MSRB NOTICE 2002-34 (NOVEMBER 18, 2002)

DRAFT INTERPRETIVE NOTICE ON MARKETING OF 529 COLLEGE SAVINGS PLAN EMPLOYEE PAYROLL DEDUCTION PROGRAMS

The Municipal Securities Rulemaking Board (“MSRB”) has received a number of requests for interpretive guidance on the responsibilities of brokers, dealers and municipal securities dealers (“dealers”) under MSRB rules with respect to the marketing to employers and their employees of payroll deduction programs for investments in 529 college savings plans. The MSRB seeks comment on the following draft interpretive notice.

Employee payroll deduction programs have been described to the MSRB as being offered through primary distributors of 529 college savings plans. Typically, a dealer that has signed a selling agreement with the primary distributor (“introducing broker”) makes available to employers the opportunity to initiate a payroll deduction program for those employees who choose to enroll and contribute a minimum amount of money each month under a 529 college savings plan. The introducing broker meets with the employer’s human resources/benefits representatives, who then may agree to have the employer participate in the payroll deduction program utilizing its existing payroll direct deposit process for after-tax contributions by employees. After the employer has agreed to participate in the payroll deduction program, its employees can establish an account with the primary distributor by completing an online account application and participation agreement, which is submitted directly to the primary distributor. Typically, the introducing broker provides the employer with materials for distribution to interested employees describing the particular 529 college savings plan, including but not limited to the program disclosure document that meets the definition of “official statement” under Exchange Act Rule 15c2-12. Further, the introducing broker may, but does not always, hold informational meetings with employees, either in groups or individually. However, once the employer has become a participant in the payroll deduction program, employees can enroll in the program directly through the primary distributor without any further involvement of the introducing broker.

When an employee enrolls in the payroll deduction program, information regarding the employee’s enrollment is made available to both the primary distributor and the employer. Typically, however, the introducing broker will receive notification of an account opening and any transactions effected for an individual employee only after the fact, either on a transaction-by-transaction basis or in periodic summaries of trade activities. Thus, the introducing broker may not learn the identity of individual employees actually making investments in the 529 college savings plan until well after the time of trade and settlement on such transactions. The introducing broker generally receives commissions on an individual participant basis for those employees who enroll and invest in the 529 college savings plan.

The MSRB has established a number of rules designed to protect customers purchasing municipal securities (including investments in 529 college savings plans) from or through dealers. In particular, under Rule G-19, a dealer that recommends a 529 college savings plan transaction to a customer must have reasonable grounds for believing that the recommendation is suitable, based upon information available from the issuer or otherwise and the facts disclosed by or otherwise known about the customer. To assure that a dealer effecting a recommended transaction with a non-institutional customer has the information needed about the customer to make its suitability determination, the rule requires the dealer to make reasonable efforts to obtain information concerning the customer’s financial status, tax status and investment objectives, as well as any other information reasonable and necessary in making the recommendation. In addition, the dealer has certain disclosure-related obligations to the customer, regardless of whether the dealer has recommended a particular transaction to the customer. For example, under Rule G-32, the dealer is obligated to deliver an official statement to the customer by settlement of the transaction.[1]

Further, under Rule G-17, each dealer, in the conduct of its municipal securities activities, must deal fairly with all persons and must not engage in any deceptive, dishonest or unfair practice. This rule has been interpreted to require a dealer to disclose to its customer, at or before the time of trade, all material facts concerning the transaction known by the dealer, as well as material facts about the security when such facts are reasonably accessible to the market.[2] This Rule G-17 disclosure obligation applies regardless of whether the dealer has made a recommendation to the customer. If the customer is investing in an out-of-state 529 college savings plan, the dealer also is obligated to inform the customer that, depending upon the laws of the customer’s home state, favorable state tax treatment for investing in a 529 college savings plan may be limited to investments made in a plan offered by the customer’s home state.[3] Further, Rule G-17 prohibits the dealer from misleading customers regarding facts material to the transaction, including but not limited to the availability of state tax benefits in connection with an investment in a 529 college savings plan.[4]

A dealer is obligated under Rule G-17 to deal fairly not only with customers but with all persons in connection with the conduct of its municipal securities activities. Thus, in addition to dealing fairly with employees that have agreed to participate in a payroll deduction program, the dealer also is obligated under Rule G-17 to deal fairly with the employer itself.[5] Whether a dealer has dealt fairly with an employer is dependent upon the facts and circumstances. However, the MSRB believes that, under these circumstances, Rule G-17 obligates the dealer to disclose to the employer all material facts known by the dealer concerning the transactions it is attempting to induce, as well as material facts about the security when such facts are reasonably accessible to the market. If the dealer knows or has reason to know that one or more employees may not be resident in the state of the 529 college savings plan being offered under the payroll deduction program, Rule G-17 requires the dealer to disclose to the employer that, depending upon the laws of the state of residence of an employee, favorable state tax treatment for investing in a 529 college savings plan may be limited to investments made in a 529 college savings plan offered by the employee’s home state.

Where an introducing broker has recommended a transaction in a 529 college savings plan to an employee through his or her employer’s payroll deduction program, the introducing broker is fully obligated to make a suitability determination under Rule G-19.[6] The introducing broker would be responsible for obtaining and maintaining the information required under Rule G-19(b) in connection with such suitability determination and the additional information required under Rule G-8(a)(xi), as well as for maintaining proper supervision.[7] The MSRB has previously stated that whether a particular transaction is in fact recommended depends on an analysis of all the relevant facts and circumstances.[8] Among the facts and circumstances that generally would be relevant in this context is the nature of the statements made by the introducing broker if it conducts any informational meetings with employees. If, for example, the introducing broker conducts an employee informational meeting at which it states that the particular 529 college savings plan is appropriate for most or all employees, or at which it advises individual employees that the plan or specific investment options within the plan are appropriate for such individuals, the introducing broker most likely has made a recommendation. If, however, the introducing broker provides, at most, only generalized recommendations about the 529 college savings plan accompanied by clear statements that enrollment in this particular 529 college savings plan or investment in any particular investment option within the plan may not be appropriate for all employees, the introducing broker must have reasonable grounds for the generalized recommendation in light of the information about the security but need not make a determination that the investment is suitable for each employee in attendance.[9] An introducing broker making a recommendation to a particular employee also is fully responsible for providing the required disclosure information under Rules G-17 and G-32.

