MSRB Notice 2003-15 (April 29, 2003)

NOTICE OF FILING WITH SEC OF INTERPRETIVE NOTICE ON MARKETING OF 529 COLLEGE SAVINGS PLANS IN THE WORKPLACE

           On April 29, 2003, the Municipal Securities Rulemaking Board (the “MSRB”) filed with the Securities and Exchange Commission (the “SEC”) a proposed rule change consisting of an interpretive notice on marketing by brokers, dealers and municipal securities dealers (“dealers”) of 529 college savings plans in the workplace.^[1]  The proposed interpretive notice provides guidance on the application of Rule G-8, on recordkeeping, Rule G-17, on fair dealing, Rule G-19, on suitability, Rule G-27, on supervision, and Rule G-32, on disclosure, in the context of workplace marketing programs relating to 529 college savings plans.  The proposed interpretive notice will become effective upon approval by the SEC.

Draft Interpretive Guidance

           On November 18, 2002, the MSRB published for comment draft interpretive guidance on marketing of 529 college savings plan employee payroll deduction programs.^[2]  The MSRB received six comment letters.  After reviewing these comments, the MSRB approved the draft interpretive guidance, with certain modifications, for filing with the SEC.  The MSRB modified the draft interpretive guidance to:  (i) change the term “introducing broker” to “selling broker;” (ii) reflect the existence of other scenarios in which 529 college savings plans are marketed in the workplace; (iii) provide more guidance as to when dealers may rely on others to fulfill regulatory responsibilities; and (iv) clarify certain recordkeeping obligations.  The text of the proposed interpretive notice filed with the SEC appears at the end of this notice.

Summary of Comments on Draft Interpretive Guidance

           One commentator fully supported the draft interpretive notice, stating that it “clearly sets out the rationale for providing guidance in this area … [and] will make it possible for our Representatives to assist companies in offering 529 college savings plans to their employees.”  Four other commentators generally supported the draft interpretive notice, although each requested that the MSRB further broaden and/or clarify the guidance in various respects.^[3]

           Three commentators requested that the MSRB substitute the term “selling broker” or “selling dealer” for the term “introducing broker” used in the draft interpretive notice.  They stated that the term “introducing broker” is used with different meanings under the federal securities laws applicable to other types of securities and may cause some confusion.  In addition, one of these commentators recommended that, for purposes of the interpretation, the term “selling broker” also encompass the primary distributor where it directly establishes the relationship with the employer.  It stated, “In addition to recognizing that a selling broker rarely, if ever, has a suitability obligation in the context of a payroll deduction program, the Notice should clarify that a primary distributor who makes 529 Plan investments available through a third-party broker would not have a suitability obligation under Rule G-19, as it too makes no recommendation to an employee.”  The MSRB has changed the term “introducing broker” to “selling broker” in the revised interpretive notice.  Contrary to the statement that the interpretive notice recognizes “that a selling broker rarely, if ever, has a suitability obligation,” the notice does not assess the likelihood or frequency of recommendations being made by selling brokers.  The notice does provide some guidance regarding the factors to consider when determining whether a recommendation has occurred.  The MSRB believes that no further guidance in this area is necessary.

           Four commentators noted that the scenario described in the draft interpretive notice is not the only form in which dealers may seek to market 529 college savings plans through employers. In addition to arrangements where selling brokers having a contractual relationship with the primary distributor to market through employers, with the employees making investments directly through the primary distributor (as described in the draft interpretive notice), these commentators noted that: (1) primary distributors may themselves market 529 college savings plans through employers; (2) selling brokers sometimes have contractual relationships with the issuer rather than the primary distributor; (3) selling brokers may handle employee investments and maintain long-term relationships with employees, rather than merely introducing employees to the primary distributor; (4) transfer agents may undertake significant responsibilities in connection with employees’ investments; and (5) employees may in some instances use a dealer other than the selling broker or primary distributor to make an investment that may still be considered part of the employer-sponsored program.  These commentators requested that the MSRB address some or all of these additional scenarios.  In addition, one of these commentators suggested that the MSRB make clear that the scenarios addressed in the draft interpretive notice are illustrative and that other models may be implemented.

