The MSRB has become aware of problems in transaction reporting as a result of dealers "bunching" certain inter-dealer transactions in the comparison system.  Recently, some dealers have reported the sum of two trades as one transaction in instances when two dealers effected two trades with each other in the same issue and at the same price.  When two transactions are effected, two transactions should be reflected in each dealer's books and records and two transactions are required to be reported to the MSRB.  The time of trade for each transaction also must accurately reflect the time at which a contractual commitment was formed for each quantity of securities.  For example, if Dealer A purchases $50,000 of a municipal issue at a price of par from Dealer B at 11:00 am and then purchases an additional $50,000 at par from Dealer B at 2:00 pm, two transactions are required to be reflected on each dealers' books and records and two transactions are required to be reported to the MSRB. 

Since the same inter-dealer trade record submitted for automated comparison under Rule G-12(f) also is used to satisfy the requirements of Rule G-14, on transaction reporting, each inter-dealer transaction should be submitted for automated comparison separately in order to comply with Rule G-14's requirement to report all transactions.  Failure to do so causes erroneous information concerning transaction size and time of trade to appear in the transparency reports published by the MSRB as well as in the audit trail used by regulators and enforcement agencies.  To the extent that dealers use the records generated by the comparison system for purposes of complying with MSRB Rule G-8, on recordkeeping, it may also create erroneous information as to the size of transactions effected or time of trade execution.

In recent months, the MSRB has received a number of questions relating to certain kinds of transactions in which independent investment advisors instruct selling dealers to make deliveries to other dealers.  This notice addresses questions that have been raised relating to Rule G-12(f)(i), on automated comparison, and Rule G-14, on transaction reporting.  It describes existing requirements that follow from the language of the rules and does not set forth any new policies or procedures.

An independent investment advisor purchasing securities from one dealer sometimes instructs that dealer to make delivery of the securities to other dealers where the investment advisor's clients have accounts.  The identities of individual account holders typically are not given.[1] The dealers receiving the deliveries in these cases generally are providing "wrap fee" or similar types of accounts that allow investors to use independent investment advisors to manage their municipal securities portfolios. In these kinds of arrangements, the investment advisor chosen by the account holder may be picked from a list of advisors approved by the dealer; however, dealers offering these accounts have indicated that the investment advisor acts independently in effecting transactions for the client's municipal securities portfolio.

The following example illustrates the situation. An Investment Advisor purchases a $1 million block of municipal bonds from the Selling Dealer and instructs the Selling Dealer to deliver $300,000 of the bonds to Dealer X and $700,000 to Dealer Y. The Investment Advisor does not give the Selling Dealer the individual client accounts at Dealer X and Dealer Y to which the bonds will be allocated and there is no contact between the Selling Dealer and Dealers X and Y at the time of trade. The Investment Advisor, however, later informs Dealer X and Dealer Y to expect the delivery from the Selling Dealer, and gives the identity and quantity of securities that will be delivered, the final monies, and the individual account allocations. For example, the Investment Advisor may instruct Dealer X to allocate its $300,000 delivery by placing $100,000 in John Doe's account and $200,000 in Mary Smith's account. 

With respect to transaction reporting requirements in this situation, the Selling Dealer should report a $1 million sale to a customer.  No other dealer should report a transaction.  The comparison system should not be used for the inter-dealer transfers between the Selling Dealer and Dealers X and Y because this would cause them to be reported as inter-dealer trades. 

Frequently Asked Questions

One frequently asked question in the context of the above example is whether the transfers of the $300,000 and $700,000 blocks by the Selling Dealer to Dealer X and Dealer Y should be reported as inter-dealer transactions.  Another question is whether these transfers may be accomplished by submitting them to the automated comparison system for inter-dealer transactions.  Based on the information that has been provided to the MSRB, these transfers do not appear to represent inter-dealer trades and thus should not be reported under Rule G-14 or compared under Rule G-12(f)(i) using the current central comparison system. 

One reason for the conclusion that no inter-dealer trade exists is that municipal securities professionals for firms in the roles of Dealer X and Y have stated that the Investment Advisor is acting independently and is not acting as their agent when effecting the trade with the Selling Dealer.  In support of this assertion, they note that they often are not informed of the transaction or the deliveries that they should expect until well after the trade has been effected by the Investment Advisor.  They also note that the actions of the Investment Advisor are not subject to their control or supervision.  Thus, the $300,000 and $700,000 inter-dealer transfers in the above example appear to be simply deliveries made in accordance with a contract made by, and the instructions given by, the Investment Advisor.  The inter-dealer transfers thus do not constitute inter-dealer transactions.

Because Rule G-14 transaction reporting of inter-dealer trades is accomplished through the central comparison system, any dealer submitting the $300,000 and $700,000 inter-dealer transfers to the comparison system is in effect reporting inter-dealer transactions that did not occur.  In addition, this practice tends to drive down comparison rates and the overall performance of dealers in the automated comparison system.  As noted above, the trading desks of Dealer X and Dealer Y generally do not know about the Investment Advisor's transaction at the time of trade.  They consequently cannot submit comparison information to the system unless the Investment Advisor provides them with the trade details in a timely, accurate and complete manner.  Since the Investment Advisor is acting independently and is not supervised by municipal securities professionals at Dealer X and Dealer Y, there is no means for the municipal securities professionals at Dealer X and Dealer Y to ensure that this happens.

Questions also have been received on whether the individual allocations to investor accounts (e.g., the $100,000 and $200,000 allocations to the accounts of John Doe and Mary Smith in the example above) should be reported under Rule G-14 as customer transactions.  Even though the dealer housing these accounts obviously has important obligations to the investor with respect to receiving deliveries, paying the Selling Dealer for the securities, and processing the allocations under the instructions of the Investment Advisor, it does not appear that the dealer entered into a purchase or sale contract with the investor and thus nothing is reportable under Rule G-14.  This conclusion again is based upon statements by dealers providing the "wrap fee" and similar accounts, who indicate that the investment advisor acts independently and not as the dealer's agent when it effects the original block transaction and when it makes allocation decisions. 

For purposes of price transparency, the only transaction to be reported in the above example is a single $1 million sale to a customer.  This is appropriate because the only market price to be reported is the one set between the Selling Dealer and the Investment Advisor for the $1 million block of securities.  It is appropriate that the $300,000 and $700,000 inter-dealer transfers, and the $100,000 or $200,000 investor allocations are not disseminated as transactions since they would have to be reported using the price for the $1 million block.  This could be misleading in that market for $1 million round lots are often different than market prices for smaller transaction sizes.

Draft Interpretive Guidance

On November 18, 2002, the MSRB published for comment draft interpretive guidance on marketing of 529 college savings plan employee payroll deduction programs.[2] The MSRB received six comment letters. After reviewing these comments, the MSRB approved the draft interpretive guidance, with certain modifications, for filing with the SEC. The MSRB modified the draft interpretive guidance to: (i) change the term “introducing broker” to “selling broker;” (ii) reflect the existence of other scenarios in which 529 college savings plans are marketed in the workplace; (iii) provide more guidance as to when dealers may rely on others to fulfill regulatory responsibilities; and (iv) clarify certain recordkeeping obligations. The text of the proposed interpretive notice filed with the SEC appears at the end of this notice.

Summary of Comments on Draft Interpretive Guidance

One commentator fully supported the draft interpretive notice, stating that it “clearly sets out the rationale for providing guidance in this area … [and] will make it possible for our Representatives to assist companies in offering 529 college savings plans to their employees.” Four other commentators generally supported the draft interpretive notice, although each requested that the MSRB further broaden and/or clarify the guidance in various respects.[3]

Three commentators requested that the MSRB substitute the term “selling broker” or “selling dealer” for the term “introducing broker” used in the draft interpretive notice. They stated that the term “introducing broker” is used with different meanings under the federal securities laws applicable to other types of securities and may cause some confusion. In addition, one of these commentators recommended that, for purposes of the interpretation, the term “selling broker” also encompass the primary distributor where it directly establishes the relationship with the employer. It stated, “In addition to recognizing that a selling broker rarely, if ever, has a suitability obligation in the context of a payroll deduction program, the Notice should clarify that a primary distributor who makes 529 Plan investments available through a third-party broker would not have a suitability obligation under Rule G-19, as it too makes no recommendation to an employee.” The MSRB has changed the term “introducing broker” to “selling broker” in the revised interpretive notice. Contrary to the statement that the interpretive notice recognizes “that a selling broker rarely, if ever, has a suitability obligation,” the notice does not assess the likelihood or frequency of recommendations being made by selling brokers. The notice does provide some guidance regarding the factors to consider when determining whether a recommendation has occurred. The MSRB believes that no further guidance in this area is necessary.

Four commentators noted that the scenario described in the draft interpretive notice is not the only form in which dealers may seek to market 529 college savings plans through employers. In addition to arrangements where selling brokers having a contractual relationship with the primary distributor to market through employers, with the employees making investments directly through the primary distributor (as described in the draft interpretive notice), these commentators noted that: (1) primary distributors may themselves market 529 college savings plans through employers; (2) selling brokers sometimes have contractual relationships with the issuer rather than the primary distributor; (3) selling brokers may handle employee investments and maintain long-term relationships with employees, rather than merely introducing employees to the primary distributor; (4) transfer agents may undertake significant responsibilities in connection with employees’ investments; and (5) employees may in some instances use a dealer other than the selling broker or primary distributor to make an investment that may still be considered part of the employer-sponsored program. These commentators requested that the MSRB address some or all of these additional scenarios. In addition, one of these commentators suggested that the MSRB make clear that the scenarios addressed in the draft interpretive notice are illustrative and that other models may be implemented.

The MSRB has made significant modifications to the initial paragraphs of the notice to reflect the existence of these other scenarios. No significant change in interpretation results from a primary distributor acting in the role of a selling broker. The identity of the selling broker’s counterparty on the selling agreement also does not significantly change its regulatory obligations. Selling brokers that make recommendations remain fully obligated under MSRB rules and remain ultimately responsible where the primary distributor has not affirmatively undertaken regulatory obligations on behalf of the selling broker (as discussed below). The guidance provided by the notice is primarily intended for dealers that are formally involved in a workplace marketing program; thus, the notice is of limited applicability to dealers that do not have a formal role in such a program.

A commentator observed that the draft interpretive notice referred to on-line enrollment with the primary distributor and noted that in many circumstances enrollment and investments continue to be handled by mail. Also, three commentators noted that other forms of payment, such as ACH (automated clearing house) bank transfers, may be used in addition to traditional employee payroll deductions. These commentators requested that the MSRB recognize these variants in its final notice. The revised interpretive notice now more clearly acknowledges these different processes.

Four commentators sought further clarification on the circumstances under which selling brokers may rely on other parties to meet their regulatory obligations. Two of these commentators stated that dealers should be able to rely on issuers to distribute official statements to customers. One noted its concern that customers may be confused by the receipt of redundant (and possibly out-dated) disclosure documents if dealers must deliver official statements regardless of whether the issuer has sent them to customers. Another suggested that the ability of the selling broker to rely on the primary distributor for delivery of the official statement as provided in the draft interpretive notice be extended to the ability to rely on other parties, such as other dealers, employers and issuers.

The revised interpretive notice permits a selling broker to conclusively rely on the primary distributor to meet its disclosure obligations and certain supervisory obligations (described below) only under the limited circumstances in which employee orders are not accepted without actual delivery of the official statement and the primary distributor has affirmatively agreed to undertake such regulatory obligations on behalf of the selling broker. In such circumstances, the primary distributor will be responsible for fulfilling such obligations. In all other circumstances, the notice clarifies that a selling broker may agree with another party to take certain actions on its behalf but that if such other party fails to take such actions, the selling broker remains responsible for fulfilling its regulatory obligation.

One commentator suggested that the MSRB should permit selling brokers to enter into arrangements with the primary distributor to meet their supervisory obligations to review and approve customer accounts and transactions based upon having procedures in place that provide assurances to the selling brokers that such review and approval is being undertaken by the primary distributor. Another commentator questioned the value of requiring a selling broker to review customer accounts and transactions well after the transaction is executed, especially if the transaction was not recommended. In addition, it questioned why a requirement for such review and related recordkeeping would be dependent upon whether the selling broker receives compensation for a transaction.

The revised interpretive notice clarifies that, where a selling broker does not make a recommendation and the primary distributor affirmatively agrees to take on both the disclosure responsibilities and the supervisory responsibilities with regard to opening of accounts and approval of transactions, the regulatory obligation may be shifted to the primary distributor. However, supervisory responsibility remains with the selling broker so long as the selling broker retains any affirmative duties to employees. The MSRB believes that the limited recordkeeping obligations imposed on all selling brokers in the notice are appropriate. The revised interpretive notice makes clear that the limited recordkeeping requirements that remain for subsequent transactions effected by the primary distributor where compensation is paid to the selling broker applies only when such compensation is transaction based since, depending on the facts and circumstances, this information may be necessary to determine compliance with MSRB’s fair pricing and fair commission requirements.

With respect to transfer agents, a commentator noted that many plans provide for applications and customer orders to be sent directly to a transfer agent, with the primary distributor’s activities “limited to managing the overall marketing of the program and the production of marketing and promotional materials.” It stated that “only the transfer agent maintains any investor records and these records are the plan’s investor records. Thus, in this model, the primary distributor’s regulatory responsibilities are limited primarily to compliance with applicable rules governing marketing materials but not those rules mandating customer account related procedures.” The commentator sought assurance that primary distributors did not retain residual customer protection obligations under MSRB rules in the scenario where applications and orders are submitted directly to the transfer agent.

The MSRB notes that transfer agents generally are viewed under the Exchange Act as working on behalf of the issuer but that, in the 529 college savings plan market, transfer agents also sometimes contractually agree to act on behalf of the primary distributor. In the revised interpretive notice, where transactions are effected through a transfer agent without the direct involvement of the primary distributor or the selling broker, the selling broker is permitted to conclusively rely on the primary distributor to fulfill certain of the selling broker’s regulatory obligations only if the transfer agent has contractually agreed to act on behalf of the primary distributor. Otherwise, the transfer agent is effectively treated as an agent of the issuer and the dealer that enlisted the corresponding employer to participate in the workplace marketing plan remains ultimately responsible for compliance with MSRB rules.

A commentator asked why a selling broker would have a fair dealing obligation under Rule G-17 to an employer since the employer is not the dealer’s client. It also sought guidance regarding the nature of information that a dealer would be obligated to provide to the employer under the Rule G-17 disclosure obligation. Two commentators also questioned the need for the selling broker to maintain a record of the name and address of an employer that the dealer solicited, as well as for principal review of such solicitation. Another commentator sought assurances that the fair dealing obligation toward the employer would not give rise to any inference that the issuer has any federal securities law obligation to employers under the scenario described in the draft interpretive notice.

The fair dealing requirement of Rule G-17 applies, on its face, to all persons, not just customers. The MSRB believes that it appropriately applies to the selling broker’s relationship with employers, particularly since the selling broker is inducing the employer to create a captive audience of investors and the employer’s agreement to participate in the program may lead employees to believe that the employer endorses investment under the program. Under these circumstances, it is important that selling brokers provide adequate information regarding the program to the employer so that it can make an informed decision with regard to enrollment in the program. The limited recordkeeping regarding the employer required by the notice is important in the context of documenting the ability of a selling broker to rely on the guidance provided in the notice with respect to particular transactions. The revised interpretive notice provides assurances that a dealer’s fair dealing obligation to the employer is not intended to imply that the issuer has a similar legal obligation to the employer.

* * * * *

[1] The Daily Report is available by subscription at no cost. Currently, "frequently traded" securities are those that traded two or more times during a trading day. As noted below, inter-dealer transactions must be compared on trade date to be eligible for this report.

[2] The MSRB also publishes a "Daily Comprehensive Report," providing details of all municipal securities transactions that were effected during the trading day one week earlier. The Daily Comprehensive Report is available by subscription for $2,000 per year. Along with trades in issues that are not "frequently traded," this report includes transactions reported to the MSRB late, inter-dealer trades compared after trade date, and transaction data corrected by dealers after trade date.

[3] A dealer may call the MSRB at (703) 797-6600 and ask to speak with a Transaction Reporting Assistant who can check to see if its firm is signed up for this free service.

[4] A complete description of the service is available at www.msrb.org in the Municipal Price Reporting / Transaction Reporting System section. NASD also has informed dealers of this service in "Municipal Transaction Reporting Compliance Information," Regulatory and Compliance Alert (Summer 2002).

[5] Under NSCC procedures, no buy-side trade report should be submitted for comparison against a syndicate "takedown" trade submitted by the syndicate manager. Syndicate transactions are "one-sided submissions" and compare automatically after being submitted by the syndicate manager. Paragraph (a) (ii) of Rule G-14 procedures thus requires that only the syndicate manager submit the trade.

[6] The EBS statistics reflect the aggregate number of such errors found in transaction data submitted by a particular NSCC member firm for itself and/or for its correspondents. This statistic cannot be generated individually for each correspondent because the EBS needed to identify the correspondent is itself missing or invalid. EBS statistics only measure the validity of the input the submitter provides to identify its own side of the trade and do not measure the accuracy with which a dealer uses EBSs to identify its contra-parties.

[7] In 1994, the MSRB stated that, "introducing brokers share the responsibility for complying with [Rule G-12(f)] with their clearing brokers. Introducing brokers who fail to submit transaction information in a timely and accurate manner could subject either or both parties to enforcement action for violating [Rule G-12(f)]." See "Enforcement Initiative," MSRB Reports, Vol. 14, No. 3 (June 1994) at 35. NASD has since reiterated this policy; see the following articles in Regulatory and Compliance Alert: "Introducing Firm Responsibility When Reporting Municipal Trades Through Service Bureaus and Clearing Firms" (Winter 2000) and "Municipal Securities Transaction Reporting Compliance Information" (Spring 2001).

[8] As explained above, one of the problems often associated with stamped advisories is that the EBS on transaction records may be missing or inaccurate. Since a clearing broker may have many correspondents, stamping an advisory can make it impossible for market regulators to know which correspondent actually effected the trade.

[9] Of course, if the initial information reported to the MSRB, such as total par value, is changed, the trade record must be amended to make it correct.

Background

In the municipal securities markets, dealers[1] typically communicate with investors one-on-one, in person, or by telephone. These dealer/customer communications are made to provide the investor with information concerning the municipal securities the dealer wants to sell and to allow the dealer to find out about the customer’s investment objectives. Over the last few years there has been a dramatic increase in the use of the Internet for communication between dealers and their customers. Dealers are looking to the Internet as a mechanism for offering customers new and improved services and for enhancing the efficiency of delivering traditional services to customers. For example, dealers have developed online search tools that computerize the process by which customers can obtain and compare information on the availability of municipal securities of a specific type that are offered for sale by a particular dealer.[2] Technological advancements have provided many benefits to investors and the brokerage industry. These technological innovations, however, also have presented new regulatory challenges, including those arising from the application of the suitability rule to online activities. In consideration of this, the Municipal Securities Rulemaking Board (“MSRB”) is issuing this notice to provide dealers with guidance concerning their obligations under MSRB Rule G-19, relating to suitability of recommendations,[3] in the electronic environment.[4]

Rule G-19 prohibits a dealer from recommending transactions in municipal securities to a customer unless the dealer makes certain determinations with respect to the suitability of the transactions.[5] Specifically, the dealer 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 the customer or otherwise known about such customer.

As the rule states, a dealer's suitability obligation only applies to securities that the dealer recommends to a customer.[6] A dealer or associated person who simply effects a trade initiated by a customer without a related recommendation from the dealer or associated person is not required to perform a suitability analysis. However, under MSRB Rules, even when a dealer does not recommend a municipal security transaction to a customer but simply effects or executes the transaction, the dealer is obligated to fulfill certain other important fair practice obligations. For example, under Rule G-17, when effecting a municipal security transaction for a customer, a dealer is required to disclose all material facts about a municipal security that are known by the dealer and those that are reasonably accessible.[7] In addition, Rule G-18 requires that each dealer, when executing a municipal securities transaction for or on behalf of a customer as agent, make a reasonable effort to obtain a price for the customer that is fair and reasonable in relation to prevailing market conditions. Similarly, under Rule G-30, if a dealer engages in principal transactions with a customer, the dealer is responsible for ensuring that it is charging a fair and reasonable price. The MSRB wishes to emphasize the importance of these fair practice obligations even when a dealer effects a non-recommended transaction online.[8]

Applicability of the Suitability Rule to Electronic Communications—General Principles  

There has been much debate about the application of the suitability rule to online activities.[9]  Industry commentators and regulators have debated two questions: first, whether the current suitability rule should even apply to online activities, and second, if so, what types of online communications constitute recommendations for purposes of the rule. The NASD published NASD Notice to Members 01-23, Online Suitability-Suitability Rule and Online Communication (the “NASD Online Suitability Notice”) (April 2001) to provide guidance to its members in April 2001.[10] In answer to the first question, the MSRB, like the NASD, believes that the suitability rule applies to all recommendations made by dealers to customers—including those made via electronic means—to purchase, sell, or exchange a security. Electronic communications from dealers to their customers clearly can constitute recommendations. The suitability rule, therefore, remains fully applicable to online activities in those cases where the dealer recommends securities to its customers. 

With regard to the second question, the MSRB does not seek to identify in this notice all of the types of electronic communications that may constitute recommendations. As the MSRB has often emphasized, "[w]hether a particular transaction is in fact recommended depends on an analysis of all the relevant facts and circumstances."[11] That is, the test for determining whether any communication (electronic or traditional) constitutes a recommendation remains a "facts and circumstances" inquiry to be conducted on a case-by-case basis. 

