Municipal finance professional: supervisor.  This is in response to your inquiry seeking guidance regarding the possible classification as a municipal finance professional under rule G-37 of a Taxable Department Head at your firm. You stated that the Taxable Department Head is the direct supervisor of a Branch Manager and this Branch Manager manages a sales representative who has solicited municipal securities business from an issuer. You state that it is clear that the Branch Manager and the sales representative are both municipal finance professionals. However, you further state that the Taxable Department Head has delegated all Public Finance/Municipal oversight responsibilities to the Public Finance Department Head for the Taxable Department Head's personnel. You ask whether, under these circumstances, the Taxable Department Head would be considered a municipal finance professional under rule G-37 as a result of his or her supervisory position.

The term "municipal finance professional" is defined in rule G-37(g)(iv). Clauses (C) and (D) of the definition set forth the basis for considering an associated person of a dealer to be a municipal finance professional as a result of his or her supervisory position. Clause (C) includes any associated person who is both (i) either a municipal securities principal or municipal securities sales principal and (ii) a supervisor of any associated person either primarily engaged in municipal securities representative activities or who solicits municipal securities business (referred to herein as a "primary municipal securities supervisor"). Clause (D) includes any associated person who is a supervisor of a primary municipal securities supervisor up through and including (in the case of a non-bank dealer) the Chief Executive Officer or similarly situation official (referred to herein as a "secondary municipal securities supervisor").

Unlike in the case of a primary municipal securities supervisor, a secondary municipal securities supervisor is not required to be a municipal securities principal or municipal securities sales principal. The status of a secondary municipal securities supervisor as a municipal finance professional is not conditioned on the areas in which such supervisor has responsibility over a primary municipal securities supervisor, so long as such secondary municipal securities supervisor retains some degree of supervisory responsibility (whether or not relating to municipal securities activities) over the primary municipal securities supervisor.  MSRB interpretation of November 23, 1999.

Financial advisory relationship: private placements. This is in response to your letter in which you seek clarification on certain matters related to rules G-23, on activities of financial advisors, and G-37, on political contributions and prohibitions on municipal securities business.

You ask when it is "necessary in the process of commencing preliminary work with a potential financial advisory client to enter into a formal written financial advisory contract." Rule G-23(c) states that "[e]ach financial advisory relationship shall be evidenced by a writing entered into prior to, upon or promptly after the inception of the financial advisory relationship (or promptly after the creation or selection of the issuer if the issuer does not exist or has not been determined at the time the relationship commences)." 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 or in expectation of such compensation for the rendering of such services."

You ask whether you are to advise the Board by means of reporting on Form G-37/G-38 or by any other means when you commence work on subsequent financing transactions with an issuer with which your firm has an ongoing financial advisory contract. The Instructions for Completing and Filing Form G-37/G-38 provide a guideline to use in determining when to report financial advisory services on Form G-37/G-38.[1] Pursuant to these Instructions, dealers should indicate financial advisory services when an agreement is reached to provide the services. In addition, the Instructions note that dealers also should indicate financial advisory services during a reporting period when the settlement date for a new issue on which the dealer acted as financial advisor occurred during such period. There are no other requirements for reporting financial advisory services to the Board.

Finally, you ask whether rules G-23 or G-37 contain requirements concerning private placement activities. The term "municipal securities business" is defined in rule G-37 to include "the offer or sale of a primary offering of municipal securities on behalf of any issuer ( e.g. , private placement)..." The Instructions for Completing and Filing Form G-37/G-38 provide that private placements should be indicated at least by the settlement date if within the reporting period.

