All Rule G-37 interpretive guidance for dealers shall apply to the analogous interpretive issues for municipal advisors, with the exception of interpretive guidance issued on February 21, 1997, and April 2, 2002. See Notice of Filing of Proposed Rule Change Consisting of Proposed Amendments to Rule G-37, on Political Contributions and Municipal Securities Business, Rule G-8, on Books and Records, Rule G-9 on Preservation of Records, and Form G-37 and G-37x, Release No. 34-76763 (December 16, 2015), 80 FR 81710, at 81718, 81735 (December 30, 2015) (File No. SR-MSRB-2015-14).

 

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I. PERSONS/ENTITIES SUBJECT TO THE RULE

I.1
Q: To whom does Rule G-37 apply?
A: In general, Rule G-37 applies to brokers, dealers and municipal securities dealers (collectively referred to as dealers), municipal finance professionals, and PACs controlled by the dealer or any municipal finance professional. In addition, the recordkeeping and disclosure provisions apply to non-MFP executive officers of the dealer.

(May 24, 1994)

II. PROHIBITION ON ENGAGING IN MUNICIPAL SECURITIES BUSINESS (Rule G-37(b))

II.1
Q: What actions would cause a dealer to be prohibited from engaging in municipal securities business with an issuer?
A: Rule G-37(b) prohibits a dealer from engaging in municipal securities business with an issuer within two years after any contribution to an official of such issuer made by: (i) the dealer, (ii) any municipal finance professional associated with such dealer; or (iii) any PAC controlled by the dealer or any municipal finance professional.

(May 24, 1994)

II.2
Q: Is there an exception to this prohibition on engaging in municipal securities business?
A: There is one exception to Rule G-37(b). The prohibition does not apply if the only contributions to officials of issuers are made by municipal finance professionals entitled to vote for such officials, and provided such contributions, in total, are not in excess of $250 by each such municipal finance professional to each official of such issuer, per election.

(May 24, 1994)

II.3
Q: What is the municipal securities business that a dealer would be banned from engaging in with an issuer if certain political contributions are made to officials of such issuers?
A: The term "municipal securities business" is defined in Rule G-37(g)(vii) to encompass certain activities of dealers, such as acting as negotiated underwriters (as managing underwriter or as syndicate member), financial advisors and consultants, placement agents, and negotiated remarketing agents. The rule does not prohibit a dealer from engaging in competitive underwritings or competitive remarketing services for the issuer.

(May 24, 1994)

II.4
Q: If a non-MFP executive officer makes a contribution to an official of an issuer, is the dealer prohibited from engaging in municipal securities business with that issuer?
A: No. The prohibition section applies only to contributions made by the dealer, its municipal finance professionals, or any PAC controlled by the dealer or any of its municipal finance professionals. The definition of non-MFP executive officer does not include any municipal finance professional. However, contributions by non-MFP executive officers are subject to the reporting/disclosure provisions of the rule. In addition, pursuant to section (d), dealers are prohibited from using non-MFP executive officers (as well as any other person or entity) as a conduit for making contributions to officials of issuers.

(May 24, 1994)

II.5
Q: Would a dealer be prohibited from engaging in municipal securities business with a state agency, whose board members are appointed by the governor, if the dealer makes contributions to the governor?
A: Yes, the definition of “official of an issuer” in Rule G-37(g)(vi) includes any person who was, at the time of the contribution, an incumbent, candidate or successful candidate for any elective office of a state or of any political subdivision, which office has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by an issuer.

(May 24, 1994, revised October 30, 2003)

II.6
Q: May a municipal finance professional who is entitled to vote for an issuer official make contributions to pay for such official’s transition or inaugural expenses without causing a prohibition on municipal securities business with the issuer?
A: Yes, under certain conditions. The de minimis exception allows a municipal finance professional to contribute up to $250 per candidate per election if the municipal finance professional is entitled to vote for that issuer official. The de minimis exception is keyed to an election cycle; therefore, if a municipal finance professional contributed $250 to the general election of an issuer official, the municipal finance professional would not be able to make any contributions to pay for transition or inaugural expenses without causing a prohibition on municipal securities business with the issuer. If a municipal finance professional made no contributions to an issuer official prior to the election, then the municipal finance professional may, if entitled to vote for the candidate, contribute up to $250 to pay for transition or inaugural expenses and payment of debt incurred in connection with the election without causing a prohibition on municipal securities business.

(September 9, 1997)

II.7
Q: Are any payments made to issuer officials, other than political contributions, covered by the rule?
A: No. However, any other payments may be subject to Rule G‑20 on gifts and gratuities.

(May 24, 1994)

Primary, State Caucus or Convention

II.8
Q: If an issuer official is involved in a primary election prior to the general election, may a municipal finance professional who is entitled to vote for such official contribute $250 to the issuer official's primary as well as general election?
A: Yes, the municipal finance professional could contribute up to $500 to each such official (i.e., $250 per election).

(May 24, 1994)

II.9
Q: If the locality in which the incumbent or candidate is seeking election as an issuer official holds a convention or caucus (instead of a primary election) prior to the general election, may a municipal finance professional entitled to vote in that locality contribute $250 to the incumbent or candidate's convention or caucus election campaign, as well as $250 to the incumbent or candidate's general election, without causing a ban on municipal securities business with the issuer?
A: Yes, if the issuer official has been qualified to be considered at the state caucus or convention.

(June 15, 1995)

MFP as Incumbent or Candidate

II.10
Q: If a municipal finance professional also is an incumbent or candidate for political office in a municipality in which the municipal finance professional's employer (i.e., the dealer) conducts municipal securities business, must the dealer terminate the municipal finance professional or are there any restrictions on the kind of business a dealer can engage in with that issuer?
A: No. However, the dealer, any municipal finance professional and any PAC controlled by the dealer or municipal finance professional must ensure that the dealer does not engage in municipal securities business with the issuer if contributions (other than the de minimis contributions allowed under section (b)) are made to an official of the issuer. The municipal finance professional who is an incumbent or candidate for office is not limited to contributing the de minimis amount to his or her own campaign in such instances.

(May 24, 1994)

Attendance at Fund-Raising Dinner

II.11
Q: May a dealer continue to engage in municipal securities business with an issuer if a municipal finance professional pays for and attends a fund-raising dinner for a candidate who is seeking election to a position as an official of such issuer?
A: A municipal finance professional who contributes funds in this instance would subject the dealer to a prohibition on municipal securities business with the issuer unless the municipal finance professional is entitled to vote for such candidate and any contributions do not exceed $250 to such candidate per election. In addition, any municipal finance professional who attends the dinner for the purpose of soliciting contributions by others for the issuer official would violate Rule G-37's prohibition on soliciting contributions. See also Rule G-37(c).

(May 24, 1994)

Two-Year Look Back

II.12
Q: A municipal finance professional (i.e., a municipal investment banker subject to the two year look back) was associated with dealer X at the time he made a contribution which resulted in the dealer being prohibited from engaging in municipal securities business with the issuer. Then, less than two years after making the contribution, the municipal finance professional becomes associated with dealer Y. Is dealer Y also subject to the prohibition on business?
A: Both dealers are subject to the prohibition for two years from the date the municipal finance professional made the contribution. Of course, dealer Y's prohibition on business only begins when the municipal finance professional becomes associated with that dealer.

(May 24, 1994, revised October 30, 2003)

II.13
Q: Prior to becoming associated with any dealer, a person makes a contribution to an issuer official. Less than two years after making the contribution, that person becomes a municipal finance professional (i.e., a municipal investment banker subject to the two year look back). Would the hiring dealer be prohibited from engaging in municipal securities business with that issuer?
A: Yes. Rule G-37 attempts to sever any connection between the making of contributions and the awarding of municipal securities business by prohibiting the dealer from engaging in municipal securities business with the issuer for two years from the date the contribution was made. As noted above, the dealer's prohibition on business would begin when the municipal finance professional becomes associated with that dealer. Thus, if the individual was hired, for example, six months after making the contribution, then the dealer's prohibition on business would extend for one and one half years.

(May 24, 1994, revised October 30, 2003)

II.14
Q: If a dealer hires an individual as a retail sales person, would the contributions made by that person prior to being hired subject the dealer to the two-year prohibition on municipal securities business?
A: The rule's two-year prohibition is triggered by contributions by dealers, municipal finance professionals, and political action committees controlled by a dealer or a municipal finance professional. If a retail sales person is not a municipal finance professional and does not become a municipal finance professional within two years after making a contribution to an issuer official, then such contributions will not trigger the ban on business. However, if the retail sales person is, or within two years becomes, a municipal finance professional (e.g., by solicitation of officials of an issuer), then contributions made by that person will subject the hiring dealer to the two-year ban on business. A retail sales person would not be considered to be a municipal finance professional solely because of his or her municipal securities retail sales activities. (See Rule G-37(g)(iv)).

(December 7, 1994, revised October 30, 2003)

II.15
Q: A person is associated with a dealer in a non-municipal finance professional capacity, and makes a contribution to an issuer official. Less than two years after making the contribution, that person becomes a municipal finance professional (i.e., a municipal investment banker subject to the two year look back). Would the dealer be prohibited from engaging in a negotiated underwriting with that issuer?
A: Yes, the dealer is subject to the prohibition for two years from the date the contribution was made.

(May 24, 1994, revised October 30, 2003)

II.16
Q: A person is associated with a dealer in a non-municipal finance professional capacity and makes a political contribution to an official of an issuer for whom such person is not entitled to vote. Less than two years after such person made the contribution, the dealer merges with another dealer and, solely as a result of the merger, that person becomes a municipal finance professional of the surviving dealer. Would the surviving dealer be prohibited from engaging in municipal securities business with that issuer?
A: Yes. Rule G-37 would prohibit the surviving dealer from engaging in municipal securities business with the issuer for two years from the date the contribution was made. Of course, the surviving dealer’s prohibition on business would only begin when the person who made the contribution becomes a municipal finance professional of the surviving dealer.

The Board notes, however, that Rule G-37 was not intended to prevent mergers in the municipal securities industry or, once a merger is consummated, to seriously hinder the surviving dealer’s municipal securities business if the merger was not an attempt to circumvent the letter or spirit of rule G-37. Thus, the dealer may wish to seek an exemption from the ban on business pursuant to Rule G-37(i) from its appropriate regulatory authority.

(June 29, 1998, revised October 30, 2003)

Refund of Inadvertent Contribution

II.17
Q: A disgruntled municipal finance professional made a contribution purposely to subject the dealer to the two-year prohibition on business. When the contribution is discovered by the dealer, a refund of the contribution is requested and obtained. Is the dealer still banned from engaging in business with that issuer? In addition, does the contribution have to be disclosed on Form G-37?
A: Rule G-37(b) prohibits a dealer from engaging in municipal securities business with an issuer within two years after any contribution to an official of such issuer by any municipal finance professional associated with such dealer if the contribution does not meet the de minimis exemption. Section (i) of the rule provides a procedure whereby dealers may seek relief from the appropriate enforcement agency of the rule G-37 prohibition on business. In determining whether to grant such an exemption, one of the factors the enforcement agency will consider is whether the dealer has taken all available steps to obtain a return of the contribution. Even if a refund of the contribution has been obtained, dealers are required to seek an exemption from the ban on business. In addition, dealers also must disclose the contribution on Form G-37. Dealers may wish to indicate on the form (and in their own records) that a refund of the contribution was obtained. See Rule G-37(i).

(August 18, 1994)

Volunteer Work

II.18
Q: Is a municipal finance professional prohibited from performing volunteer work on an issuer official's behalf?
A: Rule G-37 is not intended to prohibit or restrict municipal finance professionals from engaging in personal volunteer work. However, soliciting and bundling of contributions would invoke application of the rule. In addition, if the municipal finance professional uses the dealer's resources (e.g., a political position paper prepared by dealer personnel) or incurs expenses in the conduct of such volunteer work (e.g., hosting a reception), then the value of such resources or expenses would constitute a contribution. Personal expenses incurred by the municipal finance professional in the conduct of such volunteer work, which expenses are purely incidental to such work and unreimbursed by the dealer (e.g., cab fares and personal meals), would not constitute a contribution.

(May 24, 1994)

Dealer Resources

II.19
Q: If an employee of a dealer is donating his or her time to an issuer official's campaign, does the dealer have to disclose this as a contribution to such official? In addition, would the fact that the employee is taking a leave of absence from the dealer cause a different result?
A: An employee of a dealer generally can donate his or her time to an issuer official's campaign without this being viewed as a contribution by the dealer to the official, as long as the employee is volunteering his or her time during non-work hours, or is using previously accrued vacation time or the dealer is not otherwise paying the employee's salary (e.g., an unpaid leave of absence).

(August 18, 1994)

Making Contributions to Issuer Officials on Behalf of Other Persons

II.20
Q: A municipal finance professional signs a check drawn on a joint account, which is owned by the municipal finance professional and another person, and submits it to an issuer official as a contribution along with a writing which states that the contribution is being made solely by the other holder of the joint account. Would any portion of this contribution be attributable to the municipal finance professional under Rule G-37?
A: If a municipal finance professional signs a check, whether the check was drawn on a joint account or not, and submits it as a contribution to an issuer official, then the municipal finance professional is deemed to have made the full contribution, regardless of any writing accompanying the check that provides or directs otherwise. Moreover, if this amount exceeds, or does not qualify for, the de minimis exception, then by making such a contribution the municipal finance professional will trigger the rule's ban on business thereby prohibiting his dealer/employer from engaging in municipal securities business with the particular issuer for two years.

(February 16, 1996)

II.21
Q: If a municipal finance professional and another person (e.g., her spouse) both sign a check drawn on their joint account and submit the check to an issuer official as a contribution, would the contribution amount be attributable equally between them (i.e., 50% to each person) for purposes of Rule G-37?
A: Yes. If a municipal finance professional and any other person both sign a check drawn on their joint account and submit it to an issuer official as a contribution, then each person is deemed to have made half of the contribution, regardless of any writing accompanying the check that provides or directs otherwise.