The MSRB also recognizes that many forms of electronic communications defy easy characterization. The MSRB believes this is especially true in the online municipal securities market, which is in a relatively early stage of development. Nevertheless, the MSRB offers as guidance the following general principles for dealers to use in determining whether a particular communication could be deemed a recommendation.[12] The "facts and circumstances" determination of whether a communication is a recommendation requires an analysis of the content, context, and presentation of the particular communication or set of communications. The determination of whether a recommendation has been made, moreover, is an objective rather than a subjective inquiry. An important factor in this regard is whether—given its content, context, and manner of presentation—a particular communication from a dealer to a customer reasonably would be viewed as a "call to action," or suggestion that the customer engage in a securities transaction. Dealers should bear in mind that an analysis of the content, context, and manner of presentation of a communication requires examination of the underlying substantive information transmitted to the customer and consideration of any other facts and circumstances, such as any accompanying explanatory message from the dealer.[13] Another principle that dealers should keep in mind is that, in general, the more individually tailored the communication is to a specific customer or a targeted group of customers about a security or group of securities, the greater the likelihood is that the communication may be viewed as a recommendation.

Scope of the Term Recommendation

As noted earlier, the MSRB agrees with and has in this guidance adopted the general principles enunciated in the NASD Online Suitability Notice as well as the NASD guidelines for evaluating suitability obligations discussed below. While the MSRB believes that the additional examples of communications that do not constitute recommendations provided by the NASD in its Online Suitability Notice are useful instruction for dealers who develop equity trading web sites, as the examples are based upon communications that exist with great regularity in the Nasdaq market, the MSRB believes that the examples have limited application to the types of information and electronic trading systems that are present in the municipal securities market. 

For example, the NASD’s third example of a communication that is not a recommendation describes a system that permits customer-directed searches of a “wide-universe” of securities and references all exchange-listed or Nasdaq securities, or externally recognized indexes.[14] The NASD example therefore applies to dealer web sites that effectively allow customers to request lists of securities that meet broad objective criteria from a list of all the securities available on an exchange or Nasdaq. These are examples of groups of securities in which the dealer does not exercise any discretion as to which securities are contained within the group of securities shown to customers. This example makes sense in the equity market where there are centralized exchanges and where electronic trading platforms routinely utilize databases that provide customer access to all of the approximately 7,300 listed securities on Nasdaq, the NYSE and Amex. However, no dealer in the municipal securities market has the ability to offer all of the approximately 1.3 million outstanding municipal securities for sale or purchase. The municipal securities market is a fragmented dealer market. Municipal securities do not trade through a centralized exchange and only a small number of securities (approximately 10,000) trade at all on any given day. Therefore, there is no comparable central exchange that could serve as a reference point for a database that is used in connection with municipal securities research engines. The databases used by dealer systems typically are limited to the municipal securities that a dealer, or a consortium of dealers, holds in inventory. In these types of systems the customer’s ability to search for desirable securities that meet the broad, objective criteria chosen by the customer (e.g., all insured investment grade general obligation bonds offered by a particular state) is limited. The concept of a wide universe of securities, which is central to all of the NASD’s examples, is thus difficult to define and has extremely limited, or no, application in the municipal securities market. 

Given the distinct features of the municipal securities market and the existing online trading systems, the MSRB believes it would be impractical to attempt to define the features of an electronic trading system that would have to be present for the system transactions to not be considered the result of a dealer recommendation. The online trading systems for municipal securities that are in place today limit customer choices to the inventory that the dealer or dealer consortium hold, and therefore, the dealer will always have a significant degree of discretion over the securities offered to the customer. A system that allows this degree of dealer discretion is a dramatic departure from the types of no recommendation examples provided by the NASD guidance, and thus, these communications must be carefully analyzed to determine whether or not a recommendation has been made.  

 The MSRB, however, does believe that the examples of communications that are recommendations provided in the NASD Online Suitability Notice are communications that take place in the municipal securities market. Therefore, the MSRB has adopted these examples and generally would view the following communications as falling within the definition of recommendation:

• A dealer sends a customer-specific electronic communication (e.g., an e-mail or pop-up screen) to a targeted customer or targeted group of customers encouraging the particular customer(s) to purchase a municipal security.[15]
• A dealer sends its customers an e-mail stating that customers should be invested in municipal securities from a particular state or municipal securities backed by a particular sector (such as higher education) and urges customers to purchase one or more stocks from a list with "buy" recommendations.
• A dealer provides a portfolio analysis tool that allows a customer to indicate an investment goal and input personalized information such as age, financial condition, and risk tolerance. The dealer in this instance then sends (or displays to) the customer a list of specific municipal securities the customer could buy or sell to meet the investment goal the customer has indicated.[16]
• A dealer uses data-mining technology (the electronic collection of information on Web Site users) to analyze a customer's financial or online activity—whether or not known by the customer—and then, based on those observations, sends (or "pushes") specific investment suggestions that the customer purchase or sell a municipal security.

Dealers should keep in mind that these examples are meant only to provide guidance and are not an exhaustive list of communications that the MSRB does consider to be recommendations. As stated earlier, many other types of electronic communications are not easily characterized. In addition, changes to the factual predicates upon which these examples are based (or the existence of additional factors) could alter the determination of whether similar communications may or may not be viewed as recommendations. Dealers, therefore, should analyze all relevant facts and circumstances, bearing in mind the general principles noted earlier and discussed below, to determine whether a communication is a recommendation, and they should take the necessary steps to fulfill their suitability obligations. Furthermore, these examples are based on technological services that are currently used in the marketplace. They are not intended to direct or limit the future development of delivery methods or products and services provided online.  

Guidelines for Evaluating Suitability Obligations 

Dealers should consider, at a minimum, the following guidelines when evaluating their suitability obligations with respect to municipal securities transactions.[17] None of these guidelines is determinative of whether a recommendation exists. However, each should be considered in evaluating all of the facts and circumstances surrounding the communication and transaction.

• A dealer cannot avoid or discharge its suitability obligation through a disclaimer where the particular communication reasonably would be viewed as a recommendation given its content, context, and presentation.[18] The MSRB, however, encourages dealers to include on their web sites (and in other means of communication with their customers) clear explanations of the use and limitations of tools offered on those sites.[19]   
• Dealers should analyze any communication about a security that reasonably could be viewed as a "call to action" and that they direct, or appear to direct, to a particular individual or targeted group of individuals—as opposed to statements that are generally made available to all customers or the public at large—to determine whether a recommendation is being made.[20]
• Dealers should scrutinize any communication to a customer that suggests the purchase, sale, or exchange of a municipal security—as opposed to simply providing objective data about a security—to determine whether a recommendation is being made.[21] 
• A dealer's transmission of unrequested information will not necessarily constitute a recommendation. However, when a dealer decides to send a particular customer unrequested information about a security that is not of a generalized or administrative nature (e.g., notification of an official communication), the dealer should carefully review the circumstances under which the information is being provided, the manner in which the information is delivered to the customer, the content of the communication, and the original source of the information. The dealer should perform this review regardless of whether the decision to send the information is made by a representative employed by the dealer or by a computer software program used by the dealer.
• Dealers should be aware that the degree to which the communication reasonably would influence an investor to trade a particular municipal security or group of municipal securities—either through the context or manner of presentation or the language used in the communication—may be considered in determining whether a recommendation is being made to the customer.

The MSRB emphasizes that the factors listed above are guidelines that may assist dealers in complying with the suitability rule. Again, the presence or absence of any of these factors does not by itself control whether a recommendation has been made or whether the dealer has complied with the suitability rule. Such determinations can be made only on a case-by-case basis taking into account all of the relevant facts and circumstances.

Conclusion

The foregoing discussion highlights some suggested principles and guidelines to assist in determining when electronic communications constitute recommendations, thereby triggering application of the MSRB's suitability rule. The MSRB acknowledges the numerous benefits that may be realized by dealers and their customers as a result of the Internet and online brokerage services. The MSRB emphasizes that it neither takes a position on, nor seeks to influence, any dealer's or customer's choice of a particular business model in this electronic environment. At the same time, however, the MSRB urges dealers both to consider carefully whether suitability requirements are adequately being addressed when implementing new services and to remember that customers' best interests must continue to be of paramount importance in any setting, traditional or online.

As new technologies and/or services evolve, the MSRB will continue to work with regulators, members of the industry and the public on these and other important issues that arise in the online trading environment.

[1] The term “dealer” is used in this notice as shorthand for “broker,” “dealer” or “municipal securities dealer,” as those terms are defined in the Securities Exchange Act of 1934. The use of the term in this notice does not imply that the entity is necessarily taking a principal position in a municipal security.

[2] The Bond Market Association’s (“TBMA”) 2001 Review of Electronic Transaction Systems found that at the end of 2001, there were at least 23 systems based in the United States that allow dealers or institutional investors to buy or sell municipal securities electronically compared to just 3 such systems in 1997. While dealers are also developing electronic trading platforms that allow retail customers to buy or sell municipal securities online, the development of online retail trading systems for municipal securities lags far behind that for equities.

[3] Rule G-19 provides in pertinent part:

(c) Suitability of Recommendations. In recommending to a customer any municipal security transaction, a [dealer] shall have reasonable grounds:

(i) based upon information available from the issuer of the security or otherwise, and

(ii) based upon the facts disclosed by such customer or otherwise known about such customer for believing that the recommendation is suitable.

[4] Although the focus of this notice is on the application of the suitability rule to electronic communications, much of the discussion is also relevant to more traditional communications, such as discussions made in person, over the telephone, or through postal mail.

[5] This notice focuses on customer-specific suitability under Rule G-19. Under Rule G-19, a dealer must also have a reasonable basis to believe that the recommendation could be suitable for at least some customers. See e.g., Rule G-19 Interpretation—Notice Concerning the Application of Suitability Requirements to Investment Seminars and Customer Inquiries Made in Response to a Dealer’s Advertisement, May 7, 1985, MSRB Rule Book (July 1, 2002) at 143; In re F.J. Kaufman and Company of Virginia, 50 S.E.C. 164, 168, 1989 SEC LEXIS 2376, *10 (1989) (the “reasonable basis” obligation relates only to the particular recommendation, rather than to any particular customer). The SEC, in its discussion of municipal underwriters’ responsibilities in a 1988 Release, noted that “a broker-dealer recommending securities to investors implies by its recommendation that it has an adequate basis for the recommendation.” Municipal Securities Disclosure, Securities Exchange Act Release No. 26100 (September 22, 1988) (the “1988 SEC Release”) at text accompanying note 72.

[6] Similarly, the suitability rule does not apply where a dealer merely gathers information on a particular customer, but does not make any recommendations. This is true even if the information is the type of information generally gathered to satisfy a suitability obligation. Dealers should nonetheless remember that regardless of any determination of whether the dealer is making a recommendation and subject to the suitability requirement, the dealer is required to make reasonable efforts to obtain certain customer specific information pursuant to rule G-8 (a)(xi) so that dealers can protect themselves and the integrity of the securities markets from customers who do not have the financial means to pay for transactions.

[7] See Rule G-17 Interpretation—Notice Regarding Rule G-17, on Disclosure of Material Facts, March 20, 2002, MSRB Rule Book (July 1, 2002) at 135.

[8] On April 30, 2002, the Securities and Exchange Commission (“SEC”) approved a proposed rule change relating to the manner in which dealers fulfill their fair practice obligations to certain institutional customers.  Release No. 34-45849 (April 30, 2002), 67 FR 30743.  See Rule G-17 Interpretation—Notice Regarding the Application of MSRB Rules to Transactions With Sophisticated Municipal Market Professionals (“SMMPs”) (the “SMMP Notice”), MSRB Rule Book (July 1, 2002) at 136. The SMMP Notice recognizes the different capabilities of SMMPs and retail or non-sophisticated institutional customers and provides that dealers may consider the nature of the institutional customer when determining what specific actions are necessary to meet the dealer’s fair practice obligations to such customers. The SMMP Notice provides that, while it is difficult to define in advance the scope of a dealer’s fair practice obligations with respect to a particular transaction, by making a reasonable determination that an institutional customer is an SMMP, then certain of the dealer’s fair practice obligations remain applicable but are deemed fulfilled.

[9] See generally Report of Commissioner Laura S. Unger to the SEC, On-Line Brokerage: Keeping Apace of Cyberspace, at n. 64 (Nov. 1999) (“Unger Report”) (discussing various views espoused by online brokerage firms, regulators and academics on the topic of online suitability); Developments in the Law—The Law of Cyberspace, 112 Harv. L. Rev. 1574, 1582-83 (1999) (The article highlights the broader debate by academics and judges over whether "to apply conventional models of regulation to the Internet.").

[10] The guidance contained in this notice is intended to be consistent with the general statements and guidelines contained in the NASD Online Suitability Notice. 

[11] See e.g., Rule G-19 Interpretive Letter dated February 17, 1998, MSRB Rule Book (July 1, 2002) at 144.

[12] These general principles were first enunciated in the NASD Online Suitability Notice.

[13] For example, if a dealer transmitted a rating agency research report to a customer at the customer's request, that communication may not be subject to the suitability rule; whereas, if the same dealer transmitted the very same research report with an accompanying message, either oral or written, that the customer should act on the report, the suitability analysis would be different.

[14] NASD Online Suitability Notice at 3.

[15] Note that there are instances where sending a customer an electronic communication that highlights a particular municipal security (or securities) will not be viewed as a recommendation. For instance, while each case requires an analysis of the particular facts and circumstances, a dealer generally would not be viewed as making a recommendation when, pursuant to a customer's request, it sends the customer (1) electronic "alerts" (such as account activity alerts, market alerts, or rating agency changes) or (2) research announcements (e.g., sector reports) that are not tailored to the individual customer, as long as neither—given their content, context, and manner of presentation—would lead a customer reasonably to believe that the dealer is suggesting that the customer take action in response to the communication.

[16] Note, however, that a portfolio analysis tool that merely generates a suggested mix of general classes of financial assets (e.g., 60 percent equities, 20 percent bonds, and 20 percent cash equivalents), without an accompanying list of securities that the customer could purchase to achieve that allocation, would not trigger a suitability obligation. On the other hand, a series of actions which may not constitute recommendations when considered individually, may amount to a recommendation when considered in the aggregate. For example, a portfolio allocator's suggestion that a customer could alter his or her current mix of investments followed by provision of a list of municipal securities that could be purchased or sold to accomplish the alteration could be a recommendation. Again, however, the determination of whether a portfolio analysis tool's communication constitutes a recommendation will depend on the content, context, and presentation of the communication or series of communications.

[17] These guidelines were originally set forth in the NASD Online Suitability Notice.

[18] Although a dealer cannot disclaim away its suitability obligation, informing customers that generalized information provided is not based on the customer's particular financial situation or needs may help clarify that the information provided is not meant to be a recommendation to the customer. Whether the communication is in fact a recommendation would still depend on the content, context, and presentation of the communication. Accordingly, a dealer that sends a customer or group of customers information about a security might include a statement that the dealer is not providing the information based on the customers' particular financial situation or needs. Dealers may properly disclose to customers that the opinions or recommendations expressed in research do not take into account individual investors' circumstances and are not intended to represent recommendations by the dealer of particular municipal securities to particular customers. Dealers, however, should refer to previous guidelines issued by the SEC that may be relevant to these and/or related topics. For instance, the SEC has issued guidelines regarding whether and under what circumstances third-party information is attributable to an issuer, and the SEC noted that the guidance also may be relevant regarding the responsibilities of dealers. See SEC Guidance on the Use of Electronic Media, Release Nos. 34-7856, 34-42728, IC-24426, 65 Fed. Reg. 25843 at 25848-25849 (April 28, 2000).

[19] The MSRB believes that a dealer should, at a minimum, clearly explain the limitations of its search engine and the decentralized nature of the municipal securities market. The dealer should also clearly explain that securities that meet the customer’s search criteria might be available from other sources.

[20] The MSRB notes that there are circumstances where the act of sending a communication to a specific group of customers will not necessarily implicate the suitability rule. For instance, a dealer's business decision to provide only certain types of investment information (e.g., research reports) to a category of "premium" customers would not, without more, trigger application of the suitability rule. Conversely, dealers may incur suitability obligations when they send a communication to a large group of customers urging those customers to invest in a municipal security.

[21] As with the other general guidelines discussed in this notice, the presence of this factor alone does not automatically mean that a recommendation has been made. 

The MSRB understands that an issuer [of municipal fund securities] may make minor modifications to the official statement in order to correct typographical or grammatical errors, or to make such other modifications that the issuer may deem to be immaterial.  If the issuer has acknowledged in writing to the primary distributor that it does not consider such modification to be material to investors and does not believe that such modification is required to make the statements in the official statement not misleading, then the modification need not be sent by a dealer to a customer that has previously received the official statement, notwithstanding the provisions of Rule G-32(a)(i).[1]  The primary distributor must maintain the issuer’s written acknowledgement under Rule G-8(a)(xiii), relating to records concerning deliveries of official statements.  The primary distributor must send all amendments, regardless of materiality, to the MSRB under Rule G-36.

ENDNOTES

[*] [This interpretation is an excerpt from “Application of Fair Practice and Advertising Rules to Municipal Fund Securities,” May 14, 2002.  The remaining portions of the 2002 interpretation have been superseded by other interpretations and rule changes.]

[1] Rule G-32(a)(i) requires delivery of an official statement to a customer purchasing municipal fund securities by settlement of the transaction.  In the case of a repeat purchaser who has already received the official statement, dealers generally are required to deliver any amendments or supplements to the official statement in connection with subsequent purchases of the securities. [footnote has been renumbered]

Rule G-37, on political contributions and prohibitions on municipal securities business, prohibits any broker, dealer or municipal securities dealer (a "dealer") from engaging in municipal securities business with an issuer within two years after any contribution (other than certain de minimis contributions) to an official of such issuer made by: (i) the dealer; (ii) any municipal finance professional associated with such dealer; or (iii) any political action committee controlled by the dealer or any municipal finance professional. The Municipal Securities Rulemaking Board ("MSRB") has received inquiries regarding the effect of a ban on municipal securities business with an issuer arising from a contribution made after a dealer has entered into a long-term contract to serve as the primary distributor of the issuer's municipal fund securities.

In an interpretive notice published in 1997 (the "1997 Interpretation"), the MSRB stated that a dealer subject to a prohibition on municipal securities business with an issuer is allowed to continue to execute certain issue-specific contractual obligations in effect prior to the date of the contribution that caused the prohibition.[1] For example, dealers that had already executed a contract with the issuer to serve as underwriter or financial advisor for a new issue of debt securities prior to the contribution could continue in these capacities.

The 1997 Interpretation also addressed certain types of on-going, non-issue-specific municipal securities business that a dealer may have contracted with an issuer to perform prior to the making of a contribution that causes a prohibition on municipal securities business with the issuer. For example, the MSRB noted that a dealer may act as remarketing agent for an outstanding issue of municipal securities or may continue to underwrite a specific commercial paper program so long as the contract for such services was in effect prior to the contribution. The MSRB stated that these activities are not considered new municipal securities business and may be performed by dealers that are banned from municipal securities business with an issuer. The MSRB further stated, however, that provisions in existing contracts that allow for changes in the services provided by the dealer or compensation paid by the issuer would be viewed by the MSRB as new municipal securities business and, therefore, rule G-37 would preclude a dealer subject to a ban on municipal securities business from performing such additional functions or receiving additional compensation. The MSRB cited two examples of these types of provisions. The first involved a contract to serve as remarketing agent for a variable rate issue that might permit a fixed rate conversion, with a concomitant increase in the per bond compensation. The second example involved an agreement to underwrite a commercial paper program that might include terms for increasing the size of the program, with no increase in per bond fees but an increase in overall compensation resulting from the larger outstanding balance of commercial paper. In both cases, the MSRB viewed the exercise of these provisions as new municipal securities business that would be banned under the rule.

In the 1997 Interpretation, the MSRB recognized that there is great variety in the terms of agreements regarding municipal securities business and that its guidance in the 1997 Interpretation may not adequately deal with all such agreements. The MSRB sought input on other situations where contracts obligate dealers to perform various types of activities after the date of a contribution that triggers a ban on municipal securities business and stated that additional interpretations might be issued based upon such input.

The MSRB understands that dealers typically are selected by issuers to serve as primary distributors of municipal fund securities on terms that differ significantly from those of a dealer selected to underwrite an issue of debt securities. Issuers generally enter into long-term agreements (in many cases with terms of ten years or longer) with the primary distributor of municipal fund securities for services that include the sale in a continuous primary offering of one or more categories or classes of the securities issued within the framework of a single program of investments.[2] In addition, an issuer may often engage a particular dealer to serve as the primary distributor of its municipal fund securities as part of a team of professionals that includes the dealer's affiliated investment management firm, which is charged with managing the investment of the underlying portfolios.

The MSRB believes that the guidance provided in the 1997 Interpretation, although appropriate for the circumstances discussed therein, may not be adequate to address the unique features of municipal fund securities programs. For example, so long as a program realizes net in-flows of investor cash, the size of an offering of municipal fund securities will necessarily increase over time. Under most compensation arrangements in the market, any net in-flow of cash generally would result in an increase in total compensation, causing any new sales of municipal fund securities that exceed redemptions to be considered new municipal securities business under the 1997 Interpretation. Also, the addition by the issuer of a new category of investments (e.g., a new portfolio in an aged-based Section 529 college savings plan created for children born in the most recent year) could be considered a new offering from which such dealer might be banned, even where such new category may have been clearly contemplated at the outset of the dealer's engagement. Further, the MSRB understands that the repercussions to an issuer of municipal fund securities or investors in such securities of a sudden change in the primary distributor (and possible concurrent change in the investment manager) resulting from a ban on municipal securities business arising during the term of an existing arrangement often will be significantly greater than in the case of an underwriting or other primary market activity relating to the typical debt offering. Issuers could be faced with redesigning existing programs and investors may need to establish new relationships with different dealers in order to maintain their investments.