With respect to rule G-23, section (d) of the rule states that no dealer that has a financial advisory relationship with respect to a new issue of municipal securities shall acquire as principal either alone or as a participant in a syndicate or other similar account formed for the purpose of purchasing, directly or indirectly, from the issuer all or any portion of such issue, or act as agent for the issuer in arranging the placement of such issue, unless various actions are taken.[2] In addition, rule G-23(g) states that each dealer subject to the provisions of sections (d), (e) or (f) of rule G-23 shall maintain a copy of the written disclosures, acknowledgments and consents required by these sections in a separate file and in accordance with the provisions of rule G-9, on preservation of records. Finally, rule G-23(h) states that, if a dealer acquires new issue municipal securities or participates in a syndicate or other account that acquires new issue municipal securities in accordance with section (d) of rule G-23, such dealer shall disclose the existence of the financial advisory relationship in writing to each customer who purchases such securities from such dealer, at or before the completion of the transaction with the customer. MSRB interpretation of October 5, 1999.

[1] I have enclosed a copy of the Instructions for Completing and Filing Form G-37/G-38 as contained in the MSRB Rule Book. The instructions are also contained on the Board's web site (www.msrb.org) under the link for rule G-37.

[2] These actions are: (i) if such issue is to be sold by the issuer on a negotiated basis, (A) the financial advisory relationship with respect to such issue has been terminated in writing and at or after such termination the issuer has expressly consented in writing to such acquisition or participation, as principal or agent, in the purchase of the securities on a negotiated basis; (B) the dealer has expressly disclosed in writing to the issuer at or before such termination that there may be a conflict of interest in changing from the capacity of financial advisor to purchaser of or placement agent for the securities with respect to which the financial advisory relationship exists and the issuer has expressly acknowledged in writing to the dealer receipt of such disclosure; and (C) the dealer has expressly disclosed in writing to the issuer at or before such termination the source and anticipated amount of all remuneration to the dealer with respect to such issue in addition to the compensation referred to in section (c) of rule G-23, and the issuer has expressly acknowledged in writing to the dealer receipt of such disclosure; or (ii) if such issue is to be sold by the issuer at competitive bid, the issuer has expressly consented in writing prior to the bid to such acquisition or participation.

Solicitation of contributions.  This is in response to your letter in which you summarize your understanding of our telephone conversation relating to section (c) of rule G-37, on political contributions and prohibitions on municipal securities business. As I noted during our conversation, the Board’s rules, including rule G-37, apply solely to brokers, dealers and municipal securities dealers (“dealers”). The Board’s rulemaking authority, granted under Section 15B of the Securities Exchange Act of 1934, does not extend to issuers of municipal securities. Thus, rule G-37 does not impose any obligations upon issuers or officials of issuers. Although the Board appreciates your interest in not placing dealers and their associated persons in a position to violate their obligations under the rule, it is ultimately the responsibility of such dealers and associated persons, in consultation with appropriate compliance personnel, to ensure compliance with Board rules.

As you know, rule G-37(c) provides that no dealer or municipal finance professional shall solicit any person or political action committee to make any contribution, or shall coordinate any contributions, to an official of an issuer with which the dealer is engaging or is seeking to engage in municipal securities business. The Board has previously stated that this provision would:

prohibit a dealer and any municipal finance professional from soliciting . . . any other person or entity, to make contributions to an official of an issuer with which the dealer engages or is seeking to engage in municipal securities business or to coordinate (i.e., bundle) contributions. . .[*] [M]unicipal finance professionals may volunteer their personal services in other ways to political campaigns.[1]

You had sought guidance regarding what activities would be covered by this provision of the rule. As you noted in your letter, I had indicated that the term “solicit” is not explicitly defined for purposes of section (c) of the rule. I had stated that whether a particular activity can be characterized as a solicitation of a contribution for purposes of section (c) is dependent upon the facts and circumstances surrounding such activity. I had noted, however, that the rule does not prohibit or restrict municipal finance professionals from engaging in personal volunteer work, unless such work constituted solicitation or bundling of contributions for an official of an issuer with which the municipal finance professional’s dealer is engaging or seeking to engage in municipal securities business[2] Municipal finance professionals are therefore free to, among other things, solicit votes or other assistance for such an issuer official so long as the solicitation does not constitute a solicitation or coordination of contributions for the official. [3]

