Background

In the municipal securities markets, dealers[1] typically communicate with investors one-on-one, in person, or by telephone. These dealer/customer communications are made to provide the investor with information concerning the municipal securities the dealer wants to sell and to allow the dealer to find out about the customer’s investment objectives. Over the last few years there has been a dramatic increase in the use of the Internet for communication between dealers and their customers. Dealers are looking to the Internet as a mechanism for offering customers new and improved services and for enhancing the efficiency of delivering traditional services to customers. For example, dealers have developed online search tools that computerize the process by which customers can obtain and compare information on the availability of municipal securities of a specific type that are offered for sale by a particular dealer.[2] Technological advancements have provided many benefits to investors and the brokerage industry. These technological innovations, however, also have presented new regulatory challenges, including those arising from the application of the suitability rule to online activities. In consideration of this, the Municipal Securities Rulemaking Board (“MSRB”) is issuing this notice to provide dealers with guidance concerning their obligations under MSRB Rule G-19, relating to suitability of recommendations,[3] in the electronic environment.[4]

Rule G-19 prohibits a dealer from recommending transactions in municipal securities to a customer unless the dealer makes certain determinations with respect to the suitability of the transactions.[5] Specifically, the dealer must have reasonable grounds for believing that the recommendation is suitable based upon information available from the issuer of the security or otherwise and the facts disclosed by the customer or otherwise known about such customer.

As the rule states, a dealer's suitability obligation only applies to securities that the dealer recommends to a customer.[6] A dealer or associated person who simply effects a trade initiated by a customer without a related recommendation from the dealer or associated person is not required to perform a suitability analysis. However, under MSRB Rules, even when a dealer does not recommend a municipal security transaction to a customer but simply effects or executes the transaction, the dealer is obligated to fulfill certain other important fair practice obligations. For example, under Rule G-17, when effecting a municipal security transaction for a customer, a dealer is required to disclose all material facts about a municipal security that are known by the dealer and those that are reasonably accessible.[7] In addition, Rule G-18 requires that each dealer, when executing a municipal securities transaction for or on behalf of a customer as agent, make a reasonable effort to obtain a price for the customer that is fair and reasonable in relation to prevailing market conditions. Similarly, under Rule G-30, if a dealer engages in principal transactions with a customer, the dealer is responsible for ensuring that it is charging a fair and reasonable price. The MSRB wishes to emphasize the importance of these fair practice obligations even when a dealer effects a non-recommended transaction online.[8]

Applicability of the Suitability Rule to Electronic Communications—General Principles  

There has been much debate about the application of the suitability rule to online activities.[9]  Industry commentators and regulators have debated two questions: first, whether the current suitability rule should even apply to online activities, and second, if so, what types of online communications constitute recommendations for purposes of the rule. The NASD published NASD Notice to Members 01-23, Online Suitability-Suitability Rule and Online Communication (the “NASD Online Suitability Notice”) (April 2001) to provide guidance to its members in April 2001.[10] In answer to the first question, the MSRB, like the NASD, believes that the suitability rule applies to all recommendations made by dealers to customers—including those made via electronic means—to purchase, sell, or exchange a security. Electronic communications from dealers to their customers clearly can constitute recommendations. The suitability rule, therefore, remains fully applicable to online activities in those cases where the dealer recommends securities to its customers. 

With regard to the second question, the MSRB does not seek to identify in this notice all of the types of electronic communications that may constitute recommendations. As the MSRB has often emphasized, "[w]hether a particular transaction is in fact recommended depends on an analysis of all the relevant facts and circumstances."[11] That is, the test for determining whether any communication (electronic or traditional) constitutes a recommendation remains a "facts and circumstances" inquiry to be conducted on a case-by-case basis. 

The MSRB also recognizes that many forms of electronic communications defy easy characterization. The MSRB believes this is especially true in the online municipal securities market, which is in a relatively early stage of development. Nevertheless, the MSRB offers as guidance the following general principles for dealers to use in determining whether a particular communication could be deemed a recommendation.[12] The "facts and circumstances" determination of whether a communication is a recommendation requires an analysis of the content, context, and presentation of the particular communication or set of communications. The determination of whether a recommendation has been made, moreover, is an objective rather than a subjective inquiry. An important factor in this regard is whether—given its content, context, and manner of presentation—a particular communication from a dealer to a customer reasonably would be viewed as a "call to action," or suggestion that the customer engage in a securities transaction. Dealers should bear in mind that an analysis of the content, context, and manner of presentation of a communication requires examination of the underlying substantive information transmitted to the customer and consideration of any other facts and circumstances, such as any accompanying explanatory message from the dealer.[13] Another principle that dealers should keep in mind is that, in general, the more individually tailored the communication is to a specific customer or a targeted group of customers about a security or group of securities, the greater the likelihood is that the communication may be viewed as a recommendation.

Scope of the Term Recommendation

As noted earlier, the MSRB agrees with and has in this guidance adopted the general principles enunciated in the NASD Online Suitability Notice as well as the NASD guidelines for evaluating suitability obligations discussed below. While the MSRB believes that the additional examples of communications that do not constitute recommendations provided by the NASD in its Online Suitability Notice are useful instruction for dealers who develop equity trading web sites, as the examples are based upon communications that exist with great regularity in the Nasdaq market, the MSRB believes that the examples have limited application to the types of information and electronic trading systems that are present in the municipal securities market. 

For example, the NASD’s third example of a communication that is not a recommendation describes a system that permits customer-directed searches of a “wide-universe” of securities and references all exchange-listed or Nasdaq securities, or externally recognized indexes.[14] The NASD example therefore applies to dealer web sites that effectively allow customers to request lists of securities that meet broad objective criteria from a list of all the securities available on an exchange or Nasdaq. These are examples of groups of securities in which the dealer does not exercise any discretion as to which securities are contained within the group of securities shown to customers. This example makes sense in the equity market where there are centralized exchanges and where electronic trading platforms routinely utilize databases that provide customer access to all of the approximately 7,300 listed securities on Nasdaq, the NYSE and Amex. However, no dealer in the municipal securities market has the ability to offer all of the approximately 1.3 million outstanding municipal securities for sale or purchase. The municipal securities market is a fragmented dealer market. Municipal securities do not trade through a centralized exchange and only a small number of securities (approximately 10,000) trade at all on any given day. Therefore, there is no comparable central exchange that could serve as a reference point for a database that is used in connection with municipal securities research engines. The databases used by dealer systems typically are limited to the municipal securities that a dealer, or a consortium of dealers, holds in inventory. In these types of systems the customer’s ability to search for desirable securities that meet the broad, objective criteria chosen by the customer (e.g., all insured investment grade general obligation bonds offered by a particular state) is limited. The concept of a wide universe of securities, which is central to all of the NASD’s examples, is thus difficult to define and has extremely limited, or no, application in the municipal securities market. 

