation under rule G-32. Broker-dealers are cautioned, when using a range to disclose initial offering prices, to make such range as narrow as reasonably possible in order to avoid violations of rules G-17 and G-32. For example, if broker-dealers have established discrete price ranges for specific securities within the issue (e.g., separate maturities) or for specific types of transactions (e.g., different lot sizes), they should include such discrete ranges in the disclosure made to customers. The initial offering price range must be expressed either in terms of dollar prices or yields.

In expressing the underwriting spread as a range of values, the range must be no broader than would be obtained by calculating the lowest possible spread based on all of the lowest initial offering price values and the highest possible spread based on all of the highest initial offering price values. This range should be further refined based on specific information available to the broker-dealer (e.g., minimum or maximum spreads agreed to between the issuer and the underwriter, fixed components of the gross spread, known levels of transactions at particular prices, etc.).[12] Broker-dealers may show this spread range either as a range of a total amount or as a listing of the components of the spread range. If components of the spread range are listed, that portion of the range which represents compensation to the underwriter must be clearly identified as such. The spread range must be expressed either in dollars or points per bond.

Rule G-21, on Advertising

You state that you do not believe that Electronic Notices constitute advertisements within the meaning of rule G-21, which sets forth certain requirements with respect to advertisements of municipal securities. An advertisement is defined as any material (other than listings of offerings) published or designed for use in the public, including electronic, media or any promotional literature designed for dissemination to the public, including any notice, circular, report, market letter, form letter, telemarketing script or reprint or excerpt of the foregoing. The rule covers communications that are intended to reach a broad segment of the public rather than individually tailored communications between two specific parties and communications between broker-dealers. Thus, if the use of Electronic Notices is limited in the manner you describe in your letter, it appears that such Electronic Notices would not constitute advertisements within the meaning of rule G-21. However, we express no opinion as to whether Electronic Notices might constitute advertisements if they were to be disseminated to investors.

* * * * * * * * * *

I must emphasize once again that the guidance provided in this letter cannot be considered an “approval” of the System. Further, this guidance cannot be considered to provide or imply that broker-dealers using the System will, under all circumstances, be in compliance with the rules discussed herein. Nor can this guidance be considered to provide or imply that the operation of the System or the use of the System by broker-dealers is in compliance with any other rules of the MSRB or the laws, rules or regulations of any other entity. MSRB interpretation of December 11, 2001.

The MSRB has received inquiries on the applicability of rule G-37 to certain activities by dealers and municipal finance professionals relating to the transition period during which an issuer official has won an election but has not yet taken office.  The definition of “contribution” in rule G-37(g)(i) includes any gift, subscription, loan, advance, or deposit of money or anything of value made for transition or inaugural expenses incurred by the successful candidate.

The MSRB stated in a Question and Answer Notice dated May 24, 1994 (Q&A number 24) that rule G-37 is not intended to prohibit or restrict municipal finance professionals from engaging in personal volunteer work; however, if the municipal finance professional uses the dealer’s resources (e.g., a political position paper prepared by dealer personnel) or incurs expenses in the conduct of such volunteer work (e.g., hosting a reception), then the value of such resources or expenses would constitute a contribution.  In addition, personal expenses incurred by the municipal finance professional in the conduct of such volunteer work, which expenses are purely incidental to such work and unreimbursed by the dealer (e.g., cab fares and personal meals), would not constitute a contribution.  In a Question and Answer Notice dated August 18, 1994 (Q&A number 3), the MSRB stated that an employee of a dealer generally can donate his or her time to an issuer official’s campaign without this being viewed as a contribution by the dealer to the official, as long as the employee is volunteering his or her time during non-work hours, or is using previously accrued vacation time or the dealer is not otherwise paying the employee’s salary (e.g., an unpaid leave of absence).  Thus, rule G-37 does not prohibit a municipal finance professional from serving on an issuer official’s transition team or performing other transition-related activities; however, as noted above, the use of dealer resources in connection with such activity would be considered a contribution by the dealer to the issuer official thereby resulting in the dealer being prohibited from engaging in municipal securities business with the issuer for two years.

The MSRB also recognizes that dealers and their municipal finance professionals may solicit issuer officials for municipal securities business during the transition period prior to these officials taking office.  In the course of making such solicitations, dealers may sometimes prepare and present materials such as financing plans and economic development studies.  The provision of these types of materials to an issuer official during the transition period would not constitute contributions under rule G-37 if performed as part of a solicitation for municipal securities business.

Finally, in a Question and Answer Notice dated September 9, 1997 (Q&A number 1), the MSRB addressed whether a municipal finance professional who is entitled to vote for an issuer official may make contributions to pay for such official’s transition or inaugural expenses without causing a prohibition on municipal securities business with the issuer.  If a municipal finance professional contributed $250 to the general election of an issuer official, the municipal finance professional would not be able to make any contributions to pay for transition or inaugural expenses without causing a prohibition on municipal securities business with the issuer.  If a municipal finance professional made no contributions to an issuer official prior to the election, then the municipal finance professional may, if entitled to vote for the candidate, contribute up to $250 to pay for transition or inaugural expenses and payment of debt incurred in connection with the election without causing a prohibition on municipal securities business.

The MSRB has received inquiries regarding an interpretation of rule G-15(a) from dealers who offer automated execution of transactions and charge a small, flat "transaction fee" per transaction.  These dealers asked whether a $15.00 flat fee qualifies as a miscellaneous transaction charge. 

Rule G-15(a) sets out confirmation requirements for transactions with customers and specifies that dealers include a yield on the confirmation.  In computing yield, G-15(a)(i)(A)(5)(c)(iii) states that such "computations shall take into account ... commissions charged to the customer ... but shall not take into account incidental transaction fees or miscellaneous charges, provided, however, that ... such fees or charges [are] indicated on the confirmation."  

In a May 14, 1990 Notice Concerning Confirmation Disclosure of Miscellaneous Transaction Charges[1], the MSRB reminded dealers that clear disclosure of the nature and amount of miscellaneous fees is required.  The notice stated that these fees should not be incorporated into the stated yield because they are small and do not significantly affect a customer's return on investment, as shown in the yield.  The notice also stated that miscellaneous fees differ from commissions because they are flat amounts, and, unlike the common practice used in computing commissions for agency transactions, are not related to the par value of the transaction. 

The dealers who contacted the MSRB will charge a flat transaction fee of $15.00 for trades executed through an automated trading system.  Since this fee is relatively small and unrelated to the par value of the transaction, the MSRB believes that the transaction fee should be considered a miscellaneous transaction fee.  Therefore the fee would not have to be incorporated into the stated yield, but would need to be separately disclosed on the confirmation.

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