Whether a municipal finance professional is permitted by section (c) of the rule to indicate to third parties that someone is a “great candidate” or to provide a list of third parties for the candidate to call would be dependent upon all the facts and circumstances surrounding such action. The facts and circumstances that may be relevant for this purpose may include, among any number of other factors, whether the municipal finance professional has made an explicit or implicit reference to campaign contributions in his or her conversations with third parties whom the candidate may contact and whether the candidate contacts such third parties seeking campaign contributions. However, the totality of the facts and circumstances surrounding any particular activity must be considered in determining whether such activity may constitute a solicitation of contributions for purposes of section (c) of the rule. Therefore, the Board cannot prescribe an exhaustive list of precautions that would assure that no violation of this section would occur as a result of such activity.  MSRB interpretation of May 21, 1999.
__________

[1] MSRB Reports, Vol. 14, No. 3 (June 1994) at 5. See Securities Exchange Act Release No. 33868 (April 7, 1994), 59 FR 17621 (April 13, 1994). See also Questions and Answers Concerning Political Contributions and Prohibitions on Municipal Securities Business: Rule G-37, May 24, 1994, reprinted in MSRB Rule Book; MSRB Interpretation of November 7, 1994, reprinted in MSRB Rule Book; MSRB Interpretation of May 31, 1995, reprinted in MSRB Rule Book. Furthermore, the Board stated in its filing of the rule with the Securities and Exchange Commission that the rule’s “anti-solicitation and anti-bundling proscriptions are intended to prohibit covered parties from: (i) soliciting others, including spouses and family members, to make contributions to issuer officials; and (ii) coordinating, or soliciting others to coordinate, contributions to issuer officials in order to influence the awarding of municipal securities business.” SEC File No. SR-MSRB-94-2.

[2] See Question and Answer No. 24, May 24, 1994, reprinted in MSRB Rule Book; Question and Answer No. 3, August 18, 1994, reprinted in MSRB Rule Book. In addition, if the municipal finance professional used dealer resources or incurred expenses that could be considered contributions in the course of undertaking such volunteer work, the ban on municipal securities business under section (b) of the rule could be triggered.

[3] In upholding the constitutionality of rule G-37, the United States Court of Appeals for the District of Columbia Circuit observed that “municipal finance professionals are not in any way restricted from engaging in the vast majority of political activities, including making direct expenditures for the expression of their views, giving speeches, soliciting votes, writing books, or appearing at fundraising events.” Blount v. SEC, 61 F.3d 938, 948 (D.C. Cir. 1995), cert. denied, 116 S. Ct. 1351 (1996). However, the Board has stated that hosting or paying to attend a fundraising event may constitute a contribution subject to section (b) of the rule. See Questions and Answers Nos. 24 and 29, May 24, 1994, reprinted in MSRB Rule Book.

[*][sentence deleted to reflect current rule provisions.]

In response to numerous calls on this subject, the Board wishes to reiterate its position on the application of rule G-37, on political contributions and prohibitions on municipal securities business, to Presidential campaigns of issuer officials. The Board directs persons interested in contributing to an issuer official's Presidential campaign to the MSRB Interpretation of May 31, 1995 (the “1995 Interpretive Letter”).[1]

Rule G-37, among other things, prohibits a broker, dealer or municipal securities dealer (“dealer”) from engaging in municipal securities business with an issuer within two years after any contribution to an official of an issuer made by the dealer; any municipal finance professional associated with the dealer; or any political action committee controlled by the dealer or any municipal finance professional. In the 1995 Interpretive Letter, the Board noted that rule G-37 is applicable to contributions given to officials of issuers who seek election to federal office, such as the Presidency. The Board also explained that the only exception to rule G-37's absolute prohibition on business is for certain contributions made to issuer officials by municipal finance professionals.[2] Specifically, contributions by such persons to officials of issuers would not invoke application of the prohibition if the municipal finance professional is entitled to vote for such official, and provided that any contributions by such municipal finance professional do not exceed, in total, $250 to each official, per election. In the example of an issuer official running for President, any municipal finance professional in the country can contribute the de minimis amount to the official's Presidential campaign without causing a ban on municipal securities business with that issuer.