As a result, the MSRB believes that further interpretive guidance is necessary in this area. The MSRB is of the view that, where a dealer has become subject to a ban on municipal securities business with an issuer of municipal fund securities with which it is currently serving as primary distributor, any continued sales of existing categories of municipal fund securities for such issuer during the duration of the ban would not be considered new municipal securities business if the basis for determining compensation does not change during that period, even if total compensation increases as a result of net in-flows of cash. Further, the MSRB believes that any changes in the services to be provided by the dealer to the issuer throughout the duration of the ban that are contemplated under the pre-existing contractual arrangement (e.g., the addition of new categories of securities within the framework of the existing program) would not be considered new municipal securities business so long as such changes do not result in: (1) an increase in total compensation received by the dealer for services performed for the duration of the ban (whether paid during the ban or as a deferred payment after the ban); or (2) in an extension of the term of the dealer in its current role.

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).

[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.

The Municipal Securities Rulemaking Board (the “MSRB”) understands that, over time, the advent of new trading systems will present novel situations in applying MSRB uniform practice rules. The MSRB is prepared to provide interpretative guidance in these situations as they arise, and, if necessary, implement formal rule interpretations or rule changes to provide clarity or prevent unintended results in novel situations. The MSRB has been asked to provide guidance on the application of certain of its rules to transactions effected on a proposed electronic trading system with features similar to those described below.

Description of System

The system is an electronic trading system offering a variety of trading services and operated by an entity registered as a dealer under the Securities Exchange Act of 1934. The system is qualified as an alternative trading system under Regulation ATS. Trading in the system is limited to brokers, dealers and municipal securities dealers (“dealers”). Purchase and sale contracts are created in the system through various types of electronic communications via the system, including acceptance of priced offers, a bid-wanted process, and through negotiation by system participants with each other. System rules govern how the bid/offer process is conducted and otherwise govern how contracts are formed between buyers and sellers.

Participants are, or may be, anonymous during the bid/offer/negotiation process. After a sales contract is formed, the system immediately sends an electronic communication to the buyer and seller, noting the transaction details as well as the identity of the contra-party. The transaction is then sent by the buyer and seller to a registered securities clearing agency for comparison and is settled without involvement of the system operator.

The system operator does not take a position in the securities traded on the system, even for clearance purposes. Dealers trading on the system are required by system rules to clear and settle transactions directly with each other even though the parties do not know each other at the time the sale contract is formed. If a dealer using the system does not wish to do business with another specific contra-party using the system, it may direct the system operator to adjust the system so that contracts with that contra-party cannot be formed through the system.

Application of Certain Uniform Practice Rules to System

It appears to the MSRB that the dealer operating the system is effecting agency transactions for dealer clients.[1] The system operator does not have a role in clearing the transactions and is not taking principal positions in the securities being traded. However, the system operator is participating in the transactions at key points by providing anonymity to buyers and sellers during the formation of contracts and by setting system rules for the formation of contracts. Consequently, all MSRB rules generally applicable to inter-dealer transactions would apply except to the extent that such rules explicitly, or by context, are limited to principal transactions.

Automated Comparison

One issue raised by the description of the system above is the planned method of clearance and settlement. Rule G-12(f)(i) requires that inter-dealer transactions be compared in an automated comparison system operated by a clearing corporation registered with the Securities and Exchange Commission. The purpose of rule G-12(f)(i) is to facilitate clearance and settlement of inter-dealer transactions. In this case, the system operator: (i) electronically communicates the transaction details to the buyer and seller; (ii) requires the buyer and seller to compare the transaction directly with each other in a registered securities clearing corporation; and (iii) is not otherwise involved in clearing or settling the transaction. The MSRB believes that under these circumstances, it is unnecessary for the system operator to obtain a separate comparison of its agency transactions with the buyer and seller.

Although automated comparison is not required between the system operator and the buyer and seller, the transaction details sent to each party by the system must conform to the information requirements for inter-dealer confirmations contained in rule G-12(c). Since system participants implicitly agree to receive this information in electronic form by participating in the system, a paper confirmation is not necessary. Also, the system operator may have an agreement with its participants that participants are not required to confirm the transactions back to the system operator, which normally would be required by rule G-12(c).

The system operator, which is subject to Regulation ATS, will be governed by the recordkeeping requirements of Regulation ATS for purposes of transaction records, including municipal securities transactions. However, the system operator also must comply with any applicable recordkeeping requirements in rule G-8(f), which relate to records specific to effecting municipal securities transactions. With respect to recordkeeping by dealers using the system, the specific procedures associated with this system require that transactions be recorded as principal transactions directly between buyer and seller, with notations of the fact that the transactions were effected through the system.

Transaction Reporting

Rule G-14 requires inter-dealer transactions to be reported to the MSRB for the purposes of price transparency, market surveillance and fee assessment. The mechanism for reporting inter-dealer transactions is through National Securities Clearing Corporation (“NSCC”). In the system described above, the buyer and seller clear and settle transactions directly as principals with each other, and without the involvement of the dealer operating the system. The buyer and seller therefore will report transactions directly to NSCC. No transaction or pricing information will be lost if the system operator does not report the transaction. Consequently, it is not necessary for the system operator separately to report the transactions to the MSRB.

March 26, 2001

The Municipal Securities Rulemaking Board (the “MSRB”) has received requests for interpretive guidance regarding the maintenance in electronic form of records under rule G-8, on books and records, and rule G-9, on preservation of records. As the MSRB has previously noted, rules G-8 and G-9 provide significant flexibility to brokers, dealers and municipal securities dealers (“dealers”) concerning the manner in which their records are to be maintained, recognizing that various recordkeeping systems could provide a complete and accurate record of a dealer’s municipal securities activities.[1] Part of the reason for providing this flexibility was that a variety of enforcement agencies, including the Securities and Exchange Commission, NASD Regulation, Inc. and the banking regulatory agencies, all may inspect dealer records.

Rule G-8(b) does not specify that a dealer is required to maintain its books and records in a specific manner so long as the information required to be shown by the rule is clearly and accurately reflected and provides an adequate basis for the audit of such information. Further, rule G-9(e) allows records to be retained electronically provided that the dealer has adequate facilities for ready retrieval and inspection of any such record and for production of easily readable facsimile copies.

The MSRB previously has recognized that efficiencies would be obtained by the replacement of paper files with electronic data bases and filing systems and stated that it generally allows records to be retained in that form.[2] In noting that increased automation would likely lead to elimination of most physical records, the MSRB has stated that electronic trading tickets and automated customer account information satisfy the recordkeeping requirements of rule G-8 so long as such information is maintained in compliance with rule G-9(e). The MSRB believes that this position also applies with respect to the other recordkeeping requirements of rule G-8 so long as such information is maintained in compliance with rule G-9(e) and the appropriate enforcement agency is satisfied that such manner of record creation and retention provides an adequate basis for the audit of the information to be maintained. In particular, the MSRB believes that a dealer that meets the requirements of Rule 17a-4(f) under the Securities Exchange Act of 1934 with respect to maintenance and preservation of required books and records in the formats described therein would presumptively meet the requirements of rule G-9(e).

March 26, 2001

The Municipal Securities Rulemaking Board (the “MSRB”) understands that, over time, the advent of new trading systems will present novel situations in applying MSRB uniform practice rules. The MSRB is prepared to provide interpretative guidance in these situations as they arise, and, if necessary, implement formal rule interpretations or rule changes to provide clarity or prevent unintended results in novel situations. The MSRB has been asked to provide guidance on the application of certain of its rules to transactions effected on a proposed electronic trading system with features similar to those described below.

Description of System

The system is an electronic trading system offering a variety of trading services and operated by an entity registered as a dealer under the Securities Exchange Act of 1934. The system is qualified as an alternative trading system under Regulation ATS. Trading in the system is limited to brokers, dealers and municipal securities dealers (“dealers”). Purchase and sale contracts are created in the system through various types of electronic communications via the system, including acceptance of priced offers, a bid-wanted process, and through negotiation by system participants with each other. System rules govern how the bid/offer process is conducted and otherwise govern how contracts are formed between buyers and sellers.

Participants are, or may be, anonymous during the bid/offer/negotiation process. After a sales contract is formed, the system immediately sends an electronic communication to the buyer and seller, noting the transaction details as well as the identity of the contra-party. The transaction is then sent by the buyer and seller to a registered securities clearing agency for comparison and is settled without involvement of the system operator.

The system operator does not take a position in the securities traded on the system, even for clearance purposes.  Dealers trading on the system are required by system rules to clear and settle transactions directly with each other even though the parties do not know each other at the time the sale contract is formed. If a dealer using the system does not wish to do business with another specific contra-party using the system, it may direct the system operator to adjust the system so that contracts with that contra-party cannot be formed through the system.

Application of Certain Uniform Practice Rules to System

It appears to the MSRB that the dealer operating the system is effecting agency transactions for dealer clients.[1]  The system operator does not have a role in clearing the transactions and is not taking principal positions in the securities being traded. However, the system operator is participating in the transactions at key points by providing anonymity to buyers and sellers during the formation of contracts and by setting system rules for the formation of contracts. Consequently, all MSRB rules generally applicable to inter-dealer transactions would apply except to the extent that such rules explicitly, or by context, are limited to principal transactions.

Automated Comparison

One issue raised by the description of the system above is the planned method of clearance and settlement. Rule G-12(f)(i) requires that inter-dealer transactions be compared in an automated comparison system operated by a clearing corporation registered with the Securities and Exchange Commission. The purpose of rule G-12(f)(i) is to facilitate clearance and settlement of inter-dealer transactions. In this case, the system operator: (i) electronically communicates the transaction details to the buyer and seller; (ii) requires the buyer and seller to compare the transaction directly with each other in a registered securities clearing corporation; and (iii) is not otherwise involved in clearing or settling the transaction. The MSRB believes that under these circumstances, it is unnecessary for the system operator to obtain a separate comparison of its agency transactions with the buyer and seller.

Although automated comparison is not required between the system operator and the buyer and seller, the transaction details sent to each party by the system must conform to the information requirements for inter-dealer confirmations contained in rule G-12(c).  Since system participants implicitly agree to receive this information in electronic form by participating in the system, a paper confirmation is not necessary. Also, the system operator may have an agreement with its participants that participants are not required to confirm the transactions back to the system operator, which normally would be required by rule G-12(c).

The system operator, which is subject to Regulation ATS, will be governed by the recordkeeping requirements of Regulation ATS for purposes of transaction records, including municipal securities transactions. However, the system operator also must comply with any applicable recordkeeping requirements in rule G-8(f), which relate to records specific to effecting municipal securities transactions. With respect to recordkeeping by dealers using the system, the specific procedures associated with this system require that transactions be recorded as principal transactions directly between buyer and seller, with notations of the fact that the transactions were effected through the system.

Transaction Reporting

Rule G-14 requires inter-dealer transactions to be reported to the MSRB for the purposes of price transparency, market surveillance and fee assessment. The mechanism for reporting inter-dealer transactions is through National Securities Clearing Corporation (“NSCC”). In the system described above, the buyer and seller clear and settle transactions directly as principals with each other, and without the involvement of the dealer operating the system. The buyer and seller therefore will report transactions directly to NSCC. No transaction or pricing information will be lost if the system operator does not report the transaction. Consequently, it is not necessary for the system operator separately to report the transactions to the MSRB.

[1] This situation can be contrasted with the typical broker’s broker operation in which the broker’s broker effects riskless principal transactions for dealer clients. The nature of the transactions as either agency or principal is governed for purposes of MSRB rules by whether a principal position is taken with respect to the security. “Riskless principal” transactions in this context are considered to be principal transactions in which a dealer has a firm order on one side at the time it executes a matching transaction on the contraside. For purposes of the uniform practice rules, the MSRB considers broker’s broker transactions to be riskless principal transactions even though the broker’s broker may be acting for one party and may have agency or fiduciary obligations toward that party.

The MSRB published a notice regarding Interpretation on the Application of Rules G-32 and G-36 to New Issue Offerings Through Auction Procedures.

Traditionally, brokers, dealers and municipal securities dealers (“dealers”) have underwritten new issue municipal securities through syndicates in which one dealer serves as the managing underwriter. In some cases, a single dealer may serve as the sole underwriter for a new issue. Typically, these underwritings are effected on an “all-or-none” basis, meaning that the underwriters bid on the entire new issue. In addition, new issues are occasionally sold to two or more underwriters that have not formed a syndicate but instead each underwriter has purchased a separate portion of the new issue (in effect, each underwriter serving as the sole underwriter for its respective portion of the new issue).

In the primary market in recent years, some issuers have issued their new offerings through an electronic “auction” process that permits the taking of bids from both dealers and investors directly. In some cases, these bids may be taken on other than an all-or-none basis, with bidders making separate bids on each maturity of a new issue. The issuer may engage a dealer as an auction agent to conduct the auction process on its behalf. In addition, to effectuate the transfer of the securities from the issuer to the winning bidders and for certain other purposes connected with the auction process, the issuer may engage a dealer to serve in the role of settlement agent or in some other intermediary role.

Although the Municipal Securities Rulemaking Board (the “MSRB”) has not examined all forms that these auction agent, settlement agent or other intermediary roles (collectively referred to as “dealer-intermediaries”) may take, it believes that in most cases such dealer-intermediary is effecting a transaction between the issuer and each of the winning bidders. The MSRB also believes that in many cases such dealer-intermediary may be acting as an underwriter, as such term is defined in Rule 15c2-12(f)(8) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).[1] A dealer-intermediary that is effecting transactions in connection with such an auction process has certain obligations under rule G-32. If it is also an underwriter with respect to an offering, it has certain additional obligations under rules G-32 and G-36.

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

Rule G-32(a) generally requires that any dealer (i.e., not just the underwriter) selling municipal securities to a customer during the issue’s underwriting period must deliver the official statement in final form, if any, to the customer by settlement of the transaction. Any dealer selling a new issue municipal security to another dealer is obligated under rule G-32(b) to send such official statement to the purchasing dealer within one business day of request. In addition, under rule G-32(c), the managing or sole underwriter for new issue municipal securities is obligated to send to any dealer purchasing such securities (regardless of whether the securities were purchased from such managing or sole underwriter or from another dealer), within one business day of request, one official statement plus one additional copy per $100,000 par value of the new issue municipal securities sold by such dealer to customers. Where multiple underwriters underwrite a new issue without forming an underwriting syndicate, each underwriter is considered a sole underwriter for purposes of rule G-32 and therefore each must undertake the official statement delivery obligation described in the preceding sentence.

If a dealer-intermediary is involved in an auction or similar process of primary offering of municipal securities in which all or a portion of the securities are sold directly to investors that have placed winning bids with the issuer, the dealer-intermediary is obligated under rule G-32(a) to deliver an official statement to such investors by settlement of their purchases. If all or a portion of the securities are sold to other dealers that have placed winning bids with the issuer, the dealer-intermediary is obligated under rule G-32(b) to send an official statement to such purchasing dealers within one business day of a request. Further, to the extent that the dealer-intermediary is an underwriter, such dealer-intermediary typically would have the obligations of a sole underwriter under rule G-32(c) to distribute the official statement to any other dealer that subsequently purchases the securities during the underwriting period and requests a copy. Any dealer that has placed a winning bid in a new issue auction would have the same distribution responsibility under rule G-32(c), to the extent that it is acting as an underwriter.

The MSRB views rule G-32 as permitting one or more dealer-intermediaries involved in an auction process to enter into an agreement with one or more other dealers that have purchased securities through a winning bid in which the parties agree that one such dealer (i.e., a dealer-intermediary or one of the winning bidders) will serve in the role of managing underwriter for purposes of rule G-32. In such a case, such single dealer (rather than all dealers individually) would have the responsibility for distribution of official statements to the marketplace typically undertaken by a managing or sole underwriter under rule G-32(c).[2] Such an agreement may be entered into by less than all dealers that have purchased securities through the auction process. All dealers that agree to delegate this duty to a single dealer may rely on such delegation to the same extent as if they had in fact formed an underwriting syndicate.

Application of Rule G-36, on Delivery of Official Statements, Advance Refunding Documents and Forms G-36(OS) and G-36(ARD) to the MSRB

Rule G-36 requires that the managing or sole underwriter for most primary offerings send the official statement and Form G-36(OS) to the MSRB within certain time frames set forth in the rule. In addition, if the new issue is an advance refunding and an advance refunding document has been prepared, the advance refunding document and Form G-36(ARD) also must be sent to the MSRB by the managing or sole underwriter. Where multiple underwriters underwrite an offering without forming an underwriting syndicate, the MSRB has stated that each underwriter would have the role of sole underwriter for purposes of rule G-36 and therefore each would have a separate obligation to send official statements, advance refunding documents and Forms G-36(OS) and G-36(ARD) to the MSRB.[3]

To the extent that the dealer-intermediary in an auction or similar process of primary offering of municipal securities is an underwriter for purposes of the Exchange Act, such dealer-intermediary would have obligations under rule G-36. If all or a portion of the securities are sold directly to investors that have placed winning bids with the issuer, the dealer-intermediary would be obligated to send the official statement and Form G-36(OS) (as well as any applicable advance refunding document and Form G-36(ARD)) to the MSRB with respect to the issue or portion thereof purchased by investors. If all or a portion of the securities are sold to other dealers that have placed winning bids with the issuer, the dealer-intermediary and each of the purchasing dealers (to the extent that they are underwriters for purposes of the Exchange Act) also typically would be separately obligated to send such documents to the MSRB with respect to the issue or portion thereof purchased by dealers.

To avoid duplicative filings under rule G-36, the MSRB believes that one or more dealer-intermediaries involved in an auction process may enter into an agreement with one or more other dealers that have purchased securities through a winning bid in which the parties agree that one such dealer (i.e., a dealer-intermediary or one of the winning bidders) will serve in the role of managing underwriter for purposes of rule G-36. In such a case, such single dealer (rather than all dealers individually) would have the responsibility for sending the official statement, advance refunding document and Forms G-36(OS) and G-36(ARD) to the MSRB.[4] Such an agreement may be entered into by less than all dealers that have purchased securities. All dealers that agree to delegate this duty to a single dealer may rely on such delegation to the same extent as if they had in fact formed an underwriting syndicate.

March 26, 2001

[1] Questions regarding whether an entity acting in an intermediary role is effecting a transaction or whether a dealer acting in such an intermediary role for a particular primary offering of municipal securities would constitute an underwriter should be addressed to staff of the Securities and Exchange Commission.

[2] Each dealer that is party to this agreement would be required to inform any dealer seeking copies of the official statement from such dealer under rule G-32(c) of the identity of the dealer that has by agreement undertaken this obligation or, in the alternative, may fulfill the request for official statements. In either case, the dealer would be required to act promptly so as either to permit the dealer undertaking the distribution obligation to fulfill its duty in a timely manner or to provide the official statement itself in the time required by the rule. Such agreement would not affect the obligation of a dealer that sells new issue securities to another dealer to provide a copy of the official statement to such dealer upon request as required under rule G-32(b), nor would it affect the obligation to deliver official statements to customers as required under rule G-32(a).

The Municipal Securities Rulemaking Board (the “MSRB”) has received requests for interpretive guidance regarding the maintenance in electronic form of records under rule G-8, on books and records, and rule G-9, on preservation of records. As the MSRB has previously noted, rules G-8 and G-9 provide significant flexibility to brokers, dealers and municipal securities dealers (“dealers”) concerning the manner in which their records are to be maintained, recognizing that various recordkeeping systems could provide a complete and accurate record of a dealer’s municipal securities activities.[1]  Part of the reason for providing this flexibility was that a variety of enforcement agencies, including the Securities and Exchange Commission, NASD Regulation, Inc. and the banking regulatory agencies, all may inspect dealer records.

Rule G-8(b) does not specify that a dealer is required to maintain its books and records in a specific manner so long as the information required to be shown by the rule is clearly and accurately reflected and provides an adequate basis for the audit of such information. Further, rule G-9(e) allows records to be retained electronically provided that the dealer has adequate facilities for ready retrieval and inspection of any such record and for production of easily readable facsimile copies.

[1] See Rule G-8 Interpretation – Interpretive Notice on Recordkeeping, July 29, 1977, reprinted in MSRB Rule Book (January 1, 2001) at 42.

The Securities and Exchange Commission has approved the National Securities Clearing Corporation's ("NSCC") proposed rule change (SR-NSCC-00-13) regarding the submission of trade data for comparison of fixed income inter-dealer transactions.[1]  NSCC proposes to offer its members the ability to submit their fixed income transaction information "locked-in" through Qualified Special Representatives ("QSR") for trades executed via an Alternative Trading System ("ATS").  Locked-in QSR trade data submission currently is only available for transactions in equity securities.  The Municipal Securities Rulemaking Board ("MSRB") is publishing this notice to clarify the requirements of MSRB rules G-12(f) and G-14 as they pertain to the submission of locked-in transactions.   

To accomplish a locked-in QSR submission, NSCC members on each side of a trade must have executed, or clear for a firm that executed, their trade through an ATS and previously authorized a specific NSCC-authorized QSR to submit locked-in trades to NSCC on their behalf.  The locked-in transaction records are not compared in the traditional manner through the two-sided NSCC comparison process.  Instead, the QSR itself takes responsibility to ensure that the trade data is correct and the parties have agreed to the trade according to the stated terms.  Once NSCC receives a locked-in trade, it treats it as compared so that the transaction can proceed to netting or other automated settlement procedures. 

MSRB rule G-12(f) on inter-dealer comparison and rule G-14 on Transaction Reporting Procedures each refer to the NSCC comparison process for inter-dealer transactions in municipal securities.  These rules require dealers to submit their inter-dealer trade data to NSCC for purposes of comparison and for forwarding to the MSRB for trade-reporting purposes.  Questions may arise as to whether the submission of trade data already locked-in by a QSR complies with these rules.  

