[Federal Register Volume 61, Number 221 (Thursday, November 14, 1996)]
[Notices]
[Pages 58431-58434]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-29150]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-37928; File No. SR-MSRB-96-7]


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

November 6, 1996.

I. Introduction

    On August 6, 1996,\1\ the Municipal Securities Rulemaking Board 
(``Board'' or ``MSRB'') submitted to the Securities and Exchange 
Commission (``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \2\ and Rule 19b-4 
thereunder,\3\ a proposed rule change to amend rule G-37, on political 
contributions and prohibitions on municipal securities business, and 
rule G-8, on books and records. Notice of the proposed rule change 
appeared in the Federal Register on September 19, 1996.\4\
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    \1\ On September 9, 1996, the MSRB filed Amendment No. 1 with 
the Commission. Amendment No. 1 amends proposed language to rule G-
37(g)(vii). See letter from Ronald W. Smith, Legal Associate, MSRB, 
to Katherine England, Assistant Director, Division of Market 
Regulation, SEC, dated September 9, 1996.
    \2\ 15 U.S.C. 78s(b)(1) (1988).
    \3\ 17 CFR 240.19b-4.
    \4\ Securities Exchange Act Release No. 37675 (September 12, 
1996), 61 FR 49368.
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    The Commission received three comment letters addressing the 
proposed rule change.\5\ One commenter endorsed the proposed amendments 
to

[[Page 58432]]

both rules,\6\ while another endorsed only the amendments to rule G-
37.\7\ Finally, the third commenter, while not objecting to the 
amendments, reserved judgment pending clarification of certain 
issues.\8\ This order approves the proposed rule change.
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    \5\ Letter from Douglas L. Kelly, Vice President and Corporate 
Secretary, A.G. Edwards & Sons, Inc., to Jonathan G. Katz, 
Secretary, SEC, dated October 11, 1996 (``A.G. Edwards Letter''); 
Letter from E. Stephen Walsh, Administrative and Compliance Partner, 
David J. Greene and Company, to Jonathan Katz, Secretary, SEC, dated 
October 9, 1996 (``Greene Letter''); Letter from Irwin D. Rowe, 
Executive Vice President, Loeb Partners Corporation, to Jonathan G. 
Katz, Secretary, SEC, dated October 4, 1996 (``Loeb Letter'').
    \6\ Loeb Letter, p. 2.
    \7\ Greene Letter.
    \8\ A.G. Edwards Letter, p. 1.
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II. Description of the Amendments

    The rule change: (i) amends the definition of ``municipal finance 
professional''; (ii) amends the definition of ``executive officer''; 
(iii) clarifies the definition of ``official of an issuer''; (iv) 
clarifies the definition of ``municipal securities business''; and (v) 
requires the retention of Forms G-37/G-38 and of records itemizing 
mailing of the same.

A. Definition of ``Municipal Finance Professional''

    Currently, subparagraph (E) of rule G-37(g)(iv) states that an 
associated person who is a member of the dealer executive or management 
committee or similarly situated official is a municipal finance 
professional. This provision is the only part of the definition of 
municipal finance professional that does not depend upon the municipal 
securities activities of the person or the supervision of persons 
engaged in municipal securities activities. This provision was intended 
to prevent issuer officials from seeking contributions from dealers' 
senior executives once rule G-37 precluded municipal finance 
professionals from contributing to those officials. The Statement of 
Initiative by Dealers regarding Political Contributions also included 
executive or management committee members within its voluntary 
prohibition on political contributions.\9\
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    \9\ In October 1993, at the urging of SEC Chairman Levitt, a 
number of dealers agreed to a Statement of Initiative to support the 
principle that political contributions which are intended to 
influence the awarding of municipal securities business should be 
prohibited.
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    The MSRB stated in its filing that there are certain dealers that 
occasionally engage in municipal securities sales transactions, but do 
not engage in municipal securities business as defined in rule G-
37(g)(vii). As a result, the only individuals of those dealers who meet 
the definition of municipal finance professional are executive 
management committee members. Because such dealers do not engage in 
municipal securities business, the ban on business based on political 
contributions does not affect them. However, such dealers also are 
required to record and report the contributions and payments of these 
municipal finance professionals. This amendment recognizes that there 
is no useful purpose served in requiring dealers to record and report 
the political contributions of executive or management committee 
members if their firm does not engage in municipal securities business. 
The rule change approved today amends the definition of municipal 
finance professional in rule G-37(g)(iv)(E) to exempt executive or 
management committee members from the definition of municipal finance 
professional (and thus the applicable recording and reporting 
requirements) if these are the only individuals within a firm who would 
meet the definition as described in subparagraphs (A) through (E).\10\
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    \10\ Rule G-37(g)(iv) states that each person designated by the 
dealer as a municipal finance professional is deemed to be a 
municipal finance professional and that each person so designated 
will retain this designation for two years after the last activity 
or position which gave rise to the designation. The rule change 
approved today, permits dealers to remove individuals subject to the 
new rule language from their lists of designated municipal finance 
professionals and to cease recording and reporting their 
contributions.
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B. Definition of ``Executive Officer''

