MSRB NOTICE 2011-43 (AUGUST 11, 2011)

MSRB FILES WITH THE SEC AMENDMENTS TO RULE A-3 TO ESTABLISH A PERMANENT BOARD STRUCTURE

Today, the MSRB filed with the Securities and Exchange Commission (the “SEC”) a proposed rule change consisting of amendments to Rule A-3, on membership on the Board, in order to establish a permanent Board structure of 21 Board members divided into three classes, each class being comprised of seven members who would serve three year terms.  The terms would be staggered and, each year, one class would be nominated and elected to the Board of Directors.[1]  The proposed rule change will become effective upon approval by the SEC.

In order to facilitate the transition to three staggered classes, Rule A-3 would include a transitional provision, Rule A-3(h), applicable for the Board’s fiscal years commencing October 1, 2012 and ending September 30, 2014, which would provide that Board members who were elected prior to July 2011 and whose terms end on or after September 30, 2012 may be considered for term extensions not exceeding two years, in order to facilitate the transition to three staggered classes of seven Board members per class.  The transitional provision would further provide that Board members would be nominated for term extensions by a Special Nominating Committee formed pursuant to Rule A-6, on committees of the Board, and that the Board would then vote on each proposed term extension.  The selection of Board members whose terms would be extended would be consistent with ensuring that the Board is in compliance with the composition requirements of revised Section (a) of Rule A-3 during such extension periods.

In an order approving changes to MSRB Rule A-3 to comply with the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) (Pub. L. No. 111-203, 124 Stat. 1376 (2010)) requiring the Board to have a majority of independent public members and municipal advisor representation,[2] the SEC approved a transitional provision of the rule that increased the Board from 15 to 21 members, 11 of whom would be independent public members and 10 of whom would be members representing regulated entities.  Of the public members, at least one would be representative of municipal entities, at least one would be representative of institutional or retail investors, and at least one would be a member of the public with knowledge of or experience in the municipal industry.  Of the regulated members, at least one would be representative of broker-dealers, at least one would be representative of bank dealers, and at least one, but not less than 30% of the regulated members, would be representative of municipal advisors that are not associated with broker-dealers or bank dealers.

The SEC also approved a provision in MSRB Rule A-3 that defined an independent public member as one with no material business relationship with an MSRB regulated entity, meaning that, within the last two years, the individual was not associated with a municipal securities broker, municipal securities dealer, or municipal advisor, and that the individual has no relationship with any such entity, whether compensatory or otherwise, that reasonably could affect the independent judgment or decision making of the individual. The rule further provided that the Board, or by delegation, its Nominating and Governance Committee, could also determine that additional circumstances involving the individual could constitute a material business relationship with an MSRB regulated entity.

In finding that the proposed rule change was reasonable and consistent with the requirements of the Securities Exchange Act of 1934 (the “Exchange Act”) (15 U.S.C. 78o-4), in that it provided for fair representation of public representatives and MSRB regulated entities, the SEC noted that the MSRB had committed to monitor the effectiveness of the structure of the Board to determine to what extent, if any, proposed changes might be appropriate.  Additionally, in its response to comment letters, the MSRB suggested that, at the end of the transitional period, the MSRB would be in a better position to make long-term decisions regarding representation, size and related matters.

While the transitional period has not yet concluded, the Board believes it is now in a position to establish a permanent structure.  The MSRB has now operated as an expanded, majority-public Board with representation of municipal advisors, as approved by the Commission, for approximately one fiscal year.  During this period, the Board has engaged in the full range of MSRB activities.  In a typical year, the Board meets quarterly, but this year, due to the requirements of the Dodd-Frank Act and the new rulemaking authority over municipal advisors, the Board met six times in person and numerous times by phone.  Additionally, Board members participated in committee meetings and informal conversations. The Board has undertaken many significant rulemaking initiatives regulating the activities of brokers, dealers, municipal securities dealers and municipal advisors that would provide important protections for investors, municipal entities, obligated persons and the public interest.  In particular, notwithstanding its larger size, the Board acted swiftly to propose and, in many cases, adopt baseline rules for municipal advisors, and also promulgate additional rules and interpretive guidance applicable to brokers, dealers and municipal securities dealers.  The insight of Board members with diverse backgrounds and viewpoints contributed considerably to the quality of the initiatives.  In addition, the Board has continued to develop, operate and maintain information systems critical to investors, municipal entities and market professionals.  Furthermore, the Board has made significant efforts to orient previously unregulated municipal advisors to the realities of a regulated environment through an unprecedented level of outreach and education activities.

