[Federal Register Volume 59, Number 14 (Friday, January 21, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-1454]


[[Page Unknown]]

[Federal Register: January 21, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33482; File No. SR-MSRB-94-02]

 

Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Municipal Securities Rulemaking Board Relating to 
Political Contributions and Prohibitions on Municipal Securities 
Business

January 14, 1994.
    On January 12, 1994, the Municipal Securities Rulemaking board 
(``Board'' or ``MSRB'') filed with the Securities and Exchange 
Commission (``Commission'' or ``SEC'') a proposed rule change (File No. 
SR-MSRB-94-2), pursuant to Section 19(b)(1) of the Securities Exchange 
Act of 1934 (``Act''), 15 U.S.C. 78s(b)(1), and Rule 19b-4 thereunder. 
The MSRB filed the proposal to adopt rules relating to political 
contributions and prohibitions on municipal securities business. The 
proposed rule change is described in Items I, II, and III below, which 
Items have been prepared by the Board. The Commission is publishing 
this notice to solicit comments on the proposed rule change from 
interested people.
    Comments should be filed by February 11, 1994. The Commission 
encourages interested persons to file their views promptly, recognizing 
the statutory timeframe described in Section III below. The role of 
political contributions in the municipal securities market and the 
integrity of the underwriting process has been a matter of concern to 
the MSRB for several years and has been the subject of extensive public 
debate, even before the MSRB released its draft proposal in August 
1993.

