MSRB NOTICE 2011-38 (AUGUST 4, 2011)

AMENDMENTS FILED REGARDING MSRB RULE G-20 ON GIFTS AND GRATUITIES

On August 4, 2011, the Municipal Securities Rulemaking Board (“Board” or “MSRB”) filed with the Securities and Exchange Commission (“SEC” or “Commission”) a proposed rule change (the “proposed rule change”) consisting of: (i) proposed amendments to MSRB Rule G-20 (on gifts and gratuities), which would apply the rule to municipal advisors, along with related proposed amendments to Rule G-8 (on books and records) and Rule G-9 (on preservation of records); and (ii) clarification that certain interpretations by the Financial Industry Regulatory Authority (“FINRA”) of its gifts rule (FINRA Rule 3220) and its predecessor, the National Association of Securities Dealers (“NASD”) of its gift rule (NASD Rule 3060), would be applicable to municipal advisors.[1]

The MSRB requests that the proposed rule change be made effective on the date that rules defining the term “municipal advisor” under the Securities Exchange Act of 1934 (“Exchange Act”) are first made effective by the Commission.

BACKGROUND

Rule G-20 was adopted by the MSRB to prevent brokers, dealers, and municipal securities dealers (“dealers”) from attempting to induce other organizations active in the municipal securities market to engage in business with such dealers by means of personal gifts or gratuities given to employees of the organizations, including, but not limited to, acts of commercial bribery,[2] and to help to ensure that dealers’ municipal securities activities are undertaken in arm’s-length, merit-based transactions in which conflicts of interest are minimized. The MSRB has interpreted Rule G-20 to preclude the payment by dealers of “excessive or lavish” entertainment or travel expenses of issuer personnel, as follows:[3]

Payment of excessive or lavish entertainment or travel expenses may violate Rule G-20 if they result in benefits to issuer personnel that exceed the limits set forth in the rule, and can be especially problematic where such payments cover expenses incurred by family or other guests of issuer personnel.  Depending on the specific facts and circumstances, excessive payments could be considered to be gifts or gratuities made to such issuer personnel in relation to the issuer’s municipal securities activities.

The Dodd-Frank Act[4] authorized the MSRB to establish a comprehensive body of regulation for all municipal advisors.[5]  The Dodd-Frank Act requires the MSRB to adopt rules for municipal advisors that are designed to prevent fraudulent and manipulative acts and practices and to promote just and equitable principles of trade.[6]  It also expands the mission of the MSRB to include the protection of municipal entities[7] and obligated persons, in addition to the protection of investors and the public interest.

SUMMARY OF PROPOSED RULE CHANGE

Proposed amendments to MSRB Rule G-20.  Pursuant to the authority granted to it by the Dodd-Frank Act, the MSRB is proposing the amendments to Rule G-20.  Just as the existing rule helps to ensure that dealers’ municipal securities activities are undertaken in arm’s-length, merit-based transactions in which conflicts of interest are minimized, the MSRB seeks to reduce the potential for conflicts of interest in municipal advisory activities.[8]  The proposed amendments to Rule G-20 would help to ensure that engagements of municipal advisors, as well as engagements of dealers, other municipal advisors, and investment advisers for which municipal advisors serve as solicitors, are awarded on the basis of merit and not as a result of gifts made to employees controlling the award of such business. The proposed amendments to Rule G-20 would make the rule applicable to municipal advisors and would:

  • prohibit municipal advisors, in connection with their municipal advisory activities, from, directly or indirectly, making a gift or permitting a gift to be made in excess of $100 per year to a natural person other than an employee or partner of the municipal advisor, if such gifts are in relation to the activities of the employer of the recipient of the gift;[9]
  • provide certain exemptions from the above prohibition, including: (i) occasional gifts of meals or tickets to theatrical, sporting, and other entertainments hosted by the municipal advisor; or (ii) legitimate business functions sponsored by the municipal advisor that are recognized by the Internal Revenue Service as deductible business expenses;[10]
  • permit contracts of employment or compensation for services rendered by a person other than an employee of the municipal advisor; provided that there is a written agreement[11] between the municipal advisor and the person who is to perform such services, prior to the time of employment or before the services are rendered;[12]
  • remove gifts of reminder advertising as a permissible exemption from the $100 gift limit of Rule G-20(a) for municipal advisors and dealers;[13] and
  • clarify that existing FINRA and NASD interpretations of the FINRA and NASD gift rules, respectively,[14] apply to comparable MSRB provisions of Rule G-20 applicable to municipal advisors, with new FINRA interpretations of its gifts rule made applicable to municipal advisors if the MSRB determines that it is appropriate to do so.

