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MSRB Notice 2004-17 (June 15, 2004)

Request for Comments on Draft Amendments to Rules G-20 and G-8 Relating to Gifts, Gratuities and Non-Cash Compensation in Municipal Debt Offerings and Sales of Municipal Fund Securities

  

 

The Municipal Securities Rulemaking Board (“MSRB”) adopted Rule G-20, on gifts and gratuities, 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 such other organizations, including but not limited to acts of commercial bribery.  In general, the rule limits such gifts to no more than $100 to each recipient in any year, with certain exceptions.  The 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.

In furtherance of the rule’s goal of reducing the possibilities of conflicts of interest and strengthening the arm’s length, merit-based environment in the municipal securities market, the MSRB is publishing for industry comment draft amendments to Rule G-20 that would prohibit dealers from accepting or making payments of non-cash compensation in connection with a primary offering of municipal securities (including municipal debt offerings and sales of municipal fund securities), with limited exceptions consistent with those permitted in other securities markets.  The draft amendments also would modify a “normal business dealings” exception from the rule’s $100 gift limitation.  In addition, Rule G-8, on recordkeeping, would be amended to create recordkeeping requirements in connection with the foregoing draft amendments to Rule G-20.  The draft amendments appear at the end of this notice and are described more fully below.  Comments are due by July 30, 2004.

DRAFT AMENDMENTS TO RULE G-20

Existing Provisions of Rule G-20

Section (a) of Rule G-20 prohibits dealers from directly or indirectly giving or permitting to be given any thing or service of value in excess of $100 per year to any person, other than an employee or partner of the dealer, in relation to the municipal securities activities of the person’s employer.  Section (b) provides an exception for “normal business dealings,” including occasional gifts of meals or tickets to theatrical, sporting and other entertainment that are recognized by the Internal Revenue Service as deductible business expenses, or gifts of reminder advertising.  However, such gifts must not be so frequent or excessive as to raise a suggestion of unethical conduct.  Section (c) provides that the $100 annual limit does not apply to contracts of employment with, or compensation for services rendered by, a person other than an employee of the dealer, provided that there is a written agreement in place that contains specified information.

The MSRB has interpreted Rule G-20(c) to provide that sales contests that involve gifts or payments to employees of dealers other than the dealer sponsoring the contest constitute “compensation for services.”  Accordingly, the dealer sponsoring the sales contest must obtain a written agreement with each person participating in the contest (other than an employee of that dealer) prior to the time services are rendered.  The agreement must include the nature of the proposed services, the amount of the proposed compensation, and the written consent of the person’s employer.[1]

While the MSRB does not currently mandate specific requirements with respect to sales incentives, the general fair practice principles of Rule G-17 apply.  The MSRB has interpreted Rule G-17 in the context of college savings plans to provide that a dealer may violate that rule by engaging in marketing activities that result in a customer being treated unfairly, or by engaging in any deceptive, dishonest or unfair practice in connection with such marketing activities.[2]  Further, depending on the particular facts and circumstances, a dealer may violate Rule G-17 if it acts in a manner that is reasonably likely to induce another dealer to violate the principles of Rule G-17 or other MSRB customer protection rules, such as Rule G-19 on suitability or Rule G-30 on fair pricing.[3]

The MSRB believes that it is appropriate to strengthen its rule against improper use of gifts and other non-cash compensation to reduce the incidence of conflicts-of-interest and to eliminate incentives for recommending or otherwise entering into transactions for reasons unrelated to their merits.  Thus, the MSRB is proposing draft amendments to Rule G-20 that would limit the circumstances under which dealers could accept or make payments of non-cash compensation in connection with a primary offering of municipal securities and would refine the “normal business dealings” exception from the rule’s $100 gift limitation.  The MSRB seeks comments on all aspects of the draft amendments.