I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Board is filing herewith proposed rule G-37 regarding political 
contributions and prohibitions on municipal securities business, and 
proposed amendments to existing rules G-8 and G-9 on recordkeeping and 
record retention, respectively.
    Proposed rule G-37 would prohibit brokers, dealers and municipal 
securities dealers (hereafter referred to as ``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 (``PAC'') controlled by the dealer 
or any municipal finance professional. The prohibition on business 
would arise from contributions made on or after April 1, 1994. There is 
one exception to this prohibition: contributions made by municipal 
finance professionals to officials of issuers would not invoke 
application of the prohibition on business, but only if the municipal 
finance professional is entitled to vote for such official and provided 
any contributions by such municipal finance professional do not exceed, 
in total, $250 to each official, per election.
    Proposed rule G-37 also would require dealers to disclose to the 
Board certain political contributions, as well as other summary 
information, to allow public scrutiny of political contributions and 
the municipal securities business of a dealer. Contributions to be 
reported would include those to officials of issuers and political 
parties of states and political subdivisions made by the dealer, any 
municipal finance professional, any executive officer, and any PAC 
controlled by the dealer or by any municipal finance professional. Only 
such contributions, over a de minimis amount, by municipal finance 
professionals and executive officers would be disclosed. The names of 
individual municipal finance professionals and executive officers would 
not be disclosed. Such reports also would include a list of issuers 
with which the dealer has engaged in municipal securities business 
during the reporting period, along with the type of municipal 
securities business and the name, company, role and compensation 
arrangement of any person employed by the dealer to obtain or retain 
municipal securities business with such issuers. The reports would be 
made on proposed Form G-37 and would be submitted to the board in 
accordance with rule G-37 filing procedures, quarterly, with due dates 
determined by the Board.
    The proposed amendment to rule G-8 would require a dealer to 
maintain a list of: (i) Names, titles, city/county and state of 
residence of every municipal finance professional; (ii) names, titles, 
city/county and state of residence of all executive officers; (iii) the 
states in which the dealer is engaging or is seeking to engage in 
municipal securities business; (iv) every issuer with which municipal 
securities business has been conducted during the current year, as well 
as the previous two years and, where applicable, the name, company, 
role and compensation arrangement of any person employed by the dealer 
to obtain or retain municipal securities business with such issuer; and 
(v) all contributions, direct or indirect, to officials of issuers and 
to political parties of states and political subdivisions made by the 
dealer, any dealer-controlled PAC, any municipal finance professional 
or executive officer. The dealer would not, however, be required to 
maintain a list of contributions by its municipal finance professionals 
or executive officers that are made: (i) To officials for whom the 
person is entitled to vote, provided such contributions do not exceed 
$250 to each issuer official, per election; and (ii) to political 
parties for the state and political subdivision in which the person is 
entitled to vote, provided such contributions do not exceed $250 per 
party, per year. In addition, dealers would not be required to maintain 
a list of contributions by any other employees, affiliate companies and 
their employees, spouses of covered employees, or any other person or 
entity unless the contributions were directed by persons or entities 
subject to proposed rule G-37. The required records pursuant to the 
proposed amendment to rule G-8 would not have to be maintained for 
contributions made or business engaged in prior to April 1, 1994.
    The proposed amendment to rule G-9 would require dealers to 
maintain, for a six-year period, those records required pursuant to the 
proposed amendment to rule G-8.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Board included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Board has prepared summaries, set forth in Sections 
(A), (B), and (C) below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    (a) Over the last few years, the Board has become increasingly 
concerned about the opportunity for abuses and the problems associated 
with political contributions in connection with the awarding of 
municipal securities business. The Board believes, based on comment 
letters and other information, that there have been numerous instances 
in which dealers have been awarded municipal securities business based 
on their political contributions. Even where such improprieties have 
not transpired, political contributions create a potential conflict of 
interest for issuers, or at the very least the appearance of a 
conflict, when dealers make contributions to officials responsible for, 
or capable of influencing the outcome of, the awarding of municipal 
securities business and then are awarded business by issuers associated 
with these officials. The problems associated with political 
contributions undermine investor confidence in the municipal securities 
market, which is crucial to the long-term health of the market, both in 
terms of liquidity and capital-raising ability. In addition, in order 
to promote just and equitable principles of trade, the awarding of 
business should be based on merit, and not on political contributions. 
The payment of such contributions to obtain business creates artificial 
barriers to those dealers not willing or able to make such payments, 
thereby harming investors and the public interest by stifling 
competition and increasing market costs associated with doing municipal 
securities business. Accordingly, the Board has determined that 
regulatory action is necessary, among other things, to protect 
investors and maintain the integrity of the market.
Background
    The Board has monitored and discussed the issues surrounding 
political contributions since its November 1990 meeting. In August 
1991, the Board published a notice expressing its concern that the 
process of selecting an underwriting team not be influenced by 
political contributions. The Board stated that it is critical that the 
market engender the highest degree of public confidence so that 
investors will provide much needed capital to state and local 
governments. Toward this end, the Board encouraged underwriters and 
state and local governments to maintain the integrity of the 
underwriter selection process. In May 1993, the Board published a press 
release noting continuing concern by the Board, industry members and 
others regarding political contributions. The Board indicated that it 
planned to review its authority and options for rulemaking in this 
area.
    In August 1993, the Board published for comment draft rule G-37 
(``August 1993 draft rule''), which would have (1) prohibited brokers, 
dealers and municipal securities dealers (``dealers'') and their 
associated persons from making political contributions, directly or 
indirectly, to officials of issuers for the purpose of obtaining or 
retaining municipal securities business, and (2) required dealers and 
their associated persons to disclose, for a four-year period, all 
political contributions to officials of such issuers with whom they 
have done business. The Board also requested comments on draft 
amendments to rule G-8 and G-9, on recordkeeping and record retention, 
respectively, requiring the recording of information regarding certain 
political contributions. The vast majority of commentators supported 
the Board's efforts to alleviate the problems, both actual and 
potential, associated with political contributions, and thereby 
maintain the integrity of the market and protect investors and the 
public interest. However, none gave unqualified support for the August 
1993 draft rule; every commentator suggested modifications. At its 
November and December 1993 meetings, the Board carefully considered the 
commentators' concerns and suggestions, and adopted the proposed rule 
change. The Board believes that the proposed rule change effectively 
addresses the problems of political contributions and the awarding of 
municipal securities business.
General Prohibition on Engaging in Municipal Securities Business
    Proposed rule G-37 would prohibit any dealer 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 (``PAC'') controlled by the dealer 
or any municipal finance professional. One exception to this 
prohibition is discussed below.
    The proposed rule change is not a ban on political contributions--
it is a ban on engaging in municipal securities business with an issuer 
after certain contributions are made to officials of such issuer. The 
term ``municipal securities business'' is defined in the proposed rule 
to encompass certain activities of dealers, such as acting as 
negotiated underwriters (as managing underwriter or as syndicate 
member), financial advisors and consultants, placement agents, and 
negotiated remarketing agents.\1\ Thus, a dealer could not provide any 
of these services to an issuer within two years after the dealer, any 
dealer-controlled PAC or any municipal finance professional made 
contributions to an official of such issuer. This prohibition on 
business also would result if a municipal finance professional 
associated with a dealer made such a contribution prior to becoming 
associated with the dealer (i.e., the two-year ban on business applies 
to both the current and prior employer of the municipal finance 
professional). This is intended to prohibit the new employer from 
obtaining municipal securities business based on prior contributions by 
its municipal finance professionals.
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    \1\The proposed rule would not prohibit dealers from acting as 
competitive underwriters or competitive remarketing agents.
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    The prohibitions on business under the rule arise from 
contributions made on or after April 1, 1994. This date was set so that 
dealers could begin to monitor those political contributions that may 
subject them to restrictions on engaging in municipal securities 
business.
    An ``official of an issuer'' is defined as any incumbent, candidate 
or successful candidate for elective office of the issuer, which office 
is directly or indirectly responsible for, or can influence the outcome 
of, the hiring of a dealer for municipal securities business. The 
definition includes any issuer official or candidate (or successful 
candidate) who has influence over the awarding of municipal securities 
business so that contributions to certain state-wide executive or 
legislative officials (e.g., governors) would be included within the 
proposed rule change's prohibition on engaging in municipal securities 
business.
    ``Contributions'' which invoke application of the prohibition 
include any gift, subscription, loan, advance, or deposit of money or 
anything of value made: (i) For the purpose of influencing any election 
for federal, state,\2\ or local office; (ii) for payment or reduction 
of debt incurred in connection with any such election; or (iii) for 
transition or inaugural expenses incurred by the successful candidate 
for state or local office. The Board has decided to include all such 
payments within the parameters of proposed rule G-37 because of concern 
that such types of payments, in the past, have or may have been 
connected to the awarding of municipal securities business. The Board 
believes that the proposed rule's definition of contribution will cover 
all circumstances in which political contributions are made to state 
and local issuer officials and candidates who can influence the 
awarding of municipal securities business, both before and after 
election to state and local office. The Board wishes to sever any 
connection between contributions and municipal securities business. Any 
other payments to issuer officials are addressed in other Board rules, 
such as rule G-20 on gifts and gratuities.
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    \2\The term ``state'' is defined in Section 3(a)(16) of the Act 
to mean any state of the United States, the District of Columbia, 
Puerto Rico, the Virgin Islands, or any other possession of the 
United States. Rule D-1 provides that, unless the context otherwise 
requires, the terms used in the Board's rules shall have the same 
meanings set forth in the Act.
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    Finally, the Board does not seek, through its definition of 
contribution, to restrict the personal volunteer work of municipal 
finance professionals in political campaigns other than soliciting or 
coordinating contributions.\3\ However, if resources of the dealer are 
used (e.g., a political position paper is prepared by dealer personnel) 
or expenses are incurred by the municipal finance professional in such 
personal volunteer work, the value of such resources or expenses would 
be included within the definition of contribution.
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    \3\Restrictions on soliciting or coordinating contributions are 
described below.
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Exception for Certain Contributions
    The only exception to the proposed rule change's absolute 
prohibition on business is for certain contributions made to issuer 
officials by municipal finance professionals. Contributions by such 
persons to officials of issuers would not invoke application of the 
prohibition on business, but only if the municipal finance professional 
is entitled to vote for such official and provided any contributions by 
such municipal finance professional do not exceed, in total, $250 to 
each official, per election.\4\ The Board believes that this exception 
is appropriate because contributions of this nature present less 
opportunity for a conflict of interest or the appearance of a conflict 
of interest on the part of an issuer official in the awarding of 
municipal securities business.
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    \4\Thus, if an issuer official (i.e., incumbents and/or 
candidates) for whom the municipal finance professional is entitled 
to vote is involved in a primary prior to the general election, the 
municipal finance professional could contribute up to $500 for each 
such official (i.e., $250 per election).
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    The term ``municipal finance professional'' means: (i) Any 
associated person primarily engaged in municipal securities 
representative activities, as defined in rule G-3(a)(i),\5\ (ii) any 
associated person who solicits municipal securities business; (iii) any 
direct supervisor of such persons up through and including, in the case 
of a dealer other than a bank dealer, the Chief Executive Officer or 
similarly situated official and, in the case of a bank dealer, the 
officer or officers designated by the board of directors of the bank as 
responsible for the day-to-day conduct of the bank's municipal 
securities dealer activities, as required pursuant to rule G-1(a); or 
(iv) any member of the dealer executive or management committee or 
similarly situated officials, if any (or, in the case of a bank dealer, 
similarly situated officials in the separately identifiable department 
of division of the bank, as defined in rule G-1).
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    \5\Rule G-3(a)(i) defines the term ``municipal securities 
representative'' as a person associated with a dealer, other than a 
person whose functions are solely clerical or ministerial, whose 
activities include one or more of the following: (A) Underwriting, 
trading or sales of municipal securities; (B) financial advisory or 
consultant services for issuers in connection with the issuance of 
municipal securities; (C) research or investment advice with respect 
to municipal securities; or (D) any other activities which involve 
communication, directly or indirectly, with pubic investors in 
municipal securities; provided, however, that the activities 
enumerated in subparagraphs (C) and (D) are limited to such 
activities as they relate to the activities enumerated in 
subparagraphs (A) and (B).
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    Included within the definition of municipal finance professional is 
any associated person of the dealer involved in the solicitation of 
municipal securities business or bringing to market new issue municipal 
securities. The definition also includes those individuals who have an 
economic interest in seeing that the dealer is awarded municipal 
securities business and who thus may be in a position to make political 
contributions for the purpose of influencing the awarding of such 
business by issuer officials. Such persons would include those in the 
public finance department, as well as underwriters, traders and 
institutional and retail sales persons primarily engaged in municipal 
securities activities. The Board does not intend to include within the 
definition of municipal finance professional retail sales persons who 
primarily sell other products or associated persons employed in 
departments other than the municipal securities department.
Direct and Indirect Contributions
    In addition to the prohibition on business described above, the 
proposed rule also would prohibit a dealer and any municipal finance 
professional from doing any act indirectly which would result in a 
violation of the proposed rule if done directly by the dealer or 
municipal finance professional. This proscription was modeled after 
Section 20(b) of the Act\6\ and is intended to prohibit those parties 
subject to the proposed rule from using other persons or entities as 
conduits in order to circumvent the proposed rule. A dealer would 
violate the proposed rule by engaging in municipal securities business 
with an issuer after directing a person to make a contribution to an 
official of such issuer. For example, a violation would result if a 
dealer does business with an issuer after directing contributions by 
associated persons, family members of associated persons, consultants, 
lobbyists, attorneys, other dealer affiliates, their employees or PACs, 
or other persons or entities as a means to circumvent the rule. 
Finally, the dealer would violate the rule by doing 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 business. For example, in certain 
instances, a local political party may be soliciting contributions for 
the purpose of supporting one issuer official. If this is the case, 
contributions made to the political party would result in these same 
prohibition on municipal securities business as would a contribution 
made directly to the issuer official.
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    \6\Section 20(b) provides that: ``It shall be unlawful for any 
person, directly or indirectly, to do any act or thing which it 
would be unlawful for such person to do under the provisions of this 
title or any rule or regulation thereunder through or by means of 
any other person.''
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Solicitation and Bundling Prohibition
    The proposed rule also would prohibit a dealer and any municipal 
finance professional from soliciting the parties described above, as 
well as any other person or entity, to make contributions to an 
official of an issuer with which the dealer engages or is seeking to 
engage in municipal securities business or to coordinate (i.e., bundle) 
contributions.\7\ Dealers may not engage in municipal securities 
business with issuers if they or their municipal finance professionals 
engage in any kind of fund-raising activities for officials of such 
issuers. As noted previously, municipal finance professionals may 
volunteer their personal services in other ways to political campaigns.
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    \7\By the term ``seeking to engage in municipal securities 
business'' the Board means dealer activities including responding to 
Requests for Proposals, making presentations of public finance 
capabilities, and other soliciting of business with issuer 
officials.
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Recordkeeping Requirements
    To facilitate compliance with, and enforcement of, proposed rule G-
37, the Board also proposes to amend existing rules G-8 and G-9, 
concerning recordkeeping and record retention, respectively. The 
amendment to rule G-8 is designed to assist dealers in determining 
whether or not they may engage in business with a particular issuer. 
These amendments would require a dealer to maintain a list of: (i) 
Names, titles, city/county and state of residence of every municipal 
finance professional; (ii) names, titles, city/county and state of 
residence of all executive officers;\8\ (iii) the states in which the 
dealer is engaging or is seeking to engage in municipal securities 
business; (iv) every issuer with which municipal securities business 
has been conducted during the current year, as well as the previous two 
years and, where applicable, the name, company, role and compensation 
arrangement of any person employed by the dealer to obtain or retain 
municipal securities business with such issuer; and (v) all 
contributions, direct or indirect, to officials of issuers and to 
political parties of states and political subdivisions made by the 
dealer, any dealer-controlled PAC, any municipal finance professional 
or executive officer. The dealer would not, however, be required to 
maintain a list of contributions by its municipal finance professionals 
or executive officers that are made: (i) To officials for whom the 
person is entitled to vote, provided such contributions do not exceed 
$250 to each issuer official, per election; and (ii) to political 
parties for the state and political subdivision in which the person is 
entitled to vote, provided such contributions do not exceed $250 per 
party, per year. In addition, dealers would not be required to maintain 
a list of contributions by any other employees, affiliate companies and 
their employees, spouses of covered employees, or any other person or 
entity unless the contributions were directed by persons or entities 
subject to the proposed rule.
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    \8\An executive officer is defined in the proposed rule as any 
associated person in charge of a principal business unit, division 
or function or any other person who performs similar policy making 
functions for the dealer, but does not include any municipal finance 
professional.
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    The Board determined to add a recordkeeping requirement for 
contributions made by executive officers and contributions made to 
political parties to help ensure that dealers, dealer-controlled PACs 
and municipal finance professionals do not circumvent the prohibition 
on business in the proposed rule by indirect contributions to issuer 
officials through executive officers or to state or local political 
parties. Upon review by the enforcement agencies of such information, 
the Board may determine that further revisions to the proposed rule 
change in this area would be appropriate.
    In addition, a number of commentators expressed concern about the 
use of consultants by dealers to obtain or retain municipal securities 
business. Again, once the prohibition on business in the proposed rule 
change is put into effect, the Board is concerned that use of 
consultants who make contributions to issuer officials may increase. 
Thus, the proposed rule change also would require dealers to record 
every issuer with which municipal securities business has been 
conducted, the type of business, and, where applicable, the name, 
company, role and compensation arrangement of any person employed by 
the dealer to obtain or retain municipal securities business with the 
issuers listed.
    The records would not have to be maintained for contributions made 
or business engaged in prior to April 1, 1994. The amendment to rule G-
9 would require dealers to maintain these records, required pursuant to 
the proposed amendments to rule G-8, for a six-year period.
Disclosure Requirements
    Proposed rule G-37 would require dealers to report to the Board 
certain summary information concerning contributions in order to allow 
for public access to such information. Contributions to be reported 
include those to officials of issuers and political parties of states 
and political subdivisions made by: (i) the dealer; (ii) any municipal 
finance professional; (iii) any executive officer; and (iv) any PAC 
controlled by the dealer or by any municipal finance professional. Only 
such contributions over a de minimis amount, i.e., those required to be 
recorded under rule G-8, would be disclosed.
    Reports, on Form G-37, would be submitted to the Board in 
accordance with Board rule G-37 filing procedures, quarterly, with due 
dates determined by the Board and would include, by state: (i) the 
name, title (including any city/county/state or other political 
subdivision) of each official of an issuer and political party 
receiving contributions; (ii) total number and dollar amount of 
contributions made by the persons and entities described above; and 
(iii) such other identifying information as required by Form G-37. The 
names of individual municipal finance professionals and executive 
officer contributors would not be disclosed. Such reports also would 
include a list of issuers with which the dealer has engaged in 
municipal securities business during the reporting period, along with 
the type of municipal securities business and the name, company, role 
and compensation arrangement of any person employed by the dealer to 
obtain or retain municipal securities business with such issuers.
    The Board believes that it is important to provide certain summary 
information on contributions to the public to help assure investors in 
the municipal securities market that dealers are not engaging in 
municipal securities business with issuers to whom contributions have 
been made by the dealer, dealer-controlled PACs and municipal finance 
principals. In addition, the Board is concerned that, once the 
prohibition on business in the proposed rule change is put into effect, 
dealers may seek to continue making contributions to obtain business 
through contributions by executive officers or to political parties. 
Thus, the proposed rule change requires disclosure of such 
contributions. Finally, as noted above, to reduce the opportunity for 
dealers to circumvent the rule's requirements through the use of 
consultants and other persons, disclosure of the dealer's municipal 
securities business activities and information about persons hired to 
obtain or retain such business would be required.
    The Board believes that public access to this information will help 
to assure investors in the municipal securities market that dealers are 
awarded business based on merit, not political contributions. Where 
this is not the case, the information provided should assist state and 
federal officials in detecting and correcting such situations.
    In order to ensure equal public access to information provided on 
Form G-37, the Board will include this information in its Municipal 
Securities Information Library (``MSIL'') system, the Board's 
electronic library. The Board is in the process of developing 
appropriate rule G-37 filing procedures to allow for public access to 
the information to be submitted on Form G-37, as well as indexing, 
record storage, etc. It will seek information from a wide variety of 
information submitters (i.e., dealers) and potential information users 
(e.g., information services, newspapers, etc.) The Board's initial 
filing procedures, of necessity, will be flexible and may allow for 
many means of information submission (e.g., paper and electronic). Once 
the Board gains experience with such submissions, it will seek to 
modify its procedures to make searches easier and data collection and 
storage more cost-effective.
    Finally, the Board understands that a number of dealers have 
offered voluntarily to submit additional information on contributions 
to a repository for public access and dissemination. So too, certain 
non-dealer municipal market participants also may wish voluntarily to 
provide a central repository with contribution information. The 
proposed rule notes that the Board will accept additional information 
related to contributions voluntarily submitted by dealers or others as 
long as such information is submitted in accordance with Board filing 
procedures. The Board is considering whether it may have to charge a 
filing fee to cover expenses associated with certain of this 
voluntarily submitted information. It is also reviewing what kinds of 
access fees to the forms filed, if any, would be appropriate.
 Dealer Compliance Procedures
    Pursuant to rule G-27, on supervision, each dealer must adopt, 
maintain and enforce written supervisory procedures reasonably designed 
to ensure compliance with Board rules. In regard to the proposed rule 
change, effective compliance procedures are essential because the 
proposed rule would require dealers to have information regarding each 
contribution made by the dealer, dealer-controlled PACs and municipal 
finance professionals so that it can determine where and with whom it 
may or may not engage in municipal securities business. In addition, it 
must have information on executive officer and political party 
contributions and consultant hiring practices for disclosure purposes. 
Moreover, because of the ``directly and indirectly'' provision in 
section (d) of the proposed rule change, as well as the no solicitation 
and no bundling provisions in section (c), dealers would have to take 
measures to ensure that those persons and entities subject to the 
proposed rule are not causing the dealer to be in violation. 
Furthermore, the dealer must ensure that other people and entities 
hired to assist in municipal securities activities (e.g., consultants) 
are not being directed to make contributions that might result in a 
violation of the proposed rule change.
    Because dealer compliance procedures for the proposed rule change, 
of necessity, will be quite extensive, dealers may wish to review the 
work of a number of dealers and organizations that are seeking to 
develop model compliance procedures in this area. While the Board 
cannot specifically approve any such procedures, it believes that 
dealers may benefit from these efforts.
    In addition, the Board wishes to note that the proposed rule change 
sets forth a minimum standard of conduct for dealers involved in 
municipal securities business. The Board has sought to target the 
proposed rule's requirements to the areas of abuse to which it has been 
alerted, while reducing potentially burdensome requirements where 
appropriate. Dealers are urged, where possible, to do even more to 
sever any possible connection between political contributions and the 
awarding of municipal securities business.
    (b) The Board believes the proposed rule change is consistent with 
Section 15B(b)(2)(C) of the Act which provides that the Board's rules 
shall:

     * * * be designed to prevent fraudulent and manipulative acts 
and practices, to promote just and equitable principles of trade, to 
foster cooperation and coordination with persons engaged in 
regulating, clearing, settling, processing information with respect 
to, and facilitating transactions in municipal securities, to remove 
impediments to and perfect the mechanism of a free and open market 
in municipal securities, and, in general, to protect investors and 
the public interest.