Given the extensive interaction among Board members, the Board was able to evaluate its effectiveness, particularly in the development of a body of rules governing the activities of municipal advisors while maintaining its prior level of regulatory and other activities in connection with brokers, dealers and municipal securities dealers.  The Board believes that it has acted effectively as a regulator carrying out the functions contemplated by the Exchange Act and the Dodd-Frank Act and that its current size and composition have been significant factors in the Board’s efficient and effective operation during this transition period. The Board further believes there has been sufficient time to evaluate its effectiveness and has determined to proceed at this time with this proposed rule change to ensure that the federally mandated rule proposal process necessary to obtain SEC approval can be completed in time for the MSRB to undertake its Board member election process in a thorough and orderly manner for the first class of Board members to serve after the conclusion of the transition period.

In order to evaluate the effectiveness of the Board, the Nominating and Governance Committee developed a survey of the members of the Board that addressed various governance issues, such as participation in Board deliberations by individual Board members and constituencies, development of Board agendas, skills and experience of Board members, role of Board committees and staff, and management of Board meetings.  The survey inquired as to the ability of industry and public Board members to participate in Board meeting discussions and debate, such as whether the Board considers adequately the interests of municipal advisors in its deliberations, and whether discussions on key issues include a balance of perspectives.  The survey results indicated that Board members believe the 21-member Board is working effectively and that the Board, as constituted, can carry out its mission and objectives.  Board members also believe that all constituents, industry and public, are appropriately represented by Board members who are able to provide input into the development of Board agendas and participate actively in deliberations.

While the Board proposes a composition greater than the statutory minimum of 15, the Board believes this membership level is appropriate, given the diversity of the municipal securities marketplace and its constituencies, many of whom are required by statute to be represented on the Board.  The Exchange Act requires the Board to have at least one retail or institutional investor representative, at least one municipal entity representative, at least one member of the public with knowledge of or experience in the municipal securities industry, at least one broker-dealer representative, at least one bank dealer representative, and at least one municipal advisor representative.  Given the diversity of municipal entities, broker-dealers, bank dealers, and municipal advisors, a Board of 21 members provides more flexibility to provide representation from various sectors of the market.  For example, at a 21-member level, the Board would be in a position to appoint municipal entity representatives that serve large and small constituencies, such as states and state agencies, cities, and other municipal entities, while at the same time retaining the flexibility to appoint academics and others with a broader view of the market.  A smaller Board would be constrained in this regard.  Moreover, at a 21-member level, the Board would be similar in size to its counterpart, the Board of Governors of the Financial Industry Regulatory Authority (“FINRA”), the self-regulatory organization that works closely with the Board to enforce Board rules applicable to FINRA members.  Consequently, a Board of 21 members is appropriate and consistent with industry norms.

The survey results confirm the individual sentiments of Board members that the Board, as currently constituted, is effective and provides fair representation of public and industry members.  Consequently, the Board voted to approve changes to MSRB Rule A-3 to make permanent a Board of 11 independent public members and 10 regulated members, with at least 30% of the regulated members being municipal advisors who are not associated with brokers, dealers or municipal securities dealers (“non-dealer municipal advisors”).  The Board further voted to divide itself into three classes of seven, serving staggered three year terms.  Each class would be as evenly divided as possible between public members and regulated members, and there would be at least one non-dealer municipal advisor in each of the three classes.  The Board believes this permanent structure is consistent with the Exchange Act and provides fair representation of public members, broker-dealers, bank dealers and municipal advisors.

Finally, the Board voted to permit existing Board members to be considered for extended terms of up to two years, in order to transition to three staggered classes. A transition plan is necessary to balance the classes with public and regulated representatives and to ensure there is at least one non-dealer municipal advisor per class. In order to carry out the transition plan, the Board voted to create, by resolution, a Special Nominating Committee of five disinterested Board members to nominate certain Board members for extended terms.  Disinterested Board members are those members who are ineligible for a term extension and, therefore, are less likely to have a personal interest in the nomination process that could affect their independent judgment. The class of 2011 is ineligible and, hence, disinterested because the term extensions would commence as of fiscal year 2013, and these members would no longer be on the Board at that time.  Additionally, one public member from the class of 2012 is disinterested because the transition plan does not contemplate an extension for public members from that class.  Therefore, there are six disinterested Board members, five of whom comprise the Special Nominating Committee, which includes three public members and two regulated members.  The Chair of the Committee was selected from amongst the public members.  The Board believes that a Special Nominating Committee of disinterested members, led by a public chair and with a public majority, is in the best position to nominate Board members for term extensions, in that these members are least likely to have personal interests regarding the term extensions that could affect their independent judgments.

