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Rule G-27

Supervision

Rule
Summary

Outlines requirements for a dealer’s supervision of personnel engaged in activities involving municipal securities activities.

(a) Obligation to supervise. Each broker, dealer and municipal securities dealer ("dealer") shall supervise the conduct of the municipal securities activities of the dealer and its associated persons to ensure compliance with Board rules and the applicable provisions of the Act and rules thereunder ("applicable rules").

(b) Supervisory System. Each dealer shall establish and maintain a system to supervise the municipal securities activities of each registered representative, registered principal, and other associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable Board rules.  Final responsibility for proper supervision shall rest with the dealer.  A dealer's supervisory system shall provide, at a minimum, for the following:

(i) The establishment and maintenance of written procedures as required by sections (c), (d), (e) and (f) of this rule.

(ii)    (A) General. The designation of one or more associated persons qualified as municipal securities principals, municipal securities sales principals and municipal fund securities limited principals in accordance with Board rules, or as general securities principals to be responsible for the supervision of the municipal securities activities of the dealer and its associated persons as required by this rule. 

(B)  Written Record. A written record of each supervisory designation and of the designated principal's responsibilities under this rule shall be maintained and updated as required under Rule G-9.

(C)  Appropriate Principal.

(1) Each dealer shall designate a municipal securities principal as responsible for its supervision under sections (a), (b), (c), (d), (e) and (f) of this rule, except as provided in this paragraph (C).

(2) A municipal securities sales principal may be designated as responsible for supervision under paragraphs (c)(i)(B), (C) and (G) and subsection (e)(i) of this rule, to the extent the activities pertain to sales to or purchases from a customer of municipal securities.

(3) A general securities principal may be designated as responsible for supervision under paragraph (c)(i)(E) and subparagraph (c)(i)(G)(1) of this rule and under Rules G-7(b) and G-21(f).

(4) A municipal fund securities limited principal may be designated as responsible for supervision under sections (a), (b), (c), (d), (e) and (f) of this rule to the extent that the activities pertain solely to transactions in municipal fund securities.

(iii) The designation as an office of municipal supervisory jurisdiction of each location that meets the definition contained in section (g) of this rule.  Each dealer shall also designate such other offices of municipal supervisory jurisdiction as it determines to be necessary in order to supervise its registered representatives, registered principals, and other associated persons with respect to their municipal securities activities in accordance with the standards set forth in this rule, taking into consideration the following factors:

(A) whether registered persons at the location engage in retail sales of municipal securities or other activities involving regular contact with public customers with respect to municipal securities;

(B) whether a substantial number of registered persons conduct municipal securities activities at, or are otherwise supervised from, such location;

(C) whether the location is geographically distant from another office of municipal supervisory jurisdiction of the dealer;

(D) whether the dealer's registered persons are geographically dispersed; and

(E)  whether the municipal securities activities at such location are diverse and/or complex.

(iv) The designation of one or more appropriately registered principals in each office of municipal supervisory jurisdiction, including the main office, and one or more appropriately registered representatives or principals in each municipal branch office that is not an office of municipal supervisory jurisdiction with authority to carry out the supervisory responsibilities with respect to municipal securities assigned to that office by the dealer.

(v) The assignment of each registered person to an appropriately registered representative(s) and/or principal(s) who shall be responsible for supervising that person's municipal securities activities.

(vi) Reasonable efforts to determine that all supervisory personnel are qualified by virtue of experience or training to carry out their assigned responsibilities with respect to municipal securities.

(vii) The participation of each registered representative and registered principal, either individually or collectively, no less than annually, in an interview or meeting conducted by persons designated by the dealer at which compliance matters relevant to the municipal securities activities of the representative(s) and principal(s) are discussed. Such interview or meeting may occur in conjunction with the discussion of other matters and may be conducted at a central or regional location or at the representative's or principal's place of business.

(c) Written supervisory procedures.

(i) General provisions.  Each dealer shall adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance as required in section (a) of this rule. Such procedures shall codify the dealer's supervisory system for ensuring compliance and, at a minimum, shall establish procedures

(A) that state how a designated principal shall monitor for compliance by the dealer with all applicable rules and supervise the municipal securities activities of associated persons specified in Rule G-3(a)(i);

(B) a designated principal shall follow when a customer complaint concerning the dealer's municipal securities activities is received;

(C) for the regular and frequent review and approval by a designated principal of customer accounts introduced or carried by the dealer in which transactions in municipal securities are effected; such review shall be designed to ensure that such transactions are in accordance with all applicable rules and to detect and prevent irregularities and abuses;

(D) for the periodic review by a designated principal of each office which engages in municipal securities activities pursuant to section (d) of this rule;

(E) for the maintenance and preservation, by a designated principal, of the books and records required to be maintained and preserved by Rules G-8 and G-9 of the Board;

(F) for the supervision by a designated principal of the processing, clearance, and in the case of a non-bank dealer safekeeping of municipal securities; and

(G) for the prompt review and written approval by a designated principal of:

(1) the opening of each customer account introduced or carried by the dealer in which transactions in municipal securities may be effected; and

 (2) each transaction in municipal securities on a daily basis, including each transaction in municipal securities effected with or for a discretionary account introduced or carried by the dealer.

(ii) Provisions concerning tape recording of conversations.

(A) Each dealer that either is notified by the applicable regulatory authority (as defined in subsection (g)(iii)) or otherwise has actual knowledge that it meets one of the criteria in paragraph (c)(ii)(H) relating to the employment history of its registered persons at a disciplined firm (as defined in subsection (g)(v)) shall establish, maintain, and enforce special written procedures for supervising the telemarketing activities with respect to municipal securities of all of its registered persons.

(B) The dealer must establish and implement the supervisory procedures required by this subsection (ii) within 60 days of receiving notice from the applicable regulatory authority or obtaining actual knowledge that it is subject to the provisions of this subsection.

A dealer that meets one of the criteria in paragraph (c)(ii)(H) for the first time may reduce its staffing levels to fall below the threshold levels within 30 days after receiving notice from the applicable regulatory authority or obtaining actual knowledge that it is subject to the provisions of paragraph (c)(ii)(H), provided the dealer promptly notifies the applicable regulatory authority in writing of its becoming subject to this rule. Once the dealer has reduced its staffing levels to fall below the threshold levels, it shall not rehire a person terminated to accomplish the staff reduction for a period of 180 days. On or prior to reducing staffing levels pursuant to this paragraph (B), a dealer must provide the applicable regulatory authority with written notice identifying the terminated person(s).

(C) The procedures required by this subsection shall include tape-recording all telephone conversations between the dealer's registered persons and both existing and potential customers with respect to municipal securities.

(D) The dealer shall establish reasonable procedures for reviewing the tape recordings made pursuant to the requirements of this subsection to ensure compliance with applicable securities laws and regulations and applicable rules. The procedures must be appropriate for the dealer's business, size, structure, and customers.

(E) All tape recordings made pursuant to the requirements of this subsection shall be retained for a period of not less than three years from the date the tape was created, the first two years in an easily accessible place. Each dealer shall catalog the retained tapes by registered person and date.

(F) Such procedures shall be maintained for a period of three years from the date that the dealer establishes and implements the procedures required by the provisions of this subsection.

(G) By the 30th day of the month following the end of each calendar quarter, each dealer subject to the requirements of this subsection shall submit to the applicable regulatory authority a report on the dealer's supervision of the telemarketing activities with respect to municipal securities of its registered persons.

(H) The following dealers shall be required to adopt special supervisory procedures over the telemarketing activities with respect to municipal securities of their registered persons:

(1) A dealer with at least five but fewer than ten registered persons, where 40% or more of its registered persons have been associated with one or more disciplined firms in a registered capacity within the last three years;

(2) A dealer with at least ten but fewer than twenty registered persons, where four or more of its registered persons have been associated with one or more disciplined firms in a registered capacity within the last three years;

(3) A dealer with at least twenty registered persons, where 20% or more of its registered persons have been associated with one or more disciplined firms in a registered capacity within the last three years.

(4) For purposes of the calculations required in paragraph (H), dealers should not include registered persons who:

(a) have been registered for an aggregate total of 90 days or less with one or more disciplined firms within the past three years; and

(b) do not have a disciplinary history (as defined in subsection (g)(vi)).

