[Federal Register Volume 59, Number 71 (Wednesday, April 13, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-8838]


[[Page Unknown]]

[Federal Register: April 13, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33868; File No. SR-MSRB-94-2]

 

Self-Regulatory Organization; Municipal Securities Rulemaking 
Board

April 7, 1994.
    In the matter of Self-regulatory organizations; order approving 
proposed rule change by the Municipal Securities Rulemaking Board 
relating to political contributions and prohibitions on municipal 
securities business and notice of filing and order approving on an 
accelerated basis amendment No. 1 relating to the effective date and 
contribution date of the proposed rule.

    On January 12, 1994, the Municipal Securities Rulemaking Board 
(``MSRB'') submitted to the Securities and Exchange Commission 
(``Commission'') a proposed rule change (File No. SR-MSRB-94-02) 
pursuant to section 19(b)(1) of the Securities Exchange Act of 1934,\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 Commission published notice to the proposal in 
the Federal Register on January 21, 1994.\2\ On February 4, 1994, the 
Commission extended the comment period for the proposal by 30 days, to 
March 11, 1994.\3\ On March 29, 1994, the MSRB filed an Amendment to 
the proposal relating to the proposal's effective date and contribution 
date.\4\
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    \1\15 U.S.C. 78s(b)(1).
    \2\Securities Exchange Act Release No. 33482 (January 14, 1994), 
59 FR 3389.
    \3\Securities Exchange Act Release No. 33583 (February 4, 1994), 
59 FR 6320.
    \4\As originally submitted, the proposal's prohibitions on 
municipal securities business would arise from contributions made on 
or after April 1, 1994. The MSRB filed an amendment to change the 
April 1, 1994 date to a date 10 days after publication in the 
Federal Register of the Commission order approving the proposal. The 
MSRB also amended the proposal to change the effective date of the 
proposal's disclosure and recordkeeping requirements to a date 10 
days after publication of the approval order in the Federal 
Register. File No. SE-MSRB-94-2, Amendment No. 1 (March 29, 1994).
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    The Commission received 69 comment letters on the proposed rule 
change. Twenty-four commentators favor the proposal and 33 oppose the 
proposal. Several commentators raise concerns without expressly 
favoring or opposing the proposal. Several commentators that favor the 
proposal make recommendations to better enable municipal securities 
dealers to comply with the proposal. The Commission has determined, for 
the reasons discussed below, to approve the proposed rule change.

I. Executive Summary

    The MSRB's proposed rule change relating to political contributions 
and prohibitions on municipal securities business is intended to 
address practices known as ``pay to play.'' These practices typically 
involve payments in the form of political contributions to help finance 
election campaigns of state or local officials or similar arrangements 
with these officials. Widespread reports regarding the existence of 
such practices has fueled industry and regulatory concerns. These 
practices directly affect municipal securities markets by increasing 
costs borne by issuers, dealers and ultimately investors, by creating 
artificial barriers to competition, and by undermining underwriter and 
market integrity. In 1993, state and local governments awarded 
negotiated underwriting contracts for the sale of more than $250 
billion of municipal bonds, approximately 80% of all municipal 
securities underwritings, to facilitate the construction of schools, 
highways, hospitals, public housing, bridges, water and sewer systems, 
and other infrastructure projects needed to serve public needs and spur 
local and regional economic growth.\5\ As of December 31, 1993, private 
investors, including households and mutual and money market funds, held 
more than $850 billion in municipal securities, representing 
approximately 70% of outstanding municipal securities.\6\ While it is 
difficult to quantify the cost of fraudulent, unethical, and 
manipulative dealer selection practices, at a minimum, these practices 
substantially undermine the integrity of the municipal securities 
market. Congress recognized the importance of integrity in municipal 
securities financing when it directed the formation of the MSRB, as 
part of the Securities Acts Amendments of 1975, and authorized the MSRB 
to regulate the conduct of municipal securities dealers to, among other 
things, prevent fraudulent and manipulative acts and practices, promote 
just and equitable principles of trade, remove impediments to free and 
open trade, and protect investors and the public interest.
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    \5\See Public Securities Association, Review of Studies of 
Competitive and Negotiated Financing of Municipal and Corporate 
Securities (March 1994).
    \6\Board of Governors of the Federal Reserve System, Flow of 
Funds Accounts, Flows and Outstandings, Fourth Quarter 1993 (March 
9, 1994) (``Flow of Funds Accounts'').
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    As the self-regulatory organization (``SRO'') charged with primary 
oversight of municipal securities dealers' activities, the MSRB has 
proposed a series of measures designed to prevent ``pay to play'' 
practices in the awarding of municipal securities business. These 
measures include a prohibition against municipal securities dealers, 
conducting certain types of municipal securities business with an 
issuer if the dealer or affiliated persons, subject to exceptions, made 
political contributions to officials of the issuer who could influence 
the awarding of that business. The measures also include separate 
provisions requiring municipal securities dealers to maintain records 
and to disclose aggregate information to facilitate compliance and 
examinations with the goal of promoting investor confidence in the 
integrity of the municipal securities market. As discussed below, the 
Commission believes that the proposal is consistent with the Act and 
will advance the goals of the Act.

II. Background

    The market for municipal securities is characterized by great 
diversity and high volume and comprises an estimated 50,000 issuers 
including state governments, cities, towns, counties, and special 
subdivisions, such as special purpose districts and public 
authorities.\7\ There are approximately 1.3 million municipal 
securities issues outstanding, representing over $1.2 trillion in 
securities.\8\ In 1993, 17,000 new issues took place with a record 
value of $335 billion.\9\ As discussed below, negotiated underwritings 
have become the predominate method of underwriter selection. The MSRB's 
proposal is designed to address abuses involving political 
contributions inherent in using negotiated underwriting as a method of 
underwriter selection.
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    \7\Securities and Exchange Commission, Division of Market 
Regulation, Staff Report on the Municipal Securities Market, 
(September 1993) (``Municipal Securities Report'') at 1.
    \8\See Flow of Funds Accounts, supra note 6.
    \9\This record financing was heavily influenced by refundings. 
Nevertheless, the level of long term new money financing, 
representing 49% of the financing for the year, reflected continued 
market growth. In 1993, there were $142 billion of new money long 
term financings, compared to $81 billion in 1988, a 75% increase. 
``A decade of Municipal Finance,'' The Bond Buyer (Jan. 6, 1994) at 
24. See also Securities Act Release No. 7049, Securities Exchange 
Act Release No. 33741 (March 9, 1994), 59 FR 12748, and Securities 
Exchange Act Release No. 33742, (March 9, 1994), 59 FR 12759.
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A. Increasing Use of Negotiated Underwritings

    The types of securities generally issued by municipalities include 
general obligation bonds (secured by the full faith and credit and 
general taxing power of the issuer), revenue bonds (secured by the 
revenues of a particular project), and conduit bonds (securities issued 
to finance a project that is to be used in the trade or business of a 
third party, typically a private corporation or non-profit entity). At 
one time general obligation bonds were most prevalent. Today, however, 
most offerings consist of revenue bonds. During the past few years, the 
municipal bond market also has experienced a proliferation of complex 
derivative products.\10\
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    \10\Among these are principal and interest strips, pooled 
municipal investment vehicles, detachable call options, and new 
variable rate securities.
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    Although competitive bidding traditionally has been used for public 
financing,\11\ in recent years negotiated underwritings have become 
much more common.\12\ in 1993, negotiated underwritings accounted for 
approximately 80% of all long-term municipal bond offerings.
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    \11\At the time the Exchange Act was enacted, competitive 
bidding, in one form or another, was the most accepted method of 
financing used by municipalities and other public entities. L. Loss 
& J. Seligman, Securities Regulation 343 (1989). In competitive 
offerings, the issuer decides who will underwrite its bonds based 
almost entirely on price in response to the issuer's ``notice of 
sale.'' Firms wishing to bid on an issue will include other firms in 
their syndicates based on their marketing or capital needs and the 
requirements of the issuer, if any. Some issuers will require the 
underwriting syndicate to include one or more firms with significant 
minority participation or specific regional capacity. This 
requirement usually is stated in the notice of sale. See MSRB, 
Glossary of Municipal Terms, (1985), definition of ``competitive 
bid'' or ``competitive bidding.''
    \12\There can be an element of competition present in negotiated 
deals. In a negotiated offering, the issuer typically distributes a 
request for proposals (``RFP'') to provide underwriting services for 
either a single issue, or more frequently, for a set period of 
years. Underwriters that are interested then submit their responses 
and the issuer will select one or more of the respondents to provide 
underwriting services. Issuers commonly select the entire management 
group in a negotiated offering, and often select most members of the 
selling group as well. Often an issuer will use the RFP process to 
``prequalify'' a pool of underwriters as eligible to provide 
services and then select specific underwriters on a transaction by 
transaction basis. Consequently, the RFP process may not purge the 
selection process of undue influence. Notwithstanding the use of an 
RFP, issuers may award the municipal securities business according 
to existing non-merit based relationships with an underwriter.
    In a large syndicate, one or more firms will serve as senior 
syndicate managers or co-managers; a second tier of firms will be 
designated as managers; the remaining syndicate members are the 
selling group. The issuer will also designate which of the managers 
will actually ``run the books'' and manage the syndicate. The senior 
managers and managers bear a risk of loss; members of the selling 
group do not bear this risk. Some issuers may select all the firms 
and delineate the position of each; others choose several firms as 
the management group, and give the senior syndicate managers 
discretion to choose members of the selling group (or name a few 
selling group members, and allow the senior managers to choose the 
remainder); still others will choose a senior manager and no others 
and the manager may or may not form a selling group.
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    Competitive bidding offers the public some protection against the 
exertion of inappropriate influence on public officials by municipal 
underwriters. When bidding is done competitively and publicly, there is 
less possibility of collusion and political patronage. Because the 
competitive process offers all potential bidders equal opportunity to 
be awarded the deal, bidders must compete with one another based on the 
pricing of the issue and the willingness to accept market risk.\13\
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    \13\The Government Finance Officers Association (``GFOA'') cites 
three advantages to competitive sales: assurance that the bonds are 
sold at the lowest cost in the prevailing market; lower gross 
underwriting spreads than negotiated sales, historically; and 
promotion of the appearance of an open, fair process. ``Taxpayers 
have greater assurance that the bonds have been awarded at the 
lowest possible cost, and not for the benefit of underwriting firms 
engaged in political activities to support elected officials.'' An 
Elected Official's Guide to Debt Issuance, Kurish and Tigue, GFOA, 
Chicago, IL (1993) (``Elected Official's Guide'').
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    In contrast to competitive underwritings, negotiated underwritings 
present greater risk of abuse in the underwriter selection process.\14\ 
Issuers may become involved not only in selecting the lead underwriter, 
but also in controlling other provisions of the distribution. Selection 
may be based on nonmeritorious considerations, creating a genuine risk 
that underwriters will be selected on the basis of political influence 
rather than the quality of the underwriter's services in distributing 
the securities.\15\
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    \14\Negotiated sales do present advantages. GFOA notes three: 
ability to delegate tasks such as document preparation, sizing and 
structuring to the underwriter; pre-sale period in which structure 
may be tailored to investor demand; and flexibility to respond to 
market conditions. Elected Official's Guide. See also Public 
Securities Association, Review of Studies of Competitive and 
Negotiated Financing of Municipal and Corporate Securities, (March 
1994).
    \15\Regardless of whether an issue is competitive or negotiated, 
most issuers also employ financial advisers to assist in a bond 
offering. While some financial advisers are chosen on an issue by 
issue basis, others are retained to assist the issuer over a period 
of time. Financial advisers also are paid by the issuer, and their 
fees may be considered an expense of the offering.
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B. ``Pay to Play''

