[Federal Register Volume 80, Number 89 (Friday, May 8, 2015)]
[Notices]
[Pages 26752-26785]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-11054]



[[Page 26751]]

Vol. 80

Friday,

No. 89

May 8, 2015

Part III





Securities and Exchange Commission





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Self-Regulatory Organizations; Municipal Securities Rulemaking Board; 
Notice of Filing of a Proposed Rule Change Consisting of Proposed New 
Rule G-42, on Duties of Non-Solicitor Municipal Advisors, and Proposed 
Amendments to Rule G-8, on Books and Records To Be Made by Brokers, 
Dealers, Municipal Securities Dealers, and Municipal Advisors; Notice

  Federal Register / Vol. 80 , No. 89 / Friday, May 8, 2015 / Notices  

[[Page 26752]]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-74860; File No. SR-MSRB-2015-03]


Self-Regulatory Organizations; Municipal Securities Rulemaking 
Board; Notice of Filing of a Proposed Rule Change Consisting of 
Proposed New Rule G-42, on Duties of Non-Solicitor Municipal Advisors, 
and Proposed Amendments to Rule G-8, on Books and Records To Be Made by 
Brokers, Dealers, Municipal Securities Dealers, and Municipal Advisors

May 4, 2015.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on April 24, 2015, the Municipal Securities Rulemaking Board (the 
``MSRB'' or ``Board'') filed with the Securities and Exchange 
Commission (the ``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 filed with the Commission a proposed rule change 
consisting of proposed new Rule G-42, on duties of non-solicitor 
municipal advisors, and proposed amendments to Rule G-8, on books and 
records to be made by brokers, dealers, municipal securities dealers, 
and municipal advisors (the ``proposed rule change''). The MSRB 
requests that the proposed rule change be approved with an 
implementation date six months after the Commission approval date for 
all changes.
    The text of the proposed rule change is available on the MSRB's Web 
site at www.msrb.org/Rules-and-Interpretations/SEC-Filings/2015-Filings.aspx, 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
    Following the financial crisis of 2008, Congress enacted the Dodd-
Frank Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank 
Act'').\3\ The Dodd-Frank Act establishes a new federal regulatory 
regime requiring municipal advisors to register with the SEC, deeming 
them to owe a fiduciary duty to their municipal entity clients and 
granting the MSRB rulemaking authority over them. The MSRB, in the 
exercise of that authority, is currently developing a comprehensive 
regulatory framework for municipal advisors. A significant element of 
that regulatory framework is Proposed Rule G-42, which would establish 
core standards of conduct for municipal advisors that engage in 
municipal advisory activities, other than municipal advisory 
solicitation activities (hereinafter, ``municipal advisors'').\4\ 
Proposed Rule G-42 is accompanied by associated proposed amendments to 
Rule G-8.
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    \3\ Public Law No. 111-203, 124 Stat. 1376 (2010).
    \4\ See Registration of Municipal Advisors, Rel. No. 34-70462 
(Sept. 20, 2013), 78 FR 67467, at 67519, note 679 (Nov. 12, 2013) 
(``SEC Final Rule'') (recognizing that the regulation of municipal 
advisors includes the ``application of standards of conduct . . . 
that may be required by the Commission or the MSRB, and other 
requirements unique to municipal advisors that may be imposed by the 
MSRB''). The proposed rule change would not apply to municipal 
advisors when engaging in the solicitation of a municipal entity or 
obligated person within the meaning of Exchange Act Section 
15B(e)(9) (15 U.S.C. 78o-4(e)(9)).
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Proposed Rule G-42
    Proposed Rule G-42 would establish the core standards of conduct 
and duties of municipal advisors when engaging in municipal advisory 
activities. The proposed rule draws on aspects of existing law and 
regulation under other relevant regulatory regimes, including those 
applicable to brokers, dealers and municipal securities dealers under 
MSRB rules and the Exchange Act, investment advisers under the 
Investment Advisers Act of 1940 \5\ (``Investment Advisers Act'') and 
commodity trading advisors under the Commodity Exchange Act 
(``CEA'').\6\
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    \5\ 15 U.S.C. 80b-1 et seq.
    \6\ 7 U.S.C. 1 et seq.
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    In summary, the core provisions of Proposed Rule G-42 would:
     Establish certain standards of conduct consistent with the 
fiduciary duty owed by a municipal advisor to its municipal entity 
clients, which includes, without limitation, a duty of care and of 
loyalty;
     Establish the standard of care owed by a municipal advisor 
to its obligated person clients;
     Require the full and fair disclosure, in writing, of all 
material conflicts of interest and legal or disciplinary events that 
are material to a client's evaluation of a municipal advisor;
     Require the documentation of the municipal advisory 
relationship, specifying certain aspects of the relationship that must 
be included in the documentation;
     Require that recommendations made by a municipal advisor 
are suitable for its clients, or determine the suitability of 
recommendations made by third parties when appropriate; and
     Specifically prohibit a municipal advisor from engaging in 
certain activities, including, in summary:
    [cir] Receiving excessive compensation;
    [cir] delivering inaccurate invoices for fees or expenses;
    [cir] making false or misleading representations about the 
municipal advisor's resources, capacity or knowledge;
    [cir] participating in certain fee-splitting arrangements with 
underwriters;
    [cir] participating in any undisclosed fee-splitting arrangements 
with providers of investments or services to a municipal entity or 
obligated person client of the municipal advisor;
    [cir] making payments for the purpose of obtaining or retaining an 
engagement to perform municipal advisory activities, with limited 
exceptions; and
    [cir] entering into certain principal transactions with the 
municipal advisor's municipal entity clients.
    In addition, the proposed rule change would define key terms used 
in Proposed Rule G-42 and provide supplementary material. The 
supplementary material would provide additional guidance on the core 
concepts in the proposed rule, such as the duty of care, the duty of 
loyalty, suitability of recommendations and ``Know Your Client'' 
obligations; provide context for issues such as the scope of an 
engagement, conflicts of interest disclosures, excessive compensation 
and the impact of client action that is independent of or contrary to 
the advice of a municipal advisor, and the applicability of the 
proposed rule change to 529 college savings plans (``529 plans'') and 
other municipal

[[Page 26753]]

entities; provide guidance regarding the definition of ``engage in a 
principal transaction;'' the continued applicability of state and other 
laws regarding fiduciary and other duties owed by municipal advisors; 
and, finally, include information regarding requirements that must be 
met for a municipal advisor to be relieved of certain provisions of 
Proposed Rule G-42 in instances when it inadvertently engages in 
municipal advisory activities.
Standards of Conduct
    Section (a) of Proposed Rule G-42 would establish the core 
standards of conduct and duties applicable to municipal advisors. The 
approach toward the core standards and duties in Proposed Rule G-42 
flows from the distinctions drawn in the Dodd-Frank Act between a 
municipal advisor's duties owed to clients that are municipal entities 
and those duties owed to clients that are obligated persons. The Dodd-
Frank Act specifically deems a municipal advisor to owe a fiduciary 
duty to its municipal entity clients.\7\ In contrast, the Dodd-Frank 
Act does not impose a fiduciary duty with respect to a municipal 
advisor's obligated person clients.\8\
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    \7\ See Section 15B(c)(1) of the Exchange Act, 15 U.S.C. 78o-
4(c)(1) which provides:
    A municipal advisor and any person associated with such 
municipal advisor shall be deemed to have a fiduciary duty to any 
municipal entity for whom such municipal advisor acts as a municipal 
advisor, and no municipal advisor may engage in any act, practice, 
or course of business which is not consistent with a municipal 
advisor's fiduciary duty or that is in contravention of any rule of 
the Board.
    \8\ See SEC Final Rule, 78 FR at 67475, note 100.
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    Subsection (a)(i) of Proposed Rule G-42 would provide that each 
municipal advisor in the conduct of its municipal advisory activities 
for an obligated person client is subject to a duty of care. Subsection 
(a)(ii) would provide that each municipal advisor in the conduct of its 
municipal advisory activities for a municipal entity client is subject 
to a fiduciary duty, which includes, without limitation, a duty of 
loyalty and a duty of care. The standards contained in these 
subsections would not supersede any more restrictive provisions of 
state or other laws applicable to the activities of municipal advisors.
    Proposed supplementary material would provide guidance on the duty 
of care and the duty of loyalty. Generally, in lieu of providing 
detailed requirements, the duties would be described in terms that 
would empower the client to, in large part, determine the scope of 
services and control the engagement with the municipal advisor (with 
the municipal advisor's agreement).
    Paragraph .01 of the Supplementary Material would describe the duty 
of care to require, without limitation, a municipal advisor to: (1) 
Exercise due care in performing its municipal advisory activities; (2) 
possess the degree of knowledge and expertise needed to provide the 
municipal entity or obligated person client with informed advice; (3) 
make a reasonable inquiry as to the facts that are relevant to a 
client's determination as to whether to proceed with a course of action 
or that form the basis for any advice provided to the client; and (4) 
undertake a reasonable investigation to determine that the municipal 
advisor is not basing any recommendation on materially inaccurate or 
incomplete information. The duty of care that would be established in 
section (a) of Proposed Rule G-42, would also require the municipal 
advisor to have a reasonable basis for: Any advice provided to or on 
behalf of a client; \9\ any representations made in a certificate that 
it signs that will be reasonably foreseeably relied upon by the client, 
any other party involved in the municipal securities transaction or 
municipal financial product, or investors in the municipal entity 
client's securities or securities secured by payments from an obligated 
person client; and, any information provided to the client or other 
parties involved in the municipal securities transaction in connection 
with the preparation of an official statement for any issue of 
municipal securities as to which the advisor is advising.
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    \9\ The duty of care, which is applicable to all municipal 
advisory activities, would apply to the provision of comments 
following the review of any document and the provision of language 
for use in any document--including an official statement--to the 
extent that conduct constituted municipal advisory activity. 
Furthermore, such conduct would be required to comport with the 
fiduciary duty owed in the case of a municipal entity client.
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    Paragraph .02 of the Supplementary Material would describe the duty 
of loyalty to require, without limitation, a municipal advisor, when 
engaging in municipal advisory activities for a municipal entity, to 
deal honestly and with the utmost good faith with the client and act in 
the client's best interests without regard to the financial or other 
interests of the municipal advisor. Paragraph .02 would also provide 
that the duty of loyalty would preclude a municipal advisor from 
engaging in municipal advisory activities with a municipal entity 
client if it cannot manage or mitigate its conflicts of interest in a 
manner that will permit it to act in the municipal entity's best 
interests.
    Paragraph .03 of the Supplementary Material would specify that a 
municipal advisor is not required to disengage from a municipal 
advisory relationship if a municipal entity client or an obligated 
person client elects a course of action that is independent of or 
contrary to advice provided by the municipal advisor.
    Paragraph .04 of the Supplementary Material would specify that a 
municipal advisor could limit the scope of the municipal advisory 
activities to be performed to certain specified activities or services 
if requested or expressly consented to by the client, but could not 
alter the standards of conduct or impose limitations on any of the 
duties prescribed by Proposed Rule G-42. Paragraph .04 would provide 
that, if a municipal advisor engages in a course of conduct that is 
inconsistent with the mutually agreed limitations to the scope of the 
engagement, it may result in negating the effectiveness of the 
limitations.
    Paragraph .07 of the Supplementary Material would state, as a 
general matter, that, municipal advisors may be subject to fiduciary or 
other duties under state or other laws and nothing in Proposed Rule G-
42 would supersede any more restrictive provision of state or other 
laws applicable to municipal advisory activities.
Disclosure of Conflicts of Interest and Other Information
    Section (b) of Proposed Rule G-42 would require a municipal advisor 
to fully and fairly disclose to its client in writing all material 
conflicts of interest, and to do so prior to or upon engaging in 
municipal advisory activities. The provision would set forth a non-
exhaustive list of scenarios under which a material conflict of 
interest would arise or be deemed to exist and that would require a 
municipal advisor to provide written disclosures to its client.
    Paragraph (b)(i)(A) would require a municipal advisor to disclose 
any actual or potential conflicts of interest of which the municipal 
advisor becomes aware after reasonable inquiry that could reasonably be 
anticipated to impair the municipal advisor's ability to provide advice 
to or on behalf of the client in accordance with the applicable 
standards of conduct (i.e., a duty of care or a fiduciary duty). 
Paragraphs (b)(i)(B) through (F) would provide more specific scenarios 
that give rise to conflicts of interest that would be deemed to be 
material and require proper disclosure to a municipal advisor's client. 
Under the proposed rule change, a material

[[Page 26754]]

conflict of interest would always include: any affiliate of the 
municipal advisor that provides any advice, service or product to or on 
behalf of the client that is directly related to the municipal advisory 
activities to be performed by the disclosing municipal advisor; any 
payments made by the municipal advisor, directly or indirectly, to 
obtain or retain an engagement to perform municipal advisory activities 
for the client; any payments received by the municipal advisor from a 
third party to enlist the municipal advisor's recommendations to the 
client of its services, any municipal securities transaction or any 
municipal financial product; any fee-splitting arrangements involving 
the municipal advisor and any provider of investments or services to 
the client; and any conflicts of interest arising from compensation for 
municipal advisory activities to be performed that is contingent on the 
size or closing of any transaction as to which the municipal advisor is 
providing advice. Paragraph (b)(i)(G) would require municipal advisors 
to disclose any other engagements or relationships of the municipal 
advisor that could reasonably be anticipated to impair its ability to 
provide advice to or on behalf of its client in accordance with the 
applicable standards of conduct established by section (a) of the 
proposed rule.
    Under subsection (b)(i), if a municipal advisor were to conclude, 
based on the exercise of reasonable diligence, that it had no known 
material conflicts of interest, the municipal advisor would be required 
to provide a written statement to the client to that effect.
    Subsection (b)(ii) would require disclosure of any legal or 
disciplinary event that would be material to the client's evaluation of 
the municipal advisor or the integrity of its management or advisory 
personnel. To facilitate the use of existing records, a municipal 
advisor would be permitted to fulfill this disclosure obligation by 
identifying the specific type of event and specifically referring the 
client to the relevant portions of the municipal advisor's most recent 
SEC Forms MA or MA-I \10\ filed with the Commission, if the municipal 
advisor provides detailed information specifying where the client could 
access such forms electronically. The requirement to specifically refer 
to the relevant portions of the forms would not be satisfied by a broad 
reference to the section of the forms containing such disclosures. 
Similarly, the specific-information requirement for access to the forms 
would not be satisfied by a general reference to the SEC's Electronic 
Data Gathering, Analysis, and Retrieval system (``EDGAR''). A municipal 
advisor could alternatively meet this latter requirement, for example, 
by publishing its most recent forms on its own Web site and then 
providing the client with the direct web link or internet address.
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    \10\ See 17 CFR 249.1300 (SEC Form MA); 17 CFR 249.1310 (SEC 
Form MA-I).
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    Paragraph .05 of the Supplementary Material would provide that the 
required conflicts of interest disclosures must be sufficiently 
detailed to inform the client of the nature, implications and potential 
consequences of each conflict and must include an explanation of how 
the municipal advisor addresses or intends to manage or mitigate each 
conflict.\11\ Coupled with its duty to disclose material conflicts of 
interest, a municipal advisor's obligation to explain how it addresses 
or intends to manage or mitigate its material conflicts of interest was 
included in the proposed rule to reflect the Board's intent to 
eliminate, or at least to expose and reduce the occurrence of, material 
conflicts of interest that might incline a municipal adviser to provide 
advice or a recommendation which was not disinterested.\12\ If not 
properly managed or mitigated, material conflicts of interest could 
lead to a failure to protect a municipal advisor's client's interest, 
thereby causing a breach of the duty of care and/or loyalty that would 
be established by proposed section (a).
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    \11\ This requirement is analogous to the requirement of Form 
ADV (17 CFR 279.1) under the Investment Advisers Act (15 U.S.C. 80b-
1 et seq.) that obligates an investment adviser to describe how it 
addresses certain conflicts of interest with its clients. See, e.g., 
Form ADV, Part 2, Item 5.E.1 of Part 2A (requiring an investment 
adviser to describe how it will address conflicts of interest that 
arise in regards to fees and compensation it receives, including the 
investment adviser's procedures for disclosing the conflicts of 
interest with its client). See also, Form ADV, Part 2A Items 6, 10, 
11, 14 and 17.
    \12\ See, e.g., SEC v. Capital Gains Research Bureau, Inc., 375 
U.S. 180, 191-92 (1963).
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    Paragraph .06 of the Supplementary Material would provide that a 
municipal advisor that inadvertently engages in municipal advisory 
activities but does not intend to continue the municipal advisory 
activities or enter into a municipal advisory relationship \13\ would 
not be required to comply with sections (b) and (c) of Proposed Rule G-
42 (relating to disclosure of conflicts of interest and documentation 
of the relationship), if the municipal advisor takes the prescribed 
actions listed under paragraph .06 promptly after it discovers its 
provision of inadvertent advice. The municipal advisor would be 
required to provide to the client a dated document that would include: 
a disclaimer stating that the municipal advisor did not intend to 
provide advice and that, effective immediately, the municipal advisor 
has ceased engaging in municipal advisory activities with respect to 
that client in regard to all transactions and municipal financial 
products as to which advice was inadvertently provided; a notification 
that the client should be aware that the municipal advisor has not 
provided the disclosure of material conflicts of interest and other 
information required under section (b); an identification of all of the 
advice that was inadvertently provided, based on a reasonable 
investigation; and a request that the municipal entity or obligated 
person acknowledge receipt of the document. The municipal advisor also 
would be required to conduct a review of its supervisory and compliance 
policies and procedures to ensure that they are reasonably designed to 
prevent inadvertently providing advice to municipal entities and 
obligated persons. The final sentence of paragraph .06 of the 
Supplementary Material would also clarify that the satisfaction of the 
requirements of paragraph .06 would have no effect on the applicability 
of any provisions of Proposed Rule G-42 other than sections (b) and 
(c), or any other legal requirements applicable to municipal advisory 
activities. Such other legal requirements, would include, but would not 
be limited to, other MSRB rules (including Rule G-23), Financial 
Industry Regulatory Authority (``FINRA'') rules or federal or state 
laws that apply to municipal advisory activities.\14\
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    \13\ Under subsection (f)(vi) of Proposed Rule G-42, a municipal 
advisory relationship would be deemed to exist when a municipal 
advisor enters into an agreement to engage in municipal advisory 
activities for a municipal entity or obligated person, and would be 
deemed to have ended on the earlier of (i) the date on which the 
municipal advisory relationship has terminated pursuant to the terms 
of the documentation of the municipal advisory relationship required 
in section (c) of Proposed Rule G-42 or (ii) the date on which the 
municipal advisor withdraws from the municipal advisory 
relationship.
    \14\ Rule G-23, on activities of financial advisors, generally 
provides that a dealer that has a financial advisory relationship 
(as defined by Rule G-23(b)) with respect to the issuance of 
municipal securities is precluded from acquiring all or any portion 
of such issue, directly or indirectly, from the issuer as principal, 
either alone or as a participant in a syndicate or other similar 
account formed for that purpose. A dealer is also, under Rule G-23, 
precluded from arranging the placement of an issue with respect to 
which it has a financial advisory relationship.

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Documentation of the Municipal Advisory Relationship
    Section (c) of Proposed Rule G-42 would require each municipal 
advisor to evidence each of its municipal advisory relationships by a 
writing, or writings created and delivered to the municipal entity or 
obligated person client prior to, upon or promptly after the 
establishment of the municipal advisory relationship. The documentation 
would be required to be dated and include, at a minimum: \15\
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    \15\ While no acknowledgement from the client of its receipt of 
the documentation would be required, a municipal advisor must, as 
part of the duty of care it owes its client, reasonably believe that 
the documentation was received by its client.
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     the form and basis of direct or indirect compensation, if 
any, for the municipal advisory activities to be performed, as provided 
in proposed subsection (c)(i);
     the information required to be disclosed in proposed 
section (b), including the disclosures of conflicts of interest, as 
provided in proposed subsection (c)(ii);
     a description of the specific type of information 
regarding legal and disciplinary events requested by the Commission on 
SEC Form MA and SEC Form MA-I, as provided in proposed subsection 
(c)(iii), and detailed information specifying where the client may 
electronically access the municipal advisor's most recent Form MA and 
each most recent Form MA-I filed with the Commission; \16\
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    \16\ Compliance with this requirement could be achieved in the 
same manner, and (so long as done upon or prior to engaging in 
municipal advisory activities for the client) concurrently with 
providing to the client the information required under proposed 
subsection (b)(ii). However, the description of the events contained 
in Forms MA or MA-I must be sufficiently specific to allow a 
municipal entity or obligated person client to understand the nature 
of any disclosed legal or disciplinary event. In addition, the 
municipal advisor must provide detailed information specifying where 
the client could access such forms electronically. See supra note 10 
and accompanying text.
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     the date of the last material change to the legal or 
disciplinary event disclosures on any SEC Forms MA or MA-I filed with 
the Commission by the municipal advisor, as provided in proposed 
subsection (c)(iv);
     the scope of the municipal advisory activities to be 
performed and any limitations on the scope of the engagement, as 
provided in proposed subsection (c)(v);
     the date, triggering event, or means for the termination 
of the municipal advisory relationship, or, if none, a statement that 
there is none, as provided in proposed subsection (c)(vi); and
     any terms relating to withdrawal from the municipal 
advisory relationship, as provided in proposed subsection (c)(vii).
    Proposed Rule G-42(c) also would require municipal advisors to 
promptly amend or supplement the writing(s) during the term of the 
municipal advisory relationship as necessary to reflect any material 
changes or additions in the required information. For example, if the 
basis of compensation or scope of services materially changed during 
the term of the relationship, the municipal advisor would be required 
to amend or supplement the writing(s) and promptly deliver the amended 
writing(s) or supplement to the client. The same would be true in the 
case of material conflicts of interest discovered after the 
relationship documentation was last provided to the client. The 
amendment and supplementation requirement in proposed section (c) would 
apply to any material changes and additions that are discovered, or 
should have been discovered, based on the exercise of reasonable 
diligence by the municipal advisor. Any amendments or supplementation 
also would be subject to the requirements of the proposed rule change 
that would apply as if it were the first relationship documentation 
provided to the client.
    Proposed Rule G-42(c) is modeled in part on Rule G-23, which 
requires a broker, dealer or municipal securities dealer (``dealer'') 
that enters into a financial advisory relationship with an issuer to 
evidence that relationship in writing prior to, upon or promptly after 
the inception of that relationship. Like Rule G-23, proposed section 
(c) would not require that the writing(s) evidencing the relationship 
be a bilateral agreement or contract. For example, if state law 
provided for the procurement of municipal advisory services in a manner 
that did not require a writing sufficient to establish a bilateral 
agreement, a municipal advisor could send its client a writing, such as 
a letter that references the procurement document and contains the 
terms and disclosures required by proposed Rule G-42(b) and (c) to 
evidence its municipal advisory relationship with its municipal entity 
or obligated person client.
Recommendations and Review of Recommendations of Other Parties
    Section (d) of Proposed Rule G-42 would provide that a municipal 
advisor must not recommend that its client enter into any municipal 
securities transaction or municipal financial product unless the 
municipal advisor has determined, based on the information obtained 
through the reasonable diligence of the municipal advisor, whether the 
transaction or product is suitable for the client.\17\ Proposed section 
(d) also contemplates that a municipal advisor may be requested by the 
client to review and determine the suitability of a recommendation made 
by a third party to the client. If a client were to request this type 
of review, and such review were within the scope of the engagement, the 
municipal advisor's determination regarding the suitability of the 
third-party's recommendation regarding a municipal securities 
transaction or municipal financial product would be subject to the same 
reasonable diligence standard--requiring the municipal advisor to 
obtain relevant information through the exercise of reasonable 
diligence.
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    \17\ Some securities market participants are required to make 
only recommendations that are ``consistent with'' their customer's 
best interests. (See FINRA Notice 12-25, Suitability (May 2012)). As 
provided in proposed section (a) and paragraph .02 of the 
Supplementary Material to Proposed Rule G-42, a municipal advisor to 
a municipal entity client owes the client a fiduciary duty that 
includes a duty of loyalty in addition to the duty of care, which 
requires the municipal advisor to deal honestly and with the utmost 
good faith with the municipal entity client and act in the client's 
best interests without regard to the financial or other interests of 
the municipal advisor. A municipal advisor's recommendations of 
municipal securities transactions and municipal financial products 
to a municipal entity client, as is the case with all municipal 
advisory activities performed for a municipal entity client, must 
comport with the municipal advisor's fiduciary duty and particularly 
its duty of loyalty. The MSRB considers the duty of loyalty 
described in Proposed Rule G-42 to be even more rigorous than a 
standard requiring consistency with a client's best interests.
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    As to both types of review, the municipal advisor would be required 
under proposed section (d) to inform its municipal entity or obligated 
person client of its evaluation of the material risks, potential 
benefits, structure and other characteristics of the recommended 
municipal securities transaction or municipal financial product; the 
basis upon which the advisor reasonably believes the recommended 
transaction or product is, or is not, suitable for the client; and 
whether the municipal advisor has investigated or considered other 
reasonably feasible alternatives to the recommended municipal 
securities transaction or municipal financial product that might also 
or alternatively serve the client's objectives. The proposed rule does 
not include requirements regarding how such information must be 
communicated by the municipal advisor to the client, and a municipal 
advisor would be permitted to choose the appropriate method by which to 
communicate the information