(February 16, 1996)

Making Contributions to a Candidate Who Later Loses the Election

II.22
Q: If a municipal finance professional made a political contribution which was not subject to the de minimis exception to an issuer official candidate who subsequently did not win the election, is the dealer banned from engaging in municipal securities business with that issuer (i.e., the governmental entity)?
A: Yes. Rule G-37 defines the term "official of such issuer" or "official of an issuer" as "any person (including any election committee for such person) who was, at the time of the contribution, an incumbent, candidate or successful candidate: (A) for elective office of the issuer which office is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by the issuer; or (B) for any elective office of a state or of any political subdivision, which office has authority to appoint any official(s) of an issuer, as defined in subparagraph (A), above." It is clear from the rule that, at the time the contribution is made, if the recipient of that contribution is an "official of an issuer," then the dealer is subject to the two-year ban on business with the issuer, regardless of whether the candidate wins or loses the election. Any other result would mean that municipal finance professionals could make contributions to issuer officials, but the ban on business would not be triggered (if at all) until election results were known.

(February 16, 1996)

III. INDIRECT CONTRIBUTIONS (Rule G-37(d))

Contributions by Spouses and Household Members

III.1
Q: Are contributions to issuer officials by municipal finance professionals’ spouses and household members covered by the rule?
A: No, unless these contributions are directed by the municipal finance professional, which is prohibited by section (d) of the rule.

(May 24, 1994)

III.2
Q: If a municipal finance professional directs a retail sales person (who is not a municipal finance professional) to make a political contribution to an issuer official, would this trigger the rule's two-year prohibition on business with that issuer?
A: Yes. Section (d) of the rule prohibits municipal finance professionals (and dealers) from using any person or means to do, directly or indirectly, any act which would violate the rule. In other words, a municipal finance professional is prohibited from using a sales person (or any other person not otherwise subject to the rule) as a conduit to circumvent the rule. Thus, contributions made, directly or indirectly, by a municipal finance professional (or a dealer) to an issuer official will subject the dealer to the rule's two-year prohibition on municipal securities business with that issuer. In addition to triggering the prohibition, the municipal finance professional in this case has violated section (d) of the rule.

(December 7, 1994)

Political Parties

III.3
Q: Are contributions to national, state or local political parties covered by the rule?
A: Any such contributions would not trigger the prohibition on business portion of the rule (section (b)) unless such entities are used as a conduit to indirectly contribute to an issuer official, which is prohibited by section (d) of the rule. However, contributions to state or local political parties must be recorded under Rule G-8(a)(xvi) and disclosed in summary form under Rule G‑37(e), except for those contributions which meet the de minimis exemption. See also Rule G-37(e).

(May 24, 1994)

Contributions to a Non-Dealer Associated PAC and Payments to a State or Local Political Party

III.4
Q: Could contributions to a non-dealer associated PAC or payments to a state or local political party lead to a ban on municipal securities business with an issuer under Rule G-37?
A: Rule G-37(d) prohibits a dealer and any municipal finance professional from doing any act indirectly which would result in a violation of the rule if done directly by the dealer or municipal finance professional. A dealer would violate Rule G-37 by doing business with an issuer after providing money to any person or entity when the dealer knows that such money will be given to an official of an issuer who could not receive such a contribution directly from the dealer without triggering the rule’s prohibition on business. For example, in certain instances, a non-dealer associated PAC or a local political party may be soliciting funds for the purpose of supporting a limited number of issuer officials. Depending upon the facts and circumstances, contributions to the PAC or payments to the political party might well result in the same prohibition on municipal securities business as would a contribution made directly to the issuer official. (August 6, 1996)

III.5
Q: If a dealer receives a fund raising solicitation from a non-dealer associated PAC or a political party with no indication of how the collected funds will be used, can the dealer make contributions to the non-dealer associated PAC or payments to the political party without causing a ban on municipal securities business?
A: Dealers should inquire of the non-dealer associated PAC or political party how any funds received from the dealer would be used. For example, if the non-dealer associated PAC or political party is soliciting funds for the purpose of supporting a limited number of issuer officials, then, depending upon the facts and circumstances, contributions to the PAC or payments to the political party might well result in the same prohibition on municipal securities business as would a contribution made directly to the issuer official.

(August 6, 1996)

Making Payments to a National Political Party for its Non-Federal Account (Rule G-37(e))

III.6
Q: If a national political party accepts payments in which contributors have designated that their payments be deposited into the account for a state or local political party, must the dealer record such payments and report them on Form G-37?
A: Yes. Rule G-37 requires that dealers record and report payments made to state and local political parties and the ultimate recipient in the above scenario is a state or local political party so designated by the contributor.

(February 16, 1996)

Supervisory Procedures Relating to Indirect Contributions

III.7
Q: Is a broker, dealer or municipal securities dealer (“dealer”) required to have written supervisory procedures reasonably designed to ensure compliance with Rule G-37(d), on indirect contributions and solicitations, with regard to payments to political parties and PACs by a dealer or its municipal finance professionals (“MFPs”)?
A: Yes. The relevant portion of the MSRB's supervision rule, Rule G-27(c), provides that, “Each dealer shall adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance [with MSRB rules].”

Rule G-37(d) provides that: “No broker, dealer or municipal securities dealer or any municipal finance professional of the broker, dealer or municipal securities dealer shall, directly or indirectly, through or by any other person or means, do any act which would result in a violation of sections (b) or (c) of this rule.” While Rule G-37 was adopted to deal specifically with contributions made to officials of issuers by dealers and municipal finance professionals, and political action committees (“PACs”) controlled by dealers or MFPs, this section of the rule also prohibits MFPs and dealers from using conduits—such as, but not limited to parties, PACs, affiliates, consultants, lawyers or spouses—to contribute indirectly to an issuer official if such MFP or dealer can not give directly to the issuer without triggering the ban on business.

In order to ensure compliance with Rule G-27(c) as it relates to payments to political parties or PACs and Rule G-37(d), each dealer must adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that neither the dealer nor its MFPs are using payments to political parties and non-dealer controlled PACs to contribute indirectly to an official of an issuer.[1] For example, a dealer's written supervisory procedures might provide that, if the dealer or any of its MFPs want to make payments to political parties or PACs, the dealer must perform adequate due diligence prior to allowing political party or PAC payments by the dealer or its MFPs to reasonably ensure that neither the dealer nor its MFPs are using payments to political parties or non-dealer controlled PACs to contribute indirectly to an official of an issuer. [2] Such due diligence also might include inquiring about and documenting the intent or motive in making the payment, whether the party payment or PAC contribution was solicited by anyone, and if so, the identification of the person soliciting the party payment and a record of written solicitations. This information will assist the dealer in determining whether the facts and circumstances surrounding the payment support the reason given for making the payment.

In addition, to ensure compliance with Rule G-37(d) in connection with contributions by dealers or MFPs to non-controlled (but affiliated) PACs,[3]

the dealer might adopt information barriers between any affiliated PACs and the dealer or its MFPs. Examples of such information barrier provisions might include such things as:

• a prohibition on the dealer or MFPs from recommending, nominating, appointing or approving the management of affiliated PACs;

• a prohibition on sharing the affiliated PAC's meeting agenda, meeting schedule, or meeting minutes;

• a prohibition on identification of prior affiliated PAC contributions, planned PAC contributions or anticipated PAC contributions;

• a prohibition on directly providing or coordinating information about prior negotiated municipal securities business, solicited municipal securities business, and planned solicitations of municipal securities business; and

• other such information barriers as the firm deems appropriate to effectively monitor conflicting interests and prevent abuses.

These examples are not exclusive and are only suggestions for supervisory procedures that dealers could consider. Each dealer is required under Rule G-27, on supervision, to evaluate its own circumstances and develop written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance with Rule G-37, on indirect violations.

(September 22, 2005)

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[1] In addition, pursuant to MSRB Rule G-8(a)(xx), on Records Concerning Compliance with Rule G-27, each dealer must maintain and keep current the records required under Rules G-27(c) and G-27 (d).

[2] See Rule G-37 Questions and Answers Nos. III. 4 and III.5, reprinted in MSRB Rule Book.

[3] For the purposes of this guidance the term “affiliated PAC” means a PAC controlled by an affiliated entity of a dealer. An “affiliated entity” is an entity that controls, is controlled by or is under common control with the dealer.

III.8
Q: Is a dealer required to have written supervisory procedures in place to ensure compliance with Rule G-37(d) if the dealer only allows the dealer or its municipal finance professionals (“MFPs”) to make political party payments to “housekeeping”, “conference” or “overhead” type accounts of a political party?
A: Yes. There is no safe harbor under Rule G-37 for payments to “housekeeping”, “conference” or “overhead” type political party accounts. The dealer must have adequate supervisory procedures reasonably designed to prevent a violation of Rule G-37(d), on indirect political contributions, even when the payments are being made to a “housekeeping”, “conference” or “overhead” type account. While the political party itself may prohibit direct contributions to issuer official candidates from “housekeeping” accounts, payments to these accounts might be used for political party events that are focused to benefit a specific candidate or a small number of candidates. Additionally, because money is fungible, a payment made to a fund earmarked for non-issuer official elections might “free up” other money to support the candidacy of specific issuer officials.

The need for dealers to adopt adequate written supervisory procedures to prevent indirect violations via “housekeeping”, “conference” or “overhead” type political party accounts is especially important in light of media and other reports that issuer agents have informed dealers and MFPs that, if they are prohibited from contributing directly to an issuer official's campaign, they should contribute to an affiliated party's “housekeeping” account. In addition, NASD staff has informed the MSRB that some firms make contributions to “housekeeping” accounts or PAC's with explicit instructions accompanying the payment that the specific payment is not to be used for the benefit of one or a limited number of issuer officials. The MSRB does not consider such “preemptive” disclosures or instructions sufficient to meet the dealer's obligation to perform due diligence to reasonably ensure that the payment to the political party or PAC is not being made to circumvent the requirements of Rule G-37.

(September 22, 2005)

IV. DEFINITIONS (Rule G-37(g))

Contribution

IV.1
Q: How is the term "contribution" defined in Rule G-37?
A: The term "contribution" is defined in Rule G-37(g)(i) to mean any gift, subscription, loan, advance, or deposit of money or anything of value made: (i) for the purpose of influencing any election for federal, state or local office; (ii) for payment of debt incurred in connection with any such election; or (iii) for transition or inaugural expenses incurred by the successful candidate for state or local office.

(May 24, 1994)

IV.2
Q: Is Rule G-37 applicable to contributions given to officials of issuers who are seeking election to federal office, such as the House of Representatives, the Senate or the Presidency?
A: Yes. Rule G-37(g)(i) defines “contribution” as, among other things, any gift, subscription, loan, advance, or deposit of money or anything of value made for the purpose of influencing any election for federal, state or local office.

(June 15, 1995)

IV.3
Q: Does Rule G-37 encompass all contributions to candidates for federal office?
A: No. Rule G-37 encompasses, for federal offices, only those contributions to an official of an issuer who is seeking election to a federal office.

(May 24, 1994)

IV.4
Q: Are contributions to bond ballot campaigns subject to the requirements of Rule G-37.
A: Such political contributions are subject to the disclosure requirements of Rule G-37(e) (other than contributions made by a municipal finance professional or a non-MFP executive officer to a bond ballot campaign for a ballot initiative with respect to which such person is entitled to vote if all contributions by such person to such bond ballot campaign, in total, do not exceed $250 per ballot initiative). Although such contributions will not result in a ban on municipal securities business under Rule G-37(b), as with all MSRB rules, failure to comply with requirements of the rule (i.e., by failing to disclose such contributions) may subject dealers to fines and other disciplinary actions by the Securities and Exchange Commission, Financial Industry Regulatory Authority, or other appropriate regulatory agencies.

(May 24, 1994, revised February 25, 2010)

Charitable Donations

IV.5
Q: Would a charitable donation to an organization made by a dealer at the request of an issuer official meet the definition of "contribution" in Rule G-37?
A: No. Charitable donations are not considered political contributions for purposes of Rule G‑37 and therefore are not covered by the rule.

(May 24, 1994)

Municipal Finance Professional

IV.6
Q: Who is considered a municipal finance professional?
A: To determine if a particular person is a municipal finance professional, first determine whether the person is an "associated person" of a dealer (other than a bank dealer) under Section 3(a)(18) of the Securities Exchange Act of 1934 (Act), or an associated person of a bank dealer under Section 3(a)(32) of the Act. Then determine whether the associated person fits within one of the four categories listed in the definition of municipal finance professional under Rule G-37.

Under Section 3(a)(18) of the Act, "associated person of a broker or dealer" is defined as:

• Any partner, officer, director, or branch manager (or any person occupying a similar status or performing similar functions);
• Any person directly or indirectly controlling, controlled by, or under common control with the dealer;
• Or any employee of such broker or dealer, except those whose functions are solely clerical or ministerial.

Under Section 3(a)(32) of the Act, "person associated with a municipal securities dealer" when used with respect to a municipal securities dealer which is a bank or a division or department of a bank means:

• Any person directly engaged in the management, direction, supervision, or performance of any of the municipal securities dealer’s activities with respect to municipal securities; and
• Any person directly or indirectly controlling such activities or controlled by the municipal securities dealer in connection with such activities.

Under Rule G-37(g)(iv), a municipal finance professional is defined as:

1. Any associated person primarily engaged in municipal representative activities pursuant to Rule G-3(a)(i) (such activities include underwriting, trading, sales, financial advisory and consultant services, research or investment advice on municipal securities, or any other activities which involve communication, directly or indirectly, with public investors relating to the activities listed in this paragraph), provided, however, that sales activities with natural persons shall not be considered to be municipal securities representative activities for purposes of Rule G-37(g)(iv);

2. Any associated person who solicits "municipal securities business" as defined in Rule G-37 (which includes negotiated underwriting activities, private placement activities, negotiated remarketing services, financial advisory and consultant services);

3. Any associated person who is both (i) a municipal securities principal or a municipal securities sales principal and (ii) a supervisor of any persons described in paragraphs 1 or 2 above;

4. Any associated person who is a supervisor of the associated persons described in paragraph 3 above, up through and including: (i) for dealers that are not bank dealers, the CEO or similarly situated official; and (ii) for bank dealers, the officer or officers designated by the bank's board of directors as responsible for the day-to-day conduct of the bank's dealer activities.

5. For dealers other than bank dealers: any associated person who is a member of the executive or management committee, or similarly situated officials, if any. For bank dealers: any member of the executive or management committee of the separately identifiable department or division of the bank, as defined in Rule G‑1, if any. However, if the only associated persons meeting the definition of municipal finance professional are those described in this paragraph 5, the broker, dealer or municipal securities dealer shall be deemed to have no municipal finance professionals.