    The Board believes that the proposed rule change serves a number of 
its enumerated purposes, and, as such, is properly within its authority 
under the Act. The proposed rule is designed to prevent fraudulent and 
manipulative acts and practices by prohibiting brokers, dealers and 
municipal securities dealers from engaging in municipal securities 
business with issuers if contributions have been made to officials of 
such issuers and by requiring dealers to disclose contributions by 
certain persons and entities to issuer officials and political parties 
of states and political subdivisions, as well as certain other 
information about their municipal securities business activities. The 
Board believes that the proposed rule change would have many salutary 
effects on the market, including eliminating, or at the very least 
diminishing, the opportunity for abuses and the problems associated 
with political contributions in connection with the awarding of 
municipal securities business, thereby bolstering investor confidence 
in the integrity of the market. In addition, the proposed rule change 
is designed to promote just and equitable principles of trade by 
ensuring that dealers compete for the awarding of municipal securities 
business on merit rather than political contributions. Such healthy 
competition would remove artificial barriers to those dealers not 
willing or able to make such payments, thereby protecting investors and 
the public interest by fostering competition and lowering costs 
associated with doing municipal securities business.
    The Board has adopted the proposed rule change as a first step 
toward eliminating the problems associated with political contributions 
in connection with the awarding of municipal securities business. It 
believes the rule is targeted to the reported major problem areas and 
should be an effective deterrent to activities which have called into 
question the integrity of the market. Once the proposed rule is put 
into place, the Board will closely monitor its effectiveness. If it 
determines that compliance problems exist, or if dealers seek to 
circumvent the proposed rule's requirements, the Board will not 
hesitate to amend the proposed rule to make its prohibitions applicable 
to a broader range of entities and individuals or to include other 
prohibitions or disclosure requirements. The Board urges the dealer 
community to put into place as soon as possible procedures designed to 
comply effectively with the proposed rule so that the industry can move 
past the allegations of impropriety and back to providing important 
financing services, thereby effectively meeting the needs of state and 
local governments.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Board does not believe that the proposed rule change will 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act since the proposed rule change 
would apply equally to all brokers, dealers and municipal securities 
dealers. In fact, the Board believes that the proposed rule change will 
improve competition in the awarding of municipal securities business 
because dealers now will compete for such business on the basis of 
their abilities, not political contributions.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Board has received two sets of comment letters concerning 
political contributions. The first set of comments, consisting of 40 
letters and one oral comment, was received in response to the Board's 
August 1993 draft rule. The second set of comments, consisting of nine 
letters, was received in response to the Board's November 11, 1993 
press release, regarding changes to the August 1993 draft rule.\9\ 
These comments are summarized and discussed below.
---------------------------------------------------------------------------

    \9\Copies of the August 1993 notice and the Board's November 11, 
1993 press release are included in Exhibit 2 to the filing, along 
with the comment letters received.
---------------------------------------------------------------------------

Comments Received in Response to August 1993 Draft Rule
    As previously noted, the vast majority of commentators supports the 
Board's efforts to alleviate the problems associated with political 
contributions, and thereby maintain the integrity of the market and 
protect investors and the public interest. However, none gave 
unqualified support for the draft rule; every commentator suggested 
modifications. The commentators include the following:

A.G. Edwards & Sons, Inc.
Altman & Co.
American Bankers Association
Anonymous
Banc One Corporation
Central Bank of the South
Chemical Securities Inc.
Dain Bosworth, Inc.
D.A. Davidson & Co.
Dean Witter, Discover & Co.
Dupree & Company
Fenner, Joseph C.
First Securities Company of Kansas, Inc.
George K. Baum & Company
Goldman Sachs & Co.
Government Finance Officers Association
Grigsby Brandford & Co., Inc.
J.P. Morgan & Co., Inc.
Kane, KcKenna Capital, Inc.
Kidder Peabody (memorandum of oral comment)
Kiel, Frederick O.
Legg Mason Wood Walker, Inc.
Lehman Brothers Inc.
Morgan Stanley & Co., Inc.
National Association of Bond Lawyers
National Association of Independent Public Finance Advisors
National Association of State Treasurers
National League of Cities
NDB Bancorp, Inc.
Norwest Corporation
NYU Graduate School of Public Service
(The) Ohio Company
Protective Group Securities Corporation
Public Securities Association
Seasongood & Mayer
Securities Industry Association
Smith, Moore & Co.
Sonoma Securities
Trustmark National Bank
Wheat, First Securities, Inc.
William R. Hough & Co.
Summary and Discussion of Comments
    Existence and Nature of the Problem. The vast majority of 
commentators believe that problems exist in the municipal securities 
market because of political contributions and that such problems should 
be addressed. For example, many dealers commenting on the August 1993 
draft rule express concern that the payment of political contributions 
to issuer officials is a factor in the awarding of business and 
undermines investor confidence in the integrity of the municipal 
market.\10\ One dealer believes that ``[e]ven in the best of situations 
where no discussion of a business award takes place there is always the 
element of duress. Will this administration use my services, however, 
beneficial, if I don't contribute?''\11\ And another commentator states 
that the ``anti-competitive effects of political contributions are not 
only unfair to industry members who do not play the game, but costly to 
taxpayers and consumers for whose benefit state and local bonds are 
issued.``\12\ The Public Securities Association (``PSA'') states that:

    \10\See, e.g., letters from A.G. Edwards; Anonymous; Central 
Bank of the South; Dain Bosworth; Dean Witter; Dupree & Company; 
George K. Baum; Goldman Sachs; Grigsby Brandford; J.P. Morgan; Kane, 
McKenna; Lehman Brothers; Morgan Stanley; and Wheat, First 
Securities.
    \11\Letter from Dupree & Company.
    \12\Letter from Anonymous.
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    Based upon our extensive consultation with PSA's membership, 
including dealers headquartered in many regions throughout the 
country, large national and smaller regional firms, brokers, dealers 
and dealer banks, we believe that the vast majority of the dealer 
community wants to see the end of political contributions to elected 
officials as a factor, actual or apparent, in the selection of 
underwriters, the maintenance of business relationships or any other 
influence with respect to obtaining securities business from public 
entities, including what has come to be called ``pay to play.'' 
Those active in the municipal finance business for some time have 
become increasingly concerned about the escalation of pressure for 
contributions from state and local officials and candidates for such 
offices over the last decade and a half, continuing to this day. All 
are concerned about the potential negative impact of political 
contributions on the reputation of the industry, the public's 
perception of the integrity of the business and the ability of state 
and local issuers on behalf of their tax and rate payers to choose 
the most cost-effective means of financing their projects and 
programs in the tax-exempt market.\13\
---------------------------------------------------------------------------

    \13\Letter from PSA.

    Other industry associations also believe that a problem exists. For 
instance, the Securities Industry Association (``SIA'') ``share[s] the 
Board's concern that some negative public perception has been created 
by the potential, if not actual, problems associated with political 
contributions connected to the awarding of municipal securities 
business.'' The American Bankers Association (``ABA'') states that 
``the appearance of such improprieties can only serve to undermine 
investor confidence in the integrity of the market. Investor confidence 
is essential to the continued liquidity and capital raising ability of 
the municipal market.'' Similarly, the National Association of State 
---------------------------------------------------------------------------
Treasurers (``NAST'') states that:

    * * * recent reports of alleged abuses in the municipal 
securities market have raised concerns in the investing public, and 
the public generally, about the integrity of the public finance 
marketplace. Allegations that certain municipal securities 
underwriters have utilized campaign contributions to obtain or 
retain underwriting business in municipal offerings, if proven, 
undermine investor and public confidence in the integrity of market 
participants and the overall cost and value of municipal securities. 
Moreover, even if unfounded, such allegations create an appearance 
of impropriety which may be just as damaging as actual impropriety.

    The ABA further believes that the prohibition contained in the 
draft rule ``will remove many of the existing barriers to full 
participation in the business for those dealers unable or unwilling to 
make political contributions to issuer officials. Removing these 
artificial constraints will allow more competition * * * which will 
result in lower prices which can only benefit investors, issuers and 
taxpayers alike.'' Another commentator states that this issue ``is 
vitally important to taxpayers and investors alike.''\14\ Other 
commentators, however, believe that the problems associated with 
political contributions are taxpayer--not investor--problems, and that 
this subject is more appropriately regulated at the state and local 
levels.\15\ For instance, although NAST acknowledges the deleterious 
effects of political contributions on the municipal market, they are 
``concerned about the myopic focus and approach of the proposed rule * 
* * NAST believes that this subject can be better regulated by the 
states.'' The Government Finance Officers Associations (``GFOA'') 
states that they:

    \14\Letter from Morgan Stanley; see also letter from Anonymous.
    \15\See e.g., letters from Government Finance Officers 
Association; NABL; National League of Cities; Seasongood & Mayer; 
D.A. Davidson; NYU; and First Securities Company.
---------------------------------------------------------------------------

    * * * do not share the view that the improper use of political 
contributions is an investor protection problem * * * [that] 
justifies a radical regulatory response * * *. It is the taxpayers 
of a jurisdiction who are potentially harmed by improper practices 
and it is the taxpayers, and not the SEC or the MSRB, who should 
take action * * *. It is our view that political contributions are 
best regulated at the state and local levels of government. We 
believe that state and local laws governing political contributions 
to elected officials are generally adequate. However, we recognize 
that this regulatory system is not perfect and, in light of recent 
allegations, we have generally supported the MSRB's attempt to 
improve that system. Overall, we think the MSRB's suggested approach 
is better than the other alternatives * * *.

    The National League of Cities (``NLC'') similarly believes that 
this is an issue of taxpayer concern and that state and local laws 
``are generally adequate.'' The National Association of Bond Lawyers 
(``NABL'') likewise, does not believe that problems associated with 
political contributions are harmful to investors. Furthermore, NABL 
believes that ``the publicity surrounding recent allegations of scandal 
cannot be said to have materially impaired investor confidence to date. 
Most states already require disclosure of political campaign 
contributions, and such disclosure often results in local publicity 
that informs local taxpayers and voters of the actions of their elected 
officials. If such actions are viewed as improper by the voters, they 
have the opportunity to remove the official at the next election.''\16\ 
However, NABL acknowledges that ``the MSRB's authority under Section 
15B of the Securities Exchange Act of 1934 * * * is broad enough to 
include the Rule * * *. Because it is a self-regulatory organization of 
dealers, the MSRB is the appropriate body to determine `just and 
equitable principles of trade' among municipal securities dealers.''
---------------------------------------------------------------------------

    \16\See also letters from Seasongood & Mayer; D.A. Davidson & 
Co.
---------------------------------------------------------------------------

    Board Response. The Board believes that the problems, both actual 
and potential, associated with political contributions are significant 
problems that are adversely impacting investors as well as the 
municipal market in general. As discussed above, the Board believes 
that the proposed rule change is properly within its authority under 
the Act. Nonetheless, some commentators erroneously believe that the 
Board is attempting to regulate state and local campaign finance laws. 
For example, NAST assumes that rule G-37 is aimed at ``preventing the 
danger of corruption in the electoral process.'' However, the proposed 
rule is not aimed at the electoral process, but rather at problems in 
the municipal market, including the practice commonly known as ``pay to 
play,'' which compels some dealers to make contributions not only to 
gain business but also merely to be under consideration for the 
awarding of business. The proposed rule would not prohibit dealers from 
making contributions to issuers; rather, it would prohibit them from 
engaging in municipal business with issuers under certain circumstances 
and for a limited time.
    The National League of Cities is ``concerned that hasty efforts to 
devise and impose new requirements are raising doubt in the minds of 
investors about the credibility and viability of the municipal 
market.'' The Board believes that while such doubt may indeed exit, it 
is in reaction to news reports of scandals and dubious market practices 
involving political contributions and allegations of influence 
peddling. The proposed rule change is a measured response to these 
concerns and is intended, among other things, to bolster investor 
confidence in the integrity of the market by eliminating the 
opportunity for abuses in connection with the awarding of municipal 
securities business.
Constitutional Concerns
    First Amendment and Privacy Rights. As noted above, virtually all 
commentators support the Board's goals in addressing the problems 
associated with political contributions. Notwithstanding such support, 
the commentators voiced constitutional concerns with The August 1993 
draft rule. NAST states that:

    Draft Rule G-37, like other rules of the MSRB, is promulgated 
under the authority of section 15B(b)(2) of the Securities Exchange 
Act of 1934. * * * and is enforced by the * * * NASD * * * the Act. 
Thus, Draft Rule G-37 is a governmental regulation for the purpose 
of First Amendment analysis. As such, to the extent that Draft Rule 
G-37 imposes a burden on the exercise of political speech, including 
any limitation on the use of funds to support a political candidate, 
the draft rule must be narrowly tailored to serve a compelling 
governmental interest. Even if the regulatory measure simply creates 
a disincentive for the exercise of political speech, the measure 
must be narrowly tailored * * *.

