[Federal Register Volume 61, Number 221 (Thursday, November 14, 1996)]
[Notices]
[Pages 58431-58434]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-29150]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37928; File No. SR-MSRB-96-7]
Self-Regulatory Organizations; Order Granting Approval of
Proposed Rule Change by the Municipal Securities Rulemaking Board
Relating to Political Contributions and Prohibitions on Municipal
Securities Business
November 6, 1996.
I. Introduction
On August 6, 1996,\1\ the Municipal Securities Rulemaking Board
(``Board'' or ``MSRB'') submitted to the Securities and Exchange
Commission (``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act'') \2\ and Rule 19b-4
thereunder,\3\ a proposed rule change to amend rule G-37, on political
contributions and prohibitions on municipal securities business, and
rule G-8, on books and records. Notice of the proposed rule change
appeared in the Federal Register on September 19, 1996.\4\
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\1\ On September 9, 1996, the MSRB filed Amendment No. 1 with
the Commission. Amendment No. 1 amends proposed language to rule G-
37(g)(vii). See letter from Ronald W. Smith, Legal Associate, MSRB,
to Katherine England, Assistant Director, Division of Market
Regulation, SEC, dated September 9, 1996.
\2\ 15 U.S.C. 78s(b)(1) (1988).
\3\ 17 CFR 240.19b-4.
\4\ Securities Exchange Act Release No. 37675 (September 12,
1996), 61 FR 49368.
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The Commission received three comment letters addressing the
proposed rule change.\5\ One commenter endorsed the proposed amendments
to
[[Page 58432]]
both rules,\6\ while another endorsed only the amendments to rule G-
37.\7\ Finally, the third commenter, while not objecting to the
amendments, reserved judgment pending clarification of certain
issues.\8\ This order approves the proposed rule change.
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\5\ Letter from Douglas L. Kelly, Vice President and Corporate
Secretary, A.G. Edwards & Sons, Inc., to Jonathan G. Katz,
Secretary, SEC, dated October 11, 1996 (``A.G. Edwards Letter'');
Letter from E. Stephen Walsh, Administrative and Compliance Partner,
David J. Greene and Company, to Jonathan Katz, Secretary, SEC, dated
October 9, 1996 (``Greene Letter''); Letter from Irwin D. Rowe,
Executive Vice President, Loeb Partners Corporation, to Jonathan G.
Katz, Secretary, SEC, dated October 4, 1996 (``Loeb Letter'').
\6\ Loeb Letter, p. 2.
\7\ Greene Letter.
\8\ A.G. Edwards Letter, p. 1.
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II. Description of the Amendments
The rule change: (i) amends the definition of ``municipal finance
professional''; (ii) amends the definition of ``executive officer'';
(iii) clarifies the definition of ``official of an issuer''; (iv)
clarifies the definition of ``municipal securities business''; and (v)
requires the retention of Forms G-37/G-38 and of records itemizing
mailing of the same.
A. Definition of ``Municipal Finance Professional''
Currently, subparagraph (E) of rule G-37(g)(iv) states that an
associated person who is a member of the dealer executive or management
committee or similarly situated official is a municipal finance
professional. This provision is the only part of the definition of
municipal finance professional that does not depend upon the municipal
securities activities of the person or the supervision of persons
engaged in municipal securities activities. This provision was intended
to prevent issuer officials from seeking contributions from dealers'
senior executives once rule G-37 precluded municipal finance
professionals from contributing to those officials. The Statement of
Initiative by Dealers regarding Political Contributions also included
executive or management committee members within its voluntary
prohibition on political contributions.\9\
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\9\ In October 1993, at the urging of SEC Chairman Levitt, a
number of dealers agreed to a Statement of Initiative to support the
principle that political contributions which are intended to
influence the awarding of municipal securities business should be
prohibited.
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The MSRB stated in its filing that there are certain dealers that
occasionally engage in municipal securities sales transactions, but do
not engage in municipal securities business as defined in rule G-
37(g)(vii). As a result, the only individuals of those dealers who meet
the definition of municipal finance professional are executive
management committee members. Because such dealers do not engage in
municipal securities business, the ban on business based on political
contributions does not affect them. However, such dealers also are
required to record and report the contributions and payments of these
municipal finance professionals. This amendment recognizes that there
is no useful purpose served in requiring dealers to record and report
the political contributions of executive or management committee
members if their firm does not engage in municipal securities business.