           The MSRB has made significant modifications to the initial paragraphs of the notice to reflect the existence of these other scenarios.  No significant change in interpretation results from a primary distributor acting in the role of a selling broker.  The identity of the selling broker’s counterparty on the selling agreement also does not significantly change its regulatory obligations.  Selling brokers that make recommendations remain fully obligated under MSRB rules and remain ultimately responsible where the primary distributor has not affirmatively undertaken regulatory obligations on behalf of the selling broker (as discussed below).  The guidance provided by the notice is primarily intended for dealers that are formally involved in a workplace marketing program; thus, the notice is of limited applicability to dealers that do not have a formal role in such a program.

           A commentator observed that the draft interpretive notice referred to on-line enrollment with the primary distributor and noted that in many circumstances enrollment and investments continue to be handled by mail.  Also, three commentators noted that other forms of payment, such as ACH (automated clearing house) bank transfers, may be used in addition to traditional employee payroll deductions.  These commentators requested that the MSRB recognize these variants in its final notice.  The revised interpretive notice now more clearly acknowledges these different processes.

Four commentators sought further clarification on the circumstances under which selling brokers may rely on other parties to meet their regulatory obligations.  Two of these commentators stated that dealers should be able to rely on issuers to distribute official statements to customers.  One noted its concern that customers may be confused by the receipt of redundant (and possibly out-dated) disclosure documents if dealers must deliver official statements regardless of whether the issuer has sent them to customers.  Another suggested that the ability of the selling broker to rely on the primary distributor for delivery of the official statement as provided in the draft interpretive notice be extended to the ability to rely on other parties, such as other dealers, employers and issuers.

           The revised interpretive notice permits a selling broker to conclusively rely on the primary distributor to meet its disclosure obligations and certain supervisory obligations (described below) only under the limited circumstances in which employee orders are not accepted without actual delivery of the official statement and the primary distributor has affirmatively agreed to undertake such regulatory obligations on behalf of the selling broker.  In such circumstances, the primary distributor will be responsible for fulfilling such obligations.  In all other circumstances, the notice clarifies that a selling broker may agree with another party to take certain actions on its behalf but that if such other party fails to take such actions, the selling broker remains responsible for fulfilling its regulatory obligation.

           One commentator suggested that the MSRB should permit selling brokers to enter into arrangements with the primary distributor to meet their supervisory obligations to review and approve customer accounts and transactions based upon having procedures in place that provide assurances to the selling brokers that such review and approval is being undertaken by the primary distributor.  Another commentator questioned the value of requiring a selling broker to review customer accounts and transactions well after the transaction is executed, especially if the transaction was not recommended.  In addition, it questioned why a requirement for such review and related recordkeeping would be dependent upon whether the selling broker receives compensation for a transaction.

           The revised interpretive notice clarifies that, where a selling broker does not make a recommendation and the primary distributor affirmatively agrees to take on both the disclosure responsibilities and the supervisory responsibilities with regard to opening of accounts and approval of transactions, the regulatory obligation may be shifted to the primary distributor.  However, supervisory responsibility remains with the selling broker so long as the selling broker retains any affirmative duties to employees.  The MSRB believes that the limited recordkeeping obligations imposed on all selling brokers in the notice are appropriate.  The revised interpretive notice makes clear that the limited recordkeeping requirements that remain for subsequent transactions effected by the primary distributor where compensation is paid to the selling broker applies only when such compensation is transaction based since, depending on the facts and circumstances, this information may be necessary to determine compliance with MSRB’s fair pricing and fair commission requirements.

           With respect to transfer agents, a commentator noted that many plans provide for applications and customer orders to be sent directly to a transfer agent, with the primary distributor’s activities “limited to managing the overall marketing of the program and the production of marketing and promotional materials.”  It stated that “only the transfer agent maintains any investor records and these records are the plan’s investor records.  Thus, in this model, the primary distributor’s regulatory responsibilities are limited primarily to compliance with applicable rules governing marketing materials but not those rules mandating customer account related procedures.”  The commentator sought assurance that primary distributors did not retain residual customer protection obligations under MSRB rules in the scenario where applications and orders are submitted directly to the transfer agent.