Municipal advisors would not be subject to Rule G-20(d), which relates to non-cash compensation in connection with primary offerings.

Proposed amendments to MSRB Rule G-8 and Rule G-9. The proposed amendments to Rule G-20 would necessitate related amendments to Rule G-8 (on books and records) and Rule G-9 (on preservation of records). The proposed amendments to Rules G-8 and G-9 would subject municipal advisors to the same recordkeeping and record retention requirements to which dealers would be subject under amended Rule G-20. Specifically, the proposed amendments to Rule G-8 would require municipal advisors and dealers to create and maintain records of any gifts referred to in Rule G-20 and all agreements for services referred to in Rule G-20 along with the compensation paid as a result of such agreements. The proposed amendments to Rule G-9 would require municipal advisors to preserve the records required to be made pursuant to the proposed amendments to Rule G-8.

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Questions about the proposed rule change should be directed to Peg Henry, Deputy General Counsel, or Leslie Carey, Associate General Counsel, at (703) 797-6600.

August 4, 2011

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TEXT OF PROPOSED AMENDMENTS [15]

Rule G-20: Gifts, Gratuities and Non-Cash Compensation

(a)  General Limitation on Value of Gifts and Gratuities. In connection with its municipal securities activities or municipal advisory activities, Nno broker, dealer, or municipal securities dealer, or municipal advisor shall, directly or indirectly, give or permit to be given any thing or service of value, including gratuities make a gift or permit a gift to be made, in excess of $100 per year to a natural person other than an employee or partner of such broker, dealer, or municipal securities dealer, or municipal advisor, if such payments or services gifts are in relation to the municipal securities activities of the employer of the recipient of the payment or service gift.  For purposes of this rule the term "employer" shall include a principal for whom which the recipient of a payment or service gift is acting as agent or representative.

(b)  Normal Business Dealings.  Notwithstanding the foregoing, the provisions of section (a) of this rule shall not be deemed to prohibit occasional gifts of meals or tickets to theatrical, sporting, and other entertainments hosted by the broker, dealer, or municipal securities dealer, or municipal advisor; or the sponsoring by the broker, dealer, or municipal securities dealer, or municipal advisor of legitimate business functions that are recognized by the Internal Revenue Service as deductible business expenses; or gifts of reminder advertising; provided, that such gifts shall not be so frequent or so extensive as to raise any question of propriety.

(c)  Compensation for Services.  Notwithstanding the foregoing, the provisions of section (a) of this rule shall not apply to contracts of employment with or to compensation for services rendered by another person; provided, that there is in existence prior to the time of employment or before the services are rendered a written agreement between the broker, dealer, or municipal securities dealer, or municipal advisor subject to this rule and the person who is to perform such services; and provided, further, that such agreement shall include the nature of the proposed services, the amount of the proposed compensation, and the written consent of such person’s employer.

(d)-(e)  No change.

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Rule G-8: Books and Records to be Made by Brokers, Dealers, and Municipal Securities Dealers, and Municipal Advisors

(a)    (i) - (xvi)  No change.

(xvii)  Records Concerning Compliance with Rule G-20.  Each broker, dealer and municipal securities dealer shall maintain:

(A)  a separate record of any gift or gratuity referred to in Rule G-20(a);

(B)  No change.

(C)  No change.

(a)    (xviii) - (g)  No change.

(h)    Municipal Advisor Records.  Each municipal advisor shall maintain:

(i)  Reserved.

(ii) Records Concerning Gifts Pursuant to Rule G-20.

(A)  a separate record of any gift referred to in Rule G-20; and

(B)  all agreements referred to in Rule G-20(c) and all compensation paid as a result of those agreements.

(i)     The records required by section (h) of this rule shall be maintained in the manner described in section (b) of this rule.

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Rule G-9: Preservation of Records

(a)    (i) - (viii)  No change.

(ix) the records regarding information on gifts and gratuities and employment agreements required to be maintained pursuant to rule G-8(a)(xvii);

(a)    (x) - (g)  No change.

(h)    Municipal Advisor Records.  Every municipal advisor shall preserve for no less than six years:

(i)  Reserved.

(ii) the records regarding information on gifts and employment agreements required to be maintained pursuant to Rule G-8(h)(ii).

