COMMENTS DUE BY NOVEMBER 1, 1999

Municipal Fund Securities -
Revised Draft Rule Changes

 

Route To:
  • Manager, Muni Department
  • Underwriting
  • Trading
  • Sales
  • Operations
  • Public Finance
  • Compliance
Comments Requested

The Board is requesting further comments on revised draft rule changes relating to municipal fund securities. Comments are due by November 1, 1999.

 

Comments from all interested parties are welcome. Comments should be submitted no later than November 1, 1999, and may be directed to Ernesto A. Lanza, Associate General Counsel. Written comments will be available for public inspection.

On March 17, 1999, the Municipal Securities Rulemaking Board (the "Board") published a notice (the "March Notice") requesting comments on draft rule changes relating to transactions effected by or through brokers, dealers and municipal securities dealers ("dealers") in municipal fund securities (as defined below).(1) The Board received comments from eleven commentators. After reviewing these comments, the Board has determined to republish the draft rule changes, with certain modifications and additions (including a revision to exempt municipal fund securities from underwriting assessments), for further comment from industry participants.

The Board believes that many of the comments reflect a misunderstanding of the nature of the Board's rulemaking proposals and therefore the Board is taking this opportunity to clarify the scope and intent of these proposals. Specifically, the Board wishes to emphasize that the draft rule changes would not extend the reach of Board rules. Rather, they seek to make Board rules that are already applicable to municipal fund securities more accommodating to the unique features of such securities. Dealers should understand that Board rules apply to their transactions in any security that is a municipal security, regardless of whether the dealer is aware of the security's status. Although the Board does not have authority to direct enforcement of its rules, it is statutorily charged with determining the best means of protecting investors and the public interest in regard to dealer transactions in municipal securities. As such, the Board believes that, under the unique circumstances relating to municipal fund securities, enforcement of its rules with regard to transactions in such securities that occurred prior to the industry having been put on notice of their applicability would serve no substantial investor protection purpose, absent extraordinary circumstances or a showing of investor harm resulting from a material departure from standards of fairness generally applicable under the federal securities laws.

SCOPE AND INTENT OF BOARD RULEMAKING WITH RESPECT TO MUNICIPAL FUND SECURITIES


Dealers that effect transactions in municipal securities are subject to the Board's jurisdiction pursuant to Section 15B of the Securities Exchange Act of 1934 (the "Exchange Act"). In particular, Section 15B(c)(1) prohibits dealers from effecting transactions in, or inducing or attempting to induce the purchase or sale of, a municipal security in contravention of any Board rule. Thus, since enactment of Section 15B and the creation of the Board in the Securities Acts Amendments of 1975 (the "Securities Acts Amendments"), a transaction effected by a dealer in a municipal security must be effected in conformity with Board rules.

In the March Notice, the Board reviewed two types of state or local governmental programs involving investment interests in which dealers may effect transactions: pooled investment funds under trusts established by state or local governmental entities ("local government pools")(2) and higher education savings plan trusts established by states ("higher education trusts").(3) These programs had been brought to the Board's attention by staff of the Securities and Exchange Commission (the "SEC"). In response to a Board inquiry as to the SEC's position on whether interests in such programs were municipal securities, SEC staff stated that "at least some interests in local government pools and higher education trusts may be, depending on the facts and circumstances, 'municipal securities' for purposes of the Exchange Act."(4)

Board rules do not apply to any interest in a local government pool or higher education trust that is not a municipal security. In addition, Board rules apply only to activities of dealers that effect municipal securities transactions. Thus, Board rules do not apply to an issuer of, or a non-dealer entity providing advice to issuers in regard to, municipal securities, including municipal fund securities. However, to the extent that interests in a local government pool or a higher education trust are municipal securities and dealers are effecting transactions in them, Board rules automatically govern such dealer transactions, without the necessity of further Board rulemaking.(5) On several previous occasions, the Board has alerted the industry to the applicability of Board rules to (and has proposed rule changes to accommodate) transactions in new forms of municipal securities or pre-existing forms of securities that many in the industry had not previously recognized as municipal securities.(6)

A municipal fund security is defined as a municipal security issued by an issuer that, but for Section 2(b) of the Investment Company Act of 1940 (the "Investment Company Act"),(7) would constitute an investment company under that Act. Thus, Board rules on municipal fund securities would apply to interests in a state or local governmental trust, such as local government pools and higher education trusts,(8) only if the following three conditions are met:

  1. A dealer is engaging in transactions in such interests;
  2. Such interests, in fact, constitute municipal securities; and
  3. Such interests are issued by an issuer that, but for the exemption under Section 2(b) of the Investment Company Act, would be considered an investment company within the meaning of that Act.

The Board understands that municipal fund securities may not have features typically associated with more traditional municipal securities. Instead, their features are similar to those of investment company securities.(9) In the March Notice, the Board stated that, although its rules generally have been drafted to accommodate the characteristics of debt securities, it believes that most current rules can appropriately be applied to municipal fund securities. Nonetheless, the Board felt that certain rules should be amended to recognize the unique characteristics of municipal fund securities. The draft rule changes did not seek to extend the reach of Board rules, since the rules already apply to municipal fund securities, but sought to tailor certain Board rules to the nature of municipal fund securities.

DISCUSSION OF COMMENTS AND DRAFT RULE CHANGES

Authority of Board to Adopt Draft Rule Changes

Comments Received. Some commentators state that the Board has no authority to regulate municipal fund securities, particularly local government pool interests.(10) They state that such interests are not municipal securities under the Exchange Act. They argue that the term "municipal securities" is limited to debt obligations of municipal issuers and that interests in local government pools represent equity interests in trust assets, not debt obligations.(11) Another commentator questions whether Congress intended that the Board regulate local government pools when it created the Board.

Board Response. As previously stated, a security must first be a municipal security in order to be a municipal fund security. The draft rule changes would not, and existing Board rules do not, apply to local government pool or higher education trust interests that are not municipal securities. Thus, the Board does not overstep its authority by regulating dealer transactions in municipal fund securities since, by definition, regulation is limited to interests that are municipal securities.

A firm wishing to determine if Board rules apply to services it provides to an issuer of local government pool or higher education trust interests may seek advice of counsel as to whether (1) such services constitute broker-dealer activities, or (2) such interests are municipal securities. It may seek comfort on counsel's opinion from SEC staff through the SEC's no-action procedure. If a non-dealer firm's activities do not constitute broker-dealer activities, the firm need not be a registered broker or dealer subject to Board rules, even if the interests are municipal securities.(12) If the interests are not municipal securities, the dealer need not comply with Board rules; however, the dealer's activities may be subject to Exchange Act provisions and SEC and National Association of Securities Dealers ("NASD") rules, unless the interests otherwise qualify for an exemption (e.g., as exempted securities other than municipal securities) under the Exchange Act.

Of course, the Board's rulemaking proposal is meaningful only if municipal fund securities, in fact, exist. As noted above, the Board sought comfort from SEC staff that local government pool and higher education trust interests are municipal securities. SEC staff replied that "at least some interests in local government pools and higher education trusts may be, depending on the facts and circumstances, 'municipal securities' for purposes of the Exchange Act."(13) Although the Board is not empowered to determine whether a security is a municipal security within the meaning of Section 3(a)(29) of the Exchange Act, the Board believes that, based on this SEC response as well as a close review of existing no-action letters and legislative history of the Securities Acts Amendments, the Exchange Act and the Securities Act of 1933 (the "Securities Act"), as discussed below, at least some interests in local government pools and higher education trusts are municipal securities.

For example, in agreeing not to recommend enforcement action in several no-action letters, SEC staff relied on opinions of counsel that interests in state or local governmental trusts were municipal securities under the Exchange Act.(14) In one instance, SEC staff agreed not to recommend enforcement action if a dealer, in offering and selling interests in a higher education trust, were to comply with Board rules as they have been proposed to be amended in the March Notice, in lieu of complying with such rules as currently in effect.(15) In another no-action letter, SEC staff agreed not to recommend enforcement action if dealers (1) sold interests in a higher education trust through persons qualified to sell investment company products but who did not meet the Board's professional qualification requirements(16) and (2) complied with Rule 15c2-12(b)(5) through a continuing disclosure undertaking from a dealer affiliate, rather than from the issuer. In reaching this position, SEC staff noted that the higher education trust interests were "atypical municipal securities."(17)

In other instances, SEC staff agreed not to recommend enforcement action if state entities and their employees sold higher education trust interests without registering as brokers.(18) The applicants opined in these cases that the interests were municipal securities under the Exchange Act, thereby exempting the issuers from registering as brokers by virtue of the exemption for issuers of municipal securities set forth in Section 3(d).(19) SEC staff also agreed not to recommend enforcement action if interests in a state trust were not registered under the Exchange Act, in reliance on an opinion that the exemption under Section 3(a)(12) of the Exchange Act for exempted securities was available.(20)

SEC staff also has taken the position that non-debt securities may be municipal securities under the Exchange Act.(21) In one case, SEC staff was unable to conclude that receipts/certificates evidencing developers' payments to a city of fees for the issuance of building permits could not be considered municipal securities under the Exchange Act.(22) SEC staff also has advised the Board that warrants sold by a municipal corporation entitling the holders to purchase other municipal securities of that corporation are themselves municipal securities under the Exchange Act.(23) Finally, in those cases in which SEC staff concluded that an "obligation" within the meaning of the Internal Revenue Code would also constitute an "obligation" for purposes of Section 3(a)(29) of the Exchange Act, SEC staff did not conclude that the failure of a security to be an obligation for purposes of the Internal Revenue Code would mean that such security was not a municipal security for purposes of the Exchange Act.(24) In these cases, SEC staff was not presented with the issue of whether a non-debt security could be a municipal security. As noted above, on the last two occasions when SEC staff was confronted with this issue, it concluded that a non-debt security may be a municipal security for purposes of the Exchange Act.(25)

A review of legislative history also suggests that the commentators' position that the term "municipal securities" in the Exchange Act excludes non-debt securities is not justified. The Senate report on the Securities Acts Amendments notes that the legislation created a definition of municipal securities in new Section 3(a)(29) that, for all relevant purposes, used the same language as in the original version of the definition of exempted securities in Section 3(a)(12) of the Exchange Act.(26) It also states that no substantive changes in meaning would be effected by creating Section 3(a)(29).(27) Thus, the import of the term "municipal securities" must be viewed through the eyes of the original drafters of the Exchange Act in 1934 rather than the drafters of the Securities Acts Amendments in 1975.