    Recent reports regarding ``pay to play'' have raised concerns about 
the practices municipal securities dealers employ to obtain municipal 
securities business. There have been numerous reported instances where 
registered municipal securities dealers, their employees, and related 
parties, allegedly have made payments, political contributions, or 
entered into business ventures with political figures apparently to 
obtain the underwriting business of municipal securities issuers. 
Specific abuses have been alleged in several state and local 
governments including Alabama,\16\ California,\17\ Colorado,\18\ the 
District of Columbia,\19\ Florida,\20\ Illinois,\21\ Kentucky,\22\ 
Massachusetts,\23\ Michigan,\24\ New Jersey,\25\ New York,\26\ 
Ohio,\27\ Oklahoma,\28\ and Wisconsin.\29\ The widespread nature of the 
complaints concerning abuses has received considerable attention from 
Congress, the Commission, the MSRB, the securities industry, the media, 
and the public, reflecting concerns regarding the integrity, fairness, 
and sound operation of the municipal securities market.
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    \16\``Crying Cronyism, Lawmaker Seeks Alabama Ban on Negotiated 
Deals,'' The Bond Buyer, (February 7, 1994), at 1.
    \17\``Curbs Sought on Bond Firm Contributions,'' The Washington 
Post, (January 14, 1994) at B2.
    \18\``The Politics of Money,'' U.S. News and World Report, 
(September 20, 1993), at 67.
    \19\``Lazard Pushed D.C. to Arrange Swaps With Merrill Lynch, 
D.C. Official Says,'' The Bond Buyer, (January 19, 1994), at 1; 
``Lazard Partner Says Firm Unaware of Ferber's Bid to Share D.C. 
Fees,'' The Bond Buyer, (January 20, 1994), at 1; ``Cracking the 
`Club' That Controls the Muni Bond Market,'' The Washington Post, 
(November 21, 1993), at H1.
    \20\``The Bond Merchants: Wall Street Makes Millions on 
Municipal Bonds But Guess Who Pays?'' Common Cause Magazine, 
(October 1993).
    \21\``Chicago Confirms Being Subpoenaed by the Grand Jury in 
Ferber Inquiry,'' The Bond Buyer, (January 13, 1994), at 1; 
``Illinois Measure Would Restrict Campaign Giving by Bond Dealers,'' 
The Bond Buyer, (February 4, 1994), at 1; ``Push to Curb Donations 
Not So Simple,'' The Chicago Tribune, (November 17, 1993), at 1.
    \22\``At Trial, Kentucky's Bill Collins Gets Final Say as 
Prosecutors Hammer Away at the Gift Piano,'' The Bond Buyer, 
(October 11, 1993), at 1; ``Kentucky Official Says He Served as 
Middleman to Solicit Funds,'' The Bond Buyer, September 7, 1993), at 
1. Bill Collins is the husband of the former governor of Kentucky, 
Martha Layne Collins. On October 14, 1993, following a jury trial in 
the United States District Court for the Eastern District of 
Kentucky, he was convicted of extortion and conspiracy.
    \23\``Treasurer's Office in Massachusetts Confirms Existence of 
Investigations,'' The Bond Buyer, (February 7, 1994), at 1; 
``Massachusetts Bars Merrill From Top Bond-Sale Role,'' The Wall 
Street Journal, (February 7, 1994), at C19; ``Latest Accusations 
Leveled Against Ferber Provide New Details on 1990 MIFA Deal,'' The 
Bond Buyer, (December 21, 1993), at 1; ``FEDs Subpoena MIFA For 
Second Time; Bond Documents Since 1982 Sought,'' The Bond Buyer, 
(January 27, 1994); ``Papers Show New Links Between Ferber, Firm,'' 
The Boston Globe, (December 17, 1993), at 1.
    \24\``Curbs Sought on Bond Firm Contributions,'' The Washington 
Post, (January 14, 1994), at B2.
    \25\``Lazard Freres, Merrill Lynch Fee Splitting Livens 
Debate,'' The Bond Buyer, (June 25, 1993), at 1; ``New Jersey 
Turnpike, Merrill Lynch at Center of U.S. Attorney Probe,'' The Bond 
Buyer, (April 29, 1993), at 1; ``N.J. Governor Bans Negotiated 
Underwriting at State Level,'' The Bond Buyer, (May 5, 1993), at 1; 
``Turnpike Officials Said Lazard Called the Shots,'' The Bond Buyer, 
(May 26, 1993), at 1; ``Ferber Investigators Said to Pick Up Pace; 
Lazard Freres Subpoenaed, Others Wait,'' The Bond Buyer, (November 
23, 1993), at 1.
    \26\``Holtzman Dials Direct for Dollars, Asking Bankers to Help 
Pay Off Debt,'' The Bond Buyer (May 12, 1993), at 1; ``Wall Street 
Executives Appear on List of Fund-Raiser for N.Y. Comptroller,'' The 
Bond Buyer (October 29, 1993), at 1; ``Get Off McCall's Committee,'' 
The Bond Buyer (November 1, 1993), at 42; ``NYC's Stein Urges Mayor, 
Comptroller to Copy New Jersey, Ban Negotiated Debt,'' The Bond 
Buyer, (May 12, 1993), at 1; ``N.Y.C. Report Slams Holtzman For 
Negligence in Fleet Affair,'' The Bond Buyer, (September 16, 1993), 
at 1; ``The Trouble With Consultants, The Market May be Getting 
Serious About Campaign Contributions, But There's More Ways to 
Peddle Influence,'' The Bond Buyer, (November 16, 1993), at 1; 
``Holtzman Says Loan Didn't Sway Choice of Fleet to Handle New York 
City Debt,'' The Bond Buyer, (April 26, 1993), at 1.
    \27\``Armacon's Ohio Work a Smith Barney Favor After 1991 Lease 
Issue Soured in New Jersey,'' The Bond Buyer, (May 17, 1993), at 1.
    \28\``Curbs Sought on Bond Firm Contributions,'' The Washington 
Post, (January 14, 1994), at B2; ``SEC Investigates Oklahoma Issues 
for Possible Law Violations,'' The Bond Buyer, (November 23, 1993), 
at 1; ``SEC Inspects Pike Bond Refinancing,'' The Daily Oklahoman, 
(November 19, 1993), at 1; ``SEC Asks Agencies in Oklahoma for Data 
About Bond Issues,'' The Wall Street Journal, (November 24, 1993), 
at A5.
    \29\``Curbs Sought on Bond Firm Contributions,'' The Washington 
Post, (January 14, 1994), at B2.
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C. Regulation of Municipal Securities Underwritings