Amendment to Existing Provisions

The draft amendments would modify section (b) of Rule G-20, the “normal business dealings” exception to the rule’s $100 gift limitation, by requiring that meals, entertainment events and legitimate business functions recognized by the Internal Revenue Service as deductible business expenses be hosted or sponsored by the dealer in order to qualify for the exception.  Thus, in general, dealer personnel would be required to accompany recipients of such gifts, rather than merely distributing free tickets to events or paying or reimbursing costs of meals or other functions attended by the recipient without the dealer participating in such activities.  Of course, even if dealer personnel personally host such activities, gifts provided under this exception must not be so frequent or so expensive as to raise a suggestion of conduct inconsistent with high standards of professional ethics in the municipal securities industry.  This modification would make the rule more consistent with the provisions of NASD Rule 3060, on influencing or rewarding employees of others.[4]

Amendments Relating to Non-Cash Compensation

Draft new section (d) of Rule G-20 would generally prohibit non-cash compensation arrangements in connection with the distribution of new issue municipal securities, but would provide certain defined exceptions to this prohibition.  The proposed new provisions would make the use of non-cash compensation in connection with primary offerings of municipal debt securities and sales of municipal fund securities consistent with the types of non-cash compensation arrangements permitted under NASD rules with respect to corporate debt and equity offerings, sales of mutual fund shares and variable contracts, and distribution of securities offered under direct participation programs.[5]

General Prohibition.  Draft new section (d) would prohibit dealers from directly or indirectly accepting or making payments of any non-cash compensation in connection with the sale and distribution of a primary offering of municipal securities, including municipal debt offerings and sales of shares of college savings plans and other municipal fund securities.[6]  New section (e) defines the term “non-cash compensation” as any form of compensation received in connection with the sale and distribution of municipal securities that is not cash compensation, including but not limited to merchandise, gifts and prizes, travel expenses, meals and lodging.  The term “primary offering” is as defined in Exchange Act Rule 15c2-12(f)(7).

Exceptions from General Prohibition.  The draft provision would provide exceptions from this general prohibition that would permit a dealer or its associated persons to accept or make certain payments of non-cash compensation in connection with a primary offering, subject to narrowly defined conditions.  The exceptions include the following:

  • Gifts that do not exceed $100 per year and are not preconditioned on achievement of a sales target;
  • Occasional gifts of meals or tickets to theatrical, sporting, and other entertainments, provided that such gifts are not so frequent or so expensive as to raise a suggestion of conduct inconsistent with high standards of professional ethics in the municipal securities industry and are not preconditioned on achievement of a sales target;[7]
  • Payment or reimbursement by offerors[8] for meetings held by an offeror or by a dealer to train or educate associated persons of a dealer, provided that:  (A) associated persons obtain the prior approval of the dealer to attend the meeting and attendance is not preconditioned on achievement of a sales target or any other incentives pursuant to a non-cash compensation arrangement permitted by the internal arrangement exception described below; (B) the location is appropriate to the purpose of the meeting, which shall mean an office of the offeror or the dealer, a facility located in the vicinity of such office, a regional location with respect to regional meetings, or a location at which a significant asset, if any, being financed or refinanced in the primary offering is located;[9] (C) the payment or reimbursement is not applied to the expenses of the associated person’s guests; and (D) the payment or reimbursement is not preconditioned on achievement of a sales target or any other non-cash compensation arrangement permitted by the internal arrangement exception;
  • Non-cash compensation arrangements between a dealer and its associated persons, or a company that controls the dealer and the associated persons of the dealer, provided that:  (A) the non-cash compensation arrangement is based on the total production of associated persons with respect to all municipal securities within respective product types distributed by the dealer; (B) the non-cash compensation arrangement requires that the credit received for each municipal security within a municipal security product type is equally weighted;[10] and (C) no entity that is not an associated person of the dealer participates directly or indirectly in the organization of a permissible non-cash compensation arrangement (the “internal arrangement exception”); and
  • Contributions by any person other than the dealer to a non-cash compensation arrangement between a dealer and its associated persons, provided that the arrangement meets the criteria under the internal arrangement exception.

DRAFT AMENDMENTS TO RULE G-8

Paragraph (a)(xvii) of Rule G-8, on recordkeeping, would be amended to require that dealers maintain a record of all non-cash compensation received in connection with a primary offering, including the name of the person or entity making the payment, the names of the associated persons receiving the payments (if applicable), and the nature (including the location of any training or educational meeting) and value of the non-cash compensation received.

* * * * *

The MSRB seeks comments on all aspects of the draft amendments.  Comments should be submitted no later than July 30, 2004, and may be directed to Jill C. Finder, Assistant General Counsel, or Ernesto A. Lanza, Senior Associate General Counsel.  Written comments will be available for public inspection.

