[Federal Register Volume 70, Number 76 (Thursday, April 21, 2005)]
[Notices]
[Pages 20782-20787]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-1879]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51561; File No. SR-MSRB-2005-04]


Self-Regulatory Organizations; Municipal Securities Rulemaking 
Board; Notice of Filing of Proposed Rule Change Relating to 
Solicitation of Municipal Securities Business Under MSRB Rule G-38

April 15, 2005.
    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 March 22, 2005, the Municipal Securities Rulemaking Board (``MSRB'' 
or ``Board'') 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 MSRB. 
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.
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I. Self-Regulatory Organization's Statement of The Terms of Substance 
of the Proposed Rule Change

    The MSRB has filed with the Commission a proposed rule change 
deleting existing Rule G-38, on consultants, and replacing it with new 
Rule G-38, on solicitation of municipal securities business. In 
addition, the proposed rule change would make related amendments to 
Rule G-37, on political contributions and prohibitions on municipal 
securities business, Rule G-8, on recordkeeping, Form G-37/G-38 and 
Form G-37x, as well as add new

[[Page 20783]]

Form G-38t. The text of the proposed rule change, as well as proposed 
amended Form G-37, amended Form G-37x and new Form G-38t, are available 
on the MSRB's Web site (http://www.msrb.org), at the MSRB's principal 
office, and at the Commission's Public Reference Room.

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

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

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

1. Purpose
    The MSRB began its current rulemaking initiative on the 
solicitation on behalf of brokers, dealers and municipal securities 
dealers (``dealers'') of municipal securities business\3\ by 
consultants\4\ early last year because of certain practices that could 
present challenges to maintaining the integrity of the municipal 
securities market.\5\ These practices include, among other things, 
significant increases in recent years in the number of consultants 
being used, the amount these consultants are being paid and the level 
of reported political giving by consultants. The MSRB has been 
concerned that increases in levels of compensation paid to consultants 
for successfully obtaining municipal securities business may be 
motivating consultants, who currently are not subject to the basic 
standards of fair practice and professionalism embodied in MSRB rules, 
to use more aggressive or questionable tactics in their contacts with 
issuers. In addition, the MSRB has expressed concern over whether 
dealers are uniformly making the required disclosures to issuers and on 
Form G-37/G-38, and whether they are undertaking the other required 
duties imposed by Rule G-38, for all persons who by their actions 
should be considered consultants. The MSRB believes that it would be 
appropriate to apply the basic standards of fair practice and 
professionalism embodied in MSRB rules to all persons who solicit 
municipal securities business on behalf of dealers. The application of 
such standards would ensure that all solicitations are undertaken in 
accordance with the ethical standards that govern dealer personnel.
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    \3\ Municipal securities business is defined in Rule G-37 as the 
purchase of a primary offering from the issuer on other than a 
competitive bid basis (e.g., negotiated underwriting), the offer or 
sale of a primary offering on behalf of an issuer (e.g., private 
placement or offering of municipal fund securities), and the 
provision of financial advisory, consultant or remarketing agent 
services to an issuer for a primary offering in which the dealer was 
chosen on other than a competitive bid basis.