    Currently, rule G-37 requires a dealer to record and report the 
contributions of executive officers even if that dealer has no one 
meeting the definition of municipal financial professional. Even though 
contributions and payments by executive officers are subject to the 
recordkeeping and reporting provisions of rule G-37, these 
contributions do not result in a ban on business. However, paragraph 
(d) of rule G-37 prohibits dealers from using executive officers (as 
well as any other person or entity) as conduits for making 
contributions to officials of issuers. The recordkeeping and reporting 
requirements apply to contributions by executive officers to ensure 
that these individuals are not being used to circumvent the rule.
    Rule G-37 was intended to prevent the practice of pay-to-play. 
However, contributions by executive officers of a dealer to issuer 
officials cannot skew the process of selecting a dealer to conduct 
municipal securities business in favor of that particular dealer if 
that dealer does not engage in municipal securities business. Thus, the 
rule change approved today amends the definition of executive officer 
in rule G-37(g)(v) to provide that, if no associated person of the 
dealer meets the definition of municipal finance professional, the 
dealer shall be deemed to have no executive officers (and thus the 
recording and reporting requirements for executive officers are not 
applicable).\11\
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    \11\ The rule change permits dealers to remove individuals 
subject to the new rule language from their lists of executive 
officers and to cease recording and reporting their contributions.
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    In both situations involving executive officers, as well as 
municipal finance professionals described in Section (A) above, if the 
dealer later engages in municipal securities business, then the dealer 
will have to record the contributions and payments made by any 
executive officers, as well as municipal finance professionals, for the 
previous two calendar years to determine whether it is banned from any 
municipal securities business.\12\
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    \12\ Any dealer who has municipal finance professionals, even if 
the dealer currently is not engaging in municipal securities 
business, must record and report the contributions and payments of 
executive officers and municipal finance professionals.
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C. Definition of ``Official of an Issuer''

    When rule G-37 was approved, the term ``official of such issuer'' 
or ``official of an issuer'' was defined as any incumbent, candidate or 
successful candidate for elective office of the issuer, which office is 
directly or indirectly responsible for, or can influence the outcome 
of, the hiring of a dealer for municipal securities business. The 
definition was intended to include any state or local official or 
candidate (or successful candidate) who has influence over the awarding 
of municipal securities business, including certain state-wide 
executive or legislative officials.
    After rule G-37 was approved, concerns were raised that the 
definition did not properly encompass all elected officials with the 
authority to influence the awarding of municipal securities business by 
the issuer, because it focused on ``an elective office of the issuer.'' 
For example, a state may have certain issuing authorities whose boards 
of directors are appointed by the governor. Although the governor is an 
official with influence over the awarding of municipal securities 
business, the governor, in this illustration, is not incumbent or 
candidate for ``elective office of the issuer'' (i.e., the state 
authority). Thus, a contribution to the governor would not prohibit a 
dealer from engaging in business with the state authority. The rule was 
intended to include the governor as an official of the issuer in such 
circumstances. Therefore, the rule change amends that definition to 
clarify the intent of the rule.\13\
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    \13\ Securities Exchange Act Release No. 34160 (June 3, 1994), 
59 FR 30376 (June 13, 1994).

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[[Page 58433]]

    Accordingly, the rule change amends rule G-37(g)(vi) to clarify 
that the definition includes ``any elective office of a state or of any 
political subdivision, which office has authority to appoint any person 
who is directly or indirectly responsible for, or can influence the 
outcome of, the hiring of a broker, dealer or municipal securities 
dealer for municipal securities business by an issuer.'' This revised 
definition addresses situation in which an elected official may appoint 
someone to an issuer position.

