REQUEST FOR COMMENTS COMMENTS DUE BY SEPTEMBER 17, 2001
| Municipal Fund Securities—Qualification of Municipal Securities
Principals and Application of MSRB Rules to Fees, Disclosure and Other Market
Practices
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Notice of Filing and Comments RequestedThe MSRB is filing a rule change with the SEC to provide a temporary alternative method for qualification of municipal securities principals in connection with municipal fund securities. In addition, the MSRB is providing guidance and requesting comments on the application of MSRB rules to fees, disclosure and other market practices relating to municipal fund securities.. |
Comments should be submitted no later than September 17, 2001 and may be directed to Ernesto A. Lanza, Senior Associate General Counsel, or Jill C. Finder, Assistant General Counsel. Written comments will be available for public inspection.
Since 1998, the Municipal Securities Rulemaking Board (“MSRB”) has been reviewing the application of its rules to transactions in municipal fund securities by brokers, dealers and municipal securities dealers (“dealers”).[1] A municipal fund security is defined in rule D-12 as a municipal security issued by an issuer that, but for the application of Section 2(b) of the Investment Company Act of 1940 (the “Investment Company Act”), would constitute an investment company thereunder.[2] In view of the unique characteristics of municipal fund securities, the MSRB adopted a series of amendments to its existing rules and issued an interpretive notice regarding the sale of municipal fund securities in the primary market.[3] These amendments and notice became effective on January 18, 2001.
The MSRB has received inquiries regarding the disclosure of fees and other charges relating to municipal fund securities, particularly in connection with sales of interests in so-called Section 529 college savings plans.[4] In addition, in the course of its review of market practices in this area, the MSRB has learned that, in some cases, a dealer that has been engaged by an issuer of municipal fund securities to serve as its primary distributor (“primary distributor”) has in turn entered into relationships with one or more other dealers to provide further channels for distribution (“selling dealers”). A significant number of the selling dealers that have or are seeking to become involved in these multi-tiered distribution systems may be new to the municipal securities market, having previously limited their activities to sales of investment company and annuity products.[5] Further, many of these dealers are quite small, having a limited number of associated persons who may be qualified solely as investment company/variable contracts limited representatives and investment company/variable contracts limited principals.[6] Such multi-tiered distribution systems may raise issues under various MSRB rules.
In this notice, the MSRB reviews the professional qualification difficulties faced by small firms new to the municipal securities market and describes an amendment to rule G-3 designed to provide a temporary alternative method for qualification of municipal securities principals in connection with municipal fund securities. In addition, this notice provides guidance on certain rule provisions as they apply to municipal fund securities and seeks comment on various other issues regarding municipal fund securities. The MSRB seeks to clarify existing standards applicable to fees and other charges imposed by dealers, as well as the standards relating to disclosure to customers of such fees and charges of various parties involved with the issuance and sale of municipal fund securities. Guidance also is provided with respect to the submission to the MSRB of official statements for municipal fund securities by dealers acting as primary distributors. Further, the MSRB seeks comment regarding the scope of the definition “municipal securities business” under rules G-37 and G-38 with respect to sales of municipal fund securities. Finally, the MSRB seeks comment on the capacity in which dealers act with respect to sales of municipal fund securities, the structure of transactions where multiple layers of selling dealers have been established, and certain other customer protection and operational issues.
QUALIFICATION OF MUNICIPAL SECURITIES PRINCIPALS
Rule G-3, on professional qualification, permits an investment company/variable contracts limited representative to qualify as a municipal securities representative, but only in connection with transactions in municipal fund securities.[7] In addition, a dealer must have at least one municipal securities principal (and in some cases two municipal securities principals), even if the dealer’s only municipal securities transactions are sales of municipal fund securities. The MSRB has received a number of inquiries from small dealers that wish to begin selling municipal fund securities but that have previously limited their practice to the sales of investment company securities or variable annuities. These small dealers generally do not have personnel who are qualified as municipal securities principals under rule G-3 and therefore face a significant barrier to entry in this sector precisely at a time when many municipal fund securities programs are structuring their distribution channels.
A dealer that does not currently have a municipal securities principal associated with it may hire a municipal securities principal or may have one of its existing municipal securities representatives, general securities representatives or general securities principals become qualified as a municipal securities principal by taking and passing the Municipal Securities Principal Qualification Examination.[8] The MSRB is concerned that the burden to undertake either course of action may be higher for smaller firms than for larger firms. Of course, this differential also exists for firms seeking to enter the traditional debt sector of the municipal securities market. However, the repercussions of this higher burden on small firms may be considerably greater in the context of a market, such as the Section 529 college savings plan market, that is still in its formative stages and where long-term market advantages may accrue to firms that are able to enter the market more quickly.
