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.

[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 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 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.

Solicitation of contributions.  This is in response to your letter in which you summarize your understanding of our telephone conversation relating to section (c) of rule G-37, on political contributions and prohibitions on municipal securities business. As I noted during our conversation, the Board’s rules, including rule G-37, apply solely to brokers, dealers and municipal securities dealers (“dealers”). The Board’s rulemaking authority, granted under Section 15B of the Securities Exchange Act of 1934, does not extend to issuers of municipal securities. Thus, rule G-37 does not impose any obligations upon issuers or officials of issuers. Although the Board appreciates your interest in not placing dealers and their associated persons in a position to violate their obligations under the rule, it is ultimately the responsibility of such dealers and associated persons, in consultation with appropriate compliance personnel, to ensure compliance with Board rules.

As you know, rule G-37(c) provides that no dealer or municipal finance professional shall solicit any person or political action committee to make any contribution, or shall coordinate any contributions, to an official of an issuer with which the dealer is engaging or is seeking to engage in municipal securities business. The Board has previously stated that this provision would:

prohibit a dealer and any municipal finance professional from soliciting . . . any other person or entity, to make contributions to an official of an issuer with which the dealer engages or is seeking to engage in municipal securities business or to coordinate (i.e., bundle) contributions. . .[*] [M]unicipal finance professionals may volunteer their personal services in other ways to political campaigns.[1]

You had sought guidance regarding what activities would be covered by this provision of the rule. As you noted in your letter, I had indicated that the term “solicit” is not explicitly defined for purposes of section (c) of the rule. I had stated that whether a particular activity can be characterized as a solicitation of a contribution for purposes of section (c) is dependent upon the facts and circumstances surrounding such activity. I had noted, however, that the rule does not prohibit or restrict municipal finance professionals from engaging in personal volunteer work, unless such work constituted solicitation or bundling of contributions for an official of an issuer with which the municipal finance professional’s dealer is engaging or seeking to engage in municipal securities business[2] Municipal finance professionals are therefore free to, among other things, solicit votes or other assistance for such an issuer official so long as the solicitation does not constitute a solicitation or coordination of contributions for the official. [3]

Whether a municipal finance professional is permitted by section (c) of the rule to indicate to third parties that someone is a “great candidate” or to provide a list of third parties for the candidate to call would be dependent upon all the facts and circumstances surrounding such action. The facts and circumstances that may be relevant for this purpose may include, among any number of other factors, whether the municipal finance professional has made an explicit or implicit reference to campaign contributions in his or her conversations with third parties whom the candidate may contact and whether the candidate contacts such third parties seeking campaign contributions. However, the totality of the facts and circumstances surrounding any particular activity must be considered in determining whether such activity may constitute a solicitation of contributions for purposes of section (c) of the rule. Therefore, the Board cannot prescribe an exhaustive list of precautions that would assure that no violation of this section would occur as a result of such activity.  MSRB interpretation of May 21, 1999.
__________

[1] MSRB Reports, Vol. 14, No. 3 (June 1994) at 5. See Securities Exchange Act Release No. 33868 (April 7, 1994), 59 FR 17621 (April 13, 1994). See also Questions and Answers Concerning Political Contributions and Prohibitions on Municipal Securities Business: Rule G-37, May 24, 1994, reprinted in MSRB Rule Book; MSRB Interpretation of November 7, 1994, reprinted in MSRB Rule Book; MSRB Interpretation of May 31, 1995, reprinted in MSRB Rule Book. Furthermore, the Board stated in its filing of the rule with the Securities and Exchange Commission that the rule’s “anti-solicitation and anti-bundling proscriptions are intended to prohibit covered parties from: (i) soliciting others, including spouses and family members, to make contributions to issuer officials; and (ii) coordinating, or soliciting others to coordinate, contributions to issuer officials in order to influence the awarding of municipal securities business.” SEC File No. SR-MSRB-94-2.

[2] See Question and Answer No. 24, May 24, 1994, reprinted in MSRB Rule Book; Question and Answer No. 3, August 18, 1994, reprinted in MSRB Rule Book. In addition, if the municipal finance professional used dealer resources or incurred expenses that could be considered contributions in the course of undertaking such volunteer work, the ban on municipal securities business under section (b) of the rule could be triggered.

[3] In upholding the constitutionality of rule G-37, the United States Court of Appeals for the District of Columbia Circuit observed that “municipal finance professionals are not in any way restricted from engaging in the vast majority of political activities, including making direct expenditures for the expression of their views, giving speeches, soliciting votes, writing books, or appearing at fundraising events.” Blount v. SEC, 61 F.3d 938, 948 (D.C. Cir. 1995), cert. denied, 116 S. Ct. 1351 (1996). However, the Board has stated that hosting or paying to attend a fundraising event may constitute a contribution subject to section (b) of the rule. See Questions and Answers Nos. 24 and 29, May 24, 1994, reprinted in MSRB Rule Book.

[*][sentence deleted to reflect current rule provisions.]