    It appears that ``pay to play'' practices are considered by many 
municipal securities dealers to be an ordinary cost associated with 
obtaining municipal underwriting business.\30\ The widespread 
perception of such practices calls into question the integrity of the 
municipal securities market and the business practices some municipal 
underwriters utilize in order to obtain underwriting contracts. Several 
reports have suggested that the greatest cost of improper contributions 
is the cost to investors, taxpayers, and the public at large.\31\
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    \30\``Illegal Payments Mar the Muni Market,'' The Wall Street 
Journal, (May 5, 1993), at C1.
    \31\``Bond Buyers' Gain, Taxpayers' Loss,''New York Times, 
(September 5, 1993), at 11; ``The Trouble With Munis, The Market is 
Sound, But Abuses Hurt Both Investors and Taxpayers,'' Business 
Week, (September 6, 1993), at 44.
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    As a result of reports alleging improper payments regarding the New 
Jersey Turnpike refunding, in May 1993, Congress requested the 
Commission, the MSRB, and the National Association of Securities 
Dealers (``NASD'') to review the adequacy of regulation and oversight 
of the municipal securities market.\32\
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    \32\Letter from The Honorable John D. Dingell, Chairman, 
Committee on Energy and Commerce, United States House of 
Representatives, and The Honorable Edward J. Markey, Chairman, 
Subcommittee on Energy and Commerce, United States House of 
Representatives, to Mary L. Schapiro, Acting Chairman, Commission, 
Christopher A. Taylor, Executive Director, MSRB, and Joseph R. 
Hardiman, President and Chief Executive officer, NASD (May 24, 
1993).
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    This culminated in the Division's Municipal Securities Report,\33\ 
and Congressional hearings on the municipal securities market held on 
September 9, 1993. The Municipal Securities Report recommended that 
``pay to play'' contributions be addressed promptly.\34\ The Staff 
stated that an MSRB proposal to require disclosure of political 
contributions and limiting campaign contributions for the purpose of 
obtaining underwriting business represented a positive first step to 
address the misuse of political contributions.\35\
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    \33\Supra note 7.
    \34\The Commission's Chairman Arthur Levitt testified that, 
``[w]hile the Commission remains confident of the strength and 
effectiveness of the municipal securities market, we also share the 
Subcommittee's concern that investor confidence in its integrity may 
have been impaired as a result of recent serious allegations of 
abusive practices.'' Testimony of Arthur Levitt, Chairman, 
Commission, Concerning the State of the Municipal Securities Market, 
Before the Subcommittee on Telecommunications and Finance, Committee 
on Energy and Commerce, United States House of Representatives 
(September 9, 1993).
    \35\Municipal Securities Report, supra note 7, at 33.
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    The MSRB's efforts to examine the role of political contributions 
in the underwriting process pre-date recent public interest in the 
issue. In August 1991, the MSRB published a notice expressing concern 
that the process of selecting an underwriting team should not be 
influenced by political contributions, and encouraged underwriters, and 
state and local governments to maintain the integrity of the 
underwriter selection process.\36\ In May 1993, the MSRB issued a press 
release noting continued concern by the MSRB, industry members, and 
others regarding political contributions.\37\
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    \36\See MSRB Reports, Vol. 11, No. 3, (September 1991) at 11.
    \37\See MSRB Reports, Vol. 13, No. 3, (June 1993) at 15.
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    In August 1993, the MSRB published for comment draft rule G-37 
(``August 1993 draft rule'').\38\ Although the majority of commentators 
supported the MSRB proposal, none gave unqualified support. After 
considering the commentators' concerns and suggestions at its November 
and December 1993 meetings, the MSRB proposed the instant rule change.
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    \38\The draft proposal would have (1) prohibited brokers, 
dealers and municipal securities 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.
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    Some state officials and politicians have advocated or introduced 
legislation aimed at abuses resulting from political contributions and 
have made attempts to reform the municipal securities underwriter 
selection process.\39\ Voluntary industry efforts also are underway to 
reduce the presence of inappropriate political influence peddling. On 
October 18, 1993, seventeen municipal securities dealers agreed to 
adopt a ``Statement of Initiative,'' providing the political 
contributions made, in any manner, for the purpose of influencing the 
awarding of municipal finance business should be prohibited. To date, 
over 50 firms have agreed to adhere to the Statement of Initiative.\40\
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    \39\E.g., House No. 1824, The Commonwealth of Massachusetts (a 
recently introduced bill to prohibit political contributions by 
investment bankers and bond counsel); The Commonwealth of 
Massachusetts Joint Statement on Debt Policy (issued to ``[r]eaffirm 
and extend the statutory presumption that all Commonwealth Debt * * 
* shall be issued on a competitive, sealed-bid (lowest true interest 
cost) basis, and establish standards for rebutting that presumption 
* * *; [e]stablish a basic framework for the establishment of 
procurement processes for the selection of underwriters, financial 
advisors and attorneys * * *; [and] [f]urther the practice of 
requiring disclosure by underwriters, financial advisors and 
attorneys which fosters the elimination of conflicts of interest 
among those which serve the Commonwealth * * * in * * * issuances of 
debt.''). The Commonwealth of Massachusetts Treasury Department 
(October 27, 1993).
    See also ``Crying Cronyism, Lawmaker Seeks Alabama Ban on 
Negotiated Deals,'' The Bond Buyer, (February 7, 1994), at 1; 
``Curbs Sought on Bond Firm Contributions,'' The Washington Post, 
(January 14, 1994), at B2; ``Shapiro of Maine Seeks MSRB Ban on 
Political Contributions from Bond Firms,'' The Bond Buyer, (May 14, 
1993), at 1; N.J. Governor Bans Negotiated Underwriting at State 
Level,'' The Bond Buyer, (May 5, 1993), at 1; ``Following SEC, Texas 
Authority Seeks Disclosure on Political Gifts,'' the Bond Buyer, 
(June 23, 1993), at 1; ``Massachusetts Bars Merrill From Top Bond-
Sale Role,'' The Wall Street Journal, (February 7, 1994), at C19; 
``Municipal Bond Group Urges End To Being Solicited,'' The Wall 
Street Journal, (October 8, 1993), at C1.
    \40\Some state and local officials have stated their intention 
to boycott those firms that voluntarily stop political 
contributions. The Florida Association of Counties, for example, 
called for its members to boycott seventeen securities firms that 
have voluntarily banned political contributions citing these firms' 
endorsement of ``public policy damaging rules.'' See ``Politicians 
are Mobilizing to Derail Ban on Muni Underwriters' Campaign Gifts,'' 
The Wall Street Journal, (December 27, 1993), at C16.
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    While the Commission views the voluntary efforts of those firms 
adhering to the Statement of Initiative as laudable, these actions 
represent only a first step. The MSRB's proposed rule change marks a 
second step: industry-wide reform intended to respond to the 
detrimental effects of conflicts of interest.

III. Description

    The proposed rule change would establish industry-wide restrictions 
and requirements aimed at preventing fraudulent and manipulative 
practices, promoting just and equitable principles of trade, removing 
impediments to free and open trade, and protecting investors and the 
public interest. The MSRB's proposal is intended to address the real as 
well as perceived abuses resulting from ``pay to play'' practices in 
the municipal securities market. The proposal is a comprehensive scheme 
composed of several separated requirements affecting municipal 
securities dealers, including limitations on business activities 
triggered by political contributions, limitations on solicitation and 
coordination of political contributions, and dealer recordkeeping and 
disclosure.

A. Rule G-37--``Pay to Play'' Restrictions

1. Business Disqualification Provision
    Proposed rule G-37 will prohibit brokers, dealers and municipal 
securities dealers (``dealers'') from engaging in municipal securities 
business with an issuer within two years after proscribed contributions 
made by (1) the dealer, (2) any municipal finance professional 
associated with the dealer, or (3) any political action committee 
(``PAC'') controlled by the dealer or any such associated municipal 
finance professional, to an official of the issuer who can, directly or 
indirectly, influence the awarding of municipal securities business. 
``Municipal securities business'' includes certain dealer activities 
such as the purchase of a primary offering of municipal securities from 
the issuer on other than a competitive bid basis (i.e. acting as a 
managing underwriter or as a syndicate member in negotiated 
underwritings), and acting as a financial advisor, consultant, 
placement agent, or negotiated remarketing agent.\41\ The proposal 
defines an ``official of an issuer'' 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. This 
includes any issuer official, incumbent or candidate (or successful 
candidate) who has influence over the awarding of municipal securities 
business. ``Contributions'' include any gift, subscription, loan, 
advance, or deposit of money or anything of value made: (1) For the 
purpose of influencing any election of any official of a municipal 
securities issuer for federal, state,\42\ or local office; (2) for 
payment or reduction of debt incurred in connection with any election; 
or (3) for transition or inaugural expenses incurred by the successful 
candidate for state or local office.
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    \41\The proposed rule does not apply to competitive bids, i.e., 
offerings in which the securities are awarded to the underwriting 
syndicate presenting the best bid according to stipulated criteria 
set forth in the notice of sale. See Glossary of Municipal Terms, 
supra note 11. Obviously, there is potential for abuse in 
determining the criteria by which eligibility is determined. If such 
abuse occurs, we would expect the MSRB to respond appropriately.
    \42\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.
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    Thus, contributions to certain state-wide executive or legislative 
officials will affect the eligibility of the firm to engage in 
municipal securities business.\43\ The proposal applies to 
contributions made on or after April 25, 1994.\44\
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    \43\For example, governors will be included under the proposal's 
definition of official of an issuer.
    \44\File No. SR-MSRB-94-2, Amendment No. 1 (March 29, 1994). See 
supra note 4.
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    The proposal's disqualification provision also would be triggered 
by contributions from employees of dealers, defined as ``municipal 
finance professionals, '' are primarily engaged in municipal securities 
business. The proposal exempts contributions made by municipal finance 
professionals of $250 or less per election to each official for whom 
the individual is entitled to vote. The proposal defines the term 
``municipal finance professional'' to mean:
    (1) Any associated person primarily engaged in municipal securities 
representative activities, as defined in rule G-3(a)(i);\45\
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    \45\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 public 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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    (2) Any associated person who solicits municipal securities 
business;
    (3) 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
    (4) 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 
or division of the bank, as defined in rule G-1).\46\
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    \46\The proposal's prohibition on business would result if a 
municipal finance professional associated with the dealer made the 
contribution before becoming associated with the dealer, (the two 
year ban on business applies to both the current and prior employer 
of the municipal finance professional).
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    Family members are not specifically included within the definition 
of municipal finance professional. The proposal, however, prohibits 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 is 
intended to prevent dealers from funnelling funds or payments through 
other persons or entities to circumvent the proposal's requirements. 
For example, a dealer would violate the proposal if it does business 
with an issuer after contributions were made to an issuer official from 
or 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. A dealer also would violate the rule by doing 
business with an issuer after providing money to any person or entity 
when the dealer knows that the money will be given to an official of an 
issuer who could not receive the contribution directly from the dealer 
without triggering the rule's prohibition on business.
    The proposal will not restrict personal volunteer work by municipal 
finance professionals in political campaigns other than soliciting or 
coordinating contributions. However, if resources of the dealer are 
used or expenses are incurred by the municipal finance professional in 
personal volunteer work, the value of the resources or expenses must be 
included in determining whether the dealer is restricted from future 
negotiated underwritings involving that issuer or whether the municipal 
finance professional exceeded the $250 limitation.
2. Solicitation Restriction
    The proposal also will prohibit dealers from soliciting 
contributions on behalf of officials of issuers with which the dealer 
is engaging or seeking to engage in municipal securities business.\47\ 
This will prevent dealers from engaging in municipal securities 
business with issuers if they engage in any kind of fund-raising 
activities for officials of the issuers that may influence the 
underwriter selection process. This prohibition on solicitation and 
coordination also applies to municipal finance professionals. The 
proposal prohibits municipal finance professionals from soliciting 
contributions to an official of an issuer with which the dealer engages 
or is seeking to engage in municipal securities business and from 
coordinating contributions.
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    \47\The term ``seeking to engage in municipal securities 
business'' 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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B. Disclosure and Recordkeeping