Each person listed by the dealer as a municipal finance professional is deemed to be such for purposes of Rule G-37.

(May 24, 1994, revised October 30, 2003)

IV.7
Q: Does the definition of municipal finance professional include all registered representatives?
A: No. The definition of municipal finance professional includes, among others, any associated person primarily engaged in municipal representative activities pursuant to Rule G-3(a)(i), but excludes sales activities with natural persons.

(May 24, 1994, revised October 30, 2003)

IV.8
Q: Does the definition of municipal finance professional include any associated person who solicits municipal securities business, even if this solicitation activity is a very small portion of the associated person's work?
A: Yes. Even if an associated person is not "primarily engaged in municipal representative activities," that associated person can be considered a municipal finance professional if he or she solicits municipal securities business, as defined in Rule G-37 (such business includes negotiated underwriting activities, private placement activities, negotiated remarketing services, financial advisory and consultant services).

(May 24, 1994)

IV.9
Q: Does the definition of municipal finance professional include anyone other than an associated person of the dealer, for example, consultants, lawyers or spouses of municipal finance professionals?
A: No. Municipal finance professionals must be associated persons of the dealer. Of course, if a dealer or a municipal finance professional seeks indirectly to make contributions to issuer officials through consultants, lawyers or spouses, such contributions would result in the dealer being prohibited from engaging in municipal securities business with the issuer for two years from the date of such contributions.

(May 24, 1994)

Finder’s Fee

IV.10 & IV.11 Deleted

IV.12
Q: Is a "finder's fee" solely cash compensation?
A: No. Such compensation, for example, may take the form of: (i) an unusually large allocation of bonds to a particular sales person; (ii) sales credits; or (iii) any other kind of remuneration.

(December 7, 1994)

IV. 13 Deleted

Supervisors

IV.14
Q: A sales representative at a branch office solicits municipal securities business for the dealer. Such activity results in that person becoming a "municipal finance professional" under Rule G-37(g)(iv)(B). Would that person's branch manager also be considered a municipal finance professional?
A: Yes. Rule G-37(g)(iv)(C) provides that the definition of municipal finance professional includes, among others, any associated person who is both a (i) municipal securities principal or a municipal securities sales principal and (ii) a supervisor of any associated person who solicits municipal securities business (or who is primarily engaged in municipal securities representative activities). If a sales person is soliciting municipal securities business, then the supervisor of that person (i.e., the branch manager) also is included within the definition of municipal finance professional. Branch managers are included within the definition of municipal finance professional in the circumstances described above.

(March 22, 1995, revised October 30, 2003)

Designation Period for Municipal Finance Professionals

IV.15
Q: Rule G-37(g)(iv) states that each person designated a municipal finance professional shall retain this designation for one year after the last activity or position which gave rise to the designation. If a dealer terminates a municipal finance professional’s employment, and that person is no longer associated in any way with the dealer (including any affiliated entities of the dealer), must the dealer continue to designate that person a “municipal finance professional” for recordkeeping and reporting purposes under Rules G-37(g)(iv) and G-8(a)(xvi)?
A: No. If a municipal finance professional is no longer employed by the dealer, and is not an “associated person” of the dealer, then the dealer is not required to designate that person a municipal finance professional and the dealer may cease its recordkeeping and reporting obligations with respect to that person.

(August 6, 1996, revised October 30, 2003)

IV.16
Q: If a municipal finance professional is transferred from a firm’s dealer department to another non-municipal department, such as the corporate department, must the dealer continue to designate this person a municipal finance professional for recordkeeping and reporting purposes?
A: If a municipal finance professional is transferred to another department within the same firm (such as corporate, equities, etc.) and remains an “associated person” of the dealer, the dealer must continue to designate this person a municipal finance professional for one year from the date of the last activity or position which gave rise to this designation and must continue its recordkeeping and reporting obligations under Rules G-37 and G-8. It is incumbent upon each dealer to determine whether the person is an associated person pursuant to Section 3(a)(18) of the Securities Exchange Act of 1934. If so, then in addition to recordkeeping and reporting obligations, dealers should be mindful that any contributions made by this associated person during the one-year designation period (other than contributions that qualify for the rule’s $250 de minimis exception) will subject the dealer to the rule’s ban on municipal securities business for two years from the date of such contribution. Of course, the ban can only be triggered if the person previously was a municipal finance professional.

(August 6, 1996, revised October 30, 2003)

IV.17
Q: A municipal finance professional resigns from a dealer, but still remains an associated person of the dealer (e.g., by retaining a position in the dealer’s holding company). May the dealer cease designating this person a municipal finance professional for purposes of the recordkeeping and reporting requirements under Rules G-37 and G-8? In addition, may this person make contributions to issuer officials without causing the dealer to be banned from municipal securities business with such issuers?
A: If a person is no longer a municipal finance professional because he or she has left the dealer’s employ, but nevertheless remains an associated person of the dealer, then the dealer must continue to designate this person a municipal finance professional for one year from the last activity or position which gave rise to such designation. Moreover, any contributions by this associated person (other than those that qualify for the de minimis exception under Rule G-37(b)) will subject the dealer to the rule’s ban on municipal securities business for two years from the date of the contribution.

(August 6, 1996, revised October 30, 2003)

IV.18
Q: In making the determination of which associated persons of a dealer meet the definitions of municipal finance professional and non-MFP executive officer, is it correct to designate all the executives of the dealer (e.g., President, Executive Vice Presidents) under the category of non-MFP executive officers?
A: No. In making the determination of whether someone is a municipal finance professional or non-MFP executive officer, one must review the activities of the individual and not his or her title. Rule G-37(g)(iv) defines the term “municipal finance professional” as:

(A) any associated person primarily engaged in municipal securities representative activities, as defined in Rule G-3(a)(i), provided, however, that sales activities with natural persons shall not be considered to be municipal securities representative activities for purposes of this subparagraph (A);

(B) any associated person who solicits municipal securities business, as defined in paragraph (vii);

(C) any associated person who is both (i) a municipal securities principal or a municipal securities sales principal and (ii) a supervisor of any persons described in subparagraphs (A) or (B);

(D) any associated person who is a supervisor of any person described in subparagraph (C) up through and including, in the case of a broker, dealer or municipal securities dealer other than a bank dealer, the Chief Executive Officer or similarly situated official and, in the case of a bank dealer, the officer or officers 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, as required pursuant to Rule G-1(a); or

(E) any associated person who is a member of the broker, dealer or municipal securities dealer (or, in the case of a bank dealer, the separately identifiable department or division of the bank, as defined in Rule G-1) executive or management committee or similarly situated officials, if any; provided, however, that, if the only associated persons meeting the definition of municipal finance professional are those described in this subparagraph (E), the broker, dealer or municipal securities dealer shall be deemed to have no municipal finance professionals.

Rule G-37(g)(v) defines the term “non-MFP executive officer” as:

an associated person in charge of a principal business unit, division or function or any other person who performs similar policy making functions for the broker, dealer or municipal securities dealer (or, in the case of a bank dealer, the separately identifiable department or division of the bank, as defined in Rule G-1), but does not include any municipal finance professional, as defined in paragraph (iv) of this section (g); provided, however, that, if no associated person of the broker, dealer or municipal securities dealer meets the definition of municipal finance professional, the broker, dealer or municipal securities dealer shall be deemed to have no non-MFP executive officers. [emphasis added]

Dealers should first review the activities of their associated persons to determine whether they are municipal finance professionals, and then, once that list of individuals has been established, conduct a review of the remaining associated persons to determine whether they are non-MFP executive officers. Dealers should pay close attention to those associated persons who are soliciting municipal securities business and, thus, will be considered municipal finance professionals.

(September 9, 1997, revised October 30, 2003 and June 8, 2006)

Non-MFP Executive Officer

IV.19
Q: Who is a non-MFP "executive officer?"
A: Pursuant to Rule G-37(g)(v), a non-MFP executive officer is defined as any associated person in charge of a principal business unit, division or function, or any other person who performs similar policy making functions for the dealer (or, in the case of a bank dealer, the separately identifiable department or division of the bank, as defined in Rule G-1), but does not include any municipal finance professional.

(May 24, 1994)

IV.20
Q: In a bank with a separately identifiable dealer department, who would be considered a non-MFP executive officer?
A: For most bank dealer departments which deal only in municipal securities, there are no individuals who meet the definition of non-MFP executive officer within Rule G-37.

(August 18, 1994)

Official of an Issuer

IV.21
Q: How is the term "official of an issuer" defined in Rule G-37?
A: Rule G-37(g)(vi) defines the term "official of an issuer" to mean “any person (including any election committee for such person) who was, at the time of the contribution, an incumbent, candidate or successful candidate: (A) for elective office of the issuer which office is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by the issuer; or (B) for any elective office of a state or of any political subdivision, which office has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by an issuer. Thus, contributions to certain state-wide executive or legislative officials would be included within the prohibition on engaging in municipal securities business.

(May 24, 1994, revised October 30, 2003)

IV.22
Q: How can a dealer determine whether an incumbent or candidate for a particular elective office will be able to award or influence the awarding of municipal securities business? For example, in many states, such influence is found in executive branch elected officials, not legislative branch officials.
A: The dealer must review the scope of authority of the particular office at issue, whether executive or legislative branch, not the individual, to determine whether influence over the awarding of municipal securities business is present.

(May 24, 1994)

IV.23
Q: An incumbent was seeking re-election as an issuer official but she lost the election. She is now soliciting money to pay for the debt incurred in connection with this election. Would there be a prohibition on engaging in municipal securities business with the issuer if a dealer or a municipal finance professional provides money for the payment of this debt?
A: No, under certain conditions. If the incumbent is out of office at the time she is soliciting money to pay for the election debt, then she is no longer considered to be within the definition of “official of an issuer” and any monies given for the payment of debt incurred in connection with the election in this instance is not subject to Rule G-37. If the incumbent still holds her issuer official position at the time she is soliciting money to pay for the election debt, then, if a municipal finance professional contributed $250 to her during the general election, the municipal finance professional would not be able to make any contributions for the payment of debt without causing a prohibition on municipal securities business with the issuer. If a municipal finance professional made no contributions to the incumbent prior to the election, then the municipal finance professional may, if entitled to vote for the candidate, contribute up to $250 for the payment of debt incurred in connection with the election while the incumbent is still in office without causing a prohibition on municipal securities business. A dealer may not contribute any monies towards the payment of debt while the incumbent is still in office without causing a prohibition on municipal securities business with the issuer.

(September 9, 1997)

Dealer-Controlled PAC

(As updated February 7, 2019)

Background

MSRB Rule G-18, establishing the first best-execution rule for transactions in municipal securities, became effective March 21, 2016. The best-execution rule requires brokers, dealers and municipal securities dealers (dealers) to use reasonable diligence to ascertain the best market for the subject security and buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. Related amendments to MSRB Rule G‑48, on transactions with sophisticated municipal market professionals (SMMPs), and to MSRB Rule D-15, on the definition of an SMMP, exempt transactions with SMMPs from the best-execution rule. This implementation guidance provides answers to frequently asked questions about the best-execution rule and the SMMP exemption.

Use of This Document

The MSRB is providing in this document general implementation guidance on certain aspects of new Rule G-18 and amended Rules G-48 and D-15 (rules) in a question-and-answer format. This guidance is designed to support compliance with the best-execution rule and the SMMP exemption.[1] The answers are not considered rules and have neither been approved nor disapproved by the Securities and Exchange Commission (SEC).

The MSRB may update these questions and answers periodically, and any updates will include appropriate references to dates of new or modified questions and answers.

Questions and Answers Concerning Best Execution and the Exemption for Transactions with Sophisticated Municipal Market Professionals:  Rules G-18, G-48 and D-15

I. Best-Execution Standard – General

I.1: Reasonable Diligence

Q: What do dealers need to do to use reasonable diligence when selling (purchasing) municipal securities out of (into) their inventory to (from) customers[2] who are not sophisticated municipal market professionals (SMMPs)?[3]

A: Overview of Best-Execution Standard. Section (a) of MSRB Rule G-18, on best execution, requires dealers, in any transaction for or with a customer or a customer of another dealer, to use reasonable diligence to ascertain the best market for the subject security and to buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. This obligation applies to transactions in which the dealer is acting as agent and transactions in which the dealer is acting as principal.[4] Section (a) includes a non-exhaustive list of factors that dealers must consider when exercising this diligence, which includes: the character of the market for the security (e.g., price, volatility, and relative liquidity), the size and type of transaction, the number of markets checked, the information reviewed to determine the current market for the subject security or similar securities, the accessibility of quotations, and the terms and conditions of the customer’s inquiry or order, including any bids or offers, that result in the transaction, as communicated to the dealer. A dealer must make every effort to execute a customer transaction promptly,[5] but the determination as to whether a firm exercised reasonable diligence necessarily involves a “facts and circumstances” analysis, and actions that in one instance may meet a dealer’s best-execution obligation may not satisfy that obligation under another set of circumstances. The rule is designed to complement existing fair and reasonable pricing standards and improve execution quality for retail investors in municipal securities, while promoting fair competition among dealers and improving market efficiency.

Policies and Procedures. As explained during the rulemaking process for the best-execution rule, dealers can use reasonable diligence in ascertaining the best market for a security by using sound policies and procedures and periodically reviewing and improving them. Indeed, paragraph .08 of the Supplementary Material requires the development of policies and procedures reasonably designed to achieve best execution. Paragraph .08 requires dealers to conduct, at a minimum, annual reviews of their policies and procedures for determining the best available market, assessing whether they are reasonably designed to achieve best execution, taking into account the quality of the executions the dealer is obtaining under its current policies and procedures, changes in market structure, new entrants, the availability of additional pre-trade and post-trade data, and the availability of new technologies, and to make promptly any necessary modifications of their policies and procedures in light of those reviews.[6] In short, a dealer can comply with the requirement to use reasonable diligence by developing, following and maintaining policies and procedures that are themselves reasonably designed.