Given the distinct features of the municipal securities market and the existing online trading systems, the MSRB believes it would be impractical to attempt to define the features of an electronic trading system that would have to be present for the system transactions to not be considered the result of a dealer recommendation. The online trading systems for municipal securities that are in place today limit customer choices to the inventory that the dealer or dealer consortium hold, and therefore, the dealer will always have a significant degree of discretion over the securities offered to the customer. A system that allows this degree of dealer discretion is a dramatic departure from the types of no recommendation examples provided by the NASD guidance, and thus, these communications must be carefully analyzed to determine whether or not a recommendation has been made.  

 The MSRB, however, does believe that the examples of communications that are recommendations provided in the NASD Online Suitability Notice are communications that take place in the municipal securities market. Therefore, the MSRB has adopted these examples and generally would view the following communications as falling within the definition of recommendation:

• A dealer sends a customer-specific electronic communication (e.g., an e-mail or pop-up screen) to a targeted customer or targeted group of customers encouraging the particular customer(s) to purchase a municipal security.[15]
• A dealer sends its customers an e-mail stating that customers should be invested in municipal securities from a particular state or municipal securities backed by a particular sector (such as higher education) and urges customers to purchase one or more stocks from a list with "buy" recommendations.
• A dealer provides a portfolio analysis tool that allows a customer to indicate an investment goal and input personalized information such as age, financial condition, and risk tolerance. The dealer in this instance then sends (or displays to) the customer a list of specific municipal securities the customer could buy or sell to meet the investment goal the customer has indicated.[16]
• A dealer uses data-mining technology (the electronic collection of information on Web Site users) to analyze a customer's financial or online activity—whether or not known by the customer—and then, based on those observations, sends (or "pushes") specific investment suggestions that the customer purchase or sell a municipal security.

Dealers should keep in mind that these examples are meant only to provide guidance and are not an exhaustive list of communications that the MSRB does consider to be recommendations. As stated earlier, many other types of electronic communications are not easily characterized. In addition, changes to the factual predicates upon which these examples are based (or the existence of additional factors) could alter the determination of whether similar communications may or may not be viewed as recommendations. Dealers, therefore, should analyze all relevant facts and circumstances, bearing in mind the general principles noted earlier and discussed below, to determine whether a communication is a recommendation, and they should take the necessary steps to fulfill their suitability obligations. Furthermore, these examples are based on technological services that are currently used in the marketplace. They are not intended to direct or limit the future development of delivery methods or products and services provided online.  

Guidelines for Evaluating Suitability Obligations 

Dealers should consider, at a minimum, the following guidelines when evaluating their suitability obligations with respect to municipal securities transactions.[17] None of these guidelines is determinative of whether a recommendation exists. However, each should be considered in evaluating all of the facts and circumstances surrounding the communication and transaction.

• A dealer cannot avoid or discharge its suitability obligation through a disclaimer where the particular communication reasonably would be viewed as a recommendation given its content, context, and presentation.[18] The MSRB, however, encourages dealers to include on their web sites (and in other means of communication with their customers) clear explanations of the use and limitations of tools offered on those sites.[19]   
• Dealers should analyze any communication about a security that reasonably could be viewed as a "call to action" and that they direct, or appear to direct, to a particular individual or targeted group of individuals—as opposed to statements that are generally made available to all customers or the public at large—to determine whether a recommendation is being made.[20]
• Dealers should scrutinize any communication to a customer that suggests the purchase, sale, or exchange of a municipal security—as opposed to simply providing objective data about a security—to determine whether a recommendation is being made.[21] 
• A dealer's transmission of unrequested information will not necessarily constitute a recommendation. However, when a dealer decides to send a particular customer unrequested information about a security that is not of a generalized or administrative nature (e.g., notification of an official communication), the dealer should carefully review the circumstances under which the information is being provided, the manner in which the information is delivered to the customer, the content of the communication, and the original source of the information. The dealer should perform this review regardless of whether the decision to send the information is made by a representative employed by the dealer or by a computer software program used by the dealer.
• Dealers should be aware that the degree to which the communication reasonably would influence an investor to trade a particular municipal security or group of municipal securities—either through the context or manner of presentation or the language used in the communication—may be considered in determining whether a recommendation is being made to the customer.

The MSRB emphasizes that the factors listed above are guidelines that may assist dealers in complying with the suitability rule. Again, the presence or absence of any of these factors does not by itself control whether a recommendation has been made or whether the dealer has complied with the suitability rule. Such determinations can be made only on a case-by-case basis taking into account all of the relevant facts and circumstances.

Conclusion

The foregoing discussion highlights some suggested principles and guidelines to assist in determining when electronic communications constitute recommendations, thereby triggering application of the MSRB's suitability rule. The MSRB acknowledges the numerous benefits that may be realized by dealers and their customers as a result of the Internet and online brokerage services. The MSRB emphasizes that it neither takes a position on, nor seeks to influence, any dealer's or customer's choice of a particular business model in this electronic environment. At the same time, however, the MSRB urges dealers both to consider carefully whether suitability requirements are adequately being addressed when implementing new services and to remember that customers' best interests must continue to be of paramount importance in any setting, traditional or online.

As new technologies and/or services evolve, the MSRB will continue to work with regulators, members of the industry and the public on these and other important issues that arise in the online trading environment.

[1] The term “dealer” is used in this notice as shorthand for “broker,” “dealer” or “municipal securities dealer,” as those terms are defined in the Securities Exchange Act of 1934. The use of the term in this notice does not imply that the entity is necessarily taking a principal position in a municipal security.

[2] The Bond Market Association’s (“TBMA”) 2001 Review of Electronic Transaction Systems found that at the end of 2001, there were at least 23 systems based in the United States that allow dealers or institutional investors to buy or sell municipal securities electronically compared to just 3 such systems in 1997. While dealers are also developing electronic trading platforms that allow retail customers to buy or sell municipal securities online, the development of online retail trading systems for municipal securities lags far behind that for equities.