(I) The applicable regulatory authority, upon application and pursuant to such procedures as such authority shall prescribe, may in exceptional circumstances, taking into consideration all relevant factors, exempt such dealer unconditionally or on specified terms and conditions from the requirements of this subsection (ii).  A dealer seeking an exemption must file a written application within 30 days after receiving notice from the applicable regulatory authority or obtaining actual knowledge that it meets one of the criteria in paragraph (c)(ii)(H). A dealer that meets one of the criteria in paragraph (c)(ii)(H) for the first time may elect to reduce its staffing levels pursuant to the provisions of paragraph (c)(ii)(B) or, alternatively, to seek an exemption pursuant to paragraph (c)(ii)(I), as appropriate; such a dealer may not seek relief from this rule by both reducing its staffing levels pursuant to paragraph (c)(ii)(B) and requesting an exemption.

(iii)  Availability of and revisions to written supervisory procedures.  A copy of a dealer's written supervisory procedures, or the relevant portions thereof, shall be kept and maintained in each office of municipal supervisory jurisdiction and at each location where supervisory activities with respect to municipal securities are conducted on behalf of the dealer.  Each dealer shall amend its written supervisory procedures as appropriate within a reasonable time after changes occur in Board or other applicable rules and as changes occur in its supervisory system, and each dealer shall be responsible for communicating amendments through its organization.

(d) Internal Inspections.

(i) Each dealer shall conduct a review, at least annually, of the municipal securities activities in which it engages, which review shall be reasonably designed to assist in detecting and preventing violations of, and achieving compliance with, applicable securities laws and regulations, and with applicable Board rules. Each dealer shall review the municipal securities activities of each office, which shall include the periodic examination of customer accounts to detect and prevent irregularities or abuses.

(A) Each dealer shall inspect at least annually every office of municipal supervisory jurisdiction and any municipal branch office that supervises one or more non-branch locations.

(B) Each dealer shall inspect at least every three years every municipal branch office that does not supervise one or more non-branch locations. In establishing how often to inspect each non-supervisory municipal branch office, the dealer shall consider whether the nature and complexity of the municipal securities activities for which the location is responsible, the volume of business done, and the number of associated persons assigned to the location require the non-supervisory municipal branch office to be inspected more frequently than every three years. If a dealer establishes a more frequent inspection cycle, the dealer must ensure that at least every three years, the inspection requirements enumerated in subsection (d)(ii) have been met. The non-supervisory municipal branch office examination cycle, an explanation of the factors the dealer used in determining the frequency of the examinations in the cycle, and the manner in which a dealer will comply with subsection (d)(ii) if using more frequent inspections than every three years shall be set forth in the dealer's written supervisory and inspection procedures.

(C) Each dealer shall inspect on a regular periodic schedule every non-branch location. In establishing such schedule, the dealer shall consider the nature and complexity of the municipal securities activities for which the location is responsible and the nature and extent of contact with customers. The schedule and an explanation regarding how the dealer determined the frequency of the examination schedule shall be set forth in the dealer's written supervisory and inspection procedures.

Each dealer shall retain a written record of the dates upon which each review and inspection is conducted.

(ii) An office inspection and review by a dealer pursuant to subsection (d)(i) must be reduced to a written report and kept on file by the dealer for a minimum of three years, unless the inspection is being conducted pursuant to paragraph (d)(i)(C) and the regular periodic schedule is longer than a three-year cycle, in which case the report must be kept on file at least until the next inspection report has been written. The written inspection report must also include, without limitation, the testing and verification of the dealer's policies and procedures, including supervisory policies and procedures in the following areas as they relate to municipal securities:

(A) Safeguarding of customer funds and municipal securities;

(B) Maintaining books and records;

(C) Supervision of customer accounts serviced by branch office managers;

(D) Transmittal of funds between customers and registered representatives and between customers and third parties;

(E) Validation of customer address changes; and

(F) Validation of changes in customer account information.

If a dealer does not engage in all of the activities enumerated above, the dealer must identify those activities in which it does not engage in the written inspection report and document in the report that supervisory policies and procedures for such activities must be in place before the dealer can engage in them.

(iii) An office inspection by a dealer pursuant to subsection (d)(i) may not be conducted by the branch office manager or any person within that office who has supervisory responsibilities or by any individual who is supervised by such person(s). However, if a dealer is so limited in size and resources that it cannot comply with this limitation (e.g., a dealer with only one office or a dealer has a business model where small or single-person offices report directly to an office of municipal supervisory jurisdiction manager who is also considered the offices' branch office manager), the dealer may have a principal who has the requisite knowledge to conduct an office inspection perform the inspections. The dealer, however, must document in the office inspection reports the factors it has relied upon in determining that it is so limited in size and resources that it has no other alternative than to comply in this manner.

A dealer must have in place procedures that are reasonably designed to provide heightened office inspections if the person conducting the inspection reports to the branch office manager's supervisor or works in an office supervised by the branch manager's supervisor and the branch office manager generates 20% or more of the revenue of the business units supervised by the branch office manager's supervisor. For the purposes of this subsection (d)(iii) only, the term "heightened inspection" shall mean those inspection procedures that are designed to avoid conflicts of interest that serve to undermine complete and effective inspection because of the economic, commercial, or financial interests that the branch manager's supervisor holds in the associated persons and businesses being inspected. In addition, for the purpose of this subsection only, when calculating the 20% threshold, all of the revenue generated by or credited to the municipal branch office or branch office manager shall be attributed as revenue generated by the business units supervised by the branch office manager's supervisor irrespective of a dealer's internal allocation of such revenue. A dealer must calculate the 20% threshold on a rolling, twelve-month basis.

(e) Review of Correspondence.

(i) Supervision of Municipal Securities Representatives. Each dealer shall establish procedures for the review by a designated principal of incoming and outgoing written (i.e., non-electronic) and electronic correspondence of its municipal securities representatives with the public relating to the municipal securities activities of such dealer. Such procedures must be in writing and be designed to reasonably supervise each municipal securities representative. Evidence that these supervisory procedures have been implemented and carried out must be maintained and made available, upon request, to a registered securities association or the appropriate regulatory agency.

(ii)  Review of correspondence. Each dealer shall develop written procedures that are appropriate to its business, size, structure, and customers for the review of incoming and outgoing written (i.e., non-electronic) and electronic correspondence with the public relating to its municipal securities activities, including review for compliance with Rule G-21(e)(vii) to the extent applicable to such dealer's business.  Procedures shall 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 municipal securities are handled in accordance with the dealer's procedures. Where such procedures for the review of correspondence do not require review of all correspondence prior to use or distribution, they must include provisions for the education and training of associated persons as to the dealer's procedures governing correspondence; documentation of such education and training; and surveillance and follow-up to ensure that such procedures are implemented and adhered to.

(iii) Retention of correspondence. Each dealer shall retain correspondence of municipal securities representatives relating to its municipal securities activities in accordance with Rules G-8(a)(xx) and G-9(b)(viii) and (xiv). The names of the persons who prepared outgoing correspondence and who reviewed the correspondence shall be ascertainable from the retained records and the retained records shall be readily available, upon request, to a registered securities association or the appropriate regulatory agency.

(f) Supervisory Control System.

(i) Each dealer shall designate one or more principals who shall establish, maintain, and enforce a system of supervisory control policies and procedures that (A) test and verify that the dealer's supervisory procedures are reasonably designed with respect to the municipal securities activities of the dealer and its registered representatives and associated persons to achieve compliance with applicable rules and (B) create additional or amend supervisory procedures where the need is identified by such testing and verification. The designated principal or principals must submit to the dealer's senior management no less than annually a report detailing each dealer's system of supervisory controls, the summary of the test results and significant identified exceptions, and any additional or amended supervisory procedures created in response to the test results.

(ii) The establishment, maintenance, and enforcement of written supervisory control policies and procedures pursuant to subsection (f)(i) shall include:

(A) procedures that are reasonably designed to review and supervise the customer account activity relating to municipal securities conducted by the dealer's branch office managers, sales managers, regional or district sales managers, or any person performing a similar supervisory function.

(1) General Supervisory Requirement.  A person who is either senior to, or otherwise independent of, the producing manager must perform such supervisory reviews. For purposes of this rule, an "otherwise independent" person: may not report either directly or indirectly to the producing manager under review; must be situated in an office other than the office of the producing manager; must not otherwise have supervisory responsibility over the activity being reviewed (including not being directly compensated based in whole or in part on the revenues accruing for those activities); and must alternate such review responsibility with another qualified person every two years or less.