The rule change approved today amends the definition of municipal
finance professional in rule G-37(g)(iv)(E) to exempt executive or
management committee members from the definition of municipal finance
professional (and thus the applicable recording and reporting
requirements) if these are the only individuals within a firm who would
meet the definition as described in subparagraphs (A) through (E).\10\
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\10\ Rule G-37(g)(iv) states that each person designated by the
dealer as a municipal finance professional is deemed to be a
municipal finance professional and that each person so designated
will retain this designation for two years after the last activity
or position which gave rise to the designation. The rule change
approved today, permits dealers to remove individuals subject to the
new rule language from their lists of designated municipal finance
professionals and to cease recording and reporting their
contributions.
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B. Definition of ``Executive Officer''
Currently, rule G-37 requires a dealer to record and report the
contributions of executive officers even if that dealer has no one
meeting the definition of municipal financial professional. Even though
contributions and payments by executive officers are subject to the
recordkeeping and reporting provisions of rule G-37, these
contributions do not result in a ban on business. However, paragraph
(d) of rule G-37 prohibits dealers from using executive officers (as
well as any other person or entity) as conduits for making
contributions to officials of issuers. The recordkeeping and reporting
requirements apply to contributions by executive officers to ensure
that these individuals are not being used to circumvent the rule.
Rule G-37 was intended to prevent the practice of pay-to-play.
However, contributions by executive officers of a dealer to issuer
officials cannot skew the process of selecting a dealer to conduct
municipal securities business in favor of that particular dealer if
that dealer does not engage in municipal securities business. Thus, the
rule change approved today amends the definition of executive officer
in rule G-37(g)(v) to provide that, if no associated person of the
dealer meets the definition of municipal finance professional, the
dealer shall be deemed to have no executive officers (and thus the
recording and reporting requirements for executive officers are not
applicable).\11\
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\11\ The rule change permits dealers to remove individuals
subject to the new rule language from their lists of executive
officers and to cease recording and reporting their contributions.
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In both situations involving executive officers, as well as
municipal finance professionals described in Section (A) above, if the
dealer later engages in municipal securities business, then the dealer
will have to record the contributions and payments made by any
executive officers, as well as municipal finance professionals, for the
previous two calendar years to determine whether it is banned from any
municipal securities business.\12\
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\12\ Any dealer who has municipal finance professionals, even if
the dealer currently is not engaging in municipal securities
business, must record and report the contributions and payments of
executive officers and municipal finance professionals.
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C. Definition of ``Official of an Issuer''
When rule G-37 was approved, the term ``official of such issuer''
or ``official of an issuer'' was defined as any incumbent, candidate or
successful candidate for elective office of the issuer, which office is
directly or indirectly responsible for, or can influence the outcome
of, the hiring of a dealer for municipal securities business. The
definition was intended to include any state or local official or
candidate (or successful candidate) who has influence over the awarding
of municipal securities business, including certain state-wide
executive or legislative officials.
After rule G-37 was approved, concerns were raised that the
definition did not properly encompass all elected officials with the
authority to influence the awarding of municipal securities business by
the issuer, because it focused on ``an elective office of the issuer.''
For example, a state may have certain issuing authorities whose boards
of directors are appointed by the governor. Although the governor is an
official with influence over the awarding of municipal securities
business, the governor, in this illustration, is not incumbent or
candidate for ``elective office of the issuer'' (i.e., the state
authority). Thus, a contribution to the governor would not prohibit a
dealer from engaging in business with the state authority. The rule was
intended to include the governor as an official of the issuer in such
circumstances. Therefore, the rule change amends that definition to
clarify the intent of the rule.\13\
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\13\ Securities Exchange Act Release No. 34160 (June 3, 1994),
59 FR 30376 (June 13, 1994).
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[[Page 58433]]
Accordingly, the rule change amends rule G-37(g)(vi) to clarify
that the definition includes ``any elective office of a state or of any
political subdivision, which office has authority to appoint any person
who is directly or indirectly responsible for, or can influence the
outcome of, the hiring of a broker, dealer or municipal securities
dealer for municipal securities business by an issuer.'' This revised
definition addresses situation in which an elected official may appoint
someone to an issuer position.
D. Definition of ``Municipal Securities Business''
Under rule G-37, dealers could be subject to a ban on business with
an issuer if certain contributors are made to officials of that issuer.
The ban on business provision applies to business awarded on a
negotiated basis; the rule does not prohibit dealers from engaging in
business awarded on a competitive basis.
