[Federal Register Volume 64, Number 35 (Tuesday, February 23, 1999)]
[Notices]
[Pages 8894-8897]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-4428]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41053; File No. SR-MSRB-97-16]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Municipal Securities Rulemaking Board Relating to 
Activities of Financial Advisors

February 12, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on January 14, 1999,\3\ the Municipal Securities

[[Page 8895]]

Rulemaking Board (``Board'' or ``MSRB'') filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') the proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by the Board. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The Board originally filed the proposed rule change on 
December 23, 1997. On April 6, 1998, the Board filed what would have 
been Amendment No. 1, but it was withdrawn because it did not 
adequately address certain disclosure and consent issues.
    The Board filed Amendment No. 1 to the proposed rule change on 
April 16, 1998, which made certain technical changes and revised 
statements made by the Board concerning comments received on the 
draft amendment published by the Board for comment from its members. 
After further discussion with Commission staff, the Board filed 
Amendment No. 2 on January 14, 1999, which revises the rule language 
to address those disclosure and consent issues raised by the 
proposed rule change. This notice reflects the original proposal as 
modified by Amendments No. 1 and No. 2.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Board has filed with the Commission a proposed rule change 
which would amend Rule G-23 to require a dealer that has a financial 
advisory relationship with an issuer with respect to a new issue of 
municipal securities, prior to acting as a remarketing agent for such 
issue, to disclose in writing to the issuer that there may be a 
conflict of interest in acting as both financial advisor and 
remarketing agent for the securities with respect to which the 
financial advisory relationship exists and the source and basis of the 
remuneration the dealer could earn as remarketing agent on such issue. 
The proposed rule change requires that the issuer expressly acknowledge 
in writing to the broker, dealer, or municipal securities dealer 
receipt of such disclosure and consent both to the financial advisor 
acting as remarketing agent and to the source and basis of the 
remuneration. Below is the text of the proposed rule change. Additions 
are italicized; deletions are in brackets.

Rule G-23. Activities of Financial Advisors

    (a)-(d) No change.
    (e) Remarketing Activities. No broker, dealer, or municipal 
securities dealer that has a financial advisory relationship with an 
issuer with respect to a new issue of municipal securities shall act as 
agent for the issuer in remarketing such issue, unless the broker, 
dealer, or municipal securities dealer has expressly disclosed in 
writing to the issuer:
    (i) that there may be a conflict of interest in acting as both 
financial advisor and remarketing agent for the securities with respect 
to which the financial advisory relationship exists; and
    (ii) the source and basis for the remuneration the broker, dealer 
or municipal securities dealer could earn as remarketing agent on such 
issue.
    This written disclosure to the issuer may be included either in a 
separate writing provided to the issuer prior to the execution of the 
remarketing agreement or in the remarketing agreement. The issuer must 
expressly acknowledge in writing to the broker, dealer, or municipal 
securities dealer receipt of such disclosure and consent to the 
financial advisor acting in both capacities and to the source and basis 
of the remuneration.
    [(e)] (f) No change.
    [(f)] (g) Each broker, dealer, and municipal securities dealer 
subject to the provisions of sections (d), [or] (e) or (f) of this rule 
shall maintain a copy of the written disclosures, acknowledgments and 
consents required by these sections in a separate file and in 
accordance with the provisions of rule G-9.
    [(g)] (h) No change.
    [(h)] (i) No change.
* * * * *