 

June 15, 2004

 

* * * * *

 

TEXT OF DRAFT AMENDMENTS[11]

Rule G-20 – Gifts, and Gratuities and Non-Cash Compensation.

(a) General Limitation on Value of Gifts and Gratuities.  No broker, dealer or municipal securities dealer shall, directly or indirectly, give or permit to be given any thing or service of value, including gratuities, in excess of $100 per year to a person other than an employee or partner of such broker, dealer or municipal securities dealer, if such payments or services are in relation to the municipal securities activities of the employer of the recipient of the payment or service. For purposes of this rule the term “employer” shall include a principal for whom the recipient of a payment or service 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; the sponsoring by the broker, dealer or municipal securities dealer 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 expensive as to raise a suggestion of conduct inconsistent with high standards of professional ethics in the municipal securities industry.

(c) No change.

[NEW SECTION]  (d) Non-Cash Compensation in Connection with Primary Offerings.  In connection with the sale and distribution of a primary offering of municipal securities, no broker, dealer or municipal securities dealer, or any associated person thereof, shall directly or indirectly accept or make payments or offers of payments of any non-cash compensation.  Notwithstanding the provisions of section (a) of this rule, the following non-cash compensation arrangements are permitted:

(i) gifts that do not exceed $100 per individual per year and are not preconditioned on achievement of a sales target;

(ii) occasional gifts of meals or tickets to theatrical, sporting, and other entertainments; provided that such gifts are not so frequent or so expensive as to raise a suggestion of conduct inconsistent with high standards of professional ethics in the municipal securities industry and are not preconditioned on achievement of a sales target;

(iii) payment or reimbursement by offerors in connection with meetings held by an offeror or by a broker, dealer or municipal securities dealer for the purpose of training or education of associated persons of a broker, dealer or municipal securities dealer, provided that:

(A)  associated persons obtain the prior approval of the broker, dealer or municipal securities dealer to attend the meeting and attendance is not preconditioned by the broker, dealer or municipal securities dealer on achievement of a sales target or any other incentives pursuant to a non-cash compensation arrangement permitted by paragraph (d)(iv);

(B)   the location is appropriate to the purpose of the meeting, which shall mean an office of the offeror or the broker, dealer or municipal securities dealer, a facility located in the vicinity of such office, a regional location with respect to regional meetings, or a location at which a significant asset, if any, being financed or refinanced in the primary offering is located;

(C)  the payment or reimbursement is not applied to the expenses of guests of the associated person; and

(D)  the payment or reimbursement is not preconditioned by the offeror on achievement of a sales target or any other non-cash compensation arrangement permitted by paragraph (d)(iv).

(iv) non-cash compensation arrangements between a broker, dealer or municipal securities dealer and its associated persons, or a company that controls the broker, dealer or municipal securities dealer and the associated persons of the broker, dealer or municipal securities dealer, provided that:

(A)  the non-cash compensation arrangement is based on the total production of associated persons with respect to all municipal securities within respective product types distributed by the broker, dealer or municipal securities dealer;

(B)   the non-cash compensation arrangement requires that the credit received for each municipal security within a municipal security product type is equally weighted; and

(C)  no entity that is not an associated person of the broker, dealer or municipal securities dealer participates directly or indirectly in the organization of a permissible non-cash compensation arrangement.

(v) contributions by any person other than the broker, dealer or municipal securities dealer to a non-cash compensation arrangement between a broker, dealer or municipal securities dealer and its associated persons, provided that the arrangement meets the criteria in paragraph (d)(iv).  [END NEW SECTION]

[NEW SECTION]  (e) Definitions.  For purposes of this rule, the following terms have the following meanings: 

(i) The term “non-cash compensation” shall mean any form of compensation received in connection with the sale and distribution of municipal securities that is not cash compensation, including but not limited to merchandise, gifts and prizes, travel expenses, meals and lodging.

(ii) The term “offeror” shall mean, with respect to a primary offering, the issuer, any adviser to the issuer (including but not limited to the issuer’s financial adviser, bond or other legal counsel, or investment or program manager in connection with the primary offering), the underwriter of the primary offering, or any person controlling, controlled by, or under common control with any of the foregoing.