    \4\ Current Rule G-38 defines consultant as any person used by a 
dealer to obtain or retain municipal securities business through 
direct or indirect communication with an issuer on behalf of the 
dealer where such communication is undertaken in exchange for 
payment from the dealer or any other person.
    \5\ See footnotes 14 and 15 infra and accompanying text.
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    Thus, the MSRB has determined to file the proposed rule change with 
the Commission.
Summary of Proposed Amendments to Rule G-38
    Prohibited Payments. Existing Rule G-38, on consultants, is 
replaced in its entirety by new Rule G-38, on solicitation of municipal 
securities business. The new rule prohibits dealers from making any 
direct or indirect payment to any person who is not an affiliated 
person of the dealer for a solicitation of municipal securities 
business on behalf of the dealer.
    Definitions of Affiliated Person and Affiliated Company. An 
affiliated person of a dealer is defined as any partner, director, 
officer or employee of the dealer or of an affiliated company. An 
affiliated company of a dealer is an entity that controls, is 
controlled by or is under common control with the dealer and whose 
activities are not limited solely to the solicitation of municipal 
securities business. Thus, a dealer affiliate whose activities consist 
only of soliciting municipal securities business and that undertakes no 
other bona fide activities with respect to the dealer or with respect 
to any other affiliated company of the dealer does not qualify as an 
affiliated company for purposes of new Rule G-38.\6\
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    \6\ This provision is not intended to exclude from the 
definition of affiliated company any entity that is a legitimate 
member of a dealer's corporate family, so long as such entity's sole 
bona fide purpose is not to solicit municipal securities business 
for the dealer or for any of the dealer's other affiliated 
companies. In the case of a dealer organized as a separately 
identifiable department or division of a bank (``SID'') under Rule 
G-1, those portions of the bank outside of the SID would be treated 
as an affiliated company of the dealer.
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    Definition of Solicitation. Solicitation is defined as a direct or 
indirect communication with an issuer for the purpose of obtaining or 
retaining municipal securities business.
    Transitional Payments and New Form G-38t. Notwithstanding the 
foregoing, dealers are permitted to make payments to non-affiliated 
persons for solicitations of municipal securities business if such 
payments are made with respect solely to solicitation activities 
undertaken by such persons on or prior to the date of Commission 
approval of the amendments. Such payments are permitted only if (A) the 
dealer had been selected by the issuer on or prior to the approval date 
of the proposed amendments to engage in such municipal securities 
business; \7\ (B) the consultant has not solicited municipal securities 
business from any issuer on behalf of the dealer at any time after the 
approval date; and (C) the dealer submits to the MSRB, by the last day 
of the month following the end of each calendar quarter during which 
payments to the consultant are made or remain pending, new Form G-
38t.\8\ The dealer must provide on Form G-38t the same types of 
disclosures currently required to be made with respect to consultants 
under existing Rule G-38.\9\ The MSRB will make public copies of all 
Forms G-38t it receives on its Web site at http://www.msrb.org. The use 
of Form G-37/G-38 will be discontinued on the date of Commission 
approval of the amendments. All information submitted to the MSRB with 
respect to consultants on or after the date of Commission approval must 
be submitted on Form G-38t rather than old Form G-37/G-38, even if a 
payment required to be reported to the MSRB has