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

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

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

1. Purpose
    Rule G-23,\4\ on activities of financial advisors, establishes 
disclosure and other requirements for dealers that act as financial 
advisors to issuers of municipal securities. The rule is designed 
principally to minimize the prima facie conflict of interest that 
exists when a dealer acts as both financial advisor and underwriter 
with respect to the same issue of municipal securities. Specifically, 
Rule G-23 requires a financial advisor to alert the issuer to the 
potential conflict of interest that might lead the dealer to act in its 
own best interest as underwriter rather than the issuer's best 
interest.\5\
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    \4\ MSRB Manual, General Rules, Rule G-23 (CCH) para.3611.
    \5\ Rule G-23(d)(i) requires a financial advisor wishing to 
underwrite or place an issue of municipal securities on a negotiated 
basis to: (i) terminate in writing the financial advisory 
relationship with respect to such issue and obtain the issuer's 
express consent in writing to such acquisition or participation; 
(ii) disclose in writing to the issuer at or before such termination 
that there may be a conflict of interest in changing from the 
capacity of financial advisor to purchaser of or placement agent for 
the securities with respect to which the financial advisory 
relationship exists and obtain the issuer's express acknowledgment 
in writing of receipt of such disclosure; and (iii) expressly 
disclose in writing to the issuer at or before such termination the 
source and anticipated amount of all remuneration to the dealer with 
respect to such issue in addition to the compensation as financial 
advisor, and obtain the issuer's express acknowledgment in writing 
of receipt of such disclosure. If such issue is to be sold by the 
issuer at competitive bid, the issuer must expressly consent in 
writing prior to the bid to the financial advisor's acquisition or 
participation.
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    The Board recently was made aware that, in certain instances, some 
financial advisors also have acted as remarketing agents for issues on 
which they advised the issuer. To address this situation and its 
potential conflict of interest, the Board filed a proposed rule change 
to require a financial advisor, prior to entering into a remarketing 
agreement for an issue on which it advised, to disclose in writing to 
the issuer the terms of the remuneration the financial advisor could 
earn as remarketing agent on such issue and that there may be a 
conflict of interest in changing from the capacity of financial advisor 
to remarketing agent. The proposed rule change also required that the 
financial advisor receive the issuer's acknowledgment in writing of 
receipt of such disclosures. Under the proposal, when these 
requirements are met, a dealer acting as financial advisor for an issue 
also could serve as remarketing agent for such issue.
    Commission staff requested that the Board revise the proposed rule 
change to include a provision requiring issuer consent to the dealer's 
dual role, along with certain other technical language changes.\6\ 
Amendment No. 2 revises this proposal to require that a dealer which 
has a financial advisory relationship with an issuer with respect to a 
new issue of municipal securities, prior to acting as a remarketing 
agent for such issue, disclose in writing to the issuer that there may 
be a conflict of interest in acting as both financial advisor and 
remarketing agent for the securities with respect to which the 
financial advisory relationship exists and the source and basis of the 
remuneration the dealer could earn as remarketing agent on such issue. 
This written disclosure to the

[[Page 8896]]

issuer can be in a separate writing provided to the issuer prior to the 
execution of the remarketing agreement or the disclosure can be in the 
remarketing agreement. The issuer must expressly acknowledge in writing 
to the broker, dealer, or municipal securities dealer receipt of such 
disclosure and consent to the financial advisor acting in both 
capacities and to the source and basis of the remuneration. If the 
disclosure is made prior to the execution of remarketing agreement, the 
amount of the specific fee paid by the issuer to the remarketing agent 
still can be negotiated in the remarketing agreement. If the disclosure 
is made in the remarketing agreement, the dealer will have negotiated 
the amount of its fee with the issuer.
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    \6\ See supra note 3.
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2. Statutory Basis
    The Board believes the proposed rule change is consistent with 
Section 15B(b)(2)(C) \7\ of the Act, which requires that the Board's 
rules 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.
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    \7\ 15 U.S.C. 78o-4(b)(2)(C).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Board does not believe that the proposed rule change will 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act, because it would apply equally 
to all brokers, dealers, and municipal securities dealers.