The purpose of including municipal securities in the definition of exempted securities in the Exchange Act was to provide an exemption from most provisions of that Act. Although commentators suggest that Board regulation of dealer transactions in non-debt securities of municipal issuers is inconsistent with the intent of the drafters of the Securities Acts Amendments, the appropriate inquiry is whether the drafters of the original Exchange Act would have intended that only debt securities of municipal issuers be exempted from most provisions of the Exchange Act. That is, would the drafters of the original Exchange Act have intended that non-debt securities of state or local governmental entities - had such securities existed at the time - be subject to the entire range of regulation of the Exchange Act applicable to other equity securities, including in some instances a requirement for registration of such securities with the SEC? A review of Congressional debates, committee reports and hearing testimony relating to enactment of the Securities Act and the Exchange Act reveals that, in spite of differences in statutory language, both Acts were expected to exempt the same universe of municipal securities.

For example, the 1933 House report on the Securities Act speaks of exempted state and local government securities almost exclusively in terms of "obligations" and "bonds," not "securities."(28) The report explains the exemption set forth in Section 3(a) of the Securities Act as follows:

Paragraph (2) exempts United States, Territorial and State obligations, or obligations of any political subdivision of these governmental units. The term "political subdivision" carries with it the exemption of such securities as county, town, or municipal obligations, as well as school district, drainage district, and levee district, and other similar bonds. The line drawn by the expression "political subdivision" corresponds generally with the line drawn by the courts as to what obligations of States, their units and instrumentalities created by them, are exempted from Federal taxation. By such delineation, any constitutional difficulties that might arise with reference to the inclusion of State and municipal obligations are avoided.(29)

Furthermore, during Congressional debate and hearings held in 1933 on the Securities Act, members of Congress used the terms "securities," "obligations" and "bonds" interchangeably.(30) Thus, although the statutory language in the Securities Act uses only the term "securities" and not the term "obligations" when describing municipal securities, there is no suggestion that Congress had anything in mind when enacting the Securities Act other than the tax-exempt bonds and other debt obligations of state and local governments that are customarily associated with municipal securities. Nonetheless, the commentators all have agreed that local government pool and higher education trust interests are exempt from the Securities Act and none has suggested that this exemption is limited to tax-exempt debt obligations.

The initial Exchange Act draft introduced in Congress the following year exempted federal government securities but not municipal securities. Members of Congress expressed concern regarding the appropriateness of federal regulation of state and local governmental matters,(31) the burden that Exchange Act provisions would place on state and local issuers(32) and the relative detriment in the market to municipal securities if they were not exempted but federal government securities were exempted.(33) Some discussion focused on whether a distinction should be drawn between defaulted and non-defaulted municipal securities.(34) Ultimately, the language that was added to the Exchange Act to exempt municipal securities made no such distinction but instead was drafted in non-exclusive terms that paralleled the language used in the Exchange Act to describe federal government securities. This language also employed the same type of terminology that the drafters of the Securities Act had used in the legislative history to explain the statutory language on municipal securities in that Act.(35) Legislative history does not reflect any intent or understanding that the municipal securities contemplated in the Exchange Act were any different than those that were already exempted under the Securities Act.(36) It would be inconsistent with legislative intent to limit the exemption under the Exchange Act solely to debt securities of state and local governments without similarly limiting the reach of the exemption provided in the Securities Act.

Finally, in using the same term - "municipal securities" - that sets out the exemption from most Exchange Act provisions to also delineate the Board's rulemaking authority under Section 15B of the Exchange Act, Congress elected in the Securities Acts Amendments to grant the Board jurisdiction over dealer transactions in the identical universe of securities as were otherwise exempted from the Exchange Act as municipal securities. Thus, even if Congress did not have interests in local government pools or higher education trusts in mind when enacting the Securities Acts Amendments, it did have a specific intent that the Board would have authority over dealer transactions in any security that would constitute an exempted security by virtue of being a municipal security. In creating the Board, the Senate report on the Securities Acts Amendments stated that it would not "be desirable to restrict the Board's authority by a specific enumeration of subject matters. The ingenuity of the financial community and the impossibility of anticipating all future circumstances are obvious reasons for allowing the Board a measure of flexibility in laying down the rules for the municipal securities industry."(37) The fact that certain types of instruments (such as non-debt securities of state or local governments) were essentially non-existent at the time of enactment of the Securities Acts Amendments did not, in the minds of the drafters, mean that regulations relating to newly created instruments would not be within the Board's power.(38)

Appropriateness of Regulating Dealer Transactions in Municipal Fund Securities

Comments Received. Commentators state that, even if the Board has authority to adopt the draft rule changes, the Board should refrain from doing so. They argue that no need has been demonstrated for regulation to protect investors or the public interest in connection with local government pool interests. They state that investors are local governments and not the typical public investor in municipal securities.(39) They also argue that offerings of interests in local government pools do not pose risks that are similar to those identified in the legislative history of the Securities Acts Amendments.(40) One commentator argues that safeguards already exist to provide investor protections comparable to those in the draft rule changes.(41)

Some commentators state that Board rulemaking would adversely impact state and local governments. In particular, they believe that underwriting assessments would be passed on, directly or indirectly, to issuers and issuers would face additional administrative burdens as a result of the application of Board rules. They note that any increased costs to issuers likely would be passed on to investors in the form of lower returns on their investments.

Commentators also state that interests in local government pools involve transactions between the state or local government-sponsored pools and participating local governmental entities of that same state. One commentator believes that Board rulemaking would be inconsistent with the Tenth Amendment and transactions in local government pool interests do not constitute interstate commerce. Furthermore, noting that the Exchange Act does not require registration of a broker or dealer whose business is exclusively intrastate, this commentator suggests that the Board "follow Congress's restraint in approaching intrastate transactions in securities." Finally, it states that regulation of transactions in these interests would "improperly intrude on state sovereignty" by indirectly regulating states by mandating actions by their agents.

Board Response. As the Board has previously observed, the current rulemaking proposal would not subject dealer transactions in municipal fund securities to Board rules but instead would make certain Board rules, to which such transactions are already subject, better accommodate the nature of these securities. Making Board rules fit the characteristics of municipal fund securities is an appropriate Board undertaking. Also, Board rules do not govern the actions of issuers; instead, they impose standards on dealers effecting transactions in the securities of such issuers. In establishing the Board, Congress determined that dealer regulation was the appropriate manner of providing investor protection in the municipal securities market while maintaining the existing exemption for issuers.(42)

The definition of customer under rule D-9 includes issuers, except in connection with sales of an issuer's new issue municipal securities, and therefore Board rules contemplate that governmental entities acting as investors are entitled to the protections afforded by such rules to all customers.(43) The Board understands that local government pools exist in nearly every state and that, in many states, more than one pool may be available to a local government.(44) One market observer states that these pools "can differ in their level of risk taking, internal oversight, shareholder services, and external reporting."(45) Although a number of pools have been rated, the vast majority remain unrated. Most local government pools appear to be designed to maintain, as nearly as possible, a constant net asset value (similar to regulated money market mutual funds), but some operate as variable net asset value pools that do not seek to maintain a constant share value. Furthermore, a number of local government pools have experienced financial difficulties.(46) These factors suggest that investor protection issues may be raised in connection with the sale by dealers of interests in local government pools.(47) The Board believes that investor protection issues also may arise with respect to sales by dealers of interests in higher education trusts.(48) For example, the Board believes that dealers have suitability obligations if they recommend a transaction in a local government pool or higher education trust interest to a local government or an individual, respectively, if such interest constitutes a municipal security.(49)

Commentators describe local government pools as being operated "consistent with" the federal securities laws applicable to investment companies and managed and administered in a manner "similar" to money market mutual funds, "where practicable." These comments imply that many programs in fact deviate to some degree from their voluntary compliance with existing federal regulations that would be applicable to these programs if they were not operated by state or local governmental entities. However, the Board notes that its proposed rulemaking would not impose requirements on issuers and in fact has been drafted with the understanding that dealers may be effecting transactions in securities that are similar, but not identical, to investment company securities. In that respect, the Board believes that its proposed rulemaking is more suitable for dealers effecting transactions in municipal fund securities than existing SEC and NASD rules applicable to dealer transactions in investment company securities since some such rules impose obligations on dealers based on the assumption that issuers, as registered investment companies, must comply with federal investment company laws and regulations. Thus, a dealer might have difficulty in complying with the letter of existing regulations relating to securities of registered investment companies where the issuer of a local government pool or higher education trust interest has chosen not to voluntarily comply with the provisions that would be obligatory if it were a registered investment company. As is the case with all existing Board rules, the current rulemaking proposal recognizes that issuers, as largely unregulated entities, may act in widely divergent manners. Thus, obligations placed on dealers should be sufficiently flexible to permit dealers to act in a lawful manner in view of this wide divergence of circumstances while maintaining an adequate level of customer protection.

The Board believes that state regulation, federal rules applicable to investment advisors and Governmental Accounting Standards Board statements, although providing important protections in the areas governed by such rules and standards, do not serve as a substitute for regulation tailored specifically toward dealer activities in municipal fund securities. Furthermore, the Board believes that voluntary adherence to the substance of existing rules applicable to investment company securities and/or other equity securities provides inadequate protection to investors since dealers are free to deviate from these rules in any manner and at any time they choose without any apparent legal consequence. The existence of these collateral safeguards do not justify the Board refraining from making its rules more rational with respect to such securities.

Finally, with regard to the argument that interests in local government pools are strictly intrastate in nature and therefore are not the appropriate subject of federal regulation, Board rules currently do not apply to any entity that, by virtue of the fact that its business is exclusively intrastate, is not registered as a broker or dealer under Section 15 of the Exchange Act. Beyond this, the federal securities laws provide that, once an entity engages in some interstate activities that require it to register under the Exchange Act, the broker-dealer rules applicable to such entity apply to both its interstate and intrastate transactions. We believe that Congress has made clear its policy determination that intrastate transactions of registered broker-dealers should be subject to broker-dealer regulation.(50)

Applicability of Existing Board Rules to Transactions in Municipal Fund Securities Effected Prior to Effectiveness of Draft Rule Changes

Comments Received. Two commentators argue that, to the extent that the Board may have authority to regulate dealer transactions in these interests, existing Board rules relating to municipal securities do not currently apply to transactions in local government pool interests. They state that existing Board rules were never intended to apply to securities other than debt obligations, as evidenced by the Board's statement in the March Notice that its rules "generally have been drafted to accommodate the characteristics of debt obligations and not investment interests such as municipal fund securities." As a result, they believe that any interpretation by the Board to the effect that existing rules apply to municipal fund securities can only be effected through the rulemaking process.

