MSRB PUBLISHES INTERPRETIVE LETTER REGARDING SOLICITATION ACTIVITY ON BEHALF OF AN AFFILIATED COMPANY PURSUANT TO RULES G-37 AND G-38

The Municipal Securities Rulemaking Board has published an interpretive letter pursuant to Rule G-37, on political contributions and prohibitions on municipal securities business, and Rule G-38, on solicitation of municipal securities business, concerning the activities of a broker-dealer on behalf of an affiliated company. The text of the interpretive letter is included below. Questions regarding the interpretive letter may be directed to Leslie Carey, Associate General Counsel, or Ronald W. Smith, Senior Legal Associate. 

July 2, 2009

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TEXT OF INTERPRETIVE LETTER

Rules G-37 and G-38 Interpretive Letter – Solicitation activity on behalf of affiliated company.  This is in response to your April 29, 2009 letter seeking guidance regarding Municipal Securities Rulemaking Board (“MSRB”) Rule G-38, on solicitation of municipal securities business, and MSRB Rule G-37, on political contributions and prohibitions on municipal securities business. Your letter relates to the formation of a joint venture broker-dealer (“JV B-D”) by two existing broker-dealers (the “legacy firms”). You state that JV B-D will not engage in municipal securities business[1] and that the employees of JV B-D will not retain their employment status with the legacy firms, but will be associated persons of both legacy firms.

Specifically, you request guidance on the following two issues: (i) whether the employees of the JV B-D may solicit municipal securities business, under Rule G-38, on behalf of the legacy firms; and (ii) whether an employee who solicits municipal securities business on behalf of one of the legacy firms will be considered a municipal finance professional (“MFP”) [2] solely of the legacy firm on whose behalf the MFP solicits municipal securities business under Rule G-37, rather than of both legacy firms. The Board has reviewed your letter and authorized this response.

JV B-D Employee Solicitation of Municipal Securities Business on Behalf of Legacy Firms: You ask whether employees of JV B-D, who are the prior employees of the legacy firms, may solicit municipal securities business on behalf of such firms under Rule G-38. Rule G-38(a) prohibits a broker, dealer or municipal securities dealer (“dealer”) from providing, directly or indirectly, payment to any person who is not an affiliated person[3] of the dealer for a solicitation of municipal securities business on behalf of such dealer.

You state that JV B-D will be controlled by the legacy firms and, as such, should be viewed as an affiliated company[4] of the legacy firms. Under Rule G-38, if JV B-D is controlled by the legacy firms, JV B-D and its employees should be viewed as affiliates of the legacy firms. Based on the control relationships you describe, Rule G-38 will not be violated if employees of JV B-D are paid by a legacy firm for a solicitation of municipal securities business on behalf of such legacy firms.

JV B-D Employee Status as Municipal Finance Professional for Legacy Firm on Behalf of Which the Employee Has Solicited Municipal Securities Business: You also ask whether an employee of JV B-D who solicits municipal securities business on behalf of one of the legacy firms will be considered an MFP solely of the legacy firm on whose behalf the employee solicits municipal securities business, rather than of both legacy firms. Rule G-37(g)(iv)(B) defines MFP, in relevant part, as any associated person (including, but not limited to, any affiliated person of the dealer, as defined in Rule G-38) who solicits municipal securities business (a “solicitor MFP”). You note that this language does not expressly limit MFP status to the dealer on whose behalf the municipal securities business was solicited.

The MSRB is of the view that implicit in the concept of a solicitor MFP, as set forth in Rule G-37(g)(iv)(B), is the notion that an associated person who solicits municipal securities business on behalf of a dealer becomes an MFP of such dealer.[5] Although an individual who solicits municipal securities business on behalf of one dealer with which he or she is associated thereby becomes an MFP of such dealer, the solicitation does not by itself result in the individual becoming an MFP of a different dealer with which such individual may be associated but for which he or she has not solicited municipal securities business. Rather, such individual would have to undertake a solicitation or another activity described in Rule G-37(g)(iv) on behalf of the second dealer in order to become an MFP of such second dealer.

The MSRB notes that Rule G-38(b)(i) defines solicitation broadly to mean, any direct or indirect communication with an issuer for the purpose of obtaining or retaining municipal securities business. The MSRB has previously provided guidance regarding the types of communications that are viewed as solicitations of municipal securities business.[6] Depending upon specific facts and circumstances, a direct solicitation of municipal securities business by an individual on behalf of a dealer with which such individual is associated (the “directly-benefited dealer”) might also be considered an indirect solicitation of business on behalf of another dealer with which such individual is associated (the “indirectly-benefited dealer”). In conversations with issuers or other third parties, the individual must clearly indicate for which dealer he or she is soliciting business. For example, an individual who describes to issuer personnel two or more affiliated dealers as leading underwriting firms in that issuer’s state but only explicitly asks such personnel to hire one dealer (i.e., the directly-benefited dealer) would likely be considered to have indirectly solicited business on behalf of the other dealer as well (i.e., the indirectly-benefited dealer). An important factor in determining whether a direct solicitation on behalf of a directly-benefited dealer could also be considered an indirect solicitation on behalf of an indirectly-benefited dealer is whether the individual solely identifies his or her affiliation with the directly-benefited dealer or also identifies an affiliation with the other dealer.[7]  To the extent that multiple dealers are identified directly or indirectly, dealers would need to take extra precautions to ensure that the solicited issuer personnel understand that the solicitation is solely on behalf of the directly-benefited dealer and that the identification of the other firm is limited and does not serve to promote the other firm.[8] In circumstances similar to those described in this letter, dealers should have in place effective procedures to ensure that the solicitations for municipal securities business are tracked in a way that will properly classify individuals making solicitations as MFPs of the appropriate dealer. MSRB Interpretation of June 23, 2009.

On April 24, 2009, the Municipal Securities Rulemaking Board (the "MSRB") published Notice 2009-15 on Build America Bonds and Other Tax Credit Bonds (the "April 2009 Notice").  In the April 2009 Notice, the MSRB explained that Build America Bonds and the other tax credit bonds described in the April 2009 Notice are municipal securities and are, therefore, subject to MSRB rules, including Rule G-37 on political contributions. 

The MSRB understands that, for the purpose of obtaining municipal securities business as defined in Rule G-37,[1] personnel from the taxable desk of brokers, dealers, or municipal securities dealers ("dealers"), or personnel from other departments or divisions of dealers that do not traditionally engage in municipal securities business, may participate in presentations to potential issuers of Build America Bonds or other tax credit bonds in response to requests for proposals or in other pre-selection meetings with such potential issuers to discuss the structuring, pricing, sales, and distribution of taxable bonds.  Dealers are reminded that such participation generally will make those personnel "municipal finance professionals" under Rule G-37(g)(iv)(B), because the personnel are considered to have solicited municipal securities business.[2]

Pursuant to Rule G-37(b)(ii), political contributions made by such personnel to an official of the issuer solicited by such personnel within the two years prior to the solicitation would need to be examined by the dealer to determine whether the two-year ban on municipal securities business imposed by Rule G-37(b)(i) is triggered by the solicitation.[3]  By engaging in solicitation activities, such personnel would become municipal finance professionals and subsequent political contributions to issuer officials by such personnel would also be subject to Rule G-37.

The American Recovery and Reinvestment Act of 2009 added a provision to the Internal Revenue Code that authorizes state and local governments to issue two types of “Build America Bonds” as taxable governmental bonds with Federal subsidies for a portion of their borrowing costs.

The first type of Build America Bond provides a Federal subsidy through Federal tax credits to investors in the bonds.  The tax credits may also be “stripped” and sold to other investors, pursuant to regulations to be issued by the Treasury Department.  In its Notice 2009-26, the Treasury Department refers to this type of Build America Bond as “Build America Bonds (Tax Credit).”

The second type of Build America Bond provides a Federal subsidy through a refundable tax credit paid to state or local governmental issuers by the Treasury Department and the Internal Revenue Service.  The Treasury Department refers to this type of Build America Bond as “Build America Bonds (Direct Payment).”  This Notice refers to both Build America Bonds (Tax Credit) and Build America Bonds (Direct Payment) as “Build America Bonds.”