Rule G-18 is designed to provide sufficient flexibility to accommodate the diverse population of dealers, which can adopt policies and procedures to be reasonably related to the nature of their business, including the level of sales and trading activity and the type of customer transactions at issue, and to allow dealers to evidence that they had used reasonable diligence in a manner that is different than that used by other dealers. However, in developing policies and procedures, dealers should consider reviewing and including in their policies and procedures the existing practices of their trading operations, existing best practices within the municipal securities market (particularly those used by similarly-situated dealers), existing best practices in the corporate debt securities market with respect to compliance with FINRA Rule 5310, which requires, among other things, best execution for transactions in corporate debt securities, and any other practices they believe to be relevant. By way of example, if similarly-situated dealers in the municipal securities market typically take certain steps when purchasing municipal securities from a customer, dealers should consider whether their written policies and procedures should provide for those steps to be taken on a consistent and systematic basis.

As explained during the rulemaking process for Rule G-18, the rule is generally substantively consistent with FINRA Rule 5310, with specific tailoring to the characteristics of the municipal securities market. This substantive consistency is in recognition of the efficiencies to be gained from harmonized regulation in similar areas of the fixed income markets. Significantly, the core standard of reasonable diligence in Rule G‑18(a) is stated in identical terms to the core standard in FINRA Rule 5310; however, portions of the list of factors that are considered in determining whether a firm has used reasonable diligence are different. As a result, and also in the interests of harmonized regulation, steps by a dealer that meet the reasonable diligence standard under FINRA Rule 5310 generally will be considered to meet the reasonable diligence standard under Rule G-18 in circumstances that are substantially the same. However, dealers should consider whether any additional or different steps may need to be taken to address provisions in Rule G-18 that are tailored specifically for transactions in municipal securities.

(November 20, 2015) 

I.2: Best Price

Q: Does the term “best execution” (as it relates to municipal securities) mean every trade at a particular point in time must match the best price to have occurred within a short time thereafter?

A: As stated in paragraph .01 of the Supplementary Material to MSRB Rule G-18, “[t]he principal purpose of [the] rule is to promote, for customer transactions, dealers’ use of reasonable diligence,” and a “failure to have actually obtained the most favorable price possible will not necessarily mean that the dealer failed to use reasonable diligence.” A trade occurring shortly after a transaction at a materially more favorable price with no significant change in market conditions or the credit worthiness of the security, however, could indicate a lack of reasonable diligence on the part of the dealer or the utilization of inadequate procedures. Such occurrences would suggest that dealers should consider, as part of their periodic review of their procedures, the inclusion of additional markets when handling future customer orders or inquiries.

(November 20, 2015) 

I.3: Documentation

Q: How do dealers document reasonable diligence in compliance with the best-execution standard and does documentation need to be made for each and every transaction?

A: The issue of documentation of dealers’ compliance with MSRB Rule G-18 arises in at least three areas. First, the rule requires dealers to have written policies and procedures for compliance with the rule. Second, dealers should consider documenting their periodic reviews of their written policies and procedures and the results of those reviews. Third, dealers should consider documenting their adherence to their policies and procedures generally, and paragraph .06 of the Supplementary Material specifically requires documentation of compliance with their policies and procedures with respect to securities with limited quotations or pricing information.[7] The documentation dealers should consider in the third area necessarily would depend on the content of the policies and procedures that the dealer determines to adopt. Only by way of example, recognizing this dependence on the content of the policies and procedures, a dealer could use records providing information displayed on an alternative trading system and reviewed by a trader prior to execution, records of periodic observation of traders, notations by traders and/or records of pre- and/or post-trade reviews.[8] However, these are, again, only examples of documentation methods, and Rule G-18 is designed to provide sufficient flexibility to accommodate the diverse population of dealers, which can adopt policies and procedures to be reasonably related to the nature of their business, including the level of sales and trading activity and the type of customer transactions at issue, and to allow dealers to demonstrate that they had used reasonable diligence in a manner that is different than that used by other dealers. Given this flexibility, some firms may choose to document their adherence to their policies and procedures on a transaction-by-transaction basis, but the MSRB recognizes that there may be reasonable alternative approaches that would satisfy the requirements of MSRB rules and be sufficient to demonstrate compliance.

(November 20, 2015) 

I.4: Extreme Market Conditions

Q: How do extreme market conditions affect dealers’ best-execution obligations?

A: In the potential event of extreme market conditions impacting the trading of municipal securities (e.g., a shortage of liquidity and divergent prices during periods of significant ratings changes, interest rate movements or other market-wide events) dealers should consider establishing and implementing procedures that are designed to preserve the continued execution of customers’ orders in a manner that is consistent with their best-execution obligations while also recognizing and limiting their exposure to extraordinary market risk. Dealers should consider the following guidelines when evaluating their best-execution procedures during extreme market conditions: 

• The treatment of customer orders must remain fair, consistent and reasonable.

• To the extent that a dealer’s order-handling procedures are different during extreme market conditions, it should disclose to its customers the differences in the procedures from normal market conditions and the circumstances in which it may generally activate these procedures.[9]

• Activation of procedures designed to respond to extreme market conditions may be implemented only when warranted by market conditions. Excessive activation of modified procedures on the grounds of extreme market conditions could raise best-execution concerns. Accordingly, dealers should document the basis for activation of their modified procedures. 

Ultimately, it necessarily involves a facts and circumstances analysis to determine whether actions taken by dealers during extreme market conditions are consistent with the duty of best execution, but the MSRB recognizes that market conditions are an important factor in dealers’ best-execution determinations.

(November 20, 2015)

II. Best-Execution Standard – Applicability

II.1: Applicability to Introducing Dealers

Q: Do introducing dealers that execute and clear trades through other dealers have best-execution obligations to their customers?

A: Yes. MSRB Rule G-18 applies to any transaction in a municipal security for or with a customer or a customer of another dealer, without any exception for orders that are routed to another dealer. Paragraph .08(b) of the Supplementary Material to the rule, however, provides that “[a] dealer that routes its customers’ transactions to another dealer that has agreed to handle those transactions as agent or riskless principal for the customer (e.g., a clearing firm or other executing dealer) may rely on that other dealer’s periodic reviews [of its written policies and procedures] as long as the results and rationale of the review are fully disclosed to the dealer and the dealer periodically reviews how the other dealer’s review is conducted and the results of the review.” Under this provision, introducing dealers may rely on the best-execution policies and procedures of their clearing firms or other executing dealers, all of which are subject to their own best-execution obligations under the rule. An introducing dealer, however, is not relieved of its obligations to establish written policies and procedures of its own. For example, such an introducing dealer’s policies and procedures could provide for the reliance on another dealer’s policies and procedures and periodic reviews by the introducing dealer of the other dealer’s reviews of its policies and procedures.

(November 20, 2015) 

II.2: Inter-Dealer Trades

Q: Do trades between broker-dealers have to comply with the best-execution standard?

A: No. MSRB Rule G-18 applies to any transaction for or with a customer or a customer of another dealer. Paragraph .05 of the Supplementary Material to Rule G-18 provides that “[a] dealer’s duty to provide best execution in any transaction ‘for or with’ ‘a customer of another dealer’ does not apply in instances when the other dealer is simply executing a customer transaction against the dealer’s quote,”... and “[a] dealer’s duty to provide best execution to customer orders received from other dealers arises only when an order is routed from another dealer to the dealer for handling and execution.”

(November 20, 2015)

III. Reasonable Diligence Factors – Number of Markets Checked 

III.1: General

Q: When effecting a customer transaction in municipal securities, how many dealers and/or markets does a dealer need to check, and how much diligence does a dealer need to conduct in order to have confidence that all appropriate dealers and/or markets are included? 

A: The duty of best execution requires a dealer to use reasonable diligence. It does not require a dealer to access every available market, especially given the differences in pricing information and execution functionality offered, and there is no set number of dealers making an offer or collecting bids on behalf of a customer order, or other markets, to check that categorically qualifies as reasonable diligence for compliance with the best-execution obligation. Accordingly, a dealer does not need to post a bid-wanted simultaneously on multiple fixed income alternative trading systems (ATSs) and/or with multiple broker’s brokers, though this may be warranted in some cases, or become a subscriber to every ATS. However, in general, dealers should check more than one market or expose customer orders to multiple offerings or bids, and show external offerings and bids to retail customers, which may be accomplished by the use of ATSs or broker’s brokers that expose orders to multiple dealers, each of which constitutes a “market,” as that term is broadly defined in paragraph .04 of the Supplementary Material.[10] For example, a dealer’s policies and procedures could require that, after receiving offers or bids, the dealer must evaluate the offer or bid price versus relevant market information to determine whether any additional markets, including, but not limited to, other dealers, should be checked to perform reasonable diligence. Each dealer should consider including in its written policies and procedures how and when its trading desk exposes retail customer orders to multiple offerings or bids and shows external offerings and bids to retail customers (directly or through financial advisors). Some dealers may employ “filters,” which generally refer to automated tools that allow the dealer to limit its trading, with, for example, specific parties or parties with specified attributes with which it does not want to interact. If a dealer uses filters on counterparties or filters on specific securities intended to limit accessing bids or offers in those securities, they may be used only for a legitimate purpose consistent with obtaining the most favorable executions for non-SMMP customers, and should be reviewed on a periodic basis and adjusted as needed. The dealer, accordingly, should have policies and procedures in place that govern when and how to: reasonably use filters without negatively impacting the quality of execution of non-SMMP customer transactions; periodically reevaluate their use; and determine whether to lift them upon request.[11]  

Given that the rule is designed, in part, to promote fair competition among dealers, generally, a dealer’s policies and procedures should facilitate competition for its customer order flow, including by eliminating practices that discourage other dealers from offering (bidding on) securities to (from) its clients. However, exposing customer order flow to other dealers, alone, is not sufficient to satisfy reasonable diligence, and dealers must also consider the non-exhaustive list of factors identified in Rule G‑18(a).  

(November 20, 2015)

(Updated February 7, 2019)

III.2: Use of Broker’s Brokers and ATSs

Q: Under what circumstances must a dealer use a broker’s broker or ATS to demonstrate reasonable diligence in ascertaining the best market? 

A: There is no categorical requirement in MSRB Rule G-18 for dealers to use a broker’s broker or an ATS, and the rule is designed specifically not to favor any particular type of venue over another for dealers to meet their best-execution obligations. Paragraph .04 of the Supplementary Material construes the term “market” broadly for purposes of Rule G-18, including the rule’s core provision, section (a), requiring the exercise of reasonable diligence in ascertaining the “best market” for the security. Paragraph .04 of the Supplementary Material states: “This expansive interpretation is meant both to inform dealers as to the breadth of the scope of venues that must be considered in the furtherance of their best-execution obligations and to promote fair competition among dealers (including broker’s brokers), alternative trading systems and platforms, and any other venue that may emerge, by not mandating that certain trading venues have less relevance than others in the course of determining a dealer’s best-execution obligations.” A principal purpose of this broad and even-handed language is to tailor the definition of the critical term “market” to the characteristics of the municipal securities market and provide flexibility for future developments in both market structure and applied technology. For example, the language expressly recognizes a characteristic of the municipal securities market (i.e., the role of dealer inventories in providing liquidity) by providing that the executing dealer itself, acting in a principal capacity, may be the best market for the security. Additionally, while an ATS or a broker’s broker, individually, can be considered a market, each can also be a mechanism to expose customer orders to multiple dealers and, therefore, multiple markets. 

As the availability of electronic systems that facilitate trading in municipal securities increases, dealers need to determine whether these systems might provide benefits to their customer order flow, particularly retail order flow, and help ensure they are meeting their obligations under Rule G-18(a) with respect to ascertaining the best market for their customer transactions. Similarly, pre-trade transparency, such as through electronic trading platforms, is also increasing in the municipal securities market, and dealers need to periodically analyze and determine whether incorporating pricing information available from these systems should be incorporated into their best-execution policies and procedures. 

The MSRB recognizes that different markets provide different levels of price information and execution functionality, and that a dealer’s analysis of the available pricing information offered by different systems may take these differences into account. Some systems, including auto-execution systems, both display prices and provide execution functionality, while other systems display prices but provide no execution functionality. Still other systems, such as request-for-quotation systems, may provide indications of interest but not display prices or provide execution functionality. As such, it is the dealers’ responsibility to evaluate various markets (e.g., ATSs, inter-dealer brokers, other dealers) and to establish and periodically review reasonably designed written policies and procedures addressing when and how certain markets should be checked to satisfy the requirements of the rule. Pursuant to paragraph .08(a) of the Supplementary Material, “[i]n conducting its periodic reviews, a dealer must assess whether its policies and procedures are reasonably designed to achieve best execution, taking into account the quality of the executions the dealer is obtaining under its current policies and procedures, changes in market structure, new entrants, the availability of additional pre-trade and post-trade data, and the availability of new technologies, and to make promptly any necessary modification(s) to such policies and procedures as may be appropriate in light of such reviews.” As an aspect of this periodic review, dealers should review the execution quality provided by the various markets they choose to use (including the internalization of order flow), and, to the extent information is reasonably available, the execution quality of new markets or markets they do not use to determine whether to use them.[12] This review could include, for example, reviewing EMMA^® data for previous executions in the subject security or similar securities. 

Additionally, Rule G-18(a) provides a non-exhaustive list of factors that will be considered in determining whether a dealer has used reasonable diligence, with no single factor being determinative, including: (1) the character of the market for the security (e.g., price, volatility and relative liquidity); (2) the size and type of transaction; (3) the number of markets checked; (4) the information reviewed to determine the current market for the subject security or similar securities; (5) the accessibility of quotations; and (6) the terms and conditions of the customer’s inquiry or order, including any bids or offers, that result in the transaction, as communicated to the dealer. Accordingly, a dealer’s policies and procedures for best execution should address how these factors will affect the dealer’s municipal securities transactions with customers under various conditions. 

(November 20, 2015)

(Updated February 7, 2019)

III.3: Reliance on Broker’s Brokers for Pricing

Q: Is a dealer in compliance with MSRB Rule G-18 if it uses the best bid or offer obtained by a broker’s broker as the only basis for the price at which the dealer executes a customer order? 

A: Use of the best bid or offer obtained by a broker’s broker for a particular security as the only basis for the price at which a dealer executes a customer order will not qualify categorically as reasonable diligence in compliance with Rule G-18. To the extent a dealer uses such practice alone, the dealer’s policies and procedures should establish what facts and circumstances should be considered to allow the dealer to do so (e.g., length of collection period used, number of offers/bids received, accessibility of quotations). 