[[Page 26756]]

to its client so long as it comports with the duty of care owed.
    Section (d), like other provisions of Proposed Rule G-42, would 
reflect the basic principle that the client controls the scope of the 
engagement with its municipal advisor (with the agreement of the 
municipal advisor). For example, a municipal advisor's engagement may 
be limited in scope because the municipal advisor's client already 
reached a decision regarding a particular municipal securities 
transaction or municipal financial product, or engaged another 
professional to undertake certain duties in connection with a municipal 
securities transaction or municipal financial product. Paragraph .04 of 
the Supplementary Material would provide that a municipal advisor and 
its client could limit the scope of the municipal advisory relationship 
to certain specified activities or services. A municipal advisor, 
however, would not be permitted to alter the standards of conduct or 
duties imposed by the proposed rule with respect to that limited scope.
    The proposed rule change would adopt, and apply to municipal 
advisors, the existing MSRB interpretive guidance regarding the general 
principles currently applicable to dealers for determining whether a 
particular communication constitutes a recommendation of a securities 
transaction.\18\ Consistent with the approach in the case of dealers, a 
municipal advisor's communication to its client that could reasonably 
be viewed as a ``call to action'' to engage in a municipal securities 
transaction or enter into a municipal financial product would be 
considered a recommendation and obligate the municipal advisor to 
conduct a suitability analysis of its recommendation. Depending on all 
of the facts and circumstances, communications by a municipal advisor 
to a client that concern minor or ancillary matters that relate to, but 
are not recommendations of, a municipal securities transaction or 
municipal financial product might constitute advice (and therefore 
trigger many other provisions of the proposed rule) but would not 
trigger the suitability obligation set forth in proposed section (d).
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    \18\ See MSRB Rule G-19. See also MSRB Notice 2002-30 (Sept. 25, 
2002) Notice Regarding Application of Rule G-19, on Suitability of 
Recommendations and Transactions, to Online Communications.
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    Paragraph .08 of the Supplementary Material would provide guidance 
related to a municipal advisor's suitability obligations. Under this 
provision, a municipal advisor's determination of whether a municipal 
securities transaction or municipal financial product is suitable for 
its client must be based on numerous factors, as applicable to the 
particular type of client, including, but not limited to: the client's 
financial situation and needs, objectives, tax status, risk tolerance, 
liquidity needs, experience with municipal securities transactions or 
municipal financial products generally or of the type and complexity 
being recommended, financial capacity to withstand changes in market 
conditions during the term of the municipal financial product or the 
period that municipal securities to be issued are reasonably expected 
to be outstanding, and any other material information known by the 
municipal advisor about the client and the municipal securities 
transaction or municipal financial product, after the municipal advisor 
has conducted a reasonable inquiry.
    In connection with a municipal advisor's obligation to determine 
the suitability of a municipal securities transaction or a municipal 
financial product for a client, which should take into account its 
knowledge of the client, paragraph .09 of the Supplementary Material 
would require a municipal advisor to know its client. The obligation to 
know the client would require a municipal advisor to use reasonable 
diligence to know and retain essential facts concerning the client and 
the authority of each person acting on behalf of the client, and is 
similar to requirements in other regulatory regimes.\19\ The facts 
``essential'' to knowing one's client would include those required to 
effectively service the municipal advisory relationship with the 
client; act in accordance with any special directions from the client; 
understand the authority of each person acting on behalf of the client; 
and comply with applicable laws, rules and regulations.
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    \19\ Similar requirements apply to brokers and dealers under 
FINRA Rule 2090 (Know Your Customer) and swap dealers under 
Commodity Futures Trading Commission (``CFTC'') Rule 402(b) (General 
Provisions: Know Your Counterparty), 17 CFR 23.402(b), found in CFTC 
Rules, Ch. I, Pt. 23, Subpt. H (Business Conduct Standards for Swap 
Dealers and Major Swap Participants Dealing with Counterparties, 
including Special Entities) (17 CFR 23.400 et. seq.). Notably, the 
CFTC's rule applies to dealings with special entity clients, defined 
to include states, state agencies, cities, counties, municipalities, 
other political subdivisions of a State, or any instrumentality, 
department, or a corporation of or established by a State or 
political subdivision of a State. See CFTC Rule 401(c) (defining 
``special entity'') (17 CFR 23.401(c)).
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    As a practical matter, it is understood that a client could at 
times elect a course of action either independent of or contrary to the 
advice of its municipal advisor. Paragraph .03 of the Supplementary 
Material would provide that the municipal advisor would not be required 
to disengage from the municipal advisory relationship on that basis.
Specified Prohibitions
    Subsection (e)(i) of Proposed Rule G-42 would prohibit discrete 
conduct or activities that would conflict, or would be highly likely to 
conflict, with the core standards of conduct--the duty of loyalty and 
the duty of care--applicable to municipal advisors under Proposed Rule 
G-42 and the Exchange Act.
    Paragraph (e)(i)(A) would prohibit a municipal advisor from 
receiving compensation from its client that is excessive in relation to 
the municipal advisory activities actually performed for the client. 
Paragraph .10 of the Supplementary Material would provide additional 
guidance on how compensation would be determined to be excessive. 
Included in paragraph .10 are several factors that would be considered 
when evaluating the reasonableness of a municipal advisor's 
compensation relative to the nature of the municipal advisory 
activities performed, including, but not limited to: the municipal 
advisor's expertise, the complexity of the municipal securities 
transaction or municipal financial product, whether the fee is 
contingent upon the closing of the municipal securities transaction or 
municipal financial product, the length of time spent on the engagement 
and whether the municipal advisor is paying any other relevant costs 
related to the municipal securities transaction or municipal financial 
product.
    Paragraph (e)(i)(B) would prohibit municipal advisors from 
delivering an invoice for fees or expenses for municipal advisory 
activities that does not accurately reflect the activities actually 
performed or the personnel that actually performed those activities. 
This provision would not prohibit a municipal advisor from including a 
discount for the services it actually performed, if accurately 
disclosed.
    Paragraph (e)(i)(C) would prohibit a municipal advisor from making 
any representation or submitting any information that the municipal 
advisor knows or should know is either materially false or materially 
misleading due to the omission of a material fact, about its capacity, 
resources or knowledge in response to requests for proposals or in oral 
presentations to a client or prospective client for the purpose of 
obtaining or retaining an

[[Page 26757]]

engagement to perform municipal advisory activities. Note that, 
additionally, the MSRB's existing fundamental fair practice rule, Rule 
G-17, precludes municipal advisors, in the conduct of their municipal 
advisory activities, from engaging in any deceptive, dishonest or 
unfair practice with any person.
    Paragraph (e)(i)(D) would prohibit municipal advisors from making 
or participating in two types of fee-splitting arrangements: (1) Any 
fee-splitting arrangement with an underwriter on any municipal 
securities transaction as to which the municipal advisor has provided 
or is providing advice; and (2) any undisclosed fee-splitting 
arrangement with providers of investments or services to a municipal 
entity or obligated person client of the municipal advisor.
    Paragraph (e)(i)(E) would, generally, prohibit a municipal advisor 
from making payments for the purpose of obtaining or retaining an 
engagement to perform municipal advisory activities. However, the 
provision contains three exceptions. The prohibition would not apply 
to: (1) Payments to an affiliate of the municipal advisor for a direct 
or indirect communication with a municipal entity or obligated person 
on behalf of the municipal advisor where such communication is made for 
the purpose of obtaining or retaining an engagement to perform 
municipal advisory activities; (2) reasonable fees paid to another 
municipal advisor registered as such with the Commission and MSRB for 
making such a communication as described in subparagraph (e)(i)(E)(1); 
and (3) payments that are permissible ``normal business dealings'' as 
described in MSRB Rule G-20. The proposed rule change, however, would 
not prescribe parameters that would effectively limit a client's 
ability to decide the source of funds for the payment of fees for 
services rendered by the municipal advisor.
Principal Transactions
    Subsection (e)(ii) of Proposed Rule G-42 would prohibit a municipal 
advisor to a municipal entity, and any affiliate of such municipal 
advisor, from engaging in a principal transaction directly related to 
the same municipal securities transaction or municipal financial 
product as to which the municipal advisor is providing or has provided 
advice. The ban on principal transactions would apply only with respect 
to clients that are municipal entities. The ban would not apply to 
principal transactions between a municipal advisor (or an affiliate of 
the municipal advisor) and the municipal advisor's obligated person 
clients. Although such transactions would not be prohibited, 
importantly, all municipal advisors, including those engaging in 
municipal advisory activities for obligated person clients, are 
currently subject to the MSRB's fundamental fair-practice rule, Rule G-
17.
    Paragraph .07 of the Supplementary Material would provide an 
exception to the ban on principal transactions in subsection (e)(ii) in 
order to avoid a possible conflict with existing MSRB Rule G-23, on 
activities of financial advisors. Specifically, the ban in subsection 
(e)(ii) would not apply to an acquisition as principal, either alone or 
as a participant in a syndicate or other similar account formed for the 
purpose of purchasing, directly or indirectly, from an issuer all or 
any portion of an issuance of municipal securities on the basis that 
the municipal advisor provided advice as to the issuance, because such 
a transaction is the type of transaction that is addressed, and, in 
certain circumstances, prohibited by Rule G-23. The purpose of this 
provision would be to avoid a potential conflict in MSRB rules and 
provide, until such time as the MSRB may further review and potentially 
amend Rule G-23, that the specific prohibition against principal 
transactions contained in subsection (e)(ii) would not prohibit such 
underwriting transactions, as they are already addressed and prohibited 
in certain circumstances by Rule G-23.
    For purposes of the prohibition in proposed subsection (e)(ii), 
subsection (f)(i) would define the term ``engaging in a principal 
transaction'' to mean ``when acting as a principal for one's own 
account, selling to or purchasing from the municipal entity client any 
security or entering into any derivative, guaranteed investment 
contract, or other similar financial product with the municipal entity 
client.'' This definition draws on the statutory language regarding 
principal transactions in the Investment Advisers Act.\20\ Among other 
things, the definition was designed to exclude transactions thought to 
be potentially covered by some commenters, such as the taking of a cash 
deposit or the payment by a client solely for professional services. 
Further, paragraph .11 of the Supplementary Material would clarify that 
the term ``other similar financial products,'' as used in subsection 
(f)(i), would include a bank loan but only if it is in an aggregate 
principal amount of $1,000,000 or more and is economically equivalent 
to the purchase of one or more municipal securities. Bank loans would 
be included under the specified circumstances because, as a matter of 
market practice, they serve as a financing alternative to the issuance 
of municipal securities and pose a comparable, acute potential for 
self-dealing and other breaches of the fiduciary duty owed by a 
municipal advisor to a municipal entity client.
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    \20\ See 15 U.S.C. 80b-6(3).
---------------------------------------------------------------------------

Definitions
    Section (f) of Proposed Rule G-42 would provide definitions of the 
terms ``engaging in a principal transaction,'' ``affiliate of the 
municipal advisor,'' \21\ ``municipal advisory relationship,'' \22\ and 
``official statement.'' \23\ Further, for several terms in Proposed 
Rule G-42 that have been previously defined by federal statute or SEC 
rules, proposed section (f) would, for purposes of Proposed Rule G-42, 
adopt the same meanings. These terms would include ``advice;'' \24\ 
``municipal advisor;'' \25\ ``municipal advisory activities;'' \26\

[[Page 26758]]

``municipal entity;'' \27\ and ``obligated person.'' \28\
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    \21\ ``Affiliate of the municipal advisor'' would mean ``any 
person directly or indirectly controlling, controlled by, or under 
common control with such municipal advisor.'' See Proposed Rule G-
42(f)(iii).
    \22\ Proposed Rule G-42(f)(vi) provides that a ``municipal 
advisory relationship'' would be deemed to exist when a municipal 
advisor enters into an agreement to engage in municipal advisory 
activities for a municipal entity or obligated person. The municipal 
advisory relationship shall be deemed to have ended on the date 
which is the earlier of (i) the date on which the municipal advisory 
relationship has terminated pursuant to the terms of the 
documentation of the municipal advisory relationship required in 
section (c) of this rule or (ii) the date on which the municipal 
advisor withdraws from the municipal advisory relationship.
    \23\ ``Official statement'' would have the same meaning as in 
MSRB Rule G-32(d)(vii). See Proposed Rule G-42(f)(ix).
    \24\ ``Advice'' would have the same meaning as in Section 
15B(e)(4)(A)(i) of the Exchange Act (15 U.S.C. 78o-4(e)(4)(A)(i)); 
SEC Rule 15Ba1-1(d)(1)(ii) (17 CFR 240.15Ba1-1(d)(1)(ii)); and other 
rules and regulations thereunder. See Proposed Rule G-42(f)(ii).
    \25\ ``Municipal advisor'' would have the same meaning as in 
Section 15B(e)(4) of the Act, 17 CFR 240.15Ba1-1(d)(1)-(4) and other 
rules and regulations thereunder; provided that it shall exclude a 
person that is otherwise a municipal advisor solely based on 
activities within the meaning of Section 15B(e)(4)(A)(ii) of the Act 
and rules and regulations thereunder or any solicitation of a 
municipal entity or obligated person within the meaning of Section 
15B(e)(9) of the Act and rules and regulations thereunder.
    See Proposed Rule G-42(f)(iv).
    \26\ ``Municipal advisory activities'' would mean those 
activities that would cause a person to be a municipal advisor as 
defined in subsection (f)(iv) (definition of ``municipal advisor'') 
of Proposed Rule G-42. See Proposed Rule G-42(f)(v).
    \27\ ``Municipal entity'' would ``have the same meaning as in 
Section 15B(e)(8) of the Act, 17 CFR 240.15Ba1-1(g) and other rules 
and regulations thereunder.'' See Proposed Rule G-42(f)(vii).
    \28\ ``Obligated person'' would ``have the same meaning as in 
Section 15B(e)(10) of the Act, 17 CFR 240.15Ba1-1(k) and other rules 
and regulations thereunder.'' See Proposed Rule G-42(f)(viii).
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Applicability of Proposed Rule G-42 to 529 College Savings Plans and 
Other Municipal Fund Securities
    The regulation of municipal advisors, as the SEC has 
recognized,\29\ is relevant to municipal fund securities.\30\ Paragraph 
.12 of the Supplementary Material emphasizes the proposed rule's 
application to municipal advisors whose municipal advisory clients are 
sponsors or trustees of municipal fund securities.
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    \29\ See SEC Final Rule, 78 FR at 67472-3.
    \30\ ``Municipal fund security'' is defined in MSRB Rule D-12 to 
mean ``a municipal security issued by an issuer that, but for the 
application of Section 2(b) of the Investment Company Act of 1940, 
would constitute an investment company within the meaning of Section 
3 of the Investment Company Act of 1940.'' The term refers to, among 
other things, interests in governmentally sponsored 529 college 
savings plans and local government investment pools.
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Proposed Amendments to Rule G-8
    The proposed amendments to Rule G-8 would require each municipal 
advisor to make and keep any document created by the municipal advisor 
that was material to its review of a recommendation by another party or 
that memorialize its basis for any conclusions as to suitability.
2. Statutory Basis
    Section 15B(b)(2) of the Exchange Act \31\ provides that:
---------------------------------------------------------------------------

    \31\ 15 U.S.C. 78o-4(b)(2).

    The Board shall propose and adopt rules to effect the purposes 
of this title with respect to transactions in municipal securities 
effected by brokers, dealers, and municipal securities dealers and 
advice provided to or on behalf of municipal entities or obligated 
persons by brokers, dealers, municipal securities dealers, and 
municipal advisors with respect to municipal financial products, the 
issuance of municipal securities, and solicitations of municipal 
entities or obligated persons undertaken by brokers, dealers, 
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municipal securities dealers, and municipal advisors.

    Section 15B(b)(2)(C) of the Exchange Act \32\ provides that the 
MSRB's rules shall:

    \32\ 15 U.S.C. 78o-4(b)(2)(C).
---------------------------------------------------------------------------

    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 and 
municipal financial products, to remove impediments to and perfect 
the mechanism of a free and open market in municipal securities and 
municipal financial products, and, in general, to protect investors, 
municipal entities, obligated persons, and the public interest.

    Section 15B(b)(2)(L)(i) of the Exchange Act \33\ requires, with 
respect to municipal advisors, the Board to adopt rules to prescribe 
means reasonably designed to prevent acts, practices, and courses of 
business as are not consistent with a municipal advisor's fiduciary 
duty to its clients.
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    \33\ 15 U.S.C. 78o-4(b)(2)(L)(i).
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    The MSRB believes that, the proposed rule change is consistent with 
Sections 15B(b)(2),\34\ 15B(b)(2)(C) \35\ and 15B(b)(2)(L)(i) \36\ of 
the Exchange Act because it will enhance the protections afforded to 
municipal bond issuers and investors by providing guidance to municipal 
advisors that is designed to promote compliance with the standards of 
conduct, requirements and intent of the Dodd-Frank Act.
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 78o-4(b)(2).
    \35\ 15 U.S.C. 78o-4(b)(2)(C).
    \36\ 15 U.S.C. 78o-4(b)(2)(L)(i).
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    In this regard, neither the Dodd-Frank Act nor the recently-adopted 
SEC Final Rule prescribe the duties and obligations of municipal 
advisors beyond a general statement that municipal advisors shall be 
deemed to have a fiduciary duty to any municipal entity for whom the 
municipal advisor acts as a municipal advisor. Adoption of Proposed 
Rule G-42 will fulfill the need for regulatory guidance with respect to 
the standards of conduct and duties of municipal advisors and the 
prevention of breaches of a municipal advisor's fiduciary duty to its 
municipal entity clients. Proposed Rule G-42 also will establish 
standards of conduct and duties for municipal advisors when engaging in 
municipal advisory activities for obligated persons and provide 
guidance to these municipal advisors as to what conduct would satisfy 
these duties and obligations.
    The MSRB believes that by articulating specific standards of 
conduct and duties for municipal advisors, Proposed Rule G-42 will 
assist municipal advisors in complying with the statutorily-imposed 
requirements of the Dodd-Frank Act, and help prevent failures to meet 
those requirements. The proposed rule change will aid municipal 
entities and obligated persons that choose to engage municipal advisors 
in connection with their issuances of municipal securities as well as 
transactions in municipal financial products by promoting higher 
ethical and professional standards of such municipal advisors. The MSRB 
also believes that articulating standards of conduct and duties of 
municipal advisors will enhance the ability of the MSRB and other 
regulators to oversee the conduct of municipal advisors, as 
contemplated by the Dodd-Frank Act.
    The MSRB believes the proposed rule change will enhance municipal 
entity and obligated person protections by ensuring that these entities 
have access to sufficient information to make meaningful choices, based 
on the merits of the municipal advisor, when considering engaging a 
municipal advisor by requiring municipal advisors to provide detailed 
disclosures of material conflicts of interest and certain other 
information prior to or upon the establishment of the municipal 
advisory relationship. As a result, municipal advisor clients will be 
able to evaluate municipal advisors on this objective set of 
information. These protections will also be enhanced as a result of the 
proposed rule change's guidance for municipal advisors that could 
assist advisors in complying with, or help prevent breaches of, their 
fiduciary duty and duty of care, as well as other applicable 
obligations such as the duty of fair dealing (which is owed under MSRB 
Rule G-17 by all municipal advisors to all persons). To the extent that 
this guidance, provided in the supplementary material in the proposed 
rule change, would increase the likelihood of compliance by municipal 
advisors, municipal entities and obligated persons will benefit. 
Investors in municipal bond offerings will also benefit from the 
proposed rule change to the extent that a municipal entity or obligated 
person issuing bonds that uses a municipal advisor is more likely to 
receive services that reflect a higher ethical and professional 
standard than otherwise would be the case.
    The proposed rule change would also, to some extent, prescribe 
means for municipal advisors to help prevent breaches of these duties, 
which would include, among others: Requirements for the information 
that must be included in the documentation of the municipal advisory 
relationship; specified activities (such as certain principal 
transactions) that would be explicitly prohibited; and disclosure 
requirements that must accompany a municipal advisor's recommendation 
regarding a municipal security or a municipal financial product.
    Section 15B(b)(2)(L)(iv) of the Exchange Act \37\ requires that 
rules adopted by the Board:
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    \37\ 15 U.S.C. 78o-4(b)(2)(L)(iv).

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[[Page 26759]]

    not impose a regulatory burden on small municipal advisors that 
is not necessary or appropriate in the public interest and for the 
protection of investors, municipal entities, and obligated persons, 
provided that there is robust protection of investors against fraud.
    The MSRB believes that the proposed rule change is consistent with 
Section 15B(b)(2)(L)(iv) of the Exchange Act \38\ because the proposed 
rule change would impose on all municipal advisors, including small 
municipal advisors, only the necessary and appropriate regulatory 
burdens needed to promote compliance with the proposed rule change. To 
accomplish this, Proposed Rule G-42 would use both a principles and 
prescriptive-based approach to establish the core standards of conduct 
in order to, among other things, accommodate the diversity of the 
municipal advisor population, including small municipal advisors and 
sole proprietorships, and to provide uniform protections to its 
clients, investors and the public.
---------------------------------------------------------------------------

    \38\ 15 U.S.C. 78o-4(b)(2)(L)(iv).
---------------------------------------------------------------------------

    The MSRB recognizes that municipal advisors would incur costs to 
meet the standards of conduct and duties contained in the proposed rule 
changes. These costs also could include additional compliance and 
recordkeeping costs. To ensure compliance with the disclosure 
obligations of the proposed rule change, municipal advisors could incur 
costs by seeking advice from legal and compliance professionals when 
preparing disclosures to clients. However, the MSRB believes that some 
of these costs are accounted for in the SEC Final Rule which requires 
disclosure of at least some similar information, such as the disclosure 
of disciplinary events. Proposed Rule G-42 could also impose additional 
costs on municipal advisors by requiring the disclosure of additional 
information directly to clients, some of which must already be 
submitted to the SEC on SEC Forms MA \39\ and MA-I.\40\ The MSRB has 
considered these costs and that there could be some instances of 
duplicative disclosure, but believes that the overlap in disclosure 
requirements between the SEC and MSRB will be minimal and that the 
disclosure requirements of the proposed rule are important elements of 
Proposed Rule G-42 that protect municipal advisor clients and foster 
transparency in the municipal advisory marketplace.
---------------------------------------------------------------------------

    \39\ 17 CFR 249.1300.
    \40\ 17 CFR 249.1310.
---------------------------------------------------------------------------

    As to the potential costs associated with additional recordkeeping 
requirements, the SEC recognized in its economic analysis \41\ of its 
recordkeeping requirements that municipal advisors should already be 
maintaining books and records as part of their day-to-day operations. 
In addition, municipal advisors who are also registered as broker-
dealers or investment advisers are currently subject to the 
recordkeeping requirements of those regulatory frameworks. Against this 
back-drop, the MSRB believes that the costs associated with the few 
additional recordkeeping requirements associated with Proposed Rule G-
42 will not be significant.
---------------------------------------------------------------------------

    \41\ See SEC Final Rule, 78 FR at 67619.
---------------------------------------------------------------------------

    The MSRB believes that any increase in municipal advisory fees 
attributable to the additional costs of the proposed rule change will 
be minimal and that at least the element of fixed costs per municipal 
advisory firm will be spread across the number of advisory engagements 
for each firm. The MSRB recognizes, however, that for smaller municipal 
advisors with fewer clients, the cost of compliance with the proposed 
rule change's standards of conduct and duties could represent a greater 
percentage of annual revenues, and, thus, such advisors could be more 
likely to pass those costs along to their advisory clients.
    The MSRB also recognizes that, as a result of these costs, some 
municipal advisors could decide to exit the market, curtail their 
activities, consolidate with other firms, or pass the costs on to 
municipal entities and obligated persons in the form of higher fees. 
The MSRB believes, however, that by articulating the core standard of 
conduct and duties and obligations of municipal advisors and by 
prescribing means that would prevent breaches of these duties, the 
proposed rule change will reduce possible confusion and uncertainty 
about what is required in order to comply with relevant provisions of 
the Dodd-Frank Act. Therefore, the proposed rule change likely will 
reduce certain costs of compliance that might have otherwise been 
incurred by allowing municipal advisors to more quickly and accurately 
determine compliance requirements.
    The MSRB also believes that the proposed rule change is consistent 
with Section 15B(b)(2)(G) of the Exchange Act,\42\ which provides that 
the MSRB's rules shall:
---------------------------------------------------------------------------

    \42\ 15 U.S.C. 78o-4(b)(2)(G).

prescribe records to be made and kept by municipal securities 
brokers, municipal securities dealers, and municipal advisors and 
---------------------------------------------------------------------------
the periods for which such records shall be preserved.

    The proposed rule change would require, under the proposed 
amendments to Rule G-8, that a municipal advisor make and keep records 
of any document created by the municipal advisor that was material to 
its review of a recommendation by another party or that memorializes 
the basis for any conclusions as to suitability. The MSRB believes that 
the proposed amendments to Rule G-8 related to recordkeeping (with the 
ensuing application of existing Rule G-9 on records preservation) would 
promote compliance and facilitate enforcement of Proposed Rule G-42, 
other MSRB rules, and other applicable securities laws and regulations.

