Proposed Amendments Filed to Pending Amendments at the SEC: Rules G-38, G-37 and G-8

        On August 26, 1999, the Board filed additional amendments to the pending amendments at the Securities and Exchange Commission ("SEC") concerning the disclosure of consultants’ contributions.¹ The pending amendments to rules G-38, on consultants, and G-8, on books and records, and revisions to the attachment page to Form G-37/G-38 would require dealers to obtain from their consultants² information on the consultants’ political contributions to official(s) of an issuer and payments to state and local political parties (hereafter collectively referred to as "contributions") and to require dealers to report such information to the Board on Form G-37/G-38.³ The pending amendments contain a reasonable efforts provision which provides that a dealer will not be found to have violated rule G-38 if the dealer fails to receive from its consultants all required contribution information and thus fails to report such information to the Board if the dealer can demonstrate that it used reasonable efforts in attempting to obtain the necessary information. The proposed amendments, among other things, add two additional requirements to the reasonable efforts provision. The Board has requested that the SEC delay the effective date of the amendments until April 1, 2000.

BACKGROUND

        The Board believes it is reasonable to allow dealers to rely in good faith on information received from their consultants regarding contributions and that it would be almost impossible and unduly burdensome for dealers to investigate for contributions that were not reported by their consultants. As noted above, the pending amendments contain a reasonable efforts provision. This provision states that reasonable efforts include having a dealer: (1) state in the Consultant Agreement⁴ that Board rules require disclosure of consultant contributions, and (2) send quarterly reminders to consultants of the deadline for their submissions to the dealer of contribution information.

        After the Board filed the pending amendments with the SEC, the SEC staff recommended to Board staff that the reasonable efforts provision contain two additional requirements: (1) the dealer must disclose in its quarterly filings any consultant that does not provide a report of the information required by the rule, and (2) the dealer must terminate the contract should the consultant fail to provide such report by the next calendar quarter after it was due, and the dealer must not make any further payments pursuant to the Consultant Agreement. The SEC staff stated that these additional requirements to the reasonable efforts provision should help ensure that all required information on contributions is obtained from consultants.

        On April 19, 1999, the Board published the SEC’s additional requirements so that dealers could be given the opportunity to comment to the Board about the practical implications of the requirements.⁵ The Board has reviewed the comments received on the notice and has determined to adopt the SEC’s additional requirements and file rule language to include these requirements in the amendments pending at the SEC.

SUMMARY OF COMMENTS

        The Board received five comments in response to its request for comments about the draft amendments incorporating the SEC’s additional requirements. Most of the commentators did not limit their comments specifically to the draft amendments, which were the subject of the notice requesting comment. The commentators addressed various aspects of both the draft amendments and those amendments pending approval at the SEC. In general, none of the commentators offered support for the draft amendments.

        There was concern expressed by commentators about terminating the Consultant Agreement for failure by consultants to provide the required information. In addition, commentators were concerned about the prohibition from paying a consultant once the Consultant Agreement has been terminated because the consultant could be owed payment for work performed prior to the date of termination. The Board feels strongly that rule G-38 should require the disclosure of consultants’ contributions and dealers should be able to avail themselves of a reasonable efforts defense if they wish to do so. The provision relating to termination of the Consultant Agreement with a consultant that does not provide the required information is a pre-condition to invoking the reasonable efforts defense. A dealer that does not terminate the Consultant Agreement in these instances does not violate rule G-38, but it does lose its ability to invoke the reasonable efforts defense.

        The Board believes that the issue of a prohibition on further payments to a consultant at the time of termination of the Consultant Agreement can be addressed by dealers including a specific provision in their Consultant Agreements. This provision can indicate that, on the date of termination of the Consultant Agreement by the dealer because of the consultant’s failure to report the required information, no further payments will be provided by the dealer to the consultant, including payments for services performed by the consultant prior to the date of termination. In addition, to address any uncertainty in the rule language about payments for prior services, the proposed amendments filed with the SEC revise rule G-38 to note specifically that the prohibition on further payments at the time of termination of the Consultant Agreement includes payments for services performed prior to the date of termination.

SUMMARY OF PROPOSED AMENDMENTS

        As noted above, the SEC staff recommended that the reasonable efforts provision require that a dealer disclose in its quarterly filings any consultant that does not provide a report of the information required by the rule. The pending amendments require dealers to receive from their consultants reports on any reportable contributions but do not contain a requirement for dealers to receive reports if no such contributions were made. In order to establish a complete record of the information being reported by consultants, the proposed amendments revise the pending amendments to require all dealers using consultants to receive reports every quarter from their consultants listing all reportable contributions or stating that the consultants made no reportable contributions, as appropriate. The dealer would then indicate the contributions reported or that the consultant had no contributions to report, as appropriate, on its Form G-37/G-38 for the applicable quarter. Pursuant to the SEC staff’s recommendation, the proposed amendments also require dealers to disclose if they did not receive a report from a consultant during a particular quarter. Thus, if a consultant does not submit a report to the dealer for a particular quarter, the dealer must report that fact on its Form G-37/G-38. These additional requirements would constitute affirmative obligations on all dealers submitting Forms G-37/G-38 who use consultants, not merely pre-conditions to invoking the reasonable efforts defense.

