|
MSRB NOTICE 2006-23 (AUGUST 7, 2006)
|
|
The Municipal Securities Rulemaking Board’s interpretive guidance relating to customer protection obligations of brokers, dealers and municipal securities dealers (“dealers”) marketing 529 college savings plans has become effective today. The interpretation strengthens and clarifies the obligations of dealers to provide important disclosures to customers investing in out-of-state 529 college savings plans and to undertake active suitability analyses for recommended transactions in 529 college savings plans based on appropriately weighted factors. The text of the interpretation is set forth below. Questions regarding this notice may be directed to Ernesto A. Lanza, Senior Associate General Counsel, or Jill C. Finder, Assistant General Counsel. * * * * * Interpretation on Customer Protection Obligations Relating to the Marketing of 529 College Savings Plans
August 7, 2006 The Municipal Securities Rulemaking Board (“MSRB”) is publishing this interpretation to ensure that brokers, dealers and municipal securities dealers (“dealers”) effecting transactions in the 529 college savings plan market fully understand their fair practice and disclosure duties to their customers.[1] Basic Customer Protection Obligation At the core of the MSRB’s customer protection rules is Rule G-17, which provides that, in the conduct of its municipal securities activities, each dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest or unfair practice. The rule encompasses two basic principles: an anti-fraud prohibition similar to the standard set forth in Rule 10b-5 adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (the “Exchange Act”), and a general duty to deal fairly even in the absence of fraud. All activities of dealers must be viewed in light of these basic principles, regardless of whether other MSRB rules establish specific requirements applicable to such activities. Disclosure The MSRB has interpreted Rule G-17 to require a dealer, in connection with any transaction in municipal securities, to disclose to its customer, at or prior to the sale of the securities to the customer (the “time of trade”), all material facts about the transaction known by the dealer, as well as material facts about the security that are reasonably accessible to the market.[2] This duty applies to any dealer transaction in a 529 college savings plan interest regardless of whether the transaction has been recommended by the dealer. Many states offer favorable state tax treatment or other valuable benefits to their residents in connection with investments in their own 529 college savings plan. In the case of sales of out-of-state 529 college savings plan interests to a customer, the MSRB views Rule G-17 as requiring a dealer to make, at or prior to the time of trade, additional disclosures that:
This disclosure obligation is hereinafter referred to as the “out-of-state disclosure obligation.”[3] The out-of-state disclosure obligation may be met if the disclosure appears in the program disclosure document, so long as the program disclosure document has been delivered to the customer at or prior to the time of trade and the disclosure appears in the program disclosure document in a manner that is reasonably likely to be noted by an investor.[4] A presentation of this disclosure in the program disclosure document in close proximity and with equal prominence to the principal presentation of substantive information regarding other federal or state tax-related consequences of investing in the 529 college savings plan, and the inclusion of a reference to this disclosure in close proximity and with equal prominence to each other presentation of information regarding state tax-related consequences of investing in the 529 college savings plan, would be deemed to satisfy this requirement.[5] The MSRB has no authority to mandate inclusion of any particular items in the issuer’s program disclosure document.[6] Dealers who wish to rely on the program disclosure document for fulfillment of the out-of-state disclosure obligation are responsible for understanding what is included within the program disclosure document of any 529 college savings plan they market and for determining whether such information is sufficient to meet this disclosure obligation. Notwithstanding any of the foregoing, disclosure through the program disclosure document as described above is not the sole manner in which a dealer may fulfill its out-of-state disclosure obligation. Thus, if the issuer has not included this information in the program disclosure document in the manner described, inclusion in the program disclosure document in another manner may nonetheless fulfill the dealer’s out-of-state disclosure obligation so long as disclosure in such other manner is reasonably likely to be noted by an investor. Otherwise, the dealer would remain obligated to disclose such information separately to the customer under Rule G-17 by no later than the time of trade.[7] If the dealer proceeds to provide information to an out-of-state customer about the state tax or other benefits available through such customer’s home state, Rule G-17 requires that the dealer ensure that the information is not false or misleading. For example, a dealer would violate Rule G-17 if it were to inform a customer that investment in the 529 college savings plan of the customer’s home state did not provide the customer with any state tax benefit even though such a state tax benefit is in fact available. Furthermore, a dealer would violate Rule G-17 if it were to inform a customer that investment in the 529 college savings plan of another state would provide the customer with the same state tax benefits as would be available if the customer were to invest in his or her home state’s 529 college savings plan even though this is not the case.