(2) "Limited Size and Resources" Exception.  If a dealer is so limited in size and resources that there is no qualified person senior to, or otherwise independent of, the producing manager to conduct the reviews pursuant to subparagraph (1) above (e.g., a dealer has only one office or an insufficient number of qualified personnel who can conduct reviews on a two-year rotation), the reviews may be conducted by a principal who is sufficiently knowledgeable of the dealer's supervisory control procedures, provided that the reviews are in compliance with subparagraph (1) to the extent practicable.

(3) Notification Requirement.  If a dealer determines that it must rely on the "limited size and resources" exception set forth in subparagraph (2) above to conduct any of its producing managers' supervisory reviews, the dealer must notify the applicable regulatory authority through an electronic process (or any other process prescribed by such authority) within 30 days of the date on which the dealer first relies on the exception, and annually thereafter.  If a dealer subsequently determines that it no longer needs to rely on the exception to conduct any of its producing managers' supervisory reviews, the dealer must, within 30 days of ceasing to rely on the exception, notify the applicable regulatory authority by using the electronic process or any other process prescribed by such authority.

(4) Documentation Requirement.  A dealer relying on subparagraph (2) above must document in its supervisory control procedures the factors used to determine that complete compliance with all of the provisions of subparagraph (1) is not possible and that the required supervisory systems and procedures in place with respect to any producing manager comply with the provisions of subparagraph (1) above to the extent practicable.

(B) procedures that are reasonably designed to review and monitor the following activities relating to municipal securities:

(1) all transmittals of funds (e.g., wires or checks, etc.) or municipal securities from customers to third party accounts (i.e., a transmittal that would result in a change of beneficial ownership); from customer accounts to outside entities (e.g., banks, investment companies, etc.); from customer accounts to locations other than a customer's primary residence (e.g., post office box, "in care of" accounts, alternate address, etc.); and between customers and registered representatives, including the hand-delivery of checks;

(2) customer changes of address and the validation of such changes of address; and

(3) customer changes of investment objectives and the validation of such changes of investment objectives.

The policies and procedures established pursuant to this paragraph (f)(ii)(B) must include a means or method of customer confirmation, notification, or follow-up that can be documented. If a dealer does not engage in all of the activities enumerated above, the dealer must identify those activities in which it does not engage in its written supervisory control policies and procedures and document in those policies and procedures that additional supervisory policies and procedures for such activities must be in place before the dealer can engage in them; and

(C) procedures that are reasonably designed to provide heightened supervision over the activities of each producing manager who is responsible for generating 20% or more of the revenue of the business units supervised by the producing manager's supervisor. For the purposes of this subsection only, the term "heightened supervision" shall mean those supervisory procedures that evidence supervisory activities that are designed to avoid conflicts of interest that serve to undermine complete and effective supervision because of the economic, commercial, or financial interests that the supervisor holds in the associated persons and businesses being supervised. In addition, for the purpose of this section only, when calculating the 20% threshold, all of the revenue generated by or credited to the producing manager or the producing manager's office shall be attributed as revenue generated by the business units supervised by the producing manager's supervisor irrespective of a dealer's internal allocation of such revenue. A dealer must calculate the 20% threshold on a rolling, twelve-month basis.

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

(i) "Office of municipal supervisory jurisdiction" means any office of a dealer at which any one or more of the following functions take place with respect to municipal securities:

(A) order execution and/or market making;

(B) structuring of public offerings or private placements;

(C) maintaining custody of customers' funds and/or municipal securities;

(D) final acceptance (approval) of new accounts on behalf of the dealer;

(E) review and endorsement of customer orders, pursuant to subparagraph (c)(i)(G)(2) above;

(F) final approval of advertising for use by persons associated with the dealer, pursuant to Rule G-21(f); or

(G) responsibility for supervising the municipal securities activities of persons associated with the dealer at one or more other municipal branch offices of the dealer.

(ii)    (A) A "municipal branch office" is any location where one or more associated persons of a dealer regularly conducts the business of effecting any transactions in, or inducing or attempting to induce the purchase or sale of any municipal security, or is held out as such, excluding:

(1) Any location that is established solely for customer service and/or back office type functions where no sales activities are conducted and that is not held out to the public as a branch office;

(2) Any location that is the associated person's primary residence; provided that

(a) Only one associated person, or multiple associated persons who reside at that location and are members of the same immediate family, conduct business at the location;

(b) The location is not held out to the public as an office and the associated person does not meet with customers at the location;

(c) Neither customer funds nor securities are handled at that location;

(d) The associated person is assigned to a designated municipal branch office, and such designated municipal branch office is reflected on all business cards, stationery, advertisements and other communications to the public by such associated person;

(e) The associated person's correspondence and communications with the public are subject to the dealer's supervision in accordance with this rule;

(f) Electronic communications (e.g., e-mail) are made through the dealer's electronic system;

(g) All orders are entered through the designated municipal branch office or an electronic system established by the dealer that is reviewable at the municipal branch office;

(h) Written supervisory procedures pertaining to supervision of sales activities conducted at the residence are maintained by the dealer; and

(i) A list of the residence locations is maintained by the dealer;

(3) Any location, other than a primary residence, that is used for municipal securities activities for less than 30 business days in any one calendar year, provided the dealer complies with the provisions of clauses (ii)(A)(2)(a) through (h) above;

(4) Any office of convenience, where associated persons occasionally and exclusively by appointment meet with customers, which is not held out to the public as an office.  Where such office of convenience is located on bank premises, signage necessary to comply with applicable federal and state laws, rules and regulations, and applicable rules and regulations of any self-regulatory organizations and securities and banking regulators, may be displayed and shall not be deemed "holding out" for the purposes of this section;

(5) Any location that is used primarily to engage in non-securities activities and from which the associated person(s) effects no more than 25 municipal securities transactions in any one calendar year; provided that any advertisement identifying such location also sets forth the address and telephone number of the location from which the associated person(s) conducting business at the non-branch locations are directly supervised;

(6) The floor of a registered national securities exchange where a dealer conducts a direct access business with public customers; or

(7) A temporary location established in response to the implementation of a business continuity plan.

(B) Notwithstanding the exclusions in paragraph (ii)(A), any location that is responsible for supervising the municipal securities activities of persons associated with the dealer at one or more non-branch locations of the dealer is considered to be a municipal branch office.

(C) The term "business day" as used in paragraph (ii)(A) shall not include any partial business day provided that the associated person spends at least four hours on such business day at his or her designated municipal branch office during the hours that such office is normally open for business.

(iii) "Applicable regulatory authority" means (i) with respect to a dealer that is a member of a registered securities association, such registered securities association, and (ii) with respect to any other dealer, the appropriate regulatory agency as defined in Section 3(a)(34) of the Act.

(iv) "Registered person" means any person qualified to act as a representative, principal or limited principal pursuant to Rule G-3.

(v) "Disciplined firm" means either a dealer that, in connection with sales practices involving the offer, purchase, or sale of any security, has been expelled from membership or participation in any securities industry self-regulatory organization or is subject to an order of the Securities and Exchange Commission revoking its registration as a broker/dealer; or a futures commission merchant or introducing broker that has been formally charged by either the Commodity Futures Trading Commission or a registered futures association with deceptive telemarketing practices or promotional material relating to security futures, those charges have been resolved, and the futures commission merchant or introducing broker has been closed down and permanently barred from the futures industry as a result of those charges; or a futures commission merchant or introducing broker that, in connection with sales practices involving the offer, purchase, or sale of security futures is subject to an order of the Securities and Exchange Commission revoking its registration as a broker or dealer.

(vi) "Disciplinary history" means a finding of  violation by a registered person in the past five years by the Securities and Exchange Commission, a self-regulatory organization, or a foreign financial regulatory authority of one or more of the following rules (or comparable foreign provision):  Sections 15(b)(4)(E) and 15(c) of the Act; Section 17(a) of the Securities Act of 1933; SEC Rules 10b-5 and 15g-1 through 15g-9; FINRA Rules 2010, 2020, 2111, 2150, 22121, 3110 (failure to supervise only), 5210 and 5230; MSRB Rules G-19, G-30, and G-37(b) and (c).