[3] Rule G-19 provides in pertinent part:

(c) Suitability of Recommendations. In recommending to a customer any municipal security transaction, a [dealer] shall have reasonable grounds:

(i) based upon information available from the issuer of the security or otherwise, and

(ii) based upon the facts disclosed by such customer or otherwise known about such customer for believing that the recommendation is suitable.

[4] Although the focus of this notice is on the application of the suitability rule to electronic communications, much of the discussion is also relevant to more traditional communications, such as discussions made in person, over the telephone, or through postal mail.

[5] This notice focuses on customer-specific suitability under Rule G-19. Under Rule G-19, a dealer must also have a reasonable basis to believe that the recommendation could be suitable for at least some customers. See e.g., Rule G-19 Interpretation—Notice Concerning the Application of Suitability Requirements to Investment Seminars and Customer Inquiries Made in Response to a Dealer’s Advertisement, May 7, 1985, MSRB Rule Book (July 1, 2002) at 143; In re F.J. Kaufman and Company of Virginia, 50 S.E.C. 164, 168, 1989 SEC LEXIS 2376, *10 (1989) (the “reasonable basis” obligation relates only to the particular recommendation, rather than to any particular customer). The SEC, in its discussion of municipal underwriters’ responsibilities in a 1988 Release, noted that “a broker-dealer recommending securities to investors implies by its recommendation that it has an adequate basis for the recommendation.” Municipal Securities Disclosure, Securities Exchange Act Release No. 26100 (September 22, 1988) (the “1988 SEC Release”) at text accompanying note 72.

[6] Similarly, the suitability rule does not apply where a dealer merely gathers information on a particular customer, but does not make any recommendations. This is true even if the information is the type of information generally gathered to satisfy a suitability obligation. Dealers should nonetheless remember that regardless of any determination of whether the dealer is making a recommendation and subject to the suitability requirement, the dealer is required to make reasonable efforts to obtain certain customer specific information pursuant to rule G-8 (a)(xi) so that dealers can protect themselves and the integrity of the securities markets from customers who do not have the financial means to pay for transactions.

[7] See Rule G-17 Interpretation—Notice Regarding Rule G-17, on Disclosure of Material Facts, March 20, 2002, MSRB Rule Book (July 1, 2002) at 135.

[8] On April 30, 2002, the Securities and Exchange Commission (“SEC”) approved a proposed rule change relating to the manner in which dealers fulfill their fair practice obligations to certain institutional customers.  Release No. 34-45849 (April 30, 2002), 67 FR 30743.  See Rule G-17 Interpretation—Notice Regarding the Application of MSRB Rules to Transactions With Sophisticated Municipal Market Professionals (“SMMPs”) (the “SMMP Notice”), MSRB Rule Book (July 1, 2002) at 136. The SMMP Notice recognizes the different capabilities of SMMPs and retail or non-sophisticated institutional customers and provides that dealers may consider the nature of the institutional customer when determining what specific actions are necessary to meet the dealer’s fair practice obligations to such customers. The SMMP Notice provides that, while it is difficult to define in advance the scope of a dealer’s fair practice obligations with respect to a particular transaction, by making a reasonable determination that an institutional customer is an SMMP, then certain of the dealer’s fair practice obligations remain applicable but are deemed fulfilled.

[9] See generally Report of Commissioner Laura S. Unger to the SEC, On-Line Brokerage: Keeping Apace of Cyberspace, at n. 64 (Nov. 1999) (“Unger Report”) (discussing various views espoused by online brokerage firms, regulators and academics on the topic of online suitability); Developments in the Law—The Law of Cyberspace, 112 Harv. L. Rev. 1574, 1582-83 (1999) (The article highlights the broader debate by academics and judges over whether "to apply conventional models of regulation to the Internet.").

[10] The guidance contained in this notice is intended to be consistent with the general statements and guidelines contained in the NASD Online Suitability Notice. 

[11] See e.g., Rule G-19 Interpretive Letter dated February 17, 1998, MSRB Rule Book (July 1, 2002) at 144.

[12] These general principles were first enunciated in the NASD Online Suitability Notice.

[13] For example, if a dealer transmitted a rating agency research report to a customer at the customer's request, that communication may not be subject to the suitability rule; whereas, if the same dealer transmitted the very same research report with an accompanying message, either oral or written, that the customer should act on the report, the suitability analysis would be different.

[14] NASD Online Suitability Notice at 3.

[15] Note that there are instances where sending a customer an electronic communication that highlights a particular municipal security (or securities) will not be viewed as a recommendation. For instance, while each case requires an analysis of the particular facts and circumstances, a dealer generally would not be viewed as making a recommendation when, pursuant to a customer's request, it sends the customer (1) electronic "alerts" (such as account activity alerts, market alerts, or rating agency changes) or (2) research announcements (e.g., sector reports) that are not tailored to the individual customer, as long as neither—given their content, context, and manner of presentation—would lead a customer reasonably to believe that the dealer is suggesting that the customer take action in response to the communication.

[16] Note, however, that a portfolio analysis tool that merely generates a suggested mix of general classes of financial assets (e.g., 60 percent equities, 20 percent bonds, and 20 percent cash equivalents), without an accompanying list of securities that the customer could purchase to achieve that allocation, would not trigger a suitability obligation. On the other hand, a series of actions which may not constitute recommendations when considered individually, may amount to a recommendation when considered in the aggregate. For example, a portfolio allocator's suggestion that a customer could alter his or her current mix of investments followed by provision of a list of municipal securities that could be purchased or sold to accomplish the alteration could be a recommendation. Again, however, the determination of whether a portfolio analysis tool's communication constitutes a recommendation will depend on the content, context, and presentation of the communication or series of communications.

[17] These guidelines were originally set forth in the NASD Online Suitability Notice.