As a result, the MSRB has filed with the Securities and Exchange Commission a rule change providing a temporary alternative method for qualification of municipal securities principals in connection with municipal fund securities.[9] Under the rule change, until July 31, 2002, if a dealer’s municipal securities activities are limited exclusively to municipal fund securities and the dealer has fewer than 11 associated persons engaged in such municipal fund securities activities, it may fulfill its obligation to have a municipal securities principal by designating a general securities principal or investment company/variable contracts limited principal to act as a municipal fund securities limited principal.[10] During this temporary period, any person designated as a municipal fund securities limited principal will have all of the powers and responsibilities of a municipal securities principal under MSRB rules with respect to transactions in municipal fund securities. If at any time during this temporary period the dealer effects any transactions in municipal securities other than municipal fund securities, the dealer will be required to have a fully qualified municipal securities principal (i.e., a municipal securities principal not qualified solely by reason of being a general securities principal or investment company/variable contracts limited principal). On and after August 1, 2002, dealers effecting transactions in municipal fund securities will be required to comply with the same municipal securities principal requirements applicable to all other dealers effecting transactions in municipal securities. Dealers are advised to take all steps necessary in a timely manner to ensure full compliance with the normal municipal securities principal requirements on and after August 1, 2002.
COMMISSIONS AND OTHER PROGRAM FEES
The nature of the commissions and other program fees that may exist with respect to municipal fund securities may differ significantly from such charges that typically may exist for traditional debt securities sold in the municipal securities market. In many cases, commissions and other fees may more closely resemble those charged in connection with registered investment company securities. Although commissions and fees charged by dealers effecting transactions in municipal fund securities are subject to MSRB rules, the nature and level of fees and charges collected by other parties in connection with such securities generally are not subject to regulation. However, under certain circumstances, a dealer selling municipal fund securities may be obligated to disclose to customers such fees and charges collected by other parties. The MSRB believes that the discussion below regarding a dealer’s commissions and fees and other program fees and charges will provide guidance to dealers effecting transactions in municipal fund securities. The MSRB seeks comment on all aspects of this guidance.
Dealer’s Commissions and Fees
Rule G-30(b), on prices and commissions in agency transactions, prohibits dealers from selling municipal securities to a customer for a commission or service charge in excess of a fair and reasonable amount. In assessing the fairness and reasonableness of the commission or service charge, the rule permits the dealer to take into consideration all relevant factors, including the availability of the securities involved in the transaction, the expense of executing or filling the customer’s order, the value of the services rendered by the dealer, and the amount of any other compensation received or to be received by the dealer in connection with the transaction.[11] The MSRB has received inquiries as to whether the sales charge schedule set out in Rule 2830 of the National Association of Securities Dealers, Inc. (“NASD”) applies to or otherwise is indicative of the levels of commissions and other fees that dealers may charge in connection with sales of municipal fund securities.
The MSRB notes that its rules, not those of the NASD, apply to sales by dealers of municipal securities, including municipal fund securities. NASD Rule 2830 provides that no member firm may offer or sell shares in investment companies registered under the Investment Company Act if the sales charges are excessive. The rule then sets forth various levels of aggregate sales charges to which member firms must conform, depending upon the nature of the investment company’s sales charges, in order to ensure that such sales charges are not deemed excessive. Although the charges permitted by the NASD under its Rule 2830 in connection with the sale of registered investment company securities may, depending upon the facts and circumstances, provide some relevant information in determining whether a dealer selling municipal fund securities is charging a commission or other fee that is fair and reasonable, the NASD schedule is by no means dispositive nor is it the principal factor in determining compliance with rule G-30.[12]
Rule G-15, on confirmation, clearance and settlement of transactions with customers, and rule G-32, on disclosures in connection with new issues, specifically set forth certain obligations of dealers to disclose fees and other charges received in connection with municipal securities transactions, including transactions in municipal fund securities. Under rule G-15(a)(i)(A)(6), a dealer must disclose on the transaction confirmation (or in a periodic statement in lieu of the confirmation pursuant to rule G-15(a)(viii)) the nature and amount of any miscellaneous fees charged in connection with the transaction as well as the amount of any remuneration received or to be received by the dealer from the customer unless the remuneration is not on a transaction basis. Under rule G-15(a)(i)(A)(1)(e), customer remuneration would include any discount received resulting from the acquisition by the dealer of the security at a discount and sold to the customer at a net price. Subsection (a)(i)(A)(1)(e) also requires that the dealer disclose on the confirmation or periodic statement either the source and amount of any remuneration paid by any person other than the customer in connection with the transaction or a statement to the effect that such remuneration has been paid and information regarding the source and amount of such payment will be provided upon written request. Finally, rule G-15(a)(i)(D)(3) requires that the confirmation for securities for which a deferred commission or other charge is imposed upon redemption disclose that the customer may be required to make such deferred payment and information concerning the deferred commission or charge will be furnished upon written request.