[[Page 20784]]

been made to the consultant prior to such date of approval.
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    \7\ A dealer must be able to provide documentation from the 
issuer or other third party of its selection on or prior to the 
Commission approval date for the amendments.
    \8\ Since it is expected that Form G-38t will be used during 
only a short period of time, as discussed below, the MSRB has 
elected not to develop an electronic submission system for such 
form. Thus, dealers submitting Forms G-38t to the MSRB must send two 
copies of the form to the MSRB by certified or registered mail, or 
some other equally prompt means that provides a record of sending.
    \9\ These disclosures include the name, business address and 
role of the consultant, the compensation arrangement, any municipal 
securities business obtained or retained by the consultant for which 
payment is made or is pending and dollar amounts paid to the 
consultant in such quarter for each such item of business, the total 
dollar amount paid to each consultant in such calendar quarter, and 
the reportable political contributions and reportable political 
party payments of the consultant. Each item of municipal securities 
business for which payment remains pending must be listed on the 
quarterly reports until such quarter in which payment is finally 
made, at which time the amount paid must be listed. If no further 
payments are to be made to a consultant, such consultant need not be 
listed on Form G-38t for subsequent quarters.
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    The MSRB expects that dealers will terminate their contractual 
obligations with and remit final payments to consultants promptly 
following approval of the amendments by the Commission. The MSRB will 
ask the applicable enforcement agencies to review Forms G-38t and the 
circumstances of continuing payments to consultants in order to ensure 
that such payments are not being made in an attempt to circumvent the 
intent of the new rule provisions.
Summary of Proposed Amendments to Rule G-37 and Forms G-37/G-38 and G-
37x
    Rule G-37 is amended to (i) delete references and provisions 
relating to consultant information provided under Rule G-38, (ii) 
reflect that those associated persons who solicit municipal securities 
business and thereby are municipal finance professionals include 
affiliated persons under Rule G-38, (iii) add a reference to the 
definition of solicitation under new Rule G-38, (iv) reflect the 
renaming of Form G-37/G-38 as Form G-37, and (v) make section headings 
consistent throughout the rule. Form G-37/G-38 is renamed as Form G-37, 
and Section IV and the consultant attachment to the form are 
deleted.\10\ In addition, Form G-37x is amended to delete references to 
the reporting of consultant information.
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    \10\ The form also is amended to reflect the previous renaming 
of ``executive officers'' as ``non-MFP executive officers'' under 
Rule G-37 and to rename the municipal securities business category 
designation of ``private placement'' to ``agency offering'' to more 
accurately reflect the nature of this category. The substance of 
Section IV and the consultant attachment deleted from the form have 
been included in new Form G-38t.
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Summary of Proposed Amendments to Rule G-8
    Rule G-8, on recordkeeping, is amended to require dealers to retain 
copies of any submitted Forms G-38t and records of their submission to 
the MSRB, as well as to reflect the historical nature of the records 
that dealers must retain with respect to the deleted consultant 
provisions of existing Rule G-38.
2. Statutory Basis
    The MSRB believes that the proposed rule change is consistent with 
section 15B(b)(2)(C) of the Act,\11\ which provides that the MSRB'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 * * *.'' \12\
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    \11\ 15 U.S.C. 78o-4(b)(2)(C).
    \12\ Id.
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    The MSRB believes that the proposed rule change is consistent with 
the Act because it will further investor protection and the public 
interest by ensuring that solicitations of municipal securities 
business are undertaken in a manner consistent with standards of fair 
practice and professionalism, thereby helping to maintain public trust 
and confidence in the integrity of the municipal securities market.

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

    The MSRB does not believe that the proposed rule change will impose 
any burden on competition not necessary or appropriate in furtherance 
of the purposes of the Act since it would apply equally to all dealers.

