Rule G-37, on political contributions and prohibitions on municipal securities business, prohibits any broker, dealer or municipal securities dealer (a "dealer") from engaging in municipal securities business with an issuer within two years after any contribution (other than certain de minimis contributions) to an official of such issuer made by: (i) the dealer; (ii) any municipal finance professional associated with such dealer; or (iii) any political action committee controlled by the dealer or any municipal finance professional. The Municipal Securities Rulemaking Board ("MSRB") has received inquiries regarding the effect of a ban on municipal securities business with an issuer arising from a contribution made after a dealer has entered into a long-term contract to serve as the primary distributor of the issuer's municipal fund securities.

In an interpretive notice published in 1997 (the "1997 Interpretation"), the MSRB stated that a dealer subject to a prohibition on municipal securities business with an issuer is allowed to continue to execute certain issue-specific contractual obligations in effect prior to the date of the contribution that caused the prohibition.[1] For example, dealers that had already executed a contract with the issuer to serve as underwriter or financial advisor for a new issue of debt securities prior to the contribution could continue in these capacities.

The 1997 Interpretation also addressed certain types of on-going, non-issue-specific municipal securities business that a dealer may have contracted with an issuer to perform prior to the making of a contribution that causes a prohibition on municipal securities business with the issuer. For example, the MSRB noted that a dealer may act as remarketing agent for an outstanding issue of municipal securities or may continue to underwrite a specific commercial paper program so long as the contract for such services was in effect prior to the contribution. The MSRB stated that these activities are not considered new municipal securities business and may be performed by dealers that are banned from municipal securities business with an issuer. The MSRB further stated, however, that provisions in existing contracts that allow for changes in the services provided by the dealer or compensation paid by the issuer would be viewed by the MSRB as new municipal securities business and, therefore, rule G-37 would preclude a dealer subject to a ban on municipal securities business from performing such additional functions or receiving additional compensation. The MSRB cited two examples of these types of provisions. The first involved a contract to serve as remarketing agent for a variable rate issue that might permit a fixed rate conversion, with a concomitant increase in the per bond compensation. The second example involved an agreement to underwrite a commercial paper program that might include terms for increasing the size of the program, with no increase in per bond fees but an increase in overall compensation resulting from the larger outstanding balance of commercial paper. In both cases, the MSRB viewed the exercise of these provisions as new municipal securities business that would be banned under the rule.

In the 1997 Interpretation, the MSRB recognized that there is great variety in the terms of agreements regarding municipal securities business and that its guidance in the 1997 Interpretation may not adequately deal with all such agreements. The MSRB sought input on other situations where contracts obligate dealers to perform various types of activities after the date of a contribution that triggers a ban on municipal securities business and stated that additional interpretations might be issued based upon such input.

The MSRB understands that dealers typically are selected by issuers to serve as primary distributors of municipal fund securities on terms that differ significantly from those of a dealer selected to underwrite an issue of debt securities. Issuers generally enter into long-term agreements (in many cases with terms of ten years or longer) with the primary distributor of municipal fund securities for services that include the sale in a continuous primary offering of one or more categories or classes of the securities issued within the framework of a single program of investments.[2] In addition, an issuer may often engage a particular dealer to serve as the primary distributor of its municipal fund securities as part of a team of professionals that includes the dealer's affiliated investment management firm, which is charged with managing the investment of the underlying portfolios.

The MSRB believes that the guidance provided in the 1997 Interpretation, although appropriate for the circumstances discussed therein, may not be adequate to address the unique features of municipal fund securities programs. For example, so long as a program realizes net in-flows of investor cash, the size of an offering of municipal fund securities will necessarily increase over time. Under most compensation arrangements in the market, any net in-flow of cash generally would result in an increase in total compensation, causing any new sales of municipal fund securities that exceed redemptions to be considered new municipal securities business under the 1997 Interpretation. Also, the addition by the issuer of a new category of investments (e.g., a new portfolio in an aged-based Section 529 college savings plan created for children born in the most recent year) could be considered a new offering from which such dealer might be banned, even where such new category may have been clearly contemplated at the outset of the dealer's engagement. Further, the MSRB understands that the repercussions to an issuer of municipal fund securities or investors in such securities of a sudden change in the primary distributor (and possible concurrent change in the investment manager) resulting from a ban on municipal securities business arising during the term of an existing arrangement often will be significantly greater than in the case of an underwriting or other primary market activity relating to the typical debt offering. Issuers could be faced with redesigning existing programs and investors may need to establish new relationships with different dealers in order to maintain their investments.

As a result, the MSRB believes that further interpretive guidance is necessary in this area. The MSRB is of the view that, where a dealer has become subject to a ban on municipal securities business with an issuer of municipal fund securities with which it is currently serving as primary distributor, any continued sales of existing categories of municipal fund securities for such issuer during the duration of the ban would not be considered new municipal securities business if the basis for determining compensation does not change during that period, even if total compensation increases as a result of net in-flows of cash. Further, the MSRB believes that any changes in the services to be provided by the dealer to the issuer throughout the duration of the ban that are contemplated under the pre-existing contractual arrangement (e.g., the addition of new categories of securities within the framework of the existing program) would not be considered new municipal securities business so long as such changes do not result in: (1) an increase in total compensation received by the dealer for services performed for the duration of the ban (whether paid during the ban or as a deferred payment after the ban); or (2) in an extension of the term of the dealer in its current role.