(November 20, 2015) 

III.4: One ATS/Broker’s Broker

Q: Can a dealer comply with MSRB Rule G-18 by exposing customer orders to an ATS or broker’s broker that captures offers/bids from multiple markets? 

A: The market for municipal securities has evolved significantly in recent years. Some dealers have reduced their inventory positions in response to market and regulatory influences and the use of electronic trading systems, including ATSs, continues to grow. In addition, transaction prices for most municipal securities are now widely available to market participants and investors. Although the amount of pre-trade pricing information (e.g., bids and offers) available also has increased, it is still relatively limited as compared to equity securities and generally not readily accessible by the investing public. While new technology and communications in the municipal securities market have advanced, the market remains decentralized, with much trading still occurring primarily through individual dealers.  

In light of this evolution of the municipal securities market, the MSRB encourages the use of broker’s brokers, ATSs and other markets that typically provide exposure to offers/bids from multiple dealers, each of which could constitute a separate market, and it recognizes there may be facts and circumstances under which it may be sufficient for a dealer to check only one such market and satisfy the best-execution obligation. However, utilizing one ATS, one broker’s broker or other similar market will not qualify categorically as reasonable diligence in compliance with Rule G-18. To the extent a dealer checks only one ATS, broker’s broker or other similar market when executing customer orders, the dealer’s policies and procedures should establish what facts and circumstances may allow for the checking of only one such market (e.g., competitiveness of the ATS; the number of dealers, offerings or bids an order is generally exposed to through the ATS or broker’s broker; accessibility of quotations) and what steps would be required to be taken in those situations. 

(November 20, 2015) 

(Updated February 7, 2019)

III.5: Only One Market

Q: How does the best-execution obligation apply when there is only one dealer (i.e., only one market) offering or bidding on the subject security? 

A: There is no set number of dealers making an offer or collecting bids on behalf of a customer order the checking of which categorically qualifies as reasonable diligence for compliance with the best-execution obligation, and, in general, dealers’ procedures should provide for the checking of more than one market or the exposure of customer orders to multiple offers or bids (e.g., use of an ATS or broker’s broker). However, the MSRB recognizes there may be facts and circumstances under which it may be sufficient for a dealer to check only one market, including internal inventory only, and satisfy the best-execution obligation. In order to comply with the best-execution obligation, each dealer’s written policies and procedures should address such facts and circumstances and the steps required to be taken in those scenarios. At a minimum, dealers must also consider the other factors identified in MSRB Rule G-18(a), including, but not limited to, information to determine the current market for the subject security (e.g., recent trade history) and information on similar securities (e.g., offerings of similar securities). If a dealer has policies and procedures in place that are reasonably designed and otherwise comply with applicable rules and follows them, it could execute an order for which there is only one available market, as long as such handling and execution also are consistent with the terms of the customer’s order or inquiry as communicated to the dealer. 

(November 20, 2015)

IV. Reasonable Diligence Factors – Information Reviewed to Determine the Current Market for the Subject Security or Similar Securities 

IV.1: Similar Securities

Q: What constitutes a similar security? 

A: The municipal securities market differs significantly from the market for equity securities and options and also can vary significantly depending on the specific municipal security at issue. For example, some municipal securities may trade frequently, be relatively more liquid and have transparent, accessible and firm quotations available. Other municipal securities do not have public quotations or frequent pricing information available, and may trade infrequently; however, some municipal securities that are less liquid also are fungible, meaning that they trade like other, similar securities, and the pricing in these similar securities can be used as a basis for determining prices in a subject security.   

Given the wide variety of municipal securities, it is impracticable for the MSRB to provide an exhaustive list of characteristics that qualify a bond as a “similar security” for purposes of MSRB Rule G-18. By way of example, however, issuer, source of repayment, credit rating, coupon, maturity, redemption features, sector, geographical region and tax status are some factors a dealer could use to identify municipal bonds as similar. If a dealer uses a similar securities analysis, its written policies and procedures should establish how the dealer identifies similar securities, as well as how and when to consider the market for them for the purposes of complying with the best-execution rule. 

(November 20, 2015) 

IV.2: Trade Review

Q: In the absence of a market and the absence of previous trade history with other dealers in the subject security, how should dealers use reasonable diligence in compliance with their best-execution obligations? 

A: The MSRB encourages dealers to incorporate pre- and/or post-trade review(s) into their written policies and procedures for compliance with MSRB Rule G-18, but Rule G-18 does not mandate any specific trade review process and the MSRB recognizes that multiple approaches to trade reviews could satisfy a dealer’s best-execution obligations. Rule G-18 is designed to provide sufficient flexibility to accommodate the diverse population of dealers, which can adopt policies and procedures to be reasonably related to the nature of their business, including the level of sales and trading activity and the type of customer transactions at issue, and to allow dealers to evidence that they have used reasonable diligence in compliance with the rule in a manner different than that used by other dealers. Accordingly, dealers can use a variety of data, such as comparisons to similar securities, internal models for assessing the quality of execution or potential execution and/or other tools or measurements of quality of execution, as part of their policies and procedures for best execution or the evaluation thereof. To fully inform themselves when determining what procedures to use for customer transactions, dealers should consider what procedures they use or would use for executing the same or similar transactions for their own accounts, although such procedures are not absolutely required to be the same. 

(November 20, 2015) 

IV.3: Evaluated Pricing

Q: Can dealers use evaluated pricing as a component of their procedures to comply with the best-execution obligation? 

A: Yes. MSRB Rule G-18(a) requires dealers to use reasonable diligence to ascertain the best market for the subject security and to buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. Section (a) includes a non-exhaustive list of factors that a dealer must consider when exercising this diligence, including the information reviewed to determine the current market for the subject security or similar securities. Accordingly, dealers can use a variety of data, which is not required to include, but can include, evaluated pricing as part of their written policies and procedures for best execution or the evaluation of their policies and procedures; however, such use would not categorically make those policies and procedures sufficient for compliance with Rule G-18. 

(November 20, 2015)

V. Maintenance of Adequate Resources 

V.1: Appropriate Level of Resources

Q: How does a firm establish that it has the appropriate level of resources? 

A: Paragraph .02 of the Supplementary Material to MSRB Rule G-18 states that “[a] dealer’s failure to maintain adequate resources (e.g., staff or technology) is not a justification for executing away from the best available market.” Additionally, paragraph .02 states that “[t]he level of resources that a dealer maintains should take into account the nature of the dealer’s municipal securities business, including its level of sales and trading activity.” This provision was designed to provide flexibility to accommodate the diverse population of dealers. Accordingly, an appropriate level of resources will depend on many factors, including, but not limited to, a firm’s amount of business, and dealers need to employ enough resources to assure that they can establish, implement, follow and periodically review and improve written policies and procedures reasonably designed to achieve best execution. 

(November 20, 2015)

VI. Securities with Limited Quotations or Pricing Information 

VI.1: Execution Timing

Q: Are there municipal bonds that require more time for a dealer to use reasonable diligence when effecting a customer transaction, and how does a dealer demonstrate such diligence? 

A: Paragraph .03 of the Supplementary Material to MSRB Rule G-18 requires dealers to make every effort to execute a customer transaction promptly, taking into account prevailing market conditions. Taking a relatively shorter time can suggest a lack of reasonable diligence to ascertain the best market, while taking a relatively longer time can suggest a failure to execute promptly. There is no specific amount of time that is too short or too long to effect a customer transaction; it necessarily will depend on the particular facts and circumstances. Paragraph .03, which is tailored for the municipal securities market and varies from the language of FINRA Rule 5310, therefore, goes on to recognize that, in certain market conditions, dealers may need more time to use reasonable diligence to ascertain the best market for the subject security. This provision clarifies that a dealer should not be considered to have failed to execute promptly in market conditions that are beyond the dealer’s control that cause reasonable diligence to be more time-consuming. This provision, at the same time, is designed to temper the promptness requirement so that it does not undermine the goal of the rule to promote reasonable diligence. By way of example, such market conditions could be illiquidity or infrequent trading of the subject security, low demand for lower-rated bonds, low demand for distressed bonds and low demand for bonds with uncommon structural characteristics.  

The absence or limitation of accessible quotations or pricing information is not uncommon for many municipal securities, but does not relieve a dealer of its best-execution obligations. Indeed, paragraph .06 of the Supplementary Material to Rule G-18 specifically requires dealers to have written policies and procedures in place that address how the dealer will make its best-execution determinations with respect to securities with limited quotations or pricing information and to document its compliance with those policies and procedures. Such policies and procedures could establish what bonds/market conditions are subject to any variance in the dealer’s other order-handling procedures, including establishing what it means to have limited quotations or pricing information, what additional procedures, if any, are required to be followed by dealer personnel, and how such steps are to be documented. For example, these securities may require dealers to take additional steps in order to satisfy the best-execution standard, including, but not limited to, seeking out other sources of pricing information and potential liquidity, including, but not limited to, directly contacting dealers with which they previously have traded the security or that are otherwise known to trade in the security.

The MSRB recognizes that, in some instances, obtaining quotations from multiple markets could adversely affect execution quality due to delays in execution or other factors.[13] Therefore, a dealer generally should analyze other data to which it reasonably has access to determine whether it has ascertained the best market for the subject security, but its policies and procedures should also establish under what facts and circumstances it would be appropriate to obtain quotations or other pricing information from multiple markets. Additionally, if pricing information related to the subject security, such as a dealer’s previous trades in the security, or other pricing information, such as a quotation from another market, is limited or unavailable, a dealer may also consider previous trades in a similar security, if that security and those previous trades constitute a reasonable basis for comparison. As with all policies and procedures related to best execution, paragraph .08 of the Supplementary Material to Rule G-18 requires dealers to periodically review these specific policies and procedures, assess whether they are reasonably designed to achieve best execution, and make promptly any necessary modifications in light of such reviews. 

(November 20, 2015)

VII. Relationship To Fair Pricing 

VII.1: MSRB Rule G-30

Q: How does MSRB Rule G-18, on best execution, relate to MSRB Rule G-30, on prices and commissions? 

A: Rule G-18 is intended to complement, support and foster compliance with the MSRB’s established substantive pricing standards, which are governed by Rule G-30, by improving execution quality for customers and promoting fair competition among dealers resulting in increased market efficiency. However, the rule makes clear that its obligations are distinct from, for example, the fairness and reasonableness of commissions, markups or markdowns.  

Rule G-30 requires dealers to trade with customers at fair and reasonable prices, and to exercise diligence in establishing the market value of municipal securities and the reasonableness of their compensation. Rule G-18, on the other hand, does not contain any substantive pricing standard; it is an order-handling and transaction-execution standard, under which the goal of the dealer’s reasonable diligence is to provide the customer the most favorable price possible under prevailing market conditions. Paragraph .01 of the Supplementary Material makes explicit that Rule G-18 is not an absolute “best-price” standard. The rule requires dealers to exercise reasonable diligence with the goal of obtaining the most favorable price possible under prevailing market conditions, which is accomplished through the use and periodic improvement of policies and procedures; it does not require the dealer to actually obtain the most favorable price possible in each transaction (although it frequently will do so through the use of reasonable diligence), and a failure to obtain the most favorable price possible in a transaction will not necessarily mean that the dealer failed to use reasonable diligence under the circumstances.  

Despite the different purposes of Rules G-18 and G-30, some of the relevant factors in determining the fairness and reasonableness of prices and commissions or service charges, such as the availability of the securities and the nature of the dealer’s business, may also be relevant to the application of the best-execution requirement. Further, although the best-execution rule does not itself contain any substantive standard by which the transaction price itself is to be or could be evaluated, the requirement to use reasonable diligence in the order-handling and transaction-execution process is expected to increase the probability that customers receive fair-and-reasonable prices.  

(November 20, 2015)

VIII. SMMP Eexemption – General 

VIII.1: Qualification

Q:  Does the best-execution obligation apply to all customer transactions? 

A: No. However, the only variance in the requirements of MSRB Rule G-18, according to the characteristics of the customer, is codified in MSRB Rules G-48 and D-15 in the form of the SMMP exemption. Section (e) of Rule G-48, which is the consolidated MSRB rule under which all modified obligations of dealers when dealing with SMMPs are addressed, provides that the best-execution obligation under Rule G-18 does not apply to transactions with customers that are SMMPs as defined in Rule D-15.  

(November 20, 2015) 

VIII.2: Applicability to Non-Recommended Transactions

Q: Will the SMMP exemption from the best-execution rule apply to non-recommended transactions? 

A: Yes. The applicability of the SMMP exemption to MSRB Rule G-18 is triggered by a customer’s status as an SMMP, not whether or not a transaction is recommended by the dealer. However, the applicability of the exemption for any particular SMMP is controlled by the scope of the customer affirmation required by MSRB Rule D-15(c) and provided to the dealer. Specifically, paragraph .02 of the Supplementary Material to Rule D-15 provides that “[t]he customer affirmation may be given either orally or in writing, and may be given on a trade-by-trade basis, a type-of-transaction basis, a type-of-municipal-security basis (e.g., general obligation, revenue, variable rate), or an account-wide basis.” As such, any transaction not covered by a customer’s affirmation would remain subject to the best-execution obligation. 

(November 20, 2015) 

VIII.3: Applicability to Transactions with Other Broker-Dealers

Q: Do dealers need to rely on the SMMP exemption to be relieved of the best-execution obligation for transactions for or with broker-dealer clients? 

A: No. MSRB Rule G-18’s best-execution obligation only applies to transactions for or with a customer or a customer of another dealer, and the MSRB’s definition of “customer” in Rule D-9 does not include broker-dealers acting in their capacity as broker-dealers.[14] Accordingly, there is no need for dealers to rely on the SMMP exemption when executing transactions for or with other broker-dealers, and, therefore, no need for customer affirmations for those broker-dealers to qualify as SMMPs. 

(November 20, 2015) 

VIII.4: Existing Customer Affirmations

Q: Can dealers rely on customer affirmations based on existing MSRB Rule D-15? 

A: No. As of the effective date of MSRB Rule G-18 and the amendments to MSRB Rules G-48 and D-15, a customer will not qualify as an SMMP unless it makes the broader affirmation required by Rule D-15, as amended, which addresses all of the modified dealer obligations provided in Rule G-48, including the exemption from the best-execution obligation. Accordingly, any customer affirmations based on existing Rule D-15 would be ineffective to qualify for the SMMP exemption. 