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

    The MSRB published notices for comment on draft amendments to Rule 
G-38 on April 5, 2004 (the ``April 2004 Notice'') \13\ and September 
29, 2004 (the ``September 2004 Notice'').\14\ The April 2004 notice 
sought comments on draft amendments limiting payments by a dealer for 
the solicitation of municipal securities business on its behalf solely 
to its associated persons (the ``original draft amendments''). The MSRB 
received comments from 28 commentators.\15\
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    \13\ See MSRB Notice 2004-11 (April 5, 2004).
    \14\ See MSRB Notice 2004-32 (September 29, 2004), as modified 
by MSRB Notice 2004-33 (October 12, 2004).
    \15\ Letters from Sam Conner, Senior Vice President and Manager 
of Public Finance, J.J.B. Hilliard, W.L. Lyons, Inc. (``JJB 
Hilliard''), to Kit Taylor, Executive Director, MSRB, dated April 
14, 2004; Jerry L. Chapman (``Mr. Chapman''), to Ernesto A. Lanza, 
Senior Associate General Counsel, MSRB, dated April 22, 2004; Joe 
Jolly, Jr., Joe Jolly & Co., Inc. (``Joe Jolly''), to William J. 
Jester, Jr., Chairman, MSRB, dated April 26, 2004; Peter J. Hill, 
Managing Director, Public Finance Department, JP Morgan (``JP 
Morgan''), to Mr. Taylor dated April 26, 2004; R. Steven Crowley, 
President, Nevis Securities, LLC (``Nevis''), to Mr. Lanza dated 
April 29, 2004; Dennis G. Ciocca, Senior Managing Director, Sutter 
Securities Incorporated (``Sutter'') to Mr. Taylor, dated May 17, 
2004; Maud Daudon, Managing Director, Investment Banking, and John 
Rose, President & CEO, Seattle-Northwest Securities Corporation 
(``Seattle-Northwest'') to Mr. Taylor, dated May 19, 2004; Gordon 
Reis III, Managing Principal, Seasongood & Mayer, LLC 
(``Seasongood'') to Mr. Taylor, dated May 20, 2004; Hill A. 
Feinberg, Chairman & Chief Executive Officer, First Southwest 
Company (``First Southwest'') to Mr. Lanza, dated May 26, 2004; 
James C. Cervantes, Managing Director & Head of the Public and Non-
Profit Finance Group, and Scott C. Sollers, Managing Director, Stone 
& Youngberg (``S&Y'') to Mr. Lanza, dated June 2, 2004; Bruce 
Moland, Vice President & Assistant General Counsel, Wells Fargo & 
Company (``Wells Fargo''), to Mr. Lanza dated June 2, 2004; Amelia 
A.J. Bond, Director of Public Finance, A.G. Edwards & Sons, Inc. 
(``AG Edwards''), to Mr. Lanza dated June 3, 2004; Pfilip G. Hunt, 
Jr., President, Gardnyr Michael Capital, Inc. (``Gardnyr Michael''), 
to Mr. Taylor dated June 3, 2004; G. Douglas Edwards, President & 
CEO, Morgan Keegan & Company, Inc. (``Morgan Keegan''), to Mr. Lanza 
dated June 3, 2004; Thomas E. Lanctot, Principal and Head of the 
Public and Non-Profit Finance Group, William Blair & Company 
(``William Blair''), to Mr. Lanza dated June 3, 2004; Sarah A. 
Miller, General Counsel, ABA Securities Association (``ABA''), to 
Mr. Lanza dated June 4, 2004; Daniel L. Keating, Senior Managing 
Director, Bear Stearns & Co., Inc. (``Bear Stearns''), to Mr. Lanza 
dated June 4, 2004; Lynette Kelly Hotchkiss, Senior Vice President 
and Associate General Counsel, Bond Market Association (``BMA''), to 
Mr. Lanza dated June 4, 2004; Martin Cabrera, Jr., President, 
Cabrera Capital Markets, Inc. (``Cabrera''), to Mr. Lanza dated June 
4, 2004; Robyn A. Huffman, Vice President and Associate General 
Counsel, Goldman Sachs & Co. (``Goldman''), to Mr. Lanza dated June 