           The MSRB notes that transfer agents generally are viewed under the Exchange Act as working on behalf of the issuer but that, in the 529 college savings plan market, transfer agents also sometimes contractually agree to act on behalf of the primary distributor.  In the revised interpretive notice, where transactions are effected through a transfer agent without the direct involvement of the primary distributor or the selling broker, the selling broker is permitted to conclusively rely on the primary distributor to fulfill certain of the selling broker’s regulatory obligations only if the transfer agent has contractually agreed to act on behalf of the primary distributor.  Otherwise, the transfer agent is effectively treated as an agent of the issuer and the dealer that enlisted the corresponding employer to participate in the workplace marketing plan remains ultimately responsible for compliance with MSRB rules.

           A commentator asked why a selling broker would have a fair dealing obligation under Rule G-17 to an employer since the employer is not the dealer’s client.  It also sought guidance regarding the nature of information that a dealer would be obligated to provide to the employer under the Rule G-17 disclosure obligation.  Two commentators also questioned the need for the selling broker to maintain a record of the name and address of an employer that the dealer solicited, as well as for principal review of such solicitation.  Another commentator sought assurances that the fair dealing obligation toward the employer would not give rise to any inference that the issuer has any federal securities law obligation to employers under the scenario described in the draft interpretive notice.

           The fair dealing requirement of Rule G-17 applies, on its face, to all persons, not just customers.  The MSRB believes that it appropriately applies to the selling broker’s relationship with employers, particularly since the selling broker is inducing the employer to create a captive audience of investors and the employer’s agreement to participate in the program may lead employees to believe that the employer endorses investment under the program.  Under these circumstances, it is important that selling brokers provide adequate information regarding the program to the employer so that it can make an informed decision with regard to enrollment in the program.  The limited recordkeeping regarding the employer required by the notice is important in the context of documenting the ability of a selling broker to rely on the guidance provided in the notice with respect to particular transactions.  The revised interpretive notice provides assurances that a dealer’s fair dealing obligation to the employer is not intended to imply that the issuer has a similar legal obligation to the employer.

 

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TEXT OF PROPOSED INTERPRETIVE NOTICE

INTERPRETIVE NOTICE ON MARKETING OF 529 COLLEGE SAVINGS PLANS IN THE WORKPLACE

           The Municipal Securities Rulemaking Board (“MSRB”) has received a number of requests for interpretive guidance on the responsibilities of brokers, dealers and municipal securities dealers (“dealers”) under MSRB rules with respect to the marketing of 529 college savings plans through the workplace to employees (“workplace marketing programs”).  Workplace marketing programs have been described to the MSRB as being offered through a variety of means.^[4]  In many cases, a dealer (“selling broker”) that has signed a selling agreement with the primary distributor of a 529 college savings plan makes available to employers the opportunity to initiate a workplace marketing program for those employees who choose to enroll and make contributions under the 529 college savings plan.^[5]  The selling broker typically meets with the employer’s human resources/benefits representatives, who then may agree to have the employer participate in the workplace marketing program.  One form of workplace marketing program provides for the employer to utilize its existing payroll direct deposit process for after-tax contributions by employees.  In other cases, employee contributions may be effected by means of ACH (automated clearing house) bank transfers or other means, whether electronically or by check.

           After the employer has agreed to participate in a workplace marketing program, its employees can establish an account in a variety of manners, depending upon the specific 529 college savings plan.  For example, many workplace marketing programs provide for the employee to establish an account with the primary distributor by completing an online or paper account application and participation agreement, which is submitted directly to the primary distributor.  In other cases, applications may be submitted to a transfer agent^[6] or the issuer, or may be handled by the selling broker itself.  Typically, the selling broker provides the employer with materials for distribution to interested employees describing the particular 529 college savings plan, including but not limited to the program disclosure document that meets the definition of “official statement” under Exchange Act Rule 15c2-12.  Further, the selling broker may, but does not always, hold informational meetings with employees, either in groups or individually.  However, in many workplace marketing programs, once the employer has agreed to participate, employees can enroll in the program and make contributions directly through the primary distributor, transfer agent or issuer without any further involvement of the selling broker.