Some municipal market participants have requested guidance on whether Municipal Securities Rulemaking Board rules are applicable to Build America Bonds.  Build America Bonds are municipal securities, because they are issued by States and their political subdivisions and instrumentalities.  Accordingly, all of the MSRB’s rules apply to transactions effected by brokers, dealers, and municipal securities dealers (“dealers”) in Build America Bonds, including rules regarding uniform and fair practice, political contributions, automated clearance and settlement, the payment of MSRB underwriting and transaction assessment fees, and the professional qualifications of registered representatives and principals.

For example, dealers in the primary market should note that current Rule G-36 requires underwriters to submit official statements to the MSRB, accompanied by completed Form G-36 (OS), for most primary offerings of municipal securities.  Dealers also have official statement delivery responsibilities to customers under Rule G-32.  Once final, recently proposed revisions to Rule G-32 will require underwriters to satisfy their official statement submission obligations electronically through use of the MSRB’s Electronic Municipal Market Access system (“EMMA”) and will allow dealers to satisfy their official statement delivery obligations by means of appropriate notice to customers.

The MSRB understands that many Build America Bonds may be sold by dealers’ taxable desks and reminds dealers that Rule G-27 requires that municipal securities principals must supervise all municipal securities activities, including such sales.

Dealers in the secondary market should note that Rule G-14 requires that all transactions in municipal securities must be reported to the MSRB within certain prescribed time periods. 

The following additional types of tax credit bonds are also municipal securities subject to MSRB rules: Recovery Zone Economic Development Bonds, Qualified School Construction Bonds, Clean Renewable Energy Bonds, New Clean Renewable Energy Bonds, Midwestern Tax Credit Bonds, Energy Conservation Bonds, and Qualified Zone Academy Bonds.

In 1999, the Municipal Securities Rulemaking Board (MSRB) published a notice on the application of Rule G-37, on political contributions and prohibitions on municipal securities business, to Presidential campaigns of issuer officials.[1]  In general, the notice described a 1995 interpretive letter[2] in which the Board noted that Rule G-37 is applicable to contributions given to an official of an issuer[3] who seeks election to federal office, such as the Presidency.  The Board also explained that the only exception to Rule G-37’s absolute prohibition on business is for certain contributions made to issuer officials by municipal finance professionals.  Specifically, contributions by such persons to an official of an issuer would not invoke application of the prohibition if the municipal finance professional is entitled to vote for such official, and provided that any contributions by such municipal finance professional do not exceed, in total, $250 to each official, per election.  In the example of an issuer official running for President, any municipal finance professional in the country can contribute the de minimis amount to the official’s Presidential campaign without causing a ban on municipal securities business with that issuer.  Finally, the Board noted that a Presidential candidate who has accepted public funding for the general election is prohibited under federal law from accepting any contributions to further his or her general election campaign.  In these circumstances, federal law allows individuals to contribute to the candidate’s compliance fund, which uses the contributions solely for legal and accounting services to ensure compliance with federal law and not for campaign activities.  Thus, any municipal finance professional in the country can contribute the de minimis amount to an issuer official’s compliance fund without causing a ban on municipal securities business with that issuer.  This would apply if the issuer official runs for President or Vice President.

The MSRB wishes to remind dealers that these concepts also apply to an issuer official who campaigns for any federal office.  For example, any municipal finance professional residing in a state in which an issuer official is campaigning for a state-wide federal office may contribute the de minimis amount to the official’s campaign without causing a ban on municipal securities business with that issuer.  The MSRB does not opine whether any particular individual is or is not an issuer official. 

The MSRB also wishes to remind dealers to be aware of the Rule G-37 issues involving indirect rule violations and contributions to non-dealer associated political action committees and payments to political parties, which issues have been the subjects of previous notices and interpretive Questions and Answers.[4]

[1] See Application of Rule G-37 to Presidential Campaigns of Issuer Officials reprinted in MSRB Rule Book (January 1, 2008) at 246-247.  The notice is also available from the MSRB Rules/Interpretive Notices section of the MSRB’s website at www.msrb.org.

[2] See MSRB Interpretation of May 31, 1995, reprinted in MSRB Rule Book (January 1, 2008) at 251-253.  The letter is also available from the MSRB Rules/Interpretive Letters section of the MSRB’s website at www.msrb.org.

[3] The term “official of an issuer” is defined in Rule G-37(g)(vi) as any person (including any election committee for such person) who was, at the time of the contribution, an incumbent, candidate or successful candidate: (A) for elective office of the issuer which office is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by the issuer; or (B) for any elective office of a state or of any political subdivision, which office has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by an issuer.

[4] See Notice Concerning Indirect Rule Violations: Rules G-37 and G-38, reprinted in MSRB Rule Book (January 1, 2008) at 248-249; Rule G-37 Questions and Answers Nos.  III.4 and III.5 regarding contributions to a non-dealer associated PAC and payments to a state or local political party, reprinted in MSRB Rule Book (January 1, 2008) at 240; and Rule G-37 Question and Answer No. III.7 regarding supervisory procedures relating to indirect contributions, reprinted in MSRB Rule Book (January 1, 2008) at 240-241.  The notice and Questions and Answers are also available on the MSRB’s website at www.msrb.org.

As a result of the unprecedented number of “failed  auctions” [1] in municipal Auction Rate Securities (“ARS”) that have occurred this year, many dealers have announced plans to offer to purchase customer positions in municipal ARS at a stated price, typically par (“ARS Buybacks”). These ARS Buyback programs predominantly have occurred pursuant to settlement agreements with state attorneys general. The MSRB has received questions from dealers whether ARS Buybacks must be reported to the MSRB Real-Time Transaction Reporting System (RTRS) and, if so, whether the M9c0 “away from market - other reason” special condition indicator must be included on such trade reports.

MSRB Rule G-14, on transaction reporting, requires all purchase-sale transactions in municipal securities to be reported to RTRS. Transactions in ARS must be reported to RTRS and trade reports of ARS Buybacks must be reported to RTRS without the M9c0 special condition indicator. The primary reason a trade report would be required to include the M9c0 special condition indicator is that the trade report contains information that could be misleading to users of price transparency reports.[2] The MSRB does not believe that trade reports of ARS Buybacks would provide misleading information relating to the market value of ARS because the price at which ARS Buybacks are executed has been publicly announced. Therefore, trade reports of ARS Buybacks as well as of other purchases of ARS from holders at current market prices must be reported without the M9c0 special condition indicator.[3]

[1] A “failed auction” is not an event of default by the issuer, it only relates to the auction process not being able to determine a clearing rate and not permitting investors attempting to sell their securities from being able to do so.

[2] RTRS serves the dual purposes of price transparency and market surveillance. Transactions reported with the M9c0 special condition indicator are entered into the surveillance database but suppressed from price dissemination. The MSRB has identified three specific situations in which the M9c0 special condition indicator is required to be included on trade reports. See Notice of Interpretation of Rule G-14: “Reporting of Transactions in Certain Special Trading Situations: Rule G-14,” dated January 2, 2008.

[3] Users of the MSRB’s price transparency reports produced from RTRS should be aware that ARS Buybacks may result in a higher than normal volume of trade reports in ARS and should not use this volume as an indication that the market for ARS has fully recovered from the unprecedented number of failed auctions that have occurred in 2008. Further, the prices at which ARS Buybacks are executed may not reflect the actual market value for the security.

The Municipal Securities Rulemaking Board is concerned that the recent increase in demand for liquidity facilities in the municipal securities market due to the downgrade of the monoline insurers and the conversion of auction rate securities programs may result in certain activities that could violate federal bank tying and underpricing of credit prohibitions.  The MSRB wishes to remind dealers of these prohibitions as well as the fact that any broker, dealer or municipal securities dealer (dealer) that aids and abets a violation of federal bank tying or underpricing of credit prohibitions also would violate Rule G-17 on fair dealing.

The MSRB encourages all interested parties to provide information concerning any arrangement in which the provision of liquidity facilities may have been illegally tied to investment banking services.  Such information may be provided to the appropriate bank regulatory authority or, if provided to the MSRB, the MSRB will forward it to the  appropriate bank regulatory authority.  In addition, the MSRB cautions that any dealer that aids or abets a violation of bank tying or the underpricing of credit prohibitions also would violate Rule G-17.  A dealer would be deemed to have aided and abetted a violation of the bank tying prohibition or underpricing of credit if it knew or had reason to know that the purchase of investment banking services had been tied to the provision and/or pricing of a liquidity facility by an affiliated bank in violation of the federal banking laws.