    While NAST believes that the prohibition on certain contributions, 
as set forth in the draft rule, ``can probably be justified by the 
governmental interest in preventing the danger of corruption in the 
electoral process * * *'' it argues that the rule is not narrowly 
tailored. NAST is concerned that the rule will compel a dealer to 
intrude on the protected political speech of its employees by requiring 
them to divulge personal political contributions.
    Like NAST, a number of other commentators are concerned that draft 
rule G-37 will infringe upon employees' privacy rights and will 
discourage participation in the political process.\17\ One commentator 
states that ``the right to make political contributions has been 
afforded the protections of the First Amendment. * * * [and that the 
draft rule] would infringe upon our employees' First Amendment rights 
of political expression.''\18\ Another commentator states that:

    \17\See letters from Dean Witter; Chemical Securities; SIA; 
Lehman Brothers; Norwest; and GFOA.
    \18\Letter from Lehman Brothers.
---------------------------------------------------------------------------

    * * * the act of maintaining a record keeping system for 
employee political contributions will unfairly interfere with the 
exercise of political rights on the part of our employees * * *. 
Employees who are active in what might be considered to be unpopular 
causes might be discouraged from this activity by the knowledge that 
their political contributions would have to be reported to the 
company * * *. We are unconvinced that assurances from the company 
that we would disregard this information would counteract the 
negative effects of the proposed rule.\19\
---------------------------------------------------------------------------

    \19\Letter from Dain Bosworth.

    This commentator also notes that many of its employees regularly 
participate in state and local campaigns, and that many run for office 
---------------------------------------------------------------------------
and serve on various board and governing bodies.

    All of this participation occurs in jurisdictions which may or 
may not happen to be clients from time to time of the public finance 
department * * *. We have a strong interest in the government of our 
city [where our headquarters are located]. Our future is closely 
tied to the success of governmental efforts to promote and maintain 
the city and its economic base. Our employees have a long history of 
civic activity in the [city], and we are proud of it * * *. We have 
similar, if less extensive, relationships with every town, county or 
state in which we have offices or in which our employees live.\20\
---------------------------------------------------------------------------

    \20\Id.

    Another commentator notes that it is a regional firm and that the 
firm and its employees, ``have very strong local ties and have 
historically supported candidates based on their positions on issues 
which often have a direct effect on the firm and the community at 
large. These issues may include tax policy, banking regulation, labor 
laws and economic development policy to name a few.''\21\ Other 
commentators also believe that firms```should have the right to be 
involved in the political process when issues impact our business in 
general or good government issues are in front of us. We should be free 
to support candidates who address our concerns as a firm and also the 
private concerns of our employee.''\22\ In this regard, one commentator 
believes that the rule's ``chilling effect'' on individual 
contributions would be removed if it contained an exemption for 
individual contributions to candidates for office in the political 
jurisdiction where the contribution lives.\23\
---------------------------------------------------------------------------

    \21\Letter from Wheat First; see also letter from Public 
Securities Association.
    \22\Letter from The Ohio Company; see also letters from SIA; 
PSA.
    \23\Letter from Norwest Corporation.
---------------------------------------------------------------------------

    A number of commentators are concerned that, in view of the 
relevant privacy considerations, the draft rule will impose serious 
compliance burdens on dealers, especially when employees are unwilling 
to provide the necessary information to the dealer. One commentator 
notes that:

     * * * it is difficult to envision how municipal securities 
dealers could lawfully compel employees to disclose, document and 
obtain employer approval before they or their family members could 
make political contributions, all of which would be necessary for 
dealers to comply with the rule * * *. It is * * * unclear whether 
dealers would be able to use an employee's failure to respond to 
such inquiries fully as a lawful justification for terminating their 
employment or imposing other sanctions. Without the ability to 
impose sanctions, the reliability of the information-gathering 
process is questionable.\24\
---------------------------------------------------------------------------

    \24\Letter from Lehman Brothers.

    Another commentator states that ``some of the firm's employees may 
choose not to provide * * * information regarding their personal 
political contributions, viewing this as a private matter that 
transcends their employment relationship.''\25\ One dealer points out 
that, while the rule would not apply to clerical and ministerial 
employees, dealers could not comply with the rule ``without either 
requiring a list of all contributions from clerical and ministerial 
employees (contrary to the stated intent of the regulation) or by 
prohibiting contributions by such employees.''\26\
---------------------------------------------------------------------------

    \25\Letter from Dean Witter; see also letter from SIA.
    \26\Letter from Dain Bosworth.
---------------------------------------------------------------------------

    Finally, some commentators argue against extending the rule's 
application to contributions made by family members. One commentator 
``do[es] not believe that it is appropriate to regulate or investigate 
the political activities of spouses or other family members of our 
employees.* * * [T]here should be an explicit statement that political 
contributions of family members are not the subject of this regulation, 
and that the only activity which must be reported is an action by a 
covered employee to direct a family member to make a prohibited 
political contribution on their behalf.''\27\ Other commentators also 
believe that the draft rule should contain a section to prohibit 
covered parties from soliciting others to contribute.\28\
---------------------------------------------------------------------------

    \27\Letter from Dain Bosworth; see also letter from SIA.
    \28\See, e.g., letters from Dean Witter; Goldman Sachs.
---------------------------------------------------------------------------

    Equal Protection. In addition to their First Amendment and state 
sovereignty concerns, NAST believes that the draft rule would run afoul 
of the Equal Protection Clause by regulating dealers but not other 
market participants. NAST argues that these other market participants, 
such as bond counsel, underwriter's counsel and independent financial 
advisors, ``have an incentive and opportunity comparable to that of 
dealers to engage in the unethical, uncompetitive and destructive 
behavior regulated by Draft Rule G-37.'' Hence, the dealer 
``classification is ultimately deficient * * * as it is underinclusive 
(i.e., it impinges on the political speech of dealers and not others 
who are comparably situated).'' NAST also argues that ``Draft Rule G-37 
is, in fact, an attempt, however well-intentioned, to implement federal 
regulation of state and local political speech and the regulation of 
state and local elections in the guise of national economic 
legislation. As such, it has serious constitutional deficiencies * * 
*.''
    Board Response. The proposed rule change would not prohibit a 
dealer from making contributions to issuer officials, but rather would 
prohibit a dealer, in certain situations and for a limited time, from 
engaging in municipal securities business with a particular issuer if 
certain contributions are made. In addition, it would require dealers 
to record and disclose certain information regarding political 
contributions made as well as municipal securities business engaged in 
with issuers. In response to the constitutional concerns discussed 
above, the Board notes that constitutional constraints and review apply 
to actions by governmental actors. The Board is not a governmental 
actor; it is not the federal government, and, unlike the Commission, it 
is not an agency of the federal government. Thus, Board rules are not 
subject to constitutional constraints or review.
    In response to commentators' concerns that the draft rule would 
discourage individuals from participating in the political process, the 
Board has included in the proposed rule change a $250 de minimis 
exemption, per election, for contributions by municipal finance 
professionals to each issuer official for whom such individuals are 
entitled to vote. Such contributions would not trigger the rule's 
prohibition on engaging in business. The Board believes that this 
exemption should adequately address the commentators' concerns in this 
area. The proposed rule does not, however, provide a similar exemption 
for contributions by dealers or dealer-controlled PACs. While the Board 
is sensitive to commentators' concerns that the August 1993 draft rule 
would have discouraged or inhibited individual participation in issues 
which directly impact them and the community in which they live, it did 
not find this argument as compelling when applied to dealers and 
dealer-controlled PACs especially in light of the current municipal 
business environment and its attendant problems. The Board is committed 
to eradicating such problems, and does not believe that providing a de 
minimis exemption for dealers and their PACs would further this 
objective.
    In response to concerns about the scope of the Board's proposed 
rule, as discussed more fully below, the rule would apply only to 
dealers, dealer-controlled PACs, municipal finance professionals, and 
executive officers. The Board believes that narrowing the scope of the 
rule in this regard will ensure that ``pay to play'' practices in the 
municipal market will be halted without impacting every employee of the 
dealer or his family members.
Comments on Specific Sections of August 1993 Draft Rule
(A) Prohibition Section
    The rule will effectively ban all contributions.
    The GFOA states that it is:

not able to provide unqualified support for the * * * [prohibition 
section. They] believe that the rule is so broad it may effectively 
ban contributions. * * * While [they] support banning those 
contributions that are solely for the purpose of retaining or 
obtaining business, the rule as proposed is more far-reaching and 
may invite legal challenge from market participants or others who 
have a legitimate interest in the political process, but who could 
be prohibited under the rule from exercising their Constitutional 
right to participate in that process. * * * [A]n effective ban * * * 
is not warranted.

    Other commentators also believe that the August 1993 draft rule 
would have effectively banned all contributions and that such a result 
is not desirable.\29\ However, the PSA believes that:
---------------------------------------------------------------------------

    \29\See e.g., letters from George K. Baum; Lehman Brothers; 
National League of Cities; NAST.

    Many dealers have come to the conclusion, often reluctantly, 
that an absolute ban on political contributions to state and local 
officials who may affect public finance business decisions should be 
imposed * * *. The principal advantage of an absolute ban would be 
the removal of discretion which could lead to different 
interpretations among competing firms, as well as a removal of the 
need for internal procedures for making exceptions. Another 
advantage is the speed with which such a program could be 
implemented. Finally, any suggestion of an appearance of conflict of 
---------------------------------------------------------------------------
interest would be removed.