    The proposal would establish disclosure and recordkeeping 
requirements to facilitate enforcement of rule G-37's ``pay to play'' 
restrictions and, independently, to function as a public disclosure 
mechanism to enhance the integrity of and public confidence in 
municipal securities underwritings. Thus, although the disclosure and 
recordkeeping provisions will generally supplement the ``pay to play'' 
restrictions, the purposes served by these provisions are distinct 
from, and not dependent on, the business disqualification or 
solicitation restriction provisions.
1. Rule G-37
    Proposed rule G-37 will require dealers to disclose to the MSRB on 
Form G-37 certain information about political contributions, as well as 
other summary information, to facilitate public scrutiny of political 
contributions in the context of the municipal securities business of a 
dealer. Contributions to be reported 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.\48\ Only contributions over $250 by municipal 
finance professionals and executive officers are required to be 
disclosed. The proposal does not require dealers to disclose the names 
of individual municipal finance professionals and executive officers.
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    \48\The proposal does not require dealers to maintain a list of 
contributions by other employees, affiliated companies and their 
employees, spouses of municipal finance professionals, or any other 
person or entity unless the contributions were directed by persons 
or entities subject to the proposal.
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    The proposal requires that dealers report on Form G-37 by state: 
(1) The name and title, (including any city/county/state or other 
political subdivision) of each official of an issuer and political 
party receiving contributions; (2) the total number and dollar amount 
of contributions made by the dealer, dealer controlled PACs, and 
associated municipal finance professionals, and (3) other identifying 
information as required by Form G-37. Dealers also will be required to 
disclose 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 from the issuers. The reports 
are required to be made on Form G-37 and to be submitted to the MSRB in 
accordance with rule G-37 filing procedures, quarterly, by dates 
determined by the MSRB.
    The MSRB will include information reported on Form G-37 in its 
electronic library system, the Municipal Securities Information Library 
(``MSIL''). The MSRB will develop appropriate filing procedures to 
allow for public access to the information, as well as indexing, and 
record storage.
2. Rules G-8 and G-9
    The proposal will amend rules G-8 and G-9 on recordkeeping and 
record retention regarding political contributions. The proposed 
amendment to rule G-8 will require a dealer to maintain a list of: (1) 
Names, titles, city/county and state of residence of all associated 
municipal finance professionals; (2) names, titles, city/county and 
state of residence of all executive officers of the dealer; (3) the 
states in which the dealer is engaging or is seeking to engage in 
municipal securities business; (4) 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 the issuer; and 
(5) all contributions, direct or indirect, to officials of issuers and 
to political parties of states and political subdivisions made by the 
dealer, each dealer-controlled PAC, and each associated municipal 
finance professional and executive officer.\49\ The records required 
pursuant to the proposal apply to contributions made or business 
engaged in beginning April 25, 1994.\50\
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    \49\Dealers will be required to record, per contribution, the 
identity of the contributor and the recipient and the amount of the 
contribution.
    \50\File No. SR-MSRB-94-2, Amendment No. 1 (March 29, 1994). See 
supra note 4.
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    The proposal does not require the dealer to maintain a list of 
contributions by its municipal finance professionals or executive 
officers that are made: (1) To officials for whom the person is 
entitled to vote, provided such contributions do not exceed $250 to 
each issuer official, per election; or (2) to political parties for the 
state and political subdivision in which the person is entitled to 
vote, provided the contributions do not exceed $250 per party, per 
year. The proposal also does not require dealers 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 proposed amendment to rule G-9 requires dealers to maintain, 
for a six-year period, those records required to be made pursuant to 
the proposed amendment to rule G-8.

IV. Summary of Comments

    The Commission received 69 comment letters on the proposal. A 
separate summary of comments was prepared and is available in the 
public file. The Discussion section of this order addresses specific 
issues addressed by the commentators.

V. Discussion

    The MSRB's rule proposal seeks to end ``pay to play'' abuses in 
municipal securities underwritings. The MSRB has determined that the 
most effective means of accomplishing this goal is through adoption of 
several provisions consisting, as described above, of a business 
disqualification provision, a solicitation restriction and disclosure 
and recordkeeping requirements. These provisions reflect well-
established methods for dealing with conflicts of interest and other 
instances where improper influence is used to secure an unmerited 
benefit.
    The Commission believes that the MSRB's proposal is tailored to 
accomplish its stated goals with minimal disruption in the municipal 
securities industry and the state and local political process to which 
that industry is linked. The Commission agrees with the MSRB that its 
proposal represents an appropriate response to a compelling problem 
and, therefore, has determined to approve the proposed rule change.

A. Statutory Standard

    The proposed rule change is consistent with the requirements of the 
Act, and in particular, with sections 15B(b)(2) (C) and (G) of the 
Act.\51\ Section 15B(b)(2)(C) authorizes the MSRB to adopt rules 
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 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. Section 
15B(b)(2)(G) authorizes the MSRB to adopt rules that prescribe the 
records to be made and kept by municipal securities dealers and the 
periods for which such records shall be preserved. Because the MSRB's 
rules are to be preventive in nature, Section 15B defines the scope of 
the MSRB's authority in terms of purposes rather than subject matters. 
This authority provides the MSRB with flexibility to deal with future 
problems in the municipal securities industry.\52\ Thus, Section 15B 
provides the MSRB broad rulemaking authority to implement its 
enumerated purposes.
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    \51\Sections 15B(b)(2) (C), (G); [15 U.S.C. Secs. 78o-4(b)(2) 
(C), (G)].
    \52\The legislative history to the 1975 Acts Amendments adopting 
Section 15B indicated that Congress did not believe it would be 
desirable to restrict the MSRB's authority by a specific enumeration 
of subject matters. ``The ingenuity of the financial community and 
the impossibility of anticipating all future circumstances are 
obvious reasons for allowing the [MSRB] a measure of flexibility in 
laying down the rules of the municipal securities industry.'' S. 
Rep. No. 75, Securities Exchange Act of 1975: Report of the 
Committee on Banking, Housing, and Urban Affairs, to Accompany S. 
249, 94 Cong., 2d Sess 43 (``Senate Report'') at 225.
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1. Prevent Fraudulent and Manipulative Acts and Practices
    The Commission and the MSRB have a significant interest in 
preventing fraudulent and manipulative acts and practices, as well as 
the appearance of fraud and manipulation, in the municipal securities 
market. One of the principal goals of Section 15B is to address threats 
to the integrity of the municipal securities market.\53\ Underwriters 
perform essential functions in offerings by structuring the offering 
and preparing disclosure documents that form the basis of marketing the 
offering to the public.\54\ If underwriter selection is swayed by 
political contributions or influence, underwriters may be chosen based 
on their history of contributions or political contacts, rather than 
their expertise or competence.
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    \53\``S. 249 would provide, through amendment of the Exchange 
Act, a comprehensive pattern for the regulation of brokers, dealers, 
and banks trading municipal securities. The Committee feels that the 
lack of federal regulation . . . represents a serious threat to the 
integrity of the capital-raising system upon which local governments 
rely to finance their efforts.'' Senate Report at 215, 16.
    \54\In the proposing and adopting releases for Rule 15c2-12, the 
Commission set forth its interpretation of the obligation of 
municipal securities underwriters under the antifraud provisions of 
the federal securities laws. The interpretation discussed the duty 
of underwriters to the investing public to have a reasonable basis 
for recommending any municipal securities, and their responsibility, 
in fulfilling that obligation, to review in a professional manner 
the accuracy of statements made in connection with the offering. 
Securities Exchange Act Release No. 26100 (September 28, 1988), 53 
FR 37778; Securities Exchange Act Release No. 26985 (July 10, 1989), 
54 FR 28799.
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    Several commentators contend that reports of abuse are 
unsubstantiated,\55\ or view the issue as one of voter confidence and 
campaign reform, rather than investor protection.\56\ The Commission 
believes, however, that ``pay to play'' practices may damage the 
municipal securities market in several ways. If political influence is 
the determinative factor in the choice of municipal securities dealers 
as underwriters in an offering, the underwriter selected may be less 
likely or competent to perform a reasonable investigation of statements 
made by the issuer in connection with the offering.\57\ A decrease in 
the credit quality of the issue after it has been sold could have a 
significant adverse impact on investors, and the underwriter's 
investigation might reveal information that bears directly on the 
issuer's future ability to meet interest and principal payment 
obligations on a timely basis.
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    \55\For example, one commentator states that ``there have been 
relatively few reported instances of improper behavior in the market 
where approximately 15,000 issues are sold each year involving 
thousands of public officials * * *. Many of the high-profile cases 
of improper behavior that have been cited as evidence of corrupt 
practices caused by campaign giving are either illegal already or 
would not be affected by a prohibition on political contributions.'' 
Letter from Jeffrey L. Esser, Executive Director, Government Finance 
Officers Association, to Jonathan Katz, Secretary, Commission (March 
10, 1994). See also letter from Donald J. Borut, Executive Director, 
National League of Cities, to Jonathan Katz, Secretary, Commission 
(February 7, 1994); letter from Harlan E. Boyles, State Treasurer, 
North Carolina, to Arthur Levitt, Chairman, Commission (January 28, 
1994).
    Several commentators state that the majority of political 
contributions by municipal securities dealers and their associated 
persons are given for legitimate purposes and are unrelated to the 
selection of municipal securities underwriters. E.g., letter from 
Jeffrey L. Esser, Executive Director, Government Finance Officers 
Association, to Jonathan Katz, Secretary, Commission (March 10, 
1994).
    \56\E.g., letter from Jeffrey L. Esser, Executive Director, 
Government Finance Officers Association, to Jonathan Katz, 
Secretary, Commission, (March 10, 1994). The Government Finance 
Officers Association ``believes that any improper relationship is 
properly a voter, taxpayer and ratepayer concern because of the 
potential impact such a relationship could have on the cost of the 
financing.''
    \57\See supra note 54.
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    ``Pay to play'' also undermines the integrity of municipal 
securities underwriting. The mere perception of political influence in 
underwriter selection diminishes investor confidence in an 
underwriter's willingness to faithfully fulfill its obligations to the 
investing public. The Statement of Initiative itself attests to the 
prevalence of industry concerns regarding the effects of these 
practices on the integrity of the municipal securities market and 
underwriters.
    The perception of conflicts of interest is also damaging to 
investor confidence. Although some commentators suggest that investor 
confidence has not been affected by ``pay to play'' practices,\58\ the 
Commission, relying on its own expertise as well as the judgment of the 
MSRB, believes that the widespread reports of abuse adversely affect 
investor confidence, and that the MSRB's proposal will help to 
strengthen the integrity of the underwriting process and will help to 
restore and maintain investor confidence.\59\
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    \58\One commentator states that ``[t]o my knowledge the practice 
of campaign contributions made by participants of the municipal 
securities industry has not resulted in bond defaults or other value 
losses that directly affect individual investors. Even the most 
egregious abuses documented in the national press have not resulted 
in investor losses in either primary offerings or in the secondary 
markets.'' Letter from Kenneth L. Rust, Debt Manager, Mayor, City of 
Portland, Oregon, to Jonathan Katz, Secretary, Commission (February 
28, 1994).
    \59\Because, as discussed herein, regulation of political 
contributions by municipal securities dealers and municipal 
securities professionals is intended to enhance the fairness and 
efficiency of the municipal securities market, it is directly 
related to the purposes of the Act. Some commentators raise 
objections to the proposal on federalism grounds. E.g., letter from 
David Norcross, General Counsel, Republican National Committee to 
Jonathan Katz, Secretary, Commission (March 11, 1994). Although the 
MSRB's proposal will have some effect on political fundraising 
activities of candidates for certain state and local offices, these 
effects do not transgress any limits on federal authority over state 
political activities. The MSRB's rules are directed at municipal 
securities dealers and municipal finance professionals and do not 
regulate the conduct of state officials. Cf. New York v. United 
States, 112 S. Ct. 2408 (1992). As such, the proposed rule change 
falls within the legitimate scope of the MSRB's congressionally-
mandated jurisdiction regarding the conduct of municipal securities 
participants, notwithstanding any incidental effects on state 
elections.
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2. Perfect the Mechanism of a Free and Open Market
    As discussed above, several reports have indicated that ``pay to 
play'' practices are considered by many municipal securities 
underwriters to be an ordinary cost of doing business. Because of great 
competitive pressures to obtain business, municipal securities firms 
and the offering process are susceptible to abusive political 
contribution practices. ``Pay to play'' practices raise artificial 
barriers to competition for those firms that either cannot afford or 
decide not to make political contributions. Moreover, if ``pay to 
play'' is the determining factor in the selection of an underwriting 
syndicate, an official may not necessarily hire the most qualified 
underwriter for the issue. The proposal makes clear to municipal 
securities dealers and to officials of issuers that ``pay to play'' 
practices should no longer be employed to obtain municipal securities 
business. The proposal will further merit-based competition between 
municipal securities dealers and, thus, will remove impediments to and 
perfect the mechanism of a free and open market for municipal 
securities.
3. Promote Just and Equitable Principles of Trade
    The proposal will promote just and equitable principles of trade. 
One of the primary principles of section 15B is to raise the level of 
conduct in the municipal securities industry.\60\ ``Pay to play'' 
practices undermine these principles since underwriters working on a 
particular issuance may be assigned similar roles, and take on 
equivalent risks, but be given different allocations of bonds to sell--
resulting in differing profits--based on their political contributions 
or contacts. The MSRB, under the Commission's supervision, was given 
primary rulemaking authority to regulate the conduct of municipal 
securities dealers by adopting rules to promote just an equitable 
principles of trade. In particular, the MSRB is obligated to assure 
that municipal securities dealers observe high professional standards 
in their activities with the public. The Statement of Initiative 
demonstrates the significance with which municipal securities dealers 
address reports of abuse in the municipal securities market. The 
proposal will extend the goals of the Statement of Initiative to all 
municipal securities dealers attempting to obtain municipal securities 
business.
---------------------------------------------------------------------------