Bond insurance companies recently have been subject to increased attention in the municipal securities market as a result of credit rating agency downgrades and ongoing credit agency reviews. Because of these recent events and the prominence of bond insurance in the municipal securities market, the MSRB is publishing this notice to review some of the investor protection rules applicable to brokers, dealers and municipal securities dealers (“dealers”) effecting transactions in insured municipal securities.

RULE G-17 AND TIME OF TRADE DISCLOSURE TO CUSTOMERS

One of the most important MSRB investor protection rules is Rule G-17, which requires dealers to deal fairly with all persons and prohibits deceptive, dishonest, or unfair  practices.  A long-standing interpretation of Rule G-17 is that a dealer transacting with a customer [1] must ensure that the customer is informed of all material facts concerning the  transaction, including a complete description of the security.[2]  Disclosure of material facts to a customer under Rule G-17 may be made orally or in writing, but must be made at or prior to the time of trade. In general, a fact is considered “material” if there is a substantial likelihood that its disclosure would have been considered significant by a reasonable investor.[3]  As applied to customer transactions in insured municipal securities, the disclosures required under Rule G-17 include a description of the securities and identification of any bond insurance as well as material facts that relate to the credit rating of the issue. The disclosures required under Rule G-17 also may include material facts about the credit enhancement applicable to the issue.

March 2002 Notice

In a March 2002 Interpretative Notice, the MSRB provided specific guidance on the disclosure requirements of Rule G-17.[4] The March 2002 Notice clarified that, in addition to the requirement to disclose material facts about a transaction of which the dealer is specifically aware, the dealer is responsible for disclosing any material fact that has been made available through sources such as the NRMSIR system,[5] the Municipal Securities Information Library^® (MSIL^®) system,[6] RTRS,[7] rating agency reports and other sources of information relating to the municipal securities transaction generally used by dealers that effect transactions in the type of municipal securities at issue (collectively, “established industry sources”).[8]  The inclusion of “rating agency reports” within the list of “established industry sources” of information makes clear the Board’s view that information about the rating of a bond, or information  from the rating agency about potential rating actions with respect to a bond, may be material information about the transaction. It follows that, where the issue’s credit rating is based in whole or in part on bond insurance, the credit rating of the insurance company, or information from the rating agency about potential rating actions with respect to the bond insurance company, may be material information about the transaction.

In addition to the actual credit rating of a municipal issue, “underlying” credit ratings are assigned by  rating agencies to some municipal securities issues. An underlying credit rating is assigned to reflect the credit quality of an issue independent of credit enhancements such as bond insurance. The underlying rating (or the lack of an underlying rating)[9] may be relevant to a transaction when the credit rating of the bond insurer is downgraded or is the subject of information from the rating agency about a potential rating action with respect to the insurance company. In order to ensure all required disclosures are made under Rule G-17, a dealer must take into consideration information on underlying credit ratings that is available in established industry sources (or information otherwise known to the dealer) and must incorporate such information when determining the material facts to be disclosed about the transaction.

April 2002 Notice on Sophisticated Municipal Market Professionals

In a notice dated April 30, 2002, the MSRB provided additional guidance on Rule G-17 and other customer protection rules as they apply to transactions with a special class of institutional customers known  as “Sophisticated Municipal Market Professionals” (“SMMPs”).[10] The April 2002 Notice provides a definition of SMMP, which includes critical elements such as the customer’s financial sophistication and access to established industry sources for municipal securities information. When a dealer has reasonable grounds for concluding that the institutional customer is an SMMP as defined in the April 2002 Notice, the institutional customer necessarily is already aware, or capable of making itself aware of, material facts found in the established industry sources. In addition, the customer in such cases is able to independently understand the significance of such material facts.

The April 2002 Notice provides that a dealer’s Rule G-17 obligation to affirmatively disclose material facts available from established industry sources is qualified to some extent in certain kinds of SMMP transactions. Specifically, when effecting nonrecommended, secondary market transactions, a dealer is not required to provide an SMMP with affirmative disclosure of the material facts that already exist in established industry sources. This differs from the general Rule G-17 requirement of disclosure, discussed above, and therefore may be relevant to dealers trading with SMMPs in insured municipal securities.

RULE G-19 AND SUITABILITY DETERMINATIONS

In addition to the customer disclosure obligations relating to bond insurance and credit ratings, dealers also should be aware of how suitability requirements of MSRB Rule G-19 relate to transactions in insured bonds that are recommended to customers. Rule G-19 provides that a dealer must consider the nature of the security as well as the customer’s financial status, tax status and investment objectives when making recommendations to customers.  The dealer must have reasonable grounds for believing that the recommendation is suitable, based upon information available about the security and the facts disclosed by or otherwise known about the customer.[11] Facts relating to the credit rating of a bond insurer may affect suitability determinations, particularly for customers that have conveyed to the dealer investment objectives relating to credit quality of investments. For example, if a customer has expressed the desire to purchase only “triple A” rated securities, recommendations to the customer should take into account information from rating agencies, including information about potential rating actions that may affect the future “triple A” status of the issue.[12]

RULE G-30 AND FAIR PRICING REQUIREMENTS

Another important investor protection provision within MSRB rules is Rule G-30 on prices and commissions. Rule G-30 requires that, for principal transactions with customers, the dealer must ensure that the price of each transaction is fair and reasonable, taking into account all relevant factors. Dealers should consider the effect of ratings on the value of the securities involved in customer transactions, and should specifically consider the effect of information from rating agencies, both with respect to actual or potential changes in the underlying rating of a security and with respect to actual or potential changes in the rating of any bond insurance applicable to the security.

RULE G-15(a) AND CONFIRMATION DISCLOSURE

The content of information required to be included on customer confirmations of municipal securities transactions is set forth in MSRB Rule G-15(a). For securities with additional credit backing, such as bond insurance, the rule requires the confirmation to state “the name of any company or other person in addition to the issuer obligated, directly or indirectly, with respect to debt service.”[13]  Rule G-15(a) does not generally require that credit agency ratings be included on customer confirmations. However, if credit ratings are given on the confirmation, the ratings must be correct.

CONCLUSION

Meeting the disclosure requirements of Rule G-17 requires attention to the facts and circumstances of individual transactions as well as attention to the specific securities and customers that are involved in those transactions. In light of recent events affecting credit ratings of bond insurance companies, dealers may wish to review both the March 2002 Notice on Rule G-17 disclosure requirements and the April 2002 Notice on SMMP transactions to ensure compliance with the rule in the changing environment for bond insurance companies. In addition, dealers may wish to review how transactions in insured securities are being recommended, priced and confirmed to customers to ensure compliance with other MSRB investor protection rules.

[1] The word “customer,” as used in this notice, follows the definition in MSRB Rule D-9, which states that a “customer” is any person other than a broker, dealer, or municipal securities dealer acting in its capacity as such or an issuer in transactions involving the sale by the issuer of a new issue of its securities.

[2] See, e.g., Notice Concerning Disclosure of Call Information to Customers of Municipal Securities (March 4, 1986), MSRB Manual (CCH) para. 3591.

[3]  Se e, e.g., Basic v. Levinson, 485 U.S. 224 (1988).

[4] Interpretive Notice Regarding Rule G-17, on Disclosure of Material Facts, MSRB Notice (March 20, 2002) (hereinafter “March 2002 Notice”).

[6] The MSIL^® system collects and makes available to the marketplace official statements and advance refunding documents submitted under MSRB Rule G-36, on the delivery of official statements, as well as certain secondary market material event disclosures provided by issuers under SEC Rule 15c2-12. Municipal Securities Information Library^® and MSIL^® are registered trademarks of the MSRB.

[7] The MSRB’s Real-Time Transaction Reporting System (“RTRS”) collects and makes available to the marketplace information regarding inter-dealer and dealer-customer transactions in municipal securities.

[8] See March 2002 Notice (emphasis added).

[9] The lack of a rating for a municipal issue does not necessarily imply that the credit quality of such an issue is inferior, but is information that should be taken into account when accessing material facts about a transaction in the security.

[10] Notice Regarding the Application of MSRB Rules to Transactions with Sophisticated Municipal Market Professionals (April 30, 2002) (hereinafter “April 2002 Notice”). [This notice was revised effective July 9, 2012.]

[11] As with Rule G-17, the MSRB has provided specific qualifications with respect to how a dealer fulfills its suitability duties when making recommendations to SMMPs. These are described in the April 2002 Notice on SMMPs, discussed above.