4, 2004; Samuel C. Doyle, Executive Vice President, Kirkpatrick, 
Pettis, Smith, Polian Inc. (``Kirkpatrick''), to Mr. Jester dated 
June 4, 2004; Mike Dunn, Merchant Capital LLC (``Merchant''), to the 
MSRB dated June 4, 2004; John J. Lawlor, Managing Director, 
Municipal Markets, Merrill Lynch (``Merrill''), to Mr. Lanza dated 
June 4, 2004; Andrew Garvey, Managing Director, Morgan Stanley & Co. 
Incorporated (``Morgan Stanley''), to Mr. Lanza dated June 4, 2004; 
Bernard Beal, Chief Executive Officer, M.R. Beal & Company (``MR 
Beal''), to Mr. Lanza dated June 4, 2004; James S. Keller, Chief 
Regulatory Counsel, PNC Capital Markets, Inc. (``PNC''), to Mr. 
Lanza dated June 4, 2004; Terry L. Atkinson, Managing Director & 
Director, Municipal Securities Group, UBS Financial Services Inc., 
to Mr. Lanza dated June 4, 2004 (``UBS''); and Frank Y. Chin, 
Managing Director, Public Finance Department, Municipal Securities 
Division, Citigroup Global Markets, Inc. (``Citigroup''), to Mr. 
Lanza dated June 7, 2004.
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    The September 2004 notice sought comments on revised draft 
amendments to Rule G-38 (the ``revised draft amendments'') prohibiting 
a dealer from making payments for the solicitation of municipal 
securities business on its behalf to any person who is not an 
associated person of the dealer. The revised draft amendments would 
have imposed additional obligations on dealers with respect to any 
solicitor who is not a partner, director, officer or employee. These 
obligations would have included the entering into of a contractual 
agreement, the subjecting of such solicitors to MSRB rules (including 
but not limited to Rule G-37) with respect to their solicitation 
activities, and the disclosure of arrangements relating to such 
solicitors. The MSRB received comments from 19 commentators.\16\
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    \16\ Letters from Mr. Ciocca (``Mr. Ciocca'') to Mr. Lanza dated 
December 8, 2004; Mr. Hunt, Gardnyr Michael, to Mr. Taylor dated 
December 10, 2004; Ms. Daudon and Mr. Rose, Seattle-Northwest, to 
Mr. Lanza dated December 13, 2004; Mr. Feinberg, First Southwest, to 
Mr. Lanza dated December 14, 2004; Mr. Moland, Wells Fargo, to Mr. 
Lanza dated December 15, 2004; Robert A. Estrada, Chairman & CEO, 
Estrada Hinojosa & Company, Inc. (``Estrada''), to Mr. Lanza dated 
December 15, 2004; Ms. Hotchkiss, BMA, to Mr. Lanza dated December 
15, 2004; Ms. Huffman, Goldman, to Mr. Lanza dated December 15, 
2004; Mr. Garvey, Morgan Stanley, to Mr. Lanza dated December 15, 
2004; Mr. Atkinson, UBS, to Mr. Lanza dated December 15, 2004; Glenn 
Green, Vice President--Municipal Compliance, Wachovia Securities 
(``Wachovia''), to Mr. Lanza dated December 15, 2004; Mr. Lanctot, 
William Blair, to Mr. Lanza dated December 15 and December 16, 2004; 
Ronald J. Dieckman, Senior Vice President & Director, Municipal Bond 
Department, JJB Hilliard, to Mr. Lanza; Lawrence C. Holtz, 
President, Fixed Income Group, RBC Dain Rauscher (``Dain 
Rauscher''), to Mr. Lanza; Ms. Miller, ABA, to Mr. Lanza dated 
December 17, 2004; Mr. Doyle, Kirkpatrick, to Mr. Taylor dated 
December 17, 2004; Mr. Keating, Bear Stearns, to Mr. Lanza dated 
December 20, 2004; Mr. Lawlor, Merrill, to Mr. Lanza dated January 
20, 2005; and the Honorable Rick Santorum, United States Senate 
(``Sen. Santorum''), to Mr. Lanza dated February 16, 2005.