Board Response. As stated above, the Board believes that Section 15B(c)(1) of the Exchange Act automatically subjects any dealer transactions in municipal fund securities to Board rules. This is true regardless of whether dealers effecting such transactions are aware that municipal fund securities are, in fact, municipal securities. It is incumbent upon dealers to be aware of the nature of the securities in which they undertake transactions and it is not a defense against the applicability of Board rules that the dealer did not know that the securities were municipal securities. Thus, the Board's statement that any interest in a local government pool or a higher education trust that is a municipal security currently is subject to Board rules was a statement of fact rather than an interpretation.(51)

The Board recognizes, however, that, prior to publication of the March Notice, it may not have been readily apparent to the vast majority of dealers, as well as to most regulatory agencies, that interests that constitute municipal fund securities were municipal securities. Although the Board does not have authority to direct enforcement of its rules, it is statutorily charged with determining the best means of protecting investors and the public interest in regard to dealer transactions in municipal securities. As such, the Board believes that, under the unique circumstances relating to municipal fund securities, enforcement of its rules with regard to transactions in such securities that occurred prior to the industry having been put on notice of their applicability would serve no substantial investor protection purpose, absent extraordinary circumstances or a showing of investor harm resulting from a material departure from standards of fairness generally applicable under the federal securities laws.

Structure of Draft Rule Changes

Comments Received. Some commentators express concern that the Board's rulemaking proposal contemplates amendments to existing rules rather than creation of a separate body of regulations. One commentator states that the "attempt to fit a totally new product or way of doing business into existing regulation that was created to address fundamentally different products and a different market structure is fraught with danger." Commentators also state that transactions in municipal fund securities should be regulated in a manner as similar as possible to the existing regulatory scheme for investment company securities.

Board Response. The Board reviewed its existing rules and compared them, where relevant, to rules that govern dealer transactions in securities of registered investment companies. In many respects, Board rules are functionally identical to such existing rules. In other cases, existing SEC or NASD rules provide a more appropriate method of regulating municipal fund securities and the Board sought to modify its rules in a manner that was consistent with such other rules. In yet other cases, the regulation of the structure and marketing of securities of registered investment companies has been effected by regulations applicable to issuers, an approach which the Board cannot, and does not seek to, duplicate. Finally, certain NASD and SEC rule provisions arise out of specific Congressional authorization in the Investment Company Act applicable to securities of registered investment companies but not applicable to unregistered municipal fund securities.

Under the circumstances, the Board believes that its approach is appropriate. The Board sought industry comment on the draft rule changes and, in those circumstances where commentators noted specific shortcomings, the Board considered the merits of the comments and made revisions where appropriate. The Board was disappointed that several commentators chose to comment almost exclusively on jurisdictional issues and hopes that they will now address the details of, and any concerns raised by, the revised draft rule changes.

Specific Rule Provisions

Rule A-13, on Underwriting Assessments. In the March Notice, the Board states that sales of municipal fund securities are made in a primary offering subject to the underwriting assessment in rule A-13.(52) The draft amendment to rule A-13 would have provided for the imposition of an underwriting assessment with respect to such sales of municipal fund securities.

Most commentators express concern regarding the assessment of underwriting fees on sales of municipal fund securities. Some suggest that such sales should be exempted from the underwriting assessment. They state that the fee structure for dealers involved in the distribution of municipal fund securities is more like an administrative fee than an underwriting discount or commission since these dealers do not undertake underwriting risks. As a result, they state that fees generally are fixed and are low relative to traditional underwriting fees. Because of these small margins, a number of commentators state that underwriting assessments would be passed on to issuers and therefore would represent a financial burden on the issuers' programs.(53)

Some commentators state that, given the volume of investments and redemptions in many municipal fund securities programs,(54) the level of fees generated by the Board from underwriting assessments would be disproportionate to the resulting regulatory costs. One commentator states that, if assessments are imposed, they should be at a significantly lower level than the assessments charged in connection with more traditional municipal securities offerings.(55)

Based on the comments, the Board has revised the draft amendment to rule A-13 to exempt sales of municipal fund securities from the underwriting assessment. The continuous nature of offerings in municipal fund securities, the programmatic nature of most customer investments and the heightened potential that underwriting assessments could create significant financial burdens on issuers to their customers' detriment justify caution in imposing the underwriting assessment. The Board also wishes to make clear that it does not intend to seek payment of any previously accrued underwriting assessments that may technically be due and owing on prior sales of municipal fund securities.

Draft Rule D-12, on Definition of "Municipal Fund Security". Draft rule D-12 defines municipal fund security as a municipal security that would be an investment company security under the Investment Company Act but for the fact that the issuer is a state or local governmental entity or instrumentality. For a security to constitute a municipal fund security, the security must first constitute a municipal security. The draft amendments would not apply to any local government pool or higher education trust interest that is not a municipal security. The Board has not revised the draft definition.(56)

Rule G-3, on Professional Qualifications. The draft amendment to rule G-3 would permit an associated person qualified as an investment company limited representative to effect transactions in municipal fund securities (but no other municipal securities).(57) A dealer must have municipal securities principals as required under rule G-3(b), even if the dealer's only municipal securities transactions are sales of municipal fund securities. The Board has not revised this draft amendment.(58)

Rule G-8, on Recordkeeping. The draft amendment to rule G-8 would recognize that municipal fund securities do not have par values, dollar prices, yields and accrued interest and that some investment company limited representatives would be permitted to effect transactions in municipal fund securities. The Board did not receive comments on its draft amendment to rule G-8. However, in conjunction with revisions to the draft amendment to rule G-15 described below, the Board is proposing an additional revision to rule G-8 to require that dealers retain copies of all periodic statements delivered to customers in lieu of individual confirmations.

Rule G-14, on Transaction Reporting. The draft rule change would make a technical modification in rule G-14(b)(i) to make clear that certain types of municipal securities transactions may be excluded from transaction reporting as provided in the Rule G-14 Transaction Reporting Procedures. In the Procedures, the language change would expressly exempt any transaction in municipal fund securities from the customer transaction reporting system.(59) The Board did not receive comments on, and has not revised, these draft amendments.

Rule G-15, on Customer Confirmations. The draft amendment to rule G-15 would effect changes relating to the concepts of par value, yield, dollar price, maturity date and interest, none of which would appropriately apply to a municipal fund security. Thus, on a confirmation of a municipal fund securities transaction, a dealer would use the purchase or sale price of the securities (as appropriate) rather than par value and would omit yield, dollar price, accrued interest, extended principal, maturity date and interest rate. Dealers selling municipal fund securities would be required to include the denomination or purchase price of each share or unit as well as the number of shares or units to be delivered. Confirmations of municipal fund securities transactions would require a disclosure to the effect that a deferred commission or other charge may be imposed upon redemption, if applicable.(60) The amendment also would make clear that dealers must confirm redemptions of municipal fund securities. Finally, the amendment would permit dealers to use quarterly statements, rather than transaction-by-transaction confirmations, if customers are purchasing such securities in an agreed amount on a periodic basis, in a manner similar to the periodic reporting provision under Exchange Act Rule 10b-10.

The Board received a number of technical comments on various provisions in rule G-15:(61)

        Periodic Statements - Rule G-15(a)(vi)(G) and (a)(viii) - Some commentators state that the draft amendments would require individual confirmations for each transaction in local government pool interests and suggest that dealers be permitted to use monthly statements.(62) Another commentator states that transactions in higher education trust interests that are not effected pursuant to a periodic plan should nonetheless qualify for periodic statements in lieu of individual transaction confirmations.(63)

The Board has decided to revise the draft amendment to rule G-15 to provide that information regarding transactions in municipal fund securities effected in connection with a program that does not provide for periodic purchases or redemptions of municipal fund securities may be disclosed to customers on a monthly statement in lieu of transaction confirmations.(64) With respect to natural persons who participate in a non-periodic program, this monthly reporting would require the written consent of such individual or of the issuer. If the issuer directs that monthly statements be used in lieu of transaction confirmations, the revised draft amendment to rule G-15(a)(viii) would permit dealers effecting transactions in such municipal fund securities to use monthly statements without obtaining the consent of any customers. In addition, the draft amendment has been revised to eliminate the requirement that customers participating in a group plan consent to the use of periodic statements in lieu of transaction confirmations.(65)

Rule G-15(a)(i)(A)(7) - In order to avoid the potential for ambiguity, this subparagraph has been revised to eliminate reference to denomination and to refer solely to the share purchase price.(66)

Rule G-15(a)(i)(C) and (a)(i)(B)(1) - A commentator notes that the Board did not provide guidance regarding the securities descriptive information required to be included under paragraph (a)(i)(C) and states that such paragraph should not be applicable to municipal fund securities. In the alternative, it suggests that confirmations should not be required to state that municipal fund securities are unrated.(67) The Board has revised the draft amendment to (i) provide that a confirmation of a municipal fund security transaction need not show the information required under paragraph (a)(i)(C) other than whether the security is puttable and (ii) include a requirement in subparagraph (a)(i)(B)(1) that the confirmation include the name used by the issuer to identify the security and, to the extent necessary to differentiate the security from other municipal fund securities of the issuer, any separate program series, portfolio or fund designation. A statement to the effect that the security is unrated would not be required.

Rule G-21, on Advertising. The Board did not propose amending rule G-21 in the March Notice. One commentator states that this rule should be revised to eliminate references to price and yield for purposes of municipal fund securities. Section (d)(i) provides that an advertisement for new issue municipal securities may show the initial reoffering price or yield, even if they have changed, so long as the date of sale is shown. In addition, it provides that if the price or yield shown in the advertisement is other than the initial price or yield, the price or yield shown must have been accurate at the time the advertisement was submitted for publication. The Board believes that these provisions do not unnecessarily restrict the manner in which municipal fund securities may be advertised nor do they mandate that an advertisement for a municipal fund security specify a price or yield.(68) Therefore, no change has been proposed to rule G-21.

Rule G-26, on Customer Account Transfers. The draft amendment to rule G-26 amends the definition of "nontransferable asset" to reflect the fact that the issuer of municipal fund securities may limit which dealers may carry accounts for customers in such securities. The Board did not receive comments on, and has not revised, this draft amendment.

Rule G-32, on New Issue Disclosures. No amendments to rule G-32 were proposed in the March Notice. However, the Board stated that municipal fund securities sold in a primary offering would constitute new issue municipal securities for purposes of rule G-32 so long as the securities are in the underwriting period. Since the Board understands that issuers of municipal fund securities are continuously issuing and delivering the securities as customers make purchases, the Board believes that municipal fund securities would remain in their underwriting period so long as such issuance and delivery continues.(69) Thus, a dealer effecting a transaction in a municipal fund security would be required to deliver to the customer the official statement, if one exists, by settlement of the transaction. However, in the case of a customer purchasing such securities who is a repeat purchaser, no new delivery of the official statement would be required so long as the customer has previously received it in connection with a prior purchase and the official statement has not been changed from the one previously delivered to that customer.(70)

One commentator expresses concern regarding the timing requirement of rule G-32 in the limited circumstances where a revision has just been made to the official statement and a customer that participates in a periodic plan makes an automatic purchase of additional shares of municipal fund securities. In spite of the best efforts of the dealer and the issuer, it may be impossible for the revised official statement to be delivered to the customer by settlement. The commentator suggests that, under these circumstances, the timing requirement under rule G-32 should be based on the sending rather than the delivery of the official statement.