[8] Dealers should make certain that information they provide to their customers, whether provided under an affirmative disclosure obligation imposed by MSRB rules or in response to questions from customers, is correct and not misleading. Dealers are reminded that this out-of-state disclosure obligation is in addition to their general obligation under Rule G-17 to disclose to their customers at or prior to the time of trade all material facts known by dealers about the 529 college savings plan interests they are selling to their customers, as well as material facts about such 529 college savings plan that are reasonably accessible to the market. Further, dealers are reminded that disclosures made to customers as required under MSRB rules with respect to 529 college savings plans do not relieve dealers of their suitability obligations – including the obligation to consider the customer’s financial status, tax status and investment objectives – if they have recommended investments in 529 college savings plans. Suitability Under Rule G-19, a dealer that recommends to a customer a transaction in a security must have reasonable grounds for believing that the recommendation is suitable, based upon information available from the issuer of the security or otherwise and the facts disclosed by or otherwise known about the customer.[9] To assure that a dealer effecting a recommended transaction with a non-institutional customer has the information needed about the customer to make its suitability determination, the rule requires the dealer to make reasonable efforts to obtain information concerning the customer’s financial status, tax status and investment objectives, as well as any other information reasonable and necessary in making the recommendation.[10] Dealers are reminded that the obligation arising under Rule G-19 in connection with a recommended transaction requires a meaningful analysis, taking into consideration the information obtained about the customer and the security, that establishes the reasonable grounds for believing that the recommendation is suitable. Such suitability determinations should be based on the appropriately weighted factors that are relevant in any particular set of facts and circumstances, which factors may vary from transaction to transaction.[11] Pursuant to Rule G-27(c), dealers must have written supervisory procedures in place that are reasonably designed to ensure compliance with this Rule G-19 obligation to undertake a suitability analysis in connection with every recommended transaction, and dealers must enforce these procedures to ensure that such meaningful analysis does in fact occur in connection with the dealer’s recommended transactions. In the context of a recommended transaction relating to a 529 college savings plan, the MSRB believes that it is crucial for dealers to remain cognizant of the fact that these instruments are designed for a particular purpose and that this purpose generally should match the customer’s investment objective. For example, dealers should bear in mind the potential tax consequences of a customer making an investment in a 529 college savings plan where the dealer understands that the customer’s investment objective may not involve use of such funds for qualified higher education expenses.[12] Dealers also should consider whether a recommendation is consistent with the customer’s tax status and any customer investment objectives materially related to federal or state tax consequences of an investment. Furthermore, investors generally are required to designate a specific beneficiary under a 529 college savings plan. The MSRB believes that information known about the designated beneficiary generally would be relevant in weighing the investment objectives of the customer, including (among other things) information regarding the age of the beneficiary and the number of years until funds will be needed to pay qualified higher education expenses of the beneficiary. The MSRB notes that, since the person making the investment in a 529 college savings plan retains significant control over the investment (e.g., may withdraw funds, change plans, or change beneficiary, etc.), this person is appropriately considered the customer for purposes of Rule G-19 and other MSRB rules. As noted above, information regarding the designated beneficiary should be treated as information relating to the customer’s investment objective for purposes of Rule G-19. In many cases, dealers may offer the same investment option in a 529 college savings plan sold with different commission structures. For example, an A share may have a front-end load, a B share may have a contingent deferred sales charge or back-end load that reduces in amount depending upon the number of years that the investment is held, and a C share may have an annual asset-based charge. A customer’s investment objective – particularly, the number of years until withdrawals are expected to be made – can be a significant factor in determining which share class would be suitable for the particular customer. Rule G-19(e), on churning, prohibits a dealer from recommending transactions to a customer that are excessive in size or frequency, in view of information known to such dealer concerning the customer’s