Supplementary Material

.01 Temporary Relief to Allow Remote Inspections for Calendar Year 2020; Calendar Year 2021; and Calendar Year 2022

(a) Each dealer obligated to complete an inspection of an office of municipal supervisory jurisdiction, branch office or non-branch location in calendar years 2020, 2021 and 2022 pursuant to, as applicable, subsection (d)(i)(A), (B) and (C) of this rule, subject to the requirements of this Supplementary Material .01, may satisfy such obligation by conducting the applicable inspection(s) remotely without an on-site visit to such office(s) or location(s). In accordance with this Supplementary Material .01, the applicable inspection(s) for calendar year 2020 must be completed on or before March 31, 2021; inspections for calendar year 2021 must be completed on or before December 31, 2021; and inspections for calendar year 2022, must be completed on or before December 31, 2022. Consistent with subsection (g)(ii)(A)(7) of this rule, a temporary location established in response to the implementation of a business continuity plan is not deemed an office for purposes of complying with inspection obligations.

(b) Written Supervisory Procedures for Remote Inspections. Consistent with a dealer’s obligation under subsection (c)(i) of this rule, a dealer that elects to conduct its inspections remotely for any of the calendar years specified in this supplementary material shall amend or supplement its written supervisory procedures as appropriate to provide for remote inspections that are reasonably designed to assist in detecting and preventing violations of, and achieving compliance with, applicable securities laws and regulations, and with applicable Board rules. Reasonably designed procedures for conducting remote inspections of offices or locations should include, among other things: (1) a description of the methodology, including technologies permitted by the dealer, that may be used to conduct remote inspections; and (2) the use of other risk-based systems employed generally by the dealer to identify and prioritize for review those areas that pose the greatest risk of potential violations of applicable securities laws and regulations, and of applicable Board rules.

(c) Effective Supervisory System. The requirement to conduct inspections of offices and locations is one part of the dealer’s overall obligation to establish and maintain a supervisory system as prescribed under paragraph (b) of this rule and therefore, the dealer must continue with its ongoing review of the activities and functions occurring at all offices and locations, whether or not the dealer conducts inspections remotely. Where a dealer’s remote inspection of an office or location identifies any signs of irregularities or misconduct (i.e., “red flags”), the dealer may need to impose additional supervisory procedures for that office or location or may need to provide for more frequent monitoring of that office or location. Such monitoring may include, potentially a subsequent physical on-site visit on an announced or unannounced basis, when the dealer’s operational difficulties associated with COVID-19 subside, taking into account national or locality restrictions, as appropriate, and the other business challenges a dealer is facing in light of the public health and safety concerns, make such on-site visit(s) feasible using reasonable best efforts.

(d) Documentation Requirement. In addition to the documentation requirements under subsection (d)(ii) of this rule, a dealer that elects to conduct its inspections remotely, shall make and maintain a centralized record for each of calendar years 2020, 2021, and 2022 that separately identifies: (1) all offices or locations that had inspections that were conducted remotely; and (2) any offices or locations for which the dealer determined to impose additional supervisory procedures or more frequent monitoring, as provided for under paragraph (c) of this Supplementary Material .01. A dealer’s documentation of the results of a remote inspection for an office or location must identify any additional supervisory procedures or more frequent monitoring for that office or location that were imposed as a result of the remote inspection.

.02 Temporary Relief for Completing Annual Compliance Meeting. Each dealer obligated to have each registered representative and registered principal complete an annual compliance interview or meeting pursuant to (b)(vii) above shall be deemed to have satisfied such obligation for calendar year 2020 if such compliance interview or meeting is completed on or before March 31, 2021.

.03 Temporary Relief for Completing Annual Supervisory Testing. Each dealer obligated to complete an annual test of its supervisory control system and report such results pursuant to (f)(i) above shall be deemed to have satisfied such obligation for calendar year 2020 if such testing and reporting is completed on or before March 31, 2021.

Interpretive Guidance - Interpretive Notices
Publication date:

MSRB Reminds Firms of Their Sales Practice and Due Diligence Obligations when Selling Municipal Securities in the Secondary Market

Executive Summary

Brokers, dealers and municipal securities dealers (dealers or firms) must fully understand the bonds they sell in order to meet their disclosure, suitability and pricing obligations under the rules of the Municipal Securities Rulemaking Board (MSRB) and federal securities laws. These obligations are not limited to firms involved in primary offerings. Dealers must also obtain, analyze and disclose all material facts about secondary market transactions that are known to the dealer, or that are reasonably accessible to the market through established industry sources.

Those sources include, among other things, official statements, continuing disclosures, trade data, and other information made available through the MSRB’s Electronic Municipal Market Access system (EMMA). Firms may also have a duty to obtain and disclose information that is not available through EMMA, if it is material and available through other public sources. The public availability of material information, through EMMA or otherwise, does not relieve a firm of its duty to disclose that information. Firms must also have reasonable grounds for determining that a recommendation is suitable based on information available from the issuer of the security or otherwise. Firms must also use this information to determine the prevailing market price of a security as the basis for establishing a fair price in a transaction with a customer. To meet these requirements, firms must perform an independent analysis of the bonds they sell, and may not rely solely on a bond’s credit rating.

Continuing disclosures made by issuers to the MSRB via EMMA are part of the information that dealers must obtain, disclose and consider in meeting their regulatory obligations. The Securities and Exchange Commission (SEC) has recently approved amendments to Securities Exchange Act Rule 15c2-12, governing continuing disclosures. Firms that sell municipal securities should review and, if necessary, update their procedures to reflect the amendments, which have a compliance date of December 1, 2010.  

Background and Discussion

MSRB Disclosure, Suitability and Pricing Rules

MSRB Rule G-17 provides that, in the conduct of its municipal securities activities, each dealer must deal fairly with all persons and may not engage in any deceptive, dishonest or unfair practice. The MSRB has interpreted Rule G-17 to require a dealer, in connection with any transaction in municipal securities, to disclose to its customer, at or prior to the sale, all material facts about the transaction known by the dealer, as well as material facts about the security that are reasonably accessible to the market.[1] This includes the obligation to give customers a complete description of the security, including a description of the features that likely would be considered significant by a reasonable investor and facts that are material to assessing the potential risks of the investment.

Such disclosures must be made at the “time of trade,” which the MSRB defines as at or before the point at which the investor and the dealer agree to make the trade. Rule G-17 applies to all sales of municipal securities, whether or not a transaction was recommended by a broker-dealer.[2] This means that municipal securities dealers must disclose all information required to be disclosed by the rule even if the trade is self-directed.[3]

MSRB Rule G-19 requires that a dealer that recommends a municipal securities transaction have reasonable grounds for believing that the recommendation is suitable for the customer based upon information available from the issuer of the security or otherwise and the facts disclosed by, or otherwise known about, the customer.[4]

MSRB Rule G-30 requires that dealers trade with customers at prices that are fair and reasonable, taking into consideration all relevant factors.[5] The MSRB has stated that the concept of a “fair and reasonable” price includes the concept that the price must “bear a reasonable relationship to the prevailing market price of the security.” The impetus for the MSRB’s Real-time Transaction Reporting System (RTRS), which was implemented in January 2005, was to allow market participants to monitor market price levels on a real-time basis and thus assist them in identifying changes in market prices that may have been caused by news or market events.[6] The MSRB now makes the transaction data reported to RTRS available to the public through EMMA.

In meeting these disclosure, suitability and pricing obligations, firms must take into account all material information that is known to the firm or that is available through “established industry sources,” including official statements, continuing disclosures, and trade data, much of which is now available through EMMA. Resources outside of EMMA may include press releases, research reports and other data provided by independent sources. Established industry sources can also include material event notices and other data filed with former nationally recognized municipal securities information repositories (NRMSIRs) before July 1, 2009.[7] Therefore, firms should review their policies and procedures for obtaining material information about the bonds they sell to make sure they are reasonably designed to access all material information that is available, whether through EMMA or other established industry sources. The MSRB has also noted that the fact that material information is publicly available through EMMA does not relieve a firm of its duty to specifically disclose it to the customer at the time of trade, or to consider it in determining the suitability of a bond for a specific customer.[8] Importantly, the dealer may not simply direct the customer to EMMA to fulfill its time-of-trade disclosure obligations under Rule G-17.[9]

Amendments to Rule 15c2-12 Concerning Continuing Disclosure

Securities Exchange Act Rule 15c2-12 requires underwriters participating in municipal bond offerings that are subject to that rule[10] to receive, review, and distribute official statements of issuers of primary municipal securities offerings, and prohibits underwriters from purchasing or selling municipal securities covered by the rule unless they have first reasonably determined that the issuer or an obligated person[11] has contractually agreed to make certain continuing disclosures to the MSRB, including certain financial information and notice of certain events. The MSRB makes such disclosure public via EMMA.