The Board is proposing a draft amendment to rule G-32 that would permit a dealer to sell, pursuant to a periodic plan, a municipal fund security to a customer who has previously received the official statement so long as it sends to the customer a copy of any new, supplemented, amended or stickered official statement promptly upon receipt from the issuer. The draft amendment also would except municipal fund securities for which periodic statements in lieu of transaction confirmations are provided from the requirement that information on the underwriting arrangements (which information would be limited to the fees paid to the dealer by the issuer) be provided to customers by settlement so long as such information is disclosed at least annually and information on any fee changes paid by the issuer to the dealer be sent to customers simultaneously with or prior to the sending of the next periodic statement.

Rule G-33, on Calculations. The Board did not propose amending rule G-33 in the March Notice. One commentator states that this rule should be revised to eliminate references to par value, yield dollar price, maturity date and interest for purposes of municipal fund securities. By its terms, rule G-33 applies only to municipal securities that bear interest or are sold at a discount. Since municipal fund securities do not bear interest and are not sold at a discount, rule G-33 would by its nature not apply. Therefore, no change has been made to rule G-33.

Rule G-34, on CUSIP Numbers and Depository Eligibility. The draft amendments would exempt municipal fund securities from the requirements of rule G-34 since no secondary market is expected to develop.(71) The Board did not receive comments on, and has not revised, this draft amendment.

Rule G-36, on Delivery of Official Statements and Form G-36(OS) to the Board. The Board did not propose amending rule G-36 in the March Notice but did state that, consistent with SEC staff's view regarding the sale in primary offerings of municipal fund securities, dealers acting as underwriters in primary offerings of municipal fund securities would be subject to the requirements of rule G-36. Thus, unless such primary offering falls within one of the stated exemptions in Rule 15c2-12, the Board expects that the dealer would receive a final official statement from the issuer or its agent under its contractual agreement entered into pursuant to Rule 15c2-12(b)(3). Such official statement should be received from the issuer in sufficient time for the dealer to send the official statement, together with Form G-36(OS), to the Board within one business day of receipt but no later than 10 business days after any final agreement to purchase, offer, or sell the municipal fund securities.(72) Since municipal fund securities remain in their underwriting period so long as they continue to be sold and delivered, the dealer would remain obligated under rule G-36(d) to send to the Board, within one business day of receipt, any amendments made to the official statement during such extended underwriting period.(73) No change has been made to rule G-36.

Rule G-37, on Political Contributions and Prohibitions on Municipal Securities Business, and Rule G-38, on Consultants. The Board did not propose amending rules G-37 and G-38 in the March Notice but did reminded dealers that the definition of municipal securities business under such rules includes the purchase of a primary offering from the issuer on other than a competitive bid basis or the offer or sale of a primary offering on behalf of any issuer. Thus, a dealer's transactions in municipal fund securities may impact upon such dealer's obligations under rules G-37 and G-38. No changes have been made to rules G-37 and G-38.

* * * * *

August 27, 1999

 

TEXT OF DRAFT AMENDMENTS(74)

Rule A-13. Underwriting and Transaction Assessments for Brokers, Dealers and Municipal Securities Dealers


(a) Underwriting Assessments - Scope. Each broker, dealer and municipal securities dealer shall pay to the Board an underwriting fee as set forth in section (b) for all municipal securities purchased from an issuer by or through such broker, dealer or municipal securities dealer, whether acting as principal or agent, as part of a primary offering, provided that section (b) of this rule shall not apply to a primary offering of securities if all such securities in the primary offering:

(i)-(ii) No change.

(iii) at the option of the holder thereof, may be tendered to an issuer of such securities or its designated agent for redemption or purchase at par value or more at least as frequently as every nine months until maturity, earlier redemption, or purchase by an issuer or its designated agent; or

(iv) have authorized denominations of $100,000 or more and are sold to no more than thirty-five persons each of whom the broker, dealer or municipal securities dealer reasonably believes: (A) has the knowledge and experience necessary to evaluate the merits and risks of the investment; and (B) is not purchasing for more than one account, with a view toward distributing the securities; or

(v) constitute municipal fund securities.

If a syndicate or similar account has been formed for the purchase of the securities, the underwriting fee shall be paid by the managing underwriter on behalf of each participant in the syndicate or similar account.

(b)-(f) No change.

Rule D-12. "Municipal Fund Security"

The term "municipal fund security" shall mean a municipal security issued by an issuer that, but for the application of Section 2(b) of the Investment Company Act of 1940, would constitute an investment company within the meaning of Section 3 of the Investment Company Act of 1940.

Rule G-3. Classification of Principals and Representatives; Numerical Requirements; Testing; Continuing Education Requirements

No broker, dealer or municipal securities dealer or person who is a municipal securities representative, municipal securities principal, municipal securities sales principal or financial and operations principal (as hereafter defined) shall be qualified for purposes of rule G-2 unless such broker, dealer or municipal securities dealer or person meets the requirements of this rule.

(a) Municipal Securities Representative.

(i) No change.

(ii) Qualification Requirements.

(A)-(B) No change.

(C) The requirements of subparagraph (a)(ii)(A) of this rule shall not apply to any person who is duly qualified as a limited representative - investment company and variable contracts products by reason of having taken and passed the Limited Representative - Investment Company and Variable Contracts Products Examination, but only if such person's activities with respect to municipal securities described in paragraph (a)(i) of this rule are limited solely to municipal fund securities.

(D) Any person who ceases to be associated with a broker, dealer or municipal securities dealer (whether as a municipal securities representative or otherwise) for two or more years at any time after having qualified as a municipal securities representative in accordance with subparagraphs (a)(ii)(A), (B) or (C) or (B) shall again meet the requirements of subparagraphs (a)(ii)(A), (B) or (C) or (B) prior to being qualified as a municipal securities representative.

(iii) Apprenticeship.

(A) Any person who first becomes associated with a broker, dealer or municipal securities dealer in a representative capacity (whether as a municipal securities representative, or general securities representative or limited representative - investment company and variable contracts products) without having previously qualified as a municipal securities representative, or general securities representative or limited representative - investment company and variable contracts products shall be permitted to function in a representative capacity without qualifying pursuant to subparagraphs (a)(ii)(A), (B) or (C) or (B) for a period of at least 90 days following the date such person becomes associated with a broker, dealer or municipal securities dealer, provided, however, that such person shall not transact business with any member of the public with respect to, or be compensated for transactions in, municipal securities during such 90 day period, regardless of such person's having qualified in accordance with the examination requirements of this rule. A person subject to the requirements of this paragraph (a)(iii) shall in no event continue to perform any of the functions of a municipal securities representative after 180 days following the commencement of such person's association with such broker, dealer or municipal securities dealer, unless such person qualifies as a municipal securities representative pursuant to subparagraphs (a)(ii)(A), (B) or (C) or (B).

(B) Prior experience, of at least 90 days, as a general securities representative, limited representative - investment company and variable contracts products mutual fund salesperson or limited representative - government securities representative, will meet the requirements of this paragraph (a)(iii).

(b)-(h) No change.

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


(a) Description of Books and Records Required to be Made. Except as otherwise specifically indicated in this rule, every broker, dealer and municipal securities dealer shall make and keep current the following books and records, to the extent applicable to the business of such broker, dealer or municipal securities dealer:

(i) Records of Original Entry. "Blotters" or other records of original entry containing an itemized daily record of all purchases and sales of municipal securities, all receipts and deliveries of municipal securities (including certificate numbers and, if the securities are in registered form, an indication to such effect), all receipts and disbursement of cash with respect to transactions in municipal securities, all other debits and credits pertaining to transactions in municipal securities, and in the case of brokers, dealers and municipal securities dealers other than bank dealers, all other cash receipts and disbursements if not contained in the records required by any other provision of this rule. The records of original entry shall show the name or other designation of the account for which each such transaction was effected (whether effected for the account of such broker, dealer or municipal securities dealer, the account of a customer, or otherwise), the description of the securities, the aggregate par value of the securities, the dollar price or yield and aggregate purchase or sale price of the securities, accrued interest, the trade date, and the name or other designation of the person from whom purchased or received or to whom sold or delivered. With respect to accrued interest and information relating to "when issued" transactions which may not be available at the time a transaction is effected, entries setting forth such information shall be made promptly as such information becomes available. Dollar price, yield and accrued interest relating to any transaction shall be required to be shown only to the extent required to be included in the confirmation delivered by the broker, dealer or municipal securities dealer in connection with such transaction under rule G-12 or rule G-15.

(ii)-(viii) No change.

(ix) Copies of Confirmations, Periodic Statements and Certain Other Notices to Customers. A copy of all confirmations of purchase or sale of municipal securities, of all periodic written statements disclosing purchases, sales or redemptions of municipal fund securities pursuant to rule G-15(a)(viii) and, in the case of a broker, dealer or municipal securities dealer other than a bank dealer, of all other notices sent to customers concerning debits and credits to customer accounts or, in the case of a bank dealer, notices of debits and credits for municipal securities, cash and other items with respect to transactions in municipal securities.

(x) No change.

(xi) Customer Account Information. A record for each customer, other than an institutional account, setting forth the following information to the extent applicable to such customer:

(A)-(G) No change.

(H) signature of municipal securities representative, and general securities representative or limited representative - investment company and variable contracts products introducing the account and signature of a municipal securities principal, municipal securities sales principal or general securities principal indicating acceptance of the account;

(I)-(K) No change.

For purposes of this subparagraph, the terms "general securities representative," and "general securities principal" and "limited representative - investment company and variable contracts products" shall mean such persons as so defined by the rules of a national securities exchange or registered securities association. For purposes of this subparagraph, the term "institutional account" shall mean the account of (i) a bank, savings and loan association, insurance company, or registered investment company; (ii) an investment adviser registered either with the Commission under Section 203 of the Investment Advisers Act of 1940 or with a state securities commission (or any agency or office performing like functions); or (iii) any other entity (whether a natural person, corporation, partnership, trust, or otherwise) with total assets of at least $50 million. Anything in this subparagraph to the contrary notwithstanding, every broker, dealer and municipal securities dealer shall maintain a record of the information required by items (A), (C), (F), (H), (I) and (K) of this subparagraph with respect to each customer which is an institutional account.