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

    Section 15B(b)(2)(C) \43\ of the Exchange Act requires that MSRB 
rules not be designed to impose any burden on competition not necessary 
or appropriate in furtherance of the purposes of the Act. In addition, 
Section 15B(b)(2)(L)(iv) \44\ of the Exchange Act provides that MSRB 
rules may not impose a regulatory burden on small municipal advisors 
that is not necessary or appropriate in the public interest and for the 
protection of investors, municipal entities, and obligated persons, 
provided that there is robust protection of investors against fraud.
---------------------------------------------------------------------------

    \43\ 15 U.S.C. 78o-4(b)(2)(C).
    \44\ 15 U.S.C. 78o-4(b)(2)(L)(iv).
---------------------------------------------------------------------------

    In determining whether these standards have been met, the MSRB was 
guided by the Board's Policy on the Use of Economic Analysis in MSRB 
Rulemaking.\45\ In accordance with this policy, the Board evaluated the 
potential impacts of the proposed rule, including in comparison to 
reasonable alternative regulatory approaches, relative to the baseline 
that, inter alia, deemed municipal advisors to owe a fiduciary duty to 
their municipal entity clients and established a registration 
requirement. Based on this evaluation, the MSRB does not believe that 
the proposed rule change would impose any additional burdens on 
competition that are not necessary or appropriate in furtherance of the 
purposes of the Exchange Act.
---------------------------------------------------------------------------

    \45\ Policy on the Use of Economic Analysis in MSRB Rulemaking, 
available at http://www.msrb.org/About-MSRB/Financial-and-Other-Information/Financial-Policies/Economic-Analysis-Policy.aspx.
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    The proposed rule may also provide a range of benefits to municipal 
entities, investors and municipal advisors. Municipal entities and 
obligated persons will have access to more information about municipal 
advisors

[[Page 26760]]

and can make better, more informed choices with lower search costs. The 
availability of additional, objective information and the fostering of 
merit-based competition among municipal advisors should lead to 
enhanced issuer protections and improved outcomes. These improvements 
likely would enhance investor confidence in the integrity of the 
market. Moreover, the MSRB believes that the proposed rule change will 
provide a benefit to municipal advisors who could otherwise face 
greater uncertainty about the standards of conduct and duties required 
to meet certain of the requirements of the Dodd-Frank Act.
    The MSRB considered whether costs associated with the proposed rule 
change, relative to the baseline, could affect the competitive 
landscape by leading some municipal advisors to exit the market, 
curtail their activities, consolidate with other firms, or pass costs 
on to municipal entity and obligated person clients in the form of 
higher fees. In addition, the MSRB considered whether the costs 
associated with the proposed rule, relative to the baseline, could 
create barriers to entry for firms wishing to offer to engage in 
municipal advisory activities.
    The MSRB recognizes that some municipal advisors may exit the 
market as a result of the costs associated with the proposed rule 
relative to the baseline. However, the MSRB believes municipal advisors 
may exit the market for a number of reasons other than costs associated 
with the proposed rule. The MSRB also recognizes that some municipal 
advisors may consolidate with other municipal advisors in order to 
benefit from economies of scale (e.g., by leveraging existing 
compliance resources of a larger firm) rather than to incur separately 
the costs associated with the proposed rule. Finally, the MSRB 
acknowledges that some potential market entrants may be discouraged 
from entering the market because of costs or because the requirement to 
disclose information such as disciplinary events might make attracting 
business more difficult.
    It is also possible that competition for municipal advisory 
activities may be affected by whether incremental costs associated with 
requirements of the proposed rule are passed on to advisory clients. 
The amount of costs passed on may be influenced by the size of the 
municipal advisory firm. For smaller municipal advisors with fewer 
clients, the incremental costs associated with the requirements of the 
proposed rule may represent a greater percentage of annual revenues, 
and, thus, such advisors may be more likely to pass those costs along 
to their advisory clients. As a result, the competitive landscape may 
be altered by the potentially impaired ability of smaller firms to 
compete for advisory clients.
    In addition to the factors noted above that may affect smaller 
advisory firms, the MSRB understands that some small municipal advisors 
and sole proprietors may not employ full-time compliance staff and that 
the cost of ensuring compliance with the requirements of the proposed 
rule may be proportionally higher for these smaller firms.
    The MSRB believes these costs represent only those necessary to 
achieve the purposes of the Exchange Act. Relative to draft Rule G-42 
as initially published for comment,\46\ the MSRB has made efforts to 
minimize costs that could affect the competitive landscape including, 
narrowing the scope of the conflicts that must be disclosed, specifying 
a less burdensome method for disclosing conflicts and disciplinary 
actions and documenting the municipal advisory relationship, clarifying 
the obligations owed by municipal advisors to obligated persons, and 
removing a number of other previously considered requirements.
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    \46\ The MSRB sought comment on the initial draft Rule G-42 
(``Initial Draft Rule'') and draft amendments to Rules G-8 and G-9 
in MSRB Notice 2014-01 (Jan. 9, 2014) (``First Request for 
Comment'').
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    Further, while exit, consolidation, or a reduced number of new 
market entrants may lead to a reduced pool of municipal advisors, the 
SEC concluded in the SEC Final Rule (on the permanent registration of 
municipal advisors) that the market would be likely to remain 
competitive despite the potential exit of some municipal advisors 
(including small entity municipal advisors), consolidation of municipal 
advisors, or lack of new entrants into the market.\47\
---------------------------------------------------------------------------

    \47\ See SEC Final Rule, 78 FR at 67608.
---------------------------------------------------------------------------

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

    The MSRB solicited comment on the proposed rule change in the First 
Request for Comment, requesting comment on a draft of Rule G-42 and 
draft amendments to Rules G-8 and G-9, and a second notice requesting 
comment on a revised draft of Rule G-42 and draft amendments to Rules 
G-8 and G-9.\48\
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    \48\ See MSRB Notice 2014-12 (Jul. 23, 2014) (``Second Request 
for Comment''). The draft rule text published in the Second Request 
for Comment is hereinafter the ``Revised Draft Rule.''
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    The MSRB received forty-six comment letters in response to the 
First Request for Comment,\49\ and nineteen

[[Page 26761]]

comment letters in response to the Second Request for Comment.\50\ The 
comments are summarized below by topic and MSRB responses are 
provided.\51\
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    \49\ Comments were received in response to the First Request for 
Comment from: Acacia Financial Group, Inc.: Letter from Kim M. 
Whelan, Co-President, dated March 10, 2014 (``Acacia''); American 
Bankers Association: Letter from Cristeena G. Naser, Vice President 
and Senior Counsel, dated March 4, 2014 (``ABA''); American Council 
of Engineering Companies: Letter from David A. Raymond, President 
and CEO, dated March 7, 2014 (``ACEC''); American Public 
Transportation Association: Letter from Michael P. Melaniphy, 
President and CEO, dated March 10, 2014 (``APTA''); Bond Dealers of 
America: Letter from Michael Nicholas, Chief Executive Officer, 
dated March 10, 2014 (``BDA''); Cape Cod Five Cents Savings Bank: 
Letter from Dorothy A. Savarese, President and Chief Executive 
Officer, dated March 10, 2014 (``Cape Cod Savings''); Chancellor 
Financial Associates: Email from William J. Caraway, President, 
dated January 14, 2014 (``Chancellor Financial''); Coastal 
Securities: Letter from Chris Melton, Executive Vice President, 
dated March 10, 2014 (``Coastal''); College Savings Foundation: 
Letter from Mary G. Morris, Chair, dated March 10, 2014 (``CSF''); 
College Savings Plans Network: Letter from Betty Everitt Lochner, 
Director, Guaranteed Education Tuition Program, dated March 10, 2014 
(``CSPN''); Cooperman Associates: Letter from Joshua G. Cooperman 
dated March 10, 2014 (``Cooperman''); Erika Miller: Email dated 
February 4, 2015; FCS Group: Letter from Taree Bollinger, Vice 
President, dated March 17, 2014 (``FCS''); First River Advisory 
L.L.C.: Letter from Shelley J. Aronson, President, dated January 16, 
2014 (``First River Advisory''); First Southwest Company: Letter 
from Hill A. Feinberg, Chairman and Chief Executive Officer, and 
Michael G. Bartolotta, Vice Chairman, dated March 7, 2014 (``First 
Southwest''); Frost Bank: Letter from William H. Sirakos, Senior 
Executive Vice President, dated March 10, 2014 (``Frost''); George 
K. Baum & Company: Letter from Guy E. Yandel, EVP and Head of Public 
Finance, Dana L. Bjornson, EVP, CFO and Chief Compliance Officer, 
and Andrew F. Sears, SVP and General Counsel, dated March 10, 2014 
(``GKB''); Government Finance Officers Association: Letter from 
Dustin McDonald, Director, Federal Liaison Center, dated March 13, 
2014 (``GFOA''); Government Investment Officers Association: Letter 
from Laura Glenn, President, et al., dated March 7, 2014 (``GIOA''); 
Investment Company Institute: Letter from Tamara K. Salmon, Senior 
Associate Counsel, dated March 4, 2014 (``ICI''); J.P. Morgan: 
Letter from Paul N. Palmeri, Managing Director, dated March 10, 2014 
(``JP Morgan''); Kutak Rock LLP: Letter from John J. Wagner dated 
March 10, 2014 (``Kutak''); Lamont Financial Services Corporation: 
Letter from Robert A. Lamb, President, dated March 10, 2014 
(``Lamont''); Lewis Young Robertson & Burningham, Inc.: Letter from 
Laura D. Lewis, Principal, dated March 3, 2014 (``Lewis Young''); 
MSA Professional Services, Inc.: Letter from Gilbert A. Hantzsch, 
CEO, dated March 10, 2014 (``MSA''); National Association of Bond 
Lawyers: Letter from Allen K. Robertson, President, dated March 18, 
2014 (``NABL''); National Association of Health and Educational 
Facilities Finance Authorities: Letter from Pamela Lenane, 
President, David J. Kates, Chapman and Cutler LLP, and Charles A. 
Samuels, Mintz Levin, dated March 10, 2014 (``NAHEFFA''); National 
Association of Independent Public Finance Advisors: Letter from 
Jeanine Rodgers Caruso, President, dated March 10, 2014 
(``NAIPFA''); National Healthcare Capital LLC: Letter from Richard 
Plumstead, dated March 10, 2014; New York State Bar Association: 
Letter from Peter W. LaVigne, Chair of the Committee, dated March 
12, 2014 (``NY State Bar''); Northland Securities, Inc.: Letter from 
John R. Fifield, Jr., Director of Public Finance/Senior Vice 
President, dated March 7, 2014 (``Northland''); Oppenheimer & Co. 
Inc.: Email from John Rodstrom dated March 10, 2014 
(``Oppenheimer''); Parsons Brinckerhoff Advisory Services, Inc.: 
Letter from Mark E. Briggs, President, dated March 10, 2014 
(``Parsons''); Piper Jaffray: Letter from Frank Fairman, Managing 
Director, Head of Public Finance Services, dated March 10, 2014 
(``Piper Jaffray''); Public Financial Management, Inc.: Letter from 
John H. Bonow, Chief Executive Officer, dated March 10, 2014 
(``PFM''); Public Resources Advisory Group: Letter from Thomas 
Huestis dated March 10, 2014 (``PRAG''); Raftelis Financial 
Consultants, Inc.: Letter from Lex Warmath dated March 10, 2014 
(``Raftelis Financial''); Securities Industry and Financial Markets 
Association: Letter from Leslie M. Norwood, Managing Director and 
Associate General Counsel, dated March 10, 2014 (``SIFMA''); 
Sutherland Asbill & Brennan LLP: Letter from Michael B. Koffler 
dated March 10, 2014 (``Sutherland''); Wells Fargo Advisors, LLC: 
Letter from Robert J. McCarthy, Director of Regulatory Policy, dated 
March 10, 2014 (``Wells Fargo''); Winters & Co. Advisors, LLC: 
Letter from Christopher J. Winters dated March 10, 2014 (``Winters 
LLC''); WM Financial Strategies: Letter from Joy A. Howard, 
Principal, dated March 10, 2014 (``WM Financial''); Woodcock & 
Associates, Inc.: Email from Christopher Woodcock dated January 14, 
2014 (``Woodcock''); Wulff, Hansen & Co.: Letter from Chris Charles, 
President, dated March 17, 2014 (``Wulff Hansen''); Yuba Group: 
Letter from Linda Fan, Managing Partner, dated March 7, 2014 
(``Yuba''); Zion's First National Bank: Letter from W. David 
Hemingway, Executive Vice President, dated March 10, 2014 
(``Zion'').
    \50\ Comments were received in response to the Second Request 
for Comment from: ABA: Letter from Cristeena Naser, Vice President, 
Center for Securities, Trust & Investments, dated August 25, 2014; 
ACEC: Letter from David A. Raymond, President and CEO, dated August 
25, 2014; BDA: Letter from Michael Nicholas, Chief Executive 
Officer, dated August 25, 2014; Columbia Capital Management, LLC: 
Letter from Jeff White, Principal, dated August 25, 2014 (``Columbia 
Capital''); Dave A. Sanchez: Letter dated August 25, 2014 
(``Sanchez''); Financial Services Roundtable: Letter from Richard 
Foster, Vice President and Senior Counsel for Regulatory and Legal 
Affairs, dated August 25, 2014 (``FSR''); Florida Division of Bond 
Finance: Letter from J. Ben Watkins III, Director, dated August 22, 
2014 (``FLA DBF''); GFOA: Letter from Dustin McDonald, Director, 
Federal Liaison Center, dated September 2, 2014; ICI: Letter from 
Tamara K. Salmon, Senior Associate Counsel, dated August 19, 2014; 
Mr. Bart Leary: Email dated July 23, 2014 (``Leary''); Lewis Young: 
Letter from Laura D. Lewis, Principal, dated August 25, 2014; 
NAIPFA: Letter from Jeanine Rodgers Caruso, President, dated August 
25, 2014; New York State Bar: Letter from Peter W. LaVigne, Chair of 
the Committee, dated August 27, 2014; Piper Jaffray: Letter from 
Frank Fairman, Managing Director, Head of Public Finance Services, 
dated August 25, 2014; SIFMA: Letter from Leslie M. Norwood, 
Managing Director and Associate General Counsel, dated August 25, 
2014; Southern Municipal Advisors, Inc.: Letter from Michael C. 
Cawley, Senior Consultant, dated August 25, 2014 (``SMA''); Wells 
Fargo: Letter from Robert J. McCarthy, Director of Regulatory 
Policy, dated August 25, 2014; WM Financial: Letter from Joy A. 
Howard, Principal, dated August 25, 2014; and Zion: Letter from W. 
David Hemingway, Executive Vice President, dated August 25, 2014.
    \51\ The draft rule text included in the First Request for 
Comment is referred to herein as the ``Initial Draft Rule;'' the 
draft rule text included in the Second Request for Comment is 
referred to herein as the ``Revised Draft Rule.''
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Standards of Conduct
    Under Proposed Rule G-42(a), a municipal advisor would be subject 
to a duty of care as to its obligated person clients under subsection 
(a)(i) and a fiduciary duty as to its municipal entity clients under 
subsection (a)(ii) when engaging in municipal advisory activities for 
such clients. Several commenters raised concerns relating to the 
proposed standards of conduct that would apply to municipal advisors.
Scope of the Fiduciary Relationship
    In the First Request for Comment, the MSRB proposed that a 
municipal advisor be subject to a fiduciary duty when engaging in 
municipal advisory activities for municipal entity clients. 
Subsequently, in the Second Request for Comment, the MSRB asked whether 
the Revised Draft Rule should uniformly apply the proposed fiduciary 
standard to a municipal advisor in its relationships with all of its 
clients, including obligated persons. A number of commenters opposed 
extending the application of the fiduciary standard to municipal 
advisors in connection with their obligated person clients.\52\
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    \52\ See, e.g., comment letters from: ABA, BDA, Cape Cod 
Savings, Cooperman, GKB, Kutak, Lewis Young, NABL, NAHEFFA, Parsons, 
Piper Jaffray and SIFMA. A few commenters, including First River 
Advisory, NAIPFA and Yuba, supported the application of a fiduciary 
duty to a municipal advisor when engaging in municipal advisory 
activities on behalf of an obligated person client.
---------------------------------------------------------------------------

    The MSRB believes that the application of the fiduciary standard is 
appropriately limited to municipal advisors when engaging in municipal 
advisory activities for or on behalf of municipal entity clients and 
strikes the appropriate balance. Proposed Rule G-42 establishes a 
minimum standard, which, as noted by NABL, does not limit an obligated 
person client and its municipal advisor from agreeing to a higher 
standard of conduct, or incorporating other requirements or protections 
in the municipal advisory relationship.
Scope of the Duty/529 Plans
    Proposed paragraph .01 of the Supplementary Material provides that 
a municipal advisor acting in accordance with the duty of care must 
undertake reasonable investigation to determine that it is not basing 
any recommendation made to a client on materially inaccurate or 
incomplete information. In response to the First and Second Request for 
Comment, ICI stated that municipal advisors to 529 college savings 
plans (``529 plans'') should not be required to verify the veracity or 
completeness of the information provided to the municipal advisor by 
authorized state employees or officials who are authorized to act on 
behalf of the 529 plan. ICI requested that paragraph .01 of the 
Supplementary Material be revised not to require municipal advisors to 
investigate whether information is materially inaccurate or incomplete 
when it is provided to the municipal advisor by persons who are 
authorized by the client to act on behalf of a state's 529 plan.
    Neither the First Request for Comment nor the Second Request for 
Comment contemplated that municipal advisors in municipal advisory 
relationships with 529 plans would be exempted or excluded, in whole or 
in part, from the proposed core standards of conduct, including aspects 
of the duty of care that a municipal advisor owes to a client. The MSRB 
believes that exempting municipal advisors from the proposed core 
standards of conduct would reduce the protections that Congress through 
the Dodd-Frank Act intended to provide to municipal entity clients and 
investors in 529 plan securities.
Fiduciary Duty--Authority
    In response to the Second Request for Comment, Sanchez commented 
that the MSRB lacks the statutory authority to define ``fiduciary 
duty'' or to prescribe means designed to effectuate the performance of 
that duty.
    As discussed above, the Exchange Act grants the MSRB statutory 
authority to adopt rules with respect to municipal advisors engaging in 
municipal advisory activities that are designed to, among other things, 
prevent fraudulent and manipulative acts and practices, and acts, 
practices or courses of business that are not consistent with a 
municipal advisor's fiduciary duty to its clients.\53\ Accordingly, the 
MSRB has concluded that it is properly exercising the authority granted 
to it by statute.
---------------------------------------------------------------------------

    \53\ See, e.g., 15 U.S.C. 78o-4(b)(2)(C); and 15 U.S.C. 78o-
4(b)(2)(L)(i).
---------------------------------------------------------------------------

Fiduciary Duty--Standards
    In response to the First Request for Comment, NABL stated that the 
Initial Draft Rule should draw on established common law and similar 
standards that NABL believes are intended to provide substantive 
guidance regarding fiduciary duties (e.g., the standards applicable to 
attorneys), rather than the standards applicable to broker-dealers or 
registered investment advisers. NABL argued that the attorney-client 
relationship is more comparable to the municipal advisor-client 
relationship

[[Page 26762]]

because both can have a wide spectrum of scopes of responsibilities, 
similar contexts in which there are interactions with the client, and a 
longer duration over which the representation occurs. BDA similarly 
believed that the fiduciary standards set forth in the Initial Draft 
Rule would not operate like other well-established standards, such as 
those for attorneys, and that the MSRB did not justify why the 
standards for municipal advisors would deviate from those standards as 
outlined in the Model Rules of Professional Conduct for attorneys 
(``Model Rules''). Accordingly, BDA suggested that Proposed Rule G-42 
should adopt or parallel the same fiduciary duty standards used by 
other similarly situated professionals.
    In developing Proposed Rule G-42, the MSRB consulted various codes 
of conduct and sources of federal and state law regarding the duties 
and obligations of a fiduciary that apply to professionals who are, or, 
in certain relationships, may be, fiduciaries. Some provisions of the 
proposed rule reflect principles incorporated from MSRB Rule G-17, 
including the duties of dealers to issuers, while other provisions were 
based on principles and requirements in the Investment Advisers Act. 
The MSRB believes the Investment Advisers Act is particularly relevant 
in developing a rule regarding fiduciary duties and obligations, and 
notes that the SEC also considered the Investment Advisers Act 
informative as it developed the SEC Final Rule.\54\ Moreover, the MSRB 
believes it is important to establish rules and standards that address 
the practices of various types of municipal advisors and their clients, 
and that the provisions addressing the duties and obligations of a 
fiduciary are tailored to address the unique characteristics of the 
municipal securities market and the variety of responsibilities 
undertaken by municipal advisors in their relationships with municipal 
entity and obligated person clients. The MSRB notes that, to the extent 
that Proposed Rule G-42 does not specifically prescribe or prohibit 
certain conduct, or address certain activity, common law regarding 
fiduciary obligations and duties may be referenced by a judicial or 
adjudicatory decision-maker.
---------------------------------------------------------------------------

    \54\ See generally, SEC Final Rule, 78 FR 67467.
---------------------------------------------------------------------------

Fiduciary Duty--Obligated Persons
    A number of commenters raised concerns that Proposed Rule G-42 
implicitly and inappropriately imposes fiduciary duty obligations on 
municipal advisors whose clients are obligated persons without a 
demonstrated need for a more robust regulatory framework than that 
adopted by Congress or the SEC.\55\ Those commenters believed that the 
treatment accorded to obligated persons should be distinguished from 
that accorded to municipal entities because, as they stated, obligated 
person clients do not handle public funds, are private, domestic and 
international for-profit companies or not-for-profit businesses, and, 
therefore, operate with a different level of public accountability. 
Overall, these commenters believed that fiduciary duties should not be 
mandatorily extended to benefit obligated persons.
---------------------------------------------------------------------------

    \55\ See letters from: ABA, BDA, Cape Cod Savings, GKB, Kutak, 
Lewis Young, NABL, NAHEFFA, Parsons, Piper Jaffray, Sanchez and 
SIFMA. On the other hand, NAIPFA, First River Advisory and Yuba 
supported imposing fiduciary duties upon municipal advisors with 
respect to the advice they provide to obligated persons.
---------------------------------------------------------------------------

    NAHEFFA suggested that the duty of care and the requirements of the 
Initial Draft Rule G-42(b)-(f) be revised to state that municipal 
advisors owe a fiduciary duty only to their municipal entity clients. 
In the alternative, NAHEFFA requested that the MSRB provide 
clarification on the legal and practical distinctions among the 
standards and duties and obligations of municipal advisors vis-
[agrave]-vis both types of clients, including a clarification that an 
alleged violation of the duty of care would be subject to review under 
a negligence standard and an alleged violation of the duty of loyalty 
would require evidence of intent. Generally, NAHEFFA supported either a 
revised Rule G-42, or a separate rule that would simplify and reflect 
the duties and obligations of a municipal advisor with respect to its 
obligated person clients. NAHEFFA suggested that, as to obligated 
person clients, the duty should be to exercise professional judgment 
and expertise in providing services and to deal fairly with its 
clients. Similarly to NAHEFFA, BDA requested that the MSRB revise 
Proposed Rule G-42 to more clearly state and distinguish between the 
duties and obligations that municipal advisors would owe to each of the 
two types of clients.
    ABA commented that the MSRB lacked the requisite authority to 
impose a fiduciary duty on municipal advisors with respect to their 
obligated person clients, and that even if it had the authority, such a 
standard would be unworkable since banks would have difficulty 
identifying which of their many customers were obligated persons. ABA 
stated that the extension of a fiduciary duty to municipal advisors in 
their relationship with their obligated person clients would result in 
a significant risk that banks would inadvertently violate regulatory 
requirements by becoming an unwitting municipal advisor with respect to 
a client they did not know was an obligated person. Moreover, the banks 
would run the corresponding risk of violating the attendant fiduciary 
duty applicable to such municipal advisor.
    More specifically, Sanchez commented that the language in Revised 
Draft Rule G-42(b)(i)(A) and (b)(i)(G) appeared to import the duty of 
loyalty and duty of care into representations of obligated persons by 
using the phrase ``unbiased and competent advice'' with respect to 
advice provided to or on behalf of obligated persons. He suggested that 
these provisions be revised to say ``impair its ability to render 
advice to or on behalf of the obligated person in accordance with the 
standards of conduct required in clause (a)'' in lieu of the phrase 
referencing ``unbiased and competent advice.''
    Neither the Initial Draft Rule nor the Revised Draft Rule would 
deem municipal advisors to owe a fiduciary duty to obligated person 
clients, and the MSRB disagrees with the view that either the Initial 
or Revised Draft Rule implicitly and inappropriately imposed fiduciary 
duty obligations to such clients. After carefully considering the 
comments, the MSRB has not modified Proposed Rule G-42(a), on standards 
of conduct. Further, Proposed Rule G-42 follows the approach taken in 
the Dodd-Frank Act, deeming a municipal advisor to owe a fiduciary duty 
only to its municipal entity clients. However, although the Exchange 
Act fiduciary duty standard would not apply to a municipal advisor 
advising an obligated person client, all municipal advisors are subject 
to fair-dealing obligations under MSRB Rule G-17, which already 
requires a municipal advisor to deal fairly with all persons and 
prohibits engaging in any deceptive, dishonest or unfair practice. 
Moreover, the provisions in Proposed Rule G-42(b)-(f) appropriately 
establish the duties and obligations of municipal advisors. The MSRB 
notes that these duties are, in part, based on similar existing duties 
for other regulated entities (e.g., underwriters' duties to issuers), 
which are separate and apart from a fiduciary duty. Therefore, the MSRB 
does not believe Proposed Rule G-42 creates an implicit fiduciary duty 
for municipal advisors with respect to the advice they provide to 
obligated person clients.
    The MSRB agrees with Sanchez's specific comments regarding 
paragraphs (b)(i)(A) and (b)(i)(G) of the Revised Draft Rule and has 
revised the proposed rule change to clearly differentiate between the 
handling of conflicts of

[[Page 26763]]

interest under the duty of loyalty, as discussed in paragraph .02 of 
the Supplementary Material, and conflicts under the disclosure 
requirements that are applicable to all municipal advisory clients as 
part of a municipal advisor's duty of care, as discussed in paragraph 
.01 of the Supplementary Material. Specifically, under proposed 
subsection (a)(ii), the duty of loyalty in the proposed rule change, a 
municipal advisor must not engage in municipal advisory activities with 
a municipal entity client if it cannot manage or mitigate its conflicts 
of interest in a manner that will permit it to act in the municipal 
entity's best interests. Conversely, under proposed section (c) of 
Proposed Rule G-42 and as discussed further with respect to proposed 
paragraph .05 of the Supplementary Material, a municipal advisor can 
continue to serve as a municipal advisor to its municipal entity or 
obligated person client when an actual or potential conflict of 
interest that could be reasonably anticipated to impair its ability to 
provide that advice exists, so long as such conflict of interest is 
disclosed and addressed in accordance with the relevant provisions of 
Proposed Rule G-42 \56\ and the municipal advisor can satisfy the 
applicable standards of conduct described in section (a).
---------------------------------------------------------------------------

    \56\ Municipal advisors would be required to disclose and 
document such a material conflict of interest under Proposed Rule G-
42(b) and (c) and paragraph .05 of the Supplementary Material. With 
respect to municipal entity clients, municipal advisors also would 
need to provide an explanation to the client of how the municipal 
advisor intends to manage or mitigate its conflict in a manner that 
will permit it to act in the municipal entity's best interests.
---------------------------------------------------------------------------

    NAHEFFA requested that the MSRB clarify the legal distinctions 
between the duty of care and duty of loyalty, and suggested that the 
state of mind standard to determine a violation of the duty of care 
should be negligence, and the state of mind standard regarding a 
violation of the duty of loyalty should be intent. In response to 
NAHEFFA's request for clarification regarding such standards, the MSRB 
believes it would be appropriate for the courts and other adjudicatory 
authorities to determine the ``state-of-mind'' elements when applying 
the standards of conduct of Proposed Rule G-42 to specific sets of 
facts and circumstances presented, drawing on existing jurisprudence 
regarding analogous duties of care and fiduciary obligations.
    In response to ABA's comment, the MSRB again notes that determining 
which activities constitute municipal advisory activities requires a 
legal interpretation of the SEC Final Rule. Such authority is vested 
with the SEC rather than the MSRB.
    Finally, the MSRB notes again that the standards of conduct in 
Proposed Rule G-42 would be minimum requirements, which the MSRB has 
developed to empower the client to a large extent to determine the 
scope of services and control the engagement with the municipal 
advisor, and as suggested by NABL, any municipal advisor and its client 
may agree to more stringent standards of conduct for their specific 
engagement.
Duty of Care--Supplementary Material .01
    In response to the Second Request for Comment, WM Financial 
challenged the requirement that a municipal advisor ``undertake a 
reasonable investigation to determine that it is not basing any 
recommendation on materially inaccurate or incomplete information.'' 
While WM Financial agreed that a municipal advisor should make a 
reasonable investigation in order to determine whether a recommendation 
is in a client's best interest, WM Financial believed that a municipal 
advisor should be able to rely on publicly-available documents as being 
true and accurate, and should be able to assume that any additional 
information provided to it by the municipal entity is also true and 
accurate. WM Financial believed that requiring the municipal advisor to 
verify the accuracy of the information it receives from a client 
imposes an inappropriate burden. As noted above, ICI similarly opposed 
the requirement in the context of 529 plans, for which the municipal 
advisor that is also acting as a plan sponsor would typically work with 
and rely upon state employees who are authorized to represent a state's 
plan and requested revisions to paragraph .01 of the Supplementary 
Material.
    Proposed paragraph .01 of the Supplementary Material would provide, 
as a core general standard, that a municipal advisor must undertake a 
reasonable investigation to determine that it is not basing any 
recommendation on materially inaccurate or incomplete information. 
There is no exception for information that is provided to the advisor 
by the client. The MSRB believes that the provisions of proposed 
paragraph .01 of the Supplementary Material remain appropriate and, as 
discussed above, does not believe that advisors to 529 plans should be 
relieved from an obligation to inquire as to the accuracy of material 
that is relevant to a municipal advisor's recommendation provided by 
its client or other parties. The MSRB further believes this provision 
of proposed paragraph .01 of the Supplementary Material would provide 
an objective standard for when it is appropriate for a municipal 
advisor to rely on information provided by a client when making a 
recommendation to such client, including representatives of a 529 plan 
authorized to act on behalf of the plan. Finally, because proposed 
paragraph .01 would require municipal advisors to undertake only a 
``reasonable investigation'' of the veracity of the information on 
which it is basing a recommendation, municipal advisors would not be 
required to go to the impractical lengths suggested by commenters. The 
MSRB believes this standard would be sufficient to allow municipal 
advisors to assess their risk exposure to any reliance on that 
information and determine what potential mitigating actions need to be 
taken.
    Sanchez also commented that the MSRB should ``consider whether the 
information for which `a municipal advisor must have a reasonable basis 
for' incorporated in [subparagraphs] (a) through (c) [of paragraph .01 
of the Supplementary Material] is not already addressed in the 
standards of conduct required of municipal advisors by MSRB Rule G-17 
and general antifraud rules related to municipal securities 
disclosure.'' As such, he suggested deleting those provisions of 
paragraph .01 of the Supplementary Material to avoid unnecessarily 
duplicative regulatory requirements. The MSRB has decided to retain 
those provisions because it believes they would provide additional 
guidance regarding the proposed duty of care and would assist municipal 
advisors in satisfying that duty without unnecessarily duplicating the 
principles of MSRB Rule G-17 or other federal securities anti-fraud 
statutes.
    Finally, SIFMA noted that, while the requirement for a municipal 
advisor to make a reasonable inquiry--regarding the facts that are 
relevant to a client's determination to pursue a particular course of 
action or that form the basis of any advice to the client--could be 
appropriate in the context of arranging a municipal securities 
issuance, it could be cost prohibitive in the case of ordinary 
brokerage and related advice, given the number of trades potentially 
involved, timing considerations and the general context of broker-
related advice. Therefore, SIFMA did not believe that such a standard 
should be applied in addition to otherwise applicable suitability 
requirements that would attach to recommendations made in the context 
of brokerage/securities