[18] Although a dealer cannot disclaim away its suitability obligation, informing customers that generalized information provided is not based on the customer's particular financial situation or needs may help clarify that the information provided is not meant to be a recommendation to the customer. Whether the communication is in fact a recommendation would still depend on the content, context, and presentation of the communication. Accordingly, a dealer that sends a customer or group of customers information about a security might include a statement that the dealer is not providing the information based on the customers' particular financial situation or needs. Dealers may properly disclose to customers that the opinions or recommendations expressed in research do not take into account individual investors' circumstances and are not intended to represent recommendations by the dealer of particular municipal securities to particular customers. Dealers, however, should refer to previous guidelines issued by the SEC that may be relevant to these and/or related topics. For instance, the SEC has issued guidelines regarding whether and under what circumstances third-party information is attributable to an issuer, and the SEC noted that the guidance also may be relevant regarding the responsibilities of dealers. See SEC Guidance on the Use of Electronic Media, Release Nos. 34-7856, 34-42728, IC-24426, 65 Fed. Reg. 25843 at 25848-25849 (April 28, 2000).

[19] The MSRB believes that a dealer should, at a minimum, clearly explain the limitations of its search engine and the decentralized nature of the municipal securities market. The dealer should also clearly explain that securities that meet the customer’s search criteria might be available from other sources.

[20] The MSRB notes that there are circumstances where the act of sending a communication to a specific group of customers will not necessarily implicate the suitability rule. For instance, a dealer's business decision to provide only certain types of investment information (e.g., research reports) to a category of "premium" customers would not, without more, trigger application of the suitability rule. Conversely, dealers may incur suitability obligations when they send a communication to a large group of customers urging those customers to invest in a municipal security.

[21] As with the other general guidelines discussed in this notice, the presence of this factor alone does not automatically mean that a recommendation has been made. 

The MSRB understands that an issuer [of municipal fund securities] may make minor modifications to the official statement in order to correct typographical or grammatical errors, or to make such other modifications that the issuer may deem to be immaterial.  If the issuer has acknowledged in writing to the primary distributor that it does not consider such modification to be material to investors and does not believe that such modification is required to make the statements in the official statement not misleading, then the modification need not be sent by a dealer to a customer that has previously received the official statement, notwithstanding the provisions of Rule G-32(a)(i).[1]  The primary distributor must maintain the issuer’s written acknowledgement under Rule G-8(a)(xiii), relating to records concerning deliveries of official statements.  The primary distributor must send all amendments, regardless of materiality, to the MSRB under Rule G-36.

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ENDNOTES

[*] [This interpretation is an excerpt from “Application of Fair Practice and Advertising Rules to Municipal Fund Securities,” May 14, 2002.  The remaining portions of the 2002 interpretation have been superseded by other interpretations and rule changes.]

[1] Rule G-32(a)(i) requires delivery of an official statement to a customer purchasing municipal fund securities by settlement of the transaction.  In the case of a repeat purchaser who has already received the official statement, dealers generally are required to deliver any amendments or supplements to the official statement in connection with subsequent purchases of the securities. [footnote has been renumbered]

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.

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This notice addresses several questions that have arisen concerning Board rules G-12 and G-15. Board rule G-12 establishes uniform industry procedures for the processing, clearance, and settlement of transactions in municipal securities... Board rule G-15 requires municipal securities professionals to send written confirmations of transactions to customers, and specifies the information required to be set forth on the confirmation.

 

Settlement Dates

In order to establish uniform settlement dates for "regular way" transactions in municipal securities, rule G-12(b)(i)(B) defines the term "business day" as "a day recognized by the National Association of Securities Dealers, Inc. [the "NASD"] as a day on which securities transactions may be settled." The practice of the NASD has been to exclude from the category of "business day," any day widely designated as a legal bank holiday, and to notify the NASD membership accordingly. Such notices set forth the NASD’s trade and settlement date schedules for periods which include a legal holiday.

"Catastrophe" Call Features

Rules G-12 and G-15 require that confirmations of transactions set forth a "description of the securities, including at a minimum… if the securities are subject to redemption prior to maturity (callable)… an indication to such effect…" (paragraphs G-12(c)(v)(E) and G-15(a)(v)[*]). Both rules also require that in transactions in callable securities effected on a yield basis, dollar price must be shown and "the calculation of dollar price shall be to the lower of price to call or price to maturity" (paragraphs G-12(c)(v)(I) and G-15(a)(viii)[†]).

The references to "callable" securities and pricing to call in rules G-12 and G-15 do not refer to "catastrophe" call features, such as those relating to acts of God or eminent domain, which are beyond the control of the issuer of the securities.

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[*] [Currently codified at rule G-15(a)(i)(C)(2)(a)]

[†] [Currently codified at rule G-15(a)(i)(A)(5)]

Agency transactions: remuneration. This will acknowledge receipt of your letter dated November 1, 1977 in which you request an interpretation concerning the provision in Board rule G-15(b)(ii)[*] which requires that "the source and amount of any commission or other remuneration" received by a municipal securities dealer in a transaction in which the municipal securities dealer is acting as agent for a customer be disclosed on the confirmation to the customer.

The reference to the "amount of any commission or other remuneration" requires that an aggregate dollar amount be shown, in a purchase transaction on behalf of an equivalent of the dealer concession, and, if applicable, any additional charge to the customer above the price paid to the seller of the securities. In a sale transaction on behalf of a customer, this would normally be the difference between the net price paid by the purchaser of the securities and the proceeds to the customer. If a percentage of par value or unit profit were shown it would be difficult for many customers to relate this information to the "total dollar amount of [the] transaction" required by rule G-15(a)(xi)[†] to be shown on the confirmation.

The reference in rule G-15(b)(ii)[*] to the "source" of remuneration would not require you to differentiate between the concession and any additional charge. Standard language could be included on the confirmation to indicate that your remuneration may include dealer concessions and other charges. MSRB interpretation of November 10, 1977.

 

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[†] [Currently codified at rule G-15(a)(i)(A)(6)(a)]

[*] [Currently codified at rule G-15(a)(i)(A)(1)(e)]

Callable securities: "catastrophe" calls. This will acknowledge receipt of your letter dated October 20, 1977 which has been referred to me for reply. In your letter you request an interpretation of the provisions in rules G-12 and G-15 requiring that the dollar price for transactions in callable securities effected on a yield basis be priced to the lower of price to call or price to maturity. (See rules G-12(c)(v)(I) and G-15(a)(viii))[*].

At its meeting held October 25-26, 1977, the Board confirmed that the requirements in rules G-12 and G-15 relating to pricing to call do not include "catastrophe" calls, that is, calls which occur as a result of events specified in the bond indenture which are beyond the control of the issuer. MSRB interpretation of November 7, 1977.