financial background, tax status and investment objectives. Thus, for example, where the dealer knows that a customer is investing in a 529 college savings plan with the intention of receiving the available federal tax benefit, such dealer could, depending upon the facts and circumstances, violate rule G-19(e) if it were to recommend roll-overs from one 529 college savings plan to another with such frequency as to lose the federal tax benefit. Even where the frequency does not imperil the federal tax benefit, roll-overs recommended year after year by a dealer could, depending upon the facts and circumstances (including consideration of legitimate investment and other purposes), be viewed as churning. Similarly, depending upon the facts and circumstances, where a dealer recommends investments in one or more plans for a single beneficiary in amounts that far exceed the amount that could reasonably be used by such beneficiary to pay for qualified higher education expenses, a violation of rule G-19(e) could result.[13] Other Sales Practice Principles Dealers must keep in mind the requirements under Rule G-17 – that they deal fairly with all persons and that they not engage in any deceptive, dishonest or unfair practice – when considering the appropriateness of day-to-day sales-related activities with respect to municipal fund securities, including 529 college savings plans. In some cases, certain sales-related activities are governed in part by specific MSRB rules, such as Rule G-19 (as described above) and Rule G-30(b), on commissions.[14] Other activities may not be explicitly addressed by a specific MSRB rule. In either case, the general principles of Rule G-17 always apply. In particular, dealers must ensure that they do not engage in transactions primarily designed to increase commission revenues in a manner that is unfair to customers under Rule G-17. Thus, in addition to being a potential violation of Rule G-19 as discussed above, recommending a particular share class to a customer that is not suitable for that customer, or engaging in churning, may also constitute a violation of Rule G-17 if the recommendation was made for the purpose of generating higher commission revenues. Also, where a dealer offers investments in multiple 529 college savings plans, consistently recommending that customers invest in the one 529 college savings plan that offers the dealer the highest compensation may, depending on the facts and circumstances, constitute a violation of Rule G-17 if the recommendation of such 529 college savings plan over the other 529 college savings plans offered by the dealer does not reflect a legitimate investment-based purpose. Further, recommending transactions to customers in amounts designed to avoid commission discounts (i.e., sales below breakpoints where the customer would be entitled to lower commission charges) may also violate Rule G-17, depending upon the facts and circumstances. For example, a recommendation that a customer make two smaller investments in separate but nearly identical 529 college savings plans for the purposes of avoiding a reduced commission rate that would be available upon investing the full amount in a single 529 college savings plan, or that a customer time his or her multiple investments in a 529 college savings plan so as to avoid being able to take advantage of a lower commission rate, in either case without a legitimate investment-based purpose, could violate Rule G-17. With respect to sales incentives, the MSRB has previously interpreted Rule G-20, relating to gifts, gratuities and non-cash compensation, to require a dealer that sponsors a sales contest involving representatives who are not employed by the sponsoring dealer to have in place written agreements with these representatives.[15] In addition, the general principles of Rule G-17 are applicable. Thus, if a dealer or any of its associated persons engages in any marketing activities that result in a customer being treated unfairly, or if the dealer or any of its associated persons engages in any deceptive, dishonest or unfair practice in connection with such marketing activities, Rule G-17 could be violated. The MSRB believes that, depending upon the specific facts and circumstances, a dealer may violate Rule G-17 if it acts in a manner that is reasonably likely to induce another dealer or such other dealer’s associated persons to violate the principles of Rule G-17 or other MSRB customer protection rules, such as Rule G-19 or Rule G-30. Dealers are also reminded that Rule G-20 establishes standards regarding incentives for sales of municipal securities, including 529 college savings plan interests, that are substantially similar to those currently applicable to sales of mutual fund shares under NASD rules. [1] 529 college savings plans are established by states under Section 529(b)(A)(ii) of the Internal Revenue Code as “qualified tuition programs” through which individuals make investments for the purpose of accumulating savings for qualifying higher education costs of beneficiaries. Section 529 of the Internal Revenue Code also permits the establishment of so-called prepaid tuition plans by states and higher education institutions, which are not treated as 529 college savings plans for purposes of this notice. [2] See Rule G-17 Interpretation – Interpretive Notice Regarding Rule G-17, on Disclosure of Material Facts, March 20, 2002, reprinted in MSRB Rule Book. [3] This out-of-state disclosure obligation constitutes an expansion of, and supersedes, certain disclosure