           When an employee enrolls in the workplace marketing program, certain information regarding the employee’s enrollment is made available to the parties who are involved in the processing of the enrollment and contributions.  Typically, however, the selling broker will receive notification of an account opening and any transactions effected for an individual employee only after the fact, either on a transaction-by-transaction basis or in periodic summaries of trade activities.^[7]  Thus, unless the selling broker itself handles the enrollment and contribution functions for employees, the selling broker may not learn the identity of individual employees actually making investments in the 529 college savings plan until well after the time of trade and settlement on such transactions.  The selling broker generally receives commissions on an individual participant basis for those employees who enroll and invest in the 529 college savings plan.

           The MSRB has established a number of rules designed to protect customers purchasing municipal securities (including investments in 529 college savings plans) from or through dealers.  In particular, under Rule G-19, a dealer that recommends a 529 college savings plan transaction to a customer must have reasonable grounds for believing that the recommendation is suitable, based upon information available from the issuer or otherwise and the facts disclosed by or otherwise known about the customer.  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.  In addition, the dealer has certain disclosure-related obligations to the customer, regardless of whether the dealer has recommended a particular transaction to the customer.  For example, under Rule G-32, the dealer is obligated to deliver an official statement to the customer by settlement of the transaction.^[8]

           Further, under Rule G-17, each dealer, in the conduct of its municipal securities activities, must deal fairly with all persons and must not engage in any deceptive, dishonest or unfair practice.  This rule has been interpreted to require a dealer to disclose to its customer, at or before the time of trade, all material facts concerning the transaction known by the dealer, as well as material facts about the security when such facts are reasonably accessible to the market.^[9]  This Rule G-17 disclosure obligation applies regardless of whether the dealer has made a recommendation to the customer.  If the customer is investing in an out-of-state 529 college savings plan, the dealer also is obligated to inform the customer that, depending upon the laws of the customer’s home state, favorable state tax treatment for investing in a 529 college savings plan may be limited to investments made in a plan offered by the customer’s home state.^[10]  Further, Rule G-17 prohibits the dealer from misleading customers regarding facts material to the transaction, including but not limited to the availability of state tax benefits in connection with an investment in a 529 college savings plan.^[11]

           A dealer is obligated under Rule G-17 to deal fairly not only with customers but with all persons in connection with the conduct of its municipal securities activities.  Thus, in addition to dealing fairly with employees that have agreed to participate in a workplace marketing program, a selling broker that enters into a formal or informal agreement with an employer to undertake a workplace marketing program also is obligated under Rule G-17 to deal fairly with the employer itself.^[12]  Whether a dealer has dealt fairly with an employer is dependent upon the facts and circumstances.  However, the MSRB believes that, under these circumstances, Rule G-17 obligates the selling broker to disclose to the employer all material facts known by the selling broker concerning the transactions it is attempting to induce, as well as material facts about the security when such facts are reasonably accessible to the market.  If the selling broker knows or has reason to know that one or more employees may not be resident in the state of the 529 college savings plan being offered under the workplace marketing program, Rule G-17 requires the selling broker to disclose to the employer that, depending upon the laws of the state of residence of an employee, favorable state tax treatment for investing in a 529 college savings plan may be limited to investments made in a 529 college savings plan offered by the employee’s home state. These are the same disclosures that a dealer effecting a transaction with individual customers is required to make under Rule G-17.

           Where a selling broker has recommended a transaction in a 529 college savings plan to an employee through a workplace marketing program, the selling broker is fully obligated to make a suitability determination under Rule G-19.^[13]  The selling broker would be responsible for obtaining and maintaining the information required under Rule G-19(b) in connection with such suitability determination and the additional information required under Rule G-8(a)(xi), as well as for maintaining proper supervision.^[14]  The MSRB has previously stated that whether a particular transaction is in fact recommended depends on an analysis of all the relevant facts and circumstances.^[15]  Among the facts and circumstances that generally would be relevant in this context is the nature of the statements made by the selling broker if it conducts any informational meetings with employees.  If, for example, the selling broker conducts an employee informational meeting at which it states that the particular 529 college savings plan is appropriate for most or all employees, or at which it advises individual employees that the plan or specific investment options within the plan are appropriate for such individuals, the introducing broker most likely has made a recommendation.  If, however, the selling broker provides, at most, only generalized recommendations about the 529 college savings plan accompanied by clear statements that enrollment in this particular 529 college savings plan or investment in any particular investment option within the plan may not be appropriate for all employees, the selling broker must have reasonable grounds for the generalized recommendation in light of the information about the security but need not make a determination that the investment is suitable for each employee in attendance.^[16]  A selling broker making a recommendation to a particular employee also is fully responsible for providing the required disclosure information under Rules G-17 and G-32.