The Board previously has stated that, if an issuer official is involved in a primary election prior to the general election, a municipal finance professional who is entitled to vote for such official may contribute up to $250 for the primary election and $250 for the general election to each such official.[3] In the context of a Presidential campaign, the Board notes that the $250 de minimis amount applies to the entire primary process, up through and including the national party convention. While rule G-37 allows a municipal finance professional to then contribute another $250 to the party candidate's general election campaign fund, the Board understands that a Presidential candidate who has accepted public funding for the general election is prohibited under federal law from accepting any contributions to further his or her general election campaign.

Finally, the Board also notes that rule G-37(c) provides that no dealer or municipal finance professional shall solicit any person or political action committee to make any contributions, or shall coordinate any contributions, to an official of an issuer with which the dealer is engaging or is seeking to engage in municipal securities business.

[1] The 1995 Interpretive Letter is reprinted in MSRB Rule Book (January 1, 1999) at 201-203. It also is available from the MSRB Rules/Interpretive Letters section of the Board's Web site at www.msrb.org.

[2] The term “municipal finance professional” is a defined term in rule G-37(g)(iv). The Board wishes to remind dealers that the term is broader than persons directly involved in municipal securities activities and may include certain supervisors, including in the case of a broker, dealer or municipal securities dealer other than a bank dealer, the Chief Executive Officer, 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. It also may include members of the dealer's executive or management committee or similarly situated officials. See Question and Answer number 2 dated May 24, 1994, reprinted in MSRB Rule Book (January 1, 1999) at 192; MSRB Reports , Vol. 14, No. 3 (June 1994) at 13; Question and Answer number 3 dated September 9, 1997, reprinted in MSRB Rule Book (January 1, 1999) at 199. The Questions and Answers also are available from the MSRB Rules/Interpretive Notice section of the Board's Web site at www.msrb.org.

[3] See Question and Answer number 10 dated May 24, 1994, reprinted in MSRB Rule Book (January 1, 1999) at 192; MSRB Reports , Vol. 14, No. 3 (June 1994) at 13. The Question and Answer also is available from the MSRB Rules/Interpretive Notice section of the Board's Web site at www.msrb.org.

Rule G-34 requires underwriters and dealers participating in the placement of a new issue of municipal securities to ensure that an application is made for CUSIP numbers for the new issue.[1] The CUSIP Service Bureau assigns CUSIP numbers to reflect the differences in securities that are relevant to trading and investment decisions.[2] In addition, Board rules G-12 and G-15 require that CUSIP numbers appear on confirmations of transactions and that the securities delivered on those transactions match the CUSIP numbers appearing on the confirmations.[3]

Recently, certain questions have arisen about the proper method for assignment of CUSIP numbers to certain general obligation securities that have been issued in multiple series. In these issues, the issuer uses the proceeds from each series to fund a separate project, but the project itself offers bondholders no additional security for payment beyond that provided by the full faith and credit of the issuer. Securities within multiple series may be identical with respect to dated date, maturity, security and source of payment. However, an individual series may be called, in whole or part, at the option of the issuer, based on the series designation. In addition, the securities are subject to certain mandatory redemption features, which are exercisable by series and which are dependent upon the status of the project funded by the series.

Underwriters have encountered confusion as to whether each series within these issues should be assigned separate CUSIP numbers or whether the CUSIP number assignment for the issues should ignore the series designation. The Board wishes to clarify that, because of the possibility that the securities will be subject to early redemption by series designation, separate CUSIP numbers for each series are required.