D. Definition of ``Municipal Securities Business''

    Under rule G-37, dealers could be subject to a ban on business with 
an issuer if certain contributors are made to officials of that issuer. 
The ban on business provision applies to business awarded on a 
negotiated basis; the rule does not prohibit dealers from engaging in 
business awarded on a competitive basis.
    Some dealers have noted that it is not clear in subparagraph (C) of 
rule G-37(g)(vii) whether, for financial advisory services, the rule is 
referring to the selection of a financial advisor on other than a 
competitive bid basis or whether the rule is referring to financial 
advisory services provided only on negotiated deals. The proposed rule 
change amends rule G-37(g)(vii)(C) to clarify that the definition of 
``municipal securities business'' includes the provision of financial 
advisory services when the dealer is chosen to provide such services on 
a negotiated basis.\14\ It is irrelevant whether the financial advisory 
services provided by the dealer are with respect to a negotiated or 
competitive issue. A similar change has been made to rule G-
37(g)(vii)(D) to clarify that the definition of ``municipal securities 
business'' includes remarketing agent services when the dealer is 
chosen as remarketing agent on a negotiated basis.
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    \14\ See Amendment No. 1.
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E. Recordkeeping: Amending Rule G-8(a) (xvi)

    Rule G-8(a) (xvi), on books and records, requires municipal 
securities brokers and municipal securities dealers to make and keep 
records of all of the information on Forms G-37/G-38. While this rule 
also requires dealers to keep records of additional information (e.g., 
a listing of the names, titles, city/county and state of residence of 
all municipal finance professionals), it does not state that the 
dealers must also physically maintain copies of these forms and the 
mailing receipts in their offices.
    Requiring dealers to keep copies of the Forms G-37/G-38 submitted 
to the Board would be helpful to the agencies charged with enforcing 
rule G-37 because physically maintaining these forms on the premises 
will make them easily accessible and retrievable for review. Moreover, 
it would be helpful to those agencies to require dealers to keep the 
certified or registered mail record or other records indicating 
dispatch to ensure their timely submission.\15\ Hence, the rule has 
been revised to add section H which will provide notice that 
maintaining copies of Forms G-37/G-38 submitted to the Board, along 
with the certified or registered mail receipts is required.
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    \15\ Rule G-9, on preservation of records, requires dealers to 
retain the G-8(a) (xvi) records concerning political contributions 
and prohibitions on municipal securities pursuant to rule G-37 for a 
six year period.
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III. Summary of Comments

    The Commission received three comment letters in response to the 
proposed rule change.\16\ The Greene Letter generally endorsed the 
proposed change to rule G-37.\17\ The remaining letters, however, 
raised several issues that the Commission believes should be addressed. 
The Board, at the Commission's behest, has proffered a response.\18\
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    \16\ See supra note 5.
    \17\ Green Letter.
    \18\ Letter from Ronald W. Smith, Legal Associate, MSRB, to 
Mignon McLemore, Law Clerk, Division of Market Regulation, SEC, 
dated October 22, 1996 (``October 22 Letter'').
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    The first issue raised in the Loeb Letter concerns the definition 
of ``municipal finance professional'' in rule G-37(g) (iv). Loeb 
believes that the Board should not include within the definition of 
municipal finance professional, any person primarily engaged in the 
sale of unsolicited agency transactions for customers.\19\ The Board's 
rules apply to all transactions in municipal securities by dealers 
whether dealers act as agent or principal.\20\ Accordingly, the Board 
does not believe that it would be appropriate to exempt specific 
categories of municipal securities transactions (i.e., unsolicited 
agency transactions) from the activities that could make someone 
``primarily engaged in municipal securities representative 
activities.'' \21\ The Commission believes that exempting specific 
categories of municipal securities transactions would increase 
potential for abuse and facilitate inconsistent interpretations and 
therefore, would be inappropriate.
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    \19\ Loeb Letter, pg. 2.
    \20\ October 22 Letter, p. 1.
    \21\ Id.
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    The second issue raised in the Loeb Letter concerns the 
interpretation of the term ``primarily engaged'' as it is used in the 
definition of municipal securities professional.\22\ Loeb believes a 
definitive explanation is necessary to determine whether certain 
broker-dealers are subject to the reporting requirements of rules G-37 
and G-8.\23\ The Board has not defined the term ``primarily engaged 
in'' because it believes it is appropriate for a dealer to determine 
which of its personnel who engage in municipal securities 
representative activities could reasonably fall within the definition 
of municipal finance professional.\24\ The Commission supports the 
Board's interpretation of the term ``primarily engaged.'' To facilitate 
ease of compliance, the definition encompasses any individual and 
circumstance that could reasonably qualify as the activity of a 
municipal finance professional. Thus, a narrower interpretation is ill-
advised.
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    \22\ Loeb Letter, p. 2.
    \23\ Id.
    \24\ October 22 Letter, p. 1.
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    The first issue raised by the A.G. Edwards Letter requests 
clarification of what is meant by selection of a financial advisor on 
``other than a competitive basis.`` \25\ A.G. Edwards contends that 
``other than a competitive basis'' encompasses more than the lowest bid 
for the job; other criteria, including price, are evaluated before 
final selection is made.\26\ The Board states that the selection of a 
financial advisor on a competitive bid basis refers to selection solely 
on the basis of price.\27\ Therefore, the selection of a financial 
advisor made on other than the sole basis of price would represent a 
selection of ``other than a competitive bid basis.'' \28\ The 
Commission agrees that selection of a financial advisor on a 
competitive bid basis means selection solely on the basis of price. The 
scope of this exemption is intentionally limited because, in most 
cases, selection is made on a negotiated basis.
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    \25\ A.G. Edwards Letter, p. 1.
    \26\ Id.
    \27\ October 22 Letter, p. 2.
    \28\ Id.
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    The second issue raised by the A.G. Edwards Letter entails 
clarifying when an agreement is reached to provide financial advisory 
services and thus, when that agreement must be reported.\29\ A.G. 
Edwards notes that in many cases, financial advisory