           If a selling broker does not make a recommendation in connection with a transaction in a 529 college savings plan by an employee through a workplace marketing program, it has no suitability obligation under Rule G-19.  Although the selling broker still would be obligated to provide the required disclosures under Rules G-17 and G-32, if all employee transactions under the workplace marketing program are handled by the primary distributor or a transfer agent that has contractually agreed to act on behalf of the primary distributor, the selling broker’s responsibilities will be conclusively fulfilled if the placing of an order in that manner is conditioned upon actual receipt of the official statement and the primary distributor has formally agreed to be responsible for such delivery.^[17]  For example, if employees make investments directly through the primary distributor’s web site and the web site requires that investors first view or download the official statement before being allowed to complete transactions, then the selling broker would be able to conclusively rely on this method of delivery for purposes of fulfilling its disclosure requirements.^[18]  However, if the primary distributor does not provide assurances that necessary disclosures will be made to employees, the selling broker will be required to provide such disclosures.^[19]  The selling broker must put in place appropriate supervisory procedures to ensure that required disclosures are provided in a satisfactory manner where it is not entitled to conclusively rely on the primary distributor as described above.

           In addition, where a selling broker is entitled to conclusively rely on disclosures provided by the primary distributor or transfer agent (as described in the preceding paragraph) and the transaction is not recommended, the selling broker may conclusively rely on the primary distributor to fulfill the selling broker’s supervisory obligation to review and approve customer accounts and transactions under Rule G-27(c)(iii) and (vii) for such accounts and transactions if the primary distributor has formally agreed to be responsible for such supervision.^[20]  Under circumstances where such conclusive reliance is not available to the selling broker, the selling broker may fulfill these supervisory obligations by reviewing and approving individual account openings and transactions as information becomes available from the primary distributor, transfer agent or other relevant party.  In all cases of non-recommended transactions, the selling broker must undertake prompt reviews and approvals of agreements obtained from employers to participate in a workplace marketing program and for recording account information under Rule G-8(a)(ii) and customer specific information for each enrolled employee required under Rule G-8(a)(xi) (of which only information under items (A), (C), (E) and (H) thereunder shall be required) as it becomes available.  A selling broker wishing to rely on the guidance provided in this notice also is required to record the name and principal business address of any employer agreeing to participate in a workplace marketing program, together with the signature of an appropriate principal approving such agreement.  Selling brokers are reminded that the conclusive reliance permitted by this paragraph and the preceding paragraph is not available in the case of recommended transactions, in which case the selling broker retains the primary obligation to fulfill all customer protection, disclosure, supervisory and recordkeeping duties.

           Dealers should note that none of the foregoing obviates the need for primary distributors to fulfill all of their customer protection obligations under MSRB rules where a selling broker is not otherwise required to fulfill such obligations.  Furthermore, if transactions subsequent to the initial enrollment of an employee in a workplace marketing program are effected directly between the employee and the primary distributor, the primary distributor generally will have sole responsibility with respect to compliance with MSRB rules in connection with such subsequent transactions, provided that the selling broker will be required to record information regarding subsequent transactions as required under Rule G-8(a)(ii) to the extent that it receives transaction-based compensation for such transactions.  Dealers also should note that, if employees make their purchases directly from the governmental issuer (whether through the issuer’s own employees or any non-dealer agent of the issuer), the selling broker or primary distributor that enlists an employer to participate in a workplace marketing program is ultimately responsible for fulfilling all of its obligations under MSRB rules.  Thus, for example, although an issuer may undertake to provide disclosure materials to investors, the dealer remains responsible under MSRB rules should the issuer fail to deliver the required disclosures to an employee who enrolls in a 529 college savings plan through a workplace marketing program promoted by the dealer acting as a selling broker, or if such disclosure information is not delivered in a timely manner.

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