(xii)-(xix) No change.

(b)-(f) No change.

(g) Price substituted for par value of municipal fund securities. For purposes of this rule, each reference to the term "par value," when applied to a municipal fund security, shall be substituted with (i) in the case of a purchase of a municipal fund security by a customer, the purchase price paid by the customer, exclusive of any commission, and (ii) in the case of a sale or tender for redemption of a municipal fund security by a customer, the sale price or redemption amount paid to the customer, exclusive of any commission or other charge imposed upon redemption or sale.

Rule G-14. Reports of Sales or Purchases

(a) No change.

(b) Transactions Reporting Requirements.

(i) Each broker, dealer or municipal securities dealer shall report to the Board or its designee information about its transactions in municipal securities to the extent required by, and using the formats and within the timeframes specified in, Rule G-14 Transaction Reporting Procedures. Transaction information collected by the Board under this rule will be used to make public reports of market activity and prices and to assess transaction fees. The transaction information will be made available by the Board to the Commission, securities associations registered under Section 15A of the Act and other appropriate regulatory agencies defined in Section 3(a)(34)(A) of the Act to assist in the inspection for compliance with and the enforcement of Board rules.

(ii)-(iii) No change.

Rule G-14 Transaction Reporting Procedures

(a) No change.

(b) Customer Transactions.

(i)-(ii) No change.

(iii) The following transactions shall not be required to be reported under this section (b):

(A) A a transaction in a municipal security that is ineligible for assignment of a CUSIP number by the Board or its designee; and shall not be required to be reported under this section (b).

(B) a transaction in a municipal fund security.

(iv) No change.

Rule G-15. Confirmation, Clearance and Settlement of Transactions with Customers

(a) Customer Confirmations

(i) At or before the completion of a transaction in municipal securities with or for the account of a customer, each broker, dealer or municipal securities dealer shall give or send to the customer a written confirmation that complies with the requirements of this paragraph (i):

(A) Transaction information. The confirmation shall include information regarding the terms of the transaction as set forth in this subparagraph (A):

(1)-(2) No change.

(3) Par value. The par value of the securities shall be shown, with special requirements for the following securities:

(a) No change.

(b) Municipal fund securities. For municipal fund securities, in place of par value, the confirmation shall show (i) in the case of a purchase of a municipal fund security by a customer, the total purchase price paid by the customer, exclusive of any commission, and (ii) in the case of a sale or tender for redemption of a municipal fund security by a customer, the total sale price or redemption amount paid to the customer, exclusive of any commission or other charge imposed upon redemption or sale.

(4) No change.

(5) Yield and dollar price. Yields and dollar prices shall be computed and shown in the following manner, subject to the exceptions stated in subparagraph (A)(5)(d) of this paragraph:

(a)-(c) No change.

(d) Notwithstanding the requirements noted in subparagraphs (A)(5)(a) through (c) of this paragraph, above:

(i)-(v) No change.

(vi) Municipal fund securities. For municipal fund securities, neither yield nor dollar price shall be shown.

(6) Final Monies. The following information relating to the calculation and display of final monies shall be shown:

(a) No change.

(b) amount of accrued interest, with special requirements for the following securities:

(i)-(ii) No change.

(iii) Municipal fund securities. For municipal fund securities, no figure for accrued interest shall be shown;

(c) if the securities pay interest on a current basis but are traded without interest, a notation of "flat;"

(d) extended principal amount, with special requirements for the following securities:

(i) No change.

(ii) Municipal fund securities. For municipal fund securities, no extended principal amount shall be shown;

(e)-(h) No change.

(7) Delivery of securities. The following information regarding the delivery of securities shall be shown:

(a) Securities other than bonds or municipal fund securities. For securities other than bonds or municipal fund securities, denominations to be delivered;

(b) No change.

(c) Municipal fund securities. For municipal fund securities, the purchase price, exclusive of commission, of each share or unit and the number of shares or units to be delivered;

(d) Delivery instructions. Instructions, if available, regarding receipt or delivery of securities, and form of payment, if other than as usual and customary between the parties.

(8) No change.

(B) Securities identification information. The confirmation shall include a securities identification which includes, at a minimum:

(1) the name of the issuer, with special requirements for the following securities:

(a) For stripped coupon securities, the trade name and series designation assigned to the stripped coupon municipal security by the broker, dealer or municipal securities dealer sponsoring the program must be shown;

(b) Municipal fund securities. For municipal fund securities, the name used by the issuer to identify such securities and, to the extent necessary to differentiate the securities from other municipal fund securities of the issuer, any separate program series, portfolio or fund designation for such securities must be shown;

(2) No change.

(3) maturity date, if any, with special requirements for the following securities:

(a) No change.

(b) Municipal fund securities. For municipal fund securities, no maturity date shall be shown;

(4) interest rate, if any, with special requirements for the following securities:

(a)-(e) No change.

(f) Municipal fund securities. For municipal fund securities, no interest rate shall be shown;

(C) Securities descriptive information. The confirmation shall include descriptive information about the securities which includes, at a minimum:

(1)-(4) No change.

(5) Municipal fund securities. For municipal fund securities, the information described in clauses (1) through (4) of this subparagraph (C) is not required to be shown; provided, however, that if the municipal fund securities are puttable or otherwise redeemable by the customer, the confirmation shall include a designation to that effect.

(D) Disclosure statements:

(1)-(2) No change.

(3) The confirmation for securities for which a deferred commission or other charge is imposed upon redemption or as a condition for payment of principal or interest thereon shall include a statement that the customer may be required to make a payment of such deferred commission or other charge upon redemption of such securities or as a condition for payment of principal or interest thereon, as appropriate, and that information concerning such deferred commission or other charge will be furnished upon written request.

(ii)-(iii) No change.

(iv) Confirmation to customers who tender put option bonds or municipal fund securities. A broker, dealer, or municipal securities dealer that has an interest in put option bonds (including acting as remarketing agent) and accepts for tender put option bonds from a customer, or that has an interest in municipal fund securities (including acting as agent for the issuer thereof) and accepts for redemption municipal fund securities tendered by a customer, is engaging in a transaction in such municipal securities and shall send a confirmation under paragraph (i) of this section.

(v) No change.

(vi) Definitions. For purposes of this rule, the following terms shall have the following meanings:

(A)-(F) No change.

(G) The term "periodic municipal fund security plan" shall mean any written authorization or arrangement for a broker, dealer or municipal securities dealer, acting as agent, to purchase, sell or redeem for a customer or group of customers one or more specific municipal fund securities, in specific amounts (calculated in security units or dollars), at specific time intervals and setting forth the commissions or charges to be paid by the customer in connection therewith (or the manner of calculating them).

(H) The term "non-periodic municipal fund security program" shall mean any written authorization or arrangement for a broker, dealer or municipal securities dealer, acting as agent, to purchase, sell or redeem for a customer or group of customers one or more specific municipal fund securities, setting forth the commissions or charges to be paid by the customer in connection therewith (or the manner of calculating them) and either (1) providing for the purchase, sale or redemption of such municipal fund securities at the direction of the customer or customers or (2) providing for the purchase, sale or redemption of such municipal fund securities at the direction of the customer or customers as well as authorizing the purchase, sale or redemption of such municipal fund securities in specific amounts (calculated in security units or dollars) at specific time intervals.

(vii) Price substituted for par value of municipal fund securities. For purposes of this rule, each reference to the term "par value," when applied to a municipal fund security, shall be substituted with (i) in the case of a purchase of a municipal fund security by a customer, the purchase price paid by the customer, exclusive of any commission, and (ii) in the case of a sale or tender for redemption of a municipal fund security by a customer, the sale price or redemption amount paid to the customer, exclusive of any commission or other charge imposed upon redemption or sale.

(viii) Alternative periodic reporting for certain transactions in municipal fund securities. Notwithstanding any other provision of this section (a), a broker, dealer or municipal securities dealer may effect transactions in municipal fund securities with customers without giving or sending to such customer the written confirmation required by paragraph (i) of this section (a) at or before completion of each such transaction if:

(A) such transactions are effected pursuant to a periodic municipal fund security plan or a non-periodic municipal fund security program; and

(B) such broker, dealer or municipal securities dealer gives or sends to such customer within five business days after the end of each quarterly period, in the case of a customer participating in a periodic municipal fund security plan, or each monthly period, in the case of a customer participating in a non-periodic municipal fund security program, a written statement disclosing, for each purchase, sale or redemption effected for or with, and each payment of investment earnings credited to or reinvested for, the account of such customer during the reporting period, the information required to be disclosed to customers pursuant to subparagraphs (A) through (D) of paragraph (i) of this section (a), with the information regarding each transaction clearly segregated; provided that it is permissible for the name and address of the broker, dealer or municipal securities dealer and the customer to appear once at the beginning of the document; and

(C) in the case of a periodic municipal fund security plan that consists of an arrangement involving a group of two or more customers and contemplating periodic purchases of municipal fund securities by each customer through a person designated by the group, such broker, dealer or municipal securities dealer:

(1) gives or sends to the designated person, at or before the completion of the transaction for the purchase of such municipal fund securities, a written notification of the receipt of the total amount paid by the group;

(2) sends to anyone in the group who was a customer in the prior quarter and on whose behalf payment has not been received in the current quarter a quarterly written statement reflecting that a payment was not received on such customer's behalf; and

(3) advises each customer in the group if a payment is not received from the designated person on behalf of the group within 10 days of a date certain specified in the arrangement for delivery of that payment by the designated person and either (a) thereafter sends to each customer the written confirmation described in paragraph (i) of this section (a) for the next three succeeding payments, or (b) includes in the quarterly statement referred to in subparagraph (B) of this paragraph (viii) each date certain specified in the arrangement for delivery of a payment by the designated person and each date on which a payment received from the designated person is applied to the purchase of municipal fund securities;

(D) such customer is provided with prior notification in writing disclosing the intention to send the written information referred to in subparagraph (B) of this paragraph (viii) on a periodic basis in lieu of an immediate confirmation for each transaction; and

(E) such customer has consented in writing to receipt of the written information referred to in subparagraph (B) of this paragraph (viii) on a periodic basis in lieu of an immediate confirmation for each transaction; provided, however, that such customer consent shall not be required if (1) the customer participates in a periodic municipal fund security plan described in subparagraph (C) of this paragraph (viii), (2) the customer is not a natural person and participates in a non-periodic municipal fund security program or (3) the customer is a natural person that participates in a non-periodic municipal fund security program and the issuer has consented in writing to the use by the broker, dealer or municipal securities dealer of the periodic written information referred to in subparagraph (B) of this paragraph (viii) in lieu of an immediate confirmation for each transaction with each customer participating in the non-periodic municipal fund security program.