NSCC's proposal requires that a QSR must obtain authorization to submit locked-in transactions both from NSCC as well as from the NSCC members who wish to use the QSR for locked-in trade submission.  Given this fact, and the fact that both rules G-12(f) and G-14 specifically contemplate the use of intermediaries in submitting data to NSCC and to the MSRB, locked-in trades submitted under NSCC's program will comply both with rule G-12(f) and rule G-14.

The Municipal Securities Rulemaking Board (the “Board”) has learned that sales of certain interests in trust funds held by state or local governmental entities may be effected by or through brokers, dealers or municipal securities dealers (“dealers”). In particular, the Board has reviewed two types of state or local gov-ernmental programs in which dealers may effect transactions in such interests: pooled investment funds under trusts established by state or local governmental entities (“local government pools”) [1] and higher education savings plan trusts established by states (“higher education trusts”).[2] In response to a request of the Board, staff of the Division of Market Regulation of the Securities and Exchange Commission (the “SEC”) has stated that “at least some interests in local government pools and higher education trusts may be, depending on the facts and circumstances, ‘municipal securities’ for purposes of the [Securities] Exchange Act [of 1934].” [3] Any such interests that may, in fact, constitute municipal securities are referred to herein as “municipal fund securities.” To the extent that dealers effect transactions in municipal fund securi-ties, such transactions are subject to the jurisdiction of the Board pursuant to Section 15B of the Securities Exchange Act of 1934 (the “Exchange Act”).

With respect to the applicability to municipal fund securities of Exchange Act Rule 15c2-12, relating to municipal securities disclosure, staff of the SEC’s Division of Market Regulation has stated:

[W]e note that Rule 15c2-12(f)(7) under the Exchange Act defines a “primary  offering” as including an offering of municipal securities directly or indirectly by or on behalf of an issuer of such securities. Based upon an analysis of programs that have been brought to our attention, it appears that interests in local government pools or higher education trusts generally are offered only by direct purchase from the issuer. Accordingly, we would view those interests as having been sold in a “primary offering” as that term is defined in Rule 15c2-12. If a dealer is acting as an “underwriter” (as defined in Rule 15c2-12(f)(8)) in connection with that primary offering, the dealer may be subject to the requirements of Rule 15c2-12. [4]

Rule 15c2-12(f)(8) defines an underwriter as “any person who has purchased from an issuer of municipal securities with a view to, or offers or sells for an issuer of municipal securities in connection with, the offering of any municipal security, or participates or has a direct or indirect participation in any such undertaking, or participates or has a participation in the direct or indirect underwriting of any such undertaking.” [5]

Consistent with SEC staff’s view regarding the sale in primary offerings of municipal fund securities, dealers acting as underwriters in primary offerings of municipal fund securities generally would be subject to the requirements of rule G-36, on delivery of official statements, advance refunding documents and Forms G-36(OS) and G-36(ARD) to Board or its designee. Thus, unless such primary offering falls within one of the stated exemptions in Rule 15c2-12, the Board expects that the dealer would receive a final official statement from the issuer or its agent under its contractual agreement entered into pursuant to Rule 15c2-12(b)(3). [6] Such final official statement should be received from the issuer in sufficient time for the dealer to send it, together with Form G-36(OS), to the Board within one business day of receipt but no later than 10 business days after any final agreement to purchase, offer, or sell the municipal fund securities, as required under rule G-36(b)(i). [7]  “Final official statement,” as used in rule G-36(b)(i), has the same meaning as in Rule 15c2-12(f)(3), which states, in relevant part:

The term final official statement means a document or set of documents prepared by an issuer of municipal securities or its representatives that is complete as of the date delivered to the Participating Underwriter(s) and that sets forth information concerning the terms of the proposed issue of securi- ties; information, including financial information or operating data, concerning such issuers of municipal securities and those other entities, enterprises, funds, accounts, and other persons material to an evaluation of the Offering; and a description of the undertakings to be provided pursuant to paragraph (b)(5)(i), paragraph (d)(2)(ii), and paragraph (d)(2)(iii) of this section, if applicable, and of any instances in the previous five years in which each person specified pursuant to paragraph (b)(5)(ii) of this section failed to comply, in all material respects, with any previous undertakings in a written contract or agreement specified in paragraph (b)(5)(i) of this section. [8]

The Board understands that issuers of municipal fund securities typically issue and deliver the securities continuously as customers make purchases, rather than issuing and delivering a single issue on a specified date. As used in Board rules, the term “underwriting period” with respect to an offering involving a single dealer (i.e., not involving an underwriting syndicate) is defined as the period (A) commencing with the first submission to the dealer of an order for the purchase of the securities or the purchase of the securities from the issuer, whichever first occurs, and (B) ending at such time as the following two conditions both are met: (1) the issuer delivers the securities to the dealer, and (2) the dealer no longer retains an unsold balance of the securities purchased from the issuer or 21 calendar days elapse after the date of the first submission of an order for the securities, whichever first occurs. [9] Since an offering consisting of securities issued and de-livered on a continuous basis would not, by its very nature, ever meet the first condition for the termination of the underwriting period, such offering would continuously remain in its underwriting period. [10] Further, since rule G-36(d) requires a dealer that has previously provided an official statement to the Board to send any amendments to the official statement made by the issuer during the underwriting period, such dealer would remain obligated to send to the Board any amendments made to the official statement during such continuous underwriting period. However, in view of the increased possibility that an issuer may change the dealer that participates in the sale of its securities during such a continuous underwriting period, the Board has determined that rule G-36(d) would require that the dealer that is at the time of an amendment then serving as underwriter for securities that are still in the underwriting period send the amendment to the Board, regardless of whether that dealer or another dealer sent the original official statement to the Board.

In addition, municipal fund securities sold in a primary offering would constitute new issue municipal securities for purposes of rule G-32, on disclosures in connection with new issues, so long as the securities remain in their underwriting period. Rule G-32 generally requires that a dealer selling a new issue municipal security to a customer must deliver the official statement in final form to the customer by settlement of such transaction. Thus, a dealer effecting transactions in municipal fund securities that are sold during a continuous underwriting period would be required to deliver to the customer the official statement by settlement of each such transaction. However, in the case of a customer purchasing such securities who is a repeat purchaser, no new delivery of the official statement would be required so long as the customer has previously received it in connection with a prior purchase and the official statement has not been changed from the one previously delivered to that customer. [11]

[1]The Board understands that local government pools are established by state or local governmental entities as trusts that serve as vehicles for the pooled investment of public moneys of participating governmental entities. Participants purchase interests in the trust and trust assets are invested in a manner consistent with the trust’s stated investment objectives. Investors generally do not have a right to control investment of trust assets. See generally National Association of State Treasurers, Special Report: Local Government Investment Pools (July 1995); Standard & Poor’s Fund Services, Local Government Investment Pools (May 1999).

[2] The Board understands that higher education trusts generally are 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. Individuals purchase interests in the trust and trust assets are invested in a manner consistent with the trust’s stated investment objectives. Investors do not have a right to control investment of trust assets. See generally College Savings Plans Network, Special Report on State and College Savings Plans (1998).

[3] Letter dated February 26, 1999 from Catherine McGuire, Chief Counsel, Division of Market Regulation, SEC, to Diane G. Klinke, General Counsel of the Board, in response to letter dated June 2, 1998 from Diane G. Klinke to Catherine McGuire, published as Municipal Securities Rulemaking Board, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File  No.032299033 (Feb. 26, 1999) (the “SEC Letter”).

[4] SEC Letter.

[5] The definition of underwriter excludes any person whose interest is limited to a commission, concession, or allowance from an underwriter or dealer not in excess of the usual and customary distributors’ or sellers’ commission, concession, or allowance.

[7] If a primary offering of municipal fund securities is exempt from Rule 15c2-12 (other than as a result of being a limited offering as described in section (d)(1)(i) of the Rule) and an official statement in final form has been prepared by the issuer, then the dealer would be expected to send the official statement in final form, together with Form G-36(OS), to the Board under rule G-36(c)(i).

[8] Dealers seeking guidance as to whether a particular document or set of documents constitutes a final official statement for purposes of rule G-36(b)(i) should consult with SEC staff to determine whether such document or set of documents constitutes a final official statement for purposes of Rule 15c2-12.

[9] See rule G-32(c)(ii)(B). If approved by the SEC, the proposed rule change will redesignate this section as rule G-32(d)(ii)(B).

[10] Similarly, an offering involving an underwriting syndicate and consisting of securities issued and delivered on a continuous basis also would remain in its underwriting period under the definition thereof set forth in rule G-11(a)(ix).

[11] This is equally true for other forms of municipal securities for which a customer has already received an official statement in connection with an earlier purchase and who proceeds to make a second purchase of the same securities during the underwriting period. Furthermore, in the case of a repeat purchaser of municipal securities for which no official statement in final form is being prepared, no new delivery of the written notice to that effect or of any official statement in preliminary form would be required so long as the customer has previously received it in connection with a prior purchase. However, if an official statement in final form is subsequently prepared, the customer’s next purchase would trigger the delivery requirement with respect to such official statement. Also, if an official statement which has previously been delivered is subsequently amended during the underwriting period, the customer’s next purchase would trigger the delivery requirement with respect to such amendment.

On March 16, 2000, the Securities and Exchange Commission approved amendments to rules G-8, on books and records, G-9, on preservation of records, and G-27, on supervision.[1] The amendments will become effective on September 19, 2000. The amendments will allow brokers, dealers and municipal securities dealers ("dealers") to develop flexible supervisory procedures for the review of correspondence with the public. This notice is being issued to provide guidance to dealers on how to implement these rules.

Background

Technology has greatly expanded how communications between dealers and their customers take place. These new means of communication (e.g., e-mail, Internet) will continue to significantly affect the manner in which dealers and their associated persons conduct their business. While these changes allow timely and efficient communication with customers, prospective customers, and others, the significant changes in communications media and capacity raise questions regarding supervision, review, and retention of correspondence with the public.

In May 1996, the SEC issued an Interpretive Release on the use of Electronic Media by Broker-Dealers, Transfer Agents, and Investment Advisors for Delivery of Information.[2] That release expressed the views of the SEC with respect to the delivery of information through electronic media in satisfaction of requirements in the federal securities laws, but did not address the applicability of any self-regulatory organization ("SRO") rules. In its release the SEC did, however, strongly encourage the SROs to work with broker/dealer firms to adapt SRO supervisory review requirements governing communications with customers to accommodate the use of electronic communications.[3]

On December 31, 1997, the SEC approved proposed rule changes filed by the National Association of Securities Dealers ("NASD")[4] and the New York Stock Exchange ("NYSE")[5] to update rules governing supervision of communication with the public. NASD Notice to Members 98-11 announced approval of the proposed rule change, provided guidance to firms on how to implement these rules and stated that the amendments to NASD Rules 3010 and 3110 would be effective on February 15, 1998. Over the next year, further amendments were made to NASD Rules 3010 and 3110. NASD Regulation received final SEC approval of amendments to Rule 3010 on November 30, 1998.[6] The rule amendments were effective on March 15, 1999.[7]

As amended, NASD Rule 3010(d)(1) provides that procedures for review of correspondence with the public relating to a member's investment banking or securities business be designed to provide reasonable supervision for each registered representative, be described in an organization's written supervisory procedures, and be evidenced in an appropriate manner. NASD Rule 3010(d)(2) requires each member to develop written policies and procedures for review of correspondence with the public relating to its investment banking or securities business tailored to its structure and the nature and size of its business and customers. These procedures must also include the review of incoming, written correspondence directed to registered representatives and related to the member's investment banking or securities business to properly identify and handle customer complaints and to ensure that customer funds and securities are handled in accordance with firm procedures.

The Board has determined to adopt substantially similar rule changes. The Board believes that conforming its rule language to the language in the NASD rules will help ensure a coordinated regulatory approach to the supervision of correspondence.

Amended Rules

Rule G-27(d)(i), as revised, provides that procedures for review of correspondence with the public relating to a dealer's municipal securities activities be designed to provide reasonable supervision for each municipal securities representative, be described in the dealer's written supervisory procedures, and be evidenced in an appropriate manner.

Rule G-27(d)(ii) requires each dealer to develop written policies and procedures for review of correspondence with the public relating to its municipal securities activities, tailored to its structure and the nature and size of its business and customers. The rule requires that any dealer that does not conduct either an electronic or manual pre-use review will be required to:

• develop appropriate supervisory procedures;

• monitor and test to ensure these policies and procedures are being implemented and complied with;

• provide education and training to all appropriate employees concerning the dealer's current policies and procedures governing correspondence, and update this training as policies and procedures are changed; and

• maintain records documenting how and when employees are educated and trained.

The rule change states that these procedures must also include the review of incoming, written correspondence directed to municipal securities representatives and related to the dealer's municipal securities activities to properly identify and handle customer complaints and to ensure that customer funds and securities are handled in accordance with the dealer's procedures.

It is the understanding and view of the Board that dealers possess the legal capacity to insist that mail addressed to their offices be deemed to be related to their businesses, even if marked to the attention of a particular associated person, if they advise associated persons that personal correspondence should not be received at their firms. Dealers, other than non-NASD member bank dealers, are reminded that SEC Rule 17a-4(b)(4) requires that "originals of all communications received . . . by such member, broker or dealer, relating to its business as such . . ." must be preserved for not less than three years.

The retention requirements of the amendments to rule G-27 cross reference rules G-8(a)(xx) and G-9(b)(viii) and (xiv) and state that the names of persons who prepared, reviewed and approved correspondence must be readily ascertainable from the retained records. The records must be made available, upon request, to the appropriate enforcement agency (i.e., NASD or federal bank regulatory agency).

Guidelines For Supervision And Review

In adopting review procedures pursuant to rule G-27(d)(i), dealers must:

• specify, in writing, the dealer's policies and procedures for reviewing different types of correspondence;

• identify how supervisory reviews will be conducted and documented;

• identify what types of correspondence will be pre- or post-reviewed;

• identify the organizational position(s) responsible for conducting review of the different types of correspondence;

• specify the minimum frequency of the reviews for each type of correspondence;

• monitor the implementation of and compliance with the dealer's procedures for reviewing public correspondence; and

• periodically re-evaluate the effectiveness of the dealer's procedures for reviewing public correspondence and consider any necessary revisions.

In conducting reviews, dealers may use reasonable sampling techniques. As an example of appropriate evidence of review, e-mail related to the dealer's municipal securities activities may be reviewed electronically and the evidence of review may be recorded electronically.

In developing supervisory procedures for the review of correspondence with the public pursuant to rule G-27(d)(ii), each dealer must consider its structure, the nature and size of its business, other pertinent characteristics, and the appropriateness of implementing uniform firm-wide procedures or tailored procedures (i.e., by specific function, office/location, individual, or group of persons).

In adopting review procedures pursuant to rule G-27(d)(ii), dealers must, at a minimum:

• specify procedures for reviewing municipal securities representatives' recommendations to customers;

• require supervisory review of some of each municipal securities representative's public correspondence, including recommendations to customers;

• consider the complaint and overall disciplinary history, if any, of municipal securities representatives and other employees (with particular emphasis on complaints regarding written or oral communications with clients); and

• consider the nature and extent of training provided municipal securities representatives and other employees, as well as their experience in using communications media (although a dealer's procedures may not eliminate or provide for minimal supervisory reviews based on an employee's training or level of experience in using communications media).

Although dealers may consider the number, size, and location of offices, as well as the volume of correspondence overall or in specific areas of the organization, dealers must nonetheless develop appropriate supervisory policies and procedures in light of their duty to supervise their associated persons. The factors listed above are not exclusive and dealers must consider all appropriate factors when developing their supervisory procedures and implementing their supervisory reviews.

Supervisory policy and procedures must also:

• provide that all customer complaints, whether received via e-mail or in written form from the customer, are kept and maintained;

• describe any dealer standards for the content of different types of correspondence; and

• prohibit municipal securities representatives' and other employees' use of electronic correspondence to the public unless such communications are subject to supervisory and review procedures developed by the dealer. For example, the Board would expect dealers to prohibit correspondence with customers from employees' home computers or through third party systems unless the dealer is capable of monitoring such communications.

The method used for conducting reviews of incoming, written correspondence to identify customer complaints and funds may vary depending on the dealer's office structure. Where the office structure permits review of all correspondence, dealers should designate a municipal securities representative or other appropriate person to open and review correspondence prior to use or distribution to identify customer complaints and funds. The designated person must not be supervised or under the control of the municipal securities representative whose correspondence is opened and reviewed. Unregistered persons who have received sufficient training to enable them to identify complaints and funds would be permitted to review correspondence.

Where the office structure does not permit the review of correspondence prior to use or distribution, appropriate procedures that could be adopted include the following:

• forwarding opened incoming written correspondence related to the dealer's municipal securities activities to a designated office, or supervising branch office, for review on a weekly basis;

• maintenance of a separate log for all checks received and securities products sold, which is forwarded to the supervising branch office on a weekly basis;

• communication to clients that they can contact the dealer directly for any matter, including the filing of a complaint, and providing them with an address and telephone number of a central office of the dealer for this purpose; and

• branch examination verification that the procedures are being followed.

Regardless of the method used for initial review of incoming, written correspondence, as with other types of correspondence, rule G-27 would still require review by a designated principal of some of each municipal securities representative's correspondence with the public relating to the dealer's municipal securities activities. Given the complexity and cost of establishing appropriate systems for effectively reviewing electronic communications, some members may determine to conduct a pre-use or distribution review of all incoming and outgoing correspondence (written or electronic).

Dealers must continually assess the effectiveness of these supervisory systems. Education and training must be timely (prior to or concurrent with implementation of the policies and procedures) and must include all appropriate employees. Dealers may incorporate the required education and training on correspondence into their Continuing Education Firm Element Training Program (see rule G-3(h) on continuing education requirements). The requirement for training regarding correspondence may also apply to employees who are not included under the Continuing Education requirements.

Municipal finance professional: supervisor.  This is in response to your inquiry seeking guidance regarding the possible classification as a municipal finance professional under rule G-37 of a Taxable Department Head at your firm. You stated that the Taxable Department Head is the direct supervisor of a Branch Manager and this Branch Manager manages a sales representative who has solicited municipal securities business from an issuer. You state that it is clear that the Branch Manager and the sales representative are both municipal finance professionals. However, you further state that the Taxable Department Head has delegated all Public Finance/Municipal oversight responsibilities to the Public Finance Department Head for the Taxable Department Head's personnel. You ask whether, under these circumstances, the Taxable Department Head would be considered a municipal finance professional under rule G-37 as a result of his or her supervisory position.

The term "municipal finance professional" is defined in rule G-37(g)(iv). Clauses (C) and (D) of the definition set forth the basis for considering an associated person of a dealer to be a municipal finance professional as a result of his or her supervisory position. Clause (C) includes any associated person who is both (i) either a municipal securities principal or municipal securities sales principal and (ii) a supervisor of any associated person either primarily engaged in municipal securities representative activities or who solicits municipal securities business (referred to herein as a "primary municipal securities supervisor"). Clause (D) includes any associated person who is a supervisor of a primary municipal securities supervisor up through and including (in the case of a non-bank dealer) the Chief Executive Officer or similarly situation official (referred to herein as a "secondary municipal securities supervisor").

Unlike in the case of a primary municipal securities supervisor, a secondary municipal securities supervisor is not required to be a municipal securities principal or municipal securities sales principal. The status of a secondary municipal securities supervisor as a municipal finance professional is not conditioned on the areas in which such supervisor has responsibility over a primary municipal securities supervisor, so long as such secondary municipal securities supervisor retains some degree of supervisory responsibility (whether or not relating to municipal securities activities) over the primary municipal securities supervisor.  MSRB interpretation of November 23, 1999.

Financial advisory relationship: private placements. This is in response to your letter in which you seek clarification on certain matters related to rules G-23, on activities of financial advisors, and G-37, on political contributions and prohibitions on municipal securities business.

You ask when it is "necessary in the process of commencing preliminary work with a potential financial advisory client to enter into a formal written financial advisory contract." Rule G-23(c) states that "[e]ach financial advisory relationship shall be evidenced by a writing entered into prior to, upon or promptly after the inception of the financial advisory relationship (or promptly after the creation or selection of the issuer if the issuer does not exist or has not been determined at the time the relationship commences)." Rule G-23(b) states that "...a financial advisory relationship shall be deemed to exist when a broker, dealer or municipal securities dealer renders or enters into an agreement to render financial advisory or consultant services to or on behalf of an issuer with respect to a new issue or issues of municipal securities, including advice with respect to the structure, timing, terms and other similar matters concerning such issue or issues, for a fee or other compensation or in expectation of such compensation for the rendering of such services."

You ask whether you are to advise the Board by means of reporting on Form G-37/G-38 or by any other means when you commence work on subsequent financing transactions with an issuer with which your firm has an ongoing financial advisory contract. The Instructions for Completing and Filing Form G-37/G-38 provide a guideline to use in determining when to report financial advisory services on Form G-37/G-38.[1] Pursuant to these Instructions, dealers should indicate financial advisory services when an agreement is reached to provide the services. In addition, the Instructions note that dealers also should indicate financial advisory services during a reporting period when the settlement date for a new issue on which the dealer acted as financial advisor occurred during such period. There are no other requirements for reporting financial advisory services to the Board.

Finally, you ask whether rules G-23 or G-37 contain requirements concerning private placement activities. The term "municipal securities business" is defined in rule G-37 to include "the offer or sale of a primary offering of municipal securities on behalf of any issuer ( e.g. , private placement)..." The Instructions for Completing and Filing Form G-37/G-38 provide that private placements should be indicated at least by the settlement date if within the reporting period.