Financial information to be disclosed under the rule consists of the following:

  • Annual financial information updating the financial information in the official statement;
  • Audited financial statements, if available and not included within the annual financial information; and
  • Notices of failure to provide such financial information on a timely basis.

Currently, the rule enumerates the following as notice events, if material:

  • Principal and interest payment delinquencies;
  • Non-payment related defaults;
  • Unscheduled draws on debt service reserves reflecting financial difficulties;
  • Unscheduled draws on credit enhancements reflecting financial difficulties;
  • Substitution of credit or liquidity providers or their failure to perform;
  • Adverse tax opinions or events affecting the tax-exempt status of the security;
  • Modifications to rights of security holders;
  • Bond calls;
  • Defeasances;
  • Release, substitution or sale of property securing repayment of the securities; and
  • Rating changes.

Rule 15c2-12(c) also prohibits any dealer from recommending the purchase or sale of a municipal security unless it has procedures in place that provide reasonable assurance that it will receive prompt notice of any event notice reported pursuant to the rule. Firms should review any applicable continuing disclosures made available through EMMA and other established industry sources and take such disclosures into account in undertaking its suitability and pricing determinations. 

On May 26, 2010, the SEC amended the rule’s disclosure obligations, with a compliance date of December 1, 2010, to: (1) apply continuing disclosure requirements to new primary offerings of certain variable rate demand obligations (VRDOs); (2) add four new notice events;[12] (3) remove the materiality standard for certain notice events;[13] and (4) require that event notices be filed in a timely manner but no later than 10 business days after their occurrence. With respect to the tax status of the security, the rule has been broadened to require disclosure of adverse tax opinions, issuance by the IRS of proposed or final determinations of taxability and other material notices, and determinations or events affecting the tax status of the bonds (including a Notice of Proposed Issue). Firms that deal in municipal securities should familiarize themselves with these amendments, and, if necessary, modify their policies and procedures to incorporate this additional disclosure accordingly. 

The Financial Industry Regulatory Authority (FINRA) noted in its Regulatory Notice 09-35 that, if a firm discovers through its Rule 15c2-12 procedures or otherwise that an issuer has failed to make filings required under its continuing disclosure agreements, the firm must take this information into consideration in meeting its disclosure obligations under MSRB Rule G-17 and in assessing the suitability of the issuer’s bonds under MSRB Rule G-19.

Credit Ratings

In order to meet their obligations under MSRB Rules G-17 and G-19, firms must analyze and disclose to customers the risks associated with the bonds they sell, including, but not limited to, the bond’s credit risk. A credit rating is a third-party opinion of the of the credit quality of a municipal security. While the MSRB generally considers credit ratings and rating changes to be material information for purposes of disclosure, suitability and pricing, they are only one factor to be considered, and dealers should not solely rely on credit ratings as a substitute for their own assessment of a bond’s credit risk. [14]  Moreover, different agencies use different quantitative and qualitative criteria and methodologies to determine their rating opinions.  Dealers should familiarize themselves with the rating systems used by rating agencies in order to understand and assess the relevance of a particular rating to the firm’s overall assessment of the bond.[15]. With respect to credit or liquidity enhanced securities, the MSRB has stated that material information includes the following, if known to the dealer or if reasonably available from established industry sources: (i) the credit rating of the issue or lack thereof; (ii) the underlying credit rating or lack thereof, (iii) the identity of any credit enhancer or liquidity provider; and (iv) the credit rating of the credit provider and liquidity provider, including potential rating actions (e.g., downgrade).[16]  Additionally, material terms of the credit facility or liquidity facility should be disclosed (e.g., any circumstances under which a standby bond purchase agreement would terminate without a mandatory tender).

Other Material Information 

In addition to a bond’s credit quality, firms must obtain, analyze and disclose other material information about a bond, including but not limited to whether the bond may be redeemed prior to maturity in-whole, in-part or in extraordinary circumstances,[17] whether the bond has non-standard features that may affect price or yield calculations,[18] whether the bond was issued with original issue discount or has other features that would affect its tax status,[19] and other key features likely to be considered significant by a reasonable investor.  For example, for VRDOs, auction rate securities or other securities for which interest payments may fluctuate, firms should explain to customers the basis on which periodic interest rate resets are determined.[20] The MSRB has stated that firms should take particular care with respect to new products that may be introduced into the municipal securities market, existing products that may have complex structures that can differ materially from issue to issue, and outstanding securities that may trade infrequently, may be issued by less well-known issuers, or may have unusual features.[21]

Supervision

Firms are reminded that MSRB Rule G-27 requires firms to supervise their municipal securities business, and to ensure that they have adequate policies and procedures in place for monitoring the effectiveness of their supervisory systems. Specifically, firms must:

  • Supervise the conduct of the municipal securities activities of the firm and associated persons to ensure compliance with all MSRB rules, the Exchange Act and the rules there under;
  • Have adequate written supervisory procedures; and
  • Implement supervisory controls to ensure that their supervisory procedures are adequate.

Rule G-27 requires that a firm’s supervisory procedures provide for the regular and frequent review and approval by a designated principal of customer accounts introduced or carried by the dealer in which transactions in municipal securities are effected, with such review being designed to ensure that transactions are in accordance with all applicable rules and to detect and prevent irregularities and abuses. Although the rule does not establish a specific procedure for ensuring compliance with the requirement to provide disclosures to customers pursuant to Rule G-17, firms should consider including in their procedures for reviewing accounts and transactions specific processes for documenting or otherwise ascertaining that such disclosures have been made.  

Questions to Consider

Before selling any municipal bond, dealers should make sure that they fully understand the bonds they are selling in order to make adequate disclosure to customers under Rule G-17, to ensure that recommendations are suitable under Rule G-19, and to ensure that they are fairly priced under Rule G-30. Among other things, dealers should ask and be able to answer the following questions: 

  • What are the bond’s key terms and features and structural characteristics, including but not limited to its issuer, source of funding (e.g., general obligation or revenue bond), repayment priority, and scheduled repayment rate? (Much of this information will be in the Official Statement, which for many municipal bonds can be obtained by entering the CUSIP number in the MuniSearch box at www.emma.msrb.org). Be aware, however, data in the Official Statement may have been superseded by the issuer’s on-going disclosures.
  • Does information available through EMMA or other established industry sources indicate that an issuer is delinquent in  its material event notice and other continuing disclosure filings?  Delinquencies should be viewed as a red flag.
  • What other public material information about the bond or its issuer is available through established industry sources other than EMMA?
  • What is the bond’s rating? Has the issuer of the bond recently been downgraded? Has the issuer filed any recent default or other event notices, or has any other information become available through established industry sources that might call into question whether the published rating has been revised to take such event into consideration?
  • Is the bond insured, or does it benefit from liquidity support, a letter of credit or is it otherwise supported by a third party? If so, check the credit rating of the bond insurer or other backing, and the bond’s underlying rating (without third party support). If supported by a third party, review the terms and conditions under which the third party support may terminate.
  • How is it priced? Be aware that the price of a bond can be priced above or below its par value for many reasons, including changes in the creditworthiness of a bond's issuer and a host of other factors, including prevailing interest rates.
  • How and when will interest on the bond be paid? Most municipal bonds pay semiannually, but zero coupon municipal bonds pay all interest at the time the bond matures. Variable rate bonds typically will pay interest more frequently, usually on a monthly basis in variable amounts.
  • What is the bond’s tax status, under both state and federal laws? Is it subject to the Federal Alternate Minimum Tax? Is it fully taxable (e.g., Build America Bonds)?
  • What are its call provisions? Call provisions allow the issuer to retire the bond before it matures. How would a call affect expected future income?

[1] MSRB Rule G-17 applies to all transactions in municipal securities, including those in both the primary and secondary market. MSRB Rule G-32 specifically addresses the delivery of the official statement in connection with primary offerings.

[2] See MSRB Notice 2009-42 (July 14, 2009).

[3] A dealer’s specific investor protection obligations, including its disclosure, fair practice and suitability obligations under Rules G-17 and G-19, may be affected by the status of an institutional investor as a Sophisticated Municipal Market Professional (“SMMP”). See Rule G-17 Interpretation – Notice Regarding the Application of MSRB Rules to Transactions with Sophisticated Municipal Market Professionals (April 30, 2002).

