MSRB NOTICE 2005-41 (AUGUST 9, 2005)

MSRB FILES AMENDMENT TO PENDING RULE G-38 PROPOSAL RELATING TO SOLICITATION OF MUNICIPAL SECURITIES BUSINESS

The Municipal Securities Rulemaking Board (“MSRB”) has filed today with the Securities and Exchange Commission (“SEC”) an amendment to a proposed rule change previously filed with the SEC relating to the solicitation of municipal securities business under Rule G-38.[1]  The original proposal, filed with the SEC on March 17, 2005, would delete existing Rule G-38, on consultants, and replace it with new Rule G-38, on solicitation of municipal securities business. New Rule G-38 would prohibit brokers, dealers and municipal securities dealers (“dealers”) from paying persons who are not affiliated with the dealers for soliciting municipal securities business on their behalf.[2]  The SEC published the original proposal for comment and received comments from four commentators.[3]  Based on a review of the comments, the MSRB has determined to amend certain provisions of the original proposal relating to the effective date, transitional payments, and affiliated persons, as described below.

SUMMARY OF ORIGINAL PROPOSAL

As set forth in the original proposal, revised Rule G-38 would prohibit dealers from making direct or indirect payments to any person who is not an affiliated person of the dealer for a solicitation of municipal securities business on behalf of the dealer.[4]  An affiliated person is any partner, director, officer or employee of the dealer or of an affiliated company.[5]  Dealers would be permitted under the original proposal to make payments to non-affiliated persons for solicitations of municipal securities business if the payments are made solely for solicitation activities undertaken on or prior to the date of SEC approval of the proposal.  Such payments would be permitted only if:  (A) the dealer had been selected to engage in municipal securities business by the issuer on or prior to the approval date of the proposed rule change; (B) the consultant has not solicited municipal securities business from any issuer on behalf of the dealer after the approval date; and (C) the dealer submits new Form G-38t to the MSRB for each calendar quarter during which payments to the consultant are made or remain pending.  The dealer must provide on Form G-38t the same types of disclosures currently required to be made for consultants under existing Rule G-38, with each item of municipal securities business for which payment remains pending listed on the quarterly reports until such quarter in which payment is finally made.

SUMMARY OF AMENDMENT TO ORIGINAL PROPOSAL

Today’s amendment to the original proposal provides that the proposed rule change would become effective on the first business Monday at least five business days after SEC approval.  The amendment also deletes the requirement in the transitional payment provision that the dealer must be selected by the issuer for municipal securities business by the effective date of the rule change while adding a requirement that dealers include on their initial and all subsequent Form G-38t submissions each item of municipal securities business for which a transitional payment remains pending and the amount of such pending payment for each item of business.  Form G-38t is modified to reflect this required reporting of pending payments.  Finally, the amendment modifies the definition of “affiliated person” and adds a definition of “registered person” so that affiliated persons would include independent brokers who are duly qualified registered persons of a dealer under MSRB or NASD professional qualification requirements.

DISCUSSION OF COMMENTS

Transitional Payments.  One commentator expressed concern that, “as a practical matter, broker-dealers will have no meaningful notice as to when the SEC will approve this amendment and thus will not have an opportunity to effectively close out their relationship with Consultants under the current provision.”  This commentator suggested the elimination of the provision in Rule G-38 prohibiting payment for prior services if the dealer had not been selected for the business at the time the SEC approves the proposed rule change.  It pointed to concerns that this provision of the proposed rule change would require dealers to fail to fulfill their contractual payment obligations for actual work previously performed by consultants.[6]

The MSRB believes that the new effective date and modified transitional payment provisions, as well as the modification to Form G-38t, will address this concern.  These modifications will facilitate dealer compliance with revised Rule G-38 in an orderly and timely manner while reducing the opportunity for circumvention of the purposes of the proposed rule change.  As modified, the transitional payment provision should avoid the potential for exposing dealers to legal liability under their contracts with consultants for failure to pay for services rendered.

Independent Registered Representatives.  Two commentators argued that the definition of “affiliated person” should include registered representatives of dealers who are independent contractors, rather than employees of such dealers, noting that such independent registered representatives “are subject to the same supervision, compliance and regulatory requirements as employees.”  One of these commentators stated that “as many as 40% of the registered representatives in this country are independent contractors, not employees, and that number is increasing,” and that 85% of its own registered representatives are independent contractors.  It stated:

Given that these individuals are subject to, among other things, the broker-dealer’s supervision and compliance procedures as well as the fair practice and professionalism standards under MSRB rules, allowing independent contractor registered representatives of affiliated broker-dealers to solicit municipal securities business should be entirely consistent with the MSRB’s policy goal of applying “basic standards of fair practice and professionalism embodied in MSRB rules to all persons who solicit municipal securities business on behalf of dealers” and ensuring “that all solicitations are undertaken in accordance with the ethical standards that govern dealer personnel.”

The MSRB believes that the modified definition of affiliated person to include all duly qualified registered persons of a dealer under MSRB or NASD professional qualification requirements, regardless of their technical employment status, will address this concern.  This modification will further minimize the potential burden on competition of the proposed rule change in that it would treat dealer business models using independent brokers equally with dealer business models using directly employed brokers without reducing the effectiveness of the proposed rule change.  Registered persons included in the definition of affiliated person under this amendment are subject to federal securities laws on the same basis as directly employed brokers and therefore their inclusion is consistent with the purposes of the proposed rule change.

Other Comments.    One commentator sought further clarification on the definition of “solicitation” as used in the proposed rule change.  The MSRB has filed with the SEC a proposed interpretation providing such further clarification and will address comments on this definition in conjunction with such rule filing.[7]  Another commentator opposed changing Rule G-38.  The MSRB previously addressed this commentator’s comments in the proposed rule change.  A third commentator generally supported the proposed amendments.