(November 20, 2015) 

VIII.5: Piecemeal Customer Affirmations and Waiver of Dealer Obligations

Q: Can an SMMP waive time-of-trade disclosures, but still have its trades subject to the best-execution rule? 

A: No. A customer cannot waive, and a dealer is not exempt from the time-of-trade disclosure obligation, unless the customer qualifies as an SMMP.[15] In order to qualify as an SMMP, the customer’s affirmation, according to MSRB Rule D-15, must be unified and speak to all of the modified dealer obligations provided in MSRB Rule G-48, including the modified obligations with respect to both time-of-trade disclosure and best execution. The MSRB has determined that, if a customer is not prepared to forgo all of the legal protections afforded by the dealer obligations that would be modified under Rule G-48 if they were an SMMP, then the customer likely does not have the sophistication necessary to qualify as an SMMP. However, the exemption from the best-execution obligation provided by Rules G-48 and D-15 does not preclude a dealer from following its best-execution policies and procedures when handling SMMP orders. 

(November 20, 2015) 

VIII.6: Customer Affirmation Updates

Q: If a dealer reasonably concludes a customer is an SMMP, is the initial affirmation sufficient for all future trades for that customer, or is there a periodic update requirement for customer affirmations? 

A: Although there is no explicit periodic update requirement for customer affirmations, MSRB Rule G‑48 requires that dealers “reasonably conclude” a customer is an SMMP. After a certain lapse of time, it will become unreasonable for the dealer to continue to rely on the stale affirmation, and the dealer, therefore, could no longer “reasonably conclude,” as required, that the customer is an SMMP. 

(November 20, 2015) 

VIII.7: FINRA Rule 2111

Q: Will an institutional investor’s suitability form/letter in compliance with FINRA Rule 2111 satisfy the affirmation requirement to qualify as an SMMP pursuant to MSRB Rule D-15? 

A: No. FINRA Rule 2111(b) and paragraph .07 of the Supplementary Material thereto provide that one element of the suitability obligation of member firms under that rule is fulfilled if the institution affirmatively indicates that it is exercising independent judgment in evaluating the member's or associated person's recommendations. This is similar to the existing exemption dealers have from the suitability requirement of MSRB Rule G-19 under MSRB Rule G-48(c). But neither FINRA Rule 2111 nor any other FINRA rule provides a similar exemption from best execution or any other obligations for its member firms comparable to those included in Rule G-48. Accordingly, a suitability form/letter limited in its terms to comply with FINRA Rule 2111 would not address the full scope of obligations that dealers would be relieved of fulfilling under the exemptions provided by Rules G-48 and D-15. Therefore, a customer will not qualify as an SMMP unless it makes the affirmation required by Rule D-15, which does address all of the modified dealer obligations provided in Rule G-48.

(November 20, 2015)

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Day counting: day counts on notes. As I indicated in my letter of October 4, your September 27 letter regarding the inclusion on a customer confirmation of information with respect to the day count method used on a transaction was referred to the Board for its consideration at the December meeting. In your letter you noted that Board rule G-33 on calculations requires that

[c]omputations under the requirements of [the] rule shall be made on the basis of a thirty-day month and a three-hundred-sixty-day year, or, in the case of computations on securities paying interest solely at redemption, on the day count basis selected by the issuer of the securities.

You indicated that your bank has recently experienced problems with transactions in municipal notes ("securities paying interest solely at redemption") on which the issuer has selected a day count basis other than the traditional "30/360" basis, with the problems resulting from one party to the transaction using an incorrect day count method. You suggested that this type of problem could be partially alleviated by requiring that a municipal securities dealer selling a security on which an unusual day count method is used specify the day count method on the confirmation of the transaction.

The Board shares your concern that a failure to identify the day count method used on a particular security may subsequently cause problems in completing a transaction. Therefore, the Board believes that the parties to a transaction should exchange information at the time of trade concerning any unusual day count method used on the securities involved in the transaction. Since the party selling the securities is more likely to be aware of the unusual day count, it would be desirable that sellers take steps to ensure that they advise the contra-parties on transactions of the method to be used.

The Board does not, however, believe that it would be appropriate to require that this information be stated on the confirmation. The Board reached this determination based on its perception that the space available on the confirmation for the details of the securities description is quite limited and its belief that information regarding the day count method may not be sufficiently material to warrant its inclusion in the securities description. MSRB interpretation of December 9, 1982.

Securities description: securities backed by letters of credit. I am writing in connection with our previous telephone conversation of last June regarding the confirmation of a transaction in a municipal issue secured by an irrevocable letter of credit issued by a bank. In our conversation you noted that both rules G-12 and G-15 require confirmations to contain a:

description of the securities including at a minimum..., if necessary for a materially complete description of the securities, the name of any company or other person in addition to the issuer obligated, directly or indirectly, with respect to debt service...

You inquired whether the name of the bank issuing a letter of credit securing principal and interest payments on an issue, or securing payments under the exercise of a put option or tender option feature, need be stated on the confirmation.

At that time I indicated to you that the identity of the bank issuing the letter of credit would have to be disclosed on the confirmation if the letter of credit could be drawn upon to cover scheduled interest and principal payments when due, since the bank would be "obligated ... with respect to debt service." I am writing to advise that the committee of the Board which reviewed a memorandum of our conversation has concluded that a bank issuing a letter of credit which secures a put option or tender option feature on an issue is similarly "obligated ... with respect to debt service" on such issue. The identity of the bank issuing the letter of credit securing the put option must therefore also be indicated on the confirmation. MSRB interpretation of December 2, 1982.

Securities description: revenue securities. I am writing in response to your letter of September 30, 1982 regarding the confirmation description of revenue securities. In your letter you note that the designation "revenue" is often not included in the title of the security, and you raise several questions concerning the method of deriving a proper confirmation description of revenue securities.

As you know, rule G-15(a)(v)[*] requires that customer confirmations set forth a description of the securities [involved in the transaction] including at a minimum the name of the issuer, interest rate, maturity date and if the securities are ... revenue bonds, an indication to such effect, including in the case of revenue bonds the type of revenue, if necessary for a materially complete description of the securities...[1] [emphasis added]

The rule requires, therefore, that revenue securities be designated as such, regardless of whether or not such designation appears in the formal title of the security. The dealer preparing the confirmation is responsible for ensuring that the designation is included in the securities description. In circumstances in which standard sources of descriptive information (e.g., official statements, rating agency and service bureau publications, and the like) do not include such a designation in the security title, therefore, the dealer must augment this title to include the requisite information.

In your letter you inquire as to who is responsible for providing this type of descriptive information to the facilities manager of the CUSIP system. Although the Board does not currently have any requirements concerning this matter, proposed rule G-34 will, when approved by the Securities and Exchange Commission, require that the managing underwriter of a new issue of municipal securities apply for the assignment of CUSIP numbers of such new issue if no other person (i.e., the issuer or a person acting on behalf of the issuer) has already applied for number assignment. In connection with such application, if one is necessary, the managing underwriter is required, under the proposed rule, to provide certain information about the new issue, including a designation of the "type of issue (e.g., general obligation, limited tax, or revenue)" and an indication of the "type of revenue, if the issue is a revenue issue."

In your letter you also ask for "the official definition of a 'revenue' issue." There is no "official definition" of what constitutes a revenue issue. Various publications include a definition of the term (e.g., the PSA's Fundamentals of Municipal Bonds, the State of Florida's Glossary of Municipal Securities Terms, etc.) and I would urge you to consult these for further information. MSRB interpretation of December 1, 1982.

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[1] Rule G-12(c)(v)(E) sets forth the same requirement with respect to inter-dealer confirmations.

[*] [Currently codified at rules G-15(a)(i)(B) and G-15(a)(i)(C)]

Confirmation: Mailing of WAII, "all or none" confirmation. I understand that certain ... firms ... have raised questions concerning the application of a recent Board interpretive letter to certain types of municipal securities underwritings. I am writing to advise that these questions were recently reviewed by the Board which has authorized my sending you the following response.

The letter in question, reprinted in the Commerce Clearing House Municipal Securities Rulemaking Board Manual at ¶ 3556.55 [*], discusses the timing of the mailing of initial "when, as and if issued" confirmations on "pre-sale" orders to which new issue municipal securities have been allocated. Among other matters, the letter states that such confirmations may not be sent out prior to the date of award of the new issue, in the case of an issue purchased at competitive bid, or the date of execution of a bond purchase agreement on the new issue, in the case of a negotiated issue. [Certain] ... firms have questioned whether this interpretation ... is intended to apply to "all or none" underwritings, in which confirmations have been, at times, sent out prior to the execution of a formal purchase agreement.

As the Board understands it, an "all or none" underwriting of a new issue of municipal securities is an underwriting in which the municipal securities dealer agrees to accept liability for the issue at a given price only under a stated contingency, usually that the entire issue is sold within a stated period. The dealer typically "presettles" with the purchasers of the securities, with the customers receiving confirmations and paying for the securities while the underwriting is taking place. Pursuant to SEC rule 15c2-4 all customer funds must be held in a special escrow account for the issue until such time as the contingency is met (e.g., the entire issue is sold) and the funds are released to the issuer; if the contingency is not met, the funds are returned to the purchasers and the securities are not issued. [1]

The Board is of the view that an initial "when, as and if issued" confirmation of a transaction in a security which is the subject of an "all or none" underwriting may be sent out prior to the time a formal bond purchase agreement is executed. This would be permissible, however, only if two conditions are met: (1) that such confirmations clearly indicate the contingent nature of the transaction, through a statement that the securities are the subject of an "all or none" underwriting or otherwise; and (2) that the dealer has established, or has arranged to have established, the escrow account for the issue as required pursuant to rule 15c2-4. MSRB interpretation of October 7, 1982.

 

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[1] I note also that SEC rule 10b-9 sets forth certain conditions which must be met before a dealer is permitted to represent an underwriting as an "all or none" underwriting.

 

[*] [See Rule G-12 Interpretive Letter - Confirmation: mailing of WAII confirmation, MSRB interpretation of April 30, 1982.]

Municipal securities principal: numerical requirements. This is in response to your letter of September 28, 1982 concerning the numerical requirements for municipal securities principals in Board rule G-3 . . . Rule G-3(b)(i)(B)[*] requires that

every municipal securities broker or municipal securities dealer having fewer than eleven persons associated with it in whatever capacity on a full-time or full-time equivalent basis who are engaged in the performance of its municipal securities activities, or, in the case of a bank dealer, in the performance of its municipal securities dealer activities, shall have at least one municipal securities principal.

You inquired as to the meaning of "full-time equivalent basis" in the reference language. This phrase is intended to require the inclusion of individuals who should be considered as full-time employees, but because of some distinctive employment arrangement do not fit the norm of a full-time employee. For example, a municipal securities representative who usually works out of his home which is in a remote location might not fit the firm's norm for "full-time employment" but should nevertheless be counted for purposes of the rule as an associated person.

You also inquired as to whether a bank dealer is required to have only one municipal securities principal even if it has fifteen full-time persons working in the municipal securities business. The provisions of the rule apply equally to securities firms and to bank dealers. Therefore, a bank dealer with eleven or more associated persons "engaged in the performance of its municipal securities dealer activities" is required to have at least two municipal securities principals.

 

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

Recordkeeping by introducing brokers. Your letter of September 16, 1982, has been referred to me for response. In your letter you indicate that your firm functions as an "introducing broker", and, in such capacity, effects an occasional transaction in municipal securities. You inquire as to the recordkeeping requirements applying to a firm acting in this capacity, and you also inquire as to the possibility of an exemption from the Board's rules, in view of the extremely limited nature of your municipal securities business.

As you recognize, the provision Board rule G-8 on recordkeeping with particular relevance to introducing brokers is section (d), which provides as follows:

A municipal securities broker or municipal securities dealer which, as an introducing municipal securities broker or municipal securities dealer, clears all transactions with and for customers on a fully disclosed basis with a clearing broker, dealer or municipal securities dealer, and which promptly transmits all customer funds and securities to the clearing broker, dealer or municipal securities dealer which carries all of the accounts of such customers, shall not be required to make and keep such books and records prescribed in this rule as are customarily made and kept by a clearing broker, dealer or municipal securities dealer and which are so made and kept; and such clearing broker, dealer or municipal securities dealer shall be responsible for the accurate maintenance and preservation of such books and records. (emphasis supplied)

As you can see, this provision states that the introducing broker need not make and keep those records which are "customarily made and kept by" the clearing dealer, as long as the clearing dealer does, in fact, make and keep those records. The introducing broker is still required, however, to make and keep those records which are not "customarily made and kept by" the clearing firm.

The majority of the specific records you name in your letter fall into the latter category of records which are not customarily made and kept by the clearing firm and therefore remain the responsibility of the introducing broker. Your firm would, therefore, be required to make the records of customer account information required under rule G-8(a)(xi), with all of the itemized details of information recorded on such records. Your firm would also be required to maintain the records of agency and principal transactions ("order tickets") required under rules G-8(a)(vi) and (vii) respectively. In both cases, however, if, for some reason, the clearing firm does make and keep these records, your firm would not be required to make and keep duplicates.

In the case of the requirement to keep confirmation copies, it is my understanding that the clearing firm generally maintains such records. If the clearing firm to which you introduce transactions follows this practice and maintain copies of the confirmations of such transactions, you would not be required to maintain the same record.

In adopting each of these recordkeeping requirements the Board concluded that the information required to be recorded was the minimum basic data necessary to ensure proper handling and recordation of the transaction and customer protection. I note also that these requirements parallel in most respects those of Commission rule 17a-3, to which you are already subject by virtue of your registration as a broker/dealer.

With respect to your inquiry regarding an exemption from the Board's requirements, I must advise that the Board does not have the authority to grant such exemptions. The Securities and Exchange Commission does have the authority to grant such an exemption in unusual circumstances. Any letter regarding such an exemption should be directed to the Commission's Division of Market Regulation. MSRB interpretation of September 21, 1982.

Callable securities: disclosure. I am writing in response to your letter of August 17, 1982, concerning the requirements of Board rules G-12(c)(v)(E) and G-15(a)(v)[*] concerning securities descriptions set forth on confirmations. In your letter you note that certain descriptive details are required to be disclosed on the confirmation only "if necessary for a materially complete description of the securities," and you inquire whether information as to a security's callability is one of these details.