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

    In May 1997, the Board published a notice (the ``Notice'') that, 
among other things, proposed for comment draft amendments to Rule G-23 
concerning financial advisors also acting as remarketing agents for 
issues on which they advised the issuer.\8\
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    \8\ See MSRB Reports, Vol. 17, No. 2 (June 1997) at 3-16, 
``Board Review of Underwriting Process.''
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    In response to its request for comments, the Board received comment 
letters addressing the draft amendments from the following 20 
commenters.
     Allen Independent School District (``Allen ISD'').
     Artemis Capital Group (``Artemis'').
     Canton & Associates, Inc. (``Calton'').
     Carroll Independent School District (``Carroll ISD'').
     Dallas County Community College District (``Dallas County 
CCD'').
     First Southwest Company (``First Southwest'').
     Government Finance Officers Association (``GFOA'').
     Katy Independent School District (``Katy ISD'').
     Lehman Brothers Inc. (``Lehman Brothers'').
     Midland Independent School District (``Midland ISD'').
     Morton Clarke Fu & Metcalf Inc. (``Morton Clarke'').
     Newman and Associates, Inc. (``Newman'').
     North Harris Montgomery Community College District 
(``North Harris Montgomery CCD'').
     Pasadena Independent School District (``Pasadena ISD'').
     Rauscher Pierce Refsnes, Inc. (``Rauscher Pierce'').
     Smith Barney Inc. (``Smith Barney'').
     Southwest Securities (``Southwest'').
     State of Wisconsin Department of Administration (``State 
of Wisconsin'').
     The Bond Market Association (``BMA'').
     Wachovia Bank, N.A. (``Wachovia'').
    The draft amendment, as published in the Notice, required a dealer 
acting as both financial advisor and remarketing agent for an issue to 
meet the same disclosure and other requirements as a dealer acting as 
financial advisor and later negotiating the underwriting or acting as 
placement agent for the issue (which includes terminating the financial 
advisory relationship with regard to the issue and making certain 
disclosures regarding the potential conflict of interest). The concern 
was that there may be a potential conflict of interest for the 
financial advisor because its advice regarding the type of issue (i.e., 
variable rate) and the issue's timing and terms may be colored by the 
fees it expects to receive as remarketing agent.
    Twelve commenters were opposed to the draft amendment,\9\ while 
five commenters were in favor of the amendment.\10\ One commenter 
misunderstood the draft amendment.\11\ As an alternative to the draft 
amendment, this commenter suggested that ``[s]o long as there is full 
disclosure of all fees, risks, credit rating guidelines, and comparable 
interest rates and there is no conflict of interest in setting the 
lowest possible interest rate for a client, it seems contradictory to 
prohibit firms, probably best suited, from providing the additional 
work which is in their client's best interest.'' The seven Texas school 
districts opposed to the draft amendment \12\ wrote substantially 
similar comment letters asking that the Board limit any regulation in 
this area to ``requiring full disclosure of all fees, risks, credit 
rating guidelines, and interest rates on comparable variable rate 
issues.'' They also stated that they should not be precluded from 
selecting a financial advisor to also serve as a remarketing agent as 
long as the financial advisor acts in an agency capacity (i.e., not 
taking any underwriting risk).
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    \9\ Allen ISD, BMA, Carroll ISD, Dallas County CCD, First 
Southwest, Katy ISD, Lehman Brothers, Midland ISD, North Harris 
Montgomery CCD, Pasadena ISD, Smith Barney, and Wachovia. The 
remaining three commenters--Artemis, Newman, and State of 
Wisconsin--had general comments that were neither in favor of, nor 
opposed to, the draft amendment.
    \10\ Calton, GFOA, Morton Clarke, Rauscher Pierce, and 
Southwest.
    \11\ First Southwest had an incorrect impression that the draft 
amendment would have required a dealer to resign as an issuer's 
``overall'' financial advisor in order to be able to act as a 
remarketing agent for the issuer on an issue of municipal 
securities. The provisions of Rule G-23 are applicable on an issue-
specific basis and not on an issuer-specific basis. Thus, pursuant 
to the draft amendment published in the Notice, a dealer wishing to 
remarket an issue of municipal securities on which it acted as the 
financial advisor would make certain disclosures to the issuer and 
then resign as financial advisor to that issue while not being 
precluded from serving as financial advisor on other issues for this 
issuer.
    \12\ Allen ISD, Carroll ISD, Dallas County CCS, Katy ISD, 
Midland ISD, North Harris Montgomery CCD, and Pasadena ISD.
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    Three commenters had general comments about the current role of 
financial advisors.\13\ One of these commenters described the 
``inherent conflict of interest'' for the financial advisor for an 
issue to resign and become the underwriter for the issue and urged the 
Board to strengthen Rule G-23 ``by eliminating the role switching 
allowed by the present rule and perpetuated by the proposed changes.'' 
\14\ Another of these commenters stated that ``there is a similar and 
perhaps even greater potential for conflicts of interest when a firm 
serves as financial advisor to an issuer for a planned financing and 
then resigns to serve as underwriter on that same financing.'' \15\ One 
of these commenters questioned ``the increased regulation of only a 
small portion of the

