MSRB Reports Feb. 1998 -- Consultants: Rule G-38

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Amendments Filed

The Board has filed amendments to rule G-38, on consultants, that would give dealers the option of disclosing their consulting arrangements to issuers, pursuant to section (c) of the rule, on either an issue-specific or issuer-specific basis.

On November 24, 1997, the Board filed with the Securities and Exchange Commission (SEC) proposed amendments to rule G-38, on consultants.⁽¹⁾ The proposed amendments would give dealers the option of disclosing their consulting arrangements to issuers, pursuant to section (c) of the rule, on either an issue-specific of issuer-specific basis.

Rule G-38, on consultants, requires broker, dealers and municipal securities dealers (collectively referred to as "dealers"): (1) to have written agreements with certain individuals who are used by a dealer, directly or indirectly, to obtain or retain municipal securities business (consultants), and (2) to disclose such consulting arrangements directly to issuers and to the public through disclosure to the Board. Section (c) of the rule currently requires that each dealer disclose, in writing, to each issuer with which the dealer is engaging or is seeking to engage in municipal securities business, information on consulting arrangements relating to such issuer. The information to be disclosed includes the name, company, role and compensation arrangement of any consultant used, directly or indirectly, to obtain or retain municipal securities business with each such issuer. Dealers are required to make such disclosures prior to the issuer's selection of any dealer in connection with the particular municipal securities business sought.

It has come to the Board's attention that this issue-specific nature of the disclosure requirement can create compliance problems for dealers in the case of frequent issuers of municipal securities as well as in the co-manager selection process. For example, an issuer may bring new issues to market several times a month, and if a dealer is using a consultant to obtain a syndicate slot in each such issue, the dealer is required to disclose the same information to the same issuer month after month and possibly week after week. In addition, the Board has learned that dealers who use a consultant to help obtain co-manager business sometimes have difficulty complying with rule G-38(c) because, unlike the lead manager, a co-manager may learn of its selection for that business after the selection of the lead manager, thereby making it impossible for the dealer to disclose its consulting arrangements prior to the issuer's selection of any dealer, as required by the rule.

While the Board believes that the timing of the issue-specific disclosure requirement in rule G-38(c) is appropriate in the vast majority of cases, the Board recognizes that it can be a problem in the context of frequent issuers of municipal securities and in the co-manager selection process. Thus, the Board has determined to amend rule G-38(c) to give dealers the option of disclosing their consulting arrangements to issuers on either an issue-specific or issuer-specific basis. Pursuant to the proposed amendments, if a dealer chooses to disclose information regarding a consulting arrangement on an issuer-specific basis, the dealer must submit the information, in writing, to the issuer within three business days of the consultant's first direct or indirect communication with that issuer, but in any event prior to the issuer's selection of that dealer for any municipal securities business.⁽²⁾ To ensure that such information, once disclosed, remains current, the amendments also require dealers to (1) promptly notify the issuer in writing of any change in the information disclosed; and (2) update issuers on an annual basis concerning any information previously disclosed, even where the information has not changed.⁽³⁾ Of course, this annual updating requirement would cease to apply if the dealer is no longer using the consultant, directly or indirectly, to attempt to obtain or retain municipal securities business with a particular issuer(s).

In June, the Board published the amendments for industry comment.⁽⁴⁾ In response, the Board received comment letters from three dealers. One of these commentators expressed its belief that the amendments are helpful and may simplify the reporting process. The other two commentators also supported the draft amendments. One commentator stated that "the proposed changes will greatly simplify the disclosure process when multiple transactions develop as the result of a consultant's activities with an issuer." However, this commentator recommended that the draft amendments require dealers to advise the issuer of any material change in the information disclosed; the commentator believes that this will obviate the need for dealers to file amended disclosure reports relating to, for example, an insignificant change to a consultant's role or to a minor change in the name of the consultant's organization. The Board believes that adopting the commentator's recommendation would introduce a subjective element to the disclosure requirement and would result in differing interpretations as to what is "material." For example, by incorporating this subjective standard, the Board could not ensure that issuers would be advised of changes in the consultant's name, company, role and compensation arrangement--information which is required to be disclosed to issuers pursuant to rule G-38(c). Thus, the Board has declined to adopt the commentator's recommendation.

(c) Disclosure to Issuers. Each broker, dealer or municipal securities dealer shall submit in writing to each issuer with which the broker, dealer or municipal securities dealer is engaging or seeking to engage in municipal securities business, information on consulting arrangements relating to such issuer, which information shall include the name, company, role and compensation arrangement of any consultant used, directly or indirectly, by the broker, dealer or municipal securities dealer to attempt to obtain or retain municipal securities business with each such issuer. Such information shall be submitted to the issuer either:

(i) prior to the selection of any broker, dealer or municipal securities dealer in connection with ~~such~~ the particular municipal securities business being sought. ; or

(ii) within three business days of the consultant's first direct or indirect communication with the issuer, but in any event prior to the issuer's selection of such broker, dealer or municipal securities dealer for any municipal securities business. Each broker, dealer or municipal securities dealer shall promptly advise the issuer, in writing, of any change in the information disclosed, pursuant to this subsection (ii), on each consulting arrangement relating to such issuer. In addition, each broker, dealer or municipal securities dealer disclosing information pursuant to this subsection (ii) shall update such information by notifying each issuer in writing within one year of the previous disclosure made to such issuer even where the information has not changed; provided, however, that this annual requirement shall not apply where the broker, dealer or municipal securities dealer has ceased to use the consultant, directly or indirectly, to attempt to obtain or retain municipal securities business with the particular issuer.

1. File No. SR-MSRB-97-9. Comments submitted to the SEC should refer to this file number.

2. In contrast, the Board believes that disclosures made by a dealer on an issue-specific basis should continue to be required prior to the issuer's selection of any dealer for the particular municipal securities business being sought.

3. Pursuant to rule G-8(a)(xvii) on recordkeeping, dealers are required to maintain records of all disclosures made pursuant to rule G-38(c). This would apply to disclosures made pursuant to the amendment.