[[Page 26764]]

execution services. The MSRB believes that the duties and standards in 
the proposed rule are appropriately applied to municipal advisory 
activities (other than the undertaking of a solicitation), and notes 
that a municipal advisor to a municipal entity client will owe a 
statutory fiduciary duty to the client. If the conduct SIFMA describes 
constitutes the giving of advice under the SEC rules providing for the 
registration of municipal advisors as discussed in the SEC Final 
Rule,\57\ then Proposed Rule G-42 would apply in its entirety. 
Likewise, if such conduct did not constitute the giving of advice under 
those rules, then Proposed Rule G-42 would not apply.
---------------------------------------------------------------------------

    \57\ See generally, SEC Final Rule, 78 FR 67467.
---------------------------------------------------------------------------

Duty of Loyalty--Supplementary Material .02
    In response to the First Request for Comment, ACEC and APTA 
indicated that they believed there are circumstances when the duty of 
loyalty could directly conflict with an engineer's professional and 
ethical responsibilities, and expressed concerns as to how such 
conflicts could affect engineering firms' business. Both ACEC and APTA 
specifically stated that, in the course of providing professional 
engineering services to a client, circumstances could arise in which 
the engineer would find himself or herself facing a conflict between 
breaching its fiduciary duty in its role as municipal advisor and 
violating the ethical obligations to which the engineer is subject 
under applicable state law and regulation, or one or more professional 
associations. According to ACEC, in such circumstances, it would be 
detrimental to the health, safety and welfare of the public to 
prioritize the fiduciary duty the engineer municipal advisor owed to 
its client. ACEC argued that paragraph .02 of the Supplementary 
Material, therefore, would not serve the public interest and requested 
that the MSRB address how this type of conflict could be managed.
    The MSRB notes that SEC Rule 15Ba1-1(d)(2)(v) excludes engineers 
providing engineering advice from the definition of municipal 
advisor.\58\ The MSRB further notes that the same and similar issues 
raised by the commenters in response to the First Request for comment 
also were raised with the SEC during its rulemaking to establish the 
registration regime for municipal advisors. In the SEC Final Rule, the 
SEC provided greater clarity to engineers concerning the definition of 
``municipal advisor'' and the scope of the exclusion for engineers.\59\ 
If, given that guidance, an engineer were in fact to engage in 
municipal advisory activities, it would be subject to the statutory 
fiduciary duty to a municipal entity client, and, in the MSRB's view, 
appropriately subject to the duty of loyalty provisions in Proposed 
Rule G-42. Under certain circumstances, if a material conflict of 
interest would prevent the municipal advisor from being able to act in 
accordance with the standards of conduct of section (a) of Proposed 
Rule G-42, which the MSRB believes would be rare, the firm might need 
to determine not to provide municipal advice if it preferred to provide 
engineering services.
---------------------------------------------------------------------------

    \58\ See 17 CFR 240.15Ba1-1(d)(2)(v). See also 15 U.S.C. 78o-
4(e)(4)(C).
    \59\ See SEC Final Rule, 78 FR at 67529-32.
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Disclosure of Conflicts of Interest
    The MSRB received a number of comments regarding section (b) of 
Proposed Rule G-42 on required disclosures of material conflicts of 
interest by municipal advisors to their clients. Generally, commenters 
were supportive of, or did not express an objection to, requiring 
municipal advisors to provide written disclosure of material conflicts 
of interest. However, some commenters did express concerns about some 
of the facets of the disclosure requirements; those concerns are 
described below and followed by the MSRB's response.
Compensation Arrangements
    Several commenters expressed concern regarding paragraph (b)(i)(F) 
of Proposed Rule G-42, which requires municipal advisors to disclose 
conflicts of interest arising from compensation arrangements that are 
contingent on the size or closing of any transaction as to which the 
municipal advisor is providing advice.
    Commenting on the Initial Draft Rule, Lewis Young stated that 
contingent fee arrangements benefit clients, particularly smaller 
municipal entities, because they allow municipal entity clients to 
finance the costs of the municipal advisor with the proceeds of the 
issuance. In their view, characterizing a contingent fee arrangement as 
a conflict of interest requiring disclosure to the client amounted to 
advising a client that the municipal advisor may not be acting in the 
client's best interest. They added that they believe the disclosure 
requirement would serve no useful purpose and could confuse clients. 
Sutherland stated that the Initial Draft Rule's required disclosure of 
contingent fee arrangements was duplicative of SEC Form MA \60\ and, 
therefore, unnecessarily burdensome, and should be deleted.
---------------------------------------------------------------------------

    \60\ See SEC Form MA, Items 4.H.-4.J.
---------------------------------------------------------------------------

    Commenting on the Revised Draft Rule, Columbia Capital stated that 
the provision ``creates the appearance that the MSRB takes the position 
that one fee modality is less preferable to all others.'' Columbia 
Capital, Cooperman and Piper Jaffray commented that the proposed rule 
change should not single out one fee arrangement as being preferable to 
others. Columbia Capital, Cooperman and Piper Jaffray also contended 
that fee arrangements of any sort (hourly, fixed or non-contingent) 
create an adversarial relationship between the municipal advisor and 
its client. In Piper Jaffray's view, the potential conflicts of 
interest that are inherent in all fee arrangements are also ``generally 
knowable'' to both sides of a transaction and, therefore, the Revised 
Draft Rule's disclosure requirement would not be beneficial. Columbia 
Capital suggested deleting the provision.
    WM Financial also expressed concerns regarding paragraph (b)(i)(F) 
of the Revised Draft Rule, but differed in its reasoning from Columbia 
Capital and Piper Jaffray. WM Financial disagreed with the premise that 
all fee structures create some conflict of interest. Rather, WM 
Financial stated that, because municipal advisors would be required to 
``act in the best interest of their clients . . . good advice will 
prevent a fee arrangement from creating a `conflict'.'' In their view, 
a ``conflict of interest does not exist when payment of fees is based 
on the success of services to be provided . . . .'' Like Lewis Young, 
WM Financial stated that contingent fees serve a valuable function 
because they allow small municipal entity clients to finance the cost 
of the municipal advisor with the proceeds from the issuance and ensure 
that the cost of the municipal advisor is only incurred after the 
successful completion of the issuance. WM Financial also requested that 
paragraph (b)(i)(F) be deleted.
    The MSRB has considered the arguments and alternatives advanced by 
commenters and determined that requiring the disclosure of conflicts of 
interest arising from fee arrangements contingent on the size or 
closing of the transaction as to which the municipal advisor is 
providing advice is an appropriate and necessary measure to alert 
municipal entity and obligated person clients to the potential conflict 
of interest inherent in such fee arrangements. While the MSRB 
recognizes, as some commenters

[[Page 26765]]

pointed out, that other fee arrangements (such as hourly, fixed or 
otherwise non-contingent) might also give rise to conflicts, the MSRB 
believes that the potential harm to a client may be particularly acute 
if a client is not informed of a conflict of interest arising from a 
contingent fee arrangement. Furthermore, the MSRB does not agree with 
commenters that have argued that requiring a conflict of interest 
disclosure would suggest that the municipal advisor is not acting in 
the best interest of its client. The purpose of the disclosure 
requirement in proposed paragraph (b)(i)(F) simply would be to allow a 
municipal advisor's client to make an informed decision based on 
relevant facts and circumstances. Also, under the proposed rule change, 
municipal advisors would have the opportunity to provide a client with 
additional context about the benefits and drawbacks of other fee 
arrangements in relation to a contingent fee arrangement so that the 
client could choose a fee arrangement that serves its needs.
Disclosure of Conflicts of Interest to Investors
    The MSRB received comments that called for the deletion of a 
provision set forth previously in the Revised Draft Rule as paragraph 
.08 of the Supplementary Material. Under the provision, if all or a 
portion of a document prepared by a municipal advisor or any of its 
affiliates were included in an official statement for an issue of 
municipal securities by or on behalf of a client of the municipal 
advisor, the municipal advisor would have been required to provide 
written disclosure to investors of any affiliation that would be a 
material conflict of interest under paragraph (b)(i)(B) of the Revised 
Draft Rule. The disclosure requirement also could have been satisfied 
if the relevant affiliate provided the written disclosure to 
investors.\61\
---------------------------------------------------------------------------

    \61\ Paragraph (b)(i)(B) of the Revised Draft Rule required 
written disclosure of ``any affiliate of the municipal advisor that 
provides any advice, service, or product to or on behalf of the 
client that is directly or indirectly related to the municipal 
advisory activities to be performed by the disclosing municipal 
advisor.''
---------------------------------------------------------------------------

    SIFMA supported deleting the disclosure requirement, noting that 
``[m]unicipal advisors and their affiliates may have no contractual or 
other relationships (and in many cases have no form of privity) with 
investors, nor do they control the content of the Official Statement.'' 
SIFMA stated that it is the obligation of the issuer ``to make sure 
that its disclosure is materially accurate and complete'' and the 
responsibility of broker-dealers to comply with their obligations under 
applicable law. SIFMA observed that the municipal advisor is already 
required to provide the issuer with the same conflict disclosure under 
paragraph (b)(i)(B), arguing that the MSRB should leave the decision of 
whether to include such information in material distributed to 
investors to the issuer.
    ICI and NABL also commented in favor of deleting the requirement. 
ICI provided comments similar to SIFMA's comments in response to both 
the Initial and Revised Draft Rules, but focused on how the required 
disclosure to investors would impact municipal advisors advising 529 
plans. ICI supported requiring municipal advisors to disclose conflicts 
of interest to the municipal advisor's client but questioned why such 
information would be relevant to a person investing in 529 plan 
securities. ICI stated that if ``all material terms and conditions of 
the 529 plan offering already are disclosed in the offering document 
that is provided to investors and potential investors, this 
supplemental disclosure would not provide any additional protection to 
investors.'' In response to the First Request for Comment, NABL 
contended that requiring these disclosures would run contrary to the 
intent of the Dodd-Frank Act, which is to protect issuers. NABL 
suggested, as an alternative, that issuers be allowed to choose whether 
to disclose the conflicts of interest to investors.
    The MSRB agrees with the commenters and notes that the provision 
could put municipal advisors in the impractical position of being 
required to make conflict of interest disclosures directly to investors 
or include the content of such disclosures in an issuer's official 
statement, although the municipal advisor may not have the authority or 
the means to do so. Moreover, because the proposed rule change would 
already require the municipal advisor to disclose all material 
conflicts of interest to the issuer, the MSRB believes the issuer will 
be well positioned to make the determination of whether to include such 
information in the official statement or other investor disclosure 
documents, consistent with the issuer's duties under all applicable 
law. In light of the comments and after a re-evaluation of the purpose 
and feasibility of the disclosure provision in the supplementary 
material as described above, the MSRB has deleted the provision.
Acknowledgment or Consent to Conflicts of Interest Disclosure
    In response to the First Request for Comment, several commenters 
suggested differing approaches to the question of whether municipal 
advisors should be required to obtain some form of acknowledgment from 
their client of the conflicts of interest disclosures that municipal 
advisors are required to make under the proposed rule change.
    In response to the First Request for Comment, NABL commented that 
the MSRB should follow the approach taken in the Model Rules of Conduct 
of the American Bar Association regarding the disclosure of conflicts 
of interest as stated in the Initial Draft Rule. NABL argued that 
municipal advisors should be required to obtain ``informed consent, 
confirmed in writing'' to each potentially waivable material conflict 
of interest. NABL stated that this standard is as appropriate for 
municipal advisors as it is for common law fiduciaries or attorneys. 
NABL suggested that the ``informed consent'' it advocated could be 
accomplished in several ways, including ``a writing evidencing an 
engagement, including a letter of intent, after disclosure to the 
client sufficient to establish informed consent.'' NABL contended that 
informed written consent from a municipal advisor's client is ``a 
necessary corollary to the requirement that an advisor disclose and 
provide sufficient detail about the nature of all material conflicts of 
interest.'' NABL also noted that informed consent confirmed in writing 
would be consistent with the requirements of the CFTC for commodity 
trading advisors. NAIPFA stated that it believed municipal advisors 
should be required to obtain an acknowledgment from their clients of 
the conflicts of interest that it has disclosed, saying that this would 
conform to the obligations of underwriters and other ``professionals 
possessing fiduciary duties.'' GFOA provided similar support for 
requiring an acknowledgment of the conflicts of interest disclosures 
from the municipal advisor's client but stated that, if such a 
requirement was added to the proposed rule change it would expect an 
explanation within the proposed rule change detailing how the 
acknowledgements of such conflicts relate to a municipal advisor's 
fiduciary duty.
    In contrast to NABL, NAIPFA and GFOA, commenters including 
Cooperman, Lewis Young and Acacia commented that municipal advisors 
should not be required to obtain a written acknowledgment of 
disclosures

[[Page 26766]]

before proceeding with the engagement. Cooperman stated that 
acknowledgement of conflicts of interest disclosures from municipal 
entity clients is an unnecessary and unjustified requirement that 
should be removed. Lewis Young stated that such written disclosure 
should not be required ``so long as the disclosures provided are not 
objected to by the client.'' Proposing a somewhat different approach, 
Acacia stated that municipal advisors should not be required to obtain 
a written acknowledgement of the conflicts disclosed but should be 
required to (i) provide such information (and record such provision), 
(ii) request receipt and consent but (iii) be permitted to proceed with 
a municipal advisory engagement in the absence of such receipt and 
consent if the municipal advisor has a reasonable belief that such 
information has been received. Acacia reasoned that its approach would 
be analogous to existing MSRB guidance for underwriters under MSRB Rule 
G-17.
    The proposed rule change would not require a municipal advisor to 
obtain written acknowledgement from its client of the disclosure of 
conflicts of interest. While the MSRB understands the concerns 
expressed by commenters, the MSRB believes that the proposed rule 
change sufficiently obligates municipal advisors to ensure that their 
clients receive proper notice of material conflicts of interest. 
Proposed paragraph .05 of the Supplementary Material, for instance, 
would require municipal advisors to provide information sufficiently 
detailed to inform a client of the nature, implications and potential 
consequences of each conflict, and include an explanation of how the 
municipal advisor addresses or intends to manage or mitigate each 
conflict. Such disclosure would allow a municipal advisor's client to 
make an informed decision as to whether such conflicts can be 
adequately managed or mitigated. Furthermore, a municipal advisor's 
duty of care would require an advisor to have a reasonable basis for 
believing that its client received the disclosure and understood the 
nature, implications and potential consequences of the conflicts of 
interest that the municipal advisor disclosed. Further, the MSRB 
believes that obtaining some form of written acknowledgement from 
municipal entities and obligated persons would prove to be a 
significant procedural burden to both municipal advisors and their 
clients that would likely not result in a substantiated benefit.
Explanation of Mitigating Conflicts of Interest
    As discussed above, proposed paragraph .05 of the Supplementary 
Material to Proposed Rule G-42, on conflicts of interest, would require 
a municipal advisor to include an explanation of how the municipal 
advisor would address, or manage or mitigate, the material conflicts of 
interest that it has disclosed to its client. In response to the Second 
Request for Comment, Sanchez challenged the value and purpose of this 
requirement by opining that municipal securities brokers and dealers 
are not subjected to the burden of making such disclosures. Sanchez 
requested that the MSRB revise the proposed rule change to require such 
disclosures only if requested by the client.
    The MSRB has considered Sanchez's comments and determined not to 
amend proposed paragraph .05 of the Supplementary Material because the 
MSRB believes that the provision would serve a beneficial and 
protective function for clients. The municipal advisor's explanation 
would allow its client to adequately assess the potential effects the 
conflicts of interest could have on an engagement with the municipal 
advisor and to determine whether the actions the municipal advisor 
proposes to take to mitigate the conflicts of interest are sufficient 
and will not overly impair the quality and neutrality of the services 
to be performed by the municipal advisor.
Services for Conduit Issuers and Obligated Person Clients
    Under subsection (e)(ii) of Proposed Rule G-42, a municipal advisor 
would be precluded from serving its municipal entity client as 
underwriter for a transaction directly related to the same municipal 
securities transaction or municipal financial product as to which the 
municipal advisor is providing or has provided advice to the municipal 
entity.
    In response to the Second Request for Comment, BDA commented that 
the proposed rule should explicitly allow a dealer/municipal advisor to 
serve as an underwriter for a conduit issuer and as a municipal advisor 
for the conduit borrower, even with respect to directly related 
matters.
    Underwriting such a transaction would not be specifically 
prohibited by the ban on principal transactions in subsection (e)(ii) 
of Proposed Rule G-42, because it applies only in cases of municipal 
entity clients. A conduit borrower is typically not a municipal entity. 
Thus, depending on the specific facts and circumstances, this scenario 
could be permissible with appropriate disclosure and consent. Still, it 
is not clear that, even with disclosure and consent, such activity 
would be categorically consistent with all of the duties of a municipal 
advisor to an obligated person in all circumstances. Therefore, the 
MSRB has not amended the proposed rule as suggested by BDA.
Material Conflicts of Interest Required To Be Disclosed
    Section (b) of Proposed Rule G-42 would include a non-exhaustive 
list of matters that would always constitute material conflicts of 
interest and that would be required to be disclosed by municipal 
advisors under the proposed rule change. Matters that must be disclosed 
as material conflicts of interest under section (b) include, among 
others: Any fee-splitting arrangements involving the municipal advisor 
and any provider of investments or services to the client; any payments 
made by the municipal advisor, directly or indirectly, to obtain or 
retain an engagement to perform municipal advisory activities for the 
client; any conflicts of interest arising from compensation for 
municipal advisory activities to be performed that is contingent on the 
size or closing of any transaction as to which the municipal advisor is 
providing advice; and any legal or disciplinary event that is material 
to the client's evaluation of the municipal advisor or the integrity of 
its management or advisory personnel.
    In response to the First Request for Comment, Lewis Young stated 
that the proposed rule should only require disclosure when an actual 
conflict of interest exists because providing tailored explanations of 
potential or hypothetical situations would be ``expensive, time 
consuming, and not very helpful.'' The MSRB disagrees and believes that 
the likely benefits from these disclosures will outweigh the cost 
associated with providing them to a municipal advisor's clients because 
the proposed rule change limits the required disclosure to only 
material conflicts of interest, both actual and potential, of which a 
municipal advisor is aware of after a reasonable inquiry. The MSRB also 
believes that requiring a municipal advisor to disclose conflicts of 
interest, actual and potential, that the municipal advisor becomes 
aware of after reasonable inquiry and that could reasonably be 
anticipated to impair the municipal advisor's ability to provide advice 
in accordance with the standards of conduct in section (a) of the rule, 
is necessary to provide clients with the requisite information to make 
an

[[Page 26767]]

informed decision regarding the selection of their municipal advisor.
    ICI suggested adding prefatory language to section (b) that would 
clarify that a municipal advisor would be required to disclose only 
conflicts of interest that are applicable to its relationship with the 
specific client. ICI stated that adding such language would harmonize 
section (b) with the approach taken in the Investment Advisers Act 
regarding the delivery of brochures,\62\ which it believed permits an 
investment adviser to omit ``inapplicable information'' from a 
disclosure it is required to provide to clients. The MSRB believes that 
Proposed Rule G-42 makes clear that municipal advisors are required 
only to make disclosure of material conflicts of interest and that this 
would exclude inapplicable information.
---------------------------------------------------------------------------

    \62\ See 17 CFR 275.204-3.
---------------------------------------------------------------------------

    First Southwest expressed concern regarding the requirement of 
subsection (b)(i) that municipal advisors must provide written notice 
when they have no material conflicts of interest to disclose to their 
clients. First Southwest stated that the requirement would increase 
administrative requirements and provide little, if any, benefit in the 
event a conflict of interest were later discovered. The MSRB disagrees 
and believes that an affirmative written statement by the municipal 
advisor that it has no known material conflicts of interest would 
remove potential ambiguities about the completeness of the conflicts 
disclosure.
    Sutherland commented that the conflicts of interest required to be 
disclosed would be duplicative of information that could be found in 
SEC Forms MA and MA-I and, therefore, would be unnecessary. As an 
example, Sutherland stated that SEC Form MA requires the disclosure of 
affiliated business entities; compensation arrangements; and 
proprietary interests in municipal advisor client transactions.\63\ 
While some overlap could exist, the MSRB believes that the SEC forms do 
not solicit all of the information that would be required by the 
proposed rule change and, thus, would not serve as a sufficient 
substitute. Specifically, the SEC forms would not be a viable proxy for 
disclosing potential conflicts of interest that the municipal advisor 
could have, nor would the forms contain an explanation of how they 
intend to mitigate the material conflicts of interest that they 
disclose. The MSRB expects that the written disclosure of material 
conflicts of interest will be a useful tool to municipal advisor 
clients that will allow them to readily assess the impact of actual or 
potential conflicts of interest of potential or ongoing municipal 
advisory activities.
---------------------------------------------------------------------------

    \63\ See SEC Form MA, Items 1.K., 4.H.-4.J. and 7.A.-7.F., 
respectively.
---------------------------------------------------------------------------

    In response to the Second Request for Comment, SIFMA requested 
clarification regarding the standard for determining the materiality of 
the conflicts of interest described in paragraphs (b)(i)(A) and (G), 
and when disclosure is required. Under the Revised Draft Rule, 
paragraphs (b)(i)(A) and (G) required municipal advisors to disclose 
``any . . . potential conflicts of interest . . . that might impair'' a 
municipal advisor's advice or its ability to provide advice in 
accordance with section (a) of Proposed Rule G-42. The language in 
these paragraphs concerned certain commenters, such as SIFMA, because 
they believed that such a standard would include nearly all imaginable 
conflicts of interest and result in overly broad disclosure that could 
distract from the provision's purpose. Therefore, to clarify, the MSRB 
has amended these paragraphs to state that disclosure is required, in 
paragraph (A) for ``any actual or potential conflicts of interest,'' 
and, in paragraph (G), for ``any other engagements or relationships.'' 
The MSRB believes that this revised language would more clearly 
establish a limiting, objective standard for disclosing certain 
conflicts of interest that would be relevant to a municipal advisor's 
client.
    Further, paragraphs (b)(i)(A) and (G), as proposed, are revised to 
limit the disclosure of conflicts required under paragraphs (b)(i)(A) 
and (G) to those that potentially impact the advisor's ability to 
provide ``advice to or on behalf of the client in accordance with the 
standards of conduct of section (a) of this rule, as applicable.'' 
Previously, under the Revised Draft Rule, paragraphs (b)(i)(A) and (G) 
required a municipal advisor to provide disclosure of conflicts of 
interest that ``might impair its ability either to render unbiased and 
competent advice to'' its clients. This revision was made after re-
evaluation of the phrasing used in the paragraphs and consideration of 
comments received from Sanchez. Sanchez stated that the use of the 
phrase ``unbiased and competent advice'' in the Revised Draft Rule ``. 
. . appear[s] to import the duty of loyalty and duty of care into the 
representations of obligated persons. . . .'' The MSRB agrees that the 
use of the phrasing ``unbiased and competent advice'' does not 
encompass all of the duties municipal advisors owe their clients, nor 
would it sufficiently differentiate between the standards of conduct 
owed by municipal advisors to their municipal entity clients and 
obligated person clients. The MSRB believes that the revised standard 
for identifying material conflicts of interest under proposed 
paragraphs (b)(i)(A) and (G) will more clearly reflect the standards of 
conduct in proposed section (a) and appropriately differentiate between 
municipal entity and obligated person clients.
    In response to the Second Request for Comment, Sanchez also 
suggested a revision to clarify the last sentence of subsection (b)(i) 
of the Revised Draft Rule. Sanchez suggested deleting the term 
``written documentation'' and using ``written statement'' instead to 
clarify for municipal advisors the action required to comply with 
subsection (b)(i). To remove any ambiguity, the MSRB has revised 
proposed subsection (b)(i) to clarify that, when appropriate, a 
municipal advisor must provide a ``written statement'' that the 
municipal advisor has no known material conflicts of interest.
    Columbia Capital requested clarification regarding whether the 
disclosures required by the Revised Draft Rule may be made in more than 
one document. The required disclosures indeed may be provided to 
clients in more than one document, as long as the document and its 
delivery otherwise comply with the proposed rule. Because the language 
of the proposed rule is not to the contrary, the MSRB has not made any 
revisions in response to this comment.
    FSR commented that use of the term ``indirectly'' in paragraph 
(b)(i)(B) in the Revised Draft Rule, which required disclosure of ``any 
affiliate of the municipal advisor that provides any advice, service, 
or product to or on behalf of the client that is directly or indirectly 
related to the municipal advisory activities to be performed by the 
disclosing municipal advisor,'' expanded the scope of the required 
disclosures unnecessarily and would make compliance difficult for a 
municipal advisor that is part of a large multi-service financial 
conglomerate. FSR believed that the Revised Draft Rule did not provide 
municipal advisors with sufficient guidance to identify activity that 
could be indirectly related to municipal advisory activities, and, 
taken in its plain meaning, could lead to a substantial burden on firms 
having numerous affiliates that provide a wide array of services. After 
further consideration of the purpose and intent of the proposed 
paragraph, the MSRB has removed the clause ``or indirectly.'' The MSRB 
believes revised proposed paragraph (b)(i)(B) will provide the

