MSRB NOTICE 2008-12 (MARCH 4, 2008)

MSRB RESPONDS TO SEC REQUEST FOR REVIEW OF DEFINITION OF "ISSUER OFFICIAL" UNDER RULE G-37 ON POLITICAL CONTRIBUTIONS

On February 29, 2008, the Municipal Securities Rulemaking Board (“MSRB”) responded to a request by the Securities and Exchange Commission (“SEC”), set forth in its November 5, 2007 decision in the Sisung Matter, that the MSRB consider whether it may be appropriate to amend the definition of issuer official in Rule G-37, on political contributions, to address the kind of situation presented in the Sisung Matter.[1]  In its response, the MSRB stated that it had carefully reviewed the SEC’s request and had determined that it is appropriate to retain the current definition of issuer official and that no amendment to Rule G-37 is warranted at this time.

The MSRB’s letter is reprinted below.

March 4, 2008

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                                                                                                February 29, 2008

 

Nancy M. Morris
Secretary
U.S. Securities and Exchange Commission
100 F Street, NE
Washington, DC  20549

Re:  In the Matter of the Application of SISUNG SECURITIES CORPORATION and LAWRENCE J. SISUNG, JR., Exchange Act Release No. 56741 (November 5, 2007); Admin. Proc. File No. 3-12443

Dear Ms. Morris:                                                  

On November 5, 2007, the Securities and Exchange Commision (“Commission” or “SEC”) rendered its opinion in the Sisung Matter, in which Sisung Securities Corporation and Lawrence J. Sisung, Jr. had appealed the Financial Industry Regulatory Authority’s (“FINRA”) findings of violations of Municipal Securities Rulemaking Board (“MSRB” or “Board”) Rule G-37 on political contributions (as well as violations of MSRB Rule G-8 on recordkeeping, and Rule G-9 on record retention) and the imposition of monetary penalties based on such findings.  The central question in this matter was whether certain individuals were “issuer officials” under Rule G-37 such that contributions to these individuals triggered the rule’s two-year ban on municipal securities business.  The Commission disagreed with FINRA’s interpretation on this point and set aside the findings of violations of the rule sections concerning the ban on business and the prohibition on soliciting or coordinating contributions.  The Commission encouraged the MSRB to consider whether it may be appropriate to amend Rule G-37 “to address the kind of situation presented” in this matter, acknowledging that the MSRB must observe certain constitutional limitations in considering such an amendment.

The Board of the MSRB has carefully reviewed the Commission’s request and is pleased to submit its response below.

Summary of Relevant Facts in the Sisung Matter

Between February 1998 and October 2001, Lawrence J. Sisung, Jr. (“Sisung”) controlled Sisung Securities Corporation (“SSC”).  SSC was a member of FINRA, and Sisung was a “municipal finance professional” for purposes of Rule G-37.  He also controlled UPC, a business and real-estate development and consulting firm, and he controlled SIMS, a registered investment advisor.  During this period, UPC and SIMS made 39 contributions to Louisiana elected officials via checks drawn on their accounts and signed or authorized by Sisung.  Sisung personally delivered each contribution to the official (or to the official’s representative).  The contributions were listed on the books and records of UPC and SIMS, but not on the books and records of SSC.  SSC did not report the contributions to the MSRB.  Sisung argued that the contributions were not made to obtain municipal securities business, but rather to obtain investment advisory work on certain state pension funds, to further real estate business, and to support beneficial legislative initiatives. 

Fourteen of the 39 contributions (totaling almost $17,000) were given to incumbent statewide executive and legislative officials, including the state treasurer, secretary of state, president of the state Senate, and certain members of the Louisiana state legislature.[2]  Each of these people served as ex officio members of the Louisiana Bond Commission by virtue of the offices they held.  All members of the Bond Commission are first elected to an office that qualifies them for membership on the Commission (except the commissioner of administration, who is appointed by the governor).[3]

The Louisiana Constitution requires the Bond Commission’s prior written approval before any bonds may be issued by the state or by any political subdivision.  All state general obligation (“G.O.”) bonds are issued by the Bond Commission; as issuer for such debt, the Bond Commission is authorized to select the underwriters and financial advisors (among other financial professionals).  The Bond Commission does not issue political subdivision debt and is not authorized to select the underwriters, financial advisors and other financial professionals for such debt issuances.  However, a Louisiana statute requires that the Bond Commission receive applications from political subdivisions who wish to issue debt, and that the Commission either approve or disapprove the application, or defer action on it for further discussion.[4]