[4] See MSRB Notice 2009-42, supra n.2.

[5] Rule G-18 requires that a dealer effecting an agency trade with a customer make a reasonable effort to obtain a price for the customer that is fair and reasonable in relation to prevailing market conditions.

[6] See MSRB Notice 2004-3 (January 26, 2004).

[7] Since July 1, 2009, material event notices are required to be filed through EMMA, which has replaced Bloomberg Municipal Repository; DPC DATA Inc.; Interactive Data Pricing and Reference Data, Inc.; and Standard & Poor’s Securities Evaluations, Inc. as the sole NRMSIR.

[8] The MSRB has also stated that providing adequate disclosure does not relieve a firm of its suitability obligations. See MSRB Notice 2007-17 (March 30, 2007).

[9] Rule G-32 does allow a dealer to satisfy its obligation to deliver an official statement to its customer during the primary offering disclosure period no later than the settlement of the transaction by advising the customer of how to obtain it on EMMA, unless the customer requests a paper copy.  The delivery obligation under Rule G-32 is distinct from the duty to disclose material information under Rule G-17, which applies to all primary and secondary market transactions.

[10] Certain limited offerings, variable rate demand obligations, and small issues are exempt from Rule 15c2-12.

[11] “Obligated person” is defined as “any person, including an issuer of municipal securities, who is either generally or through an enterprise, fund or account of such person committed by contract or other arrangement to support payment of all, or part of the obligations of the municipal securities to be sold in the offering (other than providers of municipal bond insurance, letters of credit, or other liquidity facilities).”

[12] The new notice events are (1) tender offers, (2) bankruptcy, insolvency, receivership, or similar events, (3) consummation of mergers, consolidations, acquisitions, or asset sales, or entry into or termination of a definitive agreement related to do the same, if material, and (4) appointment of a successor or additional trustee or a change in the name of the trustee, if material.

[13] The amendments removed the materiality standard and require notices for the following events: (1) principal and interest payment delinquencies with respect to the securities being offered ; (2) unscheduled draws on debt service reserves reflecting financial difficulties; (3) unscheduled draws on credit enhancements reflecting financial difficulties; (4) substitution of credit or liquidity providers, or their failure to perform; (5) defeasances: and (6) rating changes. The amendments retained the materiality standard for the following events: (1) non-payment related defaults; (2) modifications to rights of security holders; (3) bond calls; and (4) release, substitution, or sale of property securing repayment of the securities.

[14] See MSRB Notice 2009-42, supra n.2. Ratings changes are reportable events under Rule 15c2-12.

[15] Not all municipal bonds are rated. While an absence of a credit rating is not, by itself, a determinant of low credit quality, it is a factor that the dealers should consider, and may warrant additional due diligence of the bond and its issuer by the dealer. In addition, MSRB Rule G-15 requires confirmation statements for customer trades in unrated municipal securities to disclose that the securities are not rated.

[16] See MSRB Notice 2009-42.  The SEC has approved the MSRB’s proposal to require dealers to submit copies of credit enhancement and liquidity facility documents to EMMA pursuant to amended MSRB Rule G-34(c), which may increase the availability of such information to dealers.  See Securities Exchange Act Release No. 62755, August 20, 2010 (File No. SR-MSRB-2010-02).

[17] See Notice Concerning Disclosure of Call Information to Customers of Municipal Securities, MSRB Interpretation of March 4, 1986.

[18] See Transactions in Municipal Securities With Non-Standard Features Affecting Price/Yield Calculations, MSRB Interpretation of June 12, 1995.

[19] See MSRB Notice 2005-01 (January 5, 2005); MSRB Notice 2009-41 (July 10, 2009).

[20] See MSRB Notice 2008-09 (February 19, 2008).

[21] See MSRB Notice 2009-42, supra n.2.
Interpretive Guidance - Interpretive Notices
Publication date:

Build America Bonds and Other Tax Credit Bonds

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

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

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

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

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

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

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

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

This Notice does not address the securities law characterization of the tax credit component of Build America Bonds (Tax Credit) or other tax credit bonds, whether the credits are used by investors in the bonds or stripped and sold to other investors.

Interpretive Guidance - Interpretive Notices
Publication date:

General Advertising Disclosures, Blind Advertisements and Annual Reports Relating to Municipal Fund Securities Under Rule G-21

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

General Disclosures in Time-Limited Broadcast Advertisements

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

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

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

Blind Advertisements

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

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

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

Required Annual Reports Excluded from Definition of Advertisement

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


[1] These methods are not intended to be the exclusive means by which a dealer could establish that the customer initiated the order.

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

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

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

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

Interpretive Guidance - Interpretive Notices
Publication date:

Reminder of Obligations Under Rule G-37 on Political Contributions and Rule G-27 on Supervision When Sponsoring Meetings and Conferences Involving Issuer Officials

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

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

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

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

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

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


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

The MSRB has stated, however, that MFPs are “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.” 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 MSRB has stated that hosting or paying to attend a fundraising event may constitute a contribution subject to section (b) of the rule.  See Question and Answers II.11 and II.18 (May 24, 1994); see also MSRB Interpretation of May 31, 1995 (Campaign for Federal Office), reprinted in MSRB Rule Book.

[2] Other amounts paid to issuer officials (such as honoraria) may be subject to Rule G-20 on gifts, gratuities and non-cash compensation, to the extent such payments are in relation to the issuer's municipal securities activities.

[3] Although Rule G-37(c) prohibits MFPs from soliciting or coordinating contributions, the MSRB has previously stated that "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." See MSRB Interpretive Notice on Solicitation of Contributions (May 21, 1999), reprinted in MSRB Rule Book

Interpretive Guidance - Interpretive Letters
Publication date:

Supervisory Procedures Relating to Indirect Contributions: Conference Accounts and 527 Organizations

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

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

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

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

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

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

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

The MSRB also has stated that payments to “housekeeping,” “conference” or “overhead” accounts of political parties are not safe harbors under Rule G-37 and that a dealer’s written supervisory procedures designed to ensure compliance with Rule G-37(d) must take into account such payments.  The MSRB noted that “preemptive” instructions accompanying payments to housekeeping accounts of political parties stating that such payments are not to be used for the benefit of one or a limited number of issuer officials are not considered sufficient to meet the dealer’s obligations with regard to ensuring that the payment is not being made to circumvent the requirements of Rule G-37.[6]  Although payments to housekeeping, conference or overhead accounts are not safe harbors and preemptive instructions are not by themselves sufficient to establish compliance with Rule G-37(d), procedures permitting payments to political parties and other political organizations only if made to these types of accounts and/or requiring preemptive instructions regarding the use of such payments may be elements in a supervisory program that, together with other appropriate procedures, could adequately ensure compliance with Rule G-37(d), depending on the specific facts and circumstances. MSRB Interpretation of December 21, 2006.
__________

[1] MFPs may make certain de minimis contributions to issuer officials without triggering the ban on business.

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

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

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

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

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

Interpretive Guidance - Interpretive Notices
Publication date:

Supervisory Procedures for the Review of Correspondence with the Public

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.


ENDNOTES

[1]See Exchange Act Release No. 42538 (March 16, 2000), 65 FR 15675 (March 23, 1999). �

[2] See Securities Act Release No. 7288, Exchange Act Release No. 37182, Investment Company Act Release No. 21945, Investment Advisor Act Release No. 1562 (May 9, 1996), 61 FR 24644 (May 15, 1996) (File No. S7-13-96).

[3]  Id.

[4] See Exchange Act Release No. 39510 (December 31, 1997), 63 FR 1131 (January 8, 1998).

[5] See Exchange Act Release No. 39511 (December 31, 1997), 63 FR 1135 (January 8, 1998).

[6] See Exchange Act Release No. 40723 (November 30, 1998), 63 FR 67496 (December 7, 1998).

[7] See Notice to Members 99-03 (January 1999).

Interpretive Guidance - Interpretive Letters
Publication date:

Review and Approval of Customer Accounts

Review and approval of customer accounts.  This is in response to your letter dated July 24, 1996, requesting an interpretation of rule G-27(c)(iii) on written supervisory procedures.

