MSRB NOTICE 2005-11 (FEBRUARY 15, 2005)

RULE G-37: REQUEST FOR COMMENTS ON DRAFT AMENDMENTS TO RULE G-37(C), RELATING TO PROHIBITING SOLITICITATION AND COORDINATION OF PAYMENTS TO POLITICAL PARTIES, AND DRAFT QUESTION AND ANSWER GUIDANCE CONCERNING INDIRECT RULE VIOLATIONS

BACKGROUND

In August 2003, the Municipal Securities Rulemaking Board (“MSRB” or “Board”) published a notice concerning indirect rule violations of Rule G-37, on political contributions, and Rule G-38, on consultants (the “2003 Notice”).[1]  In the 2003 Notice, the MSRB noted that it was concerned with increasing signs that individuals and brokers, dealers, and municipal securities dealers (collectively “dealers”) may be seeking ways around Rule G-37 through payments to political parties or non-dealer controlled political action committees (“PACs”) that benefit issuer officials; significant political contributions by dealer affiliates (e.g., bank holding companies and affiliated derivative counterparty subsidiaries) to both issuer officials and political parties; and contributions by associated persons of the dealer who are not MFPs to issuer officials and political parties.  The Board also reminded dealers that, while Rule G-37 was adopted to deal specifically with contributions made to officials of issuers by dealers and municipal finance professionals (“MFPs”), or PACs controlled by the dealer or MFPs, the rule also prohibits MFPs and dealers from using conduits—be they parties, PACs, affiliates, consultants, lawyers, or spouses—to contribute indirectly to an issuer official if such MFP or dealer can not give directly to the issuer without triggering the ban on business.[2]  

Several years prior to the publication of the 2003 Notice, the Board had provided Question and Answer (“Q&A”) guidance with regard to supervisory procedures[3] that dealers should have in place in connection with making payments to a non-dealer associated PAC or a political party to avoid indirect rule violations.  This guidance related to the need for dealers to make inquiries to a non-dealer associated PAC or a political party concerning how the funds will be used before making any payments to ensure that the funds will not be used to support one or a limited number of issuer officials.[4]  Both the 1996 Q&A guidance and the 2003 Notice were intended to alert dealers and MFPs to the realities of political fundraising and guide them toward developing procedures that would lead to compliance with both the letter and the spirit of the Rule.   The MSRB continues to be concerned, however, that dealer, MFP, and affiliated persons’ payments to political parties, including “housekeeping”, “conference” or “overhead” type accounts, and PACs give rise to at least the appearance that dealers may be circumventing the intent of Rule G-37.  In this regard, the MSRB is especially troubled by the emergence of recent media and other reports that issuer agents have informed dealers and MFPs that, if they are prohibited from contributing directly to an issuer official’s campaign, they should contribute to the affiliated party’s “housekeeping” account.  The MSRB is concerned that dealers or MFPs who make such payments may be doing so in an effort to avoid the political contribution limitations embodied in Rule G-37.

In addition, recently NASD staff advised the MSRB of its concern about the adequacy of dealers’ supervisory procedures to ensure compliance with Rule G-37(d), on indirect violations.  NASD staff informed the MSRB that they are particularly concerned about payroll deduction plans made available to MFP’s that enable automated or periodic direct payroll deductions from an MFP’s pay or compensation into an affiliated entity’s PAC, particularly when such payroll contributions are made to an affiliated PAC without appropriate information barriers, or when the contributions to the affiliated PAC constitute an amount sufficient to control the PAC on a defacto basis.   NASD staff also indicated that clearer guidance about potential indirect violations and adequate supervisory procedures by the MSRB would assist preventive compliance initiatives by dealers and would result in more effective enforcement.

Thus, the MSRB has determined to publish for comment draft amendments to Rule G-37(c), concerning solicitation and coordination of payments to political parties, and draft Q&A guidance on supervisory procedures related to Rule G-37(d).  