(b)-(e) No change.

Rule G-26. Customer Account Transfers

(a) Definitions. For purposes of this rule, the following terms have the following meanings:

(i)-(ii) No change.

(iii) The term "nontransferable asset" means an asset that is incapable of being transferred from the carrying party to the receiving party because (A) it is an issue in default for which the carrying party does not possess the proper denominations to effect delivery and no transfer agent is available to re-register the securities, or (B) it is a municipal fund security which the issuer requires to be held in an account carried by one or more specified brokers, dealers or municipal securities dealers that does not include the receiving party.

(b) No change.

(c) Transfer Instructions.

(i) No change.

(ii) If an account includes any nontransferable assets, the carrying party must request, in writing and prior to or at the time of validation of the transfer instruction, further instructions from the customer with respect to the disposition of such assets. Such request shall provide the customer with the following alternative methods of disposition of nontransferable assets, if applicable:

(A) No change.

(B) retention by the carrying party for the customer's benefit; or

(C) in the case of a nontransferable asset described in section (a)(iii)(B), transfer to another broker, dealer or municipal securities dealer, if any, which the issuer has specified as being permitted to carry such asset.

(d)-(i) No change.

Rule G-32. Disclosures in Connection with New Issues

(a) Customer Disclosure Requirements. No broker, dealer or municipal securities dealer shall sell, whether as principal or agent, any new issue municipal securities to a customer unless such broker, dealer or municipal securities dealer delivers to the customer no later than the settlement of the transaction:

(i) a copy of the official statement in final form prepared by or on behalf of the issuer or, if an official statement in final form is not being prepared by or on behalf of the issuer, a written notice to that effect together with a copy of an official statement in preliminary form, if any; provided, however, that:

(A) if a customer who participates in a periodic municipal fund security plan has previously received a copy of the official statement in final form in connection with the purchase of municipal fund securities under such plan, a broker, dealer or municipal securities dealer may sell additional shares or units of the municipal fund securities under such plan to the customer if such broker, dealer or municipal securities dealer sends to the customer a copy of any new, supplemented, amended or "stickered" official statement in final form, by first class mail or other equally prompt means, promptly upon receipt thereof; or

(B) if an official statement in final form is being prepared for new issue municipal securities issued in a primary offering that qualifies for the exemption set forth in paragraph (iii) of section (d)(1) of Securities Exchange Act Rule 15c2-12, a broker, dealer or municipal securities dealer may sell such new issue municipal securities to a customer if such broker, dealer or municipal securities dealer:

(A)-(B) Renumbered as (1)-(2).

(ii) in connection with a negotiated sale of new issue municipal securities, the following information concerning the underwriting arrangements:

(A) the underwriting spread, if any;

(B) the amount of any fee received by the broker, dealer or municipal securities dealer as agent for the issuer in the distribution of the securities; provided, however, that if a broker, dealer or municipal securities dealer selling municipal fund securities provides periodic statements to the customer pursuant to rule G-15(a)(viii) in lieu of individual transaction confirmations, this paragraph (ii)(B) shall be deemed to be satisfied if the broker, dealer or municipal securities dealer provides this information to the customer at least annually and provides information regarding any change in such fee on or prior to the sending of the next succeeding periodic statement to the customer; and

(C) except with respect to an issue of municipal fund securities, the initial offering price for each maturity in the issue that is offered or to be offered in whole or in part by the underwriters, including maturities that are not reoffered.

(b) Inter-Dealer Disclosure Requirements. Every broker, dealer or municipal securities dealer shall send, upon request, the documents and information referred to in this section (a) to any broker, dealer or municipal securities dealer to which it sells new issue municipal securities no later than the business day following the request or, if an official statement in final form is being prepared but has not been received from the issuer or its agent, no later than the business day following such receipt. Such items shall be sent by first call mail or other equally prompt means, unless the purchasing broker, dealer or municipal securities dealer arranges some other method of delivery and pays or agrees to pay for such delivery.

(b)-(c) Relettered as (c)-(d).

Rule G-34. CUSIP Numbers and New Issue Requirements

(a)-(b) No change.

(c) CUSIP Number Eligibility Exemptions. The provisions of this rule shall not apply to an issue of municipal securities (or for the purpose of section (b) any part of an outstanding maturity of an issue) which (i) does not meet the eligibility criteria for CUSIP number assignment or (ii) consists entirely of municipal fund securities.

 


ENDNOTES

1. See "Municipal Fund Securities," MSRB Reports, Vol. 19, No. 2 (April 1999) at 9.

2. The Board understands that local government pools are established by state or local governmental entities as trusts that serve as vehicles for the pooled investment of public moneys of participating governmental entities. Participants purchase interests in the trust and trust assets are invested in a manner consistent with the trust's stated investment objectives. Investors generally do not have a right to control investment of trust assets. See generally National Association of State Treasurers ("NAST"), Special Report: Local Government Investment Pools (July 1995) (the "NAST Report"); Standard & Poor's Fund Services, Local Government Investment Pools (May 1999) (the "S&P Report").

3. The Board understands that higher education trusts generally are established by states under section 529(b) of the Internal Revenue Code as "qualified state tuition programs" through which individuals make investments for the purpose of accumulating savings for qualifying higher education costs of beneficiaries. Individuals purchase interests in the trust and trust assets are invested in a manner consistent with the trust's stated investment objectives. Investors do not have a right to control investment of trust assets. See generally College Savings Plans Network, Special Report on State and College Savings Plans (1998) (the "CSPN Report").

4. Letter dated February 26, 1999 from Catherine McGuire, Chief Counsel, Division of Market Regulation, SEC, to Diane G. Klinke, General Counsel of the Board, in response to letter dated June 2, 1998 from Diane G. Klinke to Catherine McGuire, published as Municipal Securities Rulemaking Board, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 032299033 (Feb. 26, 1999) (the "SEC Letter").

5. Dealers also should consider the applicability of Exchange Act Rule 15c2-12. SEC staff has stated:

[W]e note that Rule 15c2-12(f)(7) under the Exchange Act defines a "primary offering" as including an offering of municipal securities directly or indirectly by or on behalf of an issuer of such securities. Based upon an analysis of programs that have been brought to our attention, it appears that interests in local government pools or higher education trusts generally are offered only by direct purchase from the issuer. Accordingly, we would view those interests as having been sold in a "primary offering" as that term is defined in Rule 15c2-12. If a dealer is acting as an "underwriter" (as defined in Rule 15c2-12(f)(8)) in connection with that primary offering, the dealer may be subject to the requirements of Rule 15c2-12.

SEC Letter, supra note 4. Questions on Rule 15c2-12 should be directed to SEC staff.

6. See "Transactions in Municipal Collateralized Mortgage Obligations: Rule G-15," MSRB Reports, Vol. 12, No. 1 (April 1992) at 21; "Stripped Coupon Municipal Securities," MSRB Reports, Vol. 9, No. 1 (March 1989) at 3; "Taxable Securities," MSRB Reports, Vol. 6, No. 5 (Oct. 1986) at 5; "Tender Option Programs: SEC Response to Board Letter," MSRB Reports, Vol. 5, No. 2 (Feb. 1985) at 3; "Tax-Exempt Notes: Notice Concerning Application of Board Rules to Such Notes and of Filing of Rule Change," MSRB Reports, Vol. 2, No. 7 (Oct./Nov. 1982) at 17; "Application of Board's Rules to Municipal Commercial Paper," MSRB Reports, Vol. 2, No. 1 (Jan. 1982) at 9 (the "CP Notice"); "Application of Board's Rules to Participation Interests in Municipal Tax-Exempt Financing Arrangements," MSRB Reports, Vol. 2, No. 1 (Jan. 1982) at 13; "Notice Concerning Application of Board's Rules to MAC Warrants," [1977-1987 Transfer Binder] MSRB Manual (CCH) 10,171 (Jan. 22, 1981) (the "Warrant Notice").

7. Section 2(b) provides that the Investment Company Act shall not apply to a state, or any political subdivision of a state, or any agency, authority, or instrumentality thereof.

8. As noted in the March Notice, the definition of municipal fund security is not limited to local government pool or higher education trust interests that are municipal securities but also would apply to any municipal security of an issuer that, but for the identity of the issuer as a state or local governmental entity, would constitute an investment company under the Investment Company Act.

9. Municipal fund securities generally provide investment return and are valued based on the investment performance of an underlying pool of assets having an aggregate value that may increase or decrease from day to day, rather than providing interest payments at a stated rate or discount, as is the case for more traditional municipal securities. In addition, unlike traditional municipal securities, these interests do not have stated par values or maturity dates and cannot be priced based on yield or dollar price. See generally NAST Report, supra note 2; S&P Report, supra note 2; CSPN Report, supra note 3.

10. A commentator states that, although the Board has no authority to regulate either local government pool or higher education trust interests, it believes that interested parties would not resist "appropriate regulation" of higher education trust interests. It states that regulation of transactions in such interests is "arguably both more important and less controversial" than regulation of local government pool interests, noting that higher education trust interests "clearly affect public investors and the public interest."

11. Commentators observe that municipal securities are defined in Section 3(a)(29) of the Exchange Act as "securities which are direct obligations of, or obligations guaranteed as to principal or interest by, a State or any political subdivision thereof," in contrast to the language used in Section 3(a)(2) of the Securities Act of 1933 regarding any "security issued or guaranteed ... by any State of the United States, or by any political subdivision of a State or Territory." They quote a Senate report statement on the Securities Acts Amendments that "'municipal securities' refers to debt obligations of state and local government issuers." Senate Comm. on Banking, Housing and Urban Affairs, Securities Acts Amendments of 1975, S.Rep. No. 75, 94th Cong., 1st Sess. 38 (1975) (the "1975 Senate Report"); but cf. Securities Acts Amendments of 1975, H.R. Conf. Rep. No. 229, 94th Cong., 1st Sess. 101 (1975) (the "1975 Conference Report") (amendments "provide a comprehensive pattern for the registration and regulation of securities firms and banks which underwrite and trade securities issued by States and municipalities") (emphasis added). They note references in SEC no-action letters to obligations under the Internal Revenue Code to support their position that municipal securities are limited to debt obligations. See Itel Corp., SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 100581018 (Oct. 1, 1981) (the "Itel Letter"); Bedford-Watt Enterprises, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 062678019 (June 9, 1978) (the "Bedford-Watt Letter"). In addition, an SEC no-action letter is cited to suggest that an equity security may not be a municipal security. See City Employees' Retirement System of the City of Los Angeles, SEC No-Action Letter, [1977-1978 Dec.] Fed. Sec. L. Rep. (CCH) 81,194 (May 12, 1977) (the "CERS Letter").