[12] To assure that a dealer effecting a recommended transaction with a non-SMMP customer has the information needed about the customer to make its suitability determination, Rule G-19 requires the dealer to make reasonable efforts to obtain information concerning the customer’s financial status, tax status and investment objectives, as well as any other information reasonable and necessary in making the recommendation. The obligations arising under Rule G-19 in connection with a recommended transaction require a meaningful analysis, taking into consideration the information obtained about the customer and the security, which establishes the reasonable grounds for believing that the recommendation is suitable. Such suitability determinations should be based on the appropriately weighted factors that are relevant in any particular set of facts and circumstances, which factors may vary from transaction to transaction.  See Reminder of Customer Protection Obligations In Connection With Sales of Municipal Securities, MSRB Notice 2007-17 (May 30, 2007).

[13] The rule provides that, if there is more than one such obligor, the statement “multiple obligors” may be shown.  If a security is unrated by a nationally recognized statistical rating organization, Rule G-15(a) requires dealers to disclose the fact that the security is unrated.

The MSRB Real-Time Transaction Reporting System (RTRS) serves the dual purposes of price transparency and market surveillance.  Because a comprehensive database of transactions is needed for the surveillance function of RTRS, MSRB Rule G-14, on transaction reporting, with limited exceptions, requires dealers to report all of their purchase-sale transactions to RTRS within fifteen minutes.  All reported transactions are entered into the RTRS surveillance database used by market regulators and enforcement agencies. However, the special nature of some transactions effects their value for price transparency and the ability of dealers to meet the fifteen minute reporting deadline. To address these issues, RTRS was designed so that a dealer can code a specific transaction report with a “special condition indicator” to designate the transaction as being subject to a special condition.[1]

TRANSACTIONS EXECUTED WITH SPECIAL PRICING CONDITIONS

Three trading scenarios recently have generated questions from dealers and users of the MSRB price transparency products.  Each of the three trading scenarios described below represents situations where the transaction executed is not a typical arms-length transaction negotiated in the secondary market and thus may be a misleading indicator of the market value of a security.  To clarify transaction reporting requirements and to prevent publication of a potentially misleading price, dealers are required to report these transactions with the M9c0 special condition indicator.[2] Transactions reported with this special condition indicator are entered into the surveillance database but suppressed from price dissemination to ensure that transparency products do not include prices that might be confusing or misleading.

Customer Repurchase Agreement Transactions

Some dealers have programs allowing customers to finance municipal securities positions with repurchase agreements (“repos”). Typically, a bona fide repo consists of two transactions whereby a dealer will sell securities to a customer and agree to repurchase the securities on a future date at a pre-determined price that will produce an agreed-upon rate of return. Both the sale and purchase transactions resulting from a customer repo do not represent typical arms-length transactions negotiated in the secondary market and are therefore required to be reported with the M9c0 special condition indicator.

UIT-Related Transactions

Dealers sponsoring Unit Investment Trusts (“UIT”) or similar programs sometimes purchase securities through several transactions and deposit such securities into an “accumulation” account. After the accumulation account contains the necessary securities for the UIT, the dealer transfers the securities from the accumulation account into the UIT. Purchases of securities for an accumulation account are presumably done at market value and are required to be reported normally. The transfer of securities out of the accumulation account and into the UIT, however, does not represent a typical arms-length transaction negotiated in the secondary market. Dealers are required to report the subsequent transfer of securities from the accumulation account to the UIT with the M9c0 special condition indicator.

TOB Program-Related Transactions

Dealers sponsoring tender option bond programs (“TOB Programs”) for customers sometimes transfer securities previously sold to a customer into a derivative trust from which derivative products are created. If the customer sells the securities held in the derivative trust, the trust is liquidated and the securities are reconstituted from the derivative products and transferred back to the customer. The transfer of securities into the derivative trust and the transfer of securities back to the customer upon liquidation of the trust do not represent typical arms-length transactions negotiated in the secondary market. Such transactions are required to be reported using the M9c0 special condition indicator.[3]

INTER-DEALER TRANSACTIONS REPORTED “LATE”

Inter-dealer transaction reporting is accomplished by both the purchasing and selling dealers submitting the trade to the Depository Trust and Clearing Corporation’s (DTCC) automated comparison system (RTTM) following DTCC’s procedures. RTTM forwards information about the transaction to RTRS.  The inter-dealer trade processing situations described below are the subject of dealer questions and currently result in dealers being charged with “late” reporting or reporting of a trade date and time that differs from the date and time of trade execution.  To allow dealers to report these types of transactions without receiving a late error and to allow enforcement agencies to identify these trades as reported under special circumstances, the MSRB has added two new special condition indicators.[4] New special condition indicator Mc40 is used to identify certain inter-dealer transactions that are ineligible for comparison on trade date, and new special condition indicator Mc50 is used to identify resubmissions of certain uncompared inter-dealer transactions that have been cancelled by RTTM. Described below are the procedures for reporting transactions arising in three inter-dealer transaction reporting scenarios using the new special condition indicators.

Inter-Dealer Ineligible on Trade Date

Certain inter-dealer transactions are not able to be submitted to RTTM on trade date or with the accurate trade date either because all information necessary for comparison is not available or because the trade date is not a “valid” trade date in RTTM. The two inter-dealer trading scenarios described below are required to be reported using the new Mc40 special condition indicator.

VRDO Ineligible on Trade Date

On occasion, inter-dealer secondary market transactions are effected in variable rate demand obligations (VRDOs) in which the interest rate reset date occurs between trade date and the time of settlement. Since dealers in this scenario cannot calculate accrued interest or final money on trade date, they cannot process the trade through RTTM until the interest rate reset has occurred. To report such transactions, both dealers that are party to the transaction are required to report the transaction by the end of the day that the interest rate reset occurs, including the trade date and time that the original trade was executed. Both dealers are required to include the new Mc40 special condition indicator that causes RTRS not to score either dealer late. Transactions reported using this procedure are disseminated without a special condition indicator and the trade reports reflect the original trade date and time.

Invalid RTTM Trade Dates

Dealers sometimes execute inter-dealer transactions on weekends and on certain holidays that are not valid RTTM trade dates. Such trades cannot be reported to RTRS using the actual trade date if they occur on a weekend or holiday. To accomplish automated comparison and transaction reporting of such transactions, dealers are required to submit these inter-dealer transactions to RTTM no later than fifteen minutes after the start of the next RTRS Business Day and to include a trade date and time that represents the next earliest “valid” values that can be submitted.[5] Dealers also are required to include the new Mc40 special condition indicator that allows RTRS to identify these transactions so that enforcement agencies can be alerted to the fact that the trade reports were made under special circumstances using a special trade date and time. RTRS disseminates these trade reports without a special condition indicator and the trade report includes the trade date and time reflecting the next earliest “valid” values that can be submitted.[6]

Resubmission of an RTTM Cancel

A dealer may submit an inter-dealer trade to RTTM and find that the contra-party fails to report its side of the trade.  Such “uncompared” trades are not disseminated by RTRS on price transparency products.  After two days, RTTM removes the uncompared trade report from its system and the dealer originally submitting the trade must resubmit the transaction in a second attempt to obtain a comparison with its contra-party, which currently results in RTRS scoring the resubmitted trade report “late.”

The dealer that originally submitted information to RTTM is required to resubmit identical information about the transaction in the second attempt to compare and report the trade by the end of the day after RTTM cancels the trade. The resubmitting dealer also is required to include the new Mc50 special condition indicator that causes RTRS to not score the resubmitting dealer late. The indicator may only be used by a dealer resubmitting the exact same trade information for the same trade.[7] For example, the contra-party that failed to submit its side to the trade accurately, thus preventing comparison of the transaction, is not allowed to use the indicator. RTRS disseminates trade reports made under this procedure without a special condition indicator once RTTM compares the trade and the trade report reflects the original trade date and time.

[1] See Specifications for Real-Time Reporting of Municipal Securities Transactions Section 4.3.2.

[2] In addition to the special trading situations identified in this notice, the M9c0 special condition indicator, “away from market – other reason,” is required to be included on a trade report if the transaction price differs substantially from the market price for multiple reasons or for a reason not covered by another special condition indicator.

[3] In some cases, the transfer of securities into the derivative trust and the transfer of securities back to the customer upon liquidation of the trust do not represent purchase-sale transactions due to the terms of the trust agreement.  MSRB rules on transaction reporting do not require a dealer to report a transfer of securities to RTRS that is not a purchase-sale transaction in municipal securities.