Separately identifiable department or division of a bank. This will acknowledge receipt of your letter of November 12, 1975, in which you request, on behalf of the Dealer Bank Association, an interpretative opinion with respect to the rule of the Municipal Securities Rulemaking Board (the "Board") defining the term "separately identifiable department or division of a bank," as used in section 3(a)(30) of the Securities Exchange Act of 1934, as amended (the "Act"). Such rule was originally numbered rule 4 of the Board and became effective on October 15, 1975. The rule is presently numbered rule G-1 of the Board.

In your letter you pose a series of questions concerning rule G-1, as follows: 

1. A bank has an operations department that performs processing and clearance activities, and maintains records, with respect to the bank's underwriting, trading and sales of municipal securities, as well as with respect to certain other bank activities. Can this bank have a "separately identifiable department or division" as defined in rule G-1?
2. In a bank with numerous branches, an employee or officer in a branch will on occasion accept or solicit an order from a customer for municipal securities. Does this preclude a finding that the bank has a "separately identifiable department or division"?
3. Mr. X is a senior vice president of a bank. He is not a director. Mr. X's only relationship to the bank's municipal securities dealer activities is that he is a member of a management committee within the bank that determines the amount of the bank's funds that will be made available for the bank's municipal securities dealer activities, as well as for other bank activities. The bank has a separately identifiable department or division that otherwise meets the requirements of rule G-1. Is Mr. X a person who must be designated by the board of directors of the bank under rule G-1(a)(1)?
4. A bank has a corporate trust department that, among other things, serves as paying agent for certain municipal securities and performs clearing functions in municipal securities, in addition to the processing and clearance activities performed in connection with the bank's underwriting, trading and sales of municipal securities. Are the persons in the bank's corporate trust department who engage solely in activities that do not relate to the underwriting, trading and sales of municipal securities by the bank performing municipal securities dealer activities?

With respect to question (1) above, paragraph (d) of rule G-1 contemplates that the municipal securities dealer activities of a bank, as such activities are defined in paragraph (b) of the rule, may be conducted in more than one organizational or operational unit of the bank, for example, underwriting, trading and sales activities in the bond department, and processing and clearance activities in the operations department of the bank. Under the rule, all such units can be aggregated to constitute a separately identifiable department or division within the meaning of section 3(a)(30) of the Act, provided that each such unit is identifiable and under the direct supervision of an officer designated by the board of directors of the bank as responsible for the day-to-day conduct of the bank's municipal securities dealer activities. The officer so designated need not be the same for all such units. For example, the senior officer of the bank's bond department may be designated as responsible for the municipal securities dealer activities conducted by that department, while the senior officer of the bank's operations department may be designated as responsible for the municipal securities dealer activities conducted by that department. In addition, the records of each such unit relating to municipal securities dealer activities must be separately maintained or separately extractable so as to permit independent examination of such records and enforcement of applicable provisions of the Act, the rules and regulations of the Commission thereunder and the rules of the Board. Finally, each such unit comprising the separately identifiable department or division may be engaged in activities other than those relating to municipal securities dealer activities. For example, the bond department may also engage in activities relating to United States government obligations, while the operations department may perform processing and clearance functions for departments of the bank other than the bond department.

With respect to question (2) above, paragraph (d) of rule G-1 also contemplates that the municipal securities dealer activities of a bank may be conducted at more than one geographic location. However, in order for such a bank to have a separately identifiable department or division, the branch employees who accept or solicit orders for municipal securities must, with respect to acceptance or solicitation of such orders, be affiliated with one of the identifiable units of the bank comprising such department or division and must, with respect to acceptance or solicitation of such orders, be responsible to an officer designated by the board of directors of the bank as responsible for the day-to-day conduct of the bank's municipal securities dealer activities. Further, the bank's records relating to the transactions effected by such branch employees must meet the criteria of paragraph (a) of rule G-1 with respect to separate maintenance and accessibility.

With respect to question (3) above, paragraph (c) of rule G-1 recognizes that senior officers of a bank may make determinations affecting bank policy as a whole which have an indirect effect on the municipal securities dealer activities of the bank. For example, determinations with respect to the deployment of the bank's funds may affect the size of the bank's inventory of municipal securities or volume of underwriting. Ordinarily such determinations would not directly relate to the day-to-day conduct of the bank's municipal securities dealer activities and senior officers making such determinations need not be designated by the board of directors of the bank as responsible for the conduct of such activities. However, if the determinations of senior officers have a direct and immediate impact on the day-to-day conduct of the bank's municipal securities dealer activities, whether by reason of the scope of such determinations, the frequency with which such determinations are made, or by reason of other factors, such officers may be considered to be directly engaged in the conduct of the bank's municipal securities dealer activities and required to be designated by the board of directors of the bank as responsible for the day-to-day conduct of such activities.

With respect to question (4) above, the regulatory focus of section 15B(b)(2)(H) of the Act is on the dealer activities of a bank. Accordingly, subparagraph (b)(2) of rule G-1 was intended to relate to such dealer activities, and not to describe other activities of the bank which might involve municipal securities. Employees of a bank's corporate trust department who perform clearance and other functions with respect to municipal securities, but which do not relate to the underwriting, trading and sales activities of the bank, do not perform municipal securities dealer activities within the meaning of rule G-1.

This opinion is rendered on behalf of the Board, pursuant to authority delegated by the Board. Copies of this opinion are being sent to the Securities and Exchange Commission, the bank regulatory agencies and the National Association of Securities Dealers, Inc. MSRB interpretation of November 17, 1975.