If an introducing broker does not make a recommendation in connection with a transaction in a 529 college savings plan by an employee through his or her employer’s payroll deduction program, it has no suitability obligation under Rule G-19. Although the introducing broker still would be obligated to provide the required disclosures under Rules G-17 and G-32, if all employee transactions under the payroll deduction program are handled by the primary distributor (for example, by employees making investments directly through the primary distributor’s web site or through applications and participation agreements mailed by employees directly to the primary distributor), the introducing broker’s responsibilities will be fulfilled if the placing of an order with the primary distributor is conditioned upon actual receipt of the official statement (e.g., if the employee placing an order on-line is required to first view or download the official statement before being allowed to complete the transaction).[10] However, if the primary distributor does not provide assurances that necessary disclosures will be made to employees, the introducing broker will be required to provide such disclosures.[11] The introducing broker must put in place appropriate supervisory procedures to ensure that required disclosures are provided in a satisfactory manner under these circumstances. In addition, an introducing broker may fulfill its supervisory obligation to review and approve customer accounts and transactions under Rule G-27(c)(iii) and (vii) for accounts opened and transactions effected as described in this paragraph by undertaking prompt reviews and approvals of agreements obtained from employers to participate in a payroll deduction program and subsequently reviewing and confirming individual account openings and transactions as information required under Rule G-8(a)(xi) becomes available from the primary distributor. The introducing broker remains responsible for recording account information under Rule G-8(a)(ii) and customer specific information for each enrolled employee required under Rule G-8(a)(xi) as it becomes available. The introducing broker also is required to record the name and principal business address of any employer participating in a payroll deduction program, together with the signature of the appropriate principal who undertook such review and approval.

Dealers should note that none of the foregoing obviates the need for primary distributors to fulfill all of their customer protection obligations under MSRB rules. Furthermore, if transactions subsequent to the initial enrollment of an employee in a payroll deduction program are effected directly between the employee and the primary distributor, the primary distributor generally will have sole responsibility with respect to compliance with MSRB rules in connection with such subsequent transactions, provided that the introducing broker will be required to record information regarding subsequent transactions as required under Rule G-8(a)(ii) to the extent that it receives compensation for such transactions. Dealers also should note that, if employees make their purchases directly from the governmental issuer (whether through the issuer’s own employees or any non-dealer agent of the issuer), the dealer that enlists an employer to participate in a payroll deduction program will be required to fulfill all its obligations under MSRB rules without reliance on any actions of the issuer or its employees or agents. Thus, for example, the dealer must itself ensure delivery of the official statement to individuals making investments.

* * * * *

Comments from all interested parties are welcome. Comments should be submitted no later than January 10, 2003 and may be directed to Ernesto A. Lanza, Senior Associate General Counsel, or Jill C. Finder, Assistant General Counsel. Written comments will be available for public inspection.

November 18, 2002


[1] In the case of a repeat purchaser who has already received the official statement, dealers generally are required to deliver any amendments or supplements to the official statement in connection with subsequent investments in the 529 college savings plan.

[2] See Rule G-17 Interpretation – Interpretive Notice Regarding Rule G-17, on Disclosure of Material Facts, March 20, 2002, MSRB Rule Book.

[3] See Rule G-21 Interpretation – Application of Fair Practice and Advertising Rules to Municipal Fund Securities, May 14, 2002, MSRB Rule Book.

[4] Id.

[5] Under Section 15B(c)(1) of the Exchange Act, any dealer that attempts to induce the purchase of municipal securities must do so in compliance with MSRB rules. This would include an attempt by a dealer to induce employees to invest in a 529 college savings plan through an employer participating in a payroll deduction program. Thus, the dealer generally will become obligated to comply with the duties established under Rule G-17 with respect to the employer in connection with the procurement of the employer’s agreement to participate in the payroll deduction program, even if there is no assurance that any employee ultimately will enroll.

[6] An introducing broker that recommends a transaction to an employee cannot avoid its suitability obligations and related duties simply because the employee places its order directly with the primary distributor.

[7] Rule G-27 requires a principal to review the opening of each customer account and of each transaction for such customer. In addition, Rules G-8 and G-9 require dealers to create and preserve certain records in connection with such accounts and transactions.

[8] See Rule G-19 Interpretive Letter – Recommendations, February 17, 1998, MSRB Rule Book. The MSRB has recently provided guidance on recommendations in the context of on-line communications in Notice Regarding Application of Rule G-19, on Suitability of Recommendations and Transactions, to Online Communications, September 25, 2002, available at http://ww1.msrb.org/msrb1/archive/G-19notice.htm.

[9] See Rule G-19 Interpretation – Notice Concerning the Application of Suitability Requirements to Investment Seminars and Customer Inquiries Made in Response to a Dealer’s Advertisements, May 7, 1985, MSRB Rule Book.

[10] However, if the official statement omits material information that the introducing broker would be obligated to provide under Rule G-17, the introducing broker may be responsible for providing such omitted information.

[11] Introducing brokers would be advised, for example, to provide official statements to the employer’s human resource/employee benefits department and at any employee informational meetings that it attends.