    Other commentators also favor a complete ban on all 
contributions.\30\ One commentator states that the draft rule ``should 
prohibit muni securities dealers from making political contributions to 
issuers for any reason whatsoever. * * * It's about time that we put 
ethics before commercial gain.'' [Emphasis included.]\31\ Another 
commentator suggests that the Board ban all political contributions by 
municipal department members, high ranking officers and PACs, including 
the families of municipal department members and high ranking 
officers.\32\ This commentator further suggests that the Board 
``prohibit any individual covered by the ban from soliciting 
contributions from any other employee of the firm or from third 
parties.''\33\
---------------------------------------------------------------------------

    \30\See e.g., letters from Dupree & Company; Goldman Sachs; Dain 
Bosworth.
    \31\Letter from Sonoma Securities.
    \32\Letter from Goldman Sachs.
    \33\Id.
---------------------------------------------------------------------------

    The ``intent'' element of the rule will create compliance and 
enforcement problems, as well as competitive problems.
    In addition to the difficulty noted earlier concerning employee 
compliance with the August 1993 draft rule, many commentators believe 
that the ``intent'' element of the rule would have created serious 
problems relating to dealer compliance. One commentator believes that 
determining whether a violation of the rule occurred would require a 
determination of intent, which would be difficult for enforcement 
authorities to ascertain.\34\ Hence, the commentator does not believe 
that the draft rule should be modeled after the Foreign Corrupt 
Practices Act, which is based on intent. The commentator believes 
``that the attempt by the MSRB to directly and so literally model the 
Draft rule after the [FCPA] has resulted in difficulties that may cause 
confusion and hamper enforcement.''\35\ Another commentator believes 
that ``it is extremely impractical if not actually impossible to prove 
such intent. * * * ''\36\ The PSA notes that many dealers are concerned 
that the intent element gives dealers the discretion to determine 
whether or not their contributions were made for the purpose of 
obtaining or retaining business. Such discretion could lead to 
different interpretations among competing firms. Another commentator 
echoes this concern, noting that ``dealer firms might face internal 
confusion in defining and implementing control procedures * * * [and 
will be concerned] that their activity in this regard will be 
significantly different than their competition which could result in a 
competitive disadvantage.''\37\ Another commentator states that the 
rule ``would likely foster unfair competition and a non-level playing 
field. To the extent that political contributions might influence the 
awarding of business * * * any firm that could justify contributions on 
some basis other than obtaining or retaining business would have an 
advantage over others.''\38\ However, this commentator also states that 
``[i]t is the fact of making a contribution in conjunction with a 
business interest, rather than the intention of the contributor, that 
creates an appearance of impropriety.''\39\ NABL believes that 
``[r]egulations that are subject to interpretive disputes over 
subjective standards, such as the intent of an underwriter when making 
a contribution, should be avoided.''
---------------------------------------------------------------------------

    \34\Id.
    \35\Id.
    \36\Letter from National Association of Independent Public 
Finance Advisors; see also letter from George K. Baum.
    \37\Letter from Goldman Sachs.
    \38\Letter from JP Morgan. See also letter from Grigsby 
Brandford.
    \39\Letter from JP Morgan.
---------------------------------------------------------------------------

    The rule should provide a good faith defense for dealers for 
certain violations by their employees.
    A number of commentators are concerned that the intent element of 
the August 1993 draft rule imposes a ``strict liability'' standard on 
dealers. For example, a dealer would be in violation of the rule ``if 
one of its employees * * * [made a] contribution without obtaining the 
dealer's approval, successfully concealed a corrupt intent, or used a 
friend or consultant to make a contribution that had been rejected by 
the firm.''\40\ One dealer notes that:
---------------------------------------------------------------------------

    \40\Letter from Lehman Brothers.

    As presently drafted, dealers are subject to a strict liability 
standard for any and all violations by the firms, as well as their 
employees, who may decline to disclose the required information 
pertaining to personal political contributions. Proposed rule G-37 
also imposes strict liability on dealers for violations by any of 
its ``associated persons,'' no matter how attenuated the associated 
person's relationship to the firm, nor how commendable the firm's 
good faith efforts to comply with its record-keeping and reporting 
obligations. * * * [A] good faith defense would balance the 
interests of the investing public with legitimate privacy concerns 
and constitutional protections expected by employees.\41\
---------------------------------------------------------------------------

    \41\Letter from Dean Witter; see also letter from George K. 
Baum.

    The SIA believes that a dealer's liability for violations by its 
associated persons `` should be based on the reasonableness of their 
supervision of their employees.''\42\ And NABL believes ``that if a 
dealer establishes effective internal procedures for approval and 
reporting of political contributions by employees, the dealer should be 
saved from responsibility for the unauthorized act of its employees, 
much like the controlling and controlled person concepts under Sections 
15(f) and 20 of the 1934 Act.''
---------------------------------------------------------------------------

    \42\See also letter from Wheat First.
---------------------------------------------------------------------------

    The draft rule inappropriately imposes a ``burden of proof'' on 
dealers.
    Many commentators believe that the draft rule inappropriately 
imposes a ``burden of proof'' on dealers to overcome a presumption that 
their contributions were made with an impermissible intent, i.e., to 
obtain, retain or otherwise influence the awarding of municipal 
securities business. These commentators argue that such a burden should 
be on the party challenging the legitimacy of the contribution (i.e., 
the NASD, SEC or other inspection/enforcement agency).\43\
---------------------------------------------------------------------------

    \43\See e.g., letters from SIA; PSA; Wheat First NAST; George K. 
Baum; Dain Bosworth; Lehman Brothers; Morgan Stanley; JP Morgan; 
D.A. Davidson; Smith Moore; and Protective Group.
---------------------------------------------------------------------------

    The Board should provide clear guidelines regarding permissible/
impermissible contributions.
    Many commentators believe that compliance with, and enforcement of, 
draft rule G-37 would be substantially improved if the Board provided 
guidelines regarding permissible and impermissible contributions.\44\ 
One dealer notes that the Board ``provides no guidance as to what it 
considers legitimate political activity. ``\45\ Another dealer states 
that:
---------------------------------------------------------------------------

    \44\See e.g., letters from NABL; The Ohio Company; SIA; Dain 
Bosworth; George K. Baum; JP Morgan; Lehman Brothers.
    \45\Letter from Dain Bosworth.
---------------------------------------------------------------------------

[w]ithout objective criteria to define what is prohibited, all 
political contributions by municipal securities dealers and their 
associated persons would be suspect. As a result, even those 
contributions that were innocent and permissible under the rule 
could subject municipal securities dealers and associated persons to 
time-consuming and expensive harassment in the form of complaints to 
regulators by suspicious competitors.\46\
---------------------------------------------------------------------------

    \46\Letter from JP Morgan.
---------------------------------------------------------------------------

    The SIA states that the rule ``lacks any requisite intent standards 
for violations of its reporting provisions * * *. Consequently, dealers 
would be subject to strict liability for violations * * *.'' And NABL 
expresses its hope ``that any final Rule be sufficiently clear to serve 
as a guide to dealers for developing internal procedures * * *.''
    The rule should provide a de minimis exemption for contributions.
    The SIA recommends that the rule contain a `'safe harbor'' from the 
prohibition section which would provide that any contribution under, 
for example, $200 per year per candidate would not violate the rule, 
``unless otherwise proven.''\47\ The GFOA recommends that ``consistent 
with MSRB rule G-20, certain exceptions should be identified that would 
permit participation in the political process that do not threaten the 
impartial or objective performance of an elected public official's 
duties.''\48\ Other commentators similarly believe that the Board 
should adopt a safe harbor for ``contributions which are sufficiently 
small in size * * * that they pose little or no risk of undo [sic] 
influence.''\49\ Some commentators recommend that municipal securities 
dealers, their officers and employees be prohibited from soliciting 
contributions from other officers and employees (who would not be 
subject to the rule) in order to prevent evasion of established 
limits.\50\
---------------------------------------------------------------------------

    \47\See also letters from The Ohio Company; Kane McKenna; George 
K. Baum.
    \48\See also letters from Legg Mason; William R. Hough; and 
Grigsby Brandford.
    \49\Letter from NBD Bancorp. See also letter from JP Morgan.
    \50\Letter from JP Morgan; See also letters from Frederick O. 
Kiel; Smith, Moore & Co.
---------------------------------------------------------------------------

    Board Response. As noted above, many commentators were concerned 
that the ``intent'' element of the August 1993 draft rule would have 
created a number of serious problems due to its subjective nature. The 
Board was persuaded by the commentators' arguments that, in addition to 
compliance and enforcement problems, the subjective nature of the draft 
rule would have resulted in differing interpretations among dealers, 
thereby providing a competitive advantage for some dealers and a 
competitive disadvantage for others. In response to this and other 
concerns, the Board determined to eliminate the intent element and 
replace it with an objective standard by which dealers can judge their 
compliance with the rule. Instead of proposing a prohibition on making 
contributions, the Board has proposed a prohibition on engaging in 
municipal business with issuers under certain circumstances and for a 
limited time. Accordingly, dealers would be prohibited, for two years, 
from engaging in municipal securities business with issuers if the 
dealer or any municipal finance professional associated with the 
dealer, or any PAC controlled by the dealer or any municipal finance 
professional, made a contribution to an official of an issuer. The 
Board believes that the proposed rule change provides objective 
criteria by which dealers can determine permissible from impermissible 
conduct, which should simplify compliance with, and enforcement of, the 
proposed rule. The proposed rule also should eliminate concerns over 
unfair competition, since all dealers will judge themselves, and be 
judged, according to the same standard.
    Furthermore, because the proposed rule is not intended as a ban, or 
an effective ban, on making contributions, the Board believes that it 
adequately addresses and should alleviate commentators' concerns that 
the draft rule would have operated as an effective ban. Such concerns 
were due in large part, if not completely, to the subjective nature of 
the intent element and its accompanying interpretive problems. By 
eliminating this element, the Board has obviated such concerns. 
Likewise, the proposed rule change should allay concerns regarding 
``burden of proof.''
    A number of commentators were concerned that the August 1993 draft 
rule would have imposed a ``strict liability'' standard on dealers, 
such that the dealer would have been in violation of the draft rule for 
any and all violations notwithstanding good-faith efforts to comply 
with the rule. These commentators suggested that the rule include a 
good-faith defense. The Board carefully considered this suggestion, but 
determined not to adopt such a provision. As with all Board rules, the 
relevant enforcement agencies are authorized to determine whether a 
rule violation has occurred and what action should be taken as a result 
of any such violation. The proposed amendments to rules G-8 and G-9, on 
recordkeeping and retention, are designed to assist the enforcement 
agencies (as well as dealers) in their efforts relating to compliance 
with rule G-37, as well as rules G-8 and G-9, and rule G-27 on 
supervision.
    As discussed above, in response to commentators' concerns about an 
individual's ability to participate in the political process, the Board 
determined to provide a $250 de minimis exemption, per election, for 
contributions by municipal finance professionals to each issuer 
official for whom such individuals are entitled to vote.
(B) Recordkeeping & Disclosure Section
    The rule will impose undue recordkeeping burdens on dealers.
    The ABA ``fully supports the concept of public disclosure but would 
urge the MSRB to consider other disclosure alternatives less burdensome 
than those proposed.'' Specifically, the ABA is concerned about putting 
additional burdens on banks which already ``are suffocating under 
costly and burdensome regulatory requirements.'' The SIA states that 
``[e]ven if fully achievable, compliance with the Rule would be 
excessively and unnecessarily burdensome and costly * * *. The amount 
of information which the MSRB would amass pursuant to the Rule would be 
so overwhelming that the Rule's effectiveness would be limited.'' And 
the PSA believes that ``compliance with draft rule G-37 would prove 
costly and burdensome.''
    The rule should provide a de minimis exemption before the 
disclosure/reporting requirement applies.
    In order to ameliorate some of the burdens of compliance associated 
with the August 1993 draft recordkeeping requirements, a number of 
commentators recommend that the draft rule provide a de minimis 
exemption.\51\ One commentator states that ``[t]he abuses which the 
Board is seeking to curb obviously have taken place in connection with 
large contributions, therefore it is unreasonable and inefficient to 
ask securities firms to track all contributions.''\52\ Thus, this 
commentator recommends that the Board provide a dollar limit on 
contributions that would be subject to the recordkeeping and reporting 
requirements of rule G-37. This would create a presumption that 
contributions at some level are not in violation of the draft rule. 
Another commentator also recommends the adoption of reporting 
thresholds, noting that ``[t]his would permit employees of a broker/
dealer to participate in the political process through contributions * 
* * in amounts that, in our view, should not be deemed to influence the 
recipient.''\53\ One commentator believes that such thresholds ``would 
alleviate greatly the burden imposed by the disclosure and 
recordkeeping requirements of the draft rule. Of course, such a de 
minimis exception should apply only to the disclosure requirements, not 
to the ban on improper contributions, and firms should be expressly 
forbidden from bundling * * * contributions for the purpose of evading 
the disclosure requirements.''\54\ The recommendations of those 
commentators who favor a limit, in general, fall in the range of $100-
250 per official/candidate per year.\55\ However, some commentators 
recommend higher limits.\56\ Some of the proposed limits would apply 
only to firm contributions, some only to individual contributions, and 
some limits would apply both to firm and individual contributions.
---------------------------------------------------------------------------

    \51\See e.g. letters from Dean Witter; Chemical Securities.
    \52\Letter from George K. Baum.
    \53\Letter from Norwest Corporation.
    \54\Letter from Morgan Stanley. See also letters from Dean 
Witter; A.G. Edwards.
    \55\See e.g., letters from PSA; Dean Witter; Dain Bosworth; 
Norwest Corporation; Chemical Securities; Kiel; A.G. Edwards.
    \56\See, e.g., Grigsby Brandford; D.A. Davidson; George K. Baum.
---------------------------------------------------------------------------