DRAFT RULE G-37(c) AMENDMENT

Rule G-37(c) prohibits the dealer and its MFPs from soliciting any person or PAC to make or coordinate contributions to an official of an issuer with which the dealer is engaging or is seeking to engage in municipal securities business.   The draft amendments (new section (c)(ii)) would also prohibit the dealer and certain MFPs[5] from soliciting any person or PAC to make or coordinate a payment to a political party of a state or locality where the dealer is engaging or is seeking to engage in municipal securities business.[6] 

The draft rule amendments also would specifically define any “person,”[7] in both current Rule G-37 (c) and in the draft amendments, to include any affiliated entity of the dealer.  This clarification is intended to alert dealers and MFPs that influencing the disbursement decisions of affiliated entities or PACs may constitute a direct violation of Rule G-37(c), as amended, if the dealer or MFP solicits the affiliated entity or PAC to make or coordinate contributions to an official of an issuer or a political party of a state or locality where the dealer is engaging or is seeking to engage in municipal securities business.  Accordingly, in order to ensure compliance with Rule G-37(c), dealers should consider the adequacy of their information barriers with affiliated entities, or PACs controlled by affiliated entities, to ensure that the affiliated entities’ contributions, payments, or PAC disbursement decisions are neither influenced by the dealer or its MFPs, nor communicated to its MFPs. 

DRAFT QUESTIONS AND ANSWERS

The draft Q&A guidance based on Rule G-27(c), on supervision, states that each dealer must adopt, maintain and enforce written supervisory procedures to ensure that neither the dealer nor its MFPs are using payments to political parties or PACs to contribute indirectly to an official of an issuer in contravention of Rule G-37(d).  Dealers must have written supervisory procedures to ensure that the dealer performs adequate due diligence prior to allowing political party payments by the dealer or its MFPs to ensure that the political party or PAC is not using the money for the support of one or a limited number of issuer candidates.[8]  The draft Q&A guidance also advises dealers to inquire about the dealer’s or MFP’s intent in making the political party or PAC payment to determine if the payment is made for the purpose of benefiting an issuer official.  The MSRB believes that supervisory procedures that include the obligation to do due diligence about the reason for the payment will identify and halt practices that are designed to circumvent Rule G-37.  The draft Q&A guidance also explicitly states that contributing to “housekeeping”, “conference” or “overhead” type political party accounts is not a safe harbor and does not alleviate the dealer’s supervisory obligation to conduct this due diligence. 

The notice, draft rule language amendments, and accompanying Qs&As seek to provide dealers with more guidance as they develop procedures to ensure compliance with both the language and the spirit of Rule G-37.  The Qs&As emphasize the necessity for adequate supervisory procedures to ensure compliance with Rule G-37(d) not only with respect to payments to political parties, but also with respect to contributions to and disbursements by dealer-affiliated (but not controlled) PACs.  The Board reminds dealers that a failure to implement satisfactory written procedures to ensure compliance with Rule G-37(d) could subject the dealer to enforcement actions by the appropriate regulatory authorities. 

REQUEST FOR COMMENT

The MSRB notes that its rules currently require dealers to adopt adequate supervisory procedures to ensure compliance with Rule G-37(d).  Moreover, the MSRB has long-standing Q&A guidance relating to dealers’ obligation to conduct due diligence prior to allowing political party payments by the dealer or its MFPs to ensure that the political party or PAC is not using the money for the support of one or a limited number of issuer candidates.  However, the draft Qs&As are being published with a 45-day comment period because the MSRB is adding suggestions for best practices for supervisory procedures, as well as providing clarity about the status of “housekeeping”, “conference” or “overhead” type political party accounts, and requests comment on these suggestions.   The MSRB also requests comment on the draft amendments to Rule G-37(c), on solicitation and coordination of political party payments.

Comments from all interested parties are welcome. Comments should be submitted no later than April 1, 2005 and may be directed to Carolyn Walsh, Senior Associate General Counsel. Written comments will be available for public inspection.