[4] See MSRB Notice 2007-25 (August 13, 2007).

[5] The MSRB previously provided an example of a trade date and time that would be included on a trade report using this procedure.  See “Reporting of Inter-Dealer Transactions That Occur Outside of RTRS Business Day Hours or on Invalid RTTM Trade Dates,” MSRB Notice 2007-12 (March 23, 2007).

[6] Using this procedure will result in transactions reported with a trade date and time that differs from what is recorded in a dealer’s books and records.  Dealers are reminded that books and records are required to reflect the date and time of trade execution.

[7] The resubmitting dealer would not be required to resubmit the same reference number or preparation time on the resubmitted transaction; however, other information about the transaction, such as price, quantity, trade date and time, would be required to be identical to information included in the original trade submission.

Rule G-38, on solicitation of municipal securities business, prohibits any broker, dealer or municipal securities dealer ("dealer") from making a direct or indirect payment to any person who is not an affiliated person[1] of the dealer for a solicitation of municipal securities business.[2] The current version of Rule G-38 replaced a prior version of the rule, relating to the use of consultants, effective August 29, 2005.[3]  Thus, with one narrowly defined exception discussed below, since August 29, 2005, dealers have been prohibited from making any payments to persons not affiliated with the dealer (including but not limited to any former consultant under the prior version of Rule G-38) for solicitations of municipal securities business.

A dealer is permitted to make a payment to a former consultant who is not an affiliated person of the dealer for a solicitation of municipal securities business if the payment is made solely for solicitation activities undertaken by such former consultant on or prior to August 29, 2005. A transitional payment is permitted only if (A) the former consultant has not solicited municipal securities business from any issuer on behalf of the dealer after August 29, 2005 and (B) the dealer submits Form G-38t to the MSRB for each calendar quarter during which such payment to the consultant is made or remains pending. The dealer must disclose on its initial and all subsequent Form G-38t submissions each item of municipal securities business for which a transitional payment remains pending and the amount of such pending payment, together with other required information, until such quarter in which the payment is finally made.[4]

Dealers are required to submit Form G-38t to the MSRB for a calendar quarter only if a transitional payment to a former consultant is paid during such quarter or remains pending (i.e., payable at a future date) as of such quarter. If no such payments are made or remain pending in any calendar quarter, Form G-38t is not required to be submitted and dealers should not make such submissions. Dealers should note that pending payments must continuously be disclosed on Form G-38t for every calendar quarter, beginning with the quarter ended on September 30, 2005 and each quarter thereafter, until paid. If a pending payment has not been disclosed on Form G-38t for any one or more prior calendar quarters, such payment may no longer be made under the transitional payment provision of Rule G-38 and the dealer would violate Rule G-38 if it subsequently makes such a payment.

The MSRB wishes to remind dealers that Rule G-38 strictly prohibits all payments by a dealer to a non-affiliated person for solicitation activities undertaken after August 29, 2005, even if such solicitation activities are undertaken pursuant to a contract entered into by the dealer with the non-affiliated person on or prior to August 29, 2005. In effect, all paid solicitation activities by non-affiliated persons on behalf of dealers were required to cease as of August 30, 2005, regardless of whether such activities arise from earlier contractual commitments, since any payments by dealers for such activities would violate Rule G-38. Further, as noted above, one of the conditions for permitting transitional payments for solicitations occurring on or prior to August 29, 2005 is that the former consultant does not solicit municipal securities business from any issuer on behalf of the dealer at any time after August 29, 2005. Thus, if a dealer has a pending payment to a former consultant for a solicitation made to an issuer on or prior to August 29, 2005, a subsequent solicitation on behalf of the dealer by such former consultant to the same or a different issuer after August 29, 2005 would disqualify such pending payment from being treated as a valid transitional payment under Rule G-38.  

Rule G-21, on advertising, establishes specific requirements for advertisements by brokers, dealers and municipal securities dealers (“dealers”) of municipal fund securities, including but not limited to advertisements for 529 college savings plans (“529 plans”).  This notice sets forth interpretive guidance under Rule G-21 with respect to time-limited broadcast advertisements, blind advertisements, and annual reports or other similar information required to be distributed under state mandates.

General Disclosures in Time-Limited Broadcast Advertisements

Rule G-21(e)(i)(A) requires certain basic disclosures to be provided in product advertisements for municipal fund securities. These disclosures are not legends requiring the inclusion of specific language. Rather, these disclosure requirements may be complied with if the substance of such information is effectively conveyed, regardless of the specific language used in the advertisement. In general, the context in which the information is provided is an important factor in determining whether the information is effectively conveyed.

These required disclosures may present challenges in  the context of broadcast advertisements, such as traditional television or radio commercials with 30-second run-times or public service announcements with shorter run-times.  In the context of time-limited  broadcast  advertisements,  dealers  should  provide  such disclosures in a manner that appropriately balances the intended message with the required disclosures. Given the unique nature of broadcast  advertisements, where the oral presentation of more information can often result in a decreased likelihood that  the central message of such information will be understood and retained, somewhat abbreviated forms of the required  disclosures may be appropriate for such time-limited  broadcast advertisements, particularly if the disclosures are made with close attention paid to ensuring that they are presented with equal prominence to the remainder of the message.

Thus, for example, in a time-limited broadcast  advertisement for a non-money market 529 plan, the following language, spoken in a manner consistent with the remaining oral presentation of information, generally would satisfy the disclosure requirements of Rule G-21(e)(i)(A): “To learn about [529 plan name], its investment objectives, risks and costs, read the official statement available from [source]. Check with your home state to learn if it offers tax or other benefits for investing in its own 529 plan.”  Further, in a time-limited television advertisement, the source for the official statement, together with a contact telephone number or web address, generally could be displayed on screen while other portions of the disclosures are spoken. This example is intended to be illustrative and is not intended to be exclusive or to necessarily establish a baseline for disclosure.

Blind Advertisements

Under Rule G-21(e)(i)(B)(2), certain product advertisements for municipal fund securities that promote an issuer and its public purpose without promoting specific municipal fund securities or identifying a dealer or its affiliates may omit the general disclosures otherwise required under Rule G-21(e)(i)(A). Among other things, such a blind advertisement may include contact information for the issuer or an agent of the issuer to obtain an official statement or other information, provided that if such issuer’s agent is a dealer or dealer affiliate, no orders may be accepted through such source unless initiated by the customer. Although the contact information may direct a potential customer to a dealer or its affiliate acting as agent of the issuer, the face of the advertisement may not identify such dealer or affiliate.

For example, a blind advertisement may say “call 1-800-xxx-xxxx for more information” or “go to www.[state-name]-529plan.com for more information” but may not say “call [dealer name] at 1-800-xxx-xxxx for more information” or “go to www.[dealer-name]-529plan.com for more information.” This provision does not preclude the person who answers a phone inquiry, or the website to which the URL links, from identifying the dealer or its affiliate, so long as such dealer or affiliate is clearly disclosed to be acting on behalf of the issuer identified in the advertisement.

If a potential customer initiates an order through the source identified in the advertisement, a distinct barrier between the providing of information and the seeking of orders must be maintained to qualify as a blind advertisement. For example, solely for purposes of Rule G-21(e)(i)(B)(2), a dealer may establish that the customer initiated the order by requiring, in the case of a telephone inquiry, that the customer be transferred from the initial dealer contact person to a different person before the customer provides any information used in connection with an order or, in the case of a web-based inquiry, that the customer navigate from the initial webpage referred to in the advertisement to another page on the same or different web site before entering any information used in connection with an order.[1]  Of course, the dealer must be mindful of its obligation under Rule G-17, on fair practice, to provide to the customer, at or prior to the time of trade, all material facts about the transaction known by the dealer as well as material facts about the security that are reasonably accessible to the market, regardless of whether the transaction was recommended or whether an order may be characterized as unsolicited.[2]  In addition, if the transaction is recommended, the dealer must fulfill its obligations with respect to suitability under Rule G-19, on suitability of recommendations and transactions.[3]

Required Annual Reports Excluded from Definition of Advertisement

In some cases, a dealer may be required, by state law or the rules and regulations adopted by the state or an  instrumentality thereof governing a particular 529 plan or other municipal fund security program, to prepare or distribute an annual financial re- port or other similar information regarding such plan or program. So long as a dealer provides any such required report or information with respect to a 529 plan or other municipal fund securities program solely in the manner required by such state law or rules and regulations, such report or information will not be treated as an advertisement for purposes of Rule G-21.[4] However, the dealer would remain subject to Rule G-17, which requires that the dealer deal fairly with all persons, prohibits the dealer from engaging in any deceptive, dishonest or unfair practice and requires the dealer to provide to its customer, at or prior to the time of trade, all material facts about a transaction known by the dealer or that are reasonably accessible to the market. In addition, if such information is used in any manner beyond what is narrowly required by such law, rules or regulation, such use of the information would become subject to Rule G-21 as an advertisement.[5]

[2] See Rule G-17 Interpretation – Interpretive Notice Regarding Rule G-17, on Disclosure of Material Facts, March 20, 2002, reprinted in MSRB Rule Book.