 

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[*] [Currently codified at rule G-15(a)(i)(A)(5)]

The Municipal Securities Rulemaking Board (the "Board") has received a number of inquiries concerning Board rules G-8 and G-9. These rules require municipal securities brokers and municipal securities dealers to make and keep current certain specified records concerning their municipal securities business and to preserve such records for specified periods of time. This interpretive notice addresses several of the more frequent inquiries received by the Board regarding these rules.

General Purposes of Recordkeeping Rules

The Board’s recordkeeping rules are designed to require organizations engaged in the municipal securities business to maintain appropriate records concerning their activities in such business. In writing the rules, the Board adopted the approach of specifying in some detail the information to be reflected in the various records. The Board believed that this approach would provide helpful guidance to municipal securities professionals as well as the regulatory agencies charged with the responsibility of examining the records of such firms. At the same time, the Board attempted to provide a degree of flexibility to firms concerning the manner in which their records are to be maintained, recognizing that various recordkeeping systems could provide a complete and accurate record of a firm’s municipal securities activities. The interpretations set forth in this notice are intended to be consistent with the foregoing purposes.

This notice is not intended to address all of the questions which have arisen, or may arise; the Board will continue its policy of responding to written requests for individual interpretations and may issue further interpretive notices on recordkeeping should additional questions of general interest arise.

The following topics are covered in this interpretive notice:General Purposes of Recordkeeping Rules

Election to Follow Board or Commission Recordkeeping Rules

Maintenance of Records on a Trade Date or Settlement Date Basis

Current Posting of Records

Unit System Method of Recordkeeping

Rule G-8(a)(ii)—Account Records

Rule G-8(a)(iii)—Securities Records

Rules G-8(a)(vi) and (vii)—Records for Agency and Principal Transactions

Rule G-8(a)(xi)—Customer Account Information

Rule G-8(c)—Non-Clearing Municipal Securities Brokers and Municipal Securities Dealers

Rule G-9(b)(viii)(C)—Preservation of Written Communications

Election to Follow Board or Commission Recordkeeping Rules

Rules G-8(f) and G-9(g) provide that municipal securities brokers and municipal securities dealers other than bank dealers, who are in compliance with the recordkeeping rules of the Securities and Exchange Commission (the "Commission"), will be deemed to be in compliance with Board rules G-8 and G-9, provided that the following additional records, not specified in the Commission’s rules, are maintained by such firms: records of uncompleted transactions involving customers (subparagraph (a)(iv)(D)); records relating to syndicate transactions (paragraph (a)(viii)); new account information (paragraph (a)(xi)); and information concerning customer complaints (paragraph (a)(xii)). Conversely, Commission rules 17a-3 and 17a-4 provide that securities firms engaged in the municipal securities business will satisfy all regulatory requirements concerning recordkeeping with respect to their municipal securities business if they are in compliance with the Board’s rules.

Securities firms must determine to comply with either the Board or Commission rules, but are not required to file with either the Board or the commission a formal written notice of election. Satisfactory compliance with either set of rules will be subject to determination in the course of periodic compliance examinations conducted by the regulatory organizations charged with enforcement of Board and Commission rules.

Maintenance of Records on a Trade Date or Settlement Date Basis

Under rule G-8, records concerning purchases and sales of municipal securities may be maintained on either a trade date or settlement date basis, provided that all records relating to purchases and sales are maintained on a consistent basis. For example, if a municipal securities broker or municipal securities dealer maintains its records of original entry concerning purchases and sales (rule G-8(a)(i)) on a settlement date basis, the municipal securities broker or municipal securities dealer must also maintain its account records (rule G-8(a)(ii)) and securities records (rule G-8(a)(iii)) on the same basis.

The above records may not be maintained on a clearance date basis, that is, the date the securities are actually delivered or received. Records maintained on a clearance date basis would not accurately reflect obligations of a municipal securities broker or municipal securities dealer to deliver or accept delivery of securities. Of course, the date of clearance should be noted in the records of original entry, account records and securities records, regardless of whether these records are kept on a trade date or settlement date basis.

Current Posting of Records

Rule G-8 provides that every municipal securities broker or municipal securities dealer must make and keep current the records specified in the rule. The Board has received inquiries as to the time within which records must be posted to satisfy the currency requirement.

Blotters or other records of original entry showing purchases and sales of municipal securities should be prepared no later than the end of the business day following the trade date. Transactions involving the purchase and sale of securities should be posted to the account records no later than settlement date and to the securities records no later than the end of the business day following the settlement date. Records relating to securities movements and cash receipts and disbursements should reflect such events on the date they occur and should be posted to the appropriate records no later than the end of the following business day.

Commission rule 17a-11 requires municipal securities dealers, other than bank dealers, to give immediate notice to the Commission and their designated examining authorities of any failure to make and keep current the required records, and to take corrective action within forty-eight hours after the transmittal of such notice.

Unit System Method of Recordkeeping

Under rule G-8, records may be maintained in a variety of ways, including a unit system of recordkeeping. In such a system, records are kept in the form of a group of documents or related groups of documents. For example, customer account records may consist of copies of confirmations and other related source documents, if necessary, arranged by customer.

A unit system of recordkeeping is an acceptable system for purposes of rule G-8 if the information required to be shown is clearly and accurately reflected and there is an adequate basis for audit. This would require in most instances that each record in a unit system be arranged in appropriate sequence, whether chronological or numerical, and fully integrated into the overall recordkeeping system for purposes of posting to general ledger accounts.

Rules G-8(a)(ii)—Account Records

Rule G-8(a)(ii) requires every municipal securities broker and municipal securities dealer to maintain account records for each customer account and the account of the municipal securities broker and municipal securities dealer, showing all purchases and sales, all receipts and deliveries of securities, all receipts and disbursements of cash, and all other debits and credits to such account.

The account records may be kept in several different formats. Ledger entries organized separately for each customer and for the municipal securities broker or municipal securities dealer, showing the requisite information, would clearly satisfy the requirements of rule G-8(a)(ii).

The requirements of rule G-8(a)(ii) can also be satisfied by a unit system of recordkeeping. See discussion above. Under such a system, a municipal securities professional might maintain files, organized by customer, containing copies of confirmations and other pertinent documents, if necessary, which reflect all the information required by rule G-8(a)(ii).

