[Federal Register Volume 61, Number 16 (Wednesday, January 24, 1996)]
[Notices]
[Pages 1955-1958]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-909]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36727; File No. SR-MSRB-95-15]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the Municipal Securities Rulemaking Board Relating to
Consultants
January 17, 1996.
On September 28, 1995,\1\ the Municipal Securities Rulemaking Board
(``MSRB'' or ``Board'') filed with the Securities and Exchange
Commission (``Commission'') a proposed rule change pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \2\ and Rule
19b-4 thereunder.\3\ The proposed rule change amends rules G-8 \4\ and
G-9,\5\ on recordkeeping and record retention, rule G-37,\6\ on
political contributions and prohibitions on municipal securities
business, and adds a new rule G-38 regarding consultants. The proposed
rule change also amends MSRB Form G-37, and redesignates it as Form G-
37/G-38.
\1\ On November 15, 1995, the MSRB filed Amendment No. 1 with
the Commission. Amendment No. 1 was a minor technical amendment, the
text of which may be examined in the Commission's Public Reference
Room. See Letter from Jill C. Finder, Assistant General Counsel,
MSRB, to Ethan D. Corey, Senior Counsel, Division of Market
Regulation, Commission, dated November 15, 1995.
\2\ 15 U.S.C. 78s(b)(1).
\3\ 17 CFR 240.19b-4.
\4\ MSRB Manual, General Rules, G-8 (CCH) para. 3536.
\5\ MSRB Manual, General Rules, G-9 (CCH) para. 3541.
\6\ MSRB Manual, General Rules, G-37 (CCH) para. 3681.
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Notice of the proposed rule change, together with the substance of
the proposal, was provided by issuance of a Commission release
(Securities Exchange Act Release No. 36522, November 28, 1995) and by
the publication in the Federal Register (60 FR 62275, December 5,
1995). One comment letter was received.\7\ This order approves the
proposed rule change.
\7\ Letter from David J. Rubin (``Rubin'') to Jonathan G. Katz,
Secretary, Commission, dated December 6, 1995 (``Rubin Letter'').
[[Page 1956]]
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I. Introduction
The rule change approved today will require brokers, dealers and
municipal securities dealers (collectively, ``municipal securities
firms'') to enter written agreements with ``consultants,'' as defined
in rule G-38, and to disclose such arrangement to issuers and to the
public through disclosure to the Board. It is the latest in a series of
actions taken by the Commission and the MSRB to combat abuses
associated with the awarding of municipal securities business. The
Commission approved rule G-37 on April 7, 1994 in order to cleanse the
municipal securities market of pay-to-play practices. Rule G-37
prohibits, among other things, any municipal securities firm from
engaging in municipal securities business with an issuer if: (i) it;
(ii) any municipal finance professional associated with it; or (iii)
any political action committee controlled by it or any of its municipal
finance professionals has contributed to an official of that issuer
within the previous two years.\8\ The rule also provides that no
municipal securities firm or any of its municipal finance professionals
shall, directly or indirectly, through or by any other means, do any
act that would result if a municipal securities firm engages in
municipal securities business with an issuer after directing third
parties (such as consultants) to make contributions to that issuer. In
addition to recording and disclosing political contributions, rule G-37
currently requires municipal securities firms to record and disclose on
Form G-37 those issuers with which those firms have engaged in
municipal securities business and, where applicable, the name, company,
role and compensation arrangement of any person employed by the dealer
to obtain or retain business with such issuers. The United States Court
of Appeals for the District of Columbia Circuit, in rejecting a
challenge to rule G-37, noted that ``the link between eliminating pay
to play practices and the Commission's goals of `perfecting the
mechanism of a free and open market' and promoting `just and equitable
principles of trade' is self-evident.'' \9\
\8\ Rule G-37(b) contains an exception for certain contributions
of $250 or less per election made by an municipal finance
professional to an official of an issuer for whom that municipal
finance professional was entitled to vote.
\9\ Blount v. Securities and Exchange Commission, 61 F.3d 938,
945 (D.C. Circuit 1995); rehearing and application for rehearing en
banc denied (D.C. Cir. Oct. 4, 1995).