[[Page 26768]]

appropriate notice to clients of the relationships of any affiliates of 
the municipal advisor that are likely to present material conflicts of 
interest.
Disclosure of Legal or Disciplinary Events
    Several commenters addressed the draft requirements to disclose 
legal or disciplinary events. FSR commented that subsection (b)(ii) of 
the Revised Draft Rule would require a separate written disclosure of 
legal or disciplinary events that is redundant of the requirements of 
subsection (c)(iii) of the Revised Draft Rule. FSR requested that 
``these disclosure requirements be deemed satisfied if an advisor 
provides information about where clients may access electronically the 
advisor's most recent [SEC] Forms MA and MA-I, along with the date of 
the last material amendment to any legal or disciplinary event 
disclosure on such forms.'' SIFMA, in response to the Second Request 
for Comment, similarly stated that requiring ``[duplicative] disclosure 
of specific events that are already disclosed in [SEC] Forms MA and MA-
I provides little, if any, benefit to municipal entities or obligated 
persons, while it imposes unnecessary additional burdens on municipal 
advisors.'' SIFMA suggested that providing clients with the information 
regarding how to obtain electronic access to a municipal advisor's 
legal and disciplinary history on SEC Forms MA and MA-I should suffice. 
Sanchez stated, regarding the Revised Draft Rule, that ``[t]his 
requirement appears to be overly burdensome . . . , [and] it should be 
sufficient for purposes of this rule that a municipal advisor be 
required to direct clients to their EDGAR filings by providing clients 
with sufficiently specific information to locate their EDGAR filings.'' 
\64\
---------------------------------------------------------------------------

    \64\ In response to the First Request for Comment, Sutherland 
suggested that there is sufficient disclosure about disciplinary 
history provided in a municipal advisor's SEC Forms MA and MA-I 
filed with the SEC, and Parsons stated that disclosure should not be 
required in the rule given such public disclosure on those forms. 
Similarly, Lewis Young and NAIPFA believed the disclosure of legal 
or disciplinary events would be duplicative and unnecessarily 
burdensome and also suggested that municipal advisors should be able 
to satisfy the requirement by referencing SEC Forms MA or MA-I.
---------------------------------------------------------------------------

    The MSRB contemplated that municipal advisors would be able to 
satisfy their disclosure of legal and disciplinary events under 
sections (b) and (c) of the Revised Draft Rule with specific reference 
to the relevant portions of their most recent SEC Forms MA or MA-I 
filed with the Commission. Proposed Rule G-42(b)(ii) further clarifies 
this intention, and requires the municipal advisor to provide detailed 
information specifying where the client may electronically access such 
forms. The MSRB believes this approach will address the issue of 
duplicative disclosure of the disciplinary and other legal events 
contained in SEC Forms MA and MA-I. This revision also clarifies that 
municipal advisors may satisfy the disclosure requirements of 
subsections (b)(ii) and (c)(iii) in a similar fashion.
    A municipal advisor could, conceivably, simultaneously satisfy the 
requirements of proposed subsections (b)(ii) and (c)(iii) in one 
document if it were provided to the client prior to or upon engaging in 
municipal advisory activities for the client. However, if combined 
written disclosure and relationship documentation were made after a 
municipal advisor engages in municipal advisory activities, the 
municipal advisor would only be in compliance with proposed subsection 
(c)(iii) and not subsection (b)(ii).
    SIFMA also suggested that subsection (c)(iv) of the Revised Draft 
Rule should be removed. The subsection would require municipal advisors 
to document the date of the last material change, including any 
addition, to the legal or disciplinary event disclosures on any SEC 
Form MA or MA-I filed with the Commission. Specifically, SIFMA believed 
that requiring municipal advisors to update their written disclosures 
and documentation with each of their municipal advisory clients 
whenever a material change to a legal or disciplinary event was made to 
any SEC Forms MA or MA-I would be unjustified.
    Proposed section (c) requires the documentation of the municipal 
advisory relationship to be promptly amended or supplemented to reflect 
any material changes or additions, and requires the amended 
documentation or supplement to be promptly delivered to the municipal 
entity or obligated person client. However, the MSRB does not believe 
the update requirement under proposed section (c) is overly burdensome 
because municipal advisors need only provide the date of the last 
material change, including any addition, to their legal or disciplinary 
event disclosure to their clients, as they would be permitted to 
reference their SEC Forms MA and MA-I for the details of such material 
changes. Additionally, the required documentation of the municipal 
advisory relationship could be satisfied through the use of more than 
one writing and updates or amendments to such documents could be 
additional, separate writings that either amend or supplement earlier 
writings. The MSRB believes these accommodations sufficiently address 
the concern that municipal advisors would be required to amend and 
redistribute a single writing every time a material change or addition 
needed to be included. Further, the MSRB believes that, by requiring 
municipal advisors to update the written documentation relating to 
legal or disciplinary event disclosures provided to municipal entities 
and obligated persons, proposed subsection (c)(iv) would help ensure 
that those clients have sufficient, accurate and current information to 
better inform their decisions to engage and/or continue engaging a 
municipal advisor. The MSRB notes that the requirements of proposed 
section (c) must be made in writing and delivered to the municipal 
advisor's client in accordance with the duty of care and, as 
applicable, the duty of loyalty.
    Coastal, Kutak and Parsons objected to the Initial Draft Rule's 
requirement to disclose the legal and disciplinary events for all 
individuals at a municipal advisory firm for which the firm is required 
to submit an SEC Form MA-I. They suggested that municipal advisors 
should not be required to disclose to a client legal and disciplinary 
events that relate to an individual that is employed by the municipal 
advisor, if that individual is not a part of (or reasonably expected to 
be a part of) the advisor's team working for the client. Although there 
could be numerous municipal advisors with large numbers of employees, 
as Coastal indicated, the MSRB believes there is insufficient cause to 
narrow the requirement of this disclosure obligation. Specifically, the 
MSRB notes that, although all of a municipal advisor's employees might 
not be a part of the team working on a particular client matter, the 
number of employees with legal or disciplinary events that a municipal 
advisor employs and the nature of any past legal or disciplinary events 
related to those employees could be material to the client's evaluation 
of the municipal advisor or the integrity of its management or advisory 
personnel. In any event, since a municipal advisor could satisfy 
Proposed Rule G-42(b)(ii) and (c)(iii) by providing information 
specifying where the client can electronically access SEC Forms MA and 
MA-I, there would be little additional burden imposed on municipal 
advisors by leaving the scope of these requirements unchanged.

[[Page 26769]]

Type of Writing(s) Required To Document the Municipal Advisory 
Relationship
    Several commenters discussed the matter of documenting the 
municipal advisory relationship and the type of writing that should be 
required to evidence the municipal advisory relationship between the 
municipal advisor and its client.
    FLA DBF, correctly recognizing that the Revised Draft Rule's 
reference to a ``writing'' does not require a written contract, 
suggested that the proposed rule change should be amended to require 
municipal advisors to enter into written contracts with their municipal 
entity clients regarding their municipal advisory relationships. In 
contrast, GFOA, while also correctly recognizing that the Revised Draft 
Rule does not require a written contract, supported the absence of a 
contract requirement. GFOA noted that although entering into a 
bilateral contract is a GFOA best practice, ``there may not always be a 
need for a specific contract.'' GFOA agrees with the MSRB that the 
municipal advisory relationship should be stated in writing as it would 
allow the issuer to clearly delineate the scope of work it intends its 
municipal advisor to provide.
    A number of other commenters, including ABA, BDA, ICI, Lewis Young, 
MSA, NAIPFA and SIFMA, however, construed section (c) of the proposed 
rule as requiring a written contract, leading them to raise various 
concerns about the proposed rule applying to existing contracts that 
might need to be revised. As a result, these commenters suggested the 
inclusion of various kinds of transitional rule provisions to address 
these issues. ABA and Lewis Young, for example, requested a 
transitional provision to permit advisors to honor their existing 
agreements with their clients until they expire. ICI recommended that 
the MSRB clarify that, if approved, Proposed Rule G-42 would only apply 
prospectively. SIFMA requested that the MSRB limit or eliminate the 
need for municipal advisors to re-document their municipal advisory 
relationships and apply the disclosure requirements of the proposed 
rule only to future agreements. MSA requested guidance on whether the 
obligations of section (c) of Proposed Rule G-42 could be satisfied by 
a contract (such as a Master Services or Professional Services 
Agreement) between the municipal advisor and its client.
    The documentation requirement of section (c) of Proposed Rule G-42, 
as with the Revised Draft Rule, would not require the creation of new 
contractual relationships or the modification of existing contracts or 
agreements between municipal advisors and their clients. The purpose of 
the requirement is to help ensure that certain terms of each municipal 
advisory relationship would be reduced to writing and delivered to the 
municipal advisor's municipal entity or obligated person client. So 
long as the content of the documentation adheres to the requirements of 
the proposed rule (including the standards of conduct in section (a)), 
municipal advisors and their clients have some latitude in deciding the 
exact form the documentation and writing might take. If municipal 
advisors have already delivered documentation meeting some or all of 
the requirements of proposed section (c), then municipal advisors would 
be able to rely on such documents to satisfy some or all of their 
obligations under section (c). While certainly permitted, the proposed 
rule would not require municipal advisors to enter into written 
contracts with their municipal entity or obligated person clients and 
municipal advisors could satisfy the requirements of provision (c) by 
providing separate or supplemental documents to any preexisting 
contract, agreement or writing previously provided that might be in 
place between the municipal advisor and its client. The relevant part 
of proposed section (c) has been further revised to delete the phrase 
``enter into'' (which could have connoted the formation of a contract) 
and reads as follows: ``A municipal advisor must evidence each of its 
municipal advisory relationships by a writing or writings created and 
delivered to the municipal entity or obligated person client prior to, 
upon or promptly after the establishment of the municipal advisory 
relationship.'' The MSRB believes that requiring the documentation to 
take the form of a bilateral contract would be unnecessary and could 
lead to some of the burdensome consequences identified by commenters. 
The amendments to the Revised Draft Rule should clarify that municipal 
advisors would not be required to alter or re-execute any existing 
contract and that, in the future, the documentation and disclosure 
requirements could be satisfied in writings that are either included in 
a contract or separate and independent of any contract entered into 
between the municipal advisor and its municipal entity or obligated 
person client.
    In response to the First Request for Comment, BDA and GKB stated 
that they generally supported the documentation and disclosure 
requirements of section (c) of the Initial Draft Rule but believed, 
with respect to municipal financial products, that a ``written 
agreement'' (as they believed was required by section (c)) should only 
be required when municipal advisory activities are engaged in for 
compensation. Based on their comments, it appears that BDA and GKB 
understood section (c) to implicitly require the municipal advisor and 
its client to evidence their municipal advisory relationship with a 
bilateral contract. NAIPFA, in its response to the Initial Draft Rule, 
asked the related question: ``Does this mean that the writing must be a 
two party agreement?'' NAIPFA also suggested that the MSRB amend 
section (c) to allow municipal advisors to satisfy the requirements of 
the section through an engagement letter. As previously stated, section 
(c) would not require, or preclude the use of a bilateral contract or 
engagement letter to evidence the municipal advisory relationship. So 
long as the content adheres to the requirements of Proposed Rule G-42 
(including the standards of conduct of section (a)), municipal advisors 
and their clients would have some latitude in deciding the exact form 
the documentation and writings might take.
    NAIPFA expressed concerns regarding the amount of information that 
would be required to be included in the documentation required by 
section (c), stating that municipal advisors would be put at a 
``significant competitive disadvantage to their [underwriting] 
counterparts . . . [because] underwriters are not mandated to include 
any particular contract-related terms within their engagement letter, 
such as clauses relating to the termination of the relationship or 
their obligations relating to certain aspects of the transaction . . . 
.'' The MSRB does not believe the proposed documentation requirement 
would result in the competitive disadvantages described by NAIPFA. 
First, underwriters are required to make similar disclosures to issuers 
of municipal securities under MSRB's fair dealing rule, Rule G-17, 
which includes certain disclosures regarding the underwriter's 
compensation. Second, to the extent any of the requirements of section 
(c) are included in a written agreement, contract, engagement letter or 
similar document already in possession of the client, such information 
would not need to be included in a separate writing delivered to the 
municipal advisor's client. Instead, municipal advisors would be

[[Page 26770]]

able to supplement existing writings to comply with section (c). 
Finally, because a municipal advisor generally would be prohibited from 
acting as an underwriter for a transaction directly related to the same 
municipal securities transaction or municipal financial product as to 
which the municipal advisor is providing or has provided advice, the 
MSRB believes it would be unlikely that a municipal advisor would be in 
direct competition with an underwriter as suggested by NAIPFA.
    In response to the Initial Draft Rule, ICI suggested that section 
(c) be revised to specify that only material changes to the information 
provided in the documentation required by section (c) would trigger the 
updating requirement. The MSRB did not intend by section (c) to require 
the supplementation of immaterial information and section (c) of the 
proposed rule has been revised to provide this clarification.
Triggering the Documentation Required by Section (c)
    Under the Initial Draft Rule, a municipal advisor would have been 
required to evidence each of its municipal advisory relationships by a 
writing entered into prior to, upon or promptly after the inception of 
the municipal advisory relationship. In response to the First Request 
for Comment, Northland commented that section (c) of the Initial Draft 
Rule should require that the documentation be in place prior to 
engaging in municipal advisory activities rather than being permitted 
to be created and provided subsequently (i.e., after the establishment 
of a municipal advisory relationship (as defined by the Initial Draft 
Rule)). Northland opined that its approach would align the proposed 
rule change with analogous requirements and principles of the SEC Final 
Rule. Northland also argued that earlier documentation of the municipal 
advisory relationship is warranted for the same reasons it believes 
justify the proposed rule change's requirement to disclose conflicts of 
interest upon or prior to engaging in municipal advisory activities. 
The MSRB has considered when municipal advisors should be required to 
document their relationship with their clients and determined that 
documentation should only be required after both parties have agreed 
that the municipal advisor would engage in municipal advisory 
activities for or on behalf of the client. It is understood by the MSRB 
that a municipal advisor could engage in municipal advisory activities 
while seeking an engagement to perform municipal advisory activities 
but then might ultimately not be engaged by the client. Also, in some 
instances, a municipal advisor could be called upon to engage in 
municipal advisory activities on behalf of its client on short notice 
for a time-sensitive matter. In such scenarios, the MSRB does not 
believe it would be appropriate, or necessary, to require documentation 
of the municipal advisory relationship because, as with the first case, 
there is a reasonable possibility that no municipal advisory 
relationship would materialize and, with regard to the second, the MSRB 
does not want to inhibit a municipal advisor from performing its 
municipal advisory activities for municipal entities and obligated 
persons when time is short and documenting the municipal advisory 
relationship might not be feasible. The MSRB believes that, when 
balanced against the potential benefits of requiring earlier 
documentation of the municipal advisory relationship, the timely 
disclosure of material conflicts of interest (in accordance with 
section (b) of Proposed Rule G-42) will sufficiently mitigate the 
potential consequences identified by Northland and will serve as 
sufficient protection to a municipal advisor's client to make an 
informed decision about whether to accept the advice provided by the 
municipal advisor until such time that documentation containing the 
information required by section (c) can be created and delivered.
    On a separate but related matter, Northland stated that the use of 
the term ``municipal advisory relationship'' would likely lead to 
confusion between how Northland believes the term is used by municipal 
advisors and other industry participants and how the term had been 
defined for purposes of the Initial Draft Rule. Northland believed that 
it would be difficult for municipal advisors to parse apart and 
document ``municipal advisory relationships'' when some of those 
relationships are ``historical and ongoing'' and are rarely thought of 
as separate relationships. The MSRB believes that the definition 
provided in Proposed Rule G-42(f)(vi) would provide sufficient guidance 
to municipal advisors in this regard. That provision would state that a 
municipal advisory relationship is deemed to exist when a municipal 
advisor enters into an agreement to engage in municipal advisory 
activities for a municipal entity or obligated person and ends on, the 
earlier of, the date on which the municipal advisory relationship has 
terminated pursuant to the terms of the documentation of the municipal 
advisory relationship, or the date on which the municipal advisor 
withdraws from the municipal advisory relationship.
    In response to the Second Request for Comment, Piper Jaffray, while 
generally supportive of the documentation requirement of section (c) of 
the Revised Draft Rule, expressed concern that it could require 
premature documentation of a municipal advisory relationship. 
Specifically, Piper Jaffray stated that section (c) could require 
documentation when the municipal advisor has not been selected by its 
client to be its municipal advisor and, instead, is, in fact, engaging 
in municipal advisory activities as a means to obtain the engagement 
with the client to perform municipal advisory activities. Section (c) 
of the Revised Draft Rule, however, explicitly stated that the 
documentation requirement would only be triggered ``prior to, upon or 
promptly after the establishment of the municipal advisory 
relationship'' (emphasis added). As defined in subsection (f)(vi), a 
municipal advisory relationship would only be deemed to exist when the 
``municipal advisor enters into an agreement to engage in municipal 
advisory activities for a municipal entity or obligated person.'' Thus, 
Proposed Rule G-42 would not necessarily require the provision of 
relationship documentation during an early stage of municipal advisory 
activities when the municipal advisor is still pursuing an engagement 
to perform municipal advisory activities.
Other Comments Regarding the Documentation Requirement
    Consolidation. In response to the Revised Draft Rule, Piper Jaffray 
suggested that the disclosure and documentation requirements of 
sections (b) and (c) could be more clearly established if the sections 
were merged. In particular, Piper Jaffray found it confusing that a 
municipal advisor providing ``advice,'' but that has not yet been 
engaged by an issuer, must provide disclosures related to its 
compensation under paragraph (b)(i)(F). Piper Jaffray then posed the 
question: ``[I]s the intention of the [MSRB] to assure that municipal 
advisors must provide conflicts disclosure when providing information 
that would constitute `advice' prior to [being] engaged[?]'' Piper 
Jaffray suggested that the intention and purpose of the proposed rule 
change could be better served if the required disclosures and 
documentation of the municipal advisory relationship were provided when 
the advisor is selected by the issuer to provide it with advice.
    The MSRB has considered Piper Jaffray's recommendation to merge

[[Page 26771]]

sections (b) and (c) and modify the timing of the disclosure 
requirement, but believes such amendments would conflict with the 
intention of having municipal advisors disclose conflicts of interest 
upon or prior to engaging in municipal advisory activities for the 
client. Combining the paragraphs could cause municipal advisors to 
delay making the proposed rule's required disclosures until the 
municipal advisory relationship has been reduced to writing, which 
could be a significant amount of time after the client has received, 
and potentially acted on, advice from the municipal advisor. For these 
reasons, the suggested changes are not included in Proposed Rule G-42.
    Indirect Compensation and Treatment of Incidental Informal Advice. 
Regarding the documentation of the municipal advisory relationship, 
SIFMA requested that Proposed Rule G-42 include a definition of 
``indirect compensation'' as it is used in subsection (c)(i). On a 
related topic, SIFMA requested that the MSRB ``clarify that informal 
advice that is incidental to providing brokerage/securities [services] 
would not, alone, trigger a written documentation requirement under 
[section (c) of the Revised Draft Rule] . . . .''
    The MSRB believes that additional clarification within the proposed 
rule change is not necessary because the phrase ``indirect 
compensation'' is widely used and understood in the municipal advisory 
and securities industry and is well established in securities statutes 
and jurisprudence. Providing a definition of ``indirect compensation'' 
within Proposed Rule G-42 might reduce clarity regarding the general 
understanding of the phrase and lead to unnecessary confusion in an 
instance where sufficient guidance is already available.
    Regarding SIFMA's request pertaining to advice that is incidental 
to providing brokerage/securities services, the MSRB notes that the 
proposed rule change would apply to a scope of municipal advisory 
activities as defined in the SEC Final Rule. Whether certain activities 
constitute ``advice'' under the SEC Final Rule is a legal 
interpretation within the authority of the SEC, and not the MSRB, to 
make.
Recommendations and Review of Recommendations of Other Parties
    Section (d) of Proposed Rule G-42 would provide that if a municipal 
advisor makes a recommendation of a municipal securities transaction or 
municipal financial product to its client, the municipal advisor must 
determine, based on the information obtained through reasonable 
diligence, whether the transaction or product is suitable for the 
client. Section (d) also would contemplate that a municipal advisor 
could be asked to evaluate a recommendation made to its client by 
another party, such as a recommendation by an underwriter of a new 
financing structure or a new financial product. Section (d) would 
require municipal advisors to conduct a suitability analysis--when 
requested by the client and within the scope of the engagement--of the 
recommendations of these third parties, guided by the requirements and 
principles contained in relevant portions of the supplementary material 
(such as paragraphs .01, .08 and .09).
    Commenters raised a number of issues with section (d) of Proposed 
Rule G-42 (sections (d) and (e) of the Initial Draft Rule) and the 
related paragraphs .01 (Duty of Care), .08 (Suitability) and .09 (Know 
Your Client) of the Supplementary Material to Proposed Rule G-42. Below 
is a summary of, and response to, these comments.
General Comments Regarding Section (d)
    In response to the Second Request for Comment, NAIPFA and GFOA 
expressed their general support for the Revised Draft Rule's 
suitability standard of section (d) of Proposed Rule G-42. NAIPFA 
believed it appropriately reflects a municipal advisor's fiduciary 
duties to its municipal entity clients.
    Compliance and Examination. BDA, in response to the Second Request 
for Comment, expressed its support of the Revised Draft Rule's 
requirement to have municipal advisors review recommendations of other 
parties, but requested specific guidance on how municipal advisors 
would develop reasonable policies to comply with section (d). BDA also 
expressed concern about how FINRA examiners would test a dealer's 
compliance with the requirements of section (d) when serving as a 
municipal advisor.
    The MSRB believes it has provided sufficient guidance to municipal 
advisors about the principles and requirements that should inform, and 
be incorporated in, a municipal advisor's policies and procedures by 
identifying the matters in the proposed rule text (such as in 
subsections (d)(i)-(iii) and paragraphs .01, .08 and .09 of the 
Supplementary Material) that a municipal advisor must, as applicable, 
consider when forming its advice or recommendation. The MSRB recognizes 
the diversity of the population of municipal advisors and the municipal 
advisory activities in which they engage in and believes the primarily 
principles-based approach taken by the proposed rule change will 
accommodate that diversity. The MSRB also believes this approach will 
clearly establish the minimum requirements and principles, which 
financial regulators could then consistently apply in their examination 
of municipal advisors.
    Updating Recommendations. In response to the Second Request for 
Comment, SMA requested that the MSRB clarify that the suitability of a 
recommendation would be determined by the facts and circumstances at 
the time a client enters into the municipal securities transaction and 
that the municipal advisor should not have continuing responsibility to 
update its determination.
    The MSRB believes that whether advice given or recommendations made 
by municipal advisors would need to be updated would depend on the 
facts and circumstances surrounding the advice and recommendation, 
including, but not limited to, the scope of the services that the 
municipal advisor agreed to provide its client. The MSRB believes that 
the reasonableness of a municipal advisor's recommendation or advice 
would be determined by considering the information relied upon by, and 
available to, the municipal advisor at the time the recommendation is 
made or advice is given to its client. However, over the course of an 
ongoing municipal advisory relationship, it is possible that a 
municipal advisor would, as part of its duty of care, need to apprise 
its client of changes to the suitability of the advice or 
recommendation it had previously given. In such cases, a municipal 
advisor's responsibilities would depend upon the facts and 
circumstances and the parameters of its municipal advisory 
relationship. The MSRB believes that the proposed rule change will 
provide municipal advisors with the requisite guidance to comply with 
its requirements.
    Third-Party Recommendations. Lamont and First Southwest, in 
response to the First Request for Comment, requested clarification 
regarding whether a municipal advisor must review any third-party 
recommendation related to the advice that the municipal advisor has 
agreed to provide.
    Proposed Rule G-42 would require municipal advisors to review a 
third-party recommendation when such a review is within the scope of 
the engagement between it and its client or if such a review would be 
part of the reasonable diligence required to reasonably determine 
whether a recommendation or advice is suitable

[[Page 26772]]

for its client. Therefore, a municipal advisor's obligation to review 
third-party recommendations would depend on the facts and circumstances 
of each particular instance. The MSRB believes that section (d) and the 
relevant portions of the supplementary material of the proposed rule 
change will provide sufficient guidance to municipal advisors presented 
with such scenarios.
    Informing Client of Matters Related to Review of Recommendation. In 
response to the First Request for Comment, Northland commented that the 
Initial Draft Rule's requirement that municipal advisors must, under 
section (d), discuss matters such as the material risks of a 
recommendation and the basis upon which the municipal advisor 
reasonably believes its recommendation is suitable for its client would 
encourage written documentation of such discussions and create the 
potential for conflict between the information provided by the 
municipal advisor and the actions ultimately taken by the client. It 
appears that Northland's concern is that a municipal advisor could be 
exposed to liability in an ex post review of its suitability analysis.
    The MSRB received other comments related to the Initial Draft 
Rule's requirement that municipal advisors must discuss these matters 
with their clients. In response, the Revised Draft Rule included a 
modification that required municipal advisors to inform their clients 
of the matters specified in proposed section (d). The modification was 
made to grant some flexibility to municipal advisors in the manner in 
which the matters are delivered to their clients. The MSRB understands 
that a municipal advisor's client could elect to engage in a course of 
action that deviates from the municipal advisor's recommendation. For 
purposes of compliance with section (d), however, a client's decision 
to disregard its municipal advisor's recommendation would alone have no 
bearing on whether the municipal advisor conducted an adequate analysis 
of the recommendation it provided. An examination for compliance with 
section (d) would focus on the adequacy of the suitability analysis 
provided by the municipal advisor, not whether the client ultimately 
pursued the municipal advisor's recommendation.
    Limiting Duty to Review Recommendations of Others. In response to 
the First and Second Request for Comment, NAIPFA stated that, when a 
municipal entity or obligated person has engaged an independent 
registered municipal advisor \65\ and is also obtaining advice from a 
third party that is relying upon the independent registered municipal 
advisor exemption from the SEC registration requirement \66\ to provide 
advice to the municipal entity or obligated person, the independent 
registered municipal advisor should not be permitted to limit the scope 
of the engagement with its client so as not to include the review of 
recommendations made by the third-party.
---------------------------------------------------------------------------

    \65\ See SEC Rule 15Ba1-1(d)(3)(vi) (17 CFR 240.15Ba1-
1(d)(3)(vi)). ``Independent registered municipal advisor'' is 
defined in SEC Rule 15Ba1-1(d)(3)(vi)(A) (17 CFR 240.15Ba1-
1(d)(3)(vi)(A)).
    \66\ See SEC Rule 15Ba1-1(d)(3)(iv) (17 CFR 240.15Ba1-
1(d)(3)(iv)).
---------------------------------------------------------------------------