Rules G-12(c)(v)(E) and G-15(a)(v)[*] require confirmations to set forth a

description of the securities, including at a minimum the name of the issuer, interest rate, maturity date, and if the securities are limited tax, subject to redemption prior to maturity (callable) or revenue bonds, an indication to such effect, including in the case of revenue bonds the type of revenue, if necessary for a materially complete description of the securities, and in the case of any securities, if necessary for a materially complete description of the securities, the name of any company or other person in addition to the issuer obligated, directly or indirectly, with respect to debt service or, if there is more than one such obligor, the statement 'multiple obligators' may be shown." (emphasis added)

As you can see, the phrase "if necessary for a materially complete description of the securities" modifies only the requirements for disclosure of "the type of revenue," or ... disclosure of "the name of any company or other person obligated ... with respect to debt service...," and does not modify the requirements for disclosure of the other listed information. Both rules, therefore, deem information as to the "name of the issuer, interest rate, maturity date and if the securities are limited tax, subject to redemption prior to maturity (callable) or revenue bonds" to be necessarily material and subject to disclosure on the confirmation. In the specific case which you cite, that of a security with an "in-part" sinking fund call feature, the confirmation of a transaction in such security would be required to identify the security as "callable." MSRB interpretation of August 23, 1982.

 

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[*] [Currently codified at rules G-15(a)(i)(B) and G-15(a)(i)(C)]

Advertisements of securities not owned. This is in response to your letter of May 5, 1982 concerning a dealer bank’s advertising practices. Your letter states that the dealer bank has recently published newspaper advertisements which list specific municipal securities as "Current Offerings," and that your review of the dealer’s inventory positions has disclosed that "on the date the advertisement was published the dealer held no position in four of the issues advertised and a nominal position in the fifth advertised issue." Your letter reports that the dealer stated that it was his intention to obtain the advertised issues from other dealers when customer orders were received. Your first question is whether "it is misleading and thus in violation of rule G-21, to advertise securities which the dealer does not own..."

The Board has recently considered this advertising practice and concluded that it would not violate Board rules provided that: (1) the advertisement indicates that the securities are advertised "subject to availability;" (2) the dealer placing the advertisement is not aware that the bonds are no longer available in the market; and (3) the dealer would attempt to acquire the bonds advertised if contacted by a potential customer.

Your letter also expresses concern that this type of advertising might be seriously misleading to customers since the advertisement must be prepared and the printer’s proof copy approved five days in advance of the date of publication. You note that "significant changes in the market can occur over a five, or even three-day period" and that, if such market changes had occurred between submission and publication of the advertisement, the customer could be seriously misled. The Board is aware that delays occur between the time an advertisement is composed and approved for publication by a municipal securities dealer and the time it is actually published. The Board believes that inclusion in the advertisement of a statement indicating that the securities are advertised subject to change in price provides adequate notice to a potential customer that the prices and yields quoted in the advertisement may not represent market yields and prices at the time the customer contacts the dealer. MSRB interpretation of July 1, 1982.

Original issue discount, zero coupon securities: disclosure of, pricing to call feature. I am writing in response to your inquiry in our recent telephone conversation regarding the application of Board rules to the recent original issue discount on "zero coupon" new issues of municipal securities. In particular, you indicated that these types of securities are often subject to somewhat unusual call provisions, and you inquired as to the application to these types of securities of Board rules concerning the disclosure of call provisions and the use of such call provisions in dollar price and yield computations.

Subsequent to our conversation, I obtained several examples of these call provisions, which were provided to the Board in connection with your inquiry. In the first of these examples, involving an original issue discount security, the call provision commences ten years after issuance, with the redemption price initially set at 90 and increasing by 2 points every three years, reaching a redemption price of 100 twenty-five years after issuance. In the second example, involving a "zero coupon" security, the call provision commences ten years after issuance; the redemption price is based on the compound accreted value of the security (plus a stated redemption premium for the first five years of the call provision), with certain of the securities initially redeemable at an approximate dollar price of 18.

As you know, the call provisions on "zero coupon" and original issue discount securities are one of the special characteristics of such securities, but are not, by any means, the sole special characteristic. The Board is of the view that municipal securities brokers and dealers selling such securities are obliged, under Board rule G-17 as well as under the anti-fraud rules under the Securities Exchange Act, to disclose to customers all material information regarding such special characteristics. As the Board stated in its April 27, 1982 "Notice Concerning 'Zero Coupon' and 'Stepped Coupon' Securities,"

persons selling such securities to the public have an obligation to adequately disclose the special characteristics of such securities so as to comply with the Board's fair practice rules.

Therefore, in selling an original issue discount or "zero coupon" security to a customer, a dealer would be obliged to disclose, among other matters, any material information with respect to the call provisions of such securities.

I note also that Rule G-15 requires customer confirmations of transactions in callable securities to indicate that the securities are "callable," and to contain a legend stating, in part, that information concerning the call provisions of such securities will be made available upon the customer's request. Customer confirmations of transactions in callable original issue discount or "zero coupon" securities would have to contain such a legend, in addition to the designation "callable," and the details of the call provisions of such securities would have to be provided to the customer in writing upon the customer's request.

The requirement under rules G-12 and G-15 for the computation of dollar price and (under rule G-15) yield to a call or option feature would apply to a transaction in an original issue discount or "zero coupon" security. Therefore, if the dollar price to the call on a transaction in such securities is lower than the price to maturity, such dollar price should be used. In the case of customer confirmations, if the yield to call on a transaction in such securities is lower, such yield must be shown. As you noted in our conversation, in view of the redemption price structure of the call provisions on such securities, the price or yield to call on a particular transaction might be lower than the price or yield to maturity, even though the transaction is effected at a price below par. Since heretofore the industry has been accustomed to call provisions at prices at or above par, industry members may wish to pay particular attention to the processing of transactions in original issue discount or "zero coupon" securities with these unusual types of call provisions, to ensure that the dollar price or yield of such transactions is not inadvertently overstated due to a failure to check the price or yield to call. MSRB interpretation of June 30, 1982.

Authorization of sales contests. Your letter of May 27, 1982 has been referred to me for response. In your letter you request an interpretation regarding the applicability of Board rule G-20 concerning gifts and gratuities to sales contests offered by an underwriter to participating members of a syndicate. Your letter asks specifically whether such sales contests are considered compensation for services as described in paragraph (c) of rule G-20, and, if they are, whether the requirements of rule G-20 imposed on agreements for the compensation of services must be met by the underwriter sponsoring the sales contest.

The Board believes that sales contests which provide gifts or payments to employees of municipal securities brokers and municipal securities dealers other than the broker or dealer sponsoring the contest constitute compensation for services as described in rule G-20(c). Consequently, the requirements of that rule must be met: that is, the sponsoring dealer must obtain

prior to the time of employment or before the services are rendered a written agreement between the municipal securities broker or municipal securities dealer subject to this rule and the person who is to perform such services; ... such agreement [to] include the nature of the proposed services, the amount of the proposed compensation, and the written consent of such person's employer.

In the context of sales contests, agreements of the kind referred to in the rule are required between the municipal securities broker or municipal securities dealer sponsoring the contest and all contestants employed by other municipal securities brokers and municipal securities dealers.

Please do not hesitate to contact me if you have further questions concerning this matter. MSRB interpretation of June 25, 1982.

Municipal securities principal. This will acknowledge receipt of your letter of June 10, 1981. In your letter you indicate that the dealer department of [the bank] has recently been inspected by examiners from the Office of the Comptroller of the Currency, and that, during the course of such inspection, the examiners indicated that they believed certain persons should be qualified as municipal securities principals. You indicate your disagreement with the examiners' conclusions, and request an opinion from the Board concerning the need to qualify these personnel.

The two cases you describe are as follows:

(1) Mr. "X", as head of the Operations Division of the bank's Financial Markets Group, is in charge of the operational support services for the bank's securities activities, including the Tax-Exempt Operations Department. The Tax-Exempt Operations Department is under the immediate supervision of yourself. For purposes of bank organizational structure you report to Mr. "X"; however, you also report to the head of the Tax-Exempt Securities Division in connection with "supporting the Tax-Exempt business operation." You are qualified as a municipal securities principal, as is the head of the Tax-Exempt Securities Division; Mr. "X", however, is not. The national bank examiners have expressed the view that he should be.

(2) Two "senior traders" in the Municipal Dealer Department act under the supervision of the department head with regard to the trading and positioning of municipal securities. In connection with these activities they "direct more junior traders" in their municipal securities activities. These persons are not qualified as municipal securities principals; the national bank examiners contend that they should be.

As a general matter we would hesitate to disagree with the opinion expressed by an on-site examiner in a matter of this sort. The examiner is, of course, in direct contact with the matter in question, and has access to the full details of the situation, rather than an abstraction or summary of the particulars. Accordingly, we are unable to express a view that the examiner's conclusions are incorrect in the circumstances you describe.

With respect to the specific situations presented in your letter, it is certainly not impossible to establish a reporting and supervisory structure such that a person who is in charge of the division which includes the operational aspects of a bank's municipal securities dealer department need not be qualified as a municipal securities principal. As is indicated in a Board interpretive notice concerning qualifications matters, qualification as a municipal securities principal is required of a person who supervises a bank dealer's processing and clearance activities with respect to municipal securities only to the extent that such person has policy-making authority over such activities. If such person does not have policy-making authority, or if such person's authority extends to the establishment of general guidelines or an overall framework for activities, with the specific function of making policy within that framework reserved for other persons, then such person would not be deemed to be a municipal securities principal.

Further, it is a not uncommon arrangement to have the policy-making authority with respect to the municipal dealer operations activities of a bank allocated between the immediate supervisor of the municipal operations function and a principal in the dealer department itself. In these circumstances the operation supervisor reports to the principal in connection with the municipal dealer activities, and also reports to other, non-qualified persons in connection with bank organizational requirements.

Therefore, the arrangement which you describe would not necessarily require that Mr. "X" be qualified as a municipal securities principal. Whether he should, in fact, be qualified as a municipal securities principal depends, of course, on the extent to which he does exercise policy-making authority over the municipal dealer operations functions; this is a determination that, we suggest, is most appropriately made by yourselves and the national bank examiners.

In the second situation you describe it appears to us clear that the "senior traders" are functioning as municipal securities principals and should be qualified as such. As you may know, the Board's rule defines the term "municipal securities principal" to include persons "who [are] directly engaged in the . . . direction or supervision of . . . underwriting, trading or sales of municipal securities. . ." Your description of the activities of these "senior traders" indicates that they "direct" other persons in trading activities. This certainly supports the conclusion that they are functioning as municipal securities principals. MSRB interpretation of June 24, 1981.

Persons engaged in financial advisory activities. I am writing to confirm our telephone conversation of this afternoon concerning the registration and qualification requirements applicable to persons in your firm's public finance department. In our conversation you inquired whether persons who function as financial advisors to municipal issuers, providing advice to such issuers regarding the structure, timing and terms of new issues of municipal securities to be sold by such issuers, are required to be qualified. As I indicated, such persons are required to be registered and qualified as municipal securities representatives. Furthermore, persons who supervise representatives performing such financial advisory services are required to be registered and qualified as municipal securities principals.

For your information, the provision of financial advisory services to municipal issuers is defined to be a municipal securities representative function in Board rule G-3(a)(iii)(B)[*]. The requirement that persons performing such function be qualified is set forth generally in rules G-2 and G-3, and the specific qualification requirements applicable to such persons are stated in rules G-3(e)[†] and (i)[‡]. MSRB interpretation of June 10, 1982.

 

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[*] [Currently codified at rule G-3(a)(i)(B)]

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

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

Day counting: securities dated on the 15th of a month. I am writing in response to your letter of May 26, 1982 in which you inquire as to the correct day count for calculation purposes on a security which is dated on the 15th of a month and pays interest on the first of a following month. In your letter you pose the example of a security dated on June 15, 1982 and paying interest on July 1, 1982, and you inquire whether the July 1, 1982 coupon on such security should have a value of 15 or 16 days of accrued interest.

As you know, Board rule G-33 provides the following formula for use on computations of day counts on securities calculated on a "30/360" day basis:

Number of days = (Y2 - Y1) 360 + (M2 - M1) 30 + (D2 - D1)

In this formula, the variables "Y1," "M1," and "D1" are defined as the year, month, and day, respectively, of the date on which the computation period begins (June 15, 1982, in your example), and "Y2," "M2," and "D2" as the year, month, and day of the date on which the computation period ends (July 1, 1982, in your example). In the situation you present, therefore, the number of days in the period would correctly be computed as follows:

Number of days = (1982 - 1982) 360 + (7 - 6) 30 + (1 - 15)

or

Number of days = (0) 360 + (1) 30 + (- 14)

or

Number of days = 0 + 30 + ( - 14)

or

Number of days = 16 days

If figured correctly, therefore, the coupon for such a period should have a value of 16 days of accrued interest. If the coupon is for a longer period of time, this particular portion of that longer period would still correctly be counted as 16 days (e.g., the day count on a coupon for the period June 15 to September 1 would correctly be figured as 76 days, consisting of 16 days for the period June 15 to July 1, and 30 days each for the months of July and August).

The error of computing the day count for such a period as 15 days apparently arises from an assumption that, on a security dated on the 15th of a month, accrued interest is owed only for the "second half" of that month. In reality, of course, the 15th of a month is not the first day of the "second half" of that month, but rather is the last day of the "first half" of that month (since a 30-day month consists of two 15-day half-months, the first half being from the 1st to the 15th, and the second half being from the 16th to the 30th). Again, it can clearly be seen that the correct day count for such a period is 16 days. MSRB interpretation of June 2, 1982.

Customer account information. I am writing in response to your letter of May 25, 1982 concerning the maintenance of customer account information records in connection with certain orders placed with you by a correspondent bank. In your letter you indicate that a correspondent bank periodically purchases securities from your dealer department for the accounts of specified customers. The confirmations of these transactions are sent to the correspondent bank, with a statement on each confirmation designating, by customer name, the account for which the transaction was effected. No confirmations or copies of confirmations are sent to the customers identified by the correspondent bank. You inquire whether customer account information records designating these customers as the "beneficial owners" of these accounts need be maintained by your dealer department.