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Rule G-37 complements rule G-20, on gifts and gratuities, which
prohibits dealers from, directly and indirectly, giving or permitting
to be given any thing or service of value, including gratuities, in
excess of $100 per year to any person, other than an employee of
partner of the municipal securities firm, in relation to the municipal
securities activities of the person's employer. All gifts given by the
municipal securities firm and its associated persons, or by consultants
at the direction of the municipal securities firm, are used to compute
the $100 limitation and this limitation applies to gifts and gratuities
to customers, individuals associated with issuers, and employers of
other municipal securities firms.\10\
\10\ MSRB Reports, vol. 14, no. 1 at 11 (Jan. 1994). Rule G-
20(b) exempts ``normal business dealings'' from the $100 annual
limit. These payments are defined as occasional gifts of meals or
tickets to theatrical, sporting, and other entertainments, as well
as the sponsoring of legitimate business functions that are
recognized by the IRS as deductible business expenses, and gifts of
reminder advertising. However, the rule also provides that such
gifts can not be so frequent or so expensive as to raise a
suggestion of unethical conduct.
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In addition to these initiatives, the Commission has brought
several actions against participants in the municipal securities market
in connection with payments made by underwriters to agents or employees
of issuers in order to secure municipal securities business. In one
instance, the Commission found that an employee of a municipal
securities underwriter provided certain benefits to an elected public
official of an issuer during a time when that official has an important
role in selecting the underwriter for municipal securities issued by
that issuer.\11\ In another instance, the Commission found that
employees of a municipal securities underwriter made undisclosed
payments to a third party to assure that underwriter's continued
participation as book-running senior manager for a municipal issuer's
offering of debt securities.\12\ The Commission also found that the
same municipal securities underwriter itself engaged in schemes to
defraud various municipal issuers and investors by agreeing to pay
undisclosed kickbacks to agents of those issuers in exchange for
underwriting business.\13\
\11\ See Preston C. Bynum, Securities Exchange Act Release No.
35870 (June 20, 1995), 59 SEC Dock, 1801 (July 18, 1995).
\12\ See George l. Tuttle, Jr., and Alexander S. Williams,
Securities Exchange Act Release No. 35605 (April 14, 1995), 59 SEC
Dock, 330 (May 16, 1995) (``Tuttle'').
\13\ See First Fidelity Securities Group, Securities Exchange
Act Release No. 36694 (Jan. 9, 1996) (``First Fidelity'').
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The Commission notes that past rulemaking initiatives have helped
to ensure that municipal securities firms are prohibited from engaging
in practices that bring into question the integrity of the municipal
securities market and that it has brought enforcement actions to
address fraudulent practices in the municipal securities market.
However, the Commission is concerned that abusive practices such as
those disclosed in the Tuttle and First Fidelity orders do not
represent isolated instances of wrongdoing.
The MSRB stated in its filing that it believes that municipal
securities firms may employ consultants as a result of limitations
placed on municipal securities firm activities by rule G-37 and rule G-
20.\14\ While both rules prohibit municipal securities from doing
indirectly what they are precluded from doing directly, indirect
activities often are difficult to prove. The rule approved today is
intended to provide additional information to issuers and to the public
to assist in determining the extent to which payments to consultants
influence the issuer's selection process in connection with municipal
securities business, as well as the extent to which such payments
increase the cost of bringing municipal securities issues to market.
\14\ The MSRB also stated in its filing that it believes that in
many instances the use of consultants is appropriate.
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II. Scope of Rule G-38
Rule G-38, on consultants, does not impose any substantive
restrictions on arrangements between municipal securities firms and
consultants. Rather, rule G-38 will require municipal securities firms
to enter into written agreements with ``consultants,'' as defined in
rule G-38, and to disclose such arrangements to issuers and to the
public through disclosure to the Board.
A. Definition of Consultant
Rule G-38 defines consultant as any person used by a municipal
securities firm to obtain or retain municipal securities business
through direct or indirect communication by such person with an issuer
on the municipal securities firm's behalf where the communication is
undertaken by such person in exchange for, or with the understanding of
receiving, payment from the municipal securities firm or any other
person.\15\ The definition
[[Page 1957]]
specifically excludes ``municipal finance professionals,'' as that term
is defined in rule G-37(g)(iv), because such individuals are covered by
the requirements of rule G-37. The definition also excludes any person
whose sole basis of compensation from the municipal securities firm is
the actual provision of legal advice, accounting or engineering
assistance in connection with the municipal securities business that
the municipal securities firm is seeking to obtain or retain. The
exclusion would apply, for example, to a lawyer retained to conduct a
legal analysis on a particular transaction contemplated by the
municipal securities firm, or to review local regulations; an
accountant retained to conduct a tax analysis or to scrutinize
financial reports; or an engineer retained to perform a technical
review or feasibility study. The exemption is intended to ensure that
professionals who are engaged by the municipal securities firm solely
to perform substantive working connection with municipal securities
business are not brought within the definition of consultant as long as
their compensation is in consideration of only those professional
services actually provided in connection with such municipal securities
business. Any attorney, accountant, engineer or other professional used
by the municipal securities firm as a ``finder'' for municipal
securities business would, however, be considered a consultant under
the proposed rule.