The question has also been raised whether the account records requirement of rule G-8(a)(ii) can be satisfied by an electronic data processing system which can produce account records by tracing through separate transactions. The Board is of the view that such a system is acceptable if the account records should be obtainable without delay, although the records need not be maintained by customer prior to being produced. The account records so produced must also reflect clearly and accurately all the required information, provide an adequate basis for audit and be fully integrated into the overall recordkeeping system. Under rule G-27, on supervision, a municipal securities principal is required to supervise the activities of municipal securities representatives with respect to customer accounts and other matters. In this connection, it may be appropriate to obtain printouts of customer accounts on a periodic basis.

The Board believes that it is important to maintain account records in the fashion described above in view of several of the Board’s fair practice rules, such as the rules on suitability and churning. Account records will be important both as a tool for management to detect violations of these rules and for enforcement of these rules by the regulatory agencies conducting compliance examinations or responding to complaints.

The requirement to maintain account records does not apply to a firm which effects transactions exclusively with other municipal securities professionals and has no customers, as defined in paragraph (e) of rule G-8.

Rule G-8(a)(iii)—Securities Records

Rule G-8(a)(iii) requires that records be kept showing separately for each municipal security all long and short positions carried by a municipal securities broker or municipal securities dealer for its account or for the account of a customer, the location of all such securities long and the offsetting position to all such securities short, and the name or other designation of the account in which each position is carried.

The securities records should reflect not only purchases and sales, but also any movement of securities, such as whether securities have been sent out for validation or transfer. If there is no activity with respect to a particular security, it is not necessary to make daily entries for the security in the securities records. The last entry will be deemed to be carried forward until there is further activity involving the security.

Rule G-8(a)(iii) requires that the securities records show all long security count differences and short count differences classified by the date of physical count and verification on which they were discovered. The Board currently has no rule requiring municipal securities professionals to make periodic securities counts. However, if such counts are made, all count differences must be noted as provided in this section. Commission rule 17a-13 requires municipal securities dealers, other than bank dealers and certain securities firms exempted from the rule, to examine and count securities at least once in each quarter.

The requirement to maintain securities records under rule G-8 does not apply to a firm which effects municipal securities transactions exclusively with other municipal securities professionals and has no customers, as defined in paragraph (e) of rule G-8, provided the firm does not carry positions for its own account and records or fails to deliver, fails to receive and bank loans are reflected in other records of the firm.

Rules G-8(a)(vi) and (vii)—Records for Agency and Principal Transactions

Rules G-8(a)(vi) and (vii) require municipal securities brokers and municipal securities dealers to make and keep records for each agency order and each transaction effected by the municipal securities broker or municipal securities dealer as principal. The records may be in the form of trading tickets or similar documents. In each case, the records must contain certain specified information, including "to the extent feasible, the time of execution."

The phrase "to the extent feasible" is intended to require municipal securities professionals to note the time of execution for each agency and principal transaction except in extraordinary circumstances when it is impossible to determine the exact time of execution. In such cases, the municipal securities professional should note the approximate time of execution and indicate that it is an approximation.

Rule G-8(a)(xi)—Customer Account Information

Rule G-8(a)(xi) requires a municipal securities broker or municipal securities dealer to obtain certain information for each customer. Several distinct questions have been raised with respect to this provision.

The requirement to obtain the requisite information may be satisfied in a number of ways. Some municipal securities brokers and municipal securities dealers have prepared questionnaires which they have had their customers complete and return. Others have instructed their salesmen to obtain the information from customers over the telephone at the time orders are placed. It is not necessary to obtain a written statement from a customer to be in compliance with the provision.

Except for the tax identification or social security number of a customer, the customer account information required by this provision must be obtained prior to the settlement of a transaction. The Board believes that such a requirement is reasonable since the information is basic and important.

The requirement in subparagraph (C) of rule G-8(a)(xi) to obtain the tax identification or social security number of a customer tracks the requirement in section 103.35, Part 103 of Title 31 of the Code of Federal Regulations, which was adopted by the Treasury Department and became effective in June 1972. Under this section, every broker, dealer and bank must obtain the tax identification or social security number of customers. If a broker, dealer or bank is unable to secure such information after reasonable effort, it must maintain a record identifying all such accounts. The Board interprets subparagraph (C) of rule G-8(a)(xi) in a similar fashion to require municipal securities professionals to make a reasonable effort to obtain a customer’s tax identification or social security number and, if they are unable to do so, to keep a record of that fact.

Several inquiries have focused on the scope of subparagraph (G) of rule G-8(a)(xi) which requires that a record be made and kept of the name and address of the beneficial owner or owners of such account if other than the customer and transactions are to be confirmed to such owner or owners.

This provision applies to the situation in which securities are confirmed to an account which has not directly placed the order for the securities. This frequently occurs in connection with investment advisory accounts, where the investment advisor places an order for a client and directs the executing firm to confirm the transaction directly to the investment advisor’s client.

Under rule G-8, the only information which must be obtained in such circumstances for the account to which the transaction is confirmed is the name and address of the account, information which would have to be obtained in any event in order to transmit the confirmation. Since the investment advisor itself is the customer, the other items of customer account information set forth in rule G-8(a)(xi) need not be obtained for the investment advisor’s client. The customer account information applicable to institutional accounts, however, must be obtained with respect to the investment advisor. Also, the account records required by rule G-8(a)(ii) would not be required to be maintained for the investment advisor’s client, although such records would have to be maintained with respect to the account of the investment advisor.

A municipal securities professional is not required to ascertain the name and address of the beneficial owner or owners of an account if such information is not voluntarily furnished. Subparagraph G-8(a)(xi)(G) applies only when an order is entered on behalf of another person and the transaction is to be confirmed directly to the other person.

A recent court decision, Rolf v. Blyth Eastman Dillon & Co. Inc., et al. issued on January 17, 1977, in the United States District Court, Southern District of New York, may have important implications with respect to the obligations generally of securities professionals to beneficial owners of accounts, especially to clients of investment advisors. We commend your attention to this decision, which has been appealed.