Sisung testified that outside counsel advised that the contributions to various elected officials who served as ex officio members of the Bond Commission might preclude SSC from engaging in business with the Commission as an issuer, i.e., with respect to state G.O. debt, but did not preclude SSC from engaging in municipal securities business with the political subdivisions.  Based on such advice, SSC did not engage in business with the Bond Commission as an issuer of state G.O. debt, but did engage in business with the political subdivisions as issuers.  From March 1998 through December 2002, SSC served as underwriter or financial advisor on 21 negotiated deals issued by the political subdivisions, earning over $2 million in fees.             

Rule G-37

Rule G-37 became effective in 1994 and in general prohibits brokers, dealers and municipal securities dealers (collectively, “dealers”) from engaging in municipal securities business with issuers for a two-year period if certain political contributions have been made to officials of such issuers by the dealer or a municipal finance professional (“MFP”) (other than certain de minimis contributions).  The rule also prohibits dealers and MFPs from soliciting or bundling (i) contributions to an official of an issuer with which the dealer is engaging or seeking to engage in municipal securities business, or (ii) payments to a political party of a state or locality where the dealer is engaging or seeking to engage in business; and requires dealers to record and disclose certain political party payments and municipal securities business to assist in severing the connection between contributions and the awarding of municipal securities business.[5]

Rule G-37 defines the term "official of such issuer" or "official of an issuer" as any person (including any election committee for such person) who was, at the time of the contribution, an incumbent, candidate or successful candidate: (A) for elective office of the issuer which office 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 the issuer; or (B) for 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.

Commission’s Findings & Opinion [6]

The Commission found that the contributions at issue were made by an MFP (Sisung), but disagreed with the finding that Louisiana Bond Commission members were issuer officials pursuant to subsection (B) of the definition under Rule G-37.  While noting that “the language of subsection (B) could be subject to different interpretations” the Commission stated that:

Nevertheless…the more appropriate interpretation is that, to be an official of an issuer for purposes of subsection (B), a person must be an incumbent or candidate for an office with the authority to appoint another person who (a) is responsible for the hiring of a…dealer.  Thus, an official covered by this part of the Rule must have the identified appointing authority, that is, the power to appoint a person who has responsibility for or influence over the selection of a…dealer.  The ability of the official to influence the selection is not itself sufficient.  We believe that is the more natural reading of the language of subsection (B).  It is consistent with the release adopting subsection (B), which stated that subsection (B) ‘addresses situations in which an elected official may appoint someone to an issuer position.’[7]…NASD’s conclusion that Bond Commission members were issuer officials with respect to political subdivision issuers effectively read out of the definition the requirement that the elected official have the power to appoint a person with responsibility for or influence over the awarding of municipal securities business.  We believe…that, in the absence of such authority, Bond Commission members are not issuer officials of political subdivision issuers under the rule….Thus, the contributions at issue here did not subject SSC to a two-year ban on engaging in municipal securities business with Louisiana political subdivisions.  The contributions also did not violate Rule G-37(c)’s prohibition against soliciting or coordinating contributions ‘to an official of an issuer’ with which SSC was ‘engaging or seeking to engage in municipal securities business.’[8]

The Commission then stated that:

Although the record… [in Sisung] contains no evidence that the contributions actually influenced the awarding of municipal securities business, it is nevertheless conceivable to us that they could.  We consequently encourage the MSRB to consider whether it may be appropriate to amend the rules at issue to address the kind of situation presented here…, recognizing that the MSRB must be mindful, in considering any amendment to the rule, to consider constitutional limitations.[9] 

MSRB’s Response

The MSRB adopted Rule G-37 to sever the connection between the making of political contributions and the awarding of municipal securities business in order to ensure that the high standards and integrity of the municipal securities industry are maintained; to prevent fraudulent and manipulative practices; to promote just and equitable principles of trade; to perfect a free and open market; and to protect investors and the public interest.  The rule has been very successful in severing this connection, thereby removing conflicts – real or perceived – and fostering the integrity of the market. 

Rule G-37 defines the term "official of such issuer" or "official of an issuer" as any person (including any election committee for such person) who was, at the time of the contribution, an incumbent, candidate or successful candidate:

(A) for elective office of the issuer which office 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 the issuer; or

(B) for 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.