\15\ ``Person'' is defined in Section 3(a)(9) of the Securities
Exchange Act of 1934 as ``a natural person, company, government, or
political subdivision, agency or instrumentality ``Municipal
securities business' has the same meaning as in rule G-37(g)(vii),
i.e., (A) the purchase of a primary offering (as defined in rule A-
13(d)) of municipal securities from the issuer on other than a
competitive bid basis (i.e., negotiated underwriting); (B) the offer
or sale of a primary offering of municipal securities on behalf of
any issuers (i.e., private placement); (C) the provision of
financial advisory or consultant services to or on behalf of an
issuer with respect to a primary offering of municipal securities on
other than a competitive bid basis; or (D) the provision of
remarketing agent services to or on behalf of an issuer with respect
to a primary offering of municipal securities on other than a
competitive bid basis.
``Payment'' has the same meaning as in rule G-37(g)(viii), i.e.,
any gift, subscription, loan, advance, or deposit of money or
anything of value.
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The definition of consultant also will encompass third parties who
initiate contact with prospective underwriters to offer their services
in obtaining or retaining municipal securities business through direct
or indirect communication by such person with an issuer official. The
definition does not distinguish between instances in which the
municipal securities firm initiates contact and instances in which the
third party initiates contact. The touchstone is whether that person is
used by a municipal securities firm to obtain or retain municipal
securities business through direct or indirect communication by such
person with an issuer on the municipal securities firm's behalf where
the communication is undertaken by such person in exchange for, or with
the understanding of receiving payment from the municipal securities
firm or any other person. If that person is so used, then that person
is a consultant.
B. Written Agreement
Rule G-38 will require municipal securities firms who use
consultants to evidence the consulting arrangement in writing
(``Consultant Agreement''), and that, at a minimum, the writing must
include the name, company, role and compensation arrangement of each
consultant used by the municipal securities firm. Such written
agreements must be entered into before the consultant engages in any
direct or indirect communication with an issuer on the municipal
securities firm's behalf.
C. Disclosure to Issuers
Rule G-38 will require each municipal securities firm to disclose
to an issuer with which it is engaging or seeking to engage in
municipal securities business, in writing, information on consulting
arrangements relating to that issuer. The written disclosure must
include, at a minimum, the name, company, role and compensation
arrangement with the consultant or consultants. Municipal securities
firms are required to make such written disclosures prior to the
issuer's selection of any municipal securities firm in connection with
the municipal securities business sought, regardless of whether the
municipal securities firm making the disclosure ultimately is the
municipal securities firm that obtains or retains that business.
D. Disclosure to the Board
Rule G-38 will require municipal securities firms to submit to the
Board, on a quarterly basis, reports of all consultants used by the
municipal securities firm. For each consultant, municipal securities
firms must report, in the prescribed format, the consultant's name,
company, role and compensation arrangement, as well as the dollar
amount of any payment made to the consultant during the quarterly
reporting period. If any payment made during the reporting period is
related to the consultant's efforts on the municipal securities firm's
behalf which resulted in particular municipal securities business,
whether the municipal securities business was completed during that or
a prior reporting period, then the municipal securities firm must
separately identify that business and the dollar amount of the payment.
In addition, as long as the municipal securities firm continues to use
the consultant to obtain or retain municipal securities business (i.e.,
has a continuing arrangement with the consultant), the municipal
securities firm must report information concerning such consultant
every quarter, whether or not compensation is paid to the consultant
during the reporting period. The quarterly reporting requirement is
intended to assist enforcement agencies and the public in their review
of such arrangements.
The rule change approved today deletes the current reporting
requirements regarding consultants from rule G-37. Instead, reporting
requirements imposed under rule G-37 and rule G-38 will be contained in
a single form--new G-37/G-38. Municipal securities firms will be
required to submit two copies of such reports on new Form G-37/G-
38.\16\ The quarterly due dates will be the same as the due dates
currently required under rule G-37 (i.e., within 30 calendar days after
the end of each calendar quarter, which corresponds to each January 31,
April 30, July 31, and October 31). Finally, consistent with current
rule G-37, municipal securities firms will be required to submit these
reports to the Board by certified or registered mail, or some other
equally prompt means that provides a record of sending.\17\ The Board
will then make these documents available to the public for inspection
and photocopying at its Public Access Facility in Alexandria, Virginia,
and for review by agencies charged with enforcement of Board rules.