Rule G-27(c)(iii) requires that each municipal securities dealer adopt, maintain and enforce written supervisory procedures ensuring the "regular and frequent" review and approval by a designated principal of customer accounts introduced or carried by the dealer in which transactions in municipal securities are effected. The rule further states that such review shall be designed to ensure that such transactions are in accordance with all applicable rules and to detect and prevent irregularities and abuses.

Because circumstances vary from dealer to dealer, the Board has not specified a time period to define "regular and frequent" for purposes of rule G-27(c)(iii).  As you can see, however, the purpose of this provision is to detect and prevent irregularities and abuses that may occur in customer accounts. The Board expects dealers to establish procedures that effectively obtain this objective and that are capable of compliance. While the Board has never specifically addressed "risk-focussed" methods for determining periodic account review, the Board has stated that, in determining when an account must be reviewed, a dealer might look to the volume and frequency of trading and the nature of the securities traded. The Board noted that account review guidelines based on these factors would be appropriate if they are articulated clearly in a dealer's written supervisory procedures.[1] MSRB interpretation of August 7, 1996.


[1] Supervision Requirements, MSRB Reports, Vol. 10, No. 2 (May 1990) at 6.

Interpretive Guidance - Interpretive Letters
Publication date:

Solicitation of Contributions Rule G-37

Solicitation of contributions. This is in response to your letter dated September 29, 1994 regarding rule G-37, on political contributions and prohibitions on municipal securities business. You review a situation regarding a municipal finance professional's participation in a fundraising event for a certain state official. You seek guidance on two matters. First, you inquire whether the activities of the municipal finance professional in connection with this fundraiser constitute a violation of the solicitation prohibition in rule G-37(c). Second, you inquire that, if a violation of rule G-37(c) occurred, would such violation subject your firm to a two-year ban on municipal securities business with the state. The Board has reviewed your letter and authorized this response.

Rule G-37(b) prohibits dealers from engaging in municipal securities business with an issuer within two years after any contribution 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 municipal finance professional.[1] Rule G-37(c) provides that no dealer or any 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.

With regard to your first inquiry, the Board is not the appropriate authority to determine whether in this instance the municipal finance professional's activities amounted to a solicitation of contributions in violation of rule G-37(c). While the Board has authority to adopt rules concerning transactions in municipal securities effected by brokers, dealers and municipal securities dealers, it has no enforcement authority over dealers; that authority is vested with the National Association of Securities Dealers, Inc. (NASD) for securities firms. Whether a particular activity should be characterized as a solicitation of a contribution and a violation of the rule is fact specific, and further inquiry and investigation may be appropriate prior to a determination of violation. The Board believes that it is more appropriate for the NASD to make such inquiries and determinations. Your letter has been forwarded to the NASD for its review.

The Board believes, however, that if a dealer's or a municipal finance professional's name appears on fundraising literature for an issuer official for which the dealer is engaging or seeking to engage in municipal securities business, there is a presumption that such activity is a solicitation by the named party.

With regard to your second inquiry, a violation of rule G-37(c) does not trigger a two-year ban on engaging in municipal securities business with an issuer. If the NASD finds a violation of rule G-37(c) has occurred, the NASD will determine the appropriate sanction.

Finally, rule G-27, on supervision, requires each dealer to adopt, maintain and enforce written supervisory procedures reasonably designed to ensure compliance with Board rules, including rule G-37. In view of the significant penalties associated with rule G-37, including a two-year ban on municipal securities business with an issuer in certain cases, effective compliance procedures are essential. We recognize that some dealers may focus their compliance procedures on the areas in the rule concerning certain political contributions. Rule G-37 has other important provisions, however, such as the prohibition against certain solicitations and the recordkeeping and reporting requirements. Given the situation presented in your letter, your firm may wish to review its procedures to determine whether they are sufficient to ensure compliance with all provisions of rule G-37. MSRB Interpretation of November 7, 1994.

__________

[1]  The prohibition does not apply if the only contributions to officials of issuers are made by municipal finance professionals entitled to vote for such officials, and provided, such contributions, in total, are not in excess of $250 by each such municipal finance professional to each official of such issuer, per election.

Interpretive Guidance - Interpretive Letters
Publication date:

Review and Approval of Transactions

Review and approval of transactions.  This is in response to your letter in which you ask several questions concerning Board rules.

[One paragraph deleted.][*]

With respect to your second question, someone qualified as both a municipal securities representative and as a municipal securities principal may review and approve his or her own transactions effected in the capacity as a representative.

With respect to your final question, rule G-27(c)(vii)(B), on supervision, requires the prompt review and written approval by a designated principal of each transaction in municipal securities on a daily basis.  MSRB interpretation of June 20, 1994.


[*] [The deleted paragraph concerned an unrelated question regarding a different Board rule and appears elsewhere in the MSRB Rule Book.]

Interpretive Guidance - Interpretive Letters
Publication date:

Review and Approval of Transactions

Review and approval of transactions.  This is in response to your letter requesting an interpretation of rule G-27(c)(ii)(B)[*] which requires that a [designated] principal promptly review and approve, in writing, each transaction in municipal securities. You state that your firm proposes to use a system of exception reports to review the firm's municipal securities transactions each day. Each trade will be reviewed by computer pursuant to parameters established by the Compliance Department. These parameters include the size of the order (in terms of dollars as well as a percentage of the customer's net worth), the customer's income, investment objectives and age. These parameters can be changed and fine-tuned as the situation dictates. Currently, the exception report will contain all purchases in excess of $25,000 or 10 percent of the customer's stated net worth and all sales in excess of $10,000. A review of the exception report would be conducted by a municipal securities principal. Oversight of the review process, and any required follow-up, would be conducted.

Rule G-27, on supervision, requires a dealer to supervise the municipal securities activities of its associated persons and the conduct of its business. In particular, rule G-27(c)(ii)(B)[*] requires that a [designated] principal promptly review and approve, in writing, each transaction in municipal securities. The Board believes that the requirement for written approval of each transaction by a [designated] principal is reasonable and necessary to promote proper supervision of the activities of municipal securities representatives. Among other purposes, these procedures enable [designated] principals to keep abreast of the firm's daily trading activity, to assess the appropriateness of mark-ups and mark-downs, and to assure that provisions for the prompt delivery of securities are being met. The exception reporting you propose would not comply with rule G-27(c)(ii)(B)[*] because it would not result in review and approval of each municipal securities transaction by a [designated] principal.[1]  MSRB interpretation of July 26, 1989.


[1] While exception report review is not appropriate in complying with rule G-27(c)(vii)(B),[*] we understand that certain dealers, with the approval of their enforcement agencies, use exception reports in their periodic review of customer accounts required by rule G-27(c)(iii).

[*] [Currently codified at rule G-27(c)(vii)(B).]

NOTE: Revised to reflect subsequent amendments.

Interpretive Guidance - Interpretive Letters
Publication date:

Use of Electronic Signatures

Use of electronic signatures.  This is in response to your letter and a number of subsequent telephone conversations regarding your dealer department's proposed use of a bond trading system. The system is an online, realtime system that integrates all front and back office functions. The system features screen input of customer account and trading information which would allow the dealer department to eliminate the paper documents currently in use. The signature of the representative introducing a customer account, required to be recorded with customer account information by rule G-8, and the signature of the principal signifying approval of each municipal securities transaction, required by rule G-27, would be performed electronically, i.e., by input in a restricted datafield. The signature of the principal approving the opening of the account, required by rule G-8, will continue to be performed manually on a printout of the customer information.[1]

Rule G-8(a)(vi) and (vii) require dealers to make and keep records for each agency and principal transaction. The records may be in the form of trading tickets or similar documents. In addition, rule G-8(a)(xi), on recordkeeping of customer account information, requires, among other things, the signature of the representative introducing the account and the principal indicating acceptance of the account to be included on the customer account record. Rule G-27(c)(ii)[*] requires, among other things, the prompt review and written approval of each transaction in municipal securities. In addition, the rule requires the regular and frequent examination of customer accounts in which municipal securities transactions are effected in order to detect and prevent irregularities and abuses. The approvals and review must be made by the designated municipal securities principal or the municipal securities sales principal. Rule G-9(e), on preservation of records, 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 Board recognizes that efficiencies would be obtained by the replacement of paper files with electronic data bases and filing systems and generally allows records to be retained in that form.[2] Moreover, as dealers increasingly automate, there will be more interest in deleting most physical records. Electronic trading tickets and automated customer account information satisfy the recordkeeping requirements of rule G-8 as long as such information is maintained in compliance with rule G-9(e).