    \60\See Senate Report at 224, 25. Because the MSRB is an SRO for 
municipal securities dealers, it is an appropriate body to establish 
just and equitable principles of trade.
---------------------------------------------------------------------------

4. Foster Cooperation and Coordination in Regulating Municipal 
Securities Transactions
    The proposal will foster cooperation and coordination with persons 
engaged in regulating transactions in municipal securities. The 
proposal's disclosure and recordkeeping requirements will aid the 
Commission, the MSRB, and the NASD to oversee enforcement of and dealer 
compliance with the proposal.
5. Records and Record Retention
    The proposal's record and record retention requirements are 
consistent with section 15B(b)(2)(G) of the Act which authorizes the 
MSRB to adopt rules that prescribe the records to be made and kept by 
municipal securities dealers and the periods for which such records 
shall be preserved. As discussed above, the proposal's record and 
record retention requirements, along with its prohibitions on municipal 
securities business, are designed to prevent ``pay to play'' practices 
in the awarding of municipal securities business.

B. First Amendment Guarantee of Free Speech

    Several commentators believe that the proposal's prohibitions on 
political contributions impermissibly infringe on the First Amendment 
guarantees of freedom of speech and association,\61\ and constitutional 
guarantees of equal protection.\62\ These commentators believe that 
although municipal bond business should not be a ``pay back'' for 
political contributions, the proposal restricts the ability of 
municipal securities underwriters and their employees to demonstrate 
support for state and local officials.\63\
---------------------------------------------------------------------------

    \61\One commentator, for example, states that ``it is an 
infringement on individual first amendment rights to prohibit any 
person's financial support of a candidate because it is `presumed' 
the contributor is involved in some `pay to play' scheme.'' Letter 
from Michael E. Arrington, Chairman, Bi-County Sub-Committee, 
Maryland House of Delegates, to Arthur Levitt, Chairman, Commission 
(December 22, 1993). See e.g. letter from Jeffrey L. Esser, 
Executive Director, Government Finance Officers Association, to 
Jonathan Katz, Secretary, Commission (March 10, 1994); letter from 
Marshall Bennett, President, and Bob Holden, Ethics Task Force, 
National Association of State Treasurers, to Jonathan Katz, 
Secretary, Commission (March 11, 1994); letter from David Norcross, 
General Counsel, Republican National Committee to Jonathan Katz, 
Secretary, Commission (March 11, 1994).
    \62\One commentator, for example, states that ``Rule G-37 fails 
to treat similarly-situated individuals in a like manner by 
classifying municipal broker-dealers and municipal finance 
professionals as the only persons subject to the burdens of the rule 
while other similarly situated persons, such as consultants and non-
registered municipal finance professionals, are not subject to the 
same burden.'' Letter from Raymond J. McClendon, Vice-Chairman and 
Chief Operating Officer, Pryor, McClendon, Counts & Co., Inc., to 
Margaret H. McFarland, Deputy Secretary, Commission (March 9, 1994).
    \63\See e.g. letter from Donald J. Borut, Executive Director, 
National League of Cities, to Jonathan Katz, Secretary, Commission 
(February 7, 1994); letter from Michael E. Arrington, Chairman, Bi-
County Sub-Committee, Maryland House of Delegates, to Arthur Levitt, 
Chairman, Commission (December 22, 1993); letter from Raymond J. 
McClendon, Vice-Chairman and Chief Operating Officer, Pryor, 
McClendon, Counts & Co., Inc., to Margaret H. McFarland, Deputy 
Secretary, Commission (March 9, 1994).
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    In light of the Commission's approval and enforcement of MSRB's 
rules, the Commission is sensitive to and has carefully considered 
these constitutional concerns in reviewing the proposed rule 
change.\64\ The Commission acknowledges that the business 
disqualification provision may affect the propensity of municipal 
securities underwriters to make political contributions. Although 
political contributions involve both speech and associational rights 
protected by the First Amendment, a ``limitation on the amount that any 
one person or group may contribute to a candidate or political 
committee entails only a marginal restriction upon the contributor's 
ability to engage in free communication.''\65\ Even a significant 
interference with rights protected by the First Amendment may be 
justified by a sufficiently compelling government interest so long as 
the interference is closely drawn to avoid unnecessary abridgment of 
those protected rights.\66\
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    \64\Several commentators disagree with the MSRB's conclusion 
that it is not a state actor for purposes of constitutional 
protections. See letter from William H. Ellis, President and Chief 
Operating Officer, Piper Jaffray Inc., to Jonathan Katz, Secretary, 
Commission (March 10, 1994); letter from Marshall Bennett, 
President, and Bob Holden, Ethics Task Force, National Association 
of State Treasurers, to Jonathan Katz, Secretary, Commission (March 
11, 1994); letter from Raymond J. McClendon, Vice-Chairman and Chief 
Operating Officer, Pryor, McClendon, Counts & Co., Inc., to Margaret 
H. McFarland, Deputy Secretary, Commission (March 9, 1994).
    \65\Buckley v. Valeo, 424 U.S. 1, 20 (1976).
    \66\Id. at 25.
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    Prevention of fraud and manipulation and the appearance of fraud 
and manipulation are compelling government interests. The MSRB's 
proposal is in the context of a closely regulated industry and is 
directly relevant to the concerns of the regulatory scheme. The MSRB's 
interests in seeking approval of the proposed rule change--the 
eradication of ``pay to play'' practices and other quid pro quo 
arrangements--are precisely the kind of interests which have been 
deemed sufficiently compelling to justify restrictions on political 
contributions.\67\ As discussed above, ``pay to play'' arrangements can 
have detrimental effects on the municipal securities markets; the 
widespread perception that these practices are commonplace undermines 
the integrity of the market and diminishes investor confidence. 
Moreover, the restrictions inherent in the MSRB's proposed rule change 
are in the nature of conflict of interest limitations which are 
particularly appropriate in cases of government contracting and highly 
regulated industries. Unlike general campaign financing restrictions, 
such as certain provisions of the Federal Election Campaign Act, which 
seek to combat unspecified forms of undue influence and political 
corruption, conflict of interest provisions, such as the MSRB's 
proposal, are tied to a contributor's business relationship with 
governmental entities and are intended to prevent fraud and 
manipulation.\68\
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    \67\For example, Florida's Division of Bond Finance prohibits 
the awarding of municipal securities business to firms that make 
political contributions to the governor or to cabinet members. 
Florida State Board of Administration, Rule 19A-6.004. Florida also 
prohibits investment and law firms and their officers, directors, 
and employees that make contributions or engage in fundraising for 
state-level candidates from competing for business from the Florida 
Housing Finance Agency. Rules of the Florida Housing Finance 
Authority (1991). Several states prohibit contributions from 
corporations and regulated industries in state elections including 
Arizona, Ariz. Rev. Stat. Ann. Sec. 16-919; Connecticut, Conn. Gen. 
Stat. Ann. Sec. 9-333o(a); North Dakota, N.D. Cent. Code Secs. 16.1-
08-02(1), 16.1-08-01(10); Pennsylvania, Penn. Stat. Ann. tit. 25, 
Sec. 3253; South Dakota, S.D. Codified Laws Ann. Sec. 12-25-2; West 
Virginia, W. Va. Code Sec. 3-8-8; Wisconsin, Wis. Stat. Ann. 
Sec. 11.38; and Wyoming, Wyo. Stat. Sec. 22-25-102.
    \68\Compare 2 U.S.C. 441(a), (b) (general contribution 
restrictions in federal campaigns applicable to individuals, 
corporations and labor unions) with 2 U.S.C. Sec. 441(c) 
(prohibition on contributions by federal contractors). Similarly, 
the prohibitions on solicitation and coordination of campaign 
contributions are justified by the same overriding purposes which 
support the business disqualification provisions. The provisions are 
intended to prevent circumvention of the disqualification provisions 
in cases where a dealer has or is seeking to establish a business 
relationship with a municipal issuer. Absent these restrictions, 
solicitation and coordination of contributions could be used as 
effectively as political contributions to distort the underwriter 
selection process. The solicitation and coordination restriction 
relate only to fundraising activities and would not prevent dealers 
and municipal finance professionals from expressing support for 
candidates in other ways.
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    As previously noted, the Commission believes that the MSRB's 
proposed rule change is closely tailored to accomplish its goal of 
preventing fraudulent and manipulative acts and practices that stem 
from quid pro quo arrangements and minimizes any undue burdens on the 
protected speech and associational rights of municipal securities 
dealers and municipal finance professionals. The proposed rule change 
is narrowly crafted in terms of the conduct it prohibits, the persons 
who are subject to the restriction, and the circumstances in which it 
is triggered.
    The proposal is limited to contributions to officials of municipal 
issuers who can influence the hiring of a dealer in connection with 
negotiated offerings. The restrictions are triggered only in situations 
where a business relationship exists or will be established in the near 
future between the municipal securities dealer and a municipal issuer. 
Most employees and affiliates of dealers are not covered by the 
proposal, and the dealer's municipal finance professionals will be able 
to avail themselves of a personal contribution exception of up to $250, 
individually, with respect to officials for whom they are eligible to 
vote. The proposal does not restrict uncoordinated independent 
expenditures in support of candidates or political views. Moreover, 
because the contribution limitations take the form of a business 
disqualification, the proposal does not flatly prohibit individuals 
from making, or prevent candidates from receiving contributions. In 
addition, the proposal does not, as some commentators suggest, restrict 
the ability of municipal securities underwriters and their employees to 
demonstrate support for state and local officials. Underwriters and 
their employees may continue to contribute in other ways in political 
campaigns that do not involve soliciting or coordinating 
contributions.\69\
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    \69\A number of states separately limit individual contributions 
in state elections including, for example: Arizona $640 per state 
wide candidate, $250 per other offices, and a maximum of $2,000 in 
total contribution per calendar year, Ariz. Rev. Stat. Ann. Sec. 16-
905; Florida, $500 per candidate, Flor. Stat. Ann. Sec. 106.08; and 
Montana, $1,500 collectively to candidates for governor and 
lieutenant governor, $750 to candidates for state office in a 
statewide election, $400 to candidates for public service 
commissioner, district court judge, or state senator, $250 to a 
candidate for any other public office, Mont. Code Ann. Secs. 13-1-
101, 13-37-216.
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    The Commission believes that the proposed rule change is a 
necessary and appropriate measure to prevent fraudulent and 
manipulative acts and practices and the appearance of fraud and 
manipulation in the municipal securities market by eliminating ``Pay to 
play'' arranged underwritings. The proposal represents a balanced 
response to allegations of corruption in the municipal securities 
market; it provides specific prohibitions to help ensure that 
underwriter selection is based on expertise, not on the amount of money 
given to a particular candidate for office.