12. Thus, non-dealer firms may act as investment advisers to local government pool or higher education trust programs and not become subject to Board rules.

13. SEC Letter, supra note 4.

14. See, e.g., Maine College Savings Program Fund, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 080999001 (Aug. 2, 1999) (the "Maine Letter");Teachers Personal Investors Services, Inc., SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 092898006 (Sept. 10, 1998) (the "TPIS Letter"); New Hampshire Higher Education Savings Plan Trust, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 070698010 (June 30, 1998) (the "New Hampshire Letter"); Public Employees Retirement Board of the State of Oregon, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 041398009 (March 3, 1998) (the "Oregon Letter"); North Carolina State Education Assistance Authority, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 032497016 (March 24, 1997) (the "North Carolina Letter"); Missouri Family Trust Fund, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 101392001 (Sept. 22, 1992) (the "Missouri Letter").

15. Maine Letter, supra note 14. SEC staff's position was conditioned on the dealer complying with all existing Board rules, other than those proposed to be amended in the March Notice, and complying with all Board rules upon completion of the current Board rulemaking process. Counsel had opined that the interests were direct obligations of an instrumentality of a state and therefore were municipal securities within the meaning of Section 3(a)(29) of the Exchange Act. See id. and accompanying letter of inquiry.

16. TPIS Letter, supra note 14. SEC staff stated that this no-action position expires six months after rule G-3 is amended to establish qualification requirements for persons selling such interests.

17. Id. Counsel had opined that the interests were direct obligations of an instrumentality of a state and, therefore, were municipal securities under the Exchange Act. See id. and accompanying letter of inquiry. See also New York State College Choice Tuition Savings Trust, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 091498008 (Sept. 10, 1998) and accompanying letter of inquiry.

18. See, e.g., Maine Letter, supra note 14; New Hampshire Letter, supra note 14; North Carolina Letter, supra note 14.

19. See Maine Letter, supra note 14, and accompanying letter of inquiry; New Hampshire Letter, supra note 14, and accompanying letter of inquiry; North Carolina Letter, supra note 14, and accompanying letter of inquiry. See also Missouri Letter, supra note 14, and accompanying letter of inquiry.

20. See Oregon Letter, supra note 14. Counsel opined that the interests would be exempt from the registration requirements of the Exchange Act as securities issued by a state instrumentality. See id. and accompanying letter of inquiry. See also Pennsylvania Local Government Investment Trust, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 022283009 (Feb. 21, 1983) (the "Pennsylvania Letter") and accompanying letter of inquiry, in which counsel opined that interests in a local government pool were municipal securities under the Exchange Act that qualified for the exemption from the registration requirements of Section 12(g) of the Exchange Act. SEC staff did not expressly rely on this opinion in arriving at its no-action position.

21. See, e.g., City of El Paso de Robles, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 111285020 (June 18, 1985) (the "El Paso de Robles Letter"); MAC Warrant Notice, supra note 6. The SEC's position with respect to these two types of non-debt securities stands in contrast to SEC staff's earlier position regarding call options in the CERS Letter, supra note 11.

22. See El Paso de Robles Letter, supra note 21.

23. MAC Warrant Notice, supra note 6. The MAC Warrant Notice was cited with approval by SEC staff in a letter to the Office of the Comptroller of the Currency. See letter dated August 12, 1981 (note 7) from Thomas G. Lovett, Attorney, SEC, to Owen Carney, Director, Investment Securities Division, Office of the Comptroller of the Currency (the "CP Letter"), reprinted in CP Notice, supra note 6, at 11.

24. See Itel Letter, supra note 11 (term "obligation" in Exchange Act definition of municipal security "would generally include" obligations under the Internal Revenue Code); Bedford-Watt Letter, supra note 11 (Internal Revenue Code "provides a useful analogy"). In the Bedford-Watt Letter, SEC staff recognized that "obligation" under Section 3(a)(29) of the Exchange Act could include non-financial obligations to take actions needed for payment of the security. See also Pennsylvania Letter and accompanying letter of inquiry, supra note 20. In arriving at its opinion that the local government pool interests described in the Pennsylvania Letter were municipal securities, counsel suggested, in reference to the definition of municipal securities in the Exchange Act, "that the word 'obligations' need not be read as 'debt' in this context. The Trust is under obligation to redeem all Shares of Beneficial Interest presented for redemption." In addition, the Chairman of the College Savings Plans Network noted in Congressional testimony that "state-sponsored college tuition programs are secured by the moral or political obligation of the states." Marshall Bennett, Testimony Before the House Committee on Ways and Means, Hearing on Reducing the Tax Burden: II. Providing Tax Relief to Strengthen the Family and Sustain a Strong Economy, 106th Cong., 1st Sess. (June 23, 1999), available at <http://www.house.gov/ways_means/fullcomm/106cong/6-23-99/6-23benn.htm> (visited Aug. 26, 1999) (emphasis added).

25. See El Paso de Robles Letter, supra note 21; MAC Warrant Notice, supra note 6.

26. See 1975 Senate Report, supra note 11, at 90, 92.

27. Id. at 92.

28. See, e.g., House Comm. on Interstate and Foreign Commerce, Federal Supervision of Traffic in Investment Securities in Interstate Commerce, H.R.Rep. No. 85, 73d Cong., 1st Sess. 6, 14 (1933) (the "1933 House Report").

29. Id. at 14. This view was confirmed the following year during House committee hearings on the Exchange Act by the Commissioner of the Federal Trade Commission, which was charged with enforcing the Securities Act. See Stock Exchange Regulation: Hearing on H.R. 7852 and H.R. 8720 Before the House Comm. on Interstate and Foreign Commerce, 73d Cong., 2d Sess. 899 (1934) (the "1934 House Hearings") (statement of James M. Landis, Commissioner, Federal Trade Commission). Commissioner Landis stated:

We had that same problem up in the Securities Act, where the exemption that is given to what might be called municipal bonds, and bonds of States and their instrumentalities, and is drawn according to a line that parallels the line that is drawn which makes tax-exempt municipal bonds, State instrumentalities, and so on. In other words, every instrumentality of a State which, like a municipality, or a political subdivision of a State, was exempted from taxation, would be exempted from registration upon an issue of securities. That is the line drawn in the Securities Act. If exempt from taxation they are also exempted from the necessity of registration under that act.

30. See, e.g., Securities Act: Hearings on S. 875 Before the Senate Comm. on Banking and Currency on S. 875, 73d Cong., 1st. Sess. 65 (1933) (the "1933 Senate Hearings") (statement of Sen. Reynolds); id. at 228, 232 (statement of Sen. Kean); id. at 232 (statement of Sen. Costigan); id. at 303 (statement of Sen. Norbeck); 77 Cong. Rec. 2925 (1933) (statement of Rep. Studley).

31. See 1934 House Hearings, supra note 29, at 822 (statement of Rep. Pettingill); id. at 898-9 (statements of James M. Landis, Commissioner, Federal Trade Commission; Rep. Pettingill). This concern also served as a primary basis for the exemption of municipal securities under the Securities Act. See 1933 House Report, supra note 28, at 14, and text accompanying note 29 above.

32. See 1934 House Hearings, supra note 29, at 721, 911-3 (statement of Rep. Holmes); Stock Exchange Practices: Hearings on S. Res. 84 and S. Res. 56 and S. Res. 97 Before the Senate Comm. on Banking and Currency, 73d Cong., 1st Sess. 7441-52 (1934) (the "1934 Senate Hearings") (statements of Archibald B. Roosevelt, Roosevelt & Weifold, Inc.; George B. Gibbons, George B. Gibbons & Co.; Sen. Gore; Sen. Goldsborough).

33. See 1934 House Hearings, supra note 29, at 720 (statement of Rep. Holmes).

34. See 1934 Senate Hearings, supra note 32, at 7413 (statements of H.H. Cotton, Investment Bank of Los Angeles; Ferdinand Pecora, Counsel to the Committee; Sen. Fletcher); id. at 7477 (statements of Tom K. Smith, Assistant to the Secretary of the Treasury; Sen. Adams; Sen. Walcott); 1934 House Hearings, supra note 29, at 7201(statements of Tom K. Smith, Assistant to the Secretary of the Treasury; Rep. Holmes); id. at 819-23 (statements of George B. Gibbons, George B. Gibbons & Co.; Rep. Merritt; Rep. Rayburn; Rep. Pettengill).

35. See note 29 above and accompanying text.

36. The phrase "security issued or guaranteed by" used in Section 3(a)(2) of the Securities Act introduces bank securities (including bank equity securities) as well as government and municipal securities. In contrast, the phrase "securities which are direct obligations of or obligations guaranteed as to principal or interest by" used in Section 3(a)(12) of the Exchange Act introduced only municipal and government securities. Thus, even though the drafters of both the Securities Act and the Exchange Act thought of municipal and government securities solely as debt securities, the term "obligation" (to the extent such term is limited to debt securities) could only be used in the Exchange Act.

37. 1975 Senate Report, supra note 11, at 47. See also CP Letter (note 7), supra note 23.

38. In testimony at a 1975 Senate committee hearing on the Securities Acts Amendments, a representative of the Municipal Finance Officers Association stated that the municipal securities market "is completely a debt market." Securities Acts Amendments of 1975: Hearings on S. 249 Before the Senate Comm. on Banking, Housing and Urban Affairs, 94th Cong., 1st Sess. 479 (1975) (statement of Michael S. Zarin, Member, Comm. on Governmental Debt Administration, Municipal Finance Officers Association). Having been so informed, the Senate's description in the 1975 Senate Report, supra note 11, at 38, of municipal securities as "debt obligations of state and local government issuers," as noted by some commentators on the March Notice, in fact merely reflected an understanding of the nature of the municipal securities market at such time, not an understanding that the Exchange Act definition of municipal securities was to be limited only to the debt segment of a broader municipal market that might also include equity securities.

39. As noted above, one commentator concedes that interests in higher education trusts "clearly affect public investors and the public interest."

40. Commentators list Congressional concern about unconscionable markups, churning of accounts, misrepresentations, disregard of suitability standards, high-pressure sales techniques, fraudulent trading practices resulting in substantial losses to public investors, and threats to the integrity of the local government capital-raising system. They argue that there is no opportunity for unconscionable markups and little incentive for churning of accounts or use of high-pressure sales techniques for these interests because they are purchased and redeemed at the current net asset value and purchasers do not pay commissions. Commentators also argue that suitability concerns are not raised since local government pools are operated like money market funds and invest solely in the types of investments that their participants are permitted by state law to purchase.