Some dealers have noted that it is not clear in subparagraph (C) of
rule G-37(g)(vii) whether, for financial advisory services, the rule is
referring to the selection of a financial advisor on other than a
competitive bid basis or whether the rule is referring to financial
advisory services provided only on negotiated deals. The proposed rule
change amends rule G-37(g)(vii)(C) to clarify that the definition of
``municipal securities business'' includes the provision of financial
advisory services when the dealer is chosen to provide such services on
a negotiated basis.\14\ It is irrelevant whether the financial advisory
services provided by the dealer are with respect to a negotiated or
competitive issue. A similar change has been made to rule G-
37(g)(vii)(D) to clarify that the definition of ``municipal securities
business'' includes remarketing agent services when the dealer is
chosen as remarketing agent on a negotiated basis.
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\14\ See Amendment No. 1.
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E. Recordkeeping: Amending Rule G-8(a) (xvi)
Rule G-8(a) (xvi), on books and records, requires municipal
securities brokers and municipal securities dealers to make and keep
records of all of the information on Forms G-37/G-38. While this rule
also requires dealers to keep records of additional information (e.g.,
a listing of the names, titles, city/county and state of residence of
all municipal finance professionals), it does not state that the
dealers must also physically maintain copies of these forms and the
mailing receipts in their offices.
Requiring dealers to keep copies of the Forms G-37/G-38 submitted
to the Board would be helpful to the agencies charged with enforcing
rule G-37 because physically maintaining these forms on the premises
will make them easily accessible and retrievable for review. Moreover,
it would be helpful to those agencies to require dealers to keep the
certified or registered mail record or other records indicating
dispatch to ensure their timely submission.\15\ Hence, the rule has
been revised to add section H which will provide notice that
maintaining copies of Forms G-37/G-38 submitted to the Board, along
with the certified or registered mail receipts is required.
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\15\ Rule G-9, on preservation of records, requires dealers to
retain the G-8(a) (xvi) records concerning political contributions
and prohibitions on municipal securities pursuant to rule G-37 for a
six year period.
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III. Summary of Comments
The Commission received three comment letters in response to the
proposed rule change.\16\ The Greene Letter generally endorsed the
proposed change to rule G-37.\17\ The remaining letters, however,
raised several issues that the Commission believes should be addressed.
The Board, at the Commission's behest, has proffered a response.\18\
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\16\ See supra note 5.
\17\ Green Letter.
\18\ Letter from Ronald W. Smith, Legal Associate, MSRB, to
Mignon McLemore, Law Clerk, Division of Market Regulation, SEC,
dated October 22, 1996 (``October 22 Letter'').
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The first issue raised in the Loeb Letter concerns the definition
of ``municipal finance professional'' in rule G-37(g) (iv). Loeb
believes that the Board should not include within the definition of
municipal finance professional, any person primarily engaged in the
sale of unsolicited agency transactions for customers.\19\ The Board's
rules apply to all transactions in municipal securities by dealers
whether dealers act as agent or principal.\20\ Accordingly, the Board
does not believe that it would be appropriate to exempt specific
categories of municipal securities transactions (i.e., unsolicited
agency transactions) from the activities that could make someone
``primarily engaged in municipal securities representative
activities.'' \21\ The Commission believes that exempting specific
categories of municipal securities transactions would increase
potential for abuse and facilitate inconsistent interpretations and
therefore, would be inappropriate.
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\19\ Loeb Letter, pg. 2.
\20\ October 22 Letter, p. 1.
\21\ Id.
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The second issue raised in the Loeb Letter concerns the
interpretation of the term ``primarily engaged'' as it is used in the
definition of municipal securities professional.\22\ Loeb believes a
definitive explanation is necessary to determine whether certain
broker-dealers are subject to the reporting requirements of rules G-37
and G-8.\23\ The Board has not defined the term ``primarily engaged
in'' because it believes it is appropriate for a dealer to determine
which of its personnel who engage in municipal securities
representative activities could reasonably fall within the definition
of municipal finance professional.\24\ The Commission supports the
Board's interpretation of the term ``primarily engaged.'' To facilitate
ease of compliance, the definition encompasses any individual and
circumstance that could reasonably qualify as the activity of a
municipal finance professional. Thus, a narrower interpretation is ill-
advised.
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\22\ Loeb Letter, p. 2.
\23\ Id.
\24\ October 22 Letter, p. 1.
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The first issue raised by the A.G. Edwards Letter requests
clarification of what is meant by selection of a financial advisor on
``other than a competitive basis.`` \25\ A.G. Edwards contends that
``other than a competitive basis'' encompasses more than the lowest bid
for the job; other criteria, including price, are evaluated before
final selection is made.\26\ The Board states that the selection of a
financial advisor on a competitive bid basis refers to selection solely
on the basis of price.\27\ Therefore, the selection of a financial
advisor made on other than the sole basis of price would represent a
selection of ``other than a competitive bid basis.'' \28\ The
Commission agrees that selection of a financial advisor on a
competitive bid basis means selection solely on the basis of price. The
scope of this exemption is intentionally limited because, in most
cases, selection is made on a negotiated basis.