[[Page 8897]]

financial advisory market.'' \16\ This commenter further stated that 
``[a]ny additional disclosure requirements placed on regulated 
financial advisors only continues to foster a[n] uneven playing field 
between regulated and unregulated financial advisors.''
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    \13\ Artemis, Newman, and State of Wisconsin.
    \14\ State of Wisconsin.
    \15\ Artemis.
    \16\ Newman.
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    GFOA stated that the draft amendment is consistent with its 
recommendations to state and local government issuers to avoid using a 
firm to serve as both the financial advisor and underwriter of a 
negotiated issue because conflicts of interest may arise. One commenter 
believed that the draft amendment was ``a reasonable extension of the 
existing requirement that firms resign as [financial advisors] to 
underwrite negotiated issues.'' \17\
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    \17\ Rauscher Pierce.
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    Another commenter stated that, while opposed to the amendment, it 
would not object to ``a requirement that financial advisors disclose to 
issuers fees or compensation they could earn if they were selected to 
serve as remarketing agent . . . [and that] municipal issuers are 
competent to assess that disclosure and to determine for themselves 
whether it is appropriate to then select the financial advisor to act 
as remarketing agent.'' \18\ Three other commenters noted that the 
decision should be left to the issuer as to whether there is a conflict 
of interest.\19\
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    \18\ Smith Barney.
    \19\ BMA, Lehman Brothers and Wachovia.
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    Based on the comments received, the Board determined not to adopt 
the version of the amendment published in the Notice. Instead of 
requiring another broker, dealer, or municipal securities dealer to 
resign as financial advisor for an issue prior to acting as remarketing 
agent for that issue, the Board revised the proposed rule change to 
require a financial advisor, prior to entering into a remarketing 
agreement for an issue on which it advised, to disclose, in writing, to 
the issuer the source and basis of the remuneration the financial 
advisor could earn as remarketing agent on that issue and that there 
may be a conflict of interest in acting as both financial advisor and 
remarketing agent for the securities with respect to which the 
financial advisory relationship exists. The issuer must expressly 
acknowledge in writing to the dealer receipt of such disclosure and 
consent to the financial advisor acting in both capacities and to the 
source and basis of the remuneration.
    The Board looked carefully at the different roles of underwriters 
and remarketing agents in adopting the proposed rule change. Rule G-23 
currently is written to apply on an issue-specific basis. Rule G-23 
requires a financial advisor to resign to act as underwriter on a 
specific negotiated transaction. The dealer can act as financial 
advisor to the issuer for any other issue--either during or after the 
underwriting. The potential conflict of interest in the specific 
underwriting is addressed in the rule by requiring the dealer to resign 
as financial advisor for the issue for the limited duration of the 
underwriting relationship, but permits a continuation of the long-term 
relationship between issuer and financial advisor.
    In contrast to the underwriter's relationship with the issuer, the 
remarketing agent's relationship with the issuer may continue for an 
indefinite period of time. If a dealer were obligated to resign from a 
financial advisory role on a particular issue to serve as remarketing 
agent for that issue, that dealer may be placed in the anomalous 
position of providing financial advisory services for an issuer on a 
broad range of new and outstanding issues while being prohibited on a 
long-term basis from providing financial advisory services on the one 
issue for which it also provides remarketing services. This result 
would be more severe for financial advisors serving as remarketing 
agents than for financial advisors serving as underwriters. To avoid 
this unduly harsh result, the Board believes that the potential 
conflict of interest may be adequately addressed through disclosure in 
this case.
    The proposed rule change and amendments thereto ensure that an 
issuer is made aware that there may be a conflict of interest for the 
financial advisor to change its capacity to that of remarketing agent 
for such issue and that the issuer is made aware of the source and 
basis of the remuneration the dealer could earn as remarketing agent on 
that issue. The issuer can then decide whether to allow the financial 
advisor for an issue to act as remarketing agent for that issue. The 
Board will monitor activities in this area and will not hesitate to 
consider further rulemaking if it becomes necessary.

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

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other 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 Room. Copies of the filing will also be 
available for inspection and copying at the principal offices of the 
MSRB. All submissions should refer to File No. SR-MSRB-97-16 and should 
be submitted by March 16, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-4428 Filed 2-22-99; 8:45 am]
BILLING CODE 8010-01-M