The Board previously has indicated that a designation of multiple "purposes" for general obligation debt does not require separate CUSIP numbers for each purpose if the securities otherwise are identical.[4] Accordingly, there are a number of outstanding multi-series general obligation issues which are assigned one CUSIP number for each maturity and which are traded, cleared, and settled without regard to series designation. While the Board does not wish to change this general rule, it believes that separate CUSIP number assignment is required for those multi-series issues which can be called by series. The Board notes that the probability of a partial or "in-whole" redemption of a series has the potential to become a significant factor to investors and that it therefore is necessary to preserve distinctions among the various series when trading, clearing and settling these securities.

The Board has consulted with the CUSIP Service Bureau in this matter and the Service Bureau has agreed to assign separate CUSIP numbers to multi-series general obligation issues which can be called by series. Dealers serving as underwriters for these issues therefore should not request the Service Bureau to ignore the series designation when assigning numbers to these issues.

[1]The rule applies to all issues eligible for CUSIP number assignment. This includes nearly all new issue securities over three months in maturity.

[2] CUSIP numbers are assigned to municipal issues by their issuer title, dated date, interest rate, and maturity date. Municipal securities which are identical as to these four elements are assigned different numbers if there is a further distinction between the securities involving any of the following:

(1) the call features (i.e., whether or not securities are callable, date or terms of call feature, etc.);

(2) any limitation of the pledge on a general obligation bond (e.g., limited tax versus full faith and credit);

(3) any distinction in the secondary security or the source of payment of a revenue bond;

(4) the identity of any entity, besides the issuer, obligated on the debt service of the securities (e.g., two pollution control revenue bonds secured by different corporate obligors); and

(5) any distinction in the secondary security or the source of payment of a general obligation bond.

[3] Certain exceptions to these rules exist for securities which have not been assigned CUSIP numbers and instances in which the CUSIP number on a confirmation and the CUSIP number assigned to securities differ only because of a transposition or transcription error.

[4] See MSRB Reports Vol. 2, No. 1, (January 1982), p. 3. Of course, if specific portions of a general obligation issue are additionally backed by the revenues from various issuer activity or proceeds from various projects (so-called "double-barrelled" issues), separate CUSIP numbers are required to reflect these distinctions.

Calculation of Price and Yield on Continuously Callable Securities. This will respond to your letter of May 30, 1989, relating to the calculation of price and yield in transactions involving municipal securities which can be called by the issuer at any time after the first optional "in-whole" call date. The Board reviewed your letter at its August 1989 meeting and has authorized this response.

Rules G-12(c) and G-15(a) govern inter-dealer and customer confirmations, respectively. For transactions executed on a yield basis, rules G-12(c)(v)(l) and G-15(a)(v)(l)[*] require the dollar price computed from yield and shown on the confirmation to be computed to the lower of call or maturity. The rules also require the call date and price to be shown on the confirmation when securities are priced to a call date.

In computing price to call, only "in-whole" calls, of the type which may be exercised in the event of a refunding, should be used.[1] The "in-whole" call producing the lowest price must be used when computing price to call. If there is a series of "in-whole" call dates with declining premiums, a calculation to the first premium call date generally will produce the lowest price to call. However, in certain circumstances involving premiums which decline steeply over a short time, an "intermediate" call date--a date on which a lower premium or par call becomes operative--may produce the lowest price. Dealers must calculate prices to intermediate call dates when this is the case.[2] Identical rules govern the computation and display of yield to call and yield to maturity, as required on customer confirmations under rule G-15(a).

The issues that you describe are callable at declining premiums, in part or in whole, at any time after the first optional call date. There is no restriction on the issuer in exercising a call after this date except for the requirement to give 30 to 60 days notice of the redemption. Since this "continuous" call provision is an "in-whole" call of the type which may be used for a refunding, it must be considered when calculating price or yield.