[[Page 58434]]

agreements contain an option exercisable by the issuer to extend the 
agreement for an additional year at either the same fee or at some 
other fee established at the time the initial engagement was 
entered.\30\ A.G. Edwards believes that exercising the option of the 
existing engagement does not constitute a ``new'' financial advisory 
agreement and therefore, should not be subject to rule G-37/G-38 
reporting requirements.\31\ The Board does not believe that the 
exercise of an option by an issuer to extend a financial advisory 
agreement, with such an option contained in the agreement, constitutes 
a ``new'' agreement; therefore, there is not reporting requirement for 
the exercise of this option.\32\ The Commission agrees that an 
exercised option that was contained in the initial agreement to engage 
a financial advisor would not constitute a ``new'' agreement, because 
the issuer is required to file a report on whenever the deal is 
completed, option period withstanding.
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    \29\ A.G. Edwards Letter, p. 2.
    \30\ Id.
    \31\ Id.
    \32\ October 22 Letter, p. 2.
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 IV. Discussion

    The Commission believes the proposed rule change is consistent with 
the Act and the rules and regulations promulgated thereunder. 
Specifically, the Commission believes that approval of the proposed 
rule change is consistent with Section 15B(b)(2)(C) \33\ of the Act. By 
amending rule G-37, the rule change removes impediments to the 
mechanism of a free and open market in municipal securities because (i) 
it no longer applies to persons and contributions that do not implicate 
the concern that rule G-37 was intended to address; (ii) it clarifies 
that the rule is intended to apply to contributions to any elected 
officials if that official's office gives the official the ability to 
influence the awarding of municipal securities business to an issuer; 
and (iii) clarifies the scope of activity subject to the rule. The 
amendment to rule G-8 protects investors and is in the public interest 
in that it facilitates enforcement of rule G-37.
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    \33\ Section 15B(b)(2)(C) requires the Commission to determine 
that the Board's rules are 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.
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    In revising the definitions of ``municipal finance professional'' 
and ``executive officer,'' the MSRB has provided definitive criteria 
for dealers to use in determining whether they are subject to the 
rule's reporting requirements. In so doing, the MSRB has eliminated 
some of the uncertainty associated with rule G-37 compliance issues. 
Exempting those persons and contributions that are no longer affected 
by the rule should enhance efficiency in reporting and recording, 
because dealers no longer have to make assumptions in determining to 
whom the rule applies.
    In amending the definition of ``official of an issuer,'' the Board 
has addressed situations in which an elected official may appoint 
someone to an issuer position. This amendment acknowledges the fact 
that political influence and alliances can affect the selection 
process. In clarifying its intent that a person who can directly or 
indirectly influence hiring decisions be included in the definition, 
the Board has attempted to ensure fairness in the selection process by 
removing politics from the equation.
    In revising the definition of ``municipal securities business,'' 
the Board is clarifying which dealers would be subject to the ban and 
in what situations. According to some dealers, rule G-37(g)(vii) was 
unclear as to whether ``on other than a competitive bid basis'' applied 
to the selection of a financial advisor or to the services provided by 
the financial advisor. The Board has determined that the definition 
includes financial advisory services when the dealer is chosen as 
financial advisor on a negotiated basis and therefore, the ban on 
business provision under rule G-37 would apply.
    In adding the requirement to rule G-8 that dealers maintain copies 
of Forms G-37/G-38 along with receipts of mailing the same, the Board 
has improved disclosure in the markets by making these records readily 
accessible for review. Also, the benefits of this requirement outweigh 
any burdens that additional recordkeeping may impose, because tangible 
evidence will now be available to resolve disputes and to monitor 
compliance.

V. Conclusion

    For the above reasons, the Commission believes that the proposed 
rule change is consistent with the provisions of the Act, and in 
particular with Section 15B(b)(2)(C).
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\34\ that the proposed rule change (SR-MSRB-96-07) be, and hereby 
is approved.

    \34\ 15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\35\
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    \35\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-29150 Filed 11-13-96; 8:45 am]
BILLING CODE 8010-01-M