requirements with respect to out-of-state 529 college savings plan transactions established under “Application of Fair Practice and Advertising Rules to Municipal Securities,” May 14, 2002, published in MSRB Rule Book. [4] As used in this notice, the term “program disclosure document” has the same meaning as “official statement” under the rules of the MSRB and SEC. The delivery of the program disclosure document to customers pursuant to Rule G-32, which requires delivery by settlement of the transaction, would be timely for purposes of Rule G-17 only if such delivery is accelerated so that it is received by the customer by no later than the time of trade. [5] Thus, if the program disclosure document contains a series of sections in which the principal disclosures of substantive information on federal or state-tax related consequences of investing in the 529 college savings plan appear, a single inclusion of the required disclosure within, at the beginning or at the end of such series would be satisfactory for purposes of the inclusion with the principal presentation of such other disclosures. Similarly, if the program disclosure document includes any other series of statements on state-tax related consequences, such as might exist in a summary statement appearing at the beginning of some program disclosure documents, a single prominent reference in the summary statement to the fuller disclosure made pursuant to the out-of-state disclosure obligation appearing elsewhere in the program disclosure document would be satisfactory. [6] However, the MSRB notes that Exchange Act Rule 15c2-12(f)(3) of the SEC defines a “final official statement” as:
Section (b) of that rule requires that the participating underwriter of an offering review a “deemed-final” official statement and contract to receive the final official statement from the issuer. See Rule D-12 Interpretation – Interpretation Relating to Sales of Municipal Fund Securities in the Primary Market, January 18, 2001, published in MSRB Rule Book, for a discussion of the applicability of Rule 15c2-12 to offerings of 529 college savings plans. [7] Although Rule G-17 does not dictate the precise manner in which material facts must be disclosed to the customer at or prior to the time of trade, dealers must ensure that such disclosure is effectively provided to the customer in connection with the specific transaction and cannot merely rely on the inclusion of a disclosure in general advertising materials. [8] Dealers should note that these examples are illustrative and do not limit the circumstances under which, depending on the facts and circumstances, a Rule G-17 violation could occur. [9] The MSRB has previously stated that most situations in which a dealer brings a municipal security to the attention of a customer involve an implicit recommendation of the security to the customer, but determining whether a particular transaction is in fact recommended depends on an analysis of all the relevant facts and circumstances. See Rule G-19 Interpretive Letter – Recommendations, February 17, 1998, published in MSRB Rule Book. The MSRB also has provided guidance on recommendations in the context of on-line communications in Rule G-19 Interpretation – Notice Regarding Application of Rule G-19, on Suitability of Recommendations and Transactions, to Online Communications, September 25, 2002, published in MSRB Rule Book. [10] Rule G-8(a)(xi)(F) requires that dealers maintain records for each customer of such information about the customer used in making recommendations to the customer. [11] Although certain factors relating to recommended transactions in 529 college savings plans are discussed in this notice, whether such enumerated factors or any other considerations are relevant in connection with a particular recommendation is dependent upon the facts and circumstances. The factors that may be relevant with respect to a specific transaction in a 529 college savings plan generally include the various considerations that would be applicable in connection with the process of making suitability determinations for recommendations of any other type of security. [12] See Section 529(c)(3) of the Internal Revenue Code. State tax laws also may result in certain adverse consequences for use of funds other than for educational costs. [13] The MSRB understands that investors may change designated beneficiaries and therefore amounts in excess of what a single beneficiary could use ultimately might be fully expended by additional beneficiaries. The MSRB expresses no view as to the applicability of federal tax law to any particular plan of investment and does not interpret its rules to prohibit transactions in furtherance of legitimate tax planning objectives, so long as any recommended transaction is suitable. [14] The MSRB has previously provided guidance on dealer commissions in Rule G-30 Interpretation – Interpretive Notice on Commissions and Other Charges, Advertisements and Official Statements Relating to Municipal Fund Securities, December 19, 2001, published in MSRB Rule Book. The MSRB believes that Rule G-30(b), as interpreted in this 2001 guidance, should effectively maintain dealer charges for 529 college savings plan sales at a level consistent with, if not lower than, the sales loads and commissions charged for comparable mutual fund sales. [15] See Rule G-20 Interpretive Letter – Authorization of sales contests, June 25, 1982, published in MSRB Rule Book. |
©2008 Municipal Securities Rulemaking Board. All Rights Reserved. Terms and Conditions of Use.