    The rule should require dealers to disclose all contributions on a 
periodic basis; such reporting should not be tied to the awarding of 
business.
    One dealer recommends that the Board not key the August 1993 draft 
rule's disclosure requirements to the awarding of municipal 
business.\57\ Instead, this commentator recommends ``full, periodic and 
open disclosure of all political contributions from dealers and 
associated persons to all state, local and special district officials 
and candidates for such offices.''\58\ The commentator also suggests 
that quarterly reporting to the Board's MSIL system would be 
appropriate. Another dealer states that, while it supports the 
disclosure requirements, ``the method and type of disclosure called for 
by the draft rule is not an optimal means of accomplishing the MSRB's 
objectives. * * * [B]rokers and dealers [should] periodically provide 
the MSRB with a chronological list of all municipal securities business 
it has performed in each state, along with a chronological list of all 
contributions made in that state * * *. Such ongoing disclosure will be 
more effective in deterring improper political contributions.''\59\ 
Another commentator is similarly concerned about linking the disclosure 
requirement to the award of business since this ``is unnecessarily 
burdensome and creates significant potential for inadvertent 
violations. Alternatively, we suggest that periodic reporting of all 
political contributions by dealers and/or their associated persons 
could achieve the same purpose while substantially mitigating the 
compliance burden.''\60\
---------------------------------------------------------------------------

    \57\Letter from Goldman Sachs.
    \58\Id.
    \59\Letter from Morgan Stanley.
    \60\Letter from NBD Bancorp. See also letters from National 
Association of Independent Public Finance Advisors; NYU; Chemical 
Securities; Dain Bosworth; Morgan Stanley; William R. Hough; and 
A.G. Edwards.
---------------------------------------------------------------------------

    The disclosure obligation should be on the recipient rather than 
the donor.
    Some commentators believe that the disclosure obligation concerning 
political contributions should be imposed on the recipient rather than 
the donor of such contributions.\61\ The PSA states that ``the most 
comprehensive and appropriate source of information about political 
contributions is the recipient who solicited the contribution, not the 
donor.'' Wheat First favors a rule which requires disclosure by both 
the issuer and dealer. Norwest ``urge[s] the Board to withdraw this 
proposal and urge state and local governments to adopt recipient 
disclosure.''
---------------------------------------------------------------------------

    \61\See e.g., letters from Norwest Corporation; Legg Mason; The 
Ohio Company.
---------------------------------------------------------------------------

    Board Response. While the Board is sensitive to commentators' 
concerns that the recordkeeping and disclosure requirements would 
impose a burden on dealers, it believes that any such burden is 
necessary and appropriate in furtherance of the purposes of the Board's 
mandate to, among other things, protect investors and the public 
interest, and remove impediments to and perfect a free and open market 
in municipal securities. Moreover, the Board believes that the proposed 
rule change represents a measured response to the problems noted. The 
Board has attempted to minimize any burden by:

--requiring disclosure on a periodic basis (i.e., quarterly) rather 
than linking it to the award of business;
--making the recordkeeping and disclosure requirements applicable 
only to: (i) contributions made, directly and indirectly, by dealers 
and any PAC controlled by the dealer (or a municipal finance 
professional) to officials of an issuer and to political parties; 
and (ii) contributions over the de minimis exemption made, directly 
and indirectly, by municipal finance professionals and executive 
officers to officials of an issuer and to political parties.

    The Board determined to add a recordkeeping/disclosure requirement 
for contributions by executive officers to issuer officials, and a 
recordkeeping/disclosure requirement for contributions by dealers, 
dealer-controlled PSACs, and municipal finance professionals and 
executive officers to political parties, but not to include such 
contributions as triggering events for the prohibition on business. 
These requirements will permit enforcement agencies, as well as the 
public, to examine the nature of such contributions. The information 
disclosed to the public will consist of summary information and will 
not include the names or titles of individual contributors. In 
addition, the rule's proscriptions on indirect violations, soliciting 
and bundling are intended to prohibit covered parties from 
circumventing the rule by using any other person or means, including 
executive officers and political parties, as conduits. For instance, a 
dealer may violate the rule, as well as trigger the prohibition on 
business, by making a contribution to a political party when the dealer 
knows that a contribution will be provided by the political party to a 
specific issuer official with which the dealer engages or is seeking to 
engage in business. Similarly, a dealer may violate the rule and 
trigger its prohibition by using an executive officer as a conduit for 
making contributions. Thus, dealers should ensure that their 
supervisory procedures, pursuant to rule G-27, adequately guard against 
such violations. The Board believes that the rule's prohibitions, in 
conjunction with the recordkeeping/disclosure requirements, should 
adequately protect against abuses in connection with contributions to 
political parties. However, the Board will not hesitate to impose more 
stringent requirements in this area if it becomes aware of significant 
abuses.
(C) Definitions
    The Board should narrow the definition of ``associated person''.
    Many commentators are concerned that the definition of ``associated 
person'' in draft rule G-37 is too broad and that it should be limited 
to dealers, their officers and employees who participate in the process 
of obtaining or retaining municipal securities business for their 
firm.\62\ These commentators are concerned that the scope of the rule 
would extend to holding companies, subsidiaries and affiliates of 
dealers regardless of their lack of direct or indirect involvement in 
the dealer's municipal securities business. One commentator believes 
that by narrowing the definition of associated persons, the Board ``can 
effectuate its stated purpose of seeking to prohibit only those 
political contributions made solely for the purpose of obtaining or 
retaining municipal securities business, without imposing on municipal 
securities dealers and their other employees unnecessary and unworkable 
compliance responsibilities or invading the privacy, or interfering 
with the constitutionally protected rights of those employees.''\63\ 
Another commentator also believes it is unnecessary and overly broad to 
impose the prohibition on parents and affiliates of dealers, and 
recommends that the scope of the rule be narrowed to cover ``brokers, 
dealers, municipal securities dealers, and their registered employees 
and immediate family members who reside with them, as well as 
contributions made by the dealer's affiliated political action 
committee.''\64\ Another commentator notes that it is ``a large 
organization with a great number of employees and [is] part of a large 
holding company structure * * * and [that] the reporting and 
recordkeeping requirements * * * would be an administrative 
nightmare.''\65\ This commentator states that the definition is broad 
and could be interpreted to apply to people as far removed from the 
dealer as the chairman, the chief executive office, and the chief 
operating officer of the holding company that owns the dealer. At the 
same time, this commentator acknowledges that ``the reports 
contemplated by the Draft Rule may be the only, or at the least the 
best, way for the relevant enforcement authority to become aware of a 
possible violation * * *.''\66\ The PSA notes that a ``meaningful but 
narrow definition is particularly important in order to preserve a 
`level playing field' for different types of municipal securities 
dealers. * * * [T]he limitations and reporting requirements should 
apply to municipal finance professionals engaged in the solicitation 
and conduct of municipal finance business and their direct supervisors, 
up to and including the CEO of the firm.'' And another commentator 
believes that a ``firm's municipal finance professionals are an 
identifiable group whose activities can be effectively supervised and 
monitored for compliance and enforcement purposes. The firm itself, any 
employee political action committee and the firm's municipal finance 
professionals and their supervisors should constitute the specific 
group subject to the Rule.''\67\
---------------------------------------------------------------------------

    \62\See, e.g., letters from Dean Witter; Chemical Securities; 
Dain Bosworth; Wheat First; George K. Baum; Norwest Corporation.
    \63\Letter from Dean Witter.
    \64\Letter from Lehman Brothers.
    \65\Letter from Chemical Securities. See also letters from SIA; 
Dain Bosworth.
    \66\Letter from Chemical Securities.
    \67\Letter from A.G. Edwards.
---------------------------------------------------------------------------

    The SIA states that by applying the ``directly or indirectly'' 
language of the draft rule, dealers would be required to record and 
report contribution information from ``family members, attorneys and 
other potential third-party conduits, as well as dealers' and their 
affiliated entities' clerical personnel * * *. The amount of 
information which the MSRB would amass pursuant to the Rule would be so 
overwhelming that the Rule's effectiveness would be limited. If the 
Rule is narrowed * * * the MSRB would receive much more usable and 
meaningful information.'' NAST also is concerned that this language 
``effectively compels a dealer to require employees to report all 
personal political contributions to the employer/dealer as well as 
contributions made by employees on behalf of the dealer.''
    Board Response. In response to commentators' concerns that the 
definition of ``associated person'' was too broad and would result in 
costly and burdensome compliance with the rule, the Board determined to 
limit the prohibition section of the proposed rule to individuals 
defined as ``municipal finance professionals.'' This term encompasses 
any associated person: (i) Primarily engaged in municipal securities 
activities, as defined in rule G-3(a)(i) (including bankers, traders, 
institutional salespeople , and retail salespeople);\68\ (ii) who 
solicits municipal securities business; (iii) direct supervisors of 
such persons up through and including, in the case of a dealer other 
than a bank dealer, the Chief Executive Officer or similarly situated 
official and, in the case of a bank dealer, the officer or officers 
designated by the board of directors of the bank as responsible for the 
day-to-day conduct of the bank's municipal securities dealer 
activities, as required pursuant to rule G-1(a); and (iv) members of 
the dealer's executive or management committee or similarly situated 
officials, if any (or, in the case of a bank dealer, similarly situated 
officials in the bank's separately identifiable department or division, 
as defined in rule G-1). Each person designated by the dealer as a 
``municipal finance professional'' shall be deemed as such for purposes 
of the proposed rule change.
---------------------------------------------------------------------------

    \68\Pursuant to rule G-3(a)(i), such activities include: (i) 
Underwriting, trading or sales of municipal securities; (ii) 
financial advisory or consultant services for issuers in connection 
with the issuance of municipal securities; (iii) research or 
investment advice with respect to municipal securities; or (iv) any 
other activities which involve communication, directly or 
indirectly, with public investors in municipal securities.
---------------------------------------------------------------------------

    The definition of municipal finance professional includes any 
associated person of the dealer primarily involved in the solicitation 
of municipal securities business or bringing to market new issue 
municipal securities. This includes those individuals who have an 
economic interest in seeing that the dealer is awarded municipal 
securities business and thus may be in a position to make political 
contributions for the purpose of influencing the awarding of such 
business by issuer officials. Such persons would include those in the 
public finance department, as well as underwriters, traders and 
institutional and retail sales persons primarily engaged in municipal 
securities activities. The Board does not, however, intend to include 
within the definition of municipal finance professional those persons 
who activities do not primarily involve municipal securities, such as 
those retail sales persons who primarily sell other products or 
associated persons employed in departments other than the municipal 
securities department.
    It should be noted that contributions by executive officers would 
be subject to the recordkeeping and disclosure requirements, but 
contributions by such persons would not trigger the rule's prohibition 
on business. The Board has defined ``executive officer'' as any 
associated person in charge of a principal business unit, division, or 
function or any other person who performs similar policymaking 
functions for the dealer, but does not include anyone already covered 
by the definition of municipal finance professional.\69\
---------------------------------------------------------------------------

    \69\This definition was adapted from Section 16 of the Act.
---------------------------------------------------------------------------