The Board and your enforcement agency are concerned, however, that it may be difficult to verify a representative's signature on opening the account or a principal's signature approving municipal securities transactions or periodically reviewing customer accounts if the signatures are noted only electronically. Your enforcement agency has advised us of its discussions with you. Apparently, it is satisfied that appropriate security and audit procedures can be developed to permit the use of electronic signatures of representatives and principals and ensure that such signatures are verifiable. Thus, the Board has determined that rules G-8 and G-27 permit the use of electronic signatures when security and audit procedures are agreed upon by the dealer and its appropriate enforcement agency. Whatever procedures are agreed upon must be memorialized in the dealer's written supervisory procedures required by rule G-27. MSRB Interpretation of February 27, 1989.

[1] In addition, you noted in a telephone conversation that the periodic review of customer accounts required by rule G-27(c)(ii)[*] also will be handled electronically using the principal's electronic signature to signify approval.

[2] See rule G-9(e).

[*] [Currently codified at Rule G-27(c)(i)(G)(2)]

Interpretive Guidance - Interpretive Letters
Publication date:

Supervisory Structure

Supervisory structure.  This is in response to your letter of December 31, 1986 and our subsequent telephone conversation. You note that there has been a recent reorganization within your bank. As a consequence, you, as the head of the dealer department, now will report to the bank officer who also is in charge of the trust department and the bank's investment portfolio, rather than directly to the bank's president as had been the case. You ask whether this arrangement might constitute a conflict of interest under trust regulations or otherwise under Board rules.

Board rule G-27 places an obligation upon a dealer to supervise its municipal securities activities. It requires a dealer to accomplish this objective by designating individuals with supervisory responsibility for municipal securities activities and requires the dealer to adopt written supervisory procedures to this end. The rule does not specify how a dealer should structure its supervisory procedures, provided that the dealer adopts an organizational structure which meets the intent of the rule. You should review your dealer's written supervisory procedures to ensure that they provide for the appropriate delegation of supervisory responsibilities, given the reorganization within the bank.

You noted that the individual to whom you will be reporting is presently qualified as a municipal securities representative but not as a municipal securities principal. Board rule G-3(a)(i)[*] defines a municipal securities principal as an associated person of a securities firm or bank dealer who is directly engaged in the management, direction or supervision of municipal securities activities. If, under the new reorganization, this individual will be designated with day-to-day responsibility for the management, direction or supervision of the municipal securities activities of the dealer, then he must be qualified as a municipal securities principal.

Finally, trust regulations are governed by the appropriate banking law and not by Board rules. Consequently, any concerns that you may have with respect to possible conflicts of interest with trust regulations should be directed to the appropriate bank regulatory agency. MSRB interpretation of March 11, 1987.

 


 

[*] [Currently codified at rule G-3(b)(i).]

Interpretive Guidance - Interpretive Notices
Publication date:

Municipal Securities Sales Activities in Branch Affiliate and Correspondent Banks Which Are Municipal Securities Dealers

The Board has received several inquiries from banks concerning the activities which may be performed in connection with the marketing of municipal securities through branch, affiliate, and correspondent banks. Rule G-2 of the Board provides that no municipal securities dealer may effect transactions in, or induce or attempt to induce the purchase or sale of any municipal security, unless the dealer in question and every individual associated with it is qualified in accordance with the rules of the Board. Board rule G-3 establishes qualification requirements for municipal securities representatives and other municipal securities professionals. Board rule G-27 requires supervision of municipal securities activities by qualified municipal securities principals.

Activities of Branch, Affiliate and Correspondent Bank Personnel

Bank employees who are not qualified municipal securities representatives may perform certain limited functions in connection with the marketing of municipal securities. Namely, such persons may:

  • advise customers that municipal securities investment services are available in the bank;

  • make available to customers material concerning municipal securities investments, such as market letters and listings of issues handled by the bank's dealer department, which has been approved for distribution by the dealer department's municipal securities principal; and,

  • establish contact between the customer and the dealer department.

Further sales-related activity would be construed as inducing or attempting to induce the purchase or sales of a municipal security, and may only be engaged in by duly-qualified municipal securities representatives.

The Board wishes to emphasize that each bank dealer should take steps to assure that its branch, correspondent, and affiliate bank personnel understand and observe the restrictions outlined above concerning referrals of municipal securities customers to the bank's dealer department.

Placement and Supervision of Municipal Securities Representatives

Bank dealers have also directed inquiries to the federal bank regulators and to the Board concerning whether qualified municipal securities representatives in affiliates or branches of a bank dealer may respond to customer inquiries concerning municipal securities and take customer orders for municipal securities if no municipal securities principal is located in such affiliates or branches. Board rule G-27 places on each broker, dealer, and municipal securities dealer the obligation to supervise the municipal securities activities of its associated persons and the conduct of its municipal securities business. The rule requires that municipal securities dealers designate a municipal securities principal as responsible for the supervision and review of municipal securities transactions and other activities. There is no requirement that a municipal securities principal be located in each office or branch of a municipal securities dealer, provided that adequate supervision of all municipal securities activities can be assured. For purposes of the Board rules, each employee of a branch or affiliate of a bank dealer who communicates with public customers on investment opportunities in municipal securities and who takes customers' orders for such securities would be considered an "associated person" to whom the Board's qualification and supervision requirements would apply.

Interpretive Guidance - Interpretive Notices
Publication date:

Supervisory Responsibility of Municipal Securities Principals and Municipal Securities Sales Principals

The Board has received questions concerning the appropriate allocation of supervisory responsibility between municipal securities principals and the new category of municipal securities sales principals. The Board recently amended its rule G-3 to permit a person associated with a securities firm whose activities with respect to municipal securities are limited to supervising sales to and purchases from customers to qualify as a "municipal securities sales principal" ("sales principal"). The Board also amended rules G-8 on recordkeeping, G-26 on the administration of customer accounts, and G-27 on supervision to permit securities firms to designate sales principals as responsible for certain supervisory functions insofar as they relate directly to transactions in municipal securities with customers.

In particular, rule G-27 concerning supervision requires municipal securities dealers to designate at least one municipal securities principal as responsible for supervising its municipal securities activities, including the municipal securities activities of branch offices or similar locations. In addition, rule G-27 permits the municipal securities dealer to designate a sales principal (e.g., a branch office manager) as responsible for the "direct supervision of sales to and purchases from customers." The rule also requires that a dealer adopt written supervisory procedures which, among other matters, reflect the delegation of supervisory authority to these personnel.

As a result of these amendments, in designating under rule G-27 one or more municipal securities principals as responsible for supervising the business and activities of the firm’s associated persons, a securities firm may choose to designate a qualified sales principal with limited responsibility for the direct supervision of sales to and purchases from customers. If so, the firm’s written supervisory procedures may allocate responsibility to a sales principal for reviewing and approving (to the extent that they relate to sales to and purchases from customers) the suitability of the opening of, and transactions in, customer accounts, the handling of customer complaints and other correspondence, and other matters permitted by Board rule to be reviewed or approved by a sales principal. A municipal securities principal, however, must be responsible for directly supervising the firm’s other municipal securities activities such as underwriting, trading, and pricing of inventories.

With respect to the relationship between a sales principal and the designated municipal securities principal, Board rule G-27 provides that a branch office manager who acts as the sales principal for his office will be responsible for the municipal securities sales activities under his direct supervision. Rule G-27 also provides that a designated municipal securities principal will be responsible for all municipal securities activities of the branch office including those that may be under the direct supervision of a sales principal. However, the branch office manager, under the particular organizational structure of a firm, may be responsible to some other designated supervisor for the discharge of his other duties.

Interpretive Guidance - Interpretive Notices
Publication date:

Approval of Fair Practice Rules

Rule D-11 is designed to eliminate the need to make specific reference to personnel of securities firms and bank dealers in each Board rule that applies both to the organization and its personnel.

The term “associated person” in rule D-11 has the same meaning as set forth in section 3(a)(18) and 3(a)(32) of the Act, except that clerical and ministerial personnel are excluded from the definition for purposes of the Board’s rules, unless otherwise specified. Although the statutory definitions of associated persons include individuals and organizations in a control relationship with the securities professional, the context of the fair practice rules indicates that such rules will ordinarily not apply to persons who are associated with securities firms and bank deal- ers solely by reason of a control relationship.