        The SEC staff’s second suggested requirement for the reasonable efforts provision is that a dealer must terminate the Consultant Agreement should a consultant fail to provide the required information by the next calendar quarter after it was due, and the dealer must not make any further payments to the consultant pursuant to the Consultant Agreement.

        The proposed amendments revise the pending amendments to require dealers that wish to rely on a reasonable efforts defense to include language in their Consultant Agreements to the effect that the Consultant Agreement will be terminated if the consultant fails to provide the dealer a report of the required information within the required time frame and that no further payments will be made to the consultant from the date of termination of the Consultant Agreement if the Consultant Agreement is terminated because the consultant did not provide the required information.

        If, for any calendar quarter, a consultant fails to provide the dealer with a report of its contributions or a report noting that the consultant made no reportable contributions and such failure continues up to the date by which the dealer is required to send Form G-37/G-38 to the Board with respect to the next succeeding calendar quarter, the proposed amendments requires the dealer, if it wishes to rely on the reasonable efforts defense, to terminate the Consultant Agreement by the date the form for such second quarter must be sent to the Board (i.e., January 31, April 30, July 31 or October 31).6 When a Consultant Agreement is terminated by the dealer because of a consultant’s failure to provide reports about its reportable contributions, the proposed amendments require a dealer that wishes to rely on a reasonable efforts defense to note on its Form G-37/G-38 that the Consultant Agreement has been terminated for this reason and the date of termination. The proposed amendments also clarify that dealers that wish to rely on a reasonable efforts defense will not be permitted to make any further payments pursuant to the Consultant Agreement from the date of termination, even if money is owed to the consultant for services already rendered.

        The failure by a dealer to include the termination and non-payment provisions in a Consultant Agreement or to enforce any such provisions that may be contained in the Consultant Agreement would not, in and of itself, constitute a violation of rule G-38. Such failure would instead preclude the dealer from invoking the reasonable efforts provision as a defense against a possible violation for failing to disclose consultant contribution information which the consultant may have withheld from the dealer.

        The proposed amendments also contain a clarifying amendment to rule G-38(b)(i)(B), and a technical amendment to rule G-37(e)(i)(D) to conform to the amendments to rule G-38.

        Finally, as noted above, the Board has requested that the SEC delay the effective date of the amendments until April 1, 2000. This delayed effective date should provide dealers with time to amend their Consultant Agreements to conform to the amendments and to revise their procedures for compliance with rules G-38 and G-8. Dealers should be aware that the amendments pending at the SEC contain a six-month "look-back" provision from the date of communication with an issuer. Thus, if a consultant communicates with an issuer on April 1, 2000, the consultant must disclose to the dealer the reportable contributions made by the consultant to the issuer from October 1, 1999, and the dealer must then disclose these contributions on the Form G-37/G-38 it files for the second quarter of 2000.

August 26, 1999

 

Text of Proposed Amendments Incorporated into Pending Amendments⁷

Rule G-38. Consultants

(a) No additional changes.

(b) Written Agreement

(i) No additional changes.

(A) No additional changes.

(B) if the consultant is not an individual, any partner, director, officer or employee of the consultant who communicates with an issuer to obtain municipal securities business on behalf of the broker, dealer or municipal securities dealer; and

(C) No additional changes.

(ii) The Consultant Agreement shall require that, if applicable, the consultant shall provide to the broker, dealer or municipal securities dealer a report that no reportable political contributions or reportable political party payments were made during a calendar quarter.

(iii) The Consultant Agreement shall require that the consultant provide the reportable political contributions and political party payments for each calendar quarter, or report that no reportable political contributions or political party payments were made for a particular calendar quarter, to the broker, dealer or municipal securities dealer in sufficient time for the broker, dealer or municipal securities dealer to meet its reporting obligations under paragraph (e) of this rule.

(iv) No additional changes.

(c) Information Concerning Political Contributions to Official(s) of an Issuer and Payments to State and Local Political Parties made by Consultants.