Furthermore, under rule G-32(a)(ii), a dealer selling a municipal fund security is required to disclose to the customer, by settlement, any underwriting spread as well as the amount of any fee received by the dealer as agent for the issuer in the distribution of the securities.[13] However, if the dealer provides periodic statements under rule G-15(a)(viii) in lieu of individual transaction confirmations, the dealer may instead provide information regarding such agency fee to the customer at least annually and information regarding any change in such fee on or prior to the sending of the next succeeding periodic statement to the customer.
Other Program Fees and Charges
MSRB rules do not explicitly require disclosure by dealers of fees and charges received by other parties to a transaction. These can include, among other things, administrative fees of the issuer, investment adviser and other parties payable from trust assets or directly by the customer. However, depending upon the facts and circumstances, certain MSRB rules may have the practical effect of requiring some level of disclosure of such fees and charges to the extent that they are material. For example, rule G-32(a)(i) generally obligates the dealer to provide an official statement to its customer in connection with sales of municipal fund securities.[14] Although MSRB rules do not govern the content of the disclosures included by the issuer in the official statement, the MSRB believes that an official statement prepared by an issuer of municipal fund securities that is in compliance with Exchange Act Rules 10b-5 and 15c2-12 generally would provide disclosure of any fees or other charges imposed in connection with such securities that are material to investors. The MSRB further believes that, in most respects, the disclosures provided by the issuer in the official statement would provide the dealer with the type of information it is required to disclose to customers under the MSRB’s fair dealing rule, rule G-17.
In addition, where the dealer is publishing or otherwise distributing advertisements in connection with sales of municipal fund securities, the dealer must comply with the requirements of rule G-21.[15] This rule prohibits dealers from publishing advertisements concerning municipal securities which they know or have reason to know are materially false or misleading. The MSRB has previously stated that any use of historical yields in an advertisement would be subject to this prohibition. Thus, a dealer advertisement of municipal fund securities that refers to yield typically would require a description of the nature and significance of the yield shown in the advertisement in order to assure that such advertisement is not false or misleading.[16] Further, depending upon the facts and circumstances, a dealer may be required to disclose information regarding a fee or other charge relating to municipal fund securities that may have a material effect on such advertised yield, to the extent that such disclosure is necessary to ensure that the advertisement is not materially false or misleading with respect to such yield.
SUBMISSION OF OFFICIAL STATEMENTS TO THE MSRB
The MSRB has previously stated that dealers selling municipal fund securities are subject to the requirement under rule G-36 that they submit copies of the official statement, together with completed Form G-36(OS), to the MSRB.[17] The MSRB believes that, regardless of whether a formal syndicate or similar account has been formed among a primary distributor and the selling dealers in a multi-tiered distribution system for a particular offering of municipal fund securities, the primary distributor for such offering has the responsibility set forth in rule G-36(f) to undertake all actions required under the provisions of rule G-36 and the corresponding recordkeeping requirements under rule G-8(a)(xv). These obligations include, but are not limited to, the submission of official statements (including amendments and up-dates) and completed Form G-36(OS) to the MSRB on a timely basis. The MSRB further believes that any selling dealers for such offering that might be considered underwriters of the securities may rely upon the primary distributor to undertake these actions to the same extent as if they had in fact formed an underwriting syndicate as described in rule G-36(f).
To assist dealers in completing and submitting Form G-36(OS) to the MSRB in connection with offerings of municipal fund securities, the MSRB has prepared a supplement to the Form G-36 Manual setting forth instructions for completion of certain items appearing on Form G-36(OS) for such offerings.[18] Dealers are urged to refer to the supplement whenever submitting official statements for municipal fund securities programs to the MSRB.