C. Municipal Securities Dealers: Small Firms and Minority and Women 
Owned Firms

    Several commentators believe that the proposal will disadvantage 
small, regional municipal securities firms and firms owned by 
minorities or women.\70\ Because larger firms may have more employees 
that may be eligible to use the de minimis exemption, these 
commentators believe that the proposal will provide larger firms an 
unfair advantage.\71\
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    \70\See e.g., letter from Timothy L. Firestine, Director of 
Finance, Montgomery County Government, to Jonathan Katz, Secretary, 
Commission (February 24, 1994); letter from Stan W. Helgerson, 
Finance Director, Village of Carol Stream, Illinois, to Jonathan 
Katz, Secretary, Commission (March 10, 1994); letter from Jeffrey L. 
Esser, Executive Director, Government Finance Officers Association, 
to Jonathan Katz, Secretary, Commission (March 10, 1994); letter 
from Carolie R. Smith, President, Smith Mitchell Investment Group, 
Inc., to Jonathan Katz, Secretary, Commission (March 9, 1994).
    \71\One commentator, for example, states that ``larger firms 
with multiple departments including those not devoted to public 
finance will be able to support candidates through contributions 
made by corporate or other specialists who are not affected by this 
rule. Minority- and women-owned firms typically are small speciality 
public finance firms so their employees would be barred from 
supporting candidates.'' Letter from Jeffrey L. Esser, Executive 
Director, Government Finance Officers Association, to Jonathan Katz, 
Secretary, Commission (March 10, 1994).
    Another commentator recommends that the proposal should extend 
the de minimis exemption to officials for whom the municipal 
securities finance professionals are not entitled to vote to allow 
``continuing access to clients and [enable] us to exercise our 
constitutional and political rights.'' Letter from Carolie R. Smith, 
President, Smith Mitchell Investment Group, Inc., to Jonathan Katz, 
Secretary, Commission (March 9, 1994). Another commentator 
recommends that the proposal exclude small issues (e.g $10,000,000 
par value or less) to lessen the impact of the rule on small 
regional, minority-owned, and women-owned firms. Letter from Raymond 
J. McClendon, Vice-Chairman and Chief Operating Officer, Pryor, 
McClendon, Counts & Co., Inc., to Margaret H. McFarland, Deputy 
Secretary, Commission (March 9, 1994).
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    The Commission believes that the proposal will not have a 
disproportionate effect on minority or women-owned firms or on small 
and regional firms. The proposal clearly does not prevent local and 
state officials from selecting minority or women-owned municipal 
securities dealers for participation in municipal securities 
issuances.\72\ Moreover, the proposal will apply equally to all 
municipal securities dealers seeking to obtain municipal securities 
underwriting business. The Commission is not aware of any evidence 
indicating that the proposed rule change will disproportionately affect 
minority or women-owned firms, or smaller and regional firms vis-a-vis 
large dealers. The Commission rejects the notion that campaign 
contributions are a unique and essential business development mechanism 
for small, regional, or minority and women-owned firms. As a practical 
matter, the proposal leaves open all legitimate marketing practices 
which firms, both large and small, may use to gain underwriting 
business such as sales presentations, seminars, and marketing 
documents. Moreover, the Commission believes that the costs of 
incidental, unintended effects, if any, are far outweighed by the 
benefits of restricting ``pay to play'' practices.
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    \72\The Commission believes that promoting minority and women-
owned firms is a valid goal. Other means exist to promote this goal. 
For example, the Commission understands that some issuers require 
the underwriting syndicate to include one or more minority or women-
owned firms.
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D. Effect on Women and Minority Candidates

    Some commentators suggest that the proposal will adversely affect 
women and minority candidates for state and local office, or will 
inhibit the ability of municipal securities professionals to volunteer 
for public service.\73\ The basis for this contention is uncertain, but 
the proposal is clearly not intended to affect any particular candidate 
or identifiable group of candidates in an adverse manner. As noted 
before, the restrictions relate only to those situations where 
contributions are directed to an official of a municipal issuer with 
which a dealer might do business. It does not prevent other forms of 
indirect financial support for a candidate, such as contributions to 
political action committees that are not controlled by the dealer or 
its municipal finance professionals, or independent expenditures.\74\
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    \73\``Many such candidates either lack substantial personal 
resources and/or live in districts with limited resources. It is 
essential, therefor, that such candidates be able to solicit broad 
support from outside sources.'' Letter from Marshall Bennett, 
President, and Bob Holden, Ethics Task Force, National Association 
of State Treasurers, to Jonathan Katz, Secretary, Commission (March 
11, 1994).
    \74\The proposal will not prevent contributions to ``special-
interest'' PACs that are not controlled by the dealer or municipal 
finance professional unless the special interest PAC solicits 
contributions for the purpose of supporting an identifiable 
candidate. Thus, the proposal will have no effect on the ability of 
market participants to support candidates who represent their 
ideological, political, or social interests, or on the ability to 
volunteer for public service, notwithstanding concerns expressed by 
some commentators to the contrary. Letter from Robin L. Wiessmann, 
Principal, Artemis Capital Group, Inc., to Arthur Levitt, Chairman, 
Commission (December 21, 1993).
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E. Candidates for Federal Office