With respect to rule G-23, section (d) of the rule states that no dealer that has a financial advisory relationship with respect to a new issue of municipal securities shall acquire as principal either alone or as a participant in a syndicate or other similar account formed for the purpose of purchasing, directly or indirectly, from the issuer all or any portion of such issue, or act as agent for the issuer in arranging the placement of such issue, unless various actions are taken.[2] In addition, rule G-23(g) states that each dealer subject to the provisions of sections (d), (e) or (f) of rule G-23 shall maintain a copy of the written disclosures, acknowledgments and consents required by these sections in a separate file and in accordance with the provisions of rule G-9, on preservation of records. Finally, rule G-23(h) states that, if a dealer acquires new issue municipal securities or participates in a syndicate or other account that acquires new issue municipal securities in accordance with section (d) of rule G-23, such dealer shall disclose the existence of the financial advisory relationship in writing to each customer who purchases such securities from such dealer, at or before the completion of the transaction with the customer. MSRB interpretation of October 5, 1999.

[1] I have enclosed a copy of the Instructions for Completing and Filing Form G-37/G-38 as contained in the MSRB Rule Book. The instructions are also contained on the Board's web site (www.msrb.org) under the link for rule G-37.

[2] These actions are: (i) if such issue is to be sold by the issuer on a negotiated basis, (A) the financial advisory relationship with respect to such issue has been terminated in writing and at or after such termination the issuer has expressly consented in writing to such acquisition or participation, as principal or agent, in the purchase of the securities on a negotiated basis; (B) the dealer has expressly disclosed in writing to the issuer at or before such termination that there may be a conflict of interest in changing from the capacity of financial advisor to purchaser of or placement agent for the securities with respect to which the financial advisory relationship exists and the issuer has expressly acknowledged in writing to the dealer receipt of such disclosure; and (C) the dealer has expressly disclosed in writing to the issuer at or before such termination the source and anticipated amount of all remuneration to the dealer with respect to such issue in addition to the compensation referred to in section (c) of rule G-23, and the issuer has expressly acknowledged in writing to the dealer receipt of such disclosure; or (ii) if such issue is to be sold by the issuer at competitive bid, the issuer has expressly consented in writing prior to the bid to such acquisition or participation.

MUNICIPAL FUND SECURITIES - REVISED DRAFT RULE CHANGES

The Board is requesting further comments on revised draft rule changes relating to municipal fund securities. Comments are due by November 1, 1999.
 

        On March 17, 1999, the Municipal Securities Rulemaking Board (the "Board") published a notice (the "March Notice") requesting comments on draft rule changes relating to transactions effected by or through brokers, dealers and municipal securities dealers ("dealers") in municipal fund securities (as defined below).⁽¹⁾ The Board received comments from eleven commentators. After reviewing these comments, the Board has determined to republish the draft rule changes, with certain modifications and additions (including a revision to exempt municipal fund securities from underwriting assessments), for further comment from industry participants.

        The Board believes that many of the comments reflect a misunderstanding of the nature of the Board's rulemaking proposals and therefore the Board is taking this opportunity to clarify the scope and intent of these proposals. Specifically, the Board wishes to emphasize that the draft rule changes would not extend the reach of Board rules. Rather, they seek to make Board rules that are already applicable to municipal fund securities more accommodating to the unique features of such securities. Dealers should understand that Board rules apply to their transactions in any security that is a municipal security, regardless of whether the dealer is aware of the security's status. Although the Board does not have authority to direct enforcement of its rules, it is statutorily charged with determining the best means of protecting investors and the public interest in regard to dealer transactions in municipal securities. As such, the Board believes that, under the unique circumstances relating to municipal fund securities, enforcement of its rules with regard to transactions in such securities that occurred prior to the industry having been put on notice of their applicability would serve no substantial investor protection purpose, absent extraordinary circumstances or a showing of investor harm resulting from a material departure from standards of fairness generally applicable under the federal securities laws.
 

SCOPE AND INTENT OF BOARD RULEMAKING WITH RESPECT TO MUNICIPAL FUND SECURITIES

        Dealers that effect transactions in municipal securities are subject to the Board's jurisdiction pursuant to Section 15B of the Securities Exchange Act of 1934 (the "Exchange Act"). In particular, Section 15B(c)(1) prohibits dealers from effecting transactions in, or inducing or attempting to induce the purchase or sale of, a municipal security in contravention of any Board rule. Thus, since enactment of Section 15B and the creation of the Board in the Securities Acts Amendments of 1975 (the "Securities Acts Amendments"), a transaction effected by a dealer in a municipal security must be effected in conformity with Board rules.

        In the March Notice, the Board reviewed two types of state or local governmental programs involving investment interests in which dealers may effect transactions: pooled investment funds under trusts established by state or local governmental entities ("local government pools")⁽²⁾ and higher education savings plan trusts established by states ("higher education trusts").⁽³⁾ These programs had been brought to the Board's attention by staff of the Securities and Exchange Commission (the "SEC"). In response to a Board inquiry as to the SEC's position on whether interests in such programs were municipal securities, SEC staff stated that "at least some interests in local government pools and higher education trusts may be, depending on the facts and circumstances, 'municipal securities' for purposes of the Exchange Act."⁽⁴⁾

        Board rules do not apply to any interest in a local government pool or higher education trust that is not a municipal security. In addition, Board rules apply only to activities of dealers that effect municipal securities transactions. Thus, Board rules do not apply to an issuer of, or a non-dealer entity providing advice to issuers in regard to, municipal securities, including municipal fund securities. However, to the extent that interests in a local government pool or a higher education trust are municipal securities and dealers are effecting transactions in them, Board rules automatically govern such dealer transactions, without the necessity of further Board rulemaking^.(5) On several previous occasions, the Board has alerted the industry to the applicability of Board rules to (and has proposed rule changes to accommodate) transactions in new forms of municipal securities or pre-existing forms of securities that many in the industry had not previously recognized as municipal securities.⁽⁶⁾

        A municipal fund security is defined as a municipal security issued by an issuer that, but for Section 2(b) of the Investment Company Act of 1940 (the "Investment Company Act"),⁽⁷⁾ would constitute an investment company under that Act. Thus, Board rules on municipal fund securities would apply to interests in a state or local governmental trust, such as local government pools and higher education trusts,⁽⁸⁾ only if the following three conditions are met:

1. A dealer is engaging in transactions in such interests;
2. Such interests, in fact, constitute municipal securities; and
3. Such interests are issued by an issuer that, but for the exemption under Section 2(b) of the Investment Company Act, would be considered an investment company within the meaning of that Act.

        The Board understands that municipal fund securities may not have features typically associated with more traditional municipal securities. Instead, their features are similar to those of investment company securities.⁽⁹⁾ In the March Notice, the Board stated that, although its rules generally have been drafted to accommodate the characteristics of debt securities, it believes that most current rules can appropriately be applied to municipal fund securities. Nonetheless, the Board felt that certain rules should be amended to recognize the unique characteristics of municipal fund securities. The draft rule changes did not seek to extend the reach of Board rules, since the rules already apply to municipal fund securities, but sought to tailor certain Board rules to the nature of municipal fund securities.

DISCUSSION OF COMMENTS AND DRAFT RULE CHANGES
 

Authority of Board to Adopt Draft Rule Changes
 

        Comments Received. Some commentators state that the Board has no authority to regulate municipal fund securities, particularly local government pool interests.⁽¹⁰⁾ They state that such interests are not municipal securities under the Exchange Act. They argue that the term "municipal securities" is limited to debt obligations of municipal issuers and that interests in local government pools represent equity interests in trust assets, not debt obligations.⁽¹¹⁾ Another commentator questions whether Congress intended that the Board regulate local government pools when it created the Board.

        Board Response. As previously stated, a security must first be a municipal security in order to be a municipal fund security. The draft rule changes would not, and existing Board rules do not, apply to local government pool or higher education trust interests that are not municipal securities. Thus, the Board does not overstep its authority by regulating dealer transactions in municipal fund securities since, by definition, regulation is limited to interests that are municipal securities.

        A firm wishing to determine if Board rules apply to services it provides to an issuer of local government pool or higher education trust interests may seek advice of counsel as to whether (1) such services constitute broker-dealer activities, or (2) such interests are municipal securities. It may seek comfort on counsel's opinion from SEC staff through the SEC's no-action procedure. If a non-dealer firm's activities do not constitute broker-dealer activities, the firm need not be a registered broker or dealer subject to Board rules, even if the interests are municipal securities.⁽¹²⁾ If the interests are not municipal securities, the dealer need not comply with Board rules; however, the dealer's activities may be subject to Exchange Act provisions and SEC and National Association of Securities Dealers ("NASD") rules, unless the interests otherwise qualify for an exemption (e.g., as exempted securities other than municipal securities) under the Exchange Act.

        Of course, the Board's rulemaking proposal is meaningful only if municipal fund securities, in fact, exist. As noted above, the Board sought comfort from SEC staff that local government pool and higher education trust interests are municipal securities. SEC staff replied that "at least some interests in local government pools and higher education trusts may be, depending on the facts and circumstances, 'municipal securities' for purposes of the Exchange Act."⁽¹³⁾ Although the Board is not empowered to determine whether a security is a municipal security within the meaning of Section 3(a)(29) of the Exchange Act, the Board believes that, based on this SEC response as well as a close review of existing no-action letters and legislative history of the Securities Acts Amendments, the Exchange Act and the Securities Act of 1933 (the "Securities Act"), as discussed below, at least some interests in local government pools and higher education trusts are municipal securities.

        For example, in agreeing not to recommend enforcement action in several no-action letters, SEC staff relied on opinions of counsel that interests in state or local governmental trusts were municipal securities under the Exchange Act.⁽¹⁴⁾ In one instance, SEC staff agreed not to recommend enforcement action if a dealer, in offering and selling interests in a higher education trust, were to comply with Board rules as they have been proposed to be amended in the March Notice, in lieu of complying with such rules as currently in effect.⁽¹⁵⁾ In another no-action letter, SEC staff agreed not to recommend enforcement action if dealers (1) sold interests in a higher education trust through persons qualified to sell investment company products but who did not meet the Board's professional qualification requirements⁽¹⁶⁾ and (2) complied with Rule 15c2-12(b)(5) through a continuing disclosure undertaking from a dealer affiliate, rather than from the issuer. In reaching this position, SEC staff noted that the higher education trust interests were "atypical municipal securities."⁽¹⁷⁾

        In other instances, SEC staff agreed not to recommend enforcement action if state entities and their employees sold higher education trust interests without registering as brokers.⁽¹⁸⁾ The applicants opined in these cases that the interests were municipal securities under the Exchange Act, thereby exempting the issuers from registering as brokers by virtue of the exemption for issuers of municipal securities set forth in Section 3(d).⁽¹⁹⁾ SEC staff also agreed not to recommend enforcement action if interests in a state trust were not registered under the Exchange Act, in reliance on an opinion that the exemption under Section 3(a)(12) of the Exchange Act for exempted securities was available.⁽²⁰⁾

        SEC staff also has taken the position that non-debt securities may be municipal securities under the Exchange Act.⁽²¹⁾ In one case, SEC staff was unable to conclude that receipts/certificates evidencing developers' payments to a city of fees for the issuance of building permits could not be considered municipal securities under the Exchange Act.⁽²²⁾ SEC staff also has advised the Board that warrants sold by a municipal corporation entitling the holders to purchase other municipal securities of that corporation are themselves municipal securities under the Exchange Act.⁽²³⁾ Finally, in those cases in which SEC staff concluded that an "obligation" within the meaning of the Internal Revenue Code would also constitute an "obligation" for purposes of Section 3(a)(29) of the Exchange Act, SEC staff did not conclude that the failure of a security to be an obligation for purposes of the Internal Revenue Code would mean that such security was not a municipal security for purposes of the Exchange Act.⁽²⁴⁾ In these cases, SEC staff was not presented with the issue of whether a non-debt security could be a municipal security. As noted above, on the last two occasions when SEC staff was confronted with this issue, it concluded that a non-debt security may be a municipal security for purposes of the Exchange Act.⁽²⁵⁾

        A review of legislative history also suggests that the commentators' position that the term "municipal securities" in the Exchange Act excludes non-debt securities is not justified. The Senate report on the Securities Acts Amendments notes that the legislation created a definition of municipal securities in new Section 3(a)(29) that, for all relevant purposes, used the same language as in the original version of the definition of exempted securities in Section 3(a)(12) of the Exchange Act.⁽²⁶⁾ It also states that no substantive changes in meaning would be effected by creating Section 3(a)(29).⁽²⁷⁾ Thus, the import of the term "municipal securities" must be viewed through the eyes of the original drafters of the Exchange Act in 1934 rather than the drafters of the Securities Acts Amendments in 1975.

        The purpose of including municipal securities in the definition of exempted securities in the Exchange Act was to provide an exemption from most provisions of that Act. Although commentators suggest that Board regulation of dealer transactions in non-debt securities of municipal issuers is inconsistent with the intent of the drafters of the Securities Acts Amendments, the appropriate inquiry is whether the drafters of the original Exchange Act would have intended that only debt securities of municipal issuers be exempted from most provisions of the Exchange Act. That is, would the drafters of the original Exchange Act have intended that non-debt securities of state or local governmental entities - had such securities existed at the time - be subject to the entire range of regulation of the Exchange Act applicable to other equity securities, including in some instances a requirement for registration of such securities with the SEC? A review of Congressional debates, committee reports and hearing testimony relating to enactment of the Securities Act and the Exchange Act reveals that, in spite of differences in statutory language, both Acts were expected to exempt the same universe of municipal securities.

        For example, the 1933 House report on the Securities Act speaks of exempted state and local government securities almost exclusively in terms of "obligations" and "bonds," not "securities."⁽²⁸⁾ The report explains the exemption set forth in Section 3(a) of the Securities Act as follows:

        Paragraph (2) exempts United States, Territorial and State obligations, or obligations of any political subdivision of these governmental units. The term "political subdivision" carries with it the exemption of such securities as county, town, or municipal obligations, as well as school district, drainage district, and levee district, and other similar bonds. The line drawn by the expression "political subdivision" corresponds generally with the line drawn by the courts as to what obligations of States, their units and instrumentalities created by them, are exempted from Federal taxation. By such delineation, any constitutional difficulties that might arise with reference to the inclusion of State and municipal obligations are avoided.⁽²⁹⁾

        Furthermore, during Congressional debate and hearings held in 1933 on the Securities Act, members of Congress used the terms "securities," "obligations" and "bonds" interchangeably.⁽³⁰⁾ Thus, although the statutory language in the Securities Act uses only the term "securities" and not the term "obligations" when describing municipal securities, there is no suggestion that Congress had anything in mind when enacting the Securities Act other than the tax-exempt bonds and other debt obligations of state and local governments that are customarily associated with municipal securities. Nonetheless, the commentators all have agreed that local government pool and higher education trust interests are exempt from the Securities Act and none has suggested that this exemption is limited to tax-exempt debt obligations.

        The initial Exchange Act draft introduced in Congress the following year exempted federal government securities but not municipal securities. Members of Congress expressed concern regarding the appropriateness of federal regulation of state and local governmental matters,⁽³¹⁾ the burden that Exchange Act provisions would place on state and local issuers⁽³²⁾ and the relative detriment in the market to municipal securities if they were not exempted but federal government securities were exempted.⁽³³⁾ Some discussion focused on whether a distinction should be drawn between defaulted and non-defaulted municipal securities.⁽³⁴⁾ Ultimately, the language that was added to the Exchange Act to exempt municipal securities made no such distinction but instead was drafted in non-exclusive terms that paralleled the language used in the Exchange Act to describe federal government securities. This language also employed the same type of terminology that the drafters of the Securities Act had used in the legislative history to explain the statutory language on municipal securities in that Act.⁽³⁵⁾ Legislative history does not reflect any intent or understanding that the municipal securities contemplated in the Exchange Act were any different than those that were already exempted under the Securities Act.⁽³⁶⁾ It would be inconsistent with legislative intent to limit the exemption under the Exchange Act solely to debt securities of state and local governments without similarly limiting the reach of the exemption provided in the Securities Act.

        Finally, in using the same term - "municipal securities" - that sets out the exemption from most Exchange Act provisions to also delineate the Board's rulemaking authority under Section 15B of the Exchange Act, Congress elected in the Securities Acts Amendments to grant the Board jurisdiction over dealer transactions in the identical universe of securities as were otherwise exempted from the Exchange Act as municipal securities. Thus, even if Congress did not have interests in local government pools or higher education trusts in mind when enacting the Securities Acts Amendments, it did have a specific intent that the Board would have authority over dealer transactions in any security that would constitute an exempted security by virtue of being a municipal security. In creating the Board, the Senate report on the Securities Acts Amendments stated that it would not "be desirable to restrict the Board's authority by a specific enumeration of subject matters. The ingenuity of the financial community and the impossibility of anticipating all future circumstances are obvious reasons for allowing the Board a measure of flexibility in laying down the rules for the municipal securities industry."⁽³⁷⁾ The fact that certain types of instruments (such as non-debt securities of state or local governments) were essentially non-existent at the time of enactment of the Securities Acts Amendments did not, in the minds of the drafters, mean that regulations relating to newly created instruments would not be within the Board's power.⁽³⁸⁾

Appropriateness of Regulating Dealer Transactions in Municipal Fund Securities
 

        Comments Received. Commentators state that, even if the Board has authority to adopt the draft rule changes, the Board should refrain from doing so. They argue that no need has been demonstrated for regulation to protect investors or the public interest in connection with local government pool interests. They state that investors are local governments and not the typical public investor in municipal securities.⁽³⁹⁾ They also argue that offerings of interests in local government pools do not pose risks that are similar to those identified in the legislative history of the Securities Acts Amendments.⁽⁴⁰⁾ One commentator argues that safeguards already exist to provide investor protections comparable to those in the draft rule changes.⁽⁴¹⁾

        Some commentators state that Board rulemaking would adversely impact state and local governments. In particular, they believe that underwriting assessments would be passed on, directly or indirectly, to issuers and issuers would face additional administrative burdens as a result of the application of Board rules. They note that any increased costs to issuers likely would be passed on to investors in the form of lower returns on their investments.

        Commentators also state that interests in local government pools involve transactions between the state or local government-sponsored pools and participating local governmental entities of that same state. One commentator believes that Board rulemaking would be inconsistent with the Tenth Amendment and transactions in local government pool interests do not constitute interstate commerce. Furthermore, noting that the Exchange Act does not require registration of a broker or dealer whose business is exclusively intrastate, this commentator suggests that the Board "follow Congress's restraint in approaching intrastate transactions in securities." Finally, it states that regulation of transactions in these interests would "improperly intrude on state sovereignty" by indirectly regulating states by mandating actions by their agents.

        Board Response. As the Board has previously observed, the current rulemaking proposal would not subject dealer transactions in municipal fund securities to Board rules but instead would make certain Board rules, to which such transactions are already subject, better accommodate the nature of these securities. Making Board rules fit the characteristics of municipal fund securities is an appropriate Board undertaking. Also, Board rules do not govern the actions of issuers; instead, they impose standards on dealers effecting transactions in the securities of such issuers. In establishing the Board, Congress determined that dealer regulation was the appropriate manner of providing investor protection in the municipal securities market while maintaining the existing exemption for issuers.⁽⁴²⁾

        The definition of customer under rule D-9 includes issuers, except in connection with sales of an issuer's new issue municipal securities, and therefore Board rules contemplate that governmental entities acting as investors are entitled to the protections afforded by such rules to all customers.⁽⁴³⁾ The Board understands that local government pools exist in nearly every state and that, in many states, more than one pool may be available to a local government.⁽⁴⁴⁾ One market observer states that these pools "can differ in their level of risk taking, internal oversight, shareholder services, and external reporting."⁽⁴⁵⁾ Although a number of pools have been rated, the vast majority remain unrated. Most local government pools appear to be designed to maintain, as nearly as possible, a constant net asset value (similar to regulated money market mutual funds), but some operate as variable net asset value pools that do not seek to maintain a constant share value. Furthermore, a number of local government pools have experienced financial difficulties.⁽⁴⁶⁾ These factors suggest that investor protection issues may be raised in connection with the sale by dealers of interests in local government pools.⁽⁴⁷⁾ The Board believes that investor protection issues also may arise with respect to sales by dealers of interests in higher education trusts.⁽⁴⁸⁾ For example, the Board believes that dealers have suitability obligations if they recommend a transaction in a local government pool or higher education trust interest to a local government or an individual, respectively, if such interest constitutes a municipal security.⁽⁴⁹⁾

        Commentators describe local government pools as being operated "consistent with" the federal securities laws applicable to investment companies and managed and administered in a manner "similar" to money market mutual funds, "where practicable." These comments imply that many programs in fact deviate to some degree from their voluntary compliance with existing federal regulations that would be applicable to these programs if they were not operated by state or local governmental entities. However, the Board notes that its proposed rulemaking would not impose requirements on issuers and in fact has been drafted with the understanding that dealers may be effecting transactions in securities that are similar, but not identical, to investment company securities. In that respect, the Board believes that its proposed rulemaking is more suitable for dealers effecting transactions in municipal fund securities than existing SEC and NASD rules applicable to dealer transactions in investment company securities since some such rules impose obligations on dealers based on the assumption that issuers, as registered investment companies, must comply with federal investment company laws and regulations. Thus, a dealer might have difficulty in complying with the letter of existing regulations relating to securities of registered investment companies where the issuer of a local government pool or higher education trust interest has chosen not to voluntarily comply with the provisions that would be obligatory if it were a registered investment company. As is the case with all existing Board rules, the current rulemaking proposal recognizes that issuers, as largely unregulated entities, may act in widely divergent manners. Thus, obligations placed on dealers should be sufficiently flexible to permit dealers to act in a lawful manner in view of this wide divergence of circumstances while maintaining an adequate level of customer protection.

        The Board believes that state regulation, federal rules applicable to investment advisors and Governmental Accounting Standards Board statements, although providing important protections in the areas governed by such rules and standards, do not serve as a substitute for regulation tailored specifically toward dealer activities in municipal fund securities. Furthermore, the Board believes that voluntary adherence to the substance of existing rules applicable to investment company securities and/or other equity securities provides inadequate protection to investors since dealers are free to deviate from these rules in any manner and at any time they choose without any apparent legal consequence. The existence of these collateral safeguards do not justify the Board refraining from making its rules more rational with respect to such securities.