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[[Page 20785]]

    The comments received on the April and September 2004 Notices are 
discussed below.
Need for Regulatory Action on Solicitation of Municipal Securities 
Business
    Comments Received. Many commentators believe that consultants are 
beneficial and allow dealers, especially smaller regional dealers, to 
maximize their limited resources and compete with larger national 
dealers.\17\ Some of these commentators express concern that the 
amendments would negatively impact such dealers, with the BMA stating 
that the proposal may practically eliminate an entire segment of the 
municipal securities industry. The BMA and Sen. Santorum state that the 
use of consultants increases competition and provides issuers with 
greater choice, thereby resulting in ``better service at lower rates.'' 
In addition, they argue that consultants that have a local presence 
``have unique knowledge regarding the local issuer's needs and 
requirements,'' thereby improving the effectiveness of the dealer at 
servicing the issuer. Merrill Lynch notes that ``the municipal 
marketplace is uniquely fragmented, covering myriad issuers in diverse 
locations.'' It argues that consultants are necessary to providing 
quality service to such a diverse market. UBS states that disclosure of 
consultant practices is better than a prohibition on using consultants.
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    \17\ See comments of Bear Stearns, BMA, Cabrera, Citigroup, 
Gardnyr Michael, Goldman Sachs, JJB Hilliard, Merrill Lynch, Morgan 
Stanley, MR Beal, Nevis, PNC, Sen. Santorum, Sutter, UBS and William 
Blair.
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    Other commentators believe that there is a significant problem with 
the use of consultants that is appropriately addressed by requiring 
that solicitation activity be undertaken only by persons subject to 
MSRB rules.\18\ JP Morgan agrees ``that eliminating the use of 
consultants who are not associated persons will advance the * * * 
standards of fair practice and professionalism embodied in the Board's 
rules and in the rules and regulations that govern all activities of 
brokers, dealers and municipal securities dealers and their associated 
persons.'' It views the original draft amendments as ``a sensible 
regulatory response to the increasing and evolving use of third parties 
to solicit municipal securities business.'' Seattle-Northwest states 
that ``removing the opportunity for improper conduct by consultants 
would result overall in an improved environment for issuance of 
municipal securities.'' Wells Fargo believes that the original draft 
amendments have ``the benefit of removing the ability of a dealer to 
indirectly evade the `pay to play' prohibitions * * * through the use 
of consultants.''
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    \18\ See comments of ABA, Mr. Chapman, Mr. Ciocca, Joe Jolly, JP 
Morgan, Kirkpatrick, Morgan Keegan, Seasongood, Seattle-Northwest 
and Wells Fargo.
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    The BMA contends that the amendments are not warranted, stating 
that the MSRB relies on possible abusive practices and speculative 
risks that have not been shown to exist. It questions whether there has 
been a significant increase in contributions by consultants and further 
states that, ``regardless of the level of the contributions being made, 
there is no indication whatsoever that Consultant contributions are 
being used to influence decisions regarding municipal securities 
business.'' The BMA states that coupling Rule G-37(d), on indirect 
violations, with the existing disclosure requirements of Rule G-38 
provides an effective means for addressing the MSRB's concerns.
    With regard to compensation, the BMA argues that the increase in 
payments to consultants ``does not in any way indicate or imply that 
Consultants are engaging in pay-to-play or that there is added pressure 
on Consultants to engage in aggressive or abusive practices. Rather, 
the recent increase in compensation appears to be attributable to the 
significant increase in the volume and size of municipal securities 
deals.'' On the other hand, AG Edwards, Citigroup, Goldman, Merrill and 
William Blair state that they would support a prohibition on contingent 
compensation arrangements or ``success'' fees paid to consultants. 
However, S&Y opposes the imposition of restrictions on the type and 
amount of compensation paid to consultants.
    MSRB Response. After a careful and thorough review of industry 
comments on the April and September 2004 Notices, the MSRB has 
concluded that regulatory action in this area is warranted, based on 
the concerns previously expressed by the MSRB in such notices and 
continuing revelations of questionable activities involving issuer 
personnel, dealers, other financial services organizations, and third-
party intermediaries. Such activities have the potential to severely 
undermine public confidence in the municipal securities market. The 
existing consultant disclosure requirements under current Rule G-38 
have assisted the MSRB in determining that action is necessary in this 
area but cannot serve as a substitute for such action. The MSRB 
believes that the proposed rule change represents a meaningful step 
toward further ensuring the continued integrity of the municipal 
securities market. The MSRB also believes that the benefits to the 
municipal securities market resulting from the proposed rule change 
outweigh the benefits that would accrue to permitting consultants to 
continue soliciting municipal securities business on behalf of dealers. 
Furthermore, the MSRB received comments both in favor of and in 
opposition to the original draft amendments from large national firms 
and small or regional firms. Taken as a whole, the comments do not 
provide persuasive evidence that the proposed rule change would have a 
disparate effect on different types of dealers.
Other Unregulated Municipal Securities Industry Participants
    Comments Received. Many commentators are concerned that, although 
the problems associated with pay-to-play in the municipal securities 
industry are not limited to dealers, only dealers are subject to 
regulation in this area.\19\ First Southwest and Kirkpatrick observe 
that any problem that may exist requires a broader response than 
restrictions applicable only to dealers. Several commentators also 
believe that current MSRB rules may permit dealers with affiliated 
banks to use these banks to circumvent MSRB rules.\20\ They urge the 
MSRB to coordinate efforts with the Commission, NASD and others to 
apply pay-to-play limits to financial advisors,