    Several commentators also suggest that the proposal should apply to 
contributions made to officials of or candidates for federal 
office.\75\ Several commentators raise concerns that the proposal will 
restrict contributions to state and local officials running for federal 
office, without a similar limitation on contributions to the incumbent 
federal office holder.\76\
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    \75\E.g. letter from Jeffrey L. Esser, Executive Director, 
Government Finance Officers Association, to Jonathan Katz, 
Secretary, Commission (March 10, 1994). One commentator objected to 
the proposal on the grounds that, with respect to municipal 
officials who are candidates for federal office, the MSRB's 
authority to adopt rules, subject to Commission approval, regulating 
campaign contributions of dealers and their employees conflicts with 
the jurisdiction of the Federal Election Commission (``FEC'') under 
the regulatory scheme established in the Federal Election Campaign 
Act (``FECA''). Letter from David Norcross, General Counsel, 
Republican National Committee, to Jonathan Katz, Secretary, 
Commission (March 11, 1994). Although FECA confers exclusive 
jurisdiction for enforcing the provisions of FECA, the MSRB rules 
would not affect, directly or indirectly, the provisions of FECA or 
their enforcement. Rather, as discussed above, the MSRB's proposal 
is specifically tailored to eliminate conflicts of interest arising 
from political contributions and similar activities in selecting 
underwriters in connection with negotiated offerings of municipal 
securities.
    \76\One comment letter, representing state and local officials, 
states: ``While our organizations recognize the importance of 
maintaining the integrity of the municipal bond market, we are 
greatly concerned that the proposed rule is inherently unfair in its 
limited application to only state and local officials. We fail to 
understand why this proposed action by the Securities and Exchange 
Commission is not coupled with a comprehensive limitation on 
contributions to the federal branch of government, which has perhaps 
the greatest influence over the strength of the municipal bond 
market and investor confidence in that market.''
    Letter from Jerry Abramson, President, The United States 
Conference of Mayors, Sharpe James, President, The National League 
of Cities, Barbara Sheen Todd, President, The National Association 
of Counties, and Bonnie R. Kraft, President-Elect, the Government 
Finance Officers Association, to Arthur Levitt, Chairman Commission 
(February 18, 1994).
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    The Commission believes that it is not necessary to extend the 
proposal to include contributions to candidates for federal office. The 
proposal addresses abusive political contributions to officials of 
issuers who may influence the selection of municipal securities 
underwriters. Because federal office holders do not influence the 
underwriter selection process, the Commission believes that it would 
not be appropriate to include federal candidates under the rule's 
requirements.
    By the same token, the Commission also believes that any resulting 
hardship to candidates for federal office who are currently local 
officials is not a reason for eliminating these requirements. The MSRB 
cannot overlook potential conflicts of interest solely because there 
are candidates for the same federal office who do not face the same 
conflicts. In any event, the resulting burden to current local 
officials does not appear to be significant. Generally, municipal 
underwriters play a less significant role as contributors in federal 
elections. Moreover, under federal law there exist general contribution 
restrictions that limit the amount of contributions that other 
candidates are able to obtain from municipal securities dealers and 
municipal finance professionals.\77\
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    \77\See supra note 68.
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F. Municipal Securities Dealer Affiliates

    Several commentators believe that the proposal should apply to 
contributions from all employees affiliated with the underwriter and 
from affiliated financial institutions and their employees.\78\ Several 
commentators specifically express concern that the proposal excludes 
contributions by chief executive officers of banks,\79\ or by PACs 
controlled by banks or bank holding companies, which have a municipal 
securities dealer department or subsidiary.\80\ These commentators 
believe that by exempting affiliated banks and bank holding companies, 
the proposal provides a ``loophole'' for continued abuse of political 
contributions by municipal securities dealers and their affiliates.\81\
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    \78\One commentator, for example, believes that the ``rule is 
ineffective because it does not cover all related personnel who can 
continue to contribute to officials of issuers thereby creating the 
actual or apparent conflict of interest which the MSRB rule seeks to 
prevent.'' Letter from Raymond J. McClendon, Vice-Chairman and Chief 
Operating Officer, Pryor, McClendon, Counts & Co., Inc., to Margaret 
H. McFarland, Deputy Secretary, Commission (March 9, 1994).
    \79\Once commentator, for example, states that ``[w]e 
strenuously object to a narrowly-based requirement that diminishes 
the ability of our Chief Executive and members of our executive 
committees to participate as community leaders, to engage in 
political dialogue and to develop our firm's profile in the 
communities in which we do business to the same extent as local bank 
chief executives.'' Letter from William H. Ellis, President and 
Chief Operating Officer, Piper Jaffray Inc., to Jonathan Katz, 
Secretary, Commission (March 10, 1994).
    \80\One commentator, for example, states that ``[c]ommercial 
banks would be free to continue making PAC contributions to local 
and state level political candidates and in the process gain a 
significant competitive advantage in the selection process for 
public finance undertakings. Those candidates receiving bank PAC 
contributions would certainly remember such support when bank dealer 
personnel are introduced or accompanied by commercial bankers in the 
selection process. It is a typical procedure for the local bank 
officer to lobby and/or speak in behalf of the hiring of his public 
finance entity.'' Letter from Clifford A. Lanier, Jr., The Frazer 
Lanier Company, to David C. Clapp, Chairman, MSRB (March 1, 1994).
    Another commentator states that ``[i]t is unreasonable to 
believe that political candidates, including `issuer officials,' 
will be able or need to, discern between contributions from a bank-
controlled PAC and a bank's municipal securities `dealer-controlled' 
PAC. This appears to us to represent `business as usual' for bank-
controlled municipal dealers while we are both stigmatized and 
potentially disadvantaged competitively.'' Letter from William H. 
Ellis, President and Chief Operating Officer, Piper Jaffray, Inc., 
to Jonathan Katz, Secretary, Commission (March 10, 1994).
    \81\``Unfortunately, the proposed rule as written is so severely 
deficient in ignoring the sophisticated realities of political 
fundraising undertaken by securities firms, that the loopholes and 
fine distinctions posed promise to provide a road map for more 
sinister activities, possibly making the situation worse.'' Letter 
from Mark D. Schwartz, to Arthur Levitt, Chairman, Commission 
(January 31, 1994).
    Several commentators question the ability of the MSRB or the 
NASD to enforce Rule G-37. For example, one commentator believes 
that ``[p]olitical favors will to those investment banks that flaunt 
or circumvent the rule while those firms who live by the rules will 
suffer accordingly.'' Letter from Carolie R. Smith, President, Smith 
Mitchell Investment Group, Inc., to Jonathan Katz, Secretary, 
Commission (March 9, 1994).
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    The Commission believes that the MSRB's proposed rule change is not 
deficient merely because it does not include affiliated banks and bank 
holding companies. Because of the sensitivity to constitutional and 
other concerns, the Commission believes that the coverage of the 
proposal is no broader than is necessary to effectuate its purpose and 
that extending the scope to cover affiliated banks and bank holding 
companies is not necessary.\82\
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    \82\The Commission will monitor closely the implementation of 
the proposal and its effects on the market, and if it determines 
that abusive practices continue to exist, will encourage the MSRB to 
expand the scope of the rule. In response to the suggestion that 
financial advisers be required to register as municipal securities 
broker-dealers and be subject to the proposal, the Commission notes 
that such a recommendation is beyond the scope of this proposal. See 
e.g., letter from Vivian Altman, Altman & Co., to Jonathan Katz, 
Secretary, Commission (January 31, 1994).
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G. De Minimis Exemption

    Several commentators recommend that the proposal increase the de 
minimis amount that municipal finance professionals may contribute.\83\ 
Several commentators recommend that the rule should provide a ``good 
faith'' exemption for inadvertent violations.\84\ One commentator 
recommends that the rule provide a ``safe harbor'' provision for 
certain contributions.\85\ Another commentator believes that the 
proposal should exempt contributions made for legitimate purposes.\86\
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    \83\These commentators express concern that inadvertent 
violations by municipal securities dealers or associated persons 
covered by the rule may prevent dealers from participating in an 
underwriting, and, thus, raise the cost of a municipal securities 
issuance. For example, one commentator states that ``we are 
concerned that your rule could deprive a state or local government 
of the opportunity to work with a company which may be offering the 
most desirable rates simply due to a technical infraction.'' Letter 
from Jerry Abramson, President, The United States Conference of 
Mayors, Sharpe James, President, The National League of Cities, 
Barbara Sheen Todd, President, The National Association of Counties, 
and Bonnie R. Kraft, President-Elect, the Government Finance 
Officers Association, to Arthur Levitt, Chairman, Commission 
(February 18, 1994).
    \84\For example, one commentator states that ``[c]learly, the 
tradition of broker-dealer regulation in the U.S. is based upon the 
requirement that securities firms have adequate policies and 
procedures in place to assure compliance with laws and regulations 
not that each broker-dealer be guarantor of perfect compliance.'' 
Letter from William H. Ellis, President and Chief Operating Officer, 
Piper Jaffray Inc., to Jonathan Katz, Secretary, Commission (March 
10, 1994). Another commentator believes that the proposal, 
``consistent with many other rules and regulations applicable to the 
securities industry, may achieve its purposes but temper its remedy 
for firms with adequate compliance procedures and supervision.'' 
Letter from D. Kelly, A.G. Edwards & Sons, Inc., to Jonathan Katz, 
Secretary, Commission (March 10, 1994). See also letter from Raymond 
J. McClendon, Vice-Chairman and Chief Operating Officer, Pryor, 
McClendon, Counts & Co., Inc., to Margaret H. McFarland, Deputy 
Secretary, Commission (March 9, 1994); letter from George B. Pugh, 
Jr., Chairman, Municipal Securities Division, Public Securities 
Association to Jonathan Katz, Secretary, Commission (March 11, 
1994).
    Several commentators raise concerns that aggrieved employees may 
make contributions to deliberately prevent a firm from obtaining 
municipal securities business. E.g., letter from William H. Ellis, 
President and Chief Operating Officer, Piper Jaffray Inc., to 
Jonathan Katz, Secretary, Commission (March 10, 1994); letter from 
D. Kelly, A.G. Edwards & Sons, Inc., to Jonathan Katz, Secretary, 
Commission (March 10, 1994).
    \85\For example charitable contributions, contributions to non-
partisan associations in which elected officials may be members or 
participants, support of ballot propositions, certain services in 
the normal course of business, contributions by spouses or household 
members, contributions to national political parties, contributions 
to state and local political parties and certain contributions to 
political action committees. Letter from D. Kelly, A.G. Edwards & 
Sons, Inc., to Jonathan Katz, Secretary Commission (March 10, 1994).
    \86\Letter from Raymond J. McClendon, Vice-Chairman and Chief 
Operating Officer, Pryor, McClendon, Counts and Co., Inc., to 
Margaret H. McFarland, Deputy Secretary, Commission (March 9, 1994).
---------------------------------------------------------------------------