    The MSRB has considered, yet disagrees with, NAIPFA's position. The 
MSRB believes that municipal advisor clients, with the agreement of the 
municipal advisor, should be able to define the scope of their 
municipal advisory relationships and thus determine what services the 
municipal advisor will provide. Furthermore, requiring municipal 
advisors to review all third-party recommendations could result in a 
costly burden to municipal entities and obligated persons that do not 
expect to derive sufficient value from such review. However, the MSRB 
acknowledges that limiting the scope of the engagement between a 
municipal entity or obligated person and its independent registered 
municipal advisor could affect a third party's ability to qualify and 
make use of exemptions discussed in the SEC Final Rule, including the 
exemption mentioned by NAIPFA.\67\
---------------------------------------------------------------------------

    \67\ 17 CFR 240.15Ba1-1.
---------------------------------------------------------------------------

Request for Definition of ``Independent'' as Used in Paragraph .03 of 
the Supplementary Material
    BDA, in response to the First Request for Comment, requested that 
the MSRB define the term ``independent'' for purposes of paragraph .03 
of the Supplementary Material, action independent of or contrary to 
advice, to the Initial Draft Rule. Proposed paragraph .03 states that a 
municipal advisor would not be required to disengage from a municipal 
advisory relationship if its client were to elect a course of action 
that is ``independent or contrary'' to the advice provided by the 
municipal advisor. BDA asked if ``independent'' would mean that the 
municipal advisor's client is not relying on or considering the advice 
of the municipal advisor; that the client is not seeking advice from 
the municipal advisor; or, that the client is acting contrary to advice 
given by the municipal advisor.
    Proposed paragraph .03 of the Supplementary Material was designed 
to address instances when a municipal advisor's client has decided 
either not to accept, rely on or consider the municipal advisor's 
advice or to take an approach or position that varies (completely or 
partially) from advice provided by the municipal advisor. In the event 
of such occurrences, paragraph .03 would allow a municipal advisor to 
continue in its advising capacity so long as doing so would not 
otherwise be precluded by MSRB rules or federal, state or other laws, 
as applicable.
    Scope of the Recommendations Analysis. Proposed section (d) and 
paragraph .08 of the Supplementary Material address municipal advisors' 
recommendations of municipal securities transactions or municipal 
financial products. However, as part of the duty of care articulated 
under proposed paragraph .01 of the Supplementary Material, a municipal 
advisor would be required to have a reasonable basis for any advice 
provided to its client.
    Northland requested clarification regarding whether section (d) of 
the Initial Draft Rule would be applicable to all recommendations 
provided by the municipal advisor or only when a recommendation is 
related to entering into a municipal securities transaction or 
municipal financial product. NABL stated, in response to the First 
Request for Comment, that ``suitability,'' as a general matter, is a 
regulatory concept that could not be appropriately applied to municipal 
advisors in all instances. NABL suggested that a municipal advisor 
should be permitted to make a recommendation as to a limited aspect of 
the transaction, even if the municipal advisor does not agree that the 
transaction is suitable.
    Section (d) of Proposed Rule G-42 would provide that a municipal 
advisor must not recommend that its client enter into any municipal 
securities transaction or municipal financial product unless the 
municipal advisor has determined, based on the information obtained 
through the reasonable diligence of the municipal advisor, whether the 
transaction or product is suitable for the client. A municipal advisor 
could provide advice regarding an aspect of a municipal securities 
transaction or municipal financial product that the municipal advisor 
believes to be unsuitable for its client so long as the municipal 
advisor adhered to the duty of care, duty of loyalty, and all other 
laws, as applicable, and either did not recommend the unsuitable 
transaction

[[Page 26773]]

or product or informed the client of the basis on which the municipal 
advisor reasonably believed the transaction or product to be 
unsuitable.
    Documenting Recommendations. Lewis Young expressed concern that 
section (d) of the Initial Draft Rule would require excessive and 
``defensive'' recordkeeping and documentation in order to evidence 
compliance with the section's requirement that municipal advisors 
inform their clients of certain matters pertaining to their 
recommendations. Lewis Young argued that such documentation would be a 
``waste of time and resources'' because the client has already 
determined to pursue a particular municipal securities transaction or 
municipal financial product. Accordingly, Lewis Young believed 
documenting such discussions ``so as to have a `good answer' for the 
next regulatory audit'' would be overly and unnecessarily burdensome.
    The MSRB believes that the proposed rule change sufficiently 
articulates that municipal advisors and their clients would have the 
discretion to define the parameters of their municipal advisory 
relationship and, thus, decide between them what municipal advisory 
activities would be performed by the municipal advisor for its client, 
including what matters for which a municipal advisor would be providing 
advice. As such, regarding the scenario proffered by Lewis Young, a 
municipal advisor that has not been engaged to provide advice about a 
municipal securities transaction or municipal financial product that 
was previously selected by its client would not be under an implicit 
obligation to provide the client with the suitability analysis 
described in proposed section (d) and the supplementary material. The 
municipal advisor would remain subject to (among other provisions of 
the proposed rule change) a duty of care, duty of loyalty (as 
applicable) and relevant supplementary material such as paragraphs .04 
(Limitations on the Scope of the Engagement) and .09 (Know Your 
Client). Further, the MSRB believes that the documentation required by 
proposed Rule G-8(h)(iv) is an appropriately tailored recordkeeping 
requirement that will assist regulatory examiners in assessing the 
compliance of municipal advisors with the proposed rule change. Also, 
the MSRB believes the recordkeeping requirements will not be overly 
burdensome because municipal advisors would only be required to 
maintain documents created by the municipal advisor that were material 
to its review of a recommendation by another party or that memorializes 
the basis for any conclusions as to suitability.
    Recommendations of Investment Funds. NY State Bar requested the 
MSRB to clarify the obligations owed by a municipal advisor to its 
client when the recommendation is to invest in an investment fund that 
is managed by a third-party advisor. NY State Bar's concern was that, 
under the Initial Draft Rule, a municipal advisor would be obligated to 
provide a recommendation, and therefore a suitability analysis, of the 
investment choices made by the manager of the investment fund.
    Depending on the facts and circumstance of a particular scenario, 
such as described by NY State Bar, a municipal advisor could have a 
multitude of different obligations regarding its recommendation of an 
investment fund to a client. While the proposed rule change would allow 
municipal advisors and their clients to negotiate the municipal 
advisory activities to be performed, the standards of conduct 
articulated in section (a) and the relevant paragraphs of the 
supplementary material would not be subject to alteration. Therefore, a 
municipal advisor that has agreed to provide a recommendation regarding 
the investment in an investment fund would be required to exercise a 
duty of care that could, in turn, require the municipal advisor to 
conduct a suitability analysis that might, depending on the relevant 
facts and circumstance of a particular instance, require the municipal 
advisor to conduct a suitability analysis of the investment choices 
made by the manager of the investment funds. By establishing the 
applicable standards of conduct for municipal advisors, and providing 
additional guidance regarding those standards in the supplementary 
material to Proposed Rule G-42, the MSRB believes that municipal 
advisors will be able to make a determination regarding what actions 
they must undertake when making recommendations to clients.
    Prescriptive Metrics for Suitability Analysis. In response to the 
First Request for Comment, MSA asked whether the MSRB would provide the 
``specific metrics (standard debt issuance options)'' that should be 
used to determine the suitability of a recommendation. MSA also 
inquired into whether ``there [will] be standards set for this 
quantitative review or will it be the responsibility of the individual 
[municipal advisor] to define the suitability metrics based on the 
unique circumstances of each client or project?''
    In order to accommodate the diversity of the municipal securities 
and municipal advisory marketplace, the MSRB has taken a primarily 
principles-based approach regarding the required suitability analysis 
so that municipal entities and obligated persons would receive 
appropriately tailored and relevant advice and recommendations from 
their municipal advisors. For this reason, the MSRB does not intend to 
provide the specific metrics requested by MSA and instead will rely 
upon the principles and requirements provided by the proposed rule 
change.
Municipal Advisor Reliance on Information Provided by Client
    A number of commenters voiced apprehension regarding what they 
believed to be the high standard set for providing recommendations to 
their clients or reviewing the recommendation of a third party. 
Specifically, commenters expressed concern with the portion of 
paragraph .01 (which would be applicable to recommendations 
contemplated under section (d)) that would require a municipal advisor 
to ``undertake a reasonable investigation to determine that it is not 
basing any recommendation on materially inaccurate or incomplete 
information.'' Most commenters stated that a municipal advisor should 
be able to rely on the accuracy and veracity of the information 
provided by a client and not be required to validate such information.
    Sutherland asked, in response to the First Request for Comment, in 
the context of 529 plans, what the Initial Draft Rule would require a 
municipal advisor to do in order to satisfy the proposed obligation to 
undertake a reasonable investigation to determine that it is not basing 
any recommendation on materially inaccurate or incomplete information. 
Sutherland also asked whether a municipal advisor must obtain a 
representation from the issuer that the information it provides does 
not contain any material misstatements or omissions.
    In response to the Second Request for Comment, ICI stated that 
municipal advisors to 529 plans should not be required to verify the 
veracity or completeness of the information provided to them by persons 
who are authorized by the municipal entity client to act on behalf of a 
state's 529 plan.
    NABL commented that a municipal advisor should be free to recommend 
a transaction based on facts given to it by its client, without 
exercising any diligence to check the facts, if consistent with the 
scope of the engagement with

[[Page 26774]]

its client. Regarding the review of recommendations of others, MSA 
asked whether it would be necessary to obtain documentation or 
information used by a third-party to make a recommendation that the 
municipal advisor has been engaged to review. MSA believed that the 
Initial Draft Rule should require the third party, who provided the 
recommendation and that the municipal advisor has been engaged to 
review, to disclose any documentation relied upon for that 
recommendation.
    The duty of care is a core principle underlying many of the 
obligations of the proposed rule and is included, among other reasons, 
to ensure municipal entities and obligated persons are shielded from 
the potential negative consequences that could result from not 
receiving well-informed advice and expertly-executed services from 
their municipal advisors. The MSRB believes that requiring municipal 
advisors to conduct a reasonable investigation about the accuracy and 
completeness of the information, including information pertaining to a 
529 plan, on which they will be basing their advice is necessary to 
ensure that clients will be able to make an informed decision based on 
facts and choose a prudent course of action. As stated in section (d), 
the municipal advisor would only need to exercise reasonable diligence, 
thus obviating the need for a municipal advisor to go to impractical 
lengths to determine the accuracy and completeness of the information 
on which it will be basing its advice and/or recommendation. The MSRB 
believes that obtaining a representation from the municipal advisor's 
client that the information it has provided, with no or insufficient 
diligence conducted by the municipal advisor, would not satisfy either 
section (d) or paragraph .01 of the Supplementary Material of Proposed 
Rule G-42 because such a representation would not sufficiently preclude 
the potential for the risks associated with providing advice or 
recommendations without a reasonable inquiry into the accuracy and 
completeness of the information upon which such advice or 
recommendations are based. While alone, such a representation would not 
satisfy the requirements of the proposed rule change, a municipal 
advisor would be free to seek and obtain such a representation as a 
prudent part of its process for conducting a reasonable investigation 
of the veracity and completeness of the information on which it is 
basing its recommendation.
Applicability of Suitability Analysis to 529 Plans
    Several commenters raised concerns about how section (d) and the 
related supplementary material that address suitability analysis would 
generally apply to municipal advisors advising 529 plans.
    ICI stated, in response to the Second Request for Comment, that the 
suitability standard set forth in paragraph .08 of the Supplementary 
Material should recognize what ICI believes to be differences between 
advice rendered in connection with municipal securities, generally, and 
that rendered in connection with 529 plans. Sutherland voiced concerns 
in its response to the First Request for Comment and stated that the 
suitability factors listed in paragraph .08 and section (d) are not 
workable with regard to 529 plans. ICI believed that some of the 
factors for determining suitability included in paragraph .08 would be 
``largely irrelevant in the context of rendering advice to a 529 plan'' 
and the MSRB should modify the Revised Draft Rule to explicitly state 
that such factors would not apply to advice relating to 529 plans. In 
the absence of exempting 529 plans from needing to consider such 
factors, ICI asked the MSRB to clarify how it intends the listed 
factors to apply to 529 plans.
    In consideration of these comments, the MSRB has modified proposed 
paragraph .08 (formerly paragraph .09) of the Supplementary Material to 
allow municipal advisors to base a suitability determination only on 
the listed factors that are applicable to the particular type of client 
being advised. The MSRB, accordingly, has inserted the phrase ``as 
applicable to the particular type of client'' as a qualifier to the 
list of factors in paragraph .08 that must be considered in a 
suitability analysis. The modifications proposed should address the 
commenters' concerns such as how factors such as ``financial capacity 
to withstand changes in market conditions'' would apply given that 529 
plans are not dependent on external sources of revenue or funding to 
satisfy claims of investors. However, the listed factors in paragraph 
.08, consistent with the regulation of recommendations in other 
securities law contexts, are focused on the client and not the product 
involved.
Request for Clarification of Documentation and Procedural Requirements
    In response to the Second Request for Comment, Piper Jaffray 
requested additional clarification on what a municipal advisor would 
need to do, and what documents would need to be created, to comply with 
the Revised Draft Rule's suitability requirements. Specifically, Piper 
Jaffray asked what the proposed rule change would require with regards 
to decisions that Piper Jaffray refers to as ``smaller decisions'' 
(e.g., call features and whether to utilize a premium bond structure 
that has a lower yield to call).
    The proposed rule change would require, pursuant to the duty of 
care, a municipal advisor to have a reasonable basis for any advice it 
provides to or on behalf of its client. Also, municipal advisors would 
be required to conduct a suitability analysis of recommendations of 
municipal securities transactions and municipal financial products that 
would comport with the requirements of proposed paragraph .08 of the 
Supplementary Material. Whether or not a suitability analysis would be 
required would depend, as previously discussed in Item II.A., on the 
facts and circumstances surrounding the communication made by the 
municipal advisor and whether the communication was a recommendation of 
a municipal securities transaction or municipal financial product. 
Advice as to the ``smaller decisions'' asked about by Piper Jaffray 
might, or might not, depending on the facts and circumstances of a 
particular instance, rise to the level of being a recommendation that 
would require a suitability analysis under the proposed rule change, 
even though such advice may relate to a municipal securities 
transaction or municipal financial product and therefore trigger other 
provisions of the proposed rule, because the advice might not 
reasonably be viewed as a ``call to action'' that would constitute a 
recommendation of a municipal securities transaction or municipal 
financial product. Note that even in the case of advice short of a 
recommendation, a subsequent communication that does constitute a 
recommendation requiring a suitability analysis might, depending on the 
particular facts and circumstances, require analysis at that time of a 
subject that was addressed in previous advice.
    With regard to the recordkeeping requirements that would be 
required when providing a recommendation of a municipal securities 
transaction or municipal financial product, proposed MSRB Rule G-
8(h)(iv) would require specifically that municipal advisors keep a copy 
of any document created by a municipal advisor that was material to its 
review of a recommendation by another party or that memorializes the

[[Page 26775]]

basis for any determination as to suitability for a period of not less 
than five years. The MSRB believes that the proposed recordkeeping 
requirements will allow regulatory examiners to efficiently assess a 
municipal advisor's compliance with the suitability obligations of 
Proposed Rule G-42. The MSRB also believes that the proposed 
recordkeeping requirements will not overly burden municipal advisors 
because the MSRB understands that these documents are routinely made 
and retained by municipal advisors as a part of their normal business 
operations.
Suitability and Policy Related Considerations
    In response to the First Request for Comment, BDA and Piper Jaffray 
stated that the factors to be considered by municipal advisors when 
determining whether a municipal securities transaction or municipal 
financial product is suitable for its municipal entity or obligated 
person client discussed in paragraph .08 (Suitability) of the 
Supplementary Material overlooks the effect that ``policy and political 
considerations'' could have on a suitability determination. Piper 
Jaffray requested that the MSRB clarify whether the determination of 
suitability should ``incorporate the policy directives and decisions of 
the issuer at the time the issue is undertaken.'' BDA requested that 
the MSRB clarify that, if a municipal advisor's client states its 
objective, the municipal advisor, in making its recommendation, does 
not need to assess the appropriateness of the client's stated objective 
but could ``generally accept the [objective].''
    Section (a) and paragraph .01 of the Supplementary Material to 
Proposed Rule G-42 would require that municipal advisors exercise due 
care in performing their municipal advisory activities with respect to 
all of their clients. This duty would require, among other things, 
municipal advisors to provide their clients with informed advice. The 
MSRB believes that informed advice regarding the suitability of a 
municipal securities transaction or municipal financial product is the 
result of a municipal advisor making a reasonable inquiry into certain 
relevant information about the municipal advisor's client. For this 
reason, the MSRB has included in proposed paragraph .08 the requirement 
that a municipal advisor base its determination of suitability on any 
material information known by the municipal advisor after reasonable 
inquiry. Furthermore, proposed paragraph .09 of the Supplementary 
Material would obligate a municipal advisor to know and retain the 
essential facts concerning its client to allow the municipal advisor to 
effectively service the client. The MSRB believes that policy 
considerations could be materially relevant information under all of 
the particular facts and circumstances that municipal advisors may 
consider when determining the suitability of a municipal securities 
transaction or municipal financial product. A stated objective of the 
client as BDA posits could be made most clear by reducing it to writing 
and including it in the relationship documentation on the scope of the 
engagement.
Evidencing Evaluations and Delivery of Required Information Regarding 
Recommendations
    Several commenters, including BDA, MSA, Northland and Lewis Young, 
commented on records and documentation requirements of the proposed 
rule change that would be applicable to municipal advisors.
    In response to the First Request for Comment, BDA requested 
clarification regarding what books and records a municipal advisor 
would need to maintain to evidence evaluations or recommendations made 
by the municipal advisor. BDA commented that some evaluations or 
recommendations could be delivered orally to a client and that 
requiring a municipal advisor to memorialize each recommendation or 
evaluation in writing could prove impractical and/or costly. MSA asked, 
in response to the First Request for Comment, whether the information 
regarding recommendations and evaluations of which a municipal advisor 
is required to ``inform'' its client could be ``transmitted to the 
client orally or will each alternative require empirical evidence 
demonstrating the material risks, potential benefits, structure and 
characteristics?'' If oral transmission is acceptable, MSA then asked 
whether it would need to be documented by both parties. Also in 
response to the First Request for Comment, Northland expressed concerns 
regarding the Initial Draft Rule's requirement to discuss matters with 
the client, because it believed there is an implicit need to document 
these discussions therefore necessitating the use of written 
communications. However, Northland argued that written communications 
could result in a conflicting record that shows what the municipal 
advisor recommended as possibly in opposition to the course of action 
ultimately taken by its client. Northland was concerned that these 
potential conflicts could result in some exposure to liability in the 
event the justification of the decided upon course of action is 
challenged. Lewis Young contended that requiring municipal advisors, in 
section (d) of the Initial Draft Rule, to inform their clients of the 
risks and benefits of a particular structure or product when the client 
has already decided on a course of action (prior to engaging or seeking 
the advice of the municipal advisor) would yield little, if any, 
benefit. Lewis Young suggested only requiring the municipal advisor to 
inform its client of the matters discussed in section (d) when the 
client is considering, or presented with a recommendation of, a 
financial product, transaction or mechanism that is ``novel to the 
client.''
    Proposed Rule G-8(h)(iv) would require a municipal advisor to 
maintain a copy of any document it created that was material to its 
review of a recommendation by another party or that memorializes the 
basis for any determination as to suitability. Section (d) of Proposed 
Rule G-42 would require a municipal advisor to inform its clients of 
the municipal advisor's evaluation of the material risks, potential 
benefits, structure, and other characteristics of the recommended 
municipal securities transaction or municipal financial product; the 
basis upon which the municipal advisor reasonably believes that the 
recommended municipal securities transaction or municipal financial 
product is, or is not, suitable for the client; and whether the 
municipal advisor has investigated or considered other reasonably 
feasible alternatives to the recommended municipal securities 
transaction or municipal financial product that might also or 
alternatively serve the client's objectives. The MSRB notes that 
municipal advisors, under Proposed Rule G-42, would be required to 
``inform'' their clients of such matters, rather than ``discuss,'' as 
previously required under the Initial Draft Rule. Under Proposed Rule 
G-42, a municipal advisor would be allowed to choose the appropriate 
method in which to communicate its evaluation of the material risks and 
benefits attendant to the recommendation. The method selected and used 
by the municipal advisor must, however, comport with the duty of care 
and duty of loyalty (as applicable) that is owed to its client and 
should, therefore, result in the municipal advisor's client receiving 
timely, full and fair notification of the matters provided for in 
proposed subsections (d)(i)-(iii) and that adhere to the guidance 
provided in proposed paragraph .08 of the Supplementary Material.

[[Page 26776]]

Exemption From Suitability Standard, ``Sophisticated'' Issuers
    In response to the First Request for Comment, First Southwest 
expressed general support for a suitability standard for 
recommendations by municipal advisors but stated that certain clients 
of municipal advisors are capable of independently evaluating 
recommendations of municipal advisors and these clients should be 
exempt from the suitability standard in a manner similar to the 
``sophisticated municipal market professional'' under MSRB Rule G-48. 
Lamont voiced a similar concern stating that many of its ``large 
sophisticated'' issuer clients do not want, or need, a review of the 
transaction they have already decided to undertake. Lamont commented 
that these types of clients are ``sufficiently capable of weighing the 
risks in a transaction and making their own decision about whether to 
proceed.''
    In response to the Second Request for Comment, SMA stated that when 
a municipal securities transaction or municipal financial product has 
been decided upon by a municipal advisor's client and: (a) Is related 
to a project or event determined by the governing body of the municipal 
entity or its citizens to be in its interest and consistent with its 
goals; (b) is permitted by state statute as determined by municipal or 
bond counsel; and (c) involves a transaction or product which the 
municipality has employed in the past, then it seems suitability has 
been determined and the advisor ought to be able to rely on these facts 
and the closing documents as establishing a reasonable basis for 
suitability. Southern MA suggested that a municipal advisor should not 
be put in the position of substituting its judgment as to the 
suitability of a municipal securities transaction or municipal 
financial product for that of the municipal policy makers, citizens or 
state lawmakers.
    The MSRB has determined that the requirements of section (d), and 
the related paragraphs of the supplementary material, should be 
applicable regardless of the municipal advisor's perception of the 
sophistication of its client or the client's perception of its own 
degree of sophistication. The proposed rule change is aimed at 
protecting municipal entities, obligated persons and the public 
interest and, as a result, the MSRB believes that exemptions such as 
those described by these commenters would frustrate that objective. 
However, in designing Proposed Rule G-42, the MSRB did incorporate many 
of the concepts that commenters believed were indicia of the 
sophistication of an issuer into the factors to be considered when 
determining the suitability of a recommendation. Under those factors, 
the considerations proffered by SMA could be relevant to, and therefore 
be part of, a municipal advisor's suitability analysis depending on all 
of the particular circumstances, though they might not alone be 
sufficient to support a suitability determination under the proposed 
rule change.
Specified Prohibitions
    Several commenters provided input on Proposed Rule G-42(e)(i), 
which sets forth certain activities in which municipal advisors would 
be prohibited from engaging.
General Comments
    In response to the First Request for Comment, NAIPFA and GFOA 
expressed general support for the specified prohibitions, NAIPFA stated 
that the section includes prohibitions that are ``important measures 
that are needed to eliminate certain practices that often carry 
unmanageable conflicts of interest inconsistent with Municipal Advisor 
fiduciary duties,'' and the prohibitions are appropriately tailored and 
would not impose undue regulatory burdens. Other commenters noted their 
general support for the prohibitions, but suggested some revisions or 
limitations, which are discussed in the section below.
    Cooperman commented that the MSRB should determine, after a 
monitoring period since the passage of the Dodd-Frank Act, what, if 
any, abuses or inappropriate conduct remain that would require the 
regulation set forth in the proposed rule change. Alternatively, 
Cooperman suggested that the MSRB consider, at least initially, 
``limiting the [proposed rule] to an enumeration of prohibited forms of 
conduct and practices'' rather than imposing extensive compliance, 
supervision and other requirements. In response to the Second Request 
for Comment, Lewis Young commented that the specified prohibitions 
subsections (e)(i) and (ii) (on the ban of certain principal 
transactions) are unnecessary because the matters addressed in those 
sections are adequately attended to in section (a) and should be 
intrinsic to a reputable municipal advisor's business practices. As 
such, Lewis Young recommended that these prohibitions be set forth in 
the supplementary material in order not to detract from the focus of 
the proposed rule. In response to such comments, the MSRB notes that, 
in many respects, Proposed Rule G-42 adopts a principles-based 
approach, enumerating prohibited forms of conduct and practice. 
However, regarding certain arrangements that the MSRB has identified as 
particularly prone to conflict with, or risk of breach of, the 
fiduciary duty and duty of care, the MSRB believes that the proposed 
rule change appropriately incorporates more specific requirements and 
prohibitions.
Excessive Compensation
    In response to the First Request for Comment, SIFMA, Lewis Young 
and MSA commented that the provision that would prohibit receiving 
compensation that is excessive in relation to the municipal advisory 
activities actually performed (now Proposed Rule G-42(e)(i)(A)), did 
not include a sufficiently clear standard for how excessive 
compensation would be determined and failed to provide adequate amount 
of guidance to facilitate compliance. SIFMA expressed concern that 
without a clear standard or more guidance, such determinations would be 
made in hindsight, presumably by financial regulatory examiners, and to 
the detriment of municipal advisors. Lewis Young called the prohibition 
unworkable, expressed concern that it would require advisors to 
document all of their work and requested that the paragraph be deleted. 
SIFMA and Lewis Young also commented that municipal advisor 
compensation is subject to market forces, and therefore its 
reasonableness should be determined by a negotiation between the client 
and the municipal advisor. PRAG stated that the proposed rule change 
fails to contemplate instances where transaction fees are included in a 
municipal advisor's compensation to compensate the municipal advisor 
for services that it has provided but that were unrelated to the 
issuance of municipal securities. SIFMA and Lewis Young asked whether 
the practice of including fees for services a municipal advisor 
provided, if not related to the issuance of municipal securities, would 
be permitted under the proposed rule change. Columbia Capital commented 
that the MSRB should strike the phrase ``whether the fee is contingent 
upon the closing of the municipal securities transaction or municipal 
financial product,'' in paragraph .10 of the Supplementary Material of 
Proposed Rule G-42, and add, as an additional factor to be considered 
when determining whether compensation is excessive, a comparison of the 
municipal advisor's compensation to other professionals providing 
services on the transaction in question.