[3] See Rule G-17 Interpretation – Interpretation on Customer Protection Obligations Relating to the Marketing of 529 College Savings Plans, August 7, 2006, reprinted in MSRB Rule Book.

[4] If such information is distributed through the official statement, then it would not be considered an advertisement by virtue of the exclusion of official statements from the definition of “advertisement” in Rule G-21(a)(i).

[5] This guidance is consistent with similar guidance provided by NASD with respect to its advertising rule, Rule 2210, as applied to certain performance information and hypothetical illustrations required by state laws to be provided by dealers in connection with retirement investments and variable annuity contracts. See letter dated November 29, 2004, to Therese Squillacote, Chief Compliance Officer, ING Financial Advisers,  LLC, from Philip A. Shaikun, Assistant General Counsel, NASD; letter dated September 30, 2002, to Sally Krawczyk, Esq., Sutherland, Asbill & Brennan, LLP, from Mr. Shaikun; and letter dated February 5, 1999, to W. Thomas Conner, Vice President, Regulatory Affairs, National Association of Variable  Annuities, from Robert J. Smith, Office of General Counsel,  NASD Regulation, Inc.

The Municipal Securities Rulemaking Board ("MSRB") is publishing this notice to remind brokers, dealers and municipal securities dealers ("dealers") of their customer protection obligations—specifically the application of Rule G-17, on fair dealing, and Rule G-19, on suitability—in connection with their municipal securities sales activities, including but not limited to situations in which dealers offer sales incentives.[1] 

Basic Customer Protection Obligation

At the core of the MSRB's customer protection rules is Rule G-17 which provides that, in the conduct of its municipal securities activities, each dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest or unfair practice.  The rule encompasses two basic principles: an anti-fraud prohibition similar to the standard set forth in Rule 10b-5 adopted by the Securities and Exchange Commission under the Securities Exchange Act of 1934, and a general duty to deal fairly even in the absence of fraud.  All activities of dealers must be viewed in light of these basic principles, regardless of whether other MSRB rules establish specific requirements applicable to such activities.

Disclosure

The MSRB has interpreted Rule G-17 to require a dealer, in connection with any transaction in municipal securities, to disclose to its customer, at or prior to the sale of the securities to the customer, all material facts about the transaction known by the dealer, as well as material facts about the security that are reasonably accessible to the market.[2]  This duty applies to any transaction in a municipal security regardless of whether the dealer has recommended the transaction.  Dealers should make certain that information they provide to their customers, whether provided under an affirmative disclosure obligation imposed by MSRB rules or in response to questions from customers, is correct and not misleading.  Further, dealers are reminded that disclosures made to customers as required under MSRB rules do not relieve dealers of their suitability obligations—including the obligation to consider the customer's financial status, tax status and investment objectives—if they have recommended transactions in municipal securities.

Suitability

Under Rule G-19, a dealer that recommends to a customer a transaction in a municipal security must have reasonable grounds for believing that the recommendation is suitable, based upon information available from the issuer of the security or otherwise and the facts disclosed by or otherwise known about the customer.[3]  To assure that a dealer effecting a recommended transaction with a non-institutional customer has the information needed about the customer to make its suitability determination, Rule G-19 requires the dealer to make reasonable efforts to obtain information concerning the customer's financial status, tax status and investment objectives, as well as any other information reasonable and necessary in making the recommendation.[4]  Dealers are reminded that the obligation arising under Rule G-19 in connection with a recommended transaction requires a meaningful analysis, taking into consideration the information obtained about the customer and the security, which establishes the reasonable grounds for believing that the recommendation is suitable.  Such suitability determinations should be based on the appropriately weighted factors that are relevant in any particular set of facts and circumstances, which factors may vary from transaction to transaction.  Pursuant to Rule G-27, on supervision, dealers must have written supervisory procedures in place that are reasonably designed to ensure compliance with the Rule G-19 obligation to undertake a suitability analysis in connection with every recommended transaction, and dealers must enforce these procedures to ensure that such meaningful analysis does in fact occur in connection with the dealer's recommended transactions.

Other Sales Practice Principles

Dealers must keep in mind the requirements under Rule G-17—that they deal fairly with all persons and that they not engage in any deceptive, dishonest or unfair practice—when considering the appropriateness of day-to-day sales-related activities with respect to municipal securities.  In some cases, certain sales-related activities are governed in part by specific MSRB rules, such as Rule G-19 (as described above), Rule G-18 on execution of transactions, and Rule G-30 on prices and commissions.  Other activities may not be explicitly addressed by a specific MSRB rule.  In either case, the general principles of Rule G-17 always apply.

In particular, dealers must ensure that they do not engage in transactions that are unfair to customers under Rule G-17.  This principle applies in the case of an individual transaction to ensure that the dealer does not unfairly attempt to increase its own revenue or otherwise advance its interests without due regard to the customer's interests.  In addition, where a dealer consistently recommends that customers invest in the municipal securities that offer the dealer the highest compensation, such pattern or general practice may, depending on the facts and circumstances, constitute a violation of Rule G-17 if the recommendation of such municipal securities over the other municipal securities offered by the dealer does not reflect a legitimate investment-based purpose.

With respect to sales incentives, the MSRB has previously interpreted Rule G-20, relating to gifts, gratuities and non-cash compensation, to require a dealer that sponsors a sales contest involving representatives who are not employed by the sponsoring dealer to have in place written agreements with these representatives.[5]  Dealers are also reminded that Rule G-20(d) establishes standards regarding non-cash incentives for sales of municipal securities that are substantially similar to those currently applicable to the public offering of corporate securities under NASD Rule 2710(i) but also include "total production" and "equal weighting" requirements for internal sales contests.  Dealers should be mindful that financial incentives may cause an associated person (whether an associated person of the dealer offering the sales incentive or an associated person of another dealer) to favor one municipal security over another and thereby potentially compromise the dealer's obligations under MSRB rules, including Rules G-17 and G-19.  Rule G-17 may be violated if a dealer or any of its associated persons engages in any marketing activities that result in a customer being treated unfairly, or if the dealer or any of its associated persons engages in any deceptive, dishonest or unfair practice in connection with such marketing activities.  The MSRB also believes that, depending upon the specific facts and circumstances, a dealer may violate Rule G-17 if it acts in a manner that is reasonably likely to induce another dealer or such other dealer's associated persons to violate the principles of Rule G-17 or other MSRB customer protection rules, such as Rule G-18, G-19 or Rule G-30. 

[1] The principles enunciated in this notice were previously discussed, in the context of the 529 college savings plan market, in Rule G-17 Interpretation - Interpretation on Customer Protection Obligations Relating to the Marketing of 529 College Savings Plans (August 7, 2006), reprinted in MSRB Rule Book. This notice makes clear that the general principles discussed in the August 2006 interpretation also apply in the context of the markets for municipal bonds, notes and other types of municipal securities. This notice in no way alters the substance or applicability of the August 2006 interpretation with respect to the 529 college savings plan market.

[2] See Rule G-17 Interpretation - Interpretive Notice Regarding Rule G-17, on Disclosure of Material Facts (March 20, 2002), reprinted in MSRB Rule Book.

[3] The MSRB has previously stated that most situations in which a dealer brings a municipal security to the attention of a customer involve an implicit recommendation of the security to the customer, but determining whether a particular transaction is in fact recommended depends on an analysis of all the relevant facts and circumstances.  See , February 17, 1998Rule G-19 Interpretive Letter - Recommendations, reprinted in MSRB Rule Book.  The MSRB also has provided guidance on recommendations in the context of on-line communications in , September 25, 2002Rule G-19 Interpretation - Notice Regarding Application of Rule G-19, on Suitability of Recommendations and Transaction, to Online Communications, reprinted in MSRB Rule Book.