    Several commentators believe that the de minimis exemption should 
be expanded to include contributions to officials for whom the 
municipal finance professionals are not entitled to vote.\87\ These 
commentators believe that the proposal prevents municipal securities 
dealers from establishing business relationships with issuers,\88\ and 
from supporting candidates with similar views important to the 
municipal finance professional or to the municipal securities broker-
dealer firm.\89\ One commentator recommends that the proposal allow 
contributions to candidates that represent the area in which the 
professionals' principal office is located.\90\
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    \87\For example, one commentator believes that ``[d]ealers 
should not be prohibited from making contributions to persons for 
whom they are unable to vote. They should have a right to support 
the candidates of their choice.'' Letter from Jeffrey L. Esser, 
Executive Director, Government Finance Officers Association, to 
Jonathan Katz, Secretary Commission (March 10, 1994).
    \88\Letter from Carolie R. Smith, President, Smith Mitchell 
Investment Group, Inc., to Jonathan Katz, Secretary Commission 
(March 9, 1994).
    \89\For example, one commentator believes that ``[t]he provision 
limiting contributions to one's voting jurisdiction denies municipal 
securities professionals access to politicians who influence their 
corporate and individual political interests. Specifically, 
municipal securities professionals will be denied the ability to 
support politicians who champion their personal beliefs or corporate 
concerns. For example, a firm headquartered in New York City whose 
president and employees live on Long Island would be unable to send 
a representative to a dinner for the mayor of New York City or for 
the mayor's political opponent. Yet the mayor's decisions on issues 
such as zoning, corporate taxes, and transportation policy 
significantly impact the company's viability.'' Letter from Carolie 
R. Smith, President, Smith Mitchell Investment Group, Inc., to 
Jonathan Katz, Secretary, Commission (March 9, 1994)
    \90\Letter from Gerald E. Pelzer, President, Clayton Brown & 
Associates, Inc., to Jonathan Katz, Secretary, Commission (March 10, 
1994).
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    The Commission believes that the MSRB's determinations as to the 
amount of the de minimis exemption and limiting its application to 
contributions to officials for whom the municipal finance professional 
is entitled to vote are appropriate and reasonable. As discussed, the 
proposal provides specific guidelines to prevent ``pay to play'' 
contributions. The proposal provides an appropriate balance between 
limiting ``pay to play'' practices and the ability of dealers and their 
employees to demonstrate support for state and local candidates. The 
proposal recognizes that certain contributions made for legitimate 
political purposes present less risk of a conflict of interest or the 
appearance of a conflict of interest. Although an individual may have a 
legitimate interest in making contributions to candidates for whom she 
is ineligible to vote, there is a greater risk in such circumstances 
that the contribution is motivated by an improper attempt to influence 
municipal officials. Thus, the proposal enables municipal finance 
professionals to contribute $250 per election to candidates for whom 
they are entitled to vote without triggering the proposal's business 
limitation. As discussed, the proposal does not prevent dealers or 
their employees from demonstrating support for local and state 
officials in other ways including volunteer political campaign 
activity.

H. General Provisions

    Several commentators believe that the proposal is operationally too 
burdensome to implement. These commentators believe that because of the 
number and types of persons subject to the rule's prohibitions, it will 
be difficult for municipal securities dealers to implement and enforce 
compliance procedures.\91\ Some commentators believe that the 
proposal's disclosure and recordkeeping requirements are overly 
burdensome.\92\ Several commentators also believe that the scope of the 
proposal is uncertain and recommend that it provide more complete 
standards regarding employee contributions,\93\ the use of consultants 
and law firms,\94\ bonds issued by corporations with the assistance of 
local governments,\95\ the definition of ``election,''\96\ and the 
definition of ``official of such issuer.''\97\ One commentator requests 
that the proposal contain a ``sunset'' provision to require the MSRB to 
review rule G-37 after a fixed number of years.\98\
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    \91\For example, Piper Jaffray Inc. expresses concern regarding 
the ability of broker-dealer firms to screen newly hired employees 
or current employees seeking employment with the firm's municipal 
securities departments, and the ability to hire civil servants. 
Piper Jaffray Inc. believes that ``[t]his would require firms to 
screen all applicants for these jobs by requiring them to declare to 
whom they made political contributions and make judgmental 
evaluations as to whether their earlier campaign activities would be 
potentially violative of the rule and not offer a job to any 
offending contributor.'' Piper Jaffray Inc. believes that this will 
almost certainly expose broker-dealer firms to the risk of civil 
litigation. Letter from William H. Ellis, President and Chief 
Operating Officer, Piper Jaffray Inc., to Jonathan Katz, Secretary, 
Commission (March 10, 1994). Another commentator states that ``a 
person who has made a contribution within the past two years 
apparently taints a firm which hires the individual even if the 
individual was not involved in the municipal securities business at 
the time of the contribution. Two serious problems exist. The first 
is that even a firm with strict reviews for hiring may find itself 
barred * * *. The second is that many active citizens will find 
themselves de facto barred from entering the public finance, banking 
and brokerage businesses.'' Letter from D. Kelly, A.G. Edwards & 
Sons, Inc., to Jonathan Katz, Secretary, Commission (March 10, 
1994).
    \92\E.g., letter from A.B. Krongard, Chief Executive Officer, 
Alex, Brown & Sons, to Jonathan Katz, Secretary, Commission (March 
15, 1994); letter from Robert F. Price, Chairman, Federal Regulation 
Committee, Securities Industry Association, to Jonathan Katz, 
Secretary, Commission (March 17, 1994). The Securities Industry 
Association believes that the proposal's reporting provisions should 
be amended to: (1) Require quarterly submissions for only those 
quarters in which the dealer has any contributions to report; (2) 
delete the requirement to report lists of issuers with which the 
dealer conducts municipal securities business; and (3) delete the 
requirement to disclose the name, company, role, and compensation 
arrangement of any person employed by the dealer to obtain municipal 
securities business.
    \93\For example, A.G. Edwards & Sons, Inc. believes that the 
``provision is ambiguous. Read most broadly the definition of 
municipal finance professional in proposed Rule G-37 could be 
construed to include any retail broker who sells municipal 
securities * * *. As a result of the possible ambiguity and the 
changing application, firms employing retail brokers likely will 
interpret the provision broadly to avoid being barred from the 
municipal finance business. The result will be that numerous brokers 
who have no participation in securing municipal securities business 
will be barred from political activities.'' Letter from D. Kelly, 
A.G. Edwards & Sons, Inc., to Jonathan Katz, Secretary, Commission 
(March 10, 1994).
    \94\E.g., Letter from William H. Ellis, President and Chief 
Operating Officer, Piper Jaffray Inc., to Jonathan Katz, Secretary, 
Commission (March 10, 1994). One commentator recommends the proposal 
clarify that the definition of municipal finance professional 
excludes independent law firms or persons retained by a dealer for 
purposes other than the solicitation of municipal securities 
business. Letter from Richard H. Martin, Attorney, Leonard, Street 
and Deinard, to Jonathan Katz, Secretary, Commission (March 8, 
1994).
    One commentator recommends that the proposal should be clarified 
to exclude from the definition of municipal finance professional any 
independent firms or persons retained by a broker-dealer for 
purposes other than the solicitation of municipal securities 
business. Letter from Richard H. Martin, Attorney, Leonard, Street 
and Deinard, to Jonathan Katz, Secretary, Commission (March 8, 
1994).
    \95\Id.
    \96\One commentator, for example, states that ``[a]n election 
should be defined and it should be made clear that if a contributor 
gives for a specified election, the amount shall only be considered 
as a contribution for the election for which the amount was given 
even if the candidate has the legal right to carry over amounts to 
other elections.'' Letter from D. Kelly, A.G. Edwards & Sons, Inc., 
to Jonathan Katz, Secretary, Commission (March 10, 1994).
    \97\``An influence standard leaves the industry uncertain as to 
whom contributions may be made and, judged retrospectively, may 
cause inadvertent violations.'' Id.
    \98\This ``would allow all parties to regularly review G-37 to 
determine whether G-37 is effective and meeting the goals it was 
created to achieve and to accommodate any other relevant 
developments such as campaign finance reform.'' Letter from Carolie 
R. Smith, President, Smith Mitchell Investment Group, Inc., to 
Jonathan Katz, Secretary, Commission (March 9, 1994).
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    The Commission believes that the proposal's provisions are 
sufficiently specific to permit compliance with its terms. The 
Commission also understands that industry efforts are currently 
underway to draft proposed guidelines to assist dealer compliance with 
the proposal. In addition, the MSRB will provide continued interpretive 
guidance to assist dealer compliance with the proposal. The Commission, 
in accordance with its statutory mandate, will continue to monitor the 
implementation of the proposal and the effects the proposal may have on 
the market.

I. Amendment No. 1

    The Commission finds good cause for approving the MSRB's Amendment 
No. 1, pursuant to Section 19(b)(2) of the Act, prior to the thirtieth 
day after the date of publication of notice of the amendment. As 
originally submitted, the proposal's prohibitions on municipal 
securities business would arise from contributions made on or after 
April 1, 1994. The MSRB filed the amendment to change the April 1, 1994 
date to a date 10 days after publication in the Federal Register of the 
order approving the proposal. The MSRB also amended the proposal to 
change the effective date of the proposal's disclosure and 
recordkeeping requirements to a date 10 days after publication of the 
approval order in the Federal Register. Thus the proposal's 
prohibitions will arise from contributions made on or after April 25, 
1994. The proposal's disclosure and recordkeeping requirements also 
will not be effective until April 25, 1994. The Commission believes 
that the amendments will facilitate compliance by municipal securities 
dealers. The amendments, in conjunction with the proposal's notice and 
comment period, will provide municipal securities dealers sufficient 
time to adopt and implement procedures to comply with the proposal.

VI. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the MSRB's Amendment No. 1. 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 amendment that are filed with 
the Commission, and all written communications relating to the 
amendment between the Commission and any person, other than those that 
may be withheld from the public in accordance with the provisions of 5 
U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Section. Copies of the amendment also 
will 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 May 4, 1994.

VII. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the Act and the rules and regulations 
thereunder applicable to the MSRB and, in particular, section 
15B(b)(2)(C).
    It is therefore ordered, Pursuant to section 19(b)(2) of the Act, 
that the proposed rule change and Amendment No. 1 described above be, 
and hereby are, approved, and shall be effective April 25, 1994.\99\
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    \99\The Commission simultaneously issued an order relating to 
this matter, ``Order Preliminarily Declining to Issue Stay Sua 
Sponte and Establishing Guidelines for Consideration of Stay 
Applications.'' Securities Exchange Act Release No. 33870 (April 7, 
1994).

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-8838 Filed 4-12-94; 8:45 am]
BILLING CODE 8010-01-M