February 15, 2005

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TEXT OF DRAFT AMENDMENT*

Rule G-37(c).

 (c)       (i) No broker, dealer or municipal securities dealer or any municipal finance professional of the broker, dealer or municipal securities dealer shall solicit any person, including but not limited to any affiliated entity of the broker, dealer or municipal securities dealer, or political action committee to make any contribution, or shall coordinate any contributions, to an official of an issuer with which the broker, dealer or municipal securities dealer is engaging or is seeking to engage in municipal securities business.

            (ii) No broker, dealer or municipal securities dealer or any individual designated as a municipal finance professional of the broker, dealer or municipal securities dealer pursuant to subparagraphs (A), (B), or (C) of paragraph (g)(iv) of this rule shall solicit any person, including but not limited to any affiliated entity of the broker, dealer or municipal securities dealer, or political action committee to make any payment, or shall coordinate any payments, to a political party of a state or locality where the broker, dealer or municipal securities dealer is engaging or is seeking to engage in municipal securities business.  

*          Strikethrough indicates deletions, underlining denotes additions.

 

TEXT OF DRAFT QUESTIONS AND ANSWERS

Rule G-37 Questions-and-Answers

1.

Q:  Is a broker, dealer or municipal securities dealer (“dealer”) required to have written supervisory procedures in place to ensure compliance with Rule G-37(d), on indirect contributions and solicitations, with regard to payments to political parties and PACs by a dealer or its municipal finance professionals (“MFPs”)?

A:  Yes.  The relevant portion of the MSRB’s supervision rule, Rule G-27(c), provides that, “Each dealer shall adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance [with MSRB rules].”

Rule G-37(d) provides that: “No broker, dealer or municipal securities dealer or any municipal finance professional of the broker, dealer or municipal securities dealer shall, directly or indirectly, through or by any other person or means, do any act which would result in a violation of sections (b) or (c) of this rule.”  While Rule G-37 was adopted to deal specifically with contributions made to officials of issuers by dealers and municipal finance professionals, and political action committees (“PACs”) controlled by dealers or MFPs, this section of the rule also prohibits MFPs and dealers from using conduits—be they parties, PACs, affiliates, consultants, lawyers or spouses—to contribute indirectly to an issuer official if such MFP or dealer can not give directly to the issuer without triggering the ban on business.

Therefore, each dealer must adopt, maintain and enforce written supervisory procedures to ensure that neither the dealer nor its MFPs are using payments to political parties and non-dealer controlled PACs to contribute indirectly to an official of an issuer.[9] For example, a dealer’s written supervisory procedures might provide that, if the dealer or any of its MFPs want to make payments to political parties or PACs, the dealer must perform adequate due diligence prior to allowing political party or PAC payments by the dealer or its MFPs to ensure that the political party or political organization is not using the money for the support of one or a limited number of issuer candidates (i.e., that the party or PAC itself does not raise money to support one or a limited number of issuer officials, and the party does not transfer money to other state or local parties that support one or a limited number of issuer officials).[10]  Such due diligence might include inquiring about and documenting the intent or motive in making the payment, whether the party payment or PAC contribution was solicited by anyone, and if so, the identification of the person soliciting the party payment and a record of written solicitations.  This information will assist the dealer in determining whether the facts and circumstances surrounding the payment support the reason given for making the payment. 

Finally, to ensure compliance with Rule G-37(d) in connection with contributions by dealers or MFPs to non-controlled (but affiliated) PACs, the dealer might adopt information barriers between any affiliated PACs and the dealer or its MFPs.  Examples of such information barrier provisions might include:

•       a prohibition on the dealer or MFPs from recommending, nominating, appointing or approving the management of affiliated PACs;

•       a prohibition on sharing the affiliated PAC’s meeting agenda, meeting schedule, or meeting minutes;

•       a prohibition on identification of prior affiliated PAC contributions, planned PAC contributions or anticipated PAC contributions;

•       a prohibition on information sharing about prior negotiated municipal securities business, solicited municipal securities business, and planned solicitations of municipal securities business; and

•       other such information barriers as the firm deems appropriate to effectively monitor conflicting interests and prevent abuses.