The procedure for calculating price to call for these issues is the same as for other securities with declining premium calls. Dealers must take the lowest price possible from the operation of an "in-whole" call feature, compare it to the price calculated to maturity and use the lower of the two figures on the confirmation. For settlement dates prior to the first "in-whole" call, it generally should be sufficient to check the first and intermediate call dates (including the par call), determine which produces the lowest price, and compare that price to the price calculated to maturity. For settlement dates occurring after the first "in-whole" call date, it must be assumed that a notice of call could be published on the day after trade date, which would result in the redemption of the issue 31 days after trade date.[3] The price calculated to this possible redemption date should be compared to prices calculated to subsequent intermediate call dates and the lowest of these prices used as the price to call. The price computed to call then can be compared to the price computed to maturity and the lower of the two included on the confirmation. If a price to call is used, the date and redemption price of the call must be stated. Identical procedures are used for computing yield from price for display on customer confirmations under rule G-15(a).

You also have asked for the Board's interpretation of two official statements which you believe have a continuous call feature and ask whether securities with continuous call features typically are called between the normal coupon dates. The Board's rulemaking authority does not extend to the interpretation of official statements and the Board does not collect information on issuer practices in calling securities. Therefore, the Board cannot assist you with these inquiries. MSRB Interpretation of August 15, 1989.

[1] The parties to a transaction may agree at the time of trade to price securities to a date other than an "in-whole" call date or maturity. If such an agreement is reached, it must be noted on the confirmation.

[2] See [Rule G-15 Interpretation] Notice Concerning Pricing to Call, December 10, 1980, MSRB Manual (CCH) paragraph 3571.

[3] If a notice of call for the entire issue occurs on or prior to the trade date, delivery cannot be made on the transaction and it must be worked out or arbitrated by the parties. See rules G-12(e)(x)(B) and G-15(c)(viii)(B).

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

Confirmation requirements for partially refunded securities. This will respond to your letter of May 16, 1989. The Board reviewed your letter at its August 1989 meeting and authorized this response.

You ask what is the correct method of computing price from yield on certain types of "partially prerefunded" issues having a mandatory sinking fund redemption. The escrow agreement for the issues provides for a stated portion of the issue to be redeemed at a premium price on an optional, "in-whole," call date for the issue. The remainder of the issue is subject to a sinking fund redemption at par.[1] Unlike some issues that are prerefunded by certificate number, the certificates that will be called at a premium price on the optional call date are not identified and published in advance. Instead, they are selected by lottery 30 to 60 days before the redemption date for the premium call. Prior to this time, it is not known which certificates will be called at a premium price on the optional call date. In the particular issues you have described, the operation of the sinking fund redemption will retire the entire issue prior to the stated maturity date for the issue.

As you know, rules G-12(c) and G-15(a) govern inter-dealer and customer confirmations, respectively. Rules G-12(c)(v)(1) and G-15(a)(i)(1)[*] require the dollar price computed from yield and shown on the confirmation to be computed to the lower of call date or maturity. For purposes of computing price to call, only "in-whole" calls, of the type which may be exercised in the event of a refunding, are used.[2] Accordingly, the Board previously has concluded that the sinking fund redemption in the type of issue you have described should be ignored and the dollar price should be calculated to the lowest of the "in-whole" call date for the issue (i.e., the redemption date of the prerefunding) or maturity. In addition, the stated maturity date must be used for the calculation of price to maturity rather than any "effective" maturity which results from the operation of the sinking fund redemption. Identical rules apply when calculating yield from dollar price. Of course, the parties to a transaction may agree to calculate price or yield to a specific date, e.g., a date which takes into account a sinking fund redemption. If this is done, it should be noted on the confirmation.[3]

In our telephone conversations, you also asked what is the appropriate securities description for securities that are advance refunded in this manner. Rules G-12(c)(v)(E) and G-15(a)(i)(E)[†] require that confirmations of securities that are "prerefunded" include a notation of this fact along with the date of "maturity" that has been fixed by the advance refunding and the redemption price. The rules also state that securities that are redeemable prior to maturity must be described as "callable".[4] In addition, rules G-12(c)(vi)(I) and G-15(a)(iii)(J)[‡] state that confirmations must include information not specifically required by the rules if the information is necessary to ensure that the parties agree to the details of the transaction. Since, in this case, only a portion of the issue will be chosen by lot and redeemed at a premium price under the prerefunding, this fact must be noted on the confirmation. As an example, the issue could be described as "partially prerefunded to [redemption date] at [premium price] to be chosen by lot-callable." The notation of this fact must be included within the securities description shown on the front of the confirmation. MSRB Interpretation of August 15, 1989.