[[Page 20786]]

derivatives advisors, bond lawyers and other market participants.
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    \19\ See comments of Mr. Chapman, First Southwest, Kirkpatrick, 
Merrill and Morgan Keegan.
    \20\ See comments of Goldman, Merchant, Morgan Stanley and 
William Blair. 20
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    MSRB Response. The MSRB recognizes that other participants in the 
municipal securities industry face the same types of challenges as does 
the dealer community. Given the limited jurisdictional reach of MSRB 
rules, however, a more complete response to concerns in this area 
requires voluntary action on the part of the unregulated parties in the 
municipal securities market. The MSRB strongly encourages other 
industry participants--including but not limited to financial advisers, 
lawyers and swap participants--to take affirmative steps to ensure the 
integrity of their portion of the marketplace and toward severing the 
connection of political contributions and other payments that benefit 
public officials and their surrogates from the awarding of contracts 
relating to the municipal securities, derivative products and other 
financial activities of issuers. The MSRB observes that the failure of 
such other parties to take meaningful steps to deter potential 
conflicts of interests and other possibly abusive practices may merit 
further consideration by the Commission or Congress.
Effect of Becoming an Associated Person
    Comments Received. Many commentators note that the associated 
person concept used in the draft amendments triggers requirements under 
the Exchange Act and rules of other self-regulatory organizations, and 
can also raise state tax and labor law issues.\21\ They argue that 
these non-MSRB requirements may be practically impossible to apply to 
many solicitors. Several commentators also state that there is no 
guidance as to how solicitors serving multiple dealers are to be 
supervised.
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    \21\ See comments of BMA, Gardnyr Michael, Goldman, Morgan 
Stanley, PNC, UBS and William Blair.
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    MSRB Response. The MSRB recognizes the concerns over the associated 
person concept. The MSRB's intent in using the associated person 
concept in the draft amendments was to ensure that outside solicitors 
were fully subject to MSRB rules and did not extend to making other 
legal requirements applicable to such solicitors. The MSRB has 
therefore abandoned the associated person concept in the proposed rule 
change. The MSRB believes that, as formulated, the proposed rule change 
does not raise the concerns expressed by these commentators.
Apply Only G-37 to Consultants
    Comments Received. Many commentators suggest that the applicability 
of MSRB rules to solicitors be limited to Rule G-37 itself, or that the 
MSRB draft new provisions having varying degrees of similarity to those 
of Rule G-37.\22\
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    \22\ See comments of AG Edwards, BMA, Gardnyr Michael, Goldman, 
Merrill, Morgan Stanley, S&Y and William Blair.
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    MSRB Response. The MSRB disagrees that only Rule G-37, and not the 
other rules of the MSRB, should apply to the activities of solicitors. 
As noted above, one of the principal purposes of this proposal was to 
make the process of soliciting municipal securities business subject to 
the standards of fair practice and professionalism that apply to the 
other municipal securities activities of dealers. Imposition solely of 
Rule G-37 would fall short of this objective.
Suggested Alternative
    Comments Received. The BMA suggests that, as an alternative means 
of subjecting consultants to fair practice and professionalism 
standards, the MSRB require that such standards be embodied in a 
dealer's agreement with its consultant. It suggests that the consultant 
agreement include provisions that would impose by contract the 
requirements of certain MSRB rules, such as Rules G-17, G-20 and G-37, 
as well as assurances of compliance with state and local ethics, 
conflicts of interest, and lobbying disclosures laws. The alternative 
proposal would, however, limit the application of Rule G-37 so as to 
impose prohibitions on certain contributions by consultants, rather 
than imposing a ban on municipal securities business on the dealer as a 
result of such contributions. In addition, failure by consultants to 
comply with their contractual obligations would result in termination 
of such contracts and a prohibition on dealers engaging consultants who 
have previously violated their consultant contracts. Dealers would not 
be subject to rule violations as a result of a consultant's violation 
of its contractual obligation. Bear Stearns, Dain Rauscher, Goldman, 
JJB Hilliard, Merrill, Morgan Stanley, UBS, and William Blair support 
this approach, particularly with respect to the more limited 
application of Rule G-37 to contributions made by consultants.
    MSRB Response. Although the suggested contractual alternative to 
the revised draft amendments might provide some incremental improvement 
in the regulation of solicitation of municipal securities business over 
the existing rule, the MSRB believes that its concerns dictate that the 
MSRB take significantly more decisive action that ensures that dealers 
are fully responsible for solicitation activities undertaken for their 
benefit.
Definition of Solicitation
    Comments Received. The BMA states that the term solicitation should 
be limited to ``activity aimed at an issuer'' out of concern that any 
communication with a third party regarding a municipal securities issue 
could potentially become a solicitation of an issuer if the third party 
passes such communication on to the issuer. Many commentators are 
concerned with specific scenarios where they believe that certain types 
of communications should not be considered solicitations, particularly 
where communications are directed at conduit borrowers or where small 
payments are made in exchange for a communications.
    MSRB Response. The MSRB considered the comments related to the 
definition of solicitation included in the April 2004 Notice and 
provided more specific guidance with respect to this definition in the 
September 2004 Notice. Although such guidance in the September 2004 
Notice represents the MSRB's current view regarding this definition, 
comments received on this topic have been taken under advisement for 
further consideration by the MSRB.
Constitutionality of Proposal
    Comments Received. The BMA states that the draft amendments would 
violate the First Amendment of the U.S. Constitution by requiring 
consultants to become municipal finance professionals (``MFPs'') under 
Rule G-37. The BMA argues that the U.S. Supreme Court has equated 
political contributions with protected speech, and any restriction on 
speech must be narrowly tailored to advance a compelling governmental 
interest. It further asserts that, assuming for the sake of argument 
that pay-to-play problems exist relating to consultants, the draft 
amendments' restrictions ``far exceed what would be necessary to 
address that problem.''
    MSRB Response. In upholding the constitutionality of Rule G-37 in 
Blount v. SEC,\23\ the courts recognized that, at its core, the rule 
was intended to sever the connection between the making of political 
contributions and the awarding of municipal securities business. The 
rule as then written (and as found constitutional) applied to various