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\25\ A.G. Edwards Letter, p. 1.
\26\ Id.
\27\ October 22 Letter, p. 2.
\28\ Id.
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The second issue raised by the A.G. Edwards Letter entails
clarifying when an agreement is reached to provide financial advisory
services and thus, when that agreement must be reported.\29\ A.G.
Edwards notes that in many cases, financial advisory
[[Page 58434]]
agreements contain an option exercisable by the issuer to extend the
agreement for an additional year at either the same fee or at some
other fee established at the time the initial engagement was
entered.\30\ A.G. Edwards believes that exercising the option of the
existing engagement does not constitute a ``new'' financial advisory
agreement and therefore, should not be subject to rule G-37/G-38
reporting requirements.\31\ The Board does not believe that the
exercise of an option by an issuer to extend a financial advisory
agreement, with such an option contained in the agreement, constitutes
a ``new'' agreement; therefore, there is not reporting requirement for
the exercise of this option.\32\ The Commission agrees that an
exercised option that was contained in the initial agreement to engage
a financial advisor would not constitute a ``new'' agreement, because
the issuer is required to file a report on whenever the deal is
completed, option period withstanding.
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\29\ A.G. Edwards Letter, p. 2.
\30\ Id.
\31\ Id.
\32\ October 22 Letter, p. 2.
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IV. Discussion
The Commission believes the proposed rule change is consistent with
the Act and the rules and regulations promulgated thereunder.
Specifically, the Commission believes that approval of the proposed
rule change is consistent with Section 15B(b)(2)(C) \33\ of the Act. By
amending rule G-37, the rule change removes impediments to the
mechanism of a free and open market in municipal securities because (i)
it no longer applies to persons and contributions that do not implicate
the concern that rule G-37 was intended to address; (ii) it clarifies
that the rule is intended to apply to contributions to any elected
officials if that official's office gives the official the ability to
influence the awarding of municipal securities business to an issuer;
and (iii) clarifies the scope of activity subject to the rule. The
amendment to rule G-8 protects investors and is in the public interest
in that it facilitates enforcement of rule G-37.
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\33\ Section 15B(b)(2)(C) requires the Commission to determine
that the Board's rules are designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
municipal securities, to remove impediments to and perfect the
mechanism of a free and open market in municipal securities, and, in
general, to protect investors and the public interest.
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In revising the definitions of ``municipal finance professional''
and ``executive officer,'' the MSRB has provided definitive criteria
for dealers to use in determining whether they are subject to the
rule's reporting requirements. In so doing, the MSRB has eliminated
some of the uncertainty associated with rule G-37 compliance issues.
Exempting those persons and contributions that are no longer affected
by the rule should enhance efficiency in reporting and recording,
because dealers no longer have to make assumptions in determining to
whom the rule applies.
In amending the definition of ``official of an issuer,'' the Board
has addressed situations in which an elected official may appoint
someone to an issuer position. This amendment acknowledges the fact
that political influence and alliances can affect the selection
process. In clarifying its intent that a person who can directly or
indirectly influence hiring decisions be included in the definition,
the Board has attempted to ensure fairness in the selection process by
removing politics from the equation.
In revising the definition of ``municipal securities business,''
the Board is clarifying which dealers would be subject to the ban and
in what situations. According to some dealers, rule G-37(g)(vii) was
unclear as to whether ``on other than a competitive bid basis'' applied
to the selection of a financial advisor or to the services provided by
the financial advisor. The Board has determined that the definition
includes financial advisory services when the dealer is chosen as
financial advisor on a negotiated basis and therefore, the ban on
business provision under rule G-37 would apply.
In adding the requirement to rule G-8 that dealers maintain copies
of Forms G-37/G-38 along with receipts of mailing the same, the Board
has improved disclosure in the markets by making these records readily
accessible for review. Also, the benefits of this requirement outweigh
any burdens that additional recordkeeping may impose, because tangible
evidence will now be available to resolve disputes and to monitor
compliance.
V. Conclusion
For the above reasons, the Commission believes that the proposed
rule change is consistent with the provisions of the Act, and in
particular with Section 15B(b)(2)(C).
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\34\ that the proposed rule change (SR-MSRB-96-07) be, and hereby
is approved.
\34\ 15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\35\
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\35\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-29150 Filed 11-13-96; 8:45 am]
BILLING CODE 8010-01-M