[1] In some issues, a sinking fund redemption operates prior to the optional call date, while, in others, the sinking fund redemption does not begin until on or after that date.

[2] See [Rule G-15 Interpretation –] Notice of December 10, 1980, Concerning Pricing to Call, MSRB Manual, paragraph 3571.

[3] These rules on pricing partially prerefunded securities with sinking funds are set forth in [Rule G-15 Interpretive Letter – Disclosure of pricing: calculating the dollar price of partially prerefunded bonds,] MSRB  interpretation of May 15, 1986, MSRB Manual, paragraph 3571.26.

[4] The Board has published an interpretive notice providing specific guidance on the confirmation of advanced refunded securities that are callable pursuant to an optional call. See Application of Rules G-12(c) and G-15(a) on Confirmation Disclosure of Escrowed-to-Maturity Securities [in Rule G-17 Interpretation – Notice of Interpretation on Escrowed-to-Maturity Securities: Rules G-17, G-12 and G-15], MSRB Manual, paragraph 3581.

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

[†] [Currently codified at rule G-15(a)(i)(C)(3)(a)]

[‡] [Currently codified at rule G-15(a)(i)(A)(8)]

Review and approval of transactions.  This is in response to your letter requesting an interpretation of rule G-27(c)(ii)(B)^[*] which requires that a [designated] principal promptly review and approve, in writing, each transaction in municipal securities. You state that your firm proposes to use a system of exception reports to review the firm's municipal securities transactions each day. Each trade will be reviewed by computer pursuant to parameters established by the Compliance Department. These parameters include the size of the order (in terms of dollars as well as a percentage of the customer's net worth), the customer's income, investment objectives and age. These parameters can be changed and fine-tuned as the situation dictates. Currently, the exception report will contain all purchases in excess of $25,000 or 10 percent of the customer's stated net worth and all sales in excess of $10,000. A review of the exception report would be conducted by a municipal securities principal. Oversight of the review process, and any required follow-up, would be conducted.

Rule G-27, on supervision, requires a dealer to supervise the municipal securities activities of its associated persons and the conduct of its business. In particular, rule G-27(c)(ii)(B)^[*] requires that a [designated] principal promptly review and approve, in writing, each transaction in municipal securities. The Board believes that the requirement for written approval of each transaction by a [designated] principal is reasonable and necessary to promote proper supervision of the activities of municipal securities representatives. Among other purposes, these procedures enable [designated] principals to keep abreast of the firm's daily trading activity, to assess the appropriateness of mark-ups and mark-downs, and to assure that provisions for the prompt delivery of securities are being met. The exception reporting you propose would not comply with rule G-27(c)(ii)(B)^[*] because it would not result in review and approval of each municipal securities transaction by a [designated] principal.[1]  MSRB interpretation of July 26, 1989.

[1] While exception report review is not appropriate in complying with rule G-27(c)(vii)(B),^[*] we understand that certain dealers, with the approval of their enforcement agencies, use exception reports in their periodic review of customer accounts required by rule G-27(c)(iii).

^[*] [Currently codified at rule G-27(c)(vii)(B).]

NOTE: Revised to reflect subsequent amendments.

Syndicate records: sole underwriter.  This is in response to your letter regarding rule G-8 on recordkeeping. You note that rule G-8(a)(viii) requires the managing underwriter of a syndicate to maintain certain records pertaining to syndicate transactions. You ask if this rule applies to an underwriter in a sole underwriting.

Rule G-11(a)(viii) defines a syndicate as an account formed by two or more persons for the purpose of purchasing, directly or indirectly, all or any part of a new issue of municipal securities from the issuer, and making a