[[Page 20787]]

categories of persons associated with dealers in addition to those who 
solicit municipal securities business. For example, the rule covers 
those persons who underwrite or trade municipal securities or who 
supervise such activities. Given that the act of soliciting municipal 
securities business more closely touches on the core purpose of Rule G-
37 than do some of the other municipal securities activities that are 
undertaken by persons already treated as MFPs and therefore 
demonstrates a particularly close nexus between the actions the MSRB 
seeks to regulate and the purpose of its rulemaking, the MSRB continues 
to firmly believe that the argument that it is unconstitutional to 
require a person who solicits municipal securities business on behalf 
of a dealer to be treated as an MFP subject to Rule G-37 has no merit. 
The current formulation of the proposed rule change, which effectively 
prohibits paid outside consultants rather than requiring that such 
consultants become MFPs subject to Rule G-37, further negates this 
argument.
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    \23\ Blount v. SEC, 61 F. 3d 938 (D.C. Cir. 1995), cert. denied, 
116 S. Ct. 1351 (1996).
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Effective Date
    Comments Received. Several commentators express concern about 
existing contractual obligations if the draft amendments were to be 
adopted and urge the MSRB to make the effective date apply 
prospectively so as not to disrupt or dismantle existing contracts.\24\
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    \24\ See comments of BMA, Seattle-Northwest, Sutter and UBS.
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    MSRB Response. The proposed rule change prohibits dealers from 
making any payments for solicitation activities undertaken by non-
affiliated persons after the date of Commission approval of the 
amendments. The provisions of the proposed rule change permitting 
certain transitional payments for solicitation activities undertaken by 
consultants prior to the approval of the amendments should address the 
commentators' concerns.

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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-MSRB-2005-04 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-MSRB-2005-04. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 such 
filing also will be available for inspection and copying at the MSRB's 
offices. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-
MSRB-2005-04 and should be submitted on or before June 6, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E5-1879 Filed 4-20-05; 8:45 am]
BILLING CODE 8010-01-P