Rule G-8(c)—Non-Clearing Municipal Securities Brokers and Municipal Securities Dealers

Rule G-8(c) provides that a non-clearing municipal securities broker or municipal securities dealer is not required to make and keep the books and records prescribed by rule G-8 if they are made and kept by a clearing broker, dealer, bank or clearing agency. Accordingly, to the extent that records required by rule G-8 are maintained for a municipal securities broker or municipal securities dealer by a clearing agent, the municipal securities broker or municipal securities dealer does not have to maintain such records. A non-clearing municipal securities broker or municipal securities dealer is still responsible for the accurate maintenance and preservation of the records if they are maintained by a clearing agent other than a clearing broker or dealer, and should assure itself that the records are being maintained by the clearing agent in accordance with applicable recordkeeping requirements of the Board.

In the case of a bank dealer, clearing arrangements must be approved by the appropriate regulatory agency for the bank dealer. The bank regulatory agencies are each considering the adoption of procedures to approve clearing arrangements. It is contemplated that these procedures will require the inclusion of certain provisions in clearing agreements, such as an undertaking by the clearing agent to maintain the bank dealer’s records in compliance with rules G-8 and G-9, and will specify the mechanics for having such arrangements considered and approved. The bank regulatory agencies indicate that they will advise bank dealers subject to their respective jurisdictions on this matter in the near future.

In the case of a securities firm, Commission approval is required for all clearing arrangements with entities other than a broker, dealer or bank. The Commission has recently proposed an amendment to its rule 17a-4 which would eliminate the need to obtain Commission approval of clearing arrangements with such other entities, provided that certain specified conditions are met. If the proposed rule is adopted, the Board would make a corresponding change in rule G-8.

If an agent clears transactions, but transmits copies of all records to the municipal securities broker or municipal securities dealer, and these records are preserved by the municipal securities broker or municipal securities dealer in accordance with rule G-9, the clearing arrangement is not subject to the rule G-8(c).

Rule G-9(b)(viii)(C)—Preservation of Written Communications

Subparagraph (C) of rule G-9(b)(viii) requires municipal securities brokers and municipal securities dealers to preserve for three years all written communications received or sent, including inter-office memoranda, relating to the conduct of the activities of such municipal securities broker or municipal securities dealer with respect to municipal securities.

The communications required to be preserved by this provision relate to the conduct of a firm’s activities with respect to municipal securities. Accordingly, such documents as internal memoranda regarding offerings or bids, letters to or from customers and other municipal securities professionals regarding municipal securities, and research reports must be preserved. Documents pertaining purely to administrative matters, such as vacation policy and the like, would not have to be preserved for purposes of the rule.

Quotation of municipal securities. This will acknowledge receipt of your letter dated February 9, 1977 concerning the Board’s proposed rule G-13 on quotations relating to municipal securities. In your letter you raise certain questions concerning the intent and application of paragraph (b)(ii) of proposed rule G-13, which prohibits a municipal securities professional from distributing or publishing a municipal securities quotation, or causing such a quotation to be distributed or published, unless the quotation is based upon the professional’s best judgment as to the fair market value of the security.

While the provision in question would undoubtedly apply to situations involving outright fraud, the Board believes the rule to have appropriate application in other circumstances as well.  Thus, the Board has attempted in paragraph (b)(ii) to proscribe conduct which, in the Board’s opinion, constitutes bad business practice but may not, depending on the circumstances, constitute fraud. The Board firmly believes that as a matter of just and equitable principles of trade in the municipal securities industry and with a view to promoting free and open markets in municipal securities, certain practices should not be condoned, even though they do not necessarily rise to the level of fraud or cannot be proven to constitute fraud.

Some examples of how paragraph (b)(ii) would operate may be useful.  First, assume that a dealer submits a bid for bonds, knowing that they have been called by the issuer.  The bonds are not general market bonds and the fact that they have been called is not widely known. While called bonds ordinarily trade at a premium, the dealer’s bid is based on the value of the bonds as though they had not been called and is accepted by the dealer on the other side of the trade who is unaware of the called status of the bonds.  In these circumstances, the bid clearly would not have been based upon the best judgment of the dealer making it as to the fair market value of the bonds. While one might argue that the dealer accepting the bid should have known of the called status of the bonds, the dealer making the bid acted unethically and in a manner not conducive to free and open markets in municipal securities. In the Board’s view, the actions of the dealer making the bid should not be condoned, although a charge of fraud might be difficult to sustain in dealings between professionals and might be inappropriate. The improper nature of the dealer’s conduct would be exacerbated, of course, if the person on the other side of the transaction is a non-professional.  However, difficulties in proof that the conduct of the dealer was fraudulent suggest that the best judgment rule would provide an appropriate alternative basis for enforcement action.

Another situation that would be covered by the best judgment rule is one in which a dealer submits a bid for bonds based on valuations obtained from independent sources, which in turn are based on mistaken assumptions concerning the nature of the securities in question.  The circumstances indicate that the dealer submitting the bid knows that the securities have a substantially greater market value than the price bid, but the fact that independent valuations were obtained, albeit based on mistaken facts, clouds the dealer’s culpability.

A third situation to which the best judgment rule would apply is one in which a dealer makes a bid for or offer of a security without any knowledge as to the value of the security or the value of comparable securities. While the Board does not intend that the best judgment of a dealer as to the fair market value of a security be second-guessed for purposes of the proposed rule, the Board does intend that the dealer be required to act responsibly and to exercise some judgment in submitting a quotation.  In other words, a quotation which has been “pulled out of the air” is not based on the best judgment of the dealer and, in the interests of promoting free and open markets in municipal securities, should not be encouraged.

Given the manner in which the Board intends the “best judgment” rule to operate, the Board concluded that it would not have an anti-competitive impact on the municipal markets. The proposed rule is not intended to prohibit legitimate price discounts or mark-ups, as the case may be, based upon a dealer’s anticipation of the direction of the movement of the markets and other factors. The Board does not intend to interfere with legitimate pricing mechanisms and recognizes that there may be a variety of quotations with respect to a given security, each of which would comply with the terms of the proposed rule.

While it is not possible to anticipate all of the specific fact situations that might run afoul of the “best judgment” rule, I would like to make some general observations concerning the operation of the proposed rule. As you know, one of Congress’ principal purposes in calling for the establishment of the Board was to promote the development of a body of rules for the municipal securities industry that would furnish quidelines for good business conduct. The Senate Committee on Banking, Housing and Urban Affairs observed in its Report on the Securities Acts Amendments of 1975 that prior to the legislation, the conduct of municipal market professionals could be controlled only after the fact through enforcement by the Commission of the fraud prohibitions of the federal securities laws.  The Senate Committee expressed hope that a self-regulatory body like the Board would develop prophylactic rules for the industry which would deter unethical and fraudulent practices in the first instance. See Senate Report 94-75, 94th Cong., 1st Sess., 42-43. MSRB interpretation of February 24, 1977.