41. One commentator states that protections exist under the Investment Advisers Act of 1940, state regulations, voluntary adherence to the Investment Company Act and related federal regulations applicable to investment company securities, and Governmental Accounting Standards Board Statement No. 31 relating to accounting and financial reporting for certain investments and for external investment pools.

42. See 1975 Conference Report, supra note 11, at 101.

43. As originally proposed, rule D-9 would have excluded from the definition of customer "the issuer of securities which are the subject of the transaction in question." See "Notice of Filing of Fair Practice Rules," [1977-1987 Transfer Binder] MSRB Manual (CCH) 10,030 (Sept. 20, 1977). In amending the original proposed rule language to limit this exclusion solely to "the issuer in connection with the sale of a new issue of its securities," the Board stated that it believed "that the protections afforded customers by its rules should be extended to issuers when they act in secondary market transactions." See "Notice of Filing of Amendments to Fair Practice Rules," [1977-1987 Transfer Binder] MSRB Manual (CCH) 10,058 (Feb. 28, 1978). Given that the Board has always felt that issuers should be considered customers even in secondary market transactions involving their own securities, issuers certainly should be considered customers in transactions involving securities of other issuers. Furthermore, in Congressional testimony on the bankruptcy filing of Orange County, California and its local government pool, SEC Chairman Arthur Levitt discussed customer protection rules of self-regulatory organizations as they may apply to state or local governmental entities acting as customers. See Derivative Financial Instruments Relating to Banks and Financial Institutions: Hearings Before the Senate Comm. on Banking, Housing and Urban Affairs, 104th Cong., 1st Sess. (1995) ("SEC Testimony").

44. S&P Report, supra note 2, at 3, 6-11. The Board takes no position as to which of these local government pools may issue interests that would constitute municipal fund securities.

45. Id. at 3.

46. One commentator identifies several state-run and county-run pools (including the Orange County, California pool) as having had recent financial difficulties. See also NAST Report, supra note 2, at 2, 5, 38; S&P Report, supra note 2, at 5.

47. NAST has stated that it:

recognizes that potential pool participants have numerous alternative investment vehicles from which to choose. The goal of the … [NAST Guidelines for Local Government Investment Pools] is to insure that local government investment officials, when choosing among their available investment options, are fully aware of significant investment and administrative policies, practices and restrictions of the pool and are thereby able to make informed investment decisions on behalf of the local governments. … NAST further recommends that the broker/dealer community govern itself to follow the same standards of conduct NAST has recommended for treasurers.

NAST Report, supra note 2, at 8. As the self-regulatory organization established by Congress to adopt rules for dealer transactions in municipal securities, the Board has created a body of rules which, together with these proposed rule changes, constitute the self-governance and standards of conduct which NAST has recommended be established.

48. The Board understands that investment strategies, pay-out restrictions, and fees and redemption charges or penalties of the existing higher education trusts vary. At least some higher education trusts permit sales of interests to persons living in other states and permit redemption proceeds to be used to pay higher education expenses in any state. In other cases, redemption proceeds may be limited for use within a specific state. See generally CSPN Report, supra note 3. Thus, a single customer may have a choice of investments in various higher education trusts having widely differing investment strategies and terms. The Board takes no position as to which of these higher education trusts may issue interests that would constitute municipal fund securities.

49. See NAST Report, supra note 2, at 8 ("The investment alternatives offered by brokers/dealers to public finance officials should be suitable for the public entity's objectives."). The fact that a local government pool's assets are invested in investments that are legally available as direct investments by local governments does not resolve suitability issues. See note 39 above. As with transactions in any other municipal security, rule G-19 would require a dealer recommending a transaction in a municipal fund security to 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. These suitability requirements do not differ in substance from those of the NASD, to which dealers effecting transactions in such interests might otherwise be subject if these interests are not municipal securities. See also SEC Testimony, supra note 43.

50. See, e.g., Sections 15(b)(3) and 15B(a)(3) of the Exchange Act.

51. Actual interpretations relating to how certain rules would be applied to transactions in municipal fund securities would be filed with the SEC to the extent required under Section 19(b) of the Exchange Act and Exchange Act Rule 19b-4.

52. This view regarding sales of municipal fund securities as part of a primary offering is based on SEC staff's statement in the SEC Letter, supra note 4, that it would view such securities as having been sold in a primary offering for purposes of Rule 15c2-12.

53. Two commentators suggest that the Board exempt municipal fund securities from the prohibition in rule A-13(e) from passing through underwriting assessments to issuers.

54. Commentators note that many local government pools have annual share turn-over rates of 3 to 4 times their assets, due to the fact that many participants are investing short-term funds that move in and out of the pools frequently during the course of the year. Another commentator believes that this multiplier may reach as high as 10 times assets. One commentator estimates that total issuances of interests in local government pools may be on the same order of magnitude as issuances of traditional municipal securities.

55. In the alternative, some commentators suggest that underwriting assessments should be based on net issuances of municipal fund securities, taking into account all securities retired. Another commentator suggests a flat annual or monthly fee set at a modest level.

56. Two commentators suggest that local government pool interests be excluded from this definition. The Board declines to do so for the reasons noted above.

57. Thus, an associated person who sells both municipal fund securities and other types of municipal securities would be required to qualify as a municipal securities representative or general securities representative.

58. One commentator suggests exempting dealers in local government pool interests from the requirement of having municipal securities principals, provided that they meet the requirements regarding principals established by the NASD. The Board believes that dealers effecting transactions in municipal fund securities must have a municipal securities principal who is required to be familiar with Board rules.

59. Several factors influenced the Board's determination to exempt such securities from rule G-14, as set forth in the March Notice. If the Board receives information in the future that practices have developed in the municipal fund security market that merit reporting of transaction information, it will consider whether to revisit the exemption from rule G-14.

60. Disclosure of deferred commissions or other charges would cover, for example, any deferred sales load or, in the case of interests in certain higher education trusts, any penalty imposed on a redemption that is not for a qualifying higher education expense.

61. In addition to the comments described below, one commentator suggests that the draft amendment relating to disclosure of deferred commissions or redemption charges be clarified to indicate that information may be disclosed in a program description document together with the confirmation or periodic statement. The Board believes that this provision does not require revision since it already permits disclosure of such information in a document separate from the confirmation or periodic statement, although the confirmation or periodic statement must disclose that such deferred commission or charge may exist and that information will be furnished upon written request.

62. They note that individual confirmations for the frequent purchases and redemptions of local government pool interests would impose high administrative and cost burdens.

63. It states that this would be "analogous to and consistent with" the provisions of Rule 10b-10 permitting periodic statements in lieu of confirmations for non-periodic transactions in tax-qualified individual retirement and individual pension plans.

64. In addition, the Board has made a minor language change to paragraph (a)(vi)(G) to make clearer that quarterly statements in lieu of individual confirmations also would be available for arrangements involving a group of two or more customers.

65. A commentator states that requiring customer consent to receive quarterly statements would impose administrative burdens on dealers that are not justified by any investor protection interest. It notes practical difficulties with sending confirmations to some members of a group plan and quarterly statements to others, stating that if the dealer fails to receive consent from any customer, it might be forced to send individual confirmations to all customers. The commentator states that, in adopting the investment company plan exception to the confirmation requirements in Rule 10b-10, the SEC recognized that securities sold through such plans do not require the same level of reporting as other securities transactions since their regularized nature raised fewer concerns about whether a particular transaction was executed consistent with the expectations of the customer.

66. A commentator states that municipal fund securities will not be issued in certificated form and therefore the delivery provisions under subparagraph (a)(i)(A)(7) would not be relevant. Subparagraph (a)(i)(A)(7) would require that the confirmation for a municipal fund security transaction indicate the purchase price (exclusive of commission) of each share or unit and the number of shares or units to be delivered, regardless of whether a physical or book-entry delivery of the securities will occur.

67. The commentator states that such securities are ineligible for ratings and such notation might be misleading. However, the Board notes that a relatively small number of local government pools have in fact been rated. See NAST Report, supra note 2, at 36. See generally S&P Report, supra note 2.

68. The Board understands that, in the context of local government pools, the term "yield" may be used to refer to historical returns that may be used as a basis for comparing investment performance. See NAST Report, supra note 2, at 8. References in rule G-21 to yield, consistent with its use in other Board rules, refer to a future rate of return on securities and do not refer to historical yields. The Board notes that any use of historical yields would be subject to section (c) of rule G-21, which provides that no dealer shall publish or cause to be published any advertisement concerning municipal securities which such dealer knows or has reason to know is materially false or misleading. Thus, a dealer advertisement of municipal fund securities that refers to yield typically would require a description of the nature and significance of the yield shown in the advertisement in order to assure that such advertisement is not false or misleading.

69. Rule G-32 defines underwriting period for securities purchased by a dealer (not in a syndicate) as the period commencing with the first submission to the dealer of an order for the purchase of the securities or the purchase of the securities from the issuer, whichever first occurs, and ending at such time as the following two conditions both are met: (1) the issuer delivers the securities to the dealer, and (2) the dealer no longer retains an unsold balance of the securities purchased from the issuer or 21 calendar days elapse after the date of the first submission of an order for the securities, whichever first occurs. However, since the issuer continuously delivers municipal fund securities, the first condition for the termination of the underwriting period remains unmet.

70. In addition, in the case of a repeat purchaser of municipal fund securities for which no official statement in final form is being prepared, no new delivery of the written notice to that effect or of any official statement in preliminary form would be required so long as the customer has previously received it in connection with a prior purchase. However, if an official statement in final form is subsequently prepared, the customer's next purchase would trigger the delivery requirement with respect to such official statement.

71. Dealers may still elect to acquire CUSIP numbers for municipal fund securities and to make such securities depository eligible, subject to meeting all of the eligibility requirements of the CUSIP Service Bureau and of any securities depository, respectively.

72. If the primary offering is exempt from Rule 15c2-12 (other than as a result of being a limited offering as described in section (d)(1)(i) of the Rule) and an official statement has been prepared by the issuer, then the dealer would be expected to send the official statement, together with Form G-36(OS), to the Board under rule G-36(c)(i).

73. Rule G-36(d) provides that a dealer that has previously sent an official statement to the Board also is required to send to the Board any amendments made by the issuer during the underwriting period. In view of the extended underwriting period for municipal fund securities and the possibility that the issuer may change the dealer that participates in the sale of the securities during the life of the program, the Board would interpret this provision of the rule to obligate any dealer that is at the time of an amendment then serving as underwriter for the municipal fund securities to send the amendment to the Board, regardless of whether that dealer or another dealer sent the original official statement to the Board.

74. Underlining indicates additions to existing Board rules; strikethrough indicates deletions from existing Board rules.

 

Contents | Home Page

Copyright 2000 Municipal Securities Rulemaking Board. All Rights Reserved. Terms and Conditions of Use