MUNICIPAL SECURITIES BUSINESS UNDER RULES G-37 AND G-38
The MSRB has previously stated that a dealer’s transactions in municipal fund securities may affect such dealer’s obligations under rule G-37, on political contributions and prohibitions on municipal securities business, and rule G-38, on consultants.[19] The MSRB noted in particular that the definition of “municipal securities business” under those rules includes the purchase of a primary offering from the issuer on other than a competitive bid basis or the offer or sale of a primary offering on behalf of any issuer. The MSRB believes that, absent unusual circumstances, the primary distributor of municipal fund securities should be considered to be engaged in municipal securities business for purposes of rules G-37 and G-38. The question arises, however, in the case of a multi-tiered distribution system of whether the selling dealers also should be considered to be engaged in municipal securities business.
In certain question and answer notices, the MSRB has provided that, for purposes of rules G-37 and G-38, dealers that are syndicate members for a particular offering of municipal debt securities should report such offering as municipal securities business but that dealers that are selling group members are not considered to be engaged in municipal securities business.[20] The MSRB has not previously provided guidance as to what factors differentiate a syndicate member from a selling group member. However, the MSRB currently is seeking comment on this question.[21] In summary, the MSRB is seeking the views of industry participants as to whether these roles should be distinguished based on the nature of the contractual relationships among the dealers and the issuer or on whether a particular firm meets (or is excepted from) the definition of “underwriter” in Exchange Act Rule 15c2-12. Of course, a dealer that would be considered a selling group member under both of these formulations with respect to a particular offering, including an offering of municipal fund securities, can be assured that it is not considered to be engaged in municipal securities business for purposes of rules G-37 and G-38.
The determination of whether a dealer is engaging in municipal securities business is important for purposes of making full and proper disclosure of such business on Form G-37/G-38 submitted to the MSRB on a quarterly basis and for ensuring that the dealer does not violate the ban on municipal securities business that may arise under rule G-37 as a result of a contribution. However, regardless of whether a dealer that effects transactions in municipal fund securities is considered to be engaged in municipal securities business for purposes of rules G-37 and G-38, such dealer nonetheless generally is subject to the reporting requirements of the rules and the related recordkeeping requirements set forth in rule G-8(a)(xvi) and (xviii). Thus, the dealer must determine whether any of its associated persons are municipal finance professionals or non-MFP executive officers, or whether any other person is a consultant of the dealer.[22] The dealer must collect the requisite information regarding contributions to issuer officials and payments to state or local political parties made by the dealer, its municipal finance professionals, any political action committees controlled by the dealer or municipal finance professionals or non-MFP executive officers and report any such reportable contributions and payments to the MSRB on Form G-37/G-38 on a quarterly basis. A dealer that determines that it is not engaging in municipal securities business and has not done so for a period of at least two years may, however, submit Form G-37x to the MSRB and thereby become exempt from most of the requirements of rule G-37 and the related recordkeeping requirements of rule G-8.
CAPACITY OF DEALER
The MSRB understands that sales of municipal fund securities currently are made primarily, if not exclusively, on an agency basis. The MSRB seeks comment on whether its understanding of the capacity in which dealers undertake transactions in municipal fund securities is accurate. If not, the MSRB would be interested in information as to the circumstances in which such transactions are undertaken in a principal (including “riskless principal”) capacity.
In particular, the MSRB seeks comment from industry participants on their views as to the capacity in which primary distributors and selling dealers in multi-tiered distribution systems effect transactions in municipal fund securities. Does a customer acquiring a municipal fund security through a selling dealer in a multi-tiered distribution system purchase the security from the selling dealer as a principal? Or does the selling dealer, as agent, effect a transaction between the customer and the primary distributor? Or between the customer and the issuer? Or is the selling dealer merely a finder, with the transaction being effected between the customer and the primary distributor, as principal, or between the customer and the issuer, with the primary distributor acting as agent? Resolution of the status of the various parties to a transaction is crucial in determining which dealer has the customer protection obligations imposed under various MSRB rules, including but not limited to rule G-19, on suitability of recommendations and transactions.
Furthermore, are there circumstances in which inter-dealer trades in municipal fund securities occur, particularly in a multi-tiered distribution system? If so, would any aspects of such transactions conflict with the provisions of rule G-12, on uniform practice? Rule G-12 provides, among other things, that any inter-dealer transaction eligible for automated trade comparison through a registered clearing agency must be compared through such an agency and any inter-dealer transaction eligible for book-entry settlement at a registered securities depository must be settled through one or more such depositories. Would application of these provisions alter the way inter-dealer municipal fund securities transactions may currently be handled?