[4] Rule G-8(a)(x)(F) requires that dealers maintain records for each customer of such information about the customer used in making recommendations to the customer. Rule G-19(e), on churning, also prohibits a dealer from recommending transactions to a customer that are excessive in size or frequency, in view of information known to such dealer concerning the customer's financial background, tax status and investment objectives.

[5] See Rule G-20 Interpretive Letter - Authorization of sales contests, June 25, 1982, reprinted in MSRB Rule Book.

The Municipal Securities Rulemaking Board (“Board” or “MSRB”) is publishing this notice to remind brokers, dealers and municipal securities dealers (“dealers”) of the possible application of Rule G-37, on political contributions and prohibitions on municipal securities business, when dealers sponsor meetings and conferences where issuer officials are invited to attend or are featured speakers.  Dealers are responsible for ensuring that their supervisory policies and procedures established under Rule G-27, on supervision, are adequate to prevent and detect violations of MSRB rules.  Thus, it is incumbent on dealers to have appropriate supervisory procedures in place to review the nature of, and activities surrounding, the types of events discussed in this notice to ensure that Rule G-37 is not violated, directly or indirectly.

Rule G-37, in general, prohibits dealers from engaging in municipal securities business with issuers for a two-year period if certain political contributions have been made to officials of such issuers by the dealer or a municipal finance professional (“MFP”) (other than certain de minimis contributions), and requires dealers to record and disclose certain political party payments and municipal securities business to assist in severing the connection between contributions and the awarding of municipal securities business.  The rule also includes, among other things, a prohibition on dealers and their MFPs from (1) soliciting any person (including, but not limited to, any affiliated entity of the dealer) or political action committee (“PAC”) to make any contribution, or (2) coordinating any contributions to an official of an issuer with which the dealer is engaging or seeking to engage in business.  Dealers and MFPs are prohibited from, directly or indirectly, through or by any other person or means, doing any act which would result in violation of the rule’s ban on business or prohibition on soliciting and coordinating (bundling) contributions.

A dealer sponsoring a meeting or conference where an issuer official is invited to attend or is a featured speaker should be mindful of the parameters of Rule G-37, including the prohibition on soliciting and coordinating contributions.  For example, if the issuer official (or his/her staff) solicits contributions in connection with the event, or dealer personnel solicit or coordinate contributions, such activities may constitute fundraising activities. [1]  If a determination is made, based on the particular facts and circumstances, that the event is a fundraising event for the issuer official, then expenses incurred by the dealer for hosting the event may be deemed a contribution, thereby triggering the two-year ban on municipal securities business with that issuer.  Such expenses may include, but are not limited to, the cost of the facility; the cost of refreshments; any expenses paid for administrative staff; and the payment or reimbursement of any of the issuer official’s expenses for the event. [2]

The dollar amount of an expense incurred by the dealer for hosting the event is not dispositive of whether that expense constitutes a contribution and therefore triggers the ban on municipal securities business under Rule G-37.  If, depending on the particular facts and circumstances, the event is a fundraising event, then any expense incurred by the dealer may be deemed a contribution to the issuer official, thereby triggering the two-year ban on municipal securities business with that issuer.

By publishing this notice, the MSRB is not suggesting that dealers curtail their legitimate hosting or sponsoring of meetings or conferences where issuer officials are invited to attend or are featured speakers.  However, dealers should consider carefully the true nature of such events and the possible application of Rule G-37 if the meeting or conference involves fundraising activities in support of an issuer official.

In addition to dealers’ Rule G-37 obligations, Rule G-27, on supervision, requires that dealers supervise the conduct of their municipal securities activities, and that of their associated persons, to ensure compliance with MSRB rules, and that dealers adopt, maintain and enforce written supervisory procedures reasonably designed to ensure such compliance.  It is therefore incumbent on dealers to have appropriate supervisory procedures in place to review the nature of, and activities surrounding, the types of events discussed in this notice to ensure that Rule G-37 is not violated, directly or indirectly. Dealers should therefore take appropriate steps to ensure that such events are not fundraising events by, among other things, ensuring that: (i) contributions are not solicited by the issuer official or his/her staff; (ii) any attendee contact information provided by the dealer is not used by the issuer official or his/her staff to solicit contributions; and (iii) contributions are not solicited, coordinated or made by dealer personnel in connection with the event. [3]

[1] The MSRB has previously stated that “Dealers may not engage in municipal securities business with issuers if they or their municipal finance professionals engage in any kind of fundraising activities for officials of such issuers….”  See Securities Exchange Act Release No. 33868 (April 7, 1994), 59 FR 17621 (April 13, 1994).  See also Questions and Answers Concerning Political Contributions and Prohibitions on Municipal Securities Business: Rule G-37 (May 24, 1994), reprinted in MSRB Rule Book; MSRB Interpretation of November 7, 1994 (Solicitation of Contributions), reprinted in MSRB Rule Book; MSRB Interpretation of May 31, 1995 (Campaign for Federal Office), reprinted in MSRB Rule Book.

The Municipal Securities Rulemaking Board (“MSRB”) is publishing this notice to remind brokers, dealers and municipal securities dealers (collectively, “dealers”) of the application of Rule G-20, on gifts, gratuities and non-cash compensation, and Rule G-17, on fair dealing, in connection with certain payments made and expenses reimbursed during the municipal bond issuance process.  These rules are designed to avoid conflicts of interest and to promote fair practices in the municipal securities market.

Rule G-20, among other things, prohibits dealers from giving, directly or indirectly, any thing or service of value, including gratuities, in excess of $100 per year to a person other than an employee or partner of the dealer, if such payments or services are in relation to the municipal securities activities of the recipient’s employer.  The rule provides an exception from the $100 annual limit for “normal business dealings,” which includes occasional gifts of meals or tickets to theatrical, sporting, and other entertainments hosted by the dealer (i.e., if dealer personnel accompany the recipient to the meal, sporting or other event), legitimate business functions sponsored by the dealer that are recognized by the Internal Revenue Service as a deductible business expense, or gifts of reminder advertising.  However, these “gifts” must not be “so frequent or so extensive as to raise any question of propriety.”  Rule G-17 provides that, in the conduct of its municipal securities activities, each dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest or unfair practice.

Dealers should consider carefully whether payments they make in regard to expenses of issuer personnel in the course of the bond issuance process, including in particular but not limited to payments for which dealers seek reimbursement from bond proceeds, comport with the requirements of these rules.  Payment of excessive or lavish entertainment or travel expenses may violate Rule G-20 if they result in benefits to issuer personnel that exceed the limits set forth in the rule, and can be especially problematic where such payments cover expenses incurred by family or other guests of issuer personnel.  Depending on the specific facts and circumstances, excessive payments could be considered to be gifts or gratuities made to such issuer personnel in relation to the issuer’s municipal securities activities.  Thus, for example, a dealer acting as a financial advisor or underwriter may violate Rule G-20 by paying for excessive or lavish travel, meal, lodging and entertainment expenses in connection with an offering (such as may be incurred for rating agency trips, bond closing dinners and other functions) that inure to the personal benefit of issuer personnel and that exceed the limits or otherwise violate the requirements of the rule.

Furthermore, dealers should be aware that characterizing excessive or lavish expenses for the personal benefit of issuer personnel as an expense of the issue may, depending on all the facts and circumstances, constitute a deceptive, dishonest or unfair practice.  A dealer may violate Rule G-17 by knowingly facilitating such a practice by, for example, making arrangements and advancing funds for the excessive or lavish expenses to be incurred and thereafter claiming such expenses as an expense of the issue.

Dealers are responsible for ensuring that their supervisory policies and procedures established under Rule G-27, on supervision, are adequate to prevent and detect violations of MSRB rules in this area.  The MSRB notes that state and local laws also may limit or proscribe activities of the type addressed in this notice. 

By publishing this notice, the MSRB does not mean to suggest that issuers or dealers curtail legitimate expenses in connection with the bond issuance process.  For example, it sometimes is advantageous for issuer officials to visit bond rating agencies to provide information that will facilitate the rating of the new issue.  It is the character, nature and extent of expenses paid by dealers or reimbursed as an expense of issue, even if thought to be a common industry practice, which may raise a question under applicable MSRB rules. 

The MSRB encourages all parties involved in the municipal bond issuance process to maintain the integrity of this process and investor and public confidence in the municipal securities market by adhering to the highest ethical standards. 