The MSRB reminds dealers that the proposed rule change, as modified by this amendment, will cover direct and indirect communications that serve as solicitations of municipal securities business for dealers, as well as direct and indirect payments by dealers in return for such solicitations.  The MSRB urges the enforcement agencies to remain vigilant to efforts by dealers to enter into arrangements that may superficially comply with the letter of revised Rule G-38 but which may be designed to benefit dealers by means of indirect communications with issuers on behalf of such dealers or to reward those who recommend such dealers with indirect payments.  In particular, dealers should exercise caution when hiring solicitors who may retain other business ties that present opportunities for their business associates to act indirectly on such solicitors’ behalf.

Furthermore, as the MSRB has previously noted,[8] Rule G-27 (on supervision) will obligate dealers to take the necessary steps to ensure that payments are not directly or indirectly being paid to any person other than an affiliated person of the dealer in exchange for such person’s solicitation of municipal securities business on the dealer’s behalf in violation of revised Rule G-38.  This will entail, among other things, understanding the true nature of the services provided by non-affiliated persons for which payments may be made.  The MSRB expects that, once the proposed rule change becomes effective, dealers will have in place the necessary policies and procedures relating to the new provisions of Rule G-38 to ensure both the achievement of compliance with such provisions and the accuracy of the required annual chief executive officer certification under NASD Rule 3013 and IM-3013 concerning compliance and supervisory policies and procedures, including those established for revised Rule G-38.

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Questions regarding this notice and the proposed rule change, as modified by this amendment, may be directed to Ernesto A. Lanza, Senior Associate General Counsel.

August 9, 2005

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TEXT OF PROPOSED AMENDMENT[9]

Rule G-38.  Solicitation of Municipal Securities Business

(a) No change.

(b) Definitions. For purposes of this rule, the following terms shall have the following meanings:

(i) No change

(ii) The term “affiliated person of the broker, dealer or municipal securities dealer” means any person who is a partner, director, officer, or employee or registered person of the broker, dealer or municipal securities dealer (or, in the case of a bank dealer, any person occupying a similar status or performing similar functions for the bank dealer) or of an affiliated company of the broker, dealer or municipal securities dealer.

(iii) No change.

(iv) The term “registered person” means any associated person of the broker, dealer or municipal securities dealer duly qualified in one or more categories of qualification under Rule G-3 or duly qualified and registered in one or more categories of registration under the rules of a registered securities association.

(v) (iv)   No change.

(c) Transitional Payments

(i) A broker, dealer or municipal securities dealer may make payments to a person other than an affiliated person of the broker, dealer or municipal securities dealer for a solicitation of municipal securities business on behalf of such broker, dealer or municipal securities dealer if such payment is made with respect solely to solicitation activities undertaken by such person on or prior to the effective date of this rule pursuant to a Consultant Agreement under former Rule G-38, but only if:

(A) the broker, dealer or municipal securities dealer had been selected by the issuer on or prior to the effective date of this rule to engage in such municipal securities business;

(A) (B)  such person has not solicited municipal securities business from any issuer on behalf of the broker, dealer or municipal securities dealer at any time after the effective date of this rule; and

(B) (C) the broker, dealer or municipal securities dealer sends to the Board, by the last day of the month following the end of each calendar quarter during which payments to such person are made or remain pending, Form G-38t, setting forth, in the prescribed format, the information required to be disclosed to the Board pursuant to section (e) of former Rule G-38; provided that each item of municipal securities business for which payment remains pending (together with a specific dollar amount or objective formula for determining the specific dollar amount of the pending payment) must be listed on the first quarterly Form G-38t due after the effective date of this rule and on each subsequent quarterly Form G-38t until such quarter in which payment is finally made.  The broker, dealer or municipal securities dealer shall send two copies of Form G-38t to the Board by certified or registered mail, or some other equally prompt means that provides a record of sending.  The Board shall make public a copy of each Form G-38t received from any broker, dealer or municipal securities dealer.

(ii) For purposes of this section (c), the term “effective date of this rule” means [INSERT DATE OF FIRST MONDAY THAT IS A BUSINESS DAY AT LEAST FIVE BUSINESS DAYS AFTER COMMISSION APPROVAL OF PROPOSED RULE CHANGE] and the term “former Rule G-38” means Rule G-38 of the Board in effect on the day prior to the effective date of this rule.

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CLICK HERE TO VIEW REVISED FORM G-38t  


[2] The original proposal also included related amendments to Rule G-37, on political contributions and prohibitions on municipal securities business, and Rule G-8, on recordkeeping, as well as to Forms G-37/G-38 and G-37x.  Today’s amendment does not modify these portions of the original proposal.

[3] See Exchange Act Release No. 51561 (April 15, 2005), 70 FR 20782 (April 21, 2005).  See also MSRB Notice 2005-16 (March 15, 2005) and MSRB Notice 2005-17 (March 17, 2005).  The comments received by the SEC on the original proposal may be viewed at http://www.sec.gov/rules/sro/msrb/msrb200504.shtml.

[4] Solicitation is defined as a direct or indirect communication with an issuer for the purpose of obtaining or retaining municipal securities business.

[5] An affiliated company is an entity that controls, is controlled by or is under common control with the dealer and whose activities are not limited solely to the solicitation of municipal securities business.

[6] This commentator also suggested that, to avoid the possibility that payments may be made for purposes other than past services, such payments could be required to be made within 30 days of the effective date.  The MSRB believes the modification provided in today’s amendment adequately addresses this concern.

[9] Underlining indicates additions to the original proposed rule change; strikethrough indicates deletions from the original proposed rule change.