If an inter-dealer transaction is eligible for automated comparison by National Securities Clearing Corporation (“NSCC”), then such transaction also must be reported to NSCC in accordance with rule G-14, on reports of sales or purchases. Municipal fund securities transactions with customers have previously been exempted from the customer transaction reporting requirements of rule G-14. Is an explicit exemption from the inter-dealer transaction reporting requirements of rule G-14 needed? Or, conversely, should such transactions be made subject to the inter-dealer reporting requirement, and should the MSRB revisit its prior decision to exempt customer transactions in municipal fund securities from transaction reporting?
An inter-dealer transaction that is ineligible for automated trade comparison through a registered clearing agency must be confirmed as provided in rule G-12. Because inter-dealer transactions in municipal fund securities were believed by the MSRB not to exist at the time it amended rule G-15 to provide for confirmation of municipal fund securities transactions with customers, comparable provisions of the rule G-12 inter-dealer confirmation requirements were not similarly amended. Does the MSRB need to revisit this decision in light of the development of multi-tiered distribution systems?
·July 11, 2001
TEXT OF AMENDMENT[23]
Rule G-3. Classification of Principals and Representatives; Numerical Requirements; Testing; Continuing Education Requirements
(a) No change.
(b) Municipal Securities Principal.
(i)-(iii) No change.
(iv) Temporary Provisions for Municipal Fund Securities Limited Principal. Until July 31, 2002, the following provisions shall apply to any broker, dealer or municipal securities dealer whose municipal securities activities are limited exclusively to municipal fund securities:
(A) notwithstanding the provisions of paragraph (b)(ii), the broker, dealer or municipal securities dealer may designate any person who has taken and passed the General Securities Principal Qualification Examination or Investment Company and Annuity Principal Qualification Examination as a municipal fund securities limited principal.
(B) any municipal fund securities limited principal designated as provided in subparagraph (b)(iv)(A) may undertake all actions required or permitted under any Board rule to be taken by a municipal securities principal.
(C) the broker, dealer or municipal securities dealer may count one municipal fund securities limited principal toward the numerical requirement for municipal securities principal set forth in paragraph (b)(iii); provided that, if such broker, dealer or municipal securities dealer is only required to have one municipal securities principal, such broker, dealer, or municipal securities dealer may count one municipal fund securities limited principal toward the numerical requirement only if the broker, dealer or municipal securities dealer is described in subparagraph (b)(iii)(B).
(c)-(h) No change.
* * * * *
Supplement to
FORM G-36 MANUAL
Relating to
Municipal Fund Securities
(July 5, 2001)
The MSRB understands that municipal fund securities generally are sold in a continuous primary offering with no single date of delivery by the issuer of the securities to the underwriters. Thus, the MSRB believes that the offering continuously remains in its underwriting period. It follows that the initial official statement[24] prepared in connection with an issuer’s offering of municipal fund securities should be treated as the final official statement for purposes of rule G-36(b)(i) and that any subsequent new, amended, revised or updated official statement for such securities should be treated as an amended official statement for purposes of rule G-36(d), regardless of how much time has elapsed since the submission to the MSRB of the initial official statement.
In completing Form G-36(OS), underwriters should follow the detailed instructions set forth on pages 7 through 12 of the Form G-36 Manual, as supplemented below.
Section I – Materials Submitted
Item A Box 1 should be checked for submissions of an initial official statement, with the appropriate dates included under (a) and (b).
Box 2 should be checked for submissions of any new, amended, revised or updated official statement submitted subsequent to the initial official statement, with the appropriate dates included under (a) and (b).
Section II – Identification of Issue(s)
Dated Date Enter “MFS” (for municipal fund securities) – municipal fund securities do not have dated dates.
Section III – Transaction Information
Item A Enter “MFS” – municipal fund securities do not have a final maturity.
Item C Enter “MFS” – municipal fund securities are continuously delivered.
Section IV – Underwriting Assessment Information
Item B Enter “MFS” – municipal fund securities do not have par value and generally are not limited in the amount issued.
Item D Boxes need not be checked, even if one or more applies.
Section V – CUSIP Information
Items A & B CUSIP numbers are not required for municipal fund securities. However, if any CUSIP numbers are obtained, they should be listed. If any 9-digit CUSIP numbers are obtained, they should be listed in Item A. If only 6-digit (root) CUSIP numbers are obtained, they should be listed in Item B, the box should be checked and “MFS” should be entered as the explanation for no CUSIP-9 numbers.
Item C If no CUSIP numbers are obtained, even if the municipal fund securities are eligible for CUSIP number assignment, check the box and enter “MFS” as the explanation for no CUSIP numbers.