        Finally, with regard to the argument that interests in local government pools are strictly intrastate in nature and therefore are not the appropriate subject of federal regulation, Board rules currently do not apply to any entity that, by virtue of the fact that its business is exclusively intrastate, is not registered as a broker or dealer under Section 15 of the Exchange Act. Beyond this, the federal securities laws provide that, once an entity engages in some interstate activities that require it to register under the Exchange Act, the broker-dealer rules applicable to such entity apply to both its interstate and intrastate transactions. We believe that Congress has made clear its policy determination that intrastate transactions of registered broker-dealers should be subject to broker-dealer regulation.⁽⁵⁰⁾
 

Applicability of Existing Board Rules to Transactions in Municipal Fund Securities Effected Prior to Effectiveness of Draft Rule Changes

        Comments Received. Two commentators argue that, to the extent that the Board may have authority to regulate dealer transactions in these interests, existing Board rules relating to municipal securities do not currently apply to transactions in local government pool interests. They state that existing Board rules were never intended to apply to securities other than debt obligations, as evidenced by the Board's statement in the March Notice that its rules "generally have been drafted to accommodate the characteristics of debt obligations and not investment interests such as municipal fund securities." As a result, they believe that any interpretation by the Board to the effect that existing rules apply to municipal fund securities can only be effected through the rulemaking process.

        Board Response. As stated above, the Board believes that Section 15B(c)(1) of the Exchange Act automatically subjects any dealer transactions in municipal fund securities to Board rules. This is true regardless of whether dealers effecting such transactions are aware that municipal fund securities are, in fact, municipal securities. It is incumbent upon dealers to be aware of the nature of the securities in which they undertake transactions and it is not a defense against the applicability of Board rules that the dealer did not know that the securities were municipal securities. Thus, the Board's statement that any interest in a local government pool or a higher education trust that is a municipal security currently is subject to Board rules was a statement of fact rather than an interpretation.⁽⁵¹⁾

        The Board recognizes, however, that, prior to publication of the March Notice, it may not have been readily apparent to the vast majority of dealers, as well as to most regulatory agencies, that interests that constitute municipal fund securities were municipal securities. Although the Board does not have authority to direct enforcement of its rules, it is statutorily charged with determining the best means of protecting investors and the public interest in regard to dealer transactions in municipal securities. As such, the Board believes that, under the unique circumstances relating to municipal fund securities, enforcement of its rules with regard to transactions in such securities that occurred prior to the industry having been put on notice of their applicability would serve no substantial investor protection purpose, absent extraordinary circumstances or a showing of investor harm resulting from a material departure from standards of fairness generally applicable under the federal securities laws.
 

Structure of Draft Rule Changes

        Comments Received. Some commentators express concern that the Board's rulemaking proposal contemplates amendments to existing rules rather than creation of a separate body of regulations. One commentator states that the "attempt to fit a totally new product or way of doing business into existing regulation that was created to address fundamentally different products and a different market structure is fraught with danger." Commentators also state that transactions in municipal fund securities should be regulated in a manner as similar as possible to the existing regulatory scheme for investment company securities.

        Board Response. The Board reviewed its existing rules and compared them, where relevant, to rules that govern dealer transactions in securities of registered investment companies. In many respects, Board rules are functionally identical to such existing rules. In other cases, existing SEC or NASD rules provide a more appropriate method of regulating municipal fund securities and the Board sought to modify its rules in a manner that was consistent with such other rules. In yet other cases, the regulation of the structure and marketing of securities of registered investment companies has been effected by regulations applicable to issuers, an approach which the Board cannot, and does not seek to, duplicate. Finally, certain NASD and SEC rule provisions arise out of specific Congressional authorization in the Investment Company Act applicable to securities of registered investment companies but not applicable to unregistered municipal fund securities.

        Under the circumstances, the Board believes that its approach is appropriate. The Board sought industry comment on the draft rule changes and, in those circumstances where commentators noted specific shortcomings, the Board considered the merits of the comments and made revisions where appropriate. The Board was disappointed that several commentators chose to comment almost exclusively on jurisdictional issues and hopes that they will now address the details of, and any concerns raised by, the revised draft rule changes.

Specific Rule Provisions
 

        Rule A-13, on Underwriting Assessments. In the March Notice, the Board states that sales of municipal fund securities are made in a primary offering subject to the underwriting assessment in rule A-13.⁽⁵²⁾ The draft amendment to rule A-13 would have provided for the imposition of an underwriting assessment with respect to such sales of municipal fund securities.

        Most commentators express concern regarding the assessment of underwriting fees on sales of municipal fund securities. Some suggest that such sales should be exempted from the underwriting assessment. They state that the fee structure for dealers involved in the distribution of municipal fund securities is more like an administrative fee than an underwriting discount or commission since these dealers do not undertake underwriting risks. As a result, they state that fees generally are fixed and are low relative to traditional underwriting fees. Because of these small margins, a number of commentators state that underwriting assessments would be passed on to issuers and therefore would represent a financial burden on the issuers' programs.⁽⁵³⁾

        Some commentators state that, given the volume of investments and redemptions in many municipal fund securities programs,⁽⁵⁴⁾ the level of fees generated by the Board from underwriting assessments would be disproportionate to the resulting regulatory costs. One commentator states that, if assessments are imposed, they should be at a significantly lower level than the assessments charged in connection with more traditional municipal securities offerings.⁽⁵⁵⁾

        Based on the comments, the Board has revised the draft amendment to rule A-13 to exempt sales of municipal fund securities from the underwriting assessment. The continuous nature of offerings in municipal fund securities, the programmatic nature of most customer investments and the heightened potential that underwriting assessments could create significant financial burdens on issuers to their customers' detriment justify caution in imposing the underwriting assessment. The Board also wishes to make clear that it does not intend to seek payment of any previously accrued underwriting assessments that may technically be due and owing on prior sales of municipal fund securities.

        Draft Rule D-12, on Definition of "Municipal Fund Security". Draft rule D-12 defines municipal fund security as a municipal security that would be an investment company security under the Investment Company Act but for the fact that the issuer is a state or local governmental entity or instrumentality. For a security to constitute a municipal fund security, the security must first constitute a municipal security. The draft amendments would not apply to any local government pool or higher education trust interest that is not a municipal security. The Board has not revised the draft definition.⁽⁵⁶⁾

        Rule G-3, on Professional Qualifications. The draft amendment to rule G-3 would permit an associated person qualified as an investment company limited representative to effect transactions in municipal fund securities (but no other municipal securities).⁽⁵⁷⁾ A dealer must have municipal securities principals as required under rule G-3(b), even if the dealer's only municipal securities transactions are sales of municipal fund securities. The Board has not revised this draft amendment.⁽⁵⁸⁾

        Rule G-8, on Recordkeeping. The draft amendment to rule G-8 would recognize that municipal fund securities do not have par values, dollar prices, yields and accrued interest and that some investment company limited representatives would be permitted to effect transactions in municipal fund securities. The Board did not receive comments on its draft amendment to rule G-8. However, in conjunction with revisions to the draft amendment to rule G-15 described below, the Board is proposing an additional revision to rule G-8 to require that dealers retain copies of all periodic statements delivered to customers in lieu of individual confirmations.

        Rule G-14, on Transaction Reporting. The draft rule change would make a technical modification in rule G-14(b)(i) to make clear that certain types of municipal securities transactions may be excluded from transaction reporting as provided in the Rule G-14 Transaction Reporting Procedures. In the Procedures, the language change would expressly exempt any transaction in municipal fund securities from the customer transaction reporting system.⁽⁵⁹⁾ The Board did not receive comments on, and has not revised, these draft amendments.

        Rule G-15, on Customer Confirmations. The draft amendment to rule G-15 would effect changes relating to the concepts of par value, yield, dollar price, maturity date and interest, none of which would appropriately apply to a municipal fund security. Thus, on a confirmation of a municipal fund securities transaction, a dealer would use the purchase or sale price of the securities (as appropriate) rather than par value and would omit yield, dollar price, accrued interest, extended principal, maturity date and interest rate. Dealers selling municipal fund securities would be required to include the denomination or purchase price of each share or unit as well as the number of shares or units to be delivered. Confirmations of municipal fund securities transactions would require a disclosure to the effect that a deferred commission or other charge may be imposed upon redemption, if applicable.⁽⁶⁰⁾ The amendment also would make clear that dealers must confirm redemptions of municipal fund securities. Finally, the amendment would permit dealers to use quarterly statements, rather than transaction-by-transaction confirmations, if customers are purchasing such securities in an agreed amount on a periodic basis, in a manner similar to the periodic reporting provision under Exchange Act Rule 10b-10.

The Board received a number of technical comments on various provisions in rule G-15:⁽⁶¹⁾

        Periodic Statements - Rule G-15(a)(vi)(G) and (a)(viii) - Some commentators state that the draft amendments would require individual confirmations for each transaction in local government pool interests and suggest that dealers be permitted to use monthly statements.⁽⁶²⁾ Another commentator states that transactions in higher education trust interests that are not effected pursuant to a periodic plan should nonetheless qualify for periodic statements in lieu of individual transaction confirmations.⁽⁶³⁾

        The Board has decided to revise the draft amendment to rule G-15 to provide that information regarding transactions in municipal fund securities effected in connection with a program that does not provide for periodic purchases or redemptions of municipal fund securities may be disclosed to customers on a monthly statement in lieu of transaction confirmations.⁽⁶⁴⁾ With respect to natural persons who participate in a non-periodic program, this monthly reporting would require the written consent of such individual or of the issuer. If the issuer directs that monthly statements be used in lieu of transaction confirmations, the revised draft amendment to rule G-15(a)(viii) would permit dealers effecting transactions in such municipal fund securities to use monthly statements without obtaining the consent of any customers. In addition, the draft amendment has been revised to eliminate the requirement that customers participating in a group plan consent to the use of periodic statements in lieu of transaction confirmations.⁽⁶⁵⁾

        Rule G-15(a)(i)(A)(7) - In order to avoid the potential for ambiguity, this subparagraph has been revised to eliminate reference to denomination and to refer solely to the share purchase price.⁽⁶⁶⁾

        Rule G-15(a)(i)(C) and (a)(i)(B)(1) - A commentator notes that the Board did not provide guidance regarding the securities descriptive information required to be included under paragraph (a)(i)(C) and states that such paragraph should not be applicable to municipal fund securities. In the alternative, it suggests that confirmations should not be required to state that municipal fund securities are unrated.⁽⁶⁷⁾ The Board has revised the draft amendment to (i) provide that a confirmation of a municipal fund security transaction need not show the information required under paragraph (a)(i)(C) other than whether the security is puttable and (ii) include a requirement in subparagraph (a)(i)(B)(1) that the confirmation include the name used by the issuer to identify the security and, to the extent necessary to differentiate the security from other municipal fund securities of the issuer, any separate program series, portfolio or fund designation. A statement to the effect that the security is unrated would not be required.

        Rule G-21, on Advertising. The Board did not propose amending rule G-21 in the March Notice. One commentator states that this rule should be revised to eliminate references to price and yield for purposes of municipal fund securities. Section (d)(i) provides that an advertisement for new issue municipal securities may show the initial reoffering price or yield, even if they have changed, so long as the date of sale is shown. In addition, it provides that if the price or yield shown in the advertisement is other than the initial price or yield, the price or yield shown must have been accurate at the time the advertisement was submitted for publication. The Board believes that these provisions do not unnecessarily restrict the manner in which municipal fund securities may be advertised nor do they mandate that an advertisement for a municipal fund security specify a price or yield.⁽⁶⁸⁾ Therefore, no change has been proposed to rule G-21.

        Rule G-26, on Customer Account Transfers. The draft amendment to rule G-26 amends the definition of "nontransferable asset" to reflect the fact that the issuer of municipal fund securities may limit which dealers may carry accounts for customers in such securities. The Board did not receive comments on, and has not revised, this draft amendment.

        Rule G-32, on New Issue Disclosures. No amendments to rule G-32 were proposed in the March Notice. However, the Board stated that municipal fund securities sold in a primary offering would constitute new issue municipal securities for purposes of rule G-32 so long as the securities are in the underwriting period. Since the Board understands that issuers of municipal fund securities are continuously issuing and delivering the securities as customers make purchases, the Board believes that municipal fund securities would remain in their underwriting period so long as such issuance and delivery continues.⁽⁶⁹⁾ Thus, a dealer effecting a transaction in a municipal fund security would be required to deliver to the customer the official statement, if one exists, by settlement of the transaction. However, in the case of a customer purchasing such securities who is a repeat purchaser, no new delivery of the official statement would be required so long as the customer has previously received it in connection with a prior purchase and the official statement has not been changed from the one previously delivered to that customer.⁽⁷⁰⁾

        One commentator expresses concern regarding the timing requirement of rule G-32 in the limited circumstances where a revision has just been made to the official statement and a customer that participates in a periodic plan makes an automatic purchase of additional shares of municipal fund securities. In spite of the best efforts of the dealer and the issuer, it may be impossible for the revised official statement to be delivered to the customer by settlement. The commentator suggests that, under these circumstances, the timing requirement under rule G-32 should be based on the sending rather than the delivery of the official statement.

        The Board is proposing a draft amendment to rule G-32 that would permit a dealer to sell, pursuant to a periodic plan, a municipal fund security to a customer who has previously received the official statement so long as it sends to the customer a copy of any new, supplemented, amended or stickered official statement promptly upon receipt from the issuer. The draft amendment also would except municipal fund securities for which periodic statements in lieu of transaction confirmations are provided from the requirement that information on the underwriting arrangements (which information would be limited to the fees paid to the dealer by the issuer) be provided to customers by settlement so long as such information is disclosed at least annually and information on any fee changes paid by the issuer to the dealer be sent to customers simultaneously with or prior to the sending of the next periodic statement.

        Rule G-33, on Calculations. The Board did not propose amending rule G-33 in the March Notice. One commentator states that this rule should be revised to eliminate references to par value, yield dollar price, maturity date and interest for purposes of municipal fund securities. By its terms, rule G-33 applies only to municipal securities that bear interest or are sold at a discount. Since municipal fund securities do not bear interest and are not sold at a discount, rule G-33 would by its nature not apply. Therefore, no change has been made to rule G-33.

        Rule G-34, on CUSIP Numbers and Depository Eligibility. The draft amendments would exempt municipal fund securities from the requirements of rule G-34 since no secondary market is expected to develop.⁽⁷¹⁾ The Board did not receive comments on, and has not revised, this draft amendment.

        Rule G-36, on Delivery of Official Statements and Form G-36(OS) to the Board. The Board did not propose amending rule G-36 in the March Notice but did state that, consistent with SEC staff's view regarding the sale in primary offerings of municipal fund securities, dealers acting as underwriters in primary offerings of municipal fund securities would be subject to the requirements of rule G-36. Thus, unless such primary offering falls within one of the stated exemptions in Rule 15c2-12, the Board expects that the dealer would receive a final official statement from the issuer or its agent under its contractual agreement entered into pursuant to Rule 15c2-12(b)(3). Such official statement should be received from the issuer in sufficient time for the dealer to send the official statement, together with Form G-36(OS), to the Board within one business day of receipt but no later than 10 business days after any final agreement to purchase, offer, or sell the municipal fund securities.⁽⁷²⁾ Since municipal fund securities remain in their underwriting period so long as they continue to be sold and delivered, the dealer would remain obligated under rule G-36(d) to send to the Board, within one business day of receipt, any amendments made to the official statement during such extended underwriting period.⁽⁷³⁾ No change has been made to rule G-36.

        Rule G-37, on Political Contributions and Prohibitions on Municipal Securities Business, and Rule G-38, on Consultants. The Board did not propose amending rules G-37 and G-38 in the March Notice but did reminded dealers that the definition of municipal securities business under such rules includes the purchase of a primary offering from the issuer on other than a competitive bid basis or the offer or sale of a primary offering on behalf of any issuer. Thus, a dealer's transactions in municipal fund securities may impact upon such dealer's obligations under rules G-37 and G-38. No changes have been made to rules G-37 and G-38.

* * * * *

Comments from all interested parties are welcome. Comments should be submitted no later than November 1, 1999, and may be directed to Ernesto A. Lanza, Associate General Counsel. Written comments will be available for public inspection.

August 27, 1999

TEXT OF DRAFT AMENDMENTS⁽⁷⁴⁾

Rule A-13. Underwriting and Transaction Assessments for Brokers, Dealers and Municipal Securities Dealers

(a) Underwriting Assessments - Scope. Each broker, dealer and municipal securities dealer shall pay to the Board an underwriting fee as set forth in section (b) for all municipal securities purchased from an issuer by or through such broker, dealer or municipal securities dealer, whether acting as principal or agent, as part of a primary offering, provided that section (b) of this rule shall not apply to a primary offering of securities if all such securities in the primary offering:

        (i)-(ii) No change.

        (iii) at the option of the holder thereof, may be tendered to an issuer of such securities or its designated agent for redemption or purchase at par value or more at least as frequently as every nine months until maturity, earlier redemption, or purchase by an issuer or its designated agent; or

        (iv) have authorized denominations of $100,000 or more and are sold to no more than thirty-five persons each of whom the broker, dealer or municipal securities dealer reasonably believes: (A) has the knowledge and experience necessary to evaluate the merits and risks of the investment; and (B) is not purchasing for more than one account, with a view toward distributing the securities; or

        (v) constitute municipal fund securities.

If a syndicate or similar account has been formed for the purchase of the securities, the underwriting fee shall be paid by the managing underwriter on behalf of each participant in the syndicate or similar account.

(b)-(f) No change.
 

Rule D-12. "Municipal Fund Security"

The term "municipal fund security" shall mean a municipal security issued by an issuer that, but for the application of Section 2(b) of the Investment Company Act of 1940, would constitute an investment company within the meaning of Section 3 of the Investment Company Act of 1940.

Rule G-3. Classification of Principals and Representatives; Numerical Requirements; Testing; Continuing Education Requirements

No broker, dealer or municipal securities dealer or person who is a municipal securities representative, municipal securities principal, municipal securities sales principal or financial and operations principal (as hereafter defined) shall be qualified for purposes of rule G-2 unless such broker, dealer or municipal securities dealer or person meets the requirements of this rule.

(a) Municipal Securities Representative.

        (i) No change.

        (ii) Qualification Requirements.

        (A)-(B) No change.

        (C) The requirements of subparagraph (a)(ii)(A) of this rule shall not apply to any person who is duly qualified as a limited representative - investment company and variable contracts products by reason of having taken and passed the Limited Representative - Investment Company and Variable Contracts Products Examination, but only if such person's activities with respect to municipal securities described in paragraph (a)(i) of this rule are limited solely to municipal fund securities.

        (D) Any person who ceases to be associated with a broker, dealer or municipal securities dealer (whether as a municipal securities representative or otherwise) for two or more years at any time after having qualified as a municipal securities representative in accordance with subparagraphs (a)(ii)(A), (B) or (C) or (B) shall again meet the requirements of subparagraphs (a)(ii)(A), (B) or (C) or (B) prior to being qualified as a municipal securities representative.

        (iii) Apprenticeship.

        (A) Any person who first becomes associated with a broker, dealer or municipal securities dealer in a representative capacity (whether as a municipal securities representative, or general securities representative or limited representative - investment company and variable contracts products) without having previously qualified as a municipal securities representative, or general securities representative or limited representative - investment company and variable contracts products shall be permitted to function in a representative capacity without qualifying pursuant to subparagraphs (a)(ii)(A), (B) or (C) or (B) for a period of at least 90 days following the date such person becomes associated with a broker, dealer or municipal securities dealer, provided, however, that such person shall not transact business with any member of the public with respect to, or be compensated for transactions in, municipal securities during such 90 day period, regardless of such person's having qualified in accordance with the examination requirements of this rule. A person subject to the requirements of this paragraph (a)(iii) shall in no event continue to perform any of the functions of a municipal securities representative after 180 days following the commencement of such person's association with such broker, dealer or municipal securities dealer, unless such person qualifies as a municipal securities representative pursuant to subparagraphs (a)(ii)(A), (B) or (C) or (B).

        (B) Prior experience, of at least 90 days, as a general securities representative, limited representative - investment company and variable contracts products mutual fund salesperson or limited representative - government securities representative, will meet the requirements of this paragraph (a)(iii).

(b)-(h) No change.
 

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

(a) Description of Books and Records Required to be Made. Except as otherwise specifically indicated in this rule, every broker, dealer and municipal securities dealer shall make and keep current the following books and records, to the extent applicable to the business of such broker, dealer or municipal securities dealer:

        (i) Records of Original Entry. "Blotters" or other records of original entry containing an itemized daily record of all purchases and sales of municipal securities, all receipts and deliveries of municipal securities (including certificate numbers and, if the securities are in registered form, an indication to such effect), all receipts and disbursement of cash with respect to transactions in municipal securities, all other debits and credits pertaining to transactions in municipal securities, and in the case of brokers, dealers and municipal securities dealers other than bank dealers, all other cash receipts and disbursements if not contained in the records required by any other provision of this rule. The records of original entry shall show the name or other designation of the account for which each such transaction was effected (whether effected for the account of such broker, dealer or municipal securities dealer, the account of a customer, or otherwise), the description of the securities, the aggregate par value of the securities, the dollar price or yield and aggregate purchase or sale price of the securities, accrued interest, the trade date, and the name or other designation of the person from whom purchased or received or to whom sold or delivered. With respect to accrued interest and information relating to "when issued" transactions which may not be available at the time a transaction is effected, entries setting forth such information shall be made promptly as such information becomes available. Dollar price, yield and accrued interest relating to any transaction shall be required to be shown only to the extent required to be included in the confirmation delivered by the broker, dealer or municipal securities dealer in connection with such transaction under rule G-12 or rule G-15.