    The proposed rule would prohibit municipal finance professionals 
(as well as dealers) from doing any act, directly or indirectly, which 
would be a violation of the proposed rule. This proscription is 
intended to prohibit such persons from circumventing the proposed rule 
by using any other person or means as conduits, including, but not 
limited to, family members, consultants, lawyers, lobbyists, non-
covered associated persons, and political parties. Some commentators 
argued against extending the August 1993 draft rule's application to 
contributions by family members. The Board determined not to 
specifically include family members within the term ``municipal finance 
professional,'' since the proscription on indirect violations 
contemplates such persons in situations in which their contributions 
are directed by municipal finance professionals. Furthermore, the 
proposed rule contains a prohibition on soliciting contributions in 
connection with the awarding of business. This prohibition is intended 
to prohibit dealers and municipal finance professionals from soliciting 
others, including family members, to make contributions to issuer 
officials in order to influence the awarding of municipal securities 
business. Finally, the proposed rule contains a prohibition on 
coordinating (i.e., bundling) contributions, which is intended to 
prevent dealers and municipal finance professionals from aggregating, 
or soliciting others to aggregate, contributions to issuer officials in 
order to influence the awarding of municipal securities business.
    The effect of the proscription on indirect violations and the anti-
solicitation provision would be to subject a dealer to the rule's 
prohibition on business if the dealer or a municipal finance 
professional uses other non-covered parties to make or solicit 
contributions. The recordkeeping and disclosure requirements would 
apply to contributions by dealers, dealer-controlled PACs, municipal 
finance professionals, and executive officers, as well as contributions 
made by any other person or entity if such contributions were directed 
by a dealer, dealer-controlled PAC, or municipal finance professional.
    PACs associated with bank dealers should be exempt from the rule.
    A few commentators express concern about inclusion of bank PACs in 
the draft rule, especially when the dealer is owned by an organization 
(i.e., a bank or bank holding company) whose primary focus is outside 
the securities business. One commentator notes that ``the draft rule is 
based on the assumption that the dealer has the ability to control or 
influence the actions of all associated PACs to obtain the favor of 
municipal issuers. This assumption is incorrect for PACs established by 
large bank holding companies whose major focus is banking and not 
securities underwriting and distribution.``\70\ This commentator notes 
that another significant concern for dealers owned by bank holding 
companies is the acquisition of new subsidiaries by the dealer's 
parent. ``The rule is unclear as to what responsibility the dealer has 
with respect to contributions made by a subsidiary in the two years 
immediately preceding the subsidiary's acquisition. * * * [T]he draft 
rule should not apply to PACs in cases where a dealer is owned by an 
organization whose primary focus is not investment banking. * * * [We 
recommend that the Board] exclude PACs which are not under the direct 
control of the dealer and removing the burden of compliance as to the 
political contributions that predate acquisition of a subsidiary of a 
dealer's parent.''\71\
---------------------------------------------------------------------------

    \70\Letter from Banc One. See also from Central Bank of the 
South.
    \71\Letter from Banc One.
---------------------------------------------------------------------------

    One commentator notes that PACs are required by various laws to 
report periodically all contributions and other disbursements that they 
make. These reports include individual contributions by bank officers 
(including associated persons of the dealer department) above de 
minimis thresholds.\72\ Thus, this commentator recommends that ``the 
reporting scheme set forth in the proposed rule as it applies to PACs 
is duplicative and unnecessarily burdensome.''\73\ In addition, the 
commentator believes that there is a significant potential for 
inadvertent violations of the rule's reporting requirements, since ``a 
PAC associated with a diversified financial institution will make a 
large number of contributions without knowledge of the potential role 
that the recipient may play in the awarding of municipal securities 
business * * *. Accordingly, we suggest that PACs be exempted from the 
* * * reporting requirements * * *. As an alternative, the Board may 
wish to consider requiring associated PACs to file copies of federal 
and/or state disbursement reports with [the MSIL system].''\74\
---------------------------------------------------------------------------

    \72\Letter From NBD Bancorp.
    \73\Id.
    \74\Id.
---------------------------------------------------------------------------

    Board Response. The August 1993 draft rule would have applied to 
``dealer-associated'' PACs, which, for dealers that are departments of 
banks or subsidiaries of banks or bank holding companies, would have 
included bank PACs. The Board recognizes that, in many instances, such 
bank PACs receive contributions from bank employees who have no 
connection of the securities business. The Board has, therefore, 
attempted to address commentators' concerns over the inclusion of bank 
PACs by changing the proposed rule's terminology to ``dealer-
controlled'' PACs. Thus, if a bank PAC is not a ``dealer-controlled'' 
PAC, then its contributions would not trigger the rule's prohibition on 
business.
    The definition of ``official of the issuer'' is too broad.
    Several commentators are concerned that the definition of 
``official of an issuer'' is too broad. The Ohio Company believes that 
``[i]t is impossible to ascertain, with total certainty in some cases 
or with even an educated guess in others, which elected official of the 
issuer is actually in a position to influence the awarding of municipal 
securities business.'' NAST asks, ``how is a dealer to know when a non-
issuer official is likely to become an issuer official? Does the draft 
rule cover an official who has the power to appoint issuer officials, 
but is not an issuer official himself or herself? * * * How does a 
dealer meet the supervision and reporting requirements when it is 
unclear who is considered to be an official of an issuer?'' Lehman 
Brothers notes that ``one may interpret the rule as also applying to 
elected officials at the federal level who may be in a position to 
influence local officials in their states. * * *'' And NBD Bancorp 
states that ``the inclusion of any elected officer who `can influence 
the outcome' of the award of business is potentially broad enough to 
effectively disenfranchise associated persons of municipal securities 
dealers from any political activities with respect to candidates for 
local office.'' However, Kane McKenna states that:


contributions are often given to an office holder who, although not 
an ``official of the issuer,'' clearly has the ability to informally 
influence the issuer. * * * [I]n our experience, it can be one of 
the most important methods of contributing to a political campaign 
for purposes of business generation.


    Board Response. The Board considered the commentators' suggestions 
to narrow the definition of ``official of the issuer,'' but determined 
that its definition is appropriate. The term includes any incumbent, 
candidate or successful candidate for elective office of the issuer, 
which office is directly or indirectly responsible for, or can 
influence the outcome of, the hiring of a dealer for municipal 
securities business. The definition is intended to include any issuer 
official, candidate or successful candidate which has influence over 
the awarding of municipal securities business so that contributions to 
certain state-wide executive or legislative officials, such as 
governors, would trigger the proposed rule's prohibition on business.
    The Board should clarify the definition of ``contributions'' 
regarding volunteer work and charitable contributions.
    Some commentators note that the definition of ``contribution,'' 
which includes ``anything of value,'' could have the unintended effect 
of regulating an employee's volunteer work on political campaigns 
during non-business hours. These commentators ask that the Board 
clarify this definition with respect to such volunteer work.\75\ Other 
commentators seek further clarification of the definition with respect 
to charitable contributions that are solicited by officials of 
issuers.\76\ Another commentator suggests that the definition 
specifically include ```in kind''' contributions, such as secretarial 
help, free rent, etc. * * * Politicians understand the phrase, and 
making the prohibition of in-kind contributions explicit would help 
protect dealers against the request for such contributions by 
politicians.''\77\ An anonymous commentator recommends expanding the 
definition of contributions ``to include any financial or economic 
benefit bestowed upon or requested by or for any person who is in a 
position to select or influence the selection of underwriters, 
financial advisors, bond lawyers, etc.'' And NAST is concerned that the 
August 1993 draft rule could be interpreted as prohibiting independent 
political expenditures.
---------------------------------------------------------------------------

    \75\See e.g., letters from PSA; Dain Bosworth; Morgan Stanley; 
Lehman Brothers; Fenner; anonymous; Kane McKenna.
    \76\See letters from PSA; Morgan Stanley.
    \77\Letter from Fenner.
---------------------------------------------------------------------------

    Board Response. The Board does not seek to regulate personal 
volunteer work on political campaigns by municipal finance 
professionals. However, if any entity or person subject to the rule 
utilizes the dealer's resources (such as a political position paper 
drafted by dealer personnel), or incurs expenses in connection with 
such activity, then the value of any such resources used or expenses 
incurred would come under the proposed rule's requirements. Other types 
of payments to issuer officials may be subject to other Board rules, 
including rule G-20, on gifts and gratuities. Finally, the Board does 
not seek to regulate independent political expenditures.\78\
---------------------------------------------------------------------------

    \78\The Federal Election Campaign Act, 2 U.S.C. Section 
431(17)(1988), defines an ``independent expenditure'' as: ``an 
expenditure by a person expressly advocating the election or defeat 
of a clearly identified candidate which is made without cooperation 
or consultation with any candidate, or any authorized committee or 
agent of such candidate, and which is not made in concert with, or 
at the request or suggestion of, any candidate, or any authorized 
committee or agent of such candidate.''
---------------------------------------------------------------------------

Other Comments and Suggestions
    A number of commentators are concerned that the draft rule creates 
an opportunity for abuse by not addressing the practice of hiring 
consultants or other third parties to solicit business on behalf of 
dealers. The GFOA states that if ```politics' is to be taken out of the 
underwriter selection process, this practice must be reviewed.'' One 
dealer describes this practice as ``arguably the most serious area in 
need of regulation with respect to political interference in the 
selection of municipal finance professionals * * *. These relationships 
and lobbying efforts take a variety of forms.''\79\ And some 
commentators are concerned that brokers and dealers will find more 
creative ways of influencing officials, such as:
---------------------------------------------------------------------------

    \79\Letter from William R. Hough.

[retaining] consultants who in turn regularly make large political 
contributions so that the consultants are in a position to influence 
the selection of an underwriter or financial advisor by an issuer. 
Firms may also make donations to charitable organizations at the 
request of governmental officials. Contributions to political 
parties and organizations, rather than directly to candidates, may 
also increase. * * * [Our] principal concern with the proposed rule 
is that as drafted it will result in a continuation of ``pay to 
play'' practices by some firms who will act in a more circuitous 
fashion.\80\
---------------------------------------------------------------------------

    \80\Letter from Morgan Stanley; see also letter from Kane 
McKenna.

    One commentator believes that the draft rule ``is not a 
comprehensive solution to the problems relating to the selection of 
underwriters and financial advisors.''\81\ This commentator suggests 
that, in addition to banning improper contributions by brokers and 
dealers, the Board should specifically prohibit such contributions by 
consultants, lawyers and other persons who seek municipal securities 
business on behalf of brokers and dealers. Furthermore, ``brokers and 
dealers should be required to disclose all consulting, lobbying and 
third party contracts relating to obtaining or retaining municipal 
securities business, whether or not those contracts involve political 
contributions. This disclosure requirement in and of itself is likely 
to act as a prophylactic measure that will discourage firms from asking 
third parties to engage in such efforts on their behalf.''\82\ Another 
commentator recommends prohibiting any individual covered by the rule 
from soliciting contributions from any other employee or from third 
parties.\83\ Another commentator is concerned that the draft rule does 
not address contributions by an associated person who may have a 
financial interest or gain income from an independent financial 
advisory or consulting firm, and that such an associated person may be 
able to circumvent the rule by funneling contributions through these 
firms.\84\ Thus, the commentator suggests that the Board require any 
associated person with a pecuniary interest in an independent firm to 
also report that firm's contributions. And the PSA ``urges the MSRB to 
consider prohibiting explicitly certain practices * * * [such as] the 
retention of consultants for the purpose of obtaining business who 
concurrently serve as public officials of the state in which 
jurisdictions are to be influenced.''
---------------------------------------------------------------------------

    \81\Letter from Morgan Stanley.
    \82\Id.
    \83\Letter from Goldman Sachs. See also letter from Trustmark.
    \84\Letter from Trustmark.
---------------------------------------------------------------------------

    One commentator is concerned that the draft rule does not apply to 
interest rate swaps, and notes that ``[s]uch transactions are becoming 
more common, can be very profitable, and are subject to the same 
intense competition which exists for municipal securities 
offerings.``\85\ This commentator is similarly concerned that the draft 
rule would not apply to U.S. Treasury Securities or other similar 
securities, regardless of whether such transactions are associated with 
a municipal offering.
---------------------------------------------------------------------------

    \85\Letter from William R. Hough.
---------------------------------------------------------------------------

    Board Response. To reduce the possibility and opportunity for 
circumvention of the proposed rule, the Board included language 
prohibiting dealers from acting ``directly or indirectly'' through any 
other person or means. This proscription was modeled after Section 
20(b) of the Act\86\ and is intended to prohibit dealers (as well as 
municipal finance professionals) from using, for example, family 
members, consultants, attorneys, finders, lobbyists, etc., as conduits. 
Again, dealers should ensure that their supervisory procedures, 
pursuant to rule G-27, adequately guard against such violations.
---------------------------------------------------------------------------

    \86\Supra note 6.
---------------------------------------------------------------------------