As you know, rule G-8(a)(xi) requires a municipal securities dealer to record certain information about each customer for which it maintains an account. Subparagraph (G) of such paragraph requires that this record identify the

name and address of beneficial owner or owners of such account if other than the customer and transactions are to be confirmed to such owner or owners...(emphasis added)

If the transactions are not to be confirmed to the customers identified as the owners of the accounts for which the transactions are effected, then such information need not be recorded.

In the situation you cite, therefore, the names of the customers need not be recorded on the customer account information record. MSRB interpretation of June 1, 1982.

The Municipal Securities Rulemaking Board has recently received inquiries concerning the application of the confirmation disclosure requirements of Board rules G-12 and G-15 to transactions in municipal securities with "zero coupons" or "stepped coupons." Certain recent new issues of municipal securities have had several maturities paying 0% interest; securities of these maturities are sold at deep discounts, with the investor's return received in the form of an accretion of this discount to par. Other issues have been sold which have "stepped coupons;" that is, all outstanding bonds pay the same interest rate each year, with the interest rate periodically rising, on a pre-established schedule, on all securities yet to be redeemed. Interested persons have inquired concerning how the description requirements of the rules apply to such securities, and whether the yield disclosure requirements of rule G-15 apply to confirmations of transactions in such securities for the accounts of customers.

Rule G-12(c)(v)(E) requires a municipal securities dealer to set forth on an inter-dealer confirmation a description of the securities which are the subject of the transaction, including the interest rate. Rule G-15(a)(i)(E)[*] imposes the same requirement with respect to customer confirmations. Further, rule G-15(a)(i)(I)(2)[†] requires that customer confirmations of transactions effected at dollar prices (except for transactions at par) state the lowest of the resulting yield to call, yield to par option, or yield to maturity.

A confirmation of a transaction in a "zero coupon" security must state that the interest rate on the security is "0%." A customer confirmation of such a transaction must state the lowest of the yield to call or yield to maturity resulting from the dollar price of the transaction.[1] The Board believes that the disclosure of the resulting yield is particularly important on such transactions, since it provides the only indication to the investor of the return he or she can expect from the investment.

A confirmation of a transaction in a "stepped coupon" security must state the interest rate currently being paid on the securities, and must identify the securities as "stepped coupon" securities. A customer confirmation of such a transaction must also state the lowest of the yield to call, yield to par option, or yield to maturity resulting from the dollar price of the transaction.[2] In view of the wide variation in the coupon interest rates that will be received over the life of a "stepped coupon" security, the Board believes that the disclosure of yield will assist customers in determining the actual return to be received on the investment.

In addition to the specific confirmation disclosure requirements of Board rules G-12 and G-15 discussed above, the Board is of the view that persons selling such securities to the public have an obligation to adequately disclose the special characteristics of such securities so as to comply with the Board's fair practice rules. For example, although the details of the increases to the interest rates on "stepped coupon" securities need not be provided on confirmations, such information is, of course, material information regarding the securities, and municipal securities dealers would be obliged to inform customers about this feature of the securities at or before the time of trade.

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[1] The Board notes that, upon the effectiveness of Board rule G-33, such yield must be computed on a basis that presumes semi-annual compounding.

[2] In the case of both "zero coupon" and "stepped coupon" securities, if the transaction is effected in a yield basis, the confirmation must show the yield price and the resulting dollar price, computed to the lowest of price to premium call, price to par option, or price to maturity.

[*] [Currently codified at rule G-15(a)(i)(B)(4)]

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

Records of original entry; accessibility of records. As I indicated to you in my previous letter of February 1, 1982, your inquiry of January 21, 1982 was referred to the committee of the Board charged with responsibility for interpreting the requirements of Board rules G-8 and G-9 on books and records. That committee has authorized my sending you this response.

In your letter you indicate that during the course of an examination of your bank's municipal securities dealer department by the Office of the Comptroller of the Currency certain criticisms were made by the examiners regarding the recordkeeping system used by your bank. In particular, the examiners noted that the "record of original entry" maintained by the bank did not contain seven specified items of information,[1] and expressed the view that customer account records more than one year old were not "maintained and preserved in an easily accessible place" within the meaning of rule G-9. You disagree with the examiner's interpretation of "easily accessible." Further, while conceding that the specified items of information are not contained on the record, you indicate that this information is readily available upon specific inquiry to the bank's system data base, and express the view that this should be sufficient for purposes of compliance with Board rule G-8. You request the Board's views on these subjects.

As a general matter we would hesitate to disagree with the opinion expressed by an on-site examiner concerning the auditability of records maintained by a municipal securities dealer. The examiner is, of course, in direct contact with the matter in question, and has access to the full details of the situation, rather than an abstraction or summary of the particulars. Accordingly, we are unable to express a view that the examiner's criticisms are incorrect in the specific circumstances you describe.

With respect to the particular questions which you raise, we note that rule G-8 does require that all of the specified information appear on the record or system of records designated as the dealer's "record of original entry." It is not sufficient that the dealer has the capability of researching specific items, or constructing a record upon request from information maintained in other formats. The record of original entry is intended to provide a journal of all of the basic details of a dealer's activity on a given day. A record that can only be put together on request, or that is missing basic details of information, is not sufficient for this purpose.

We note also that, in reviewing the attachments to your letter, it appears that the absence of several of the specified items of information would be easy to rectify--institution of controls to prevent duplication of customer and security abbreviations would appear to resolve the problems with these details, and a system of grouping transaction input could be devised so that trades for different trade dates are not shown on the same blotter. Similarly, bond or note numbers could be designated on transaction tickets maintained as an augmentation of the computerized records; the attachments indicate that you already maintain such tickets as part of an existing unit system.

With respect to the question of accessibility, we note that this is generally construed by the examining authorities to mean accessibility within 24 or 48 hours. If a system could be devised whereby requests from the dealer department for aged customer account records could be given priority and processed on an expedited basis, this might rectify the problem you describe. MSRB interpretation of April 27, 1982.

 

[1] Dollar price or yield, trade date, name of contra party (due to use of abbreviations), security identification (due to use of abbreviations), designation of account for which transaction was effected, bond or note numbers, and designation if securities were registered.

Financial advisory relationship: mortgage-related services. This is in response to your letter of March 26, 1982 requesting an opinion regarding whether Board rule G-23 concerning the activities of financial advisors applies to certain activities of [name deleted] (the "Company").

Your letter states that the Company, a mortgage banker and wholly-owned subsidiary of [name deleted] (the "Bank"), identifies "proposed real estate development projects which it believes are economically feasible" and attempts to "arrange for the financing of such projects ..." You note that a common means of financing such projects involves the issuance and sale of tax-exempt obligations, with the proceeds of the sale being made available by the issuing entity to a mortgage approved by the Federal Housing Administration ("FHA"), which in turn provides financing secured by the FHA mortgage. You indicate that the services the Company performs in such instances include "... making the initial determination as to whether the contemplated project meets FHA criteria, negotiating with the developer regarding financing terms and conditions relating to the mortgage, contacting the issuer regarding its interest in issuing the bonds for the project, and, in certain cases where the issuer is not familiar or experienced in the area, assisting the issuer in understanding the rules and regulations of the FHA or the Development of Housing and Urban Development ..." You add that "the Company may also act as servicer of the construction loans which entails processing FHA insurance request forms, disbursing funds for completed work, etc." You state that "the Company does not provide financial advice to issuers regarding the structuring of the bond issues, or receive any fees, directly or indirectly, from issuers." You emphasize that any advice regarding the structuring of the actual bond issues is provided by the issuers’ "staffs, financial advisors, bond counsel, or the underwriters of the issues." Your specific question concerns whether rule G-23 applies where the Company acts as mortgage banker and the Bank underwrites the bonds.

As you know, rule G-23(b) states that "... a financial advisory relationship shall be deemed to exist when a broker, dealer, or municipal securities dealer renders or enters into an agreement to render financial advisory or consultant services to or on behalf of an issuer with respect to a new issue or issues of municipal securities, including advice with respect to the structure, timing, terms and other similar matters concerning such issue or issues for a fee or other compensation ..." Based upon the representations contained in your letter, it would appear that the Company does not render financial advisory services to issuers with respect to new issues of municipal securities. Since the activities which you state the Company performs in the ordinary course of its mortgage banking business do not constitute financial advisory activities for the purposes of rule G-23, the rule would not apply to those financings where the Bank serves as underwriter and the Company performs its mortgage banking functions, as described. MSRB interpretation of April 12, 1982.

Yield disclosures: transactions at par. I am writing in response to your letter of April 2, 1982, concerning certain of the yield disclosure requirements of Board rule G-15 on customer confirmations. In your letter you note that item (C) of rule G-15(a)(viii)[*] requires that "for transactions at par, the dollar price shall be shown" on the confirmations of such transactions, and you inquire whether it is necessary to show a yield on such confirmations.

Please be advised that a confirmation of a transaction effected at par (i.e., at a dollar price of "100") need show only the dollar price "100" and need not, under the terms of the rule, show the resulting yield.

I note, however, that a transaction effected on the basis of a yield price equal to the interest rate of the security which is the subject of the transaction would be considered, for purposes of the rule, to be a "transaction effected on a yield basis," and therefore would be subject to the requirements of item (A) of rule G-15(a)(viii)[†]. The confirmation of such transaction would therefore be required to state "the yield at which [the] transaction was effected and the resulting dollar price[.]" MSRB interpretation of April 8, 1982.

 

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

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

The Municipal Securities Rulemaking Board has recently received complaints from certain municipal securities brokers and municipal securities dealers concerning problems with the documentation provided on rejections or reclamations of deliveries on municipal securities transactions. These brokers and dealers have alleged that other organizations, when rejecting or reclaiming deliveries, have failed to provide the requisite information regarding the return of the securities, thereby making it very difficult to accomplish prompt resolution of any delivery problems. In particular, these dealers indicate, notices of rejection or reclamation have often failed to state a reason for the rejection or reclamation, or to name a person who can be contacted regarding the delivery problem.

Rule G-12(g)(iv) requires that a dealer rejecting or reclaiming a delivery of securities must provide a notice or other document with the rejected or reclaimed securities, which notice shall include the following information:

(A) the name of the party rejecting or reclaiming the securities;

(B) the name of the party to whom the securities are being rejected or reclaimed;

(C) a description of the securities;

(D) the date the securities were delivered;

(E) the date of rejection or reclamation;

(F) the par value of the securities which are being rejected or reclaimed;

(G) in the case of a reclamation, the amount of money the securities are reclaimed for;

(H) the reason for rejection or reclamation; and

(I) the name and telephone number of the person to contact concerning the rejection or reclamation.

The Uniform Reclamation Form may be used for this purpose.

The Board believes that the required information is the minimum necessary to permit prompt resolution of the problem, and does not view the requirement to provide this information as burdensome. The Board is concerned that failure to provide this information may contribute to inefficiencies in the clearance process, and strongly urges municipal securities brokers and dealers to take steps to ensure that the requirements of the rule are complied with. The Board notes that, in the case of reclaimed securities, failure to provide this information may result in, at minimum, a refusal on the part of the receiving party to honor the reclamation.

Close-out procedures: mandatory repurchase. You recently inquired concerning the use of the "mandatory repurchase" option provided under Board rule G-12(h)(i)(D) for execution of a close-out notice. In the situation you presented, a municipal securities dealer executing a notice was requiring, under the provisions of this option, a repurchase at the original contract price. Since the transaction was originally effected on the basis of a yield price, you inquired whether the repurchase should be effected at this yield price (with the dollar price computed to the settlement date of the repurchase transaction), or at the dollar price computed from this yield price at the time of the original transaction.

At the time of your telephone call I responded that, while the Board would have to consider this inquiry, the Board’s response to somewhat similar inquiries in the past suggested that the dollar price of the original contract should be used. I am writing to advise you that the Board did not adopt this position. With respect to the specific circumstances presented in your inquiry, the Board has concluded that the purchasing dealer does have the right, in the appropriate circumstances, to execute a close-out by requiring the seller to repurchase the securities at the yield price of the original contract, with the resulting dollar price computed to the settlement date of the repurchase transaction. The Board notes that, in these circumstances, the selling dealer has failed to fulfill its contractual obligations, and believes that permitting the use of the yield price of the original contract, with the resulting dollar price computed to the settlement date of the repurchase transaction, will in the majority of cases most fairly compensate the purchaser for the time value of the investment for the period from the original execution to the mandatory repurchase.[1]

The Board also is generally of the view that purchasers executing mandatory repurchase transactions may require a mandatory repurchase at the yield basis of the original transaction, with the resulting dollar price computed to the settlement date of the repurchase transaction, except in the case where both parties to the transaction agree that the original transaction was, and the repurchase transaction should be, effected on the basis of a dollar price, or where the terms of the transaction and/or the trading characteristics of the security (e.g., issues with an active sinking fund or tender program) suggest that dollar price rather than yield was the dominant consideration in the original transaction. MSRB interpretation of March 4, 1982.

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[1] The Board notes, for example, that, in the case of a security purchased at a discount, the purchaser and the purchaser’s customer would realize the accretion of the discount for the period the security was owned. In the case of a security purchased at a premium, the premium would be amortized for the period the purchaser owned the security.

Underwriting assessment: application to private placements. This is in response to your request for a clarification of the application of Board rule A-13, concerning the underwriting assessment for municipal securities brokers and municipal securities dealers, to private placements of municipal securities.

Rule A-13 imposes an assessment fee on the underwriting of new issue municipal securities as an equitable means of defraying the costs and expenses of operating the Board. The assessment fee applies to new issue municipal securities which are "... purchased from an issuer by or through [a] municipal securities broker, or municipal securities dealer, whether acting as principal or agent." The Board has consistently interpreted the rule as requiring payment of the assessment fee where a municipal securities dealer acting as agent for the issuer arranges the direct placement of new issue municipal securities with institutional customers or individuals. In such cases it can be said that the securities are purchased from an issuer "through" the municipal securities dealer.

Of course, a municipal securities dealer who serves in an advisory role to an issuer on such matters as the structure or timing of a new issue, but who plays no part in arranging a private placement of the securities, would not be required to pay the assessment fee prescribed by rule A-13. MSRB interpretation of February 22, 1982.