(iii) The term “primary offering” shall mean a primary offering defined in Securities Exchange Act Rule 15c2-12(f)(7).  [END NEW SECTION]

*                        *                        *                        *                        *

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

(a)(i) – (xvi) No change.

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

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

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

            (C) records of all non-cash compensation referred to in rule G-20(d).  The records shall include the name of the person or entity making the payment, the names of the associated persons receiving the payments (if applicable), and the nature (including the location of meetings described in rule G-20(d)(iii), if applicable) and value of non-cash compensation received.

 (xviii) – (xxii)  No change.

(b)-(g)  No change.


[1]           See Rule G-20 Interpretation – Authorization of Sales Contests, June 25, 1982, reprinted in MSRB Rule Book.

[2]           See Rule G-21 Interpretation – Application of Fair Practice and Advertising Rules to Municipal Fund Securities, May 14, 2002, reprinted in MSRB Rule Book.

[3]           Id.

[4]           The NASD rule language does not include an exception from the general prohibition on gifts for the types of “normal business dealings” mentioned in MSRB Rule G-20.  However, NASD’s general prohibition has been interpreted as not applying to ordinary and usual business entertainment (such as an occasional meal, sporting event, theater production or comparable entertainment event) hosted by a dealer for its clients and guests, so long as it is neither so frequent nor so extensive as to raise any question of propriety.  See interpretive letter dated June 10, 1999 from R. Clark Hooper, Executive Vice President, NASD, to Henry H. Hopkins, Director, and Sarah McCafferty, Vice President, T. Rowe Price Investment Services, Inc., available at www.nasdr.com/2910/3060_01.asp.

[5]           SeeNASD rules regarding non-cash compensation in connection with corporate public offerings (NASD Rule 2710(i)), direct participation programs (NASD Rule 2810(c)), variable contracts (NASD Rule 2820(g)(4)) and investment company securities (NASD Rule 2830(l)(5)).  Certain provisions contained in draft new section (d) of Rule G-20 have been proposed but not finally adopted by NASD with respect to some of its non-cash compensation provisions, as described below.

[6]           As a general matter, this section would apply to sales of new issue municipal securities, consisting of municipal securities while they are in their underwriting period (as defined in section (d)(ii) of Rule G-32, on disclosures in connection with new issues).  Because municipal fund securities are viewed as being sold in a continuous offering for which the underwriting period does not end, all sales of municipal fund securities would be viewed as being subject to this section.  See Rule D-12 Interpretation – Interpretation Relating to Sales of Municipal Fund Securities in the Primary Market, January 18, 2001, reprinted in MSRB Rule Book.

[7]           This exception differs from the similarly worded “normal business dealings” exception under draft amended section (b) described above in that, for this exception, the gift may not be conditioned upon achieving a sales target but does not require that dealer personnel accompany the recipient at the meals or other events.

[8]           New section (e) defines the term “offeror” with respect to a primary offering as the issuer, any adviser to the issuer (including but not limited to the issuer’s financial adviser, bond or legal counsel, or investment or program manager in connection with the primary offering), the underwriter of the primary offering, or any person controlling, controlled by, or under common control with any of the foregoing.

[9]           The draft language relating to a location at which a significant asset is located has been included by NASD in proposed amendments to its Rules 2710 and 2810 with respect to corporate public offerings and direct participation programs.  See Regulation of Compensation, Fees, and Expenses in Public Offerings of Real Estate Investment Trusts; Direct Participation Programs, Including Commodity Pools; and Closed-End Funds, NASD Notice to Members 04-07 (February 2004).

[10]          The total production and equal weighting requirements currently exist under NASD Rules 2820 and 2830 with respect to variable contracts and investment company securities.  NASD has proposed an amendment to its Rules 2710 and 2810 with respect to corporate public offerings and direct participation programs to provide for similar treatment.  The draft language referring to “all municipal securities within respective product types” parallels language contained in proposed NASD amendments to Rules 2710 and 2810.  For purposes of Rule G-20, the MSRB would view the different categories of product types to consist of (i) debt securities; (ii) municipal fund securities issued by college savings plans; and (iii) municipal fund securities issued by local government investment pools.  The MSRB seeks comments on these classifications.

[11]            Underlining indicates additions; strikethroughs indicate deletions.  New sections are as indicated.

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