    In addition to the prohibition on indirect violations, the proposed 
rule would require dealers to record and disclose a list of all 
parties, including consultants, hired to obtain or retain municipal 
securities business, as well as the compensation arrangements with such 
parties. These requirements, in conjunction with the rule's other 
recordkeeping/disclosure requirements, will permit the enforcement 
agencies, as well as the public, to examine whether the hiring of such 
parties involves any impropriety in connection with business awarded to 
the dealer based on political contributions. As noted previously, 
information disclosed to the public would be in summary form.
    Finally, by requiring the recording and disclosure of all political 
contributions, the proposed rule should assist enforcement agencies in 
determining whether such contributions influence the awarding of other 
business from issuers to dealers, such as interest rate swaps or 
reinvestment of bond proceeds.
    The rule should apply to all market participants.
    A number of commentators believe that a rule concerning political 
contributions should apply to all municipal market participants.\87\ 
The commentators recognize the Board's limited authority in this 
regard, and believe that the SEC should promulgate rules in this area. 
For instance, the PSA ``strongly urge[s] the MSRB to request the 
Securities and Exchange Commission * * * to use its existing authority 
(and seek legislation if necessary) to effect this result.''\88\ At the 
same time, however, PSA believes ``that the dealer community cannot 
wait for an ideal solution to the more general problem of financing 
political campaigns for elective office, but must rather do something 
for itself.'' One commentator is concerned that independent financial 
advisors will ``still be able to curry favor with political 
contributions. * * * [A]ny individual can name themselves a financial 
advisor and employ inappropriate practices * * *. These people are not 
licensed and not regulated * * * [and] will now have a competitive 
advantage * * *.''\89\ NAST states that bond counsel, underwriter's 
counsel and independent financial advisors ``have an incentive and 
opportunity comparable to that of dealers to engage in unethical, 
anticompetitive and destructive behavior * * *.''
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    \87\See e.g., letters from PSA; SIA; Wheat First; The Ohio 
Company; George K. Baum; Lehman Brothers; Norwest Corporation; 
Morgan Stanley; Altman & Co.
    \88\See also letters from Lehman Brothers; The Ohio Company.
    \89\Letter from Altman & Co.
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    Board Response. The Board has adopted the proposed rule change as a 
first step toward eliminating the problems associated with political 
contributions in connection with the awarding of municipal securities 
business. It believes the rule is targeted to the reported major 
problem areas and should be an effective deterrent to activities which 
have called into question the integrity of the market. Once the 
proposed rule change is put into place, the Board will closely monitor 
its effectiveness. If it determines that compliance problems exist, or 
if dealers seek to circumvent the proposed rule change's requirements, 
the Board will not hesitate to amend the proposed rule change to make 
its prohibitions applicable to a broader range of entities and 
individuals or to include other prohibitions or disclosure 
requirements.
    The Board should conduct a cost/benefit analysis before adopting a 
rule on political contributions.
    The National League of Cities (``NLC'') believes ``that any 
proposal to mandate changes in the workings of the municipal market 
should only be imposed after the most careful analysis, including a 
cost-benefit and risk analysis about the impact of any proposed 
changes.'' NLC notes that ``[w]e are unaware of any detailed analysis 
of the costs and benefits to investors * * *. Nor have we discovered 
any analysis of the impact of these costs on municipal investors.'' 
Similarly, the GFOA states that the ``reservation we have about this 
new system of reporting is the lack of serious analysis to assess the 
specific nature or extent of improper practices. As a consequence, 
there is no way to determine if the costs of new regulation, which will 
inevitably be passed on to state and local government issuers, justify 
the benefits to be derived.''
    Board Response. The Board has attempted to respond appropriately to 
commentators' concerns over regulatory burdens, without sacrificing the 
proposed rule's overall effectiveness in eradicating the problems 
noted. The Board has submitted the proposed rule change because it 
believes that a significant problem exists, that this problem is 
adversely impacting investors as well as the integrity of the municipal 
market, and that it is incumbent upon the Board to seek to rectify 
known problems in the municipal market. Moreover, the Board believes 
that the proposed rule change is a measured response to the problems 
noted.
    The proposed rule change would foster competition for municipal 
securities business by removing artificial barriers to dealers who may 
have been unwilling or unable to make contributions in order to be 
considered for the awarding of business. Dealers will now compete on a 
level playing field and be awarded municipal securities business on the 
basis of merit, not political contributions. Such competition would 
lower market costs and restore investor confidence in the integrity of 
the market.
    Any reporting of information to the Board should take place on an 
annual basis.
    Two commentators believe that reporting should be on an annual 
(rather than semiannual) basis.\90\
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    \90\Letters from Dain Bosworth and Morgan Stanley.
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    Board Response. The Board believes that, for information on 
political contributions and consultants to be useful in correcting the 
problems noted, the disclosure of such information must be timely in 
relation to municipal business awarded to dealers. At the same time, 
the Board has attempted to reduce the compliance burden on dealers. 
Thus, the Board determined to adopt a quarterly disclosure requirement, 
and believes that this requirement strikes an appropriate balance of 
the competing concerns noted.
Comments Received in Response to November 1993 Press Release
    Since its November 1993 meeting, the Board has received nine 
additional comment letters on proposed rule G-37, bringing the total 
comments received to 49 letters and one oral comment.\91\ The 
additional letters were provided by the following: Anonymous (investing 
banker), Anonymous (registered principal), The Argentarius Group, Ltd., 
The City of Novato, CA, Griffin, Kubik, Stephens & Thompson, Inc., J.P. 
Morgan Securities, Inc., Public Securities Association, Seasongood & 
Mayer (two letters).
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    \91\The nine additional letters are included in Exhibit 2 to the 
filing.
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    De Minimis Exemption. One commentator is concerned that the $250 de 
minimis exemption will be abused.\92\ This commentator believes that 
the municipal industry is plagued by ``a prevalent practice for hiding 
contributions'' noting that:


    \92\Letter from The Argentarius Group.
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    Bankers, salespeople, their spouses, their * * * adult children 
as well as clerical and secretarial staff are ``encouraged'' to each 
give a certain amount of money to a candidate. The amount is usually 
$200 or less, since our [state] laws * * * do not require reporting 
contributions of that amount or less. Individual checks are then 
presented en masse by a banker for the firm to the candidate.\93\


    \93\Id.
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    Board Response. As previously described, the Board determined to 
provide a $250 de minimis exemption, per election, for contributions by 
municipal finance professionals to each issuer official for whom such 
individuals are entitled to vote. Such contributions would not trigger 
the rule's prohibition on engaging in business. The Board believes that 
this exemption is a measured response to concerns over an individual's 
ability to participate in the political process, recognizing the 
Board's statutory mandate to address known problems in the municipal 
market. Furthermore, the Board believes that its prohibitions on 
indirect activities, soliciting and bundling contributions, as well as 
the various recordkeeping/disclosure requirements will prevent 
circumvention of the proposed rule.
    Scope of Rule. One commentator is concerned that the rule's scope 
is too narrow.\94\ This commentator notes that (in addition to elected 
officials) political appointees, employees, and financial advisors act 
as decision makers in the underwriter selection process, and that 
financial advisors, in particular, have great influence, and usually 
complete control, over this process and others. The commentator also 
believes that the scope of the rule should extend beyond political 
contributions to encompass any monetary or economic benefit conferred 
upon the decision maker, noting that financial advisors commonly 
structure deals for their own pecuniary benefit, while causing issuers 
to bear additional and unnecessary costs and higher interest rates.\95\
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    \94\Letter from Anonymous (investment banker).
    \95\Id.
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    Another commentator also is concerned that the rule will be abused, 
and states that the Board should not provide exemptions for any 
affiliates, lobbyists, or related parties, and that contributions by 
such parties should trigger the rule's prohibition on business.\96\ In 
addition, this commentator believes that an issuer official's 
``transition costs'' should be addressed by the rule.\97\
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    \96\Letter from Seasongood & Mayer.
    \97\Id.
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    PSA seeks guidance from the Board on a number of issues relating to 
political contributions so that it may assist its membership in this 
area. PSA poses questions concerning the following:
--Volunteer work and charitable contributions.
--Transition and inaugural expenses.
--Contributions by spouses and other household members.
--The effect of the proposed rule on ``partisan versus non-partisan 
associations or PACs of state or local officials.''\98\
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    \98\Letter from PSA.
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    Board Response. In response to concerns about the scope of the 
proposed rule, the Board believes that the narrow scope of the rule 
will ensure that ``pay to play'' practices in the municipal market will 
be halted without impacting every employee of the dealer or his or her 
family members. As discussed, the rule would apply only to dealers, 
dealer-controlled PACs, municipal finance professionals, and executive 
officers.
    In response to concerns regarding the use of consultants and other 
parties, the proposed rule would require dealers to record and disclose 
a list of all such parties hired to obtain or retain municipal 
securities business, as well as the compensation arrangements with such 
parties. These requirements, in conjunction with the rule's other 
recordkeeping/disclosure requirements, will permit the enforcement 
agencies, as well as the public, to examine whether the hiring of such 
parties involves any impropriety in connection with business awarded to 
the dealer.
    In response to PSA's questions, the Board, as discussed above, does 
not seek to prohibit or to regulate personal volunteer work by 
municipal finance professionals so long as the professional does not 
utilize the dealer's resources or incur expenses in connection with 
such activity. The Board is in the process of reviewing its rule G-20, 
on gifts and gratuities, and will consider, among other things, 
contributions to charities in connection with this review. However, the 
proposed rule's definition of ``contributions'' would encompass 
transition and inaugural expenses. Thus, such payments would be subject 
to the proposed rule.
    As previously described, the proposed rule would prohibit covered 
parties from doing indirectly any act which would constitute a 
violation of the rule. This section is intended to prohibit covered 
parties from circumventing the proposed rule by using as conduits any 
other person or means, including, but no limited to, spouses and other 
family members. In addition, the proposed rule's anti-solicitation and 
anti-bundling proscriptions are intended to prohibit covered parties 
from: (i) Soliciting others, including spouses and family members, to 
make contributions to issuer officials; and (ii) coordinating, or 
soliciting others to coordinate, contributions to issuer officials in 
order to influence the awarding of municipal securities business.
    Finally, it is not clear what organizations the PSA is referring to 
as ``partisan versus non-partisan associations or PACs'' and, 
accordingly, the Board cannot provide any guidance with respect to this 
question.
    Ballot Referenda. One commentator expressed concern over a practice 
whereby dealers, who are seeking underwriter or financial advisory 
positions, are asked to contribute to bond election committees 
supporting ballot measures for bonds and tax levies.\99\ The 
commentator notes that such requests are made by the election committee 
or by public officials who play a role in the underwriter selection 
process, and believes ``that this practice undermines the integrity of 
our industry. * * * [and] is another example of money influencing the 
selection process.''\100\
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    \99\Letter from Anonymous (registered principal).
    \100\Id.
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    Board Response. Contributions to ballot measures, and other 
independent expenditures, would not be subject to the proposed rule. 
However, contributions to election committees for incumbents and 
candidates would be covered by the rule, since the term ``official of 
such issuer'' or ``official of an issuer'' means any person who was, at 
the time of the contribution, an incumbent, candidate or successful 
candidate for elective office of the issuer, including any election 
committee for such person, which office is directly or indirectly 
responsible for, or can influence the outcome of, the hiring of a 
dealer for municipal securities business. In addition, a dealer may 
violate the rule's proscription on indirect violations by using any 
other person or means as a conduit to contribute to an issuer official.
    Dissemination of Information on Political Contributions. One 
commentator believes that disclosure of information on political 
contributions is ``essential . . . and should be strongly 
encouraged.''\101\ The commentator is concerned, however, that there is 
no mechanism by which such information will be ``routinely 
disseminated,'' and believes that such a mechanism should provide for 
continuous, ongoing disclosure.\102\
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    \101\Letter from J.P. Morgan.
    \102\Id.
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    Board Response. In order to ensure equal public access to 
information about political contributions and parties hired by dealers 
in connection with municipal securities business, the proposed rule 
change will require dealers to submit this and other information to the 
Board on a quarterly basis. The Board will utilize its existing MSIL 
system to accept and disseminate such information, and is in the 
process of developing appropriate filing procedures to accomplish such 
purposes.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other those that may 
be withheld from the public in accordance with the provisions of 5 
U.S.C. Sec. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of the filing will also be 
available for inspection and copying at the principal office of the 
MSRB. All submissions should refer to the file number in the caption 
above and should be submitted by February 11, 1994.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority, 17 CFR 200.30-3(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-1454 Filed 1-19-94; 4:15 pm]
BILLING CODE 8010-01-M