The Dodd-Frank Act provides that the Board shall be composed of 15 members or more, provided that such number is an odd number, as specified by the rules of the Board.  The Board has voted to increase its membership to 21 and to eliminate Rule A-3(b), which provides that the Board may increase or decrease its membership by multiples of six, in order to maintain an odd number, and that the membership be equally divided among public members, bank dealers, and broker-dealers, so long as the membership is not less than 15.  This section is no longer applicable, since the Dodd-Frank Act eliminated the prior statutory requirement that the Board consist of five public members, five bank dealer representatives, and five broker-dealer representatives.  Moreover, there is no necessity to specify in a Board rule that the membership may be greater than 15, provided that the membership is set at an odd number, since such a provision is incorporated into the Exchange Act.  Future changes in size of the Board, if any, would be effected through the rule change process consistent with the Dodd-Frank Act provisions.  Hence, section (b) is no longer necessary.

Questions about the rule amendments should be directed to Lawrence P. Sandor, Senior Associate General Counsel at (703) 797-6600.

August 11, 2011 

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TEXT OF RULE AMENDMENT [3]

Rule A-3:  Membership on the Board

(a) Number and Representation. The Board shall consist of 15 21 members who are knowledgeable of matters related to the municipal securities markets and are:

(i) Public Representatives. Eleven individuals who are independent of any municipal securities broker, municipal securities dealer, or municipal advisor, of which:

(1) at least one shall be representative of institutional or retail investors in municipal securities;

(2) at least one shall be representative of municipal entities; and

(3) at least one shall be a member of the public with knowledge of or experience in the municipal industry; and

(ii) Regulated Representatives. Ten individuals who are associated with a broker, dealer, municipal securities dealer, or municipal advisor, of which:

(1) at least one shall be associated with and representative of brokers, dealers or municipal securities dealers that are not banks or subsidiaries or departments or divisions of banks;

(2) at least one shall be associated with and representative of municipal securities dealers that are banks or subsidiaries or departments or divisions of banks; and

(3) at least one, and not less than 30 percent of the total number of regulated representatives, shall be associated with and representative of municipal advisors and shall not be associated with a broker, dealer or municipal securities dealer.

, at all times equally divided among the following groups:

(i) Public Representatives. Individuals who are not associated with any broker, dealer, or municipal securities dealer (other than by reason of being under common control with, or indirectly controlling, any broker or dealer which is not a broker, dealer or municipal securities dealer that effects municipal securities transactions), at least one of whom shall be representative of investors in municipal securities, and at least one of whom shall be representative of issuers of municipal securities;

(ii) Broker-Dealer Representatives. Individuals who are associated with and representative of brokers, dealers and municipal securities dealers which are not banks or subsidiaries or departments or divisions of banks;

(iii) Bank Representatives. Individuals who are associated with and representative of municipal securities dealers which are banks or subsidiaries or departments or divisions of banks.

(b) Increase or Decrease in Number. The total number of members of the Board may be increased or decreased from time to time by rule of the Board, but in no event shall the total number of members of the Board be less than 15. Any such increase or decrease shall be in multiples of six so that the total number of members of the Board shall always be an odd number, equally divided among the three groups of representatives enumerated in section (a) of this rule.

(b) (c) Nomination and Election of Members.

(i) Members shall be nominated and elected in accordance with the procedures specified by this rule. The 21 member Board shall be divided into three classes, each class being comprised of seven members who serve three year terms. The classes shall be as evenly divided in number as possible between public representatives and regulated representatives, and there shall be at least one municipal advisor representative per class that is not associated with a broker, dealer or municipal securities dealer.  The terms will be staggered and, each year, one class shall be nominated and elected to the Board of Directors. The terms of office of all members of the Board shall commence on October 1 of the year in which elected and shall terminate on September 30 of the year in which their terms expire. Members may be elected to staggered terms. A member may not serve consecutive terms, unless special circumstances warrant that the member be nominated for a successive term or because the member served only a partial term as a result of filling a vacancy pursuant to section (d) (e) of this rule. No broker-dealer representative, bank representative, or municipal advisor representative may be succeeded in office by any person associated with the broker, dealer, municipal securities dealer, or municipal advisor with which such member was associated at the expiration of such member’s term except in the case of a Board member who succeeds himself or herself in office.