NOTE: This notice was revised effective May 6, 2016. View Notice 2015-21 (November 9, 2015).

On January 8, 2007, certain amendments to Rule G-14 concerning the “List  Offering Price/Takedown” indicator became effective. These amendments require the use of the “List Offering Price/Takedown” indicator on primary market sale transactions executed on the first day of trading of a new issue:

• by a sole underwriter, syndicate manager, syndicate member or selling group member at the published list offering price for the security (“List Offering Price Transaction”); or
• by a sole underwriter or syndicate manager to a syndicate or selling group member at a discount from the published list offering price for the security (“RTRS Takedown Transaction”).[1]

Since implementation of the revised “List Offering Price/Takedown” indicator, the MSRB has received several questions concerning the use of the indicator on certain transactions executed by sole underwriters, syndicate managers, syndicate members, or selling group members on the first day of trading in a new issue. These questions relate to whether inter-dealer transactions at a price equal to the “list offering price” are included in the definition of “List Offering Price Transactions.” The MSRB wishes to clarify that inter-dealer transactions are not included in the definition of “List Offering Price Transactions.”[2]

The MSRB has previously clarified that the published list offering price is defined as the “publicly announced ‘initial offering price’ at which a new issue of municipal securities is to be offered to the public.”[3] A large number of sales to investors at the published list price are expected on the first day of trading of a new issue, and these transactions offer relatively little value to real-time transparency. Consequently, the “List Offering Price” exception provides these transactions with an end-of-day exception to the 15-minute deadline. An inter-dealer sale transaction at a price equal to the list offering price, however, does provide useful current market information, since it can be presumed that the security is destined to be redistributed to investors at a price above the published list offering price. Inter-dealer transactions at the list offering price, therefore, are not included in the definition of “List Offering Price Transactions,” and identifying such transactions with the “List Offering Price/Takedown” indicator would violate MSRB Rule G-14.

[1] See Rule G-14 RTRS Procedures (d)(vii). A transaction reported with the “List Offering Price/Takedown” indicator receives an end-of-day exception to the 15-minute reporting deadline.

[2] An inter-dealer transaction may meet the definition of an “RTRS Takedown Transaction” when a sole underwriter or syndicate manager executes a transaction with a syndicate or selling group member at a discount from the published list offering price for the security.

[3] See “Reminder Notice on ‘List Offering Price’ and Three-Hour Exception for Real-Time Transaction Reporting: Rule G-14,” MSRB Notice 2004-40 (December 10, 2004). If the price is not publicly disseminated (e.g., if the security is a “not reoffered” maturity within a serial issue), the transaction is not considered a “List Offering Price Transaction.”

Supervisory procedures relating to indirect contributions: conference accounts and 527 organizations.  This is in response to your request for confirmation that donations to segregated conference accounts of organizations such as the Democratic Governors Association (DGA) and Republican Governors Association (RGA) do not constitute contributions to an official of an issuer within the meaning of Rule G-37(b) without an intent to use the conference accounts as a device for contributing to the election activities of individual governors or other officials of issuers.  You describe both organizations as independent, voluntary political organizations constituted under Section 527 of the Internal Revenue Code to raise money for political activities.  You note that the organizations’ activities have the primary purpose of influencing gubernatorial elections but also seek to conduct policy conferences and workshops to help their members and other interested parties to understand and participate in public policy questions that confront state governments.  You state that all Democratic governors are members of the DGA and all Republican governors are members of the RGA.

You further note that each organization has a wide variety of accounts into which it receives funds from individuals, organizations and other entities, with some accounts used to provide financial support to gubernatorial candidates and other accounts (including conference accounts) used exclusively to fund policy conferences.  You state that the conference accounts are segregated from accounts that provide financial support to gubernatorial candidates and that neither organization permits transfers of funds from their conference accounts to any of their other accounts, including their administrative accounts.  You represent that both organizations follow a standard practice of honoring any request by a donor to place donated funds in a conference account and that they have further committed to provide, upon a donor’s request, written confirmation prior to accepting a donation that the donated funds will be allocated to the conference account.

The MSRB cannot provide confirmation regarding the status under Rule G-37 of payments to any particular organization or account of such organization as such a determination requires an analysis of, among other things, the specific facts and circumstances of each individual payment, the written supervisory procedures of the broker, dealer or municipal securities dealer (“dealer”), and the efforts of the dealer to enforce such procedures.  However, this letter reviews guidance previously provided by the MSRB that may assist you in undertaking such an analysis.

Under Rule G-37, on political contributions and prohibitions on municipal securities business, contributions to officials of an issuer by a dealer, a municipal finance professional (“MFP”) of the dealer, or a political action committee (“PAC”) controlled by the dealer or an MFP can result in the dealer being banned from municipal securities business with such issuer for a period of two years.[1]  Section (d) of Rule G-37 provides, in part, that no dealer or MFP shall, directly or indirectly, through or by any other person or means, do any act which would result in a violation of the ban on municipal securities business.

The MSRB has previously provided guidance regarding the potential for payments made to political parties, PACs or others to constitute indirect contributions to issuer officials for purposes of Rule G-37(d).  In guidance published in 1996, the MSRB stated that a dealer would violate Rule G-37 by doing municipal securities business with an issuer after providing money to any person or entity when the dealer knows that such money will be given to an official of an issuer who could not receive such a contribution directly from the dealer without triggering the rule’s prohibition on municipal securities business. Further, depending on the specific facts and circumstances, a payment to a PAC or political party that is soliciting funds for the purpose of supporting a limited number of issuer officials might result in the same prohibition on municipal securities business as would a contribution made directly to an issuer official.[2]  In such circumstances, dealers should inquire of the PAC or political party how any funds received from the dealer would be used.[3]

In 2005, the MSRB published guidance on dealers’ written supervisory procedures under Rule G-27, on supervision, relating to compliance with Rule G-37(d).  The MSRB noted that each dealer must adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that neither the dealer nor its MFPs are using payments to political parties and non-dealer controlled PACs to contribute indirectly to an official of an issuer.[4]  Please note that the scope of Rule G-37(d) is not limited to the use of political parties and PACs as possible conduits for indirect contributions to issuer officials and, therefore, the need for such supervisory procedures would apply in connection with dealer and MFP payments to other types of political organizations as well, including but not limited to organizations constituted under Section 527 of the Internal Revenue Code.

The 2005 guidance on supervisory procedures included examples of certain provisions that dealers might include in their written supervisory procedures to ensure compliance with Rule G-37(d).  The MSRB stated that such examples are not exclusive and are only suggestions, and that each dealer is required to evaluate its own circumstances and develop 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 Rule G-37(d).[5]  Thus, a dealer need not include the specific supervisory procedures described in the 2005 guidance in order to meet its obligation under Rule G-27(c) so long as the dealer in fact has, and enforces, other 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 Rule G-37(d).

The MSRB also has stated that payments to “housekeeping,” “conference” or “overhead” accounts of political parties are not safe harbors under Rule G-37 and that a dealer’s written supervisory procedures designed to ensure compliance with Rule G-37(d) must take into account such payments.  The MSRB noted that “preemptive” instructions accompanying payments to housekeeping accounts of political parties stating that such payments are not to be used for the benefit of one or a limited number of issuer officials are not considered sufficient to meet the dealer’s obligations with regard to ensuring that the payment is not being made to circumvent the requirements of Rule G-37.[6]  Although payments to housekeeping, conference or overhead accounts are not safe harbors and preemptive instructions are not by themselves sufficient to establish compliance with Rule G-37(d), procedures permitting payments to political parties and other political organizations only if made to these types of accounts and/or requiring preemptive instructions regarding the use of such payments may be elements in a supervisory program that, together with other appropriate procedures, could adequately ensure compliance with Rule G-37(d), depending on the specific facts and circumstances. MSRB Interpretation of December 21, 2006.
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[1] MFPs may make certain de minimis contributions to issuer officials without triggering the ban on business.

[2] See Rule G-37 Question and Answer No. III.4 (August 6, 1996), reprinted in MSRB Rule Book.

[3] See Rule G-37 Question and Answer No. III.5 (August 6, 1996), reprinted in MSRB Rule Book.

[4] See Rule G-37 Question and Answer No. III.7 (September 22, 2005) (“Q&A-III.7”), reprinted in MSRB Rule Book.

[5] See Q&A-III.7.

[6] See Rule G-37 Question and Answer No. III.8 (September 22, 2005), reprinted in MSRB Rule Book.