2.

Q:  Is a dealer required to have written supervisory procedures in place to ensure compliance with Rule G-37(d) if the dealer only allows the dealer or its municipal finance professionals (“MFPs”) to make political party payments to “housekeeping”, “conference” or “overhead” type accounts of a political party?

A:  Yes.  There is no safe harbor under Rule G-37 for payments to “housekeeping”, “conference” or “overhead” type political party accounts.  The dealer must have adequate supervisory procedures in place to prevent a violation of Rule G-37(d), on indirect political contributions, even when the payments are being made to a “housekeeping”, “conference” or “overhead” type account.  While the political party itself may prohibit direct contributions to issuer official candidates from “housekeeping” accounts, payments to these accounts might be used for political party events that are focused to benefit a specific candidate or a small number of candidates.  Additionally, because money is fungible, a payment made to a fund earmarked for non-issuer official elections might “free up” other money to support the candidacy of specific issuer officials. 

The need for dealers to adopt adequate written supervisory procedures to prevent indirect violations via “housekeeping”, “conference” or “overhead” type political party accounts is especially important in light of media and other reports that issuer agents have informed dealers and MFPs that, if they are prohibited from contributing directly to an issuer official’s campaign, they should contribute to an affiliated party’s “housekeeping” account.  In addition, NASD staff has informed the MSRB that some firms make contributions to “housekeeping” accounts or PAC’s with explicit instructions accompanying the contribution that the contribution is not to be used for the benefit of one or a limited number of issuer officials.  In light of the above, the MSRB does not consider such “preemptive” disclosures or instructions sufficient to meet the dealer’s obligation to perform due diligence to ensure that the political party or PAC is not using the money in support of one or a limited number of candidates.  The dealer should conduct due diligence to identify the reason for making the payment and should receive affirmative assurance from the party or PAC that the party or PAC itself does not raise money to support one or a limited number of issuer officials, and the party or PAC does not transfer money to other state or local parties or PACs that support one or a limited number of issuer officials.


[3] Rule G-27, on supervision, in section (c) provides that, “Each dealer shall adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance [with MSRB rules].” 

[5] The draft amendment limits MFPs who would be prohibited from soliciting or coordinating political party payments to those persons who are directly involved in the dealer’s municipal securities business.  The draft language provides that only MFPs who are primarily engaged in municipal representative activities, solicitors of municipal securities business, or direct supervisors of MFPs that are “solicitors” or “primarily engaged” are prohibited from soliciting political party payments.  The Board limited those MFPs covered by the draft amendments to those directly involved in the municipal securities business of the dealer; recognizing that other MFPs more distant from the day-to-day operations of the dealer’s municipal securities business may have other reasons to solicit or coordinate payments to political parties (i.e., reasons related to other business activities of the dealer).

[6] The MSRB notes that, depending upon the facts and circumstances, an MFP’s solicitation of a contribution to an issuer with which the dealer is engaging or is seeking to engage in municipal securities business or the solicitation of a political party payment to a political party of a state or locality where the dealer is engaging or is seeking to engage in municipal securities, may also constitute a violation of Rule G-37(d), on indirect violations. 

[7] “Person” is defined in the Securities Exchange Act of 1934 (the “Act”), § 3(9) to mean “ a natural person, company, government, or political subdivision, agency, or instrumentality of a government.”  Unless the context otherwise specifically require, the terms used in MSRB Rules have the meanings set forth in the Act.  See MSRB Rule D-1.

[9] In addition, pursuant to MSRB Rule G-8(a)(xx), on Records Concerning Compliance with Rule G-27, each dealer must maintain and keep current the records required under Rules G-27(c) and G-27 (d).