[[Page 26777]]

    After carefully considering the comments submitted in response to 
the First Request for Comment, the MSRB incorporated guidance regarding 
excessive compensation in paragraph .10 of the Supplementary Material 
of the Revised Draft Rule and solicited further comment. Paragraph .10 
of Proposed Rule G-42 sets forth various factors that municipal 
advisors should consider when determining the reasonableness of their 
compensation. These factors include: The municipal advisor's expertise, 
the complexity of the municipal securities transaction or the financial 
product, whether the fee is contingent upon the closing of the 
transaction or financial product, the length of time spent on the 
engagement and whether the advisor is paying any other costs related to 
the transaction or financial product. Furthermore, Proposed Rule G-42 
would prohibit receiving compensation that is excessive in relation to 
the municipal advisory activities actually performed. Depending on the 
facts and circumstances of a particular municipal advisory 
relationship, either or both of these provisions could apply to a 
scenario like that posited by PRAG. The proposed rule change, however, 
would not prescribe the source of funds that could be used to pay the 
municipal advisor for its services. Finally, the phrase regarding 
contingent fees is not deleted from paragraph .10 of the Supplementary 
Material as the MSRB believes it is a relevant factor and appropriately 
included in a non-exhaustive list of other relevant factors.
Inaccurate Invoicing
    In response to the First Request for Comment, Wulff Hansen 
commented that the prohibition on the delivery of inaccurate invoices 
(now Proposed Rule G-42(e)(i)(B)) should be modified to clarify that it 
would apply only to any overstatements of fees, expenses or activities, 
and not to any fee discounting by a municipal advisor. SIFMA commented 
that the prohibition should stand but should be modified to add 
materiality and knowledge qualifiers (i.e., a municipal advisor may not 
intentionally deliver a materially inaccurate invoice).
    The MSRB believes that the proposed rule change clearly implies 
that offering a payment discount from the services actually performed 
is a permissible activity because a municipal advisor would be able to 
accurately describe such a discount on its invoice. In response to the 
SIFMA comment, the MSRB notes that the scope of inaccuracy targeted by 
the proposed provision is limited to the significant subjects of the 
services performed and personnel who performed those services, and the 
MSRB believes any inaccuracy in an invoice on those subjects should be 
proscribed. In addition, the MSRB believes that the addition to the 
proposed provision of the state-of-mind elements that SIFMA suggested 
would not sufficiently protect municipal entity and obligated person 
clients.
Prohibition on Fee-Splitting
    The Initial Draft Rule included a prohibition on making or 
participating in any fee-splitting arrangement with underwriters, and 
any undisclosed fee-splitting arrangement with providers of investments 
or services to a municipal entity or obligated person client (now 
Proposed Rule G-42(e)(i)(D)). In response to the First Request for 
Comment, GFOA supported the fee-splitting prohibition in the Initial 
Draft Rule, noting that it ``appears to be an inherent conflict, and 
should be avoided.'' NAIPFA supported the prohibition, but asked the 
MSRB to provide a definition of ``fee-splitting arrangements,'' under 
which independent contractors and subcontractors would fall outside of 
the prohibition. Lewis Young and Winters LLC stated that fee-splitting 
arrangements should be disclosed but not prohibited. SIFMA commented 
that fee-splitting arrangements with affiliates, if fully and fairly 
disclosed, should be permissible. SIFMA stated that there could be 
legitimate reasons for such arrangements, including fee structures 
requested by clients of an affiliate, and, with such disclosure, the 
parties should be free to engage in the fee arrangement believed to be 
most economical and efficient under the circumstances. NABL commented 
that the provision appears to apply to transactions even when the 
advice provided is exempted or excluded from that which would cause one 
to be a ``municipal advisor'' under the SEC Final Rule. Based on this 
assumption, NABL argued that the prohibition should apply only when a 
municipal advisor is giving ``non-exempt'' advice as part of the same 
transaction, not when it is giving advice that is exempt under the SEC 
Final Rule.
    Several commenters provided examples of fee-splitting arrangements 
that they believed should not be prohibited. Cooperman stated that a 
municipal advisor should not be prohibited from outsourcing certain 
parts of its municipal advisory activities to independent contractors 
and subcontractors, including those that may have advisors on their 
staffs, when payment to those third parties is not dependent upon 
successful conclusion of the financing or payment to the municipal 
advisor of its fee. In addition, Cooperman stated the fee-splitting 
prohibition should not prevent two advisor firms from contracting with 
an issuer to perform services for a predetermined fee that is disclosed 
to the issuer. Lewis Young, who favored disclosure of fee-splitting in 
lieu of a complete prohibition, wrote that municipal advisors should be 
permitted to enter into a fee-splitting arrangement with a structuring 
agent that provides specific quantitative services on a transaction. 
Winters LLC asserted that a municipal entity or obligated person should 
be able to have its municipal advisor or other professionals (including 
underwriters, if after the underwriting period) receive compensation 
from investment providers or other service providers for providing 
oversight and performing other services so long as there is full and 
fair written disclosure of the fee-splitting or sharing arrangements. 
Lamont stated that allowing an investment provider to pay fees related 
to the solicitation of the investment by the municipal advisor, and 
that are within the permitted limits of the Internal Revenue Service 
rules, should be acceptable as long as the payments are disclosed to 
the issuer and each investment provider on the bid list. Wulff Hansen 
asked whether it would be permissible under the provision for a 
municipal advisor to arrange for a routine purchase of services on 
behalf of the advised client in a transaction with an entity in which 
the advisor has an interest (e.g., a purchase of services from DTCC 
when the advisor is also a DTCC Participant and thus a part owner of 
DTCC). Finally, Piper Jaffray requested that the MSRB clarify that the 
fee-splitting prohibition, with regards to underwriters, applies to 
``any issue for which it is serving as municipal advisor'' because the 
failure to link the prohibition to the actual advisory engagement could 
lead to unintended and adverse consequences.
    The MSRB agrees with Piper Jaffray's comment and amended the 
provision in the Revised Draft Rule (now Proposed Rule G-42(e)(i)(D)) 
to prohibit a municipal advisor from making or participating in any 
fee-splitting arrangement with underwriters on any municipal securities 
transaction as to which it has provided or is providing advice.
    The MSRB believes that the proposed rule change would help prevent 
violations of fiduciary duties and the duty of care by clearly 
identifying and prohibiting specific fee-splitting

[[Page 26778]]

arrangements that are particularly prone to conflict with such duties. 
Other fee-splitting arrangements would be permitted, provided they are 
fully and fairly disclosed.
Payments To Obtain/Retain an Engagement To Perform Municipal Advisory 
Activities
    In response to the First Request for Comment, NABL commented that 
the Initial Draft Rule G-42 should not prohibit or require the 
disclosure of payments made to obtain or retain municipal advisory 
business, if those activities are engaged in by persons exempted from 
registration as a municipal advisor under SEC Rule 15Ba1-1.\68\ 
Similarly, the NY State Bar commented that the prohibition on making 
payments for the purpose of obtaining or retaining an engagement to 
perform municipal advisory activities under subsection (g)(v) of the 
Initial Draft Rule (now proposed Rule G-42(e)(i)(E)) is unnecessarily 
restrictive with too narrow of an exemption. The NY State Bar stated 
that the provision should also permit payments to persons subject to 
comparable regulatory regimes (e.g., banks, trust companies, broker-
dealers and investment advisors) as well as to affiliates of the 
municipal advisor so long as, in either case, the payments are 
disclosed to the client. SIFMA commented that the proposed rule should 
allow for reasonable fees to be paid to affiliates because soliciting 
on behalf of affiliates does not trigger a requirement for a person to 
register as a municipal advisor under the SEC Final Rule. In response 
to the Second Request for Comment, Sanchez made a similar comment. In 
addition, SIFMA commented that the prohibition should not cover 
expenditures for normal business entertainment expenses as well as 
marketing and sales activities.
---------------------------------------------------------------------------

    \68\ 17 CFR 240.15Ba1-1.
---------------------------------------------------------------------------

    In light of the comments received, the MSRB modified the provision 
(now Proposed Rule G-42(e)(i)(E)(1)) so that it would not specifically 
prohibit municipal advisors from making payments to an affiliate

for a direct or indirect communication with a municipal entity or 
obligated person on behalf of the municipal advisor where such 
communication is made for the purpose of obtaining or retaining an 
engagement to perform municipal advisory activities. . . .

    The modification also would align the paragraph with Section 
15B(e)(9) of the Exchange Act,\69\ which allows affiliates of the 
municipal advisor to solicit on behalf of the municipal advisor without 
triggering the municipal advisor registration requirement for the 
affiliate. The MSRB would clarify, in proposed subparagraph 
(e)(i)(E)(2), that a municipal advisor may pay reasonable fees to 
another municipal advisor registered as such with the Commission and 
the Board for making a similar communication on behalf of the municipal 
advisor making such payments. The MSRB would also clarify, in proposed 
subparagraph (e)(i)(E)(3), that payments that would qualify as 
permissible normal business dealings under current MSRB Rule G-20 also 
would not violate the prohibition. The revisions would harmonize the 
proposed rule change with relevant federal securities laws and rules.
---------------------------------------------------------------------------

    \69\ 15 U.S.C. 78o-4(e)(9).
---------------------------------------------------------------------------

Additional Comments on Specified Prohibitions
    BDA and Piper Jaffray suggested adding two prohibitions to Proposed 
Rule G-42. In response to the First and Second Requests for Comment, 
Piper Jaffray suggested adding a specified prohibition that would 
prohibit a municipal advisor from taking into account whether it 
competes with other firms when the advisor makes a recommendation to 
its client (e.g., a recommendation to the client regarding which 
broker-dealer the client should hire as underwriter). In response to 
the First Request for Comment, BDA and Piper Jaffray suggested a second 
prohibition, which would prohibit a municipal advisor that is not also 
registered as, or affiliated with, a dealer, from using the term 
``independent,'' if used in a manner intended to convey to potential 
clients that the municipal advisor is free from any potential conflicts 
of interest, and imply that, in contrast to advisors also registered as 
dealers, the municipal advisor would provide better advice. Piper 
Jaffray also stated that continued use of the term ``independent'' to 
connote an advisor free from conflicts should be specifically 
prohibited in light of the issues its continued use could create if 
market participants confused such advisors with a person acting as an 
``independent registered municipal advisor'' as used in the SEC Final 
Rule.\70\
---------------------------------------------------------------------------

    \70\ See, e.g., SEC Final Rule, 78 FR at 67471.
---------------------------------------------------------------------------

    The MSRB has not incorporated the prohibitions suggested by BDA and 
Piper Jaffray. To the extent the described conduct constitutes a 
material misrepresentation, the MSRB believes it is already 
appropriately addressed by Proposed Rule G-42 and existing MSRB Rule G-
17, under which municipal advisors, in the conduct of their municipal 
advisory activities, must not engage in any deceptive, dishonest or 
unfair practice with any person.
Prohibition on Principal Transactions
    The MSRB received extensive comments on the proposed provision to 
prohibit a municipal advisor (and its affiliates) from engaging in 
certain principal transactions (as defined in the proposed rule) with a 
municipal entity client of the municipal advisor (``prohibition on 
principal transactions'' or ``ban''). Specifically, Proposed Rule G-
42(e)(ii) generally would prohibit a municipal advisor to a municipal 
entity client, and any affiliate of such municipal advisor, from 
engaging in a principal transaction directly related to the same 
municipal securities transaction or municipal financial product as to 
which the municipal advisor is providing, or has provided, advice.\71\ 
Three related provisions of the proposed rule, subsection (f)(i) and 
paragraphs .07 and .11 of the Supplementary Material, would, 
respectively, define the phrase, ``engaging in a principal 
transaction,'' clarify the relationship between the proposed ban and 
Rule G-23, and provide guidance regarding the term ``other similar 
financial products'' in connection with principal transactions as 
defined in subsection (f)(i). Comments regarding the ban and the 
related provisions are discussed below.
---------------------------------------------------------------------------

    \71\ In the Initial Draft Rule, the ban is set forth in section 
(f); in the Revised Draft Rule and the proposed rule change, the ban 
is set forth in subsection (e)(ii).
---------------------------------------------------------------------------

General
    In response to the First Request for Comment, many commenters 
raised concerns regarding: (1) The application of the ban to obligated 
person clients of municipal advisors; (2) the scope of the ban; (3) the 
meaning of ``principal transaction'' and ``principal capacity;'' (4) 
the ban's application to transactions by affiliates of municipal 
advisors; (5) the absence of an exception to the ban for an advisor or 
its affiliate based upon full and fair disclosure and the written 
consent of a client; and (6) the relationship between the ban and Rule 
G-23. In response to the Second Request for Comment, most of the 
comments focused on: (1) The scope of principal transactions that would 
be considered ``directly related'' to the advised transaction and come 
within the ban; (2) the ban's application to transactions by affiliates 
of municipal advisors; and (3) the relationship between the ban and 
Rule G-23.

[[Page 26779]]

Ban Does Not Apply to Obligated Person Clients
    In the Initial Draft Rule, the ban prohibited a municipal advisor 
and its affiliates from engaging in principal transactions with 
municipal entity and obligated person clients. The ban in Proposed Rule 
G-42(e)(ii) no longer would apply to principal transactions with 
obligated person clients. As a result, the comments urging that the ban 
not apply to obligated persons are not incorporated in this discussion, 
except to note that such comments were considered and the MSRB modified 
the proposed ban such that it would not apply to principal transactions 
with such persons.
Scope and ``Directly Related To''
    In Initial Draft Rule G-42, the prohibition on principal 
transactions was significantly broader than the ban as modified in the 
Revised Draft Rule and as further narrowed in this proposed rule 
change. In the Initial Draft Rule, a municipal advisor (and its 
affiliates) generally were prohibited from engaging in any transaction 
in a principal capacity to which an obligated person client or a 
municipal entity client of the municipal advisor would be the 
counterparty. In response to the First Request for Comment, many 
commenters \72\ interpreted the proposed prohibition quite broadly and 
expressed concerns regarding the scope of the proposed prohibition on 
principal transactions by municipal advisors (and their affiliates) 
with the clients of such municipal advisors.\73\ Commenters, including 
ABA, BDA, NABL and Piper Jaffray, interpreted the ban as covering 
activities and transactions that were unrelated to the municipal 
advisory relationship. The ABA commented that ``because banks almost 
always provide banking products and services in a principal capacity, 
the prohibition would prevent commercial banks and their affiliates 
from providing any other banking products, such as deposit accounts, 
loans, or cash management services . . . despite the fact that these 
products and services are exempt from the municipal advisor regulatory 
regime.'' BDA, Frost, SIFMA and Zion, among others, raised similar 
concerns regarding the broad reach of the prohibition.
---------------------------------------------------------------------------

    \72\ Commenters that expressed such concerns include ABA, BDA, 
Cape Cod Savings, Coastal, Frost, GFOA, GKB, JP Morgan, Kutak, NABL, 
NY State Bar, Parsons, Piper Jaffray, SIFMA and Zion.
    \73\ SIFMA suggested narrowing the proposed provision to:
    A municipal advisor to a municipal entity client, and any 
affiliate of such municipal advisor, is prohibited from engaging in 
a principal transaction directly related to the advice rendered by 
such municipal advisor (emphasis added).
    BDA suggested the following alternative:
    A municipal advisor, and any affiliate of such municipal 
advisor, is prohibited from engaging in a principal transaction with 
a municipal entity client if the structure, timing or terms of such 
principal transaction was [sic] established on the advice of the 
municipal advisor in connection with a municipal advisory 
relationship with such municipal entity client.
---------------------------------------------------------------------------

    After carefully considering the comments, the prohibition on 
principal transactions was significantly narrowed and clarified, as set 
forth in Revised Draft Rule G-42(e)(ii). The MSRB limited the ban to 
``a principal transaction directly related to the same municipal 
securities transaction or municipal financial product as to which the 
municipal advisor is providing advice'' (emphasis added). The Revised 
Draft Rule would thus prohibit a municipal advisor (and its affiliates) 
to a municipal entity client from engaging in a principal transaction 
directly related to the same municipal securities transaction or 
municipal financial product as to which the municipal advisor is 
providing advice. The modification was designed to exclude many of the 
transactions that some commenters read as potentially covered by the 
Initial Draft Rule, including the taking of a cash deposit or the 
payment by a client solely for professional services.
    In response to the Second Request for Comment, some commenters 
supported the changes to the proposed rule text. Several other 
commenters continued to raise concerns regarding what they believed to 
be the overly broad scope of the ban. Conversely, one commenter stated 
that the ban in Revised Draft Rule G-42(e)(ii) had become too narrow. 
GFOA approved of the modification narrowing the proposed ban to ``a 
principal transaction directly related to the same municipal securities 
transaction or municipal financial product as to which the municipal 
advisor is providing advice,'' and Wells Fargo noted that the 
modification mitigated the impact of the proposed ban. ABA also 
welcomed the revision, but suggested additional changes. In addition, 
BDA, NY State Bar, Piper Jaffray and SIFMA suggested that the ban be 
modified further to narrow or clarify the scope of the ban. ABA 
recommended that the provision require the advice provided by the 
municipal advisor be provided pursuant to a municipal advisory 
relationship; NY State Bar recommended that the prohibition not apply 
where the municipal advisor does not make a recommendation to the 
municipal advisory client to enter into a transaction with the advisor 
or its affiliate; and SIFMA recommended that the provision ban only 
those principal transactions that are directly related to the advice 
the municipal advisor is providing, not merely the same municipal 
securities transaction or municipal financial product in connection 
with which the advice is provided.\74\ BDA and Piper Jaffray commented 
that the term ``directly related'' was unclear, and recommended 
alternative language. In Piper Jaffray's view, the ban should be 
limited to a transaction or issuance where a firm served as a municipal 
advisor and about which advice was rendered. Alternatively, Piper 
Jaffray suggested that the ban should cover transactions ``directly 
related to the advice given rather than directly related to the 
transaction itself.'' Applying the proposed ``directly related to'' 
standard to certain hypothetically paired transactions, BDA asked 
whether one of each pair of such transactions would be considered 
directly related to the second transaction and therefore subject to the 
proposed prohibition, and also proposed a modification to the ban.\75\ 
Conversely, Lewis Young argued that, with the changes set forth in the 
Revised Draft Rule, the scope of the prohibition on principal 
transactions has gone from ``too broad to too narrow'' because the 
definition of ``engaging in a principal transaction'' (discussed in 
greater detail

[[Page 26780]]

below) does not extend fully to the variety of principal transactions 
in which a municipal advisor could engage, which would be in conflict 
with its municipal advisory role and fiduciary duty (e.g., a bank loan 
as a substitute for an issuance of municipal securities).
---------------------------------------------------------------------------

    \74\ In response to the Second Request for Comment, ABA 
recommended the provision be modified to read:
    A municipal advisor to a municipal entity client, and any 
affiliate of such municipal advisor, is prohibited from engaging in 
a principal transaction directly related to the same municipal 
securities transaction or municipal financial product as to which 
the municipal advisor is providing advice pursuant to a municipal 
advisory relationship.
    SIFMA recommended the provision be modified to read:
    A municipal advisor to a municipal entity client, and any 
affiliate of such municipal advisor, is prohibited from knowingly 
engaging in a [prohibited] principal transaction.
    \75\ In connection with interpreting the scope of the ``directly 
related to'' standard, BDA asked whether: (1) Selling securities as 
a principal after winning a competitive bid for an open market 
refunding escrow on a refunding bond issue for which the firm was a 
municipal advisor would be a transaction ``directly related to'' the 
refunded bond issue and therefore a prohibited principal 
transaction; (2) acting as the underwriter on a series of variable 
rate bonds would be directly related to acting as the municipal 
advisor for a related swap, and be prohibited; and, (3) underwriting 
a refunding issue years after serving as a municipal advisor for the 
initial issue would be a transaction that would be considered 
directly related to the initial issue and prohibited.
    BDA recommended the provision be modified to delete the 
``directly related to'' standard and substitute: ``if the structure, 
timing or terms of such principal transaction was established on the 
advice of the municipal advisor in connection with a municipal 
advisory relationship with such municipal entity client.''
---------------------------------------------------------------------------

    The principal transactions ban is incorporated in the proposed rule 
change as Proposed Rule G-42(e)(ii). The MSRB has determined not to 
narrow, broaden or otherwise modify the standard--``directly related to 
the same municipal securities transaction or municipal financial 
product as to which the municipal advisor is providing advice''--in 
response to the comments received. The MSRB believes that the various 
alternative rule texts proposed by commenters would not be more 
effective or efficient means for achieving the stated objective of 
Proposed Rule G-42(e)(ii), which is to eliminate a category of 
particularly acute conflicts of interest that would arise in the 
fiduciary relationship between a municipal advisor and its municipal 
entity client. The alternatives offered by various commenters are 
similar in that they would seek to limit the scope of prohibited 
transactions to those pertaining to the advice rendered by the 
municipal advisor. If adopted, such a change could leave transactions 
that have a high risk of self-dealing insufficiently addressed. For 
example, a municipal advisor that provided advice to a municipal entity 
regarding the timing and structure of a new issuance arguably would not 
be prohibited from acting as principal in entering into an interest 
rate swap for the same issuance so long as the advisor refrained from 
advising on the swap. In addition, in response to the comments that the 
standard would continue to raise questions whether a transaction was 
prohibited under Proposed Rule G-42(e)(ii) and the suggestion that the 
MSRB further amend the provision to clarify the provision, the MSRB 
does not believe it would be feasible or desirable, given the 
principled nature of the provision, to specify in advance its 
application in all circumstances. As noted above, the proposed 
principal transactions ban is revised to clarify that the prohibition 
applies both to principal transactions that occur while the municipal 
advisor is providing advice with respect to a directly related 
municipal securities transaction or municipal financial product, and 
after the municipal advisor has provided such advice.
``Engaging in a Principal Transaction'' and ``Other Similar Financial 
Products''
    In response to the First Request for Comment, certain commenters, 
including GFOA, NAIPFA, SIFMA and Wulff Hansen, commented that the MSRB 
should provide additional guidance regarding the meaning of various 
terms (e.g., ``principal capacity'' and ``principal transaction'') for 
purposes of interpreting the proposed prohibition on principal 
transactions. Several commenters, including GFOA, Wulff Hansen and 
First Southwest, sought clarification regarding the types of 
transactions that would constitute principal transactions. For example, 
the GFOA requested that the MSRB provide examples of prohibited and 
acceptable practices; Wulff Hansen asked that the MSRB specify whether 
the sale of other additional municipal advisory or related services 
would constitute a prohibited principal transaction; and First 
Southwest asked whether a municipal advisor that also facilitates 
private placements would be engaged in a principal transaction.
    In response to comments, the Revised Draft Rule G-42(f)(i) added, 
for purposes of the Revised Draft Rule, a defined term, ``engaging in a 
principal transaction'' to mean: ``when acting as principal for one's 
own account, selling to or purchasing from the municipal entity client 
any security or entering into any derivative, guaranteed investment 
contract, or other similar financial product with the municipal entity 
client.''
    In response to the Second Request for Comment, ABA and GFOA 
expressed support for the proposed defined term. Another commenter, 
Sanchez, asked the MSRB to include a non-exhaustive list of specific 
common roles (such as underwriter) in addition to the general 
description. NY State Bar recommended two significant changes intended 
to narrow the scope of the prohibition and the definition of principal 
transaction: (1) The ``somewhat open-ended'' phrase ``other similar 
financial product'' should be amended to refer exclusively to municipal 
financial products, as defined in the Exchange Act; and (2) the 
definition of ``engaging in a principal transaction'' should be amended 
to make clear that the term does not include any of the banking 
activities as to which a bank may provide advice without being 
registered as a municipal advisor pursuant to the exemption in the SEC 
Rule 15Ba1-1(d)(3)(iii),\76\ including holding investments in a deposit 
or savings account, certificate of deposit or other deposit instrument 
issued by a bank; extensions of credit by a bank to a municipal entity 
or obligated person, including the issuance of a letter of credit; the 
making of a direct loan, or the purchase of a municipal security by the 
bank for its own account; holding funds in a sweep account; or 
investments made by a bank acting in the capacity of an indenture 
trustee or similar capacity.
---------------------------------------------------------------------------

    \76\ 17 CFR 240.15Ba1-1(d)(3)(iii).
---------------------------------------------------------------------------

    In response to comments filed regarding the Second Request for 
Comment, including Lewis Young's, the proposed rule would provide 
additional guidance regarding the term, ``other similar financial 
products.'' Proposed Supplemental Material paragraph .11 would provide 
that, as used in Proposed Rule G-42(f)(i), ``other similar financial 
products,'' ``includes a bank loan, but only if it is in an aggregate 
principal amount of $1,000,000 or more and it is economically 
equivalent to the purchase of one or more municipal securities.'' The 
MSRB notes that the term ``other similar financial products'' is not 
limited to refer exclusively to municipal financial products, as 
defined in the Exchange Act, in that a fiduciary's obligation to its 
client--not to engage in principal transactions in which the 
fiduciary's financial interests and concerns conflict with those of the 
client--is not so limited. For the same reason, the MSRB has determined 
not to limit the scope of banned transactions, which are covered based 
generally on conflicts principles, to the category of transactions as 
to which advising triggers a registration requirement as a municipal 
advisor.
Exceptions to Ban
    In the First Request for Comment, the MSRB specifically sought 
comments on whether a ban on principal transactions by municipal 
advisors was the appropriate regulatory approach, or whether a 
municipal advisor should be permitted to engage in certain types of 
principal transactions with its client, with full and fair disclosure 
and written client consent, and, if so, what types of principal 
transactions should be allowed.
    In response to the First Request for Comment, several commenters, 
including ABA, First Southwest, Frost, GKB, Kutak, JP Morgan, NABL and 
SIFMA, expressed concerns regarding what they viewed as the overly 
broad prohibition on principal transactions between municipal advisors 
and their clients. Several commenters, including the ABA, Cape Cod 
Savings, Frost, NABL, SIFMA and Zion, stated that the prohibition could 
do a disservice to municipal entities by unnecessarily and

[[Page 26781]]

substantially restricting the choices available to municipal entities 
that engage their municipal advisors (or their affiliates) in other 
types of transactions that would be prohibited by the Initial Draft 
Rule. In addition, several commenters, including ABA, Kutak, NABL, 
Parsons, SIFMA, Sutherland and Wells Fargo, believed that a municipal 
advisor should be permitted to engage in certain types of principal 
transactions with its clients if the municipal advisor provides its 
client with full and fair disclosure and then receives informed consent 
from the client. NABL stated that the proposed ban would conflict with 
common law, under which an agent's fiduciary duties of loyalty and care 
could be waived or otherwise modified by the principal if the principal 
is not legally incompetent. Kutak commented that the Initial Draft Rule 
should not prohibit all principal transactions with municipal entities 
when the client is sufficiently sophisticated to adequately assess the 
risks of the transactions. Kutak believed transactions involving an 
investment in an instrument where an established market exists and a 
municipal entity client could readily ascertain the reasonableness and 
fairness of the price should be allowed under the Initial Draft Rule.
    Also, multiple commenters, including ABA, Kutak, NABL and SIFMA (in 
response to the First Request for Comment) and FSR and Zion (in 
response to the Second Request for Comment), noted that under Section 
206(3) of the Investment Advisers Act and other regulatory regimes, 
certain principal transactions are permitted based upon full and fair 
disclosure and client consent.\77\ The commenters suggested that a 
similar mechanism should be included in the ban that would allow 
municipal advisors to engage in principal transactions with their 
municipal entity clients, subject to similar disclosure and consent 
requirements. NABL also commented that, if the MSRB adopted a provision 
that was consistent with the SEC's guidance under the Investment 
Advisers Act regarding an exception to a ban based on disclosure and 
informed consent, the MSRB should provide clear guidance to market 
participants to avoid confusion.
---------------------------------------------------------------------------