        (ii)-(viii) No change.

        (ix) Copies of Confirmations, Periodic Statements and Certain Other Notices to Customers. A copy of all confirmations of purchase or sale of municipal securities, of all periodic written statements disclosing purchases, sales or redemptions of municipal fund securities pursuant to rule G-15(a)(viii) and, in the case of a broker, dealer or municipal securities dealer other than a bank dealer, of all other notices sent to customers concerning debits and credits to customer accounts or, in the case of a bank dealer, notices of debits and credits for municipal securities, cash and other items with respect to transactions in municipal securities.

        (x) No change.

        (xi) Customer Account Information. A record for each customer, other than an institutional account, setting forth the following information to the extent applicable to such customer:

        (A)-(G) No change.

        (H) signature of municipal securities representative, and general securities representative or limited representative - investment company and variable contracts products introducing the account and signature of a municipal securities principal, municipal securities sales principal or general securities principal indicating acceptance of the account;

        (I)-(K) No change.

For purposes of this subparagraph, the terms "general securities representative," and "general securities principal" and "limited representative - investment company and variable contracts products" shall mean such persons as so defined by the rules of a national securities exchange or registered securities association. For purposes of this subparagraph, the term "institutional account" shall mean the account of (i) a bank, savings and loan association, insurance company, or registered investment company; (ii) an investment adviser registered either with the Commission under Section 203 of the Investment Advisers Act of 1940 or with a state securities commission (or any agency or office performing like functions); or (iii) any other entity (whether a natural person, corporation, partnership, trust, or otherwise) with total assets of at least $50 million. Anything in this subparagraph to the contrary notwithstanding, every broker, dealer and municipal securities dealer shall maintain a record of the information required by items (A), (C), (F), (H), (I) and (K) of this subparagraph with respect to each customer which is an institutional account.

        (xii)-(xix) No change.

(b)-(f) No change.

(g) Price substituted for par value of municipal fund securities. For purposes of this rule, each reference to the term "par value," when applied to a municipal fund security, shall be substituted with (i) in the case of a purchase of a municipal fund security by a customer, the purchase price paid by the customer, exclusive of any commission, and (ii) in the case of a sale or tender for redemption of a municipal fund security by a customer, the sale price or redemption amount paid to the customer, exclusive of any commission or other charge imposed upon redemption or sale.
 

Rule G-14. Reports of Sales or Purchases

(a) No change.

(b) Transactions Reporting Requirements.

        (i) Each broker, dealer or municipal securities dealer shall report to the Board or its designee information about its transactions in municipal securities to the extent required by, and using the formats and within the timeframes specified in, Rule G-14 Transaction Reporting Procedures. Transaction information collected by the Board under this rule will be used to make public reports of market activity and prices and to assess transaction fees. The transaction information will be made available by the Board to the Commission, securities associations registered under Section 15A of the Act and other appropriate regulatory agencies defined in Section 3(a)(34)(A) of the Act to assist in the inspection for compliance with and the enforcement of Board rules.

        (ii)-(iii) No change.
 

Rule G-14 Transaction Reporting Procedures

(a) No change.

(b) Customer Transactions.

        (i)-(ii) No change.

        (iii) The following transactions shall not be required to be reported under this section (b):

        (A) A a transaction in a municipal security that is ineligible for assignment of a CUSIP number by the Board or its designee; and shall not be required to be reported under this section (b).

        (B) a transaction in a municipal fund security.

        (iv) No change.

Rule G-15. Confirmation, Clearance and Settlement of Transactions with Customers

(a) Customer Confirmations

        (i) At or before the completion of a transaction in municipal securities with or for the account of a customer, each broker, dealer or municipal securities dealer shall give or send to the customer a written confirmation that complies with the requirements of this paragraph (i):

        (A) Transaction information. The confirmation shall include information regarding the terms of the transaction as set forth in this subparagraph (A):

        (1)-(2) No change.

        (3) Par value. The par value of the securities shall be shown, with special requirements for the following securities:

        (a) No change.

        (b) Municipal fund securities. For municipal fund securities, in place of par value, the confirmation shall show (i) in the case of a purchase of a municipal fund security by a customer, the total purchase price paid by the customer, exclusive of any commission, and (ii) in the case of a sale or tender for redemption of a municipal fund security by a customer, the total sale price or redemption amount paid to the customer, exclusive of any commission or other charge imposed upon redemption or sale.

        (4) No change.

        (5) Yield and dollar price. Yields and dollar prices shall be computed and shown in the following manner, subject to the exceptions stated in subparagraph (A)(5)(d) of this paragraph:

        (a)-(c) No change.

        (d) Notwithstanding the requirements noted in subparagraphs (A)(5)(a) through (c) of this paragraph, above:

        (i)-(v) No change.

        (vi) Municipal fund securities. For municipal fund securities, neither yield nor dollar price shall be shown.

        (6) Final Monies. The following information relating to the calculation and display of final monies shall be shown:

        (a) No change.

        (b) amount of accrued interest, with special requirements for the following securities:

        (i)-(ii) No change.

        (iii) Municipal fund securities. For municipal fund securities, no figure for accrued interest shall be shown;

        (c) if the securities pay interest on a current basis but are traded without interest, a notation of "flat;"

        (d) extended principal amount, with special requirements for the following securities:

        (i) No change.

        (ii) Municipal fund securities. For municipal fund securities, no extended principal amount shall be shown;

        (e)-(h) No change.

        (7) Delivery of securities. The following information regarding the delivery of securities shall be shown:

        (a) Securities other than bonds or municipal fund securities. For securities other than bonds or municipal fund securities, denominations to be delivered;

        (b) No change.

        (c) Municipal fund securities. For municipal fund securities, the purchase price, exclusive of commission, of each share or unit and the number of shares or units to be delivered;

        (d) Delivery instructions. Instructions, if available, regarding receipt or delivery of securities, and form of payment, if other than as usual and customary between the parties.

        (8) No change.

        (B) Securities identification information. The confirmation shall include a securities identification which includes, at a minimum:

        (1) the name of the issuer, with special requirements for the following securities:

        (a) For stripped coupon securities, the trade name and series designation assigned to the stripped coupon municipal security by the broker, dealer or municipal securities dealer sponsoring the program must be shown;

        (b) Municipal fund securities. For municipal fund securities, the name used by the issuer to identify such securities and, to the extent necessary to differentiate the securities from other municipal fund securities of the issuer, any separate program series, portfolio or fund designation for such securities must be shown;

        (2) No change.

        (3) maturity date, if any, with special requirements for the following securities:

        (a) No change.

        (b) Municipal fund securities. For municipal fund securities, no maturity date shall be shown;

        (4) interest rate, if any, with special requirements for the following securities:

        (a)-(e) No change.

        (f) Municipal fund securities. For municipal fund securities, no interest rate shall be shown;

        (C) Securities descriptive information. The confirmation shall include descriptive information about the securities which includes, at a minimum:

        (1)-(4) No change.

        (5) Municipal fund securities. For municipal fund securities, the information described in clauses (1) through (4) of this subparagraph (C) is not required to be shown; provided, however, that if the municipal fund securities are puttable or otherwise redeemable by the customer, the confirmation shall include a designation to that effect.

        (D) Disclosure statements:

        (1)-(2) No change.

        (3) The confirmation for securities for which a deferred commission or other charge is imposed upon redemption or as a condition for payment of principal or interest thereon shall include a statement that the customer may be required to make a payment of such deferred commission or other charge upon redemption of such securities or as a condition for payment of principal or interest thereon, as appropriate, and that information concerning such deferred commission or other charge will be furnished upon written request.

        (ii)-(iii) No change.

        (iv) Confirmation to customers who tender put option bonds or municipal fund securities. A broker, dealer, or municipal securities dealer that has an interest in put option bonds (including acting as remarketing agent) and accepts for tender put option bonds from a customer, or that has an interest in municipal fund securities (including acting as agent for the issuer thereof) and accepts for redemption municipal fund securities tendered by a customer, is engaging in a transaction in such municipal securities and shall send a confirmation under paragraph (i) of this section.

        (v) No change.

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

        (A)-(F) No change.

        (G) The term "periodic municipal fund security plan" shall mean any written authorization or arrangement for a broker, dealer or municipal securities dealer, acting as agent, to purchase, sell or redeem for a customer or group of customers one or more specific municipal fund securities, in specific amounts (calculated in security units or dollars), at specific time intervals and setting forth the commissions or charges to be paid by the customer in connection therewith (or the manner of calculating them).

        (H) The term "non-periodic municipal fund security program" shall mean any written authorization or arrangement for a broker, dealer or municipal securities dealer, acting as agent, to purchase, sell or redeem for a customer or group of customers one or more specific municipal fund securities, setting forth the commissions or charges to be paid by the customer in connection therewith (or the manner of calculating them) and either (1) providing for the purchase, sale or redemption of such municipal fund securities at the direction of the customer or customers or (2) providing for the purchase, sale or redemption of such municipal fund securities at the direction of the customer or customers as well as authorizing the purchase, sale or redemption of such municipal fund securities in specific amounts (calculated in security units or dollars) at specific time intervals.

        (vii) Price substituted for par value of municipal fund securities. For purposes of this rule, each reference to the term "par value," when applied to a municipal fund security, shall be substituted with (i) in the case of a purchase of a municipal fund security by a customer, the purchase price paid by the customer, exclusive of any commission, and (ii) in the case of a sale or tender for redemption of a municipal fund security by a customer, the sale price or redemption amount paid to the customer, exclusive of any commission or other charge imposed upon redemption or sale.

        (viii) Alternative periodic reporting for certain transactions in municipal fund securities. Notwithstanding any other provision of this section (a), a broker, dealer or municipal securities dealer may effect transactions in municipal fund securities with customers without giving or sending to such customer the written confirmation required by paragraph (i) of this section (a) at or before completion of each such transaction if:

        (A) such transactions are effected pursuant to a periodic municipal fund security plan or a non-periodic municipal fund security program; and

        (B) such broker, dealer or municipal securities dealer gives or sends to such customer within five business days after the end of each quarterly period, in the case of a customer participating in a periodic municipal fund security plan, or each monthly period, in the case of a customer participating in a non-periodic municipal fund security program, a written statement disclosing, for each purchase, sale or redemption effected for or with, and each payment of investment earnings credited to or reinvested for, the account of such customer during the reporting period, the information required to be disclosed to customers pursuant to subparagraphs (A) through (D) of paragraph (i) of this section (a), with the information regarding each transaction clearly segregated; provided that it is permissible for the name and address of the broker, dealer or municipal securities dealer and the customer to appear once at the beginning of the document; and

        (C) in the case of a periodic municipal fund security plan that consists of an arrangement involving a group of two or more customers and contemplating periodic purchases of municipal fund securities by each customer through a person designated by the group, such broker, dealer or municipal securities dealer:

        (1) gives or sends to the designated person, at or before the completion of the transaction for the purchase of such municipal fund securities, a written notification of the receipt of the total amount paid by the group;

        (2) sends to anyone in the group who was a customer in the prior quarter and on whose behalf payment has not been received in the current quarter a quarterly written statement reflecting that a payment was not received on such customer's behalf; and

        (3) advises each customer in the group if a payment is not received from the designated person on behalf of the group within 10 days of a date certain specified in the arrangement for delivery of that payment by the designated person and either (a) thereafter sends to each customer the written confirmation described in paragraph (i) of this section (a) for the next three succeeding payments, or (b) includes in the quarterly statement referred to in subparagraph (B) of this paragraph (viii) each date certain specified in the arrangement for delivery of a payment by the designated person and each date on which a payment received from the designated person is applied to the purchase of municipal fund securities;

        (D) such customer is provided with prior notification in writing disclosing the intention to send the written information referred to in subparagraph (B) of this paragraph (viii) on a periodic basis in lieu of an immediate confirmation for each transaction; and

        (E) such customer has consented in writing to receipt of the written information referred to in subparagraph (B) of this paragraph (viii) on a periodic basis in lieu of an immediate confirmation for each transaction; provided, however, that such customer consent shall not be required if (1) the customer participates in a periodic municipal fund security plan described in subparagraph (C) of this paragraph (viii), (2) the customer is not a natural person and participates in a non-periodic municipal fund security program or (3) the customer is a natural person that participates in a non-periodic municipal fund security program and the issuer has consented in writing to the use by the broker, dealer or municipal securities dealer of the periodic written information referred to in subparagraph (B) of this paragraph (viii) in lieu of an immediate confirmation for each transaction with each customer participating in the non-periodic municipal fund security program.

(b)-(e) No change.
 

Rule G-26. Customer Account Transfers

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

        (i)-(ii) No change.

        (iii) The term "nontransferable asset" means an asset that is incapable of being transferred from the carrying party to the receiving party because (A) it is an issue in default for which the carrying party does not possess the proper denominations to effect delivery and no transfer agent is available to re-register the securities, or (B) it is a municipal fund security which the issuer requires to be held in an account carried by one or more specified brokers, dealers or municipal securities dealers that does not include the receiving party.

(b) No change.

(c) Transfer Instructions.

        (i) No change.

        (ii) If an account includes any nontransferable assets, the carrying party must request, in writing and prior to or at the time of validation of the transfer instruction, further instructions from the customer with respect to the disposition of such assets. Such request shall provide the customer with the following alternative methods of disposition of nontransferable assets, if applicable:

        (A) No change.

        (B) retention by the carrying party for the customer's benefit; or

        (C) in the case of a nontransferable asset described in section (a)(iii)(B), transfer to another broker, dealer or municipal securities dealer, if any, which the issuer has specified as being permitted to carry such asset.

(d)-(i) No change.
 

Rule G-32. Disclosures in Connection with New Issues

(a) Customer Disclosure Requirements. No broker, dealer or municipal securities dealer shall sell, whether as principal or agent, any new issue municipal securities to a customer unless such broker, dealer or municipal securities dealer delivers to the customer no later than the settlement of the transaction:

        (i) a copy of the official statement in final form prepared by or on behalf of the issuer or, if an official statement in final form is not being prepared by or on behalf of the issuer, a written notice to that effect together with a copy of an official statement in preliminary form, if any; provided, however, that:

        (A) if a customer who participates in a periodic municipal fund security plan has previously received a copy of the official statement in final form in connection with the purchase of municipal fund securities under such plan, a broker, dealer or municipal securities dealer may sell additional shares or units of the municipal fund securities under such plan to the customer if such broker, dealer or municipal securities dealer sends to the customer a copy of any new, supplemented, amended or "stickered" official statement in final form, by first class mail or other equally prompt means, promptly upon receipt thereof; or

        (B) if an official statement in final form is being prepared for new issue municipal securities issued in a primary offering that qualifies for the exemption set forth in paragraph (iii) of section (d)(1) of Securities Exchange Act Rule 15c2-12, a broker, dealer or municipal securities dealer may sell such new issue municipal securities to a customer if such broker, dealer or municipal securities dealer:

        (A)-(B) Renumbered as (1)-(2).

        (ii) in connection with a negotiated sale of new issue municipal securities, the following information concerning the underwriting arrangements:

        (A) the underwriting spread, if any;

        (B) the amount of any fee received by the broker, dealer or municipal securities dealer as agent for the issuer in the distribution of the securities; provided, however, that if a broker, dealer or municipal securities dealer selling municipal fund securities provides periodic statements to the customer pursuant to rule G-15(a)(viii) in lieu of individual transaction confirmations, this paragraph (ii)(B) shall be deemed to be satisfied if the broker, dealer or municipal securities dealer provides this information to the customer at least annually and provides information regarding any change in such fee on or prior to the sending of the next succeeding periodic statement to the customer; and

        (C) except with respect to an issue of municipal fund securities, the initial offering price for each maturity in the issue that is offered or to be offered in whole or in part by the underwriters, including maturities that are not reoffered.

(b) Inter-Dealer Disclosure Requirements. Every broker, dealer or municipal securities dealer shall send, upon request, the documents and information referred to in this section (a) to any broker, dealer or municipal securities dealer to which it sells new issue municipal securities no later than the business day following the request or, if an official statement in final form is being prepared but has not been received from the issuer or its agent, no later than the business day following such receipt. Such items shall be sent by first call mail or other equally prompt means, unless the purchasing broker, dealer or municipal securities dealer arranges some other method of delivery and pays or agrees to pay for such delivery.

(b)-(c) Relettered as (c)-(d).
 

Rule G-34. CUSIP Numbers and New Issue Requirements

(a)-(b) No change.

(c) CUSIP Number Eligibility Exemptions. The provisions of this rule shall not apply to an issue of municipal securities (or for the purpose of section (b) any part of an outstanding maturity of an issue) which (i) does not meet the eligibility criteria for CUSIP number assignment or (ii) consists entirely of municipal fund securities.

ENDNOTES

1. See "Municipal Fund Securities," MSRB Reports, Vol. 19, No. 2 (April 1999) at 9.

2. The Board understands that local government pools are established by state or local governmental entities as trusts that serve as vehicles for the pooled investment of public moneys of participating governmental entities. Participants purchase interests in the trust and trust assets are invested in a manner consistent with the trust's stated investment objectives. Investors generally do not have a right to control investment of trust assets. See generally National Association of State Treasurers ("NAST"), Special Report: Local Government Investment Pools (July 1995) (the "NAST Report"); Standard & Poor's Fund Services, Local Government Investment Pools (May 1999) (the "S&P Report").

3. The Board understands that higher education trusts generally are 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. Individuals purchase interests in the trust and trust assets are invested in a manner consistent with the trust's stated investment objectives. Investors do not have a right to control investment of trust assets. See generally College Savings Plans Network, Special Report on State and College Savings Plans (1998) (the "CSPN Report").

4. Letter dated February 26, 1999 from Catherine McGuire, Chief Counsel, Division of Market Regulation, SEC, to Diane G. Klinke, General Counsel of the Board, in response to letter dated June 2, 1998 from Diane G. Klinke to Catherine McGuire, published as Municipal Securities Rulemaking Board, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 032299033 (Feb. 26, 1999) (the "SEC Letter").

5. Dealers also should consider the applicability of Exchange Act Rule 15c2-12. SEC staff has stated:

[W]e note that Rule 15c2-12(f)(7) under the Exchange Act defines a "primary offering" as including an offering of municipal securities directly or indirectly by or on behalf of an issuer of such securities. Based upon an analysis of programs that have been brought to our attention, it appears that interests in local government pools or higher education trusts generally are offered only by direct purchase from the issuer. Accordingly, we would view those interests as having been sold in a "primary offering" as that term is defined in Rule 15c2-12. If a dealer is acting as an "underwriter" (as defined in Rule 15c2-12(f)(8)) in connection with that primary offering, the dealer may be subject to the requirements of Rule 15c2-12.

SEC Letter, supra note 4. Questions on Rule 15c2-12 should be directed to SEC staff.

6. See "Transactions in Municipal Collateralized Mortgage Obligations: Rule G-15," MSRB Reports, Vol. 12, No. 1 (April 1992) at 21; "Stripped Coupon Municipal Securities," MSRB Reports, Vol. 9, No. 1 (March 1989) at 3; "Taxable Securities," MSRB Reports, Vol. 6, No. 5 (Oct. 1986) at 5; "Tender Option Programs: SEC Response to Board Letter," MSRB Reports, Vol. 5, No. 2 (Feb. 1985) at 3; "Tax-Exempt Notes: Notice Concerning Application of Board Rules to Such Notes and of Filing of Rule Change," MSRB Reports, Vol. 2, No. 7 (Oct./Nov. 1982) at 17; "Application of Board's Rules to Municipal Commercial Paper," MSRB Reports, Vol. 2, No. 1 (Jan. 1982) at 9 (the "CP Notice"); "Application of Board's Rules to Participation Interests in Municipal Tax-Exempt Financing Arrangements," MSRB Reports, Vol. 2, No. 1 (Jan. 1982) at 13; "Notice Concerning Application of Board's Rules to MAC Warrants," [1977-1987 Transfer Binder] MSRB Manual (CCH) � 10,171 (Jan. 22, 1981) (the "Warrant Notice").

7. Section 2(b) provides that the Investment Company Act shall not apply to a state, or any political subdivision of a state, or any agency, authority, or instrumentality thereof.

8. As noted in the March Notice, the definition of municipal fund security is not limited to local government pool or higher education trust interests that are municipal securities but also would apply to any municipal security of an issuer that, but for the identity of the issuer as a state or local governmental entity, would constitute an investment company under the Investment Company Act.

9. Municipal fund securities generally provide investment return and are valued based on the investment performance of an underlying pool of assets having an aggregate value that may increase or decrease from day to day, rather than providing interest payments at a stated rate or discount, as is the case for more traditional municipal securities. In addition, unlike traditional municipal securities, these interests do not have stated par values or maturity dates and cannot be priced based on yield or dollar price. See generally NAST Report, supra note 2; S&P Report, supra note 2; CSPN Report, supra note 3.

10. A commentator states that, although the Board has no authority to regulate either local government pool or higher education trust interests, it believes that interested parties would not resist "appropriate regulation" of higher education trust interests. It states that regulation of transactions in such interests is "arguably both more important and less controversial" than regulation of local government pool interests, noting that higher education trust interests "clearly affect public investors and the public interest."