(i) A broker, dealer or municipal securities dealer is required to obtain information on its consultant’s reportable political contributions and reportable political party payments beginning with a consultant=s first direct or indirect communication with an issuer on behalf of the broker, dealer or municipal securities dealer to obtain or retain municipal securities business for such broker, dealer or municipal securities dealer. The broker, dealer or municipal securities dealer shall obtain from the consultant the information concerning each reportable political contribution required to be recorded pursuant to rule G-8(a)(xviii)(F) and each reportable political party payment required to be recorded pursuant to rule G-8(a)(xviii)(G) or, if applicable, a report indicating that the consultant made no reportable political contributions and no reportable political party payments required to be recorded pursuant to rule G-8(a)(xviii)(H).

(ii) No additional changes.

(iii) No additional changes.

(A) – (B) No additional changes.

(C) the broker, dealer or municipal securities dealer including in the Consultant Agreement provisions to the effect that:

(1) the Consultant Agreement will be terminated by the broker, dealer or municipal securities dealer if, for any calendar quarter, the consultant fails to provide the broker, dealer or municipal securities dealer with information about its reportable political contributions or reportable political party payments, or a report noting that the consultant made no reportable political contributions or no reportable political party payments, and such failure continues up to the date to be determined by the dealer, but no later than the date by which the broker, dealer or municipal securities dealer is required to send Form G-37/G-38 to the Board with respect to the next succeeding calendar quarter, such termination to be effective upon the date the broker, dealer or municipal securities dealer must send its Form G-37/G-38 to the Board (i.e., January 31, April 30, July 31 or October 31); and

(2) no further payments, including payments owed for services performed prior to the date of termination, shall be made to the consultant by or on behalf of the broker, dealer or municipal securities dealer as of the date of such termination; and

(D) the broker, dealer or municipal securities dealer enforcing the Consultant Agreement provisions described in paragraph (c)(iii)(C) of this rule in a full and timely manner and indicating the reason for and date of the termination on its Form G-37/G-38 for the applicable quarter.

(d) No additional changes.

(e) No additional changes.

(i)(A) the name and title (including any city/county/state or political subdivision) of each official of an issuer and political party receiving reportable political contributions or reportable political party payments, listed by state; and (B) contribution or payment amounts made and the contributor category of the persons and entities described in paragraphs (b)(i) of this rule; or

(ii) if applicable, a statement that the consultant reported that no reportable political contributions or reportable political party payments were made; or

(iii) No additional changes.

 

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

(a) No change.

(i) - (xvii) No change.

(xviii) Records Concerning Consultants Pursuant to Rule G-38. Each broker, dealer and municipal securities dealer shall maintain:

(A) – (G) No additional changes.

(H) records indicating, if applicable, that a consultant made no reportable political contributions (as defined in rule G-38(a)(vi)) or no reportable political party payments (as defined in rule G-38(a)(vii));

(I) a statement, if applicable, that a consultant failed to provide any report of information to the dealer concerning reportable political contributions or reportable political party payments; and

(J) the date of termination of any consultant arrangement.

(xix) No change.

(b) - (f) No change.

 

Rule G-37. Political Contributions and Prohibitions on Municipal Securities Business

(a)– (d) No change.

(e)(i)(A) – (C) No change.

(D) any information required to be disclosed pursuant to section (d) (e) of rule G-38; and

(E) No change.

(ii) – (iii) No change.

(f) – (i) No change.

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ENDNOTES

1. File No. SR-MSRB-98-8, Amendment No. 1. Comments submitted to the SEC should refer to this file number.

2. Rule G-38(a) defines a consultant as "any person used by a broker, dealer or municipal securities dealer to obtain or retain municipal securities business though direct or indirect communication by such person with an issuer on behalf of such broker, dealer or municipal securities dealer where the communication is undertaken by such person in exchange for, or with the understanding of receiving, payment from the broker, dealer or municipal securities dealer or any other person."

3. For more information about the pending amendments at the SEC, see "Requirements for Dealers to Report Their Consultants’ Political Contributions and Payments to Political Parties: Rules G-38 and G-8," MSRB Reports, Vol. 18, No. 2 (August 1998) at 3-10. The notice is also posted on the Board’s web site at www.msrb.org.

4. Rule G-38 requires dealers who use consultants to evidence the consulting arrangement in writing (referred to as a "Consultant Agreement"). The rule requires that the Consultant Agreement, at a minimum, include the name, company, role and compensation arrangement of each consultant used by the dealer. The Consultant Agreement must be entered into before a consultant engages in any direct or indirect communication with an issuer on the dealer’s behalf.

5. See "Additional Requirements for Pending Amendments on Disclosure of Consultants’ Contributions: Rule G-38," MSRB Reports, Vol. 19, No. 2 (April 1999) at 3-7.

6. Rule G-37(e)(i) provides that each dealer must send to the Board two copies of Form G-37/G-38 by the last day of the month following the end of each calendar quarter (these dates correspond to January 31, April 30, July 31 and October 31).

7. Underlining indicates new language; strikethrough denotes deletions.