    \77\ See 15 U.S.C. 80b-6 and the rules adopted thereunder, which 
prohibit an adviser, acting as a principal for its own account, from 
knowingly selling any security to or purchasing any security from a 
client for its own account, without disclosing to the client in 
writing the capacity in which it (or an affiliate) is acting and 
obtaining the client's consent before the completion of the 
transaction.
    SIFMA also referred to the regulation of swap dealers and 
security-based swap dealers that also serve as advisors to Special 
Entities (which includes municipal entities) under the CEA. See 7 
U.S.C. 1 et seq. According to SIFMA, the CEA does not preclude such 
advisors from entering, in a principal capacity, into derivatives 
transactions with the Special Entities that they advise, including 
municipal entities, subject to the duty of the advisor to act in the 
best interests of the Special Entity.
---------------------------------------------------------------------------

    In contrast, commenters Lewis Young and NAIPFA supported the 
proposed ban on principal transactions and did not recommend creating 
exceptions or narrowing its scope. Lewis Young commented that the ban 
was appropriate, stating that a party cannot be both a fiduciary and a 
principal party in a buyer/seller relationship if the sale is an asset, 
financial product or something other than services that are compatible 
with the fiduciary role.
    The MSRB carefully considered the comments received that urged the 
MSRB to include one or more exceptions to the prohibition on principal 
transactions. After considering the fiduciary duty of the municipal 
advisor in its relationship to a municipal entity client and the 
possibilities for self-dealing, the MSRB believes that the proposed 
prohibition on principal transactions is sufficiently targeted and 
should be retained. In addition, the MSRB believes that exceptions to 
the prohibition based on disclosure and client consent, even if limited 
to sophisticated municipal entities, would not sufficiently protect 
municipal entity clients from potential self-dealing-related abuses. 
The prohibition has been narrowed to ban only those transactions that 
(1) are ``directly related'' to the same municipal securities 
transaction or municipal financial product as to which the municipal 
advisor is providing or has provided advice and (2) are purchases or 
sales of a security or involve entering into a derivative, guaranteed 
investment contract, or other similar financial product with the 
municipal entity client (as discussed, supra). In the MSRB's view, the 
prohibition on principal transactions should not at this juncture be 
modified or narrowed, given the acute conflicts of interest presented 
and the risk of self-dealing by a regulated entity (or its 
affiliate).\78\
---------------------------------------------------------------------------

    \78\ Similar concerns regarding conflicts of interests arising 
when a regulated entity would provide financial advice to a 
municipal issuer and also serve as underwriter were raised by the 
MSRB and commenters in connection with SR-MSRB-2011-03, a proposed 
rule change to amend MSRB Rule G-23 relating to the activities of 
financial advisors, which was approved by the Commission. See 
Exchange Act Release No. 64564 (May 27, 2011), 76 FR 32248, 32249 
(June 3, 2011) (order approving File No. SR-MSRB-2011-03) (``[T]he 
proposed rule change resulted from a concern that a dealer financial 
advisor's ability to underwrite the same issue of municipal 
securities, on which it acted as financial advisor, presented a 
conflict that is too significant for the existing disclosure and 
consent provisions of Rule G-23 to cure. Even in the case of a 
competitive underwriting, the perception on the part of issuers and 
investors that such a conflict might exist was sufficient to cause 
concern that permitting such role switching was not consistent with 
`a free and open market in municipal securities' '' (emphasis 
added)).
---------------------------------------------------------------------------

Affiliates
    In response to the First Request for Comment, a number of 
commenters commented on the ban's coverage of principal transactions by 
affiliates of a municipal advisor, including ABA, Frost, JP Morgan, 
Parsons, Piper Jaffray, SIFMA, Wells Fargo and Zion.
    The ABA, SIFMA and other commenters commented generally that other 
fiduciary regimes do not prohibit all affiliates of a fiduciary from 
engaging in principal transactions with the party owed the fiduciary 
duty. Wells Fargo also sought to limit the coverage of the ban, 
commenting that the ban should not apply to certain affiliates. In 
Wells Fargo's view, affiliates of large financial institutions often 
offer substantially different services, operate with distinct 
governance structures and employ information barriers, and, in such 
instances, if a non-municipal advisor affiliate is not connected to the 
municipal advisor relationship, the risk of a conflict of interest in a 
principal transaction between a municipal advisor client and the non-
municipal advisor affiliate is significantly diminished. Wells Fargo 
suggested that the MSRB not apply the ban to affiliates or, at a 
minimum, limit the ban to principal transactions of affiliates that are 
directly related to the municipal advisory relationship that the 
municipal advisor affiliate has with the client. ABA, NABL, SIFMA, 
Wells Fargo, Zion and other commenters generally expressed concerns 
related to regulating conduct of affiliates of municipal advisors, 
specifically the imposition of compliance burdens on the affiliates and 
possible unintended consequences to clients if certain products and 
services offered by affiliates of the municipal advisor were no longer 
available to clients. ABA and NABL commented that the MSRB does not 
have apparent authority to regulate the conduct of affiliates of 
municipal advisors that are not brokers, dealers or municipal 
securities dealers, and thus, any ban should be narrowly-tailored and 
addressed to the municipal advisor's right to advise, rather than its 
affiliates' rights to engage in unrelated transactions.
    In response to the Second Request for Comment, ABA, FSR, SIFMA and 
Wells

[[Page 26782]]

Fargo included significant comments that focused on the ban's 
application to transactions by affiliates. With respect to affiliates, 
among the concerns raised was the difficulty that municipal advisors 
and their affiliates might have in identifying transactions that are 
related to an advised transaction, particularly within large 
organizations, and the likely significant cost of compliance.
    Commenters, such as SIFMA and Wells Fargo, also questioned the 
value of extending the prohibition to affiliates of a municipal 
advisor, stating that, in scenarios where the affiliate has no 
knowledge of the municipal advisory relationship, or where the 
municipal advisor has no knowledge of an affiliate's contemplated 
principal transaction, the parties would not be likely to engage in 
self-dealing or profit from the affiliation.
    SIFMA suggested that the MSRB include the emphasized modifier in 
subsection (e)(ii) as follows: ``A municipal advisor to a municipal 
entity client, and any affiliate of such municipal advisor, is 
prohibited from knowingly engaging in a principal transaction. . . .'' 
(emphasis added), which is the same modifier contained in the provision 
on principal transactions in the Investment Advisers Act.\79\ Wells 
Fargo suggested a modification to exempt municipal advisor affiliates 
operating with information barriers, stating that such entities are 
unlikely to engage in the self-dealing that the rule is aimed at 
preventing.
---------------------------------------------------------------------------

    \79\ See 15 U.S.C. 80b-6(3).
---------------------------------------------------------------------------

    After considering the fiduciary duty of the municipal advisor in 
its relationship to a municipal entity client and the risk of self-
dealing, the MSRB believes that the proposed prohibition on principal 
transactions, including its application to affiliates, is sufficiently 
targeted. In the MSRB's view, the proposed prohibition should be 
retained without exceptions, including one based on disclosure and 
consent, for the reasons set forth above, given the acute nature of the 
conflicts of interest presented and the risks of self-dealing by 
affiliates in transactions that are ``directly related'' to the same 
municipal securities transaction or municipal financial product as to 
which the affiliated municipal advisor is providing or has provided 
advice. Significantly, the prohibition is limited to certain types of 
transactions (i.e., purchases or sales of a security or those involving 
entering into a derivative, guaranteed investment contract, or other 
similar financial product). Finally, in connection with affiliates, if 
the prohibition on principal transactions were modified by 
``knowingly,'' the MSRB believes the standard would be overly 
stringent, which could hinder regulatory examinations and enforcement.
Relationship Between the Ban and Rule G-23
    In the First Request for Comment, the ban prohibiting municipal 
advisors (and their affiliates) from engaging in principal transactions 
with the municipal advisor's clients included the exception: ``Except 
for an activity that is expressly permitted under [MSRB] Rule G-23'' 
(``Rule G-23 exception''). The Rule G-23 exception was included to 
address the interrelationship between the proposed specific prohibition 
on principal transactions in Initial Draft Rule G-42 and principal 
transactions that are permitted by underwriters under Rule G-23.
    Commenters sought clarity regarding the relationship between Rule 
G-23 and the prohibition on principal transactions in the Initial Draft 
Rule. In response to the First Request for Comment, commenters asked 
whether the prohibition on principal transactions was in conflict with 
principal transactions discussed in Rule G-23, under which a municipal 
advisor could acquire, as a principal, all or any portion of an 
issuance of municipal securities for which the municipal advisor had 
provided advice, as long as the municipal advisor complied with Rule G-
23. BDA and GKB noted that, although the provision in the proposed ban 
referenced an exception for activities that are expressly permitted 
under Rule G-23, it was unclear what principal transactions would be 
permitted. Lamont commented that MSRB rules applicable to municipal 
advisors should not conflict with MSRB rules applicable to dealers 
regarding principal transactions, observing that, in its view, a 
fiduciary duty to the issuer will require additional steps to ensure 
that the pricing has been at least as favorable as having a third party 
in the transaction.
    After careful consideration of the comments, the MSRB developed the 
Revised Draft Rule to clarify the relationship between the proposed ban 
on principal transactions and those principal transactions currently 
permitted under Rule G-23. Specifically, paragraph .07 to the 
Supplementary Material of the Revised Draft Rule described the Rule G-
23 exception to the ban, providing that subsection (e)(ii) would not 
apply to an acquisition as principal, either alone or as a participant 
in a syndicate or other similar account formed for the purpose of 
purchasing, directly or indirectly, from an issuer all or any portion 
of an issuance of municipal securities, provided that the municipal 
advisor complied with the requirements of Rule G-23. Thus, the Rule G-
23 exception was more clearly described using the particular 
terminology in Rule G-23, rather than solely cross-referencing Rule G-
23.
    Several of the comments received in response to the Second Request 
for Comment continued to seek clarification regarding the Rule G-23 
exception, desiring to avoid confusion regarding any express and direct 
conflict between the ban and Rule G-23. GFOA sought additional 
amendments to paragraph .07 of the Supplementary Material, seeking to 
``ensure that no component of a final Rule on G-42 removes the 
authority of issuers to decide for themselves how they utilize a 
[municipal advisor] or underwriter on a transaction so long as 
compliance with MSRB Rule G-23, MSRB Rule G-42 and the SEC's Municipal 
Advisor Rule are maintained.'' In BDA's view, the Revised Draft Rule 
language did not clarify the provision compared with the prior language 
regarding when a municipal advisor could act as a principal on the same 
transaction for which it is providing advice.
    Sanchez appeared to interpret the provision to mean that a 
transaction permitted by Rule G-23 would be deemed in all cases to be 
lawful vis-a-vis other requirements under proposed Rule G-42 (such as 
the duty of loyalty) and under other laws (such as the statutory 
fiduciary duty). Columbia Capital commented that the sentence regarding 
the Rule G-23 exception in paragraph .07 of the Supplementary Material 
should be deleted because it ``contemplates a situation where an MA 
could serve as a principal in a transaction for which it provides MA 
services, creating a conflict'' with the proposed prohibition on 
principal transactions. Finally, ABA commented that the clarification 
regarding the conflict between Rule G-23 and draft Rule G-42(e)(ii) is 
unnecessary, or, if the clarification is retained, the phrase, 
``provided that the municipal advisor complies with all of the 
provisions of Rule G-23,'' should be deleted and the phrase, ``provided 
that such a transaction is not prohibited by the provisions of Rule G-
23,'' should be incorporated.
    The MSRB notes that the purpose of the sentence regarding the Rule 
G-23 exception in paragraph .07 of the Supplementary Material is to 
avoid a potential inconsistency in the MSRB's

[[Page 26783]]

rules by providing specifically in Proposed Rule G-42, until such time 
as the MSRB may further review and potentially revise Rule G-23, that 
the specific ban on principal transactions in proposed subsection 
(e)(ii) does not prohibit a type of principal transaction that is 
already addressed and prohibited to a certain extent by Rule G-23. To 
further clarify this point, and respond to the comment by ABA, the MSRB 
has deleted the phrase ``provided that the municipal advisor complies 
with all the provisions of Rule G-23'' from the end of paragraph .07, 
and substituted the phrase ``that is a type of transaction that is 
addressed by Rule G-23.'' Also, in response to the comments requesting 
additional clarification, the MSRB has included the phrase ``on the 
basis that the municipal advisor provided advice as to the issuance.'' 
Proposed paragraph .07 of the Supplementary Material, as revised, would 
provide:

    In addition, the specific prohibition in subsection (e)(ii) . . 
. shall not apply to an acquisition as principal, either alone or as 
a participant in a syndicate or other similar account formed for the 
purpose of purchasing, directly or indirectly, from an issuer all or 
any portion of an issuance of municipal securities on the basis that 
the municipal advisor provided advice as to the issuance because 
that is a type of transaction that is addressed and prohibited in 
certain circumstances by Rule G-23 (emphasis added).

    The MSRB cautions that this provision is quite limited, providing 
an exception only to the specific prohibition in subsection G-
42(e)(ii); and it would not mean, for example, that a transaction not 
prohibited by Rule G-23 is deemed in all cases to be lawful vis-a-vis 
all other requirements under Proposed Rule G-42 (such as the duty of 
loyalty) and under other laws (such as the statutory fiduciary duty).
Inadvertent Advice--Supplementary Material .06
    In response to the Second Request for Comment, several commenters 
expressed concerns and suggested changes to the inadvertent advice 
exclusion in paragraph .06 of the Supplementary Material to the Revised 
Draft Rule. First, NAIPFA believed the paragraph impermissibly creates 
an additional exemption from the Commission's definition of the term 
``municipal advisor'' and is inconsistent with Rule G-23, allowing 
broker-dealers to provide advice to municipal entities and obligated 
persons as municipal advisors without becoming subject to corresponding 
fiduciary responsibilities and ultimately allowing such municipal 
advisors to serve as underwriters of the securities being issued. 
Similarly, WM Financial believed paragraph .06 negated Rule G-23 and 
effectively allowed broker-dealers to serve as municipal advisors and 
then switch to serving as underwriters, undermining the definition of 
``municipal advisor'' and the exemptions thereto provided by the SEC. 
Contrary to NAIPFA and WM Financial, Sanchez stated that ``it appears 
reasonably clear at the moment that Supplementary Material .06 is only 
intended to provide relief from subsections (b) and (c) of Proposed 
Rule G-42;'' however, he believed it would be useful for the MSRB to 
also include an affirmative statement that even inadvertent advice is 
subject to all other rules and requirements applicable to municipal 
advisory activities and financial advisory relationships entered into 
by broker-dealers under Rule G-23, Commission rules, and the fiduciary 
duty set forth in the Exchange Act.
    NAIPFA and WM Financial misinterpreted the safe harbor provided by 
paragraph .06 as broadly relieving a municipal advisor of other 
regulatory requirements. To address such confusion, the MSRB has 
revised paragraph .06 of the Supplementary Material to include a 
clarifying statement that the relief the paragraph provides ``has no 
effect on the applicability of any provisions'' of Proposed Rule G-42, 
other than sections (b) and (c) (relating to documentation of the 
municipal advisory relationship and the disclosure of conflicts of 
interest, respectively) or any other legal requirements applicable to 
municipal advisory activities, which would include, but are not limited 
to, SEC rules and Rule G-23.
    Second, SIFMA suggested that the MSRB broaden the limited safe 
harbor provided by paragraph .06 to relieve municipal advisors that 
inadvertently engage in municipal advisory activities from compliance 
with section (d) and subsection (e)(ii) of the Revised Draft Rule. 
Section (d) would require a suitability analysis of recommendations 
made by the municipal advisor or by a third party while subsection 
(e)(ii) would prohibit principal transactions directly related to the 
same municipal securities transaction or municipal financial product as 
to which the municipal advisor is providing or has provided advice. The 
MSRB believes that, despite inadvertently engaging in municipal 
securities activities, a municipal advisor should not be relieved of 
complying with the suitability analysis requirement to the extent the 
municipal advisor made or reviewed a recommendation as contemplated by 
Proposed Rule G-42(d). Further, the MSRB does not believe, as SIFMA 
suggested, that firms would be less likely to perform the disclaimer 
process under paragraph .06 because doing so would not permit them to 
engage in a principal transaction prohibited under Proposed Rule G-
42(e)(ii). Specifically, use of the exemption under paragraph .06 would 
only relieve a municipal advisor of compliance with the requirements of 
Proposed Rule G-42(b) and (c), and the prohibition on principal 
transactions would apply to the municipal advisor regardless. 
Therefore, the MSRB has not revised paragraph .06 in response to these 
comments.
    Third, NAIPFA highlighted the importance of prompt use of the safe 
harbor provided by paragraph .06, suggesting that the proposed rule 
require utilization within ten days of discovery of the inadvertent 
advice. The MSRB has not prescribed a strict time frame for when the 
documentation must be provided by the municipal advisor beyond the 
general ``promptly'' standard, as doing so would create an arbitrary 
bright line that would be of limited benefit to municipal advisors or 
their clients. In response to the comment and to ensure that municipal 
advisors seeking to obtain the relief provided under paragraph .06 do 
so in a timely manner after having discovered that they inadvertently 
provided advice, the MSRB modified paragraph .06 to require municipal 
advisors to provide the documentation it prescribes ``as promptly as 
possible after discovery'' (emphasis added).
    Fourth, SIFMA noted that there are circumstances in which a 
registered municipal advisor could be engaged in municipal advisory 
activities for some clients, but inadvertently provide advice to 
another client, and, therefore, could not state that it ``has ceased 
engaging in municipal advisory activities'' to comply with paragraph 
.06. In response to the comment, the MSRB has revised the disclaimer 
required by subparagraph (a) of paragraph .06 of the Supplementary 
Material to state that, effective immediately, the municipal advisor 
has ceased engaging in municipal advisory activities ``with respect to 
that municipal entity or obligated person in regard to all transactions 
and municipal financial products as to which advice was inadvertently 
provided . . . .'' (emphasis added). This revision would clarify that 
the municipal advisor is not required to cease all municipal advisory 
activities to obtain the relief provided by paragraph .06.
    Fifth, NAIPFA highlighted the importance of the identification of 
the

[[Page 26784]]

inadvertent advice, suggesting requiring the identification of 
absolutely all of the inadvertent advice. In response to this comment, 
the MSRB revised subparagraph (c) of paragraph .06 to require that the 
municipal advisor identify all of the advice that was provided 
inadvertently, based on a reasonable investigation. This objective 
standard for the investigation would avoid requiring municipal advisors 
to go to impractical lengths to ensure that all inadvertent advice was 
identified, and the MSRB believes this would be sufficient to allow 
municipal advisor clients to assess risk exposure from any reliance on 
the advice and determine what potential mitigating actions need to be 
taken.
    Finally, SIFMA suggested that the MSRB should carve out an 
exception for all advice that is incidental to brokerage/securities 
execution services. In the MSRB's view, SIFMA's request, as noted 
above, is a request that the MSRB interpret the SEC Final Rule and the 
definition of ``municipal advisor,'' therein. The authority to 
interpret the Commission's rule lies with the Commission and the 
request should be directed to the Commission. As such, the MSRB 
declines to revise paragraph .06 of the Supplementary Material in this 
manner.
Trigger for Municipal Advisor Relationship
    Subsection (f)(vi) would define ``municipal advisory relationship'' 
for purposes of Proposed Rule G-42 and states that a municipal advisory 
relationship will ``be deemed to exist when a municipal advisor enters 
into an agreement to engage in municipal advisory activities for a 
municipal entity or obligated person.'' In response to the Second 
Request for Comment, Columbia Capital objected to the deletion of 
``engages'' from the definition of ``municipal advisory relationship'' 
in subsection (f)(vi) of the Revised Draft Rule. Specifically, Columbia 
Capital stated that, ``[i]f a person provides `advice' he/she should 
trigger the [municipal advisor] duties at the time of providing that 
advice and should be considered [a municipal advisor] unless that 
person qualifies for an exemption or exclusion at the time such advice 
is provided.'' Under the proposed rule change, the municipal advisory 
relationship would begin at the time a municipal advisor enters into an 
agreement to engage in municipal advisory activities, which then 
triggers the documentation requirements of Proposed Rule G-42(c).
    The MSRB believes Columbia Capital's concern is moot because the 
other duties required by Proposed Rule G-42, including, but not limited 
to, providing written disclosures to clients, would be triggered when a 
municipal advisor engages in municipal advisory activities. The MSRB 
also notes that engaging in municipal advisory activities would subject 
a firm to municipal advisor registration requirements and any other 
legal requirements applicable to municipal advisory activities. 
Accordingly, the MSRB has not revised subsection (f)(vi) of the Revised 
Draft Rule, as incorporated into the proposed rule, in response to this 
comment.
Economic Analysis of Comments on Economic Implications of Proposed Rule
Economic Analysis--Cost of Compliance
    Several commenters stated that the cost of complying with the 
proposed rule would be ``burdensome'' or ``significant.'' In some 
cases, commenters identified alternative approaches that they 
considered to be less costly. No commenter provided specific cost 
information or data that would support an improved estimate of the 
costs of compliance.
    FSR and SIFMA both stated that the requirement on municipal 
advisors to provide disclosure of all material conflicts of interest 
including any of its affiliates that provides any advice, service, or 
product directly or indirectly related to performing municipal advisory 
activities would be burdensome, particularly for municipal advisors 
that are part of large financial conglomerates. Sanchez commented that 
a ``written statement'' would be less burdensome than ``written 
documentation'' when municipal advisors conclude that material 
conflicts of interest exist. FSR, SIFMA, and Sanchez commented that the 
detailed disclosure of disciplinary events material to the client's 
evaluation of the municipal advisor could be accomplished at a lower 
cost by allowing municipal advisors to reference the documentation 
provided to the SEC on Forms MA and MA-I. Columbia Capital requested 
that the MSRB consider allowing municipal advisors to use more than one 
document to meet the requirement for documentation of the municipal 
advisory relationship.
    The MSRB agrees that municipal entities and obligated persons can 
be made aware of relevant conflicts of interest at a lower cost by 
revising some of the requirements. To that end, the MSRB amended 
Proposed Rule G-42(b)(i)(A) to narrow the scope of potential conflicts 
that would need to be disclosed from those that ``might'' impair the 
advisor's ability to provide advice to those that ``could reasonably be 
anticipated to impair'' the advisor's ability and Proposed Rule G-
42(b)(i)(B) to remove the requirement to disclose potential conflicts 
that might arise from advice, service, or products provided by 
affiliates and indirectly related to the performance of municipal 
advisory activities. The MSRB also amended Rule G-42(b)(i) to allow for 
a written statement instead of written documentation if a municipal 
advisor concludes that no known material conflicts of interest exist. 
The MSRB also agrees that information regarding disciplinary events may 
be disclosed by identification of the specific type of the event and 
specific reference to the relevant portions of Forms MA and MA-I and 
has amended Proposed Rule G-42(b)(ii) to reflect this. Finally, the 
MSRB has clarified that a municipal advisor may use multiple documents 
to document the relationship by adding the plural ``writings'' to 
Proposed Rule G-42(c).
Economic Analysis--Transition Period
    Lewis Young urged the MSRB to adopt a transitional period to permit 
advisors to honor their existing financial advisory agreements. They 
stated that many financial advisory agreements are longer-term 
arrangements and that advisors should be provided with a reasonable 
opportunity to conform existing arrangements to the requirements of the 
proposed rule when they are renewed or after a reasonable phase-in 
period after the rule is finalized. Zion also urges the MSRB to include 
a transitional provision to permit advisors to honor existing 
contracts, including many that are multi-year contracts. Zion notes the 
significant time, effort, and expense that would be involved to 
supplement or amend existing contracts with additional content and 
disclosure required by the proposed rule. Zion states that under 
particular state and/or local procurement laws, the alterations to 
existing agreements may reopen the request for proposal process for 
issuers to hire municipal advisors, requiring additional (and 
significant) time, effort, and expense.
    The MSRB believes that the required disclosure can generally be 
accomplished without formal amendments and, therefore, that the costs 
imposed will be less significant than generally anticipated.

[[Page 26785]]

Economic Analysis--Burden on Small Municipal Advisors
    MSRB did not receive any comments specific to the Dodd-Frank Act 
requirement that MSRB rules not impose a regulatory burden on small 
municipal advisors that is not necessary or appropriate in the public 
interest and for the protection of investors, municipal entities, and 
obligated persons provided that there is robust protection of investors 
against fraud.\80\
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    \80\ See 15 U.S.C. 78o-4(b)(2)(L)(iv).
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    Nonetheless, the MSRB has been sensitive to the potential impact of 
the requirements contained in Proposed Rule G-42. To that end, the MSRB 
has made efforts to minimize costs, particularly those that might be 
expected to disproportionately impact smaller firms. In addition to the 
amendments discussed above that will reduce compliance costs, the MSRB 
has made changes to proposals included in prior Requests for Comment 
such as clarifying the obligations owed by municipal advisors to 
obligated persons, narrowing the circumstances under which disclosures 
related to the municipal advisory relationship and compensation 
arrangements need to be made, and removing disclosure requirements 
related to professional liability insurance.
    The MSRB acknowledges that there will be costs associated with 
complying with this proposed rule and that some municipal advisors, 
including smaller firms, may exit the market as a result. However, the 
MSRB believes the costs and burdens are limited to those necessary to 
meet the objectives of the rule, consistent with its statutory basis.

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

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period of up to 90 days (i) as 
the Commission may designate 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 or disapprove 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 email to [email protected]. Please include 
File Number SR-MSRB-2015-03 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549.

All submissions should refer to File Number SR-MSRB-2015-03. This file 
number should be included on the subject line if email 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549 on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of the filing also will be available 
for inspection and copying at the principal office of the MSRB. 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-2015-03 and should be 
submitted on or before May 29, 2015.

    For the Commission, pursuant to delegated authority.\81\
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    \81\ 17 CFR 200.30-3(a)(12).
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Brent J. Fields,
Secretary.
[FR Doc. 2015-11054 Filed 5-7-15; 8:45 am]
BILLING CODE 8011-01-P