Such records shall be accessible and available as required by subsection (d) of this rule and retained in the manner required by subsection (e) of this rule.


[1] File No. SR-MSRB-2011-10. Comments on the proposed amendments should be submitted to the SEC and should reference this file number.  On February 22, 2011, the MSRB published a notice requesting comment on draft amendments to Rule G-20.  See MSRB Notice 2011-16.  The MSRB received eight comment letters in response to its notice.  A summary of the comments received, and the MSRB’s response, may be found in File No. SR-MSRB-2011-10.

[3] See Rule G-20 Interpretation -- Dealer Payments in Connection with the Municipal Securities Issuance Process (January 29, 2007); see also In the Matter of RBC Capital Markets Corporation, SEC Rel. No. 34-59439 (Feb. 24, 2009) (settlement in connection with broker-dealer alleged to have violated MSRB Rules G-20 and G-17 for payment of lavish travel and entertainment expenses of city officials and their families associated with rating agency trips, which expenditures were subsequently reimbursed from bond proceeds as costs of issuance); In the Matter of Merchant Capital, L.L.C., SEC Rel. No. 34-60043 (June 4, 2009) (settlement in connection with broker-dealer alleged to have violated MSRB rules for payment of travel and entertainment expenses of family and friends of senior officials of issuer and reimbursement of the expenses from issuers and from proceeds of bond offerings).

[4] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).

[5] “Municipal advisor” is defined in Section 15B(e)(4) of Exchange Act.

[6] See Section 15B(b)(2)(C) of the Exchange Act.

[7] “Municipal entity” is defined in Section 15B(e)(8) of the Exchange Act as “any State, political subdivision of a State, or municipal corporate instrumentality of a State, including - (A) any agency, authority, or instrumentality of the State, political subdivision, or municipal corporate instrumentality; (B) any plan, program, or pool of assets sponsored or established by the State, political subdivision, or municipal corporate instrumentality or any agency, authority, or instrumentality thereof; and (C) any other issuer of municipal securities.”

[8] MSRB Rule D-13 defines the term “municipal advisory activities” by reference to Section 15B(e)(4)(A) of the Exchange Act (i.e., (i) providing advice to municipal entities or obligated persons on municipal financial products or the issuance of municipal securities and (ii) solicitations of municipal entities on behalf of others).

Section 15B(e)(9) of the Exchange Act defines the term “solicitation of a municipal entity or obligated person” to mean: “a direct or indirect communication with a municipal entity or obligated person made by a person, for direct or indirect compensation, on behalf of a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser (as defined in section 202 of the Investment Advisers Act of 1940) that does not control, is not controlled by, or is not under common control with the person undertaking such solicitation for the purpose of obtaining or retaining an engagement by a municipal entity or obligated person of a broker, dealer, municipal securities dealer, or municipal advisor for or in connection with municipal financial products, the issuance of municipal securities, or of an investment adviser to provide investment advisory services to or on behalf of a municipal entity.”

[9] See proposed Rule G-20(a).  The “municipal advisory activities” of the municipal advisor covered by the proposed amendments to Rule G-20(a) would include both advice provided to municipal entities and obligated persons and solicitations of municipal entities on behalf of third parties.  For example, the proposed rule amendments would apply to gifts and entertainment provided by a municipal advisor to employees of municipal entities and obligated persons for which the municipal advisor is providing advice or seeking to provide advisory services.  It would also apply to gifts and entertainment provided by a municipal advisor to employees of municipal entities being solicited by a municipal advisor to award business to a client of the municipal advisor (e.g., employees of a public pension fund who could influence the pension fund’s decision to award investment advisory business).  Even if a municipal advisor is not then engaging in any municipal advisory activities with a municipal entity or obligated person, a gift that could be reasonably viewed as an attempt by the municipal advisor to curry favor with a municipal entity or obligated person for the purpose of becoming engaged to undertake municipal advisory activities at some point in the future also would be covered by the provisions of proposed Rule G-20.

[10] See proposed Rule G-20(b).

[11] The written agreement must include the nature of the proposed services, the amount of the proposed compensation, and the written consent of such person’s employer.

[12] See proposed Rule G-20(c).

[13] See proposed Rule G-20(b).  Those gifts would be addressed, instead, by NASD Notice to Members 06-69 (December 2006), which the proposed rule change would make applicable to municipal advisors (“NASD Notice to Members 06-69”).