(ii) – (vii) No change

(c) (d) - (g) (h) No change

 (h) (i) Transitional Provision for the Board’s Fiscal Years 20113 and 20124.

(i) Notwithstanding any other provision of this rule, for the Board’s fiscal years commencing October 1, 20102 and ending September 30, 20124, the Board shall transition to three staggered classes of seven Board members per class.  During this transitional period, Board members who were elected prior to July 2011 and whose terms end on or after September 30, 2012 may be considered for term extensions not exceeding two years, in order to facilitate the transition to three staggered classes of seven Board members per class.  Board members shall be nominated for term extensions by a Special Nominating Committee formed pursuant Rule A-6.  The Board shall vote on each nominee for term extension prior to the end of fiscal year 2011. consist of 21 members who are knowledgeable of matters related to the municipal securities markets and are:

(A) Public Representatives. 11 individuals who are independent of any municipal securities broker, municipal securities dealer, or municipal advisor, of which:

(1) at least one shall be representative of institutional or retail investors in municipal securities;

(2) at least one shall be representative of municipal entities; and

(3) at least one shall be a member of the public with knowledge of or experience in the municipal industry; and

(B) Regulated Representatives. 10 individuals who are associated with a broker, dealer, municipal securities dealer, or municipal advisor, of which:

(1) at least one shall be associated with and representative of brokers, dealers or municipal securities dealers that are not banks or subsidiaries or departments or divisions of banks;

(2) at least one shall be associated with and representative of municipal securities dealers that are banks or subsidiaries or departments or divisions of banks; and

(3) at least one, and not less than 30 percent of the total number of regulated representatives, shall be associated with and representative of municipal advisors and shall not be associated with a broker, dealer or municipal securities dealer.

(ii) Prior to October 1, 2010, the Board shall elect 11 new Board members – eight public representatives and three municipal advisor representatives – with terms expiring on September 30, 2012. Prior to October 1, 2011, the Board shall elect five new Board members – two public representatives and three representatives associated with brokers, dealers, municipal securities dealers or municipal advisors – with terms expiring on September 30, 2014.

(iii) Notwithstanding any other provision of this rule, the Nominating Committee shall publish, or shall have published at any time on or after enactment of the Dodd-Frank Act, a notice in a financial journal having general national circulation among members of the municipal securities industry soliciting nominations for municipal advisor candidates for the Board for the fiscal years commencing on October 1, 2010 and ending September 30, 2012. The notice shall require that recommendations be accompanied by information concerning the background of the nominee. The Nominating Committee shall accept recommendations pursuant to such notice for a period of at least 14 days from the date of publication of the notice. Any interested member of the public, whether or not associated with a municipal advisor, may submit recommendations to the Nominating Committee. The names of all persons recommended to the Nominating Committee shall be made available to the public upon request.

(iv) On or after October 1, 2010 and prior to the formation of the Nominating Committee for purposes of nominating potential new members of the Board with terms commencing on October 1, 2011, the Board shall amend the provisions of section (c) of this rule relating to the composition and procedures of the Nominating Committee to:

(A) reflect the composition of the Board as provided under the Dodd-Frank Act;

(B) assure that the Nominating Committee shall be composed of a majority of public representatives and to assure fair representation of bank representatives, broker-dealer representatives and advisor representatives within the meaning of Section 975 of the Dodd-Frank Act; and

(C) reflect such other considerations consistent with the provisions of the Act and the Dodd-Frank Act as the Board shall determine are appropriate.

(v) The Board may take such actions as are necessary or appropriate pursuant to this section (i) prior to October 1, 2010 for the purpose of effectuating the provisions of Section 975(b) of the Dodd-Frank Act.


[1] File No. SR-MSRB-2011-11.  Comments on the proposed rule change should be submitted to the SEC and should reference this file number.

[2] See SEC Release No. 34-63025, File No. SR-MSRB-2010-08 (September 30, 2010).

[3] Underlining indicates additions; strikethrough denotes deletions.