On December 23, 1976, the Municipal Securities Rulemaking Board (the "Board") issued an interpretive notice addressing certain questions received by the Board with respect to its professional qualifications rules (rules G-2 through G-7). Since that time, the Board has received additional questions concerning rule G-3 which are discussed in this interpretive notice.

1. Requirements for Financial and Operations Principals.

Under the rule G-3(b)(ii)[*], every municipal securities broker and municipal securities dealer other than a bank dealer is required to have at least one qualified financial and operations principal. As defined in the rule, this person is responsible for the overall supervision and preparation of financial reports to the Securities and Exchange Commission and self-regulatory organizations and for the processing, clearance, safekeeping and recordkeeping activities of the firm. If more than one person shares these overall supervisory responsibilities, each such person must be qualified as a financial and operations principal.

The question has been asked whether a financial and operations principal whose duties relate solely to financial and operational matters and not, for example, to underwriting, trading, or sales functions must qualify also as a municipal securities principal by passing the Board's municipal securities principal examination when it is prescribed. The Board does not intend to impose such a requirement on persons whose functions are limited to those set forth in the definition of a financial and operations principal.

The question has also been asked whether a person performing only the functions of a financial and operations principal on and after December 1, 1975 would be "grandfathered" as a municipal securities principal for purposes of taking the Board's municipal securities principal examination when prescribed if such person begins supervising underwriting, trading or sales functions. Activities relating to financial and operational matters are substantially different from those relating to underwriting, trading and sales or other categories of activities supervised by municipal securities principals. The Board does not intend, therefore, that financial and operations principals be "grandfathered" for purposes of the Board's examination requirements for municipal securities principals, or that a financial and operations principal would be qualified to engage in such other supervisory activities solely by reason of having met the Board's requirements for financial and operations principals.

The Board has also been asked whether senior officers or general partners of a firm, who may bear ultimate legal responsibility for the financial and operational activities of the firm, must be qualified as financial and operations principals under the Board's rules. Although the answer depends on the particular factual situation, officers or partners not directly involved in the financial and operations affairs of a firm generally would not be required to qualify as financial and operations principals.

2. Activities Requiring Qualification as a Municipal Securities Principal.

The question has been asked whether supervisory personnel in the processing and clearance areas must qualify as the municipal securities principals under rule G-3. In a securities firm, the financial and operations principal ordinarily would be the only person supervising operations-related activities who will be required to pass an examination. With respect to bank dealer supervisory personnel, to whom the financial and operations principal classification does not apply, qualification in a principal capacity in the operations area will not be required unless the person in question exercises policy-making authority. Thus, an individual may supervise a bank dealer's processing activities without qualifying as a municipal securities principal, regardless of the number of persons supervised by such individual, if policy-making functions and discretionary authority are delegated to a higher level.

Somewhat different considerations apply in determining which persons are required to be qualified as municipal securities principals in connection with underwriting, trading, sales or other activities referred to in the Board's rules as municipal securities principal activities. In these areas, the qualification requirements apply to persons having supervisory responsibility with respect to the day-to-day conduct of the activities in question, even though such persons may not have a policy-making role. The Board's conclusions in this regard are based on the fact that in these other areas the supervisory person is responsible for the activities of personnel who communicate directly with issuers, traders, and investors.

3. Activities Requiring Qualification as a Municipal Securities Representative.

In certain cases, communications from customers may be received at a time when a duly qualified municipal securities representative or municipal securities principal is unavailable. Similarly, there may be situations in which it becomes important to advise a customer promptly of transactions effected and orders confirmed, even though the individual responsible for the account may not be able to communicate with the customer at that time.

In many cases under the rules of other self-regulatory organizations, communications of this nature, which in essence reflect a mechanical function, may be received and made by properly supervised competent individuals whose clerical and ministerial functions would not otherwise subject them to qualification requirements. The Board believes the principle underlying this practice and the application of other self-regulatory organizations' qualification rules is sound.

Accordingly, the Board interprets rule G-3 to permit the recording and transmission in customary channels of orders, the reading of approved quotations, and the giving of reports of transactions by non-qualified clerical personnel when the duly qualified municipal securities representative or municipal securities principal who normally handles the account or customer is unavailable. The foregoing interpretation is applicable only to clerical personnel who are: (a) deemed capable and competent by a municipal securities principal or general securities principal to engage in such activities; (b) specifically authorized in writing to perform such functions on an occasional basis as necessary or directed to perform such functions in specific instances, in either case by a duly qualified municipal securities principal or general securities principal; (c) familiar with the normal type and size of transaction effected with or for the customer or the account; and (d) closely supervised by duly qualified municipal personnel.

All orders for municipal securities received by clerical personnel under the foregoing interpretation must be reviewed and approved by duly qualified municipal personnel familiar with the customer or account prior to being accepted or effected by the municipal securities broker or municipal securities dealer. Solicitation of orders by clerical personnel is not permitted. Confirmations of transactions may be given and quotations read by clerical personnel only when approved by duly qualified municipal personnel. Individuals subject to the 90-day apprenticeship requirements of rule G-3(i)[†] are not clerical personnel and are not authorized or permitted to engage in such activities with members of the public.

Also, the question has been raised whether a bank's branch office personnel, who are not otherwise required to be qualified under rule G-3, will be required to take and pass the qualification examination for municipal securities representatives in order to respond to a depositor's inquiry concerning possible investments in municipal securities. Insofar as the branch office personnel merely refer the depositor to qualified bank dealer personnel for discussion concerning the merits of an investment in municipal securities and execution of the depositor's order, the branch office personnel would not be required to be qualified under the Board's professional qualifications requirements. However, if branch office personnel seek to advise the depositor concerning the merits of a possible investment, or otherwise perform more than a purely ministerial function, qualification under the Board's rules would be required.

 

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[*] [ Currently codified at rule G-3(d)(iii)]

[†] [ Currently codified at rule G-3(a)(iii)]