11. Commentators observe that municipal securities are defined in Section 3(a)(29) of the Exchange Act as "securities which are direct obligations of, or obligations guaranteed as to principal or interest by, a State or any political subdivision thereof," in contrast to the language used in Section 3(a)(2) of the Securities Act of 1933 regarding any "security issued or guaranteed ... by any State of the United States, or by any political subdivision of a State or Territory." They quote a Senate report statement on the Securities Acts Amendments that "'municipal securities' refers to debt obligations of state and local government issuers." Senate Comm. on Banking, Housing and Urban Affairs, Securities Acts Amendments of 1975, S.Rep. No. 75, 94th Cong., 1st Sess. 38 (1975) (the "1975 Senate Report"); but cf. Securities Acts Amendments of 1975, H.R. Conf. Rep. No. 229, 94th Cong., 1st Sess. 101 (1975) (the "1975 Conference Report") (amendments "provide a comprehensive pattern for the registration and regulation of securities firms and banks which underwrite and trade securities issued by States and municipalities") (emphasis added). They note references in SEC no-action letters to obligations under the Internal Revenue Code to support their position that municipal securities are limited to debt obligations. See Itel Corp., SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 100581018 (Oct. 1, 1981) (the "Itel Letter"); Bedford-Watt Enterprises, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 062678019 (June 9, 1978) (the "Bedford-Watt Letter"). In addition, an SEC no-action letter is cited to suggest that an equity security may not be a municipal security. See City Employees' Retirement System of the City of Los Angeles, SEC No-Action Letter, [1977-1978 Dec.] Fed. Sec. L. Rep. (CCH) � 81,194 (May 12, 1977) (the "CERS Letter").

12. Thus, non-dealer firms may act as investment advisers to local government pool or higher education trust programs and not become subject to Board rules.

13. SEC Letter, supra note 4.

14. See, e.g., Maine College Savings Program Fund, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 080999001 (Aug. 2, 1999) (the "Maine Letter");Teachers Personal Investors Services, Inc., SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 092898006 (Sept. 10, 1998) (the "TPIS Letter"); New Hampshire Higher Education Savings Plan Trust, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 070698010 (June 30, 1998) (the "New Hampshire Letter"); Public Employees Retirement Board of the State of Oregon, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 041398009 (March 3, 1998) (the "Oregon Letter"); North Carolina State Education Assistance Authority, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 032497016 (March 24, 1997) (the "North Carolina Letter"); Missouri Family Trust Fund, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 101392001 (Sept. 22, 1992) (the "Missouri Letter").

15. Maine Letter, supra note 14. SEC staff's position was conditioned on the dealer complying with all existing Board rules, other than those proposed to be amended in the March Notice, and complying with all Board rules upon completion of the current Board rulemaking process. Counsel had opined that the interests were direct obligations of an instrumentality of a state and therefore were municipal securities within the meaning of Section 3(a)(29) of the Exchange Act. See id. and accompanying letter of inquiry.

16. TPIS Letter, supra note 14. SEC staff stated that this no-action position expires six months after rule G-3 is amended to establish qualification requirements for persons selling such interests.

17. Id. Counsel had opined that the interests were direct obligations of an instrumentality of a state and, therefore, were municipal securities under the Exchange Act. See id. and accompanying letter of inquiry. See also New York State College Choice Tuition Savings Trust, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 091498008 (Sept. 10, 1998) and accompanying letter of inquiry.

18. See, e.g., Maine Letter, supra note 14; New Hampshire Letter, supra note 14; North Carolina Letter, supra note 14.

19. See Maine Letter, supra note 14, and accompanying letter of inquiry; New Hampshire Letter, supra note 14, and accompanying letter of inquiry; North Carolina Letter, supra note 14, and accompanying letter of inquiry. See also Missouri Letter, supra note 14, and accompanying letter of inquiry.

20. See Oregon Letter, supra note 14. Counsel opined that the interests would be exempt from the registration requirements of the Exchange Act as securities issued by a state instrumentality. See id. and accompanying letter of inquiry. See also Pennsylvania Local Government Investment Trust, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 022283009 (Feb. 21, 1983) (the "Pennsylvania Letter") and accompanying letter of inquiry, in which counsel opined that interests in a local government pool were municipal securities under the Exchange Act that qualified for the exemption from the registration requirements of Section 12(g) of the Exchange Act. SEC staff did not expressly rely on this opinion in arriving at its no-action position.

21. See, e.g., City of El Paso de Robles, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 111285020 (June 18, 1985) (the "El Paso de Robles Letter"); MAC Warrant Notice, supra note 6. The SEC's position with respect to these two types of non-debt securities stands in contrast to SEC staff's earlier position regarding call options in the CERS Letter, supra note 11.

22. See El Paso de Robles Letter, supra note 21.

23. MAC Warrant Notice, supra note 6. The MAC Warrant Notice was cited with approval by SEC staff in a letter to the Office of the Comptroller of the Currency. See letter dated August 12, 1981 (note 7) from Thomas G. Lovett, Attorney, SEC, to Owen Carney, Director, Investment Securities Division, Office of the Comptroller of the Currency (the "CP Letter"), reprinted in CP Notice, supra note 6, at 11.

24. See Itel Letter, supra note 11 (term "obligation" in Exchange Act definition of municipal security "would generally include" obligations under the Internal Revenue Code); Bedford-Watt Letter, supra note 11 (Internal Revenue Code "provides a useful analogy"). In the Bedford-Watt Letter, SEC staff recognized that "obligation" under Section 3(a)(29) of the Exchange Act could include non-financial obligations to take actions needed for payment of the security. See also Pennsylvania Letter and accompanying letter of inquiry, supra note 20. In arriving at its opinion that the local government pool interests described in the Pennsylvania Letter were municipal securities, counsel suggested, in reference to the definition of municipal securities in the Exchange Act, "that the word 'obligations' need not be read as 'debt' in this context. The Trust is under obligation to redeem all Shares of Beneficial Interest presented for redemption." In addition, the Chairman of the College Savings Plans Network noted in Congressional testimony that "state-sponsored college tuition programs are secured by the moral or political obligation of the states." Marshall Bennett, Testimony Before the House Committee on Ways and Means, Hearing on Reducing the Tax Burden: II. Providing Tax Relief to Strengthen the Family and Sustain a Strong Economy, 106th Cong., 1st Sess. (June 23, 1999), available at <http://www.house.gov/ways_means/fullcomm/106cong/6-23-99/6-23benn.htm> (visited Aug. 26, 1999) (emphasis added).

25. See El Paso de Robles Letter, supra note 21; MAC Warrant Notice, supra note 6.

26. See 1975 Senate Report, supra note 11, at 90, 92.

27. Id. at 92.

28. See, e.g., House Comm. on Interstate and Foreign Commerce, Federal Supervision of Traffic in Investment Securities in Interstate Commerce, H.R.Rep. No. 85, 73d Cong., 1st Sess. 6, 14 (1933) (the "1933 House Report").

29. Id. at 14. This view was confirmed the following year during House committee hearings on the Exchange Act by the Commissioner of the Federal Trade Commission, which was charged with enforcing the Securities Act. See Stock Exchange Regulation: Hearing on H.R. 7852 and H.R. 8720 Before the House Comm. on Interstate and Foreign Commerce, 73d Cong., 2d Sess. 899 (1934) (the "1934 House Hearings") (statement of James M. Landis, Commissioner, Federal Trade Commission). Commissioner Landis stated:

We had that same problem up in the Securities Act, where the exemption that is given to what might be called municipal bonds, and bonds of States and their instrumentalities, and is drawn according to a line that parallels the line that is drawn which makes tax-exempt municipal bonds, State instrumentalities, and so on. In other words, every instrumentality of a State which, like a municipality, or a political subdivision of a State, was exempted from taxation, would be exempted from registration upon an issue of securities. That is the line drawn in the Securities Act. If exempt from taxation they are also exempted from the necessity of registration under that act.

30. See, e.g., Securities Act: Hearings on S. 875 Before the Senate Comm. on Banking and Currency on S. 875, 73d Cong., 1st. Sess. 65 (1933) (the "1933 Senate Hearings") (statement of Sen. Reynolds); id. at 228, 232 (statement of Sen. Kean); id. at 232 (statement of Sen. Costigan); id. at 303 (statement of Sen. Norbeck); 77 Cong. Rec. 2925 (1933) (statement of Rep. Studley).

31. See 1934 House Hearings, supra note 29, at 822 (statement of Rep. Pettingill); id. at 898-9 (statements of James M. Landis, Commissioner, Federal Trade Commission; Rep. Pettingill). This concern also served as a primary basis for the exemption of municipal securities under the Securities Act. See 1933 House Report, supra note 28, at 14, and text accompanying note 29 above.

32. See 1934 House Hearings, supra note 29, at 721, 911-3 (statement of Rep. Holmes); Stock Exchange Practices: Hearings on S. Res. 84 and S. Res. 56 and S. Res. 97 Before the Senate Comm. on Banking and Currency, 73d Cong., 1st Sess. 7441-52 (1934) (the "1934 Senate Hearings") (statements of Archibald B. Roosevelt, Roosevelt & Weifold, Inc.; George B. Gibbons, George B. Gibbons & Co.; Sen. Gore; Sen. Goldsborough).

33. See 1934 House Hearings, supra note 29, at 720 (statement of Rep. Holmes).

34. See 1934 Senate Hearings, supra note 32, at 7413 (statements of H.H. Cotton, Investment Bank of Los Angeles; Ferdinand Pecora, Counsel to the Committee; Sen. Fletcher); id. at 7477 (statements of Tom K. Smith, Assistant to the Secretary of the Treasury; Sen. Adams; Sen. Walcott); 1934 House Hearings, supra note 29, at 7201(statements of Tom K. Smith, Assistant to the Secretary of the Treasury; Rep. Holmes); id. at 819-23 (statements of George B. Gibbons, George B. Gibbons & Co.; Rep. Merritt; Rep. Rayburn; Rep. Pettengill).

35. See note 29 above and accompanying text.

36. The phrase "security issued or guaranteed by" used in Section 3(a)(2) of the Securities Act introduces bank securities (including bank equity securities) as well as government and municipal securities. In contrast, the phrase "securities which are direct obligations of or obligations guaranteed as to principal or interest by" used in Section 3(a)(12) of the Exchange Act introduced only municipal and government securities. Thus, even though the drafters of both the Securities Act and the Exchange Act thought of municipal and government securities solely as debt securities, the term "obligation" (to the extent such term is limited to debt securities) could only be used in the Exchange Act.

37. 1975 Senate Report, supra note 11, at 47. See also CP Letter (note 7), supra note 23.

38. In testimony at a 1975 Senate committee hearing on the Securities Acts Amendments, a representative of the Municipal Finance Officers Association stated that the municipal securities market "is completely a debt market." Securities Acts Amendments of 1975: Hearings on S. 249 Before the Senate Comm. on Banking, Housing and Urban Affairs, 94th Cong., 1st Sess. 479 (1975) (statement of Michael S. Zarin, Member, Comm. on Governmental Debt Administration, Municipal Finance Officers Association). Having been so informed, the Senate's description in the 1975 Senate Report, supra note 11, at 38, of municipal securities as "debt obligations of state and local government issuers," as noted by some commentators on the March Notice, in fact merely reflected an understanding of the nature of the municipal securities market at such time, not an understanding that the Exchange Act definition of municipal securities was to be limited only to the debt segment of a broader municipal market that might also include equity securities.

39. As noted above, one commentator concedes that interests in higher education trusts "clearly affect public investors and the public interest."

40. Commentators list Congressional concern about unconscionable markups, churning of accounts, misrepresentations, disregard of suitability standards, high-pressure sales techniques, fraudulent trading practices resulting in substantial losses to public investors, and threats to the integrity of the local government capital-raising system. They argue that there is no opportunity for unconscionable markups and little incentive for churning of accounts or use of high-pressure sales techniques for these interests because they are purchased and redeemed at the current net asset value and purchasers do not pay commissions. Commentators also argue that suitability concerns are not raised since local government pools are operated like money market funds and invest solely in the types of investments that their participants are permitted by state law to purchase.

41. One commentator states that protections exist under the Investment Advisers Act of 1940, state regulations, voluntary adherence to the Investment Company Act and related federal regulations applicable to investment company securities, and Governmental Accounting Standards Board Statement No. 31 relating to accounting and financial reporting for certain investments and for external investment pools.

42. See 1975 Conference Report, supra note 11, at 101.

43. As originally proposed, rule D-9 would have excluded from the definition of customer "the issuer of securities which are the subject of the transaction in question." See "Notice of Filing of Fair Practice Rules," [1977-1987 Transfer Binder] MSRB Manual (CCH) � 10,030 (Sept. 20, 1977). In amending the original proposed rule language to limit this exclusion solely to "the issuer in connection with the sale of a new issue of its securities," the Board stated that it believed "that the protections afforded customers by its rules should be extended to issuers when they act in secondary market transactions." See "Notice of Filing of Amendments to Fair Practice Rules," [1977-1987 Transfer Binder] MSRB Manual (CCH) � 10,058 (Feb. 28, 1978). Given that the Board has always felt that issuers should be considered customers even in secondary market transactions involving their own securities, issuers certainly should be considered customers in transactions involving securities of other issuers. Furthermore, in Congressional testimony on the bankruptcy filing of Orange County, California and its local government pool, SEC Chairman Arthur Levitt discussed customer protection rules of self-regulatory organizations as they may apply to state or local governmental entities acting as customers. See Derivative Financial Instruments Relating to Banks and Financial Institutions: Hearings Before the Senate Comm. on Banking, Housing and Urban Affairs, 104th Cong., 1st Sess. (1995) ("SEC Testimony").

44. S&P Report, supra note 2, at 3, 6-11. The Board takes no position as to which of these local government pools may issue interests that would constitute municipal fund securities.

45. Id. at 3.

46. One commentator identifies several state-run and county-run pools (including the Orange County, California pool) as having had recent financial difficulties. See also NAST Report, supra note 2, at 2, 5, 38; S&P Report, supra note 2, at 5.

47. NAST has stated that it:

recognizes that potential pool participants have numerous alternative investment vehicles from which to choose. The goal of the … [NAST Guidelines for Local Government Investment Pools] is to insure that local government investment officials, when choosing among their available investment options, are fully aware of significant investment and administrative policies, practices and restrictions of the pool and are thereby able to make informed investment decisions on behalf of the local governments. … NAST further recommends that the broker/dealer community govern itself to follow the same standards of conduct NAST has recommended for treasurers.

NAST Report, supra note 2, at 8. As the self-regulatory organization established by Congress to adopt rules for dealer transactions in municipal securities, the Board has created a body of rules which, together with these proposed rule changes, constitute the self-governance and standards of conduct which NAST has recommended be established.

48. The Board understands that investment strategies, pay-out restrictions, and fees and redemption charges or penalties of the existing higher education trusts vary. At least some higher education trusts permit sales of interests to persons living in other states and permit redemption proceeds to be used to pay higher education expenses in any state. In other cases, redemption proceeds may be limited for use within a specific state. See generally CSPN Report, supra note 3. Thus, a single customer may have a choice of investments in various higher education trusts having widely differing investment strategies and terms. The Board takes no position as to which of these higher education trusts may issue interests that would constitute municipal fund securities.

49. See NAST Report, supra note 2, at 8 ("The investment alternatives offered by brokers/dealers to public finance officials should be suitable for the public entity's objectives."). The fact that a local government pool's assets are invested in investments that are legally available as direct investments by local governments does not resolve suitability issues. See note 39 above. As with transactions in any other municipal security, rule G-19 would require a dealer recommending a transaction in a municipal fund security to have reasonable grounds for believing that the recommendation is suitable, based upon information available from the issuer or otherwise and the facts disclosed by or otherwise known about the customer. These suitability requirements do not differ in substance from those of the NASD, to which dealers effecting transactions in such interests might otherwise be subject if these interests are not municipal securities. See also SEC Testimony, supra note 43.

50. See, e.g., Sections 15(b)(3) and 15B(a)(3) of the Exchange Act.

51. Actual interpretations relating to how certain rules would be applied to transactions in municipal fund securities would be filed with the SEC to the extent required under Section 19(b) of the Exchange Act and Exchange Act Rule 19b-4.

52. This view regarding sales of municipal fund securities as part of a primary offering is based on SEC staff's statement in the SEC Letter, supra note 4, that it would view such securities as having been sold in a primary offering for purposes of Rule 15c2-12.

53. Two commentators suggest that the Board exempt municipal fund securities from the prohibition in rule A-13(e) from passing through underwriting assessments to issuers.

54. Commentators note that many local government pools have annual share turn-over rates of 3 to 4 times their assets, due to the fact that many participants are investing short-term funds that move in and out of the pools frequently during the course of the year. Another commentator believes that this multiplier may reach as high as 10 times assets. One commentator estimates that total issuances of interests in local government pools may be on the same order of magnitude as issuances of traditional municipal securities.

55. In the alternative, some commentators suggest that underwriting assessments should be based on net issuances of municipal fund securities, taking into account all securities retired. Another commentator suggests a flat annual or monthly fee set at a modest level.

56. Two commentators suggest that local government pool interests be excluded from this definition. The Board declines to do so for the reasons noted above.

57. Thus, an associated person who sells both municipal fund securities and other types of municipal securities would be required to qualify as a municipal securities representative or general securities representative.

58. One commentator suggests exempting dealers in local government pool interests from the requirement of having municipal securities principals, provided that they meet the requirements regarding principals established by the NASD. The Board believes that dealers effecting transactions in municipal fund securities must have a municipal securities principal who is required to be familiar with Board rules.

59. Several factors influenced the Board's determination to exempt such securities from rule G-14, as set forth in the March Notice. If the Board receives information in the future that practices have developed in the municipal fund security market that merit reporting of transaction information, it will consider whether to revisit the exemption from rule G-14.

60. Disclosure of deferred commissions or other charges would cover, for example, any deferred sales load or, in the case of interests in certain higher education trusts, any penalty imposed on a redemption that is not for a qualifying higher education expense.

61. In addition to the comments described below, one commentator suggests that the draft amendment relating to disclosure of deferred commissions or redemption charges be clarified to indicate that information may be disclosed in a program description document together with the confirmation or periodic statement. The Board believes that this provision does not require revision since it already permits disclosure of such information in a document separate from the confirmation or periodic statement, although the confirmation or periodic statement must disclose that such deferred commission or charge may exist and that information will be furnished upon written request.

62. They note that individual confirmations for the frequent purchases and redemptions of local government pool interests would impose high administrative and cost burdens.

63. It states that this would be "analogous to and consistent with" the provisions of Rule 10b-10 permitting periodic statements in lieu of confirmations for non-periodic transactions in tax-qualified individual retirement and individual pension plans.

64. In addition, the Board has made a minor language change to paragraph (a)(vi)(G) to make clearer that quarterly statements in lieu of individual confirmations also would be available for arrangements involving a group of two or more customers.

65. A commentator states that requiring customer consent to receive quarterly statements would impose administrative burdens on dealers that are not justified by any investor protection interest. It notes practical difficulties with sending confirmations to some members of a group plan and quarterly statements to others, stating that if the dealer fails to receive consent from any customer, it might be forced to send individual confirmations to all customers. The commentator states that, in adopting the investment company plan exception to the confirmation requirements in Rule 10b-10, the SEC recognized that securities sold through such plans do not require the same level of reporting as other securities transactions since their regularized nature raised fewer concerns about whether a particular transaction was executed consistent with the expectations of the customer.

66. A commentator states that municipal fund securities will not be issued in certificated form and therefore the delivery provisions under subparagraph (a)(i)(A)(7) would not be relevant. Subparagraph (a)(i)(A)(7) would require that the confirmation for a municipal fund security transaction indicate the purchase price (exclusive of commission) of each share or unit and the number of shares or units to be delivered, regardless of whether a physical or book-entry delivery of the securities will occur.

67. The commentator states that such securities are ineligible for ratings and such notation might be misleading. However, the Board notes that a relatively small number of local government pools have in fact been rated. See NAST Report, supra note 2, at 36. See generally S&P Report, supra note 2.

68. The Board understands that, in the context of local government pools, the term "yield" may be used to refer to historical returns that may be used as a basis for comparing investment performance. See NAST Report, supra note 2, at 8. References in rule G-21 to yield, consistent with its use in other Board rules, refer to a future rate of return on securities and do not refer to historical yields. The Board notes that any use of historical yields would be subject to section (c) of rule G-21, which provides that no dealer shall publish or cause to be published any advertisement concerning municipal securities which such dealer knows or has reason to know is materially false or misleading. 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.

69. Rule G-32 defines underwriting period for securities purchased by a dealer (not in a syndicate) as the period commencing with the first submission to the dealer of an order for the purchase of the securities or the purchase of the securities from the issuer, whichever first occurs, and ending at such time as the following two conditions both are met: (1) the issuer delivers the securities to the dealer, and (2) the dealer no longer retains an unsold balance of the securities purchased from the issuer or 21 calendar days elapse after the date of the first submission of an order for the securities, whichever first occurs. However, since the issuer continuously delivers municipal fund securities, the first condition for the termination of the underwriting period remains unmet.

70. In addition, in the case of a repeat purchaser of municipal fund securities for which no official statement in final form is being prepared, no new delivery of the written notice to that effect or of any official statement in preliminary form would be required so long as the customer has previously received it in connection with a prior purchase. However, if an official statement in final form is subsequently prepared, the customer's next purchase would trigger the delivery requirement with respect to such official statement.

71. Dealers may still elect to acquire CUSIP numbers for municipal fund securities and to make such securities depository eligible, subject to meeting all of the eligibility requirements of the CUSIP Service Bureau and of any securities depository, respectively.

72. If the primary offering is exempt from Rule 15c2-12 (other than as a result of being a limited offering as described in section (d)(1)(i) of the Rule) and an official statement has been prepared by the issuer, then the dealer would be expected to send the official statement, together with Form G-36(OS), to the Board under rule G-36(c)(i).

73. Rule G-36(d) provides that a dealer that has previously sent an official statement to the Board also is required to send to the Board any amendments made by the issuer during the underwriting period. In view of the extended underwriting period for municipal fund securities and the possibility that the issuer may change the dealer that participates in the sale of the securities during the life of the program, the Board would interpret this provision of the rule to obligate any dealer that is at the time of an amendment then serving as underwriter for the municipal fund securities to send the amendment to the Board, regardless of whether that dealer or another dealer sent the original official statement to the Board.

74. Underlining indicates additions to existing Board rules; strikethrough indicates deletions from existing Board rules.

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