\16\ In addition to the new rule G-38 consultant reporting
requirements, Form G-37/G-38 includes revisions to the rule G-37
political contribution reporting requirements. Such revisions
include, for each contribution, a required notation of the category
of the contributor (e.g., municipal finance professional or
executive officer) and the amount of the contribution, as well as a
separate section for the reporting of ``payments'' to political
parties distinct from ``contributions'' to issuer officials.
\17\ Rule G-37 Filing Procedures are contained within the
language of rule G-37, and rule G-38 Filing Procedures are contained
within the language of new rule G-38.
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E. Recordkeeping Requirements
The rule change approved today also amends rules G-8 and G-9,
concerning recordkeeping and record retention, to facilitate compliance
with, and enforcement of, rule G-38. The amendments to rule G-8 will
require municipal securities firms to maintain: (i) A listing of the
name, company, role and compensation arrangement of each consultant;
(ii) a copy of each Consultant Agreement; (iii) a listing of
[[Page 1958]]
the compensation paid in connection with each Consultant Agreement;
(iv) where applicable, a listing of the municipal securities business
obtained or retained through the activities of each consultant; (v) a
listing of the issuers and a record of disclosures made to such issuers
concerning each consultant used by the municipal securities firm to
obtain or retain municipal securities business with each such issuer;
and (vi) the date of termination of any consultant arrangement. The
amendment to rule G-9 will require municipal securities firms to
maintain these records for a six-year period.
III. Comment Letters
As noted above, the Commission received one comment letter
concerning the proposed change. The Rubin Letter argued that although
the proposed rule change may assist in uncovering payments to third
parties that are intended to influence the awarding of municipal
securities business, such business will continue to be awarded based on
criteria other than merit until issuers are required to select the best
underwriters for debt issuance. The Commission agrees with the Rubin
Letter that the rule change approved today, standing alone, will not
operate to cleanse the municipal market of all practices resulting in
issuers awarding municipal securities business on a basis other than
the merits of the underwriting firm chosen.\18\ As noted above,
however, the rule change approved today is intended to provide
additional information to issuers and to the public to assist in
determining the extent to which payments to consultants influence the
issuer's selection process in connection with municipal securities
business, as well as the extent to which such payments increase the
cost of bringing municipal securities issues to market.
\18\ The MSRB determined not to include within the definition of
consultant persons who are engaged by a dealer at the request or
direction of the issuer because those persons do not assist the
dealer in obtaining or retaining municipal securities business. The
MSRB stated in its filing that it will review the issue of ``issuer-
designated'' professionals and other issuer involvement in the
underwriting process and will address this subject, including the
question of requiring disclosure of issuer-designated persons, at a
future time. The Commission encourages the MSRB to consider such
further initiatives in this area in order to promote the awarding of
municipal securities business based on merit.
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IV. Discussion and Findings
The Commission finds that the rule change is consistent with the
provisions of Section 15B(b)(2)(C) \19\ of the Act, which provides that
the Board's rules shall be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in,
municipal securities, to remove impediments to and perfect the
mechanism of a free and open market in municipal securities, and, in
general, to protect investors and the public interest. The Commission
believes that the rule change removes impediments to and perfects the
mechanism of a free and open market in municipal securities in that the
amendments enhance the ability of municipal securities firms to compete
for, and be awarded, municipal securities business on the basis of
merit, rather than political or financial influence. Such healthy
competition will act to lower artificial barriers to those municipal
securities firms not willing or able to hire consultants to obtain or
retain municipal securities business, thereby maintaining the integrity
of the municipal securities market, as well as the public trust and
confidence that is essential to the long-term health and liquidity of
the market.
\19\ 15 U.S.C. 78o-4.
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The Commission also believes that the rule change is in the public
interest in that the amendments enhance the ability of investors to
determine whether an underwriter may have made improper payments in
order to secure municipal securities business. The Commission has
recognized that ``information concerning financial and business
relationships among the parties involved in the issuance of municipal
securities may be critical to an evaluation of the underwriting.'' \20\
\20\ First Fidelity, supra n. 13, quoting Statement of the
Commission Regarding Disclosure Obligations of Municipal Securities
Issuers and Others, Securities Act Release No. 7049 (Mar. 9, 1994),
59 FR 12748 (Mar. 17, 1994).
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It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that File No. SR-MSRB-95-15 be, and hereby is, approved, effective
March 18, 1996.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority, 17 CFR 200.30-3(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-909 Filed 1-23-96; 8:45 am]
BILLING CODE 8010-01-M