When the rule became effective in April 1994, the definition contained only that portion set forth in subsection (A).  However, the Board intended that the definition also apply to those persons subject to the definition by virtue of subsection (B).  To clarify its intent, the Board amended the definition in June 1994 to add subsection (B) and published Qs&As on this matter.[10]  In its filing with the Commission, the Board stated that:

The definition is 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.  The Board, however, was concerned that because the definition focuses on ‘elective office of the issuer,’ it did not clearly include certain other officials.  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 an 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 Board intended to include the governor as an official of the issuer in such circumstances and, therefore, has determined to amend the definition to clarify its intent.[11]

Thus, the definition of issuer official and the Board’s published guidance in this area represent a longstanding aspect of the rule.[12]  The Sisung Matter is the first enforcement case involving this definition.  Notwithstanding the Commission’s reversal of the finding that members of the Louisiana Bond Commission were issuer officials, the Commission “encouraged” the Board to consider whether it may be appropriate to amend the rule to address “the kind of situation presented” in the Sisung Matter, while acknowledging that any amendment must be respectful of constitutional constraints.[13]

The Commission stated that Rule G-37 is essential to diminish pay-to-play practices in the municipal securities market.[14]  We note that the rule was drafted with respect for the constitutional rights of individuals to participate fully in the political process, and its constitutionality has been challenged and upheld.  The reviewing Court held that Rule G-37 is narrowly drawn and serves a compelling governmental interest – the essential test for determining the constitutionality of any such measure.[15]  Therefore, any discussion of an amendment to Rule G-37 should center on this constitutional analysis (i.e., a “strict scrutiny” analysis).

Under the definition of issuer official, a person would fall within subsection (B) if, at the time of the contribution, he/she was an incumbent, candidate or successful candidate (1) for an elective office, and (2) that elective office is vested with the statutory authority to appoint any person, and (3) such appointed person is responsible for, or can influence the outcome of, the selection of an underwriter or financial advisor.[16]  As the Commission stated in Sisung, “The ability of the official to influence the selection is not itself sufficient.”[17]  In other words, to be deemed an issuer official under subsection (B), the elected official must also have the requisite appointing authority.

In order to encompass a Sisung-type fact pattern (such that Louisiana Bond Commission members and similarly situated individuals would be deemed issuer officials), the MSRB would have to amend the definition of issuer official to delete such appointing authority -- that is, to “effectively read out of the definition the requirement that the elected official have the power to appoint a person with responsibility for or influence over the awarding of municipal securities business.”[18]  Such a change would mean that any elected person may be deemed an issuer official if they merely have the ability to approve or disapprove a particular issue, which would be viewed as tantamount to actually selecting (or influencing the selection of) the underwriter or financial advisor.  Thus, rather than applying the objective standard embodied in the statutory authority conferred upon the office the elected person occupies, any elected person may be deemed an issuer official if they merely have the ability to approve or disapprove a particular issue – a much more subjective standard.  Such a standard has the potential to exponentially increase the number of individuals that would fall within the definition of issuer official such that contributions to such people would trigger the ban on business.[19]  This presumes that such an expansion of the definition would survive constitutional scrutiny in order to become effective – a presumption that could prove difficult to overcome given its potentially expansive reach.

While giving due consideration to the Commission’s request, there does not appear to be a countervailing benefit to expanding the definition of issuer official at this time.  As noted, there is no prior history of significant industry confusion over this aspect of the rule.  Moreover, Rule G-37 was adopted with “sensitivity” to First Amendment concerns.[20]  As the Commission stated in its 1994 brief in the Blount case, “the disqualification provision is ‘precisely targeted’ to reach situations where the actuality or appearance of corruption is greatest.”[21]  The Board believes that any broadening of the rule’s scope beyond that which is necessary to accomplish its purposes may jeopardize the “precisely targeted” nature of Rule G-37, thereby calling into question its constitutionality.  The “actuality or appearance of corruption” that would be addressed by broadening the definition of issuer official to address the situation presented in the Sisung Matter is simply too attenuated to risk a possible restraint on First Amendment protections that such an expansion may entail.

Accordingly, the Board has determined that it is appropriate to retain the current definition of issuer official and that no amendment to Rule G-37 is warranted at this time.  The Board will continue to monitor this issue and will not hesitate to reassess its position if it later determines that such action is necessary, while giving full regard to the constitutional constraints that must be observed in contemplating any rulemaking involving Rule G-37.

If you have any questions concerning this matter, please feel free to contact me at 703-797-6600.

Sincerely,

/s/

Lynnette Kelly Hotchkiss
Executive Director

 

cc:        Eric R. Sirri, Director, SEC Division of Trading and Markets
            Martha M. Haines, Chief, SEC Office of Municipal Securities



[1] In the Matter of the Application of SISUNG SECURITIES CORPORATION and LAWRENCE J. SISUNG, JR., Exchange Act Release No. 56741 (November 5, 2007); Admin. Proc. File No. 3-12443.

[2] The other 25 contributions (totaling almost $28,000) were made to local elected officials – mayors, councilmen, aldermen, sheriffs and school board members.  

[3] The members of the Louisiana Bond Commission include the governor, lieutenant governor, state treasurer, secretary of state, attorney general, president of the state Senate, speaker of the House of Representatives, chairman of the Senate Finance Committee, chairman of the Senate Revenue and Fiscal Affairs Committee, chairman of the House Ways and Means Committee, chairman of the House Appropriations Committee, commissioner of administration, and two members of the legislature – one who is appointed by the president of the Senate, and one who is appointed by the speaker of the House of Representatives. 

[4] The Louisiana Bond Commission reviews these applications for compliance with constitutional and statutory requirements and for feasibility, including the ability to repay debt.

[5] Since 1994, the Board has reviewed many aspects of the rule, filed various rule amendments, and published interpretive guidance, including numerous questions-and-answers.  In June 2001, the Board published a notice requesting comments on all aspects of Rule G-37, highlighting certain areas in which it was particularly interested in receiving comments.  These areas included the definition of MFP, the amount and timing of de minimis contributions, the exemption provision, contributions by bank PACs, and the role of syndicate and selling group members.  Commentators requested changes to many aspects of the rule.  After carefully reviewing these comments, the Board decided to amend two provisions: the exemption provision and the definition of MFP.  In September 2002, the Board filed the amendments with the SEC, which were approved in May 2003. 

Since then, the Board has focused its attention on possible indirect violations of Rule G-37 through political party and PAC payments, as well as Rule G-38 on solicitation of municipal securities business.  See MSRB Notices 2005-36 (June 21, 2005); 2005-50 (September 26, 2005); 2004-11 (April 5, 2004); 2004-32 (September 29, 2004); 2005-16 (March 15, 2005); 2005-41 (August 9, 2005); 2005-44 (August 18, 2005); 2005-46 (August 29, 2005); 2006-15 (June 15, 2006); and 2007-29 (September 25, 2007).

[6] In the Matter of the Application of Sisung Securities Corporation and Lawrence J. Sisung, Jr. for Review of Disciplinary Action Taken by NASD, Securities Exchange Act Rel. No. 56741 (November 5, 2007), Admin. Proc. File No. 3-12443 (“SEC decision”).

[7] SEC decision at 8.

[8] SEC decision at 7-8.

[9] SEC decision at 9.  The Commission set aside the findings of violations of Rule G-37(b) and (c), but upheld the violations of Rule G-37(e) relating to reporting of contributions, as well as Rules G-8 and G-9 on recordkeeping and record retention.

[10] The amendment was approved in Securities Exchange Act Release No. 34160 (June 3, 1994).

[11] Id.

[12] As a matter of policy, the MSRB does not opine on whether a particular individual is an issuer official; it has historically been the MSRB’s position that such questions must be determined by an examination of all the facts and circumstances surrounding each case.

[13] The Commission, citing its original 1994 order approving Rule G-37, stated that:

Rule G-37 ‘minimizes any undue burdens on the protected speech’ of municipal securities dealers and municipal finance professionals because it is ‘narrowly crafted in terms of the conduct it prohibits, the persons who are subject to the restriction, and the circumstances under which it is triggered.’  We therefore recognize that the MSRB must be careful, in considering any amendment to the rule, to consider constitutional limitations.  See Sisung decision at 9.

[14] Id.

[15] Blount v. SEC, 61 F.3d 938 (D.C. Cir. 1995).

[16] To clarify, it is the elected official – not the appointed person – who would be deemed the issuer official.

[17] SEC decision at 8.

[18] Id.

[19] Such a standard could vary widely from state to state, as well as at the local level.  For example, in some states the office of the attorney general reviews and approves contracts.  Under any expanded definition, this would make the attorney general an issuer official in those jurisdictions, but not necessarily in others.

[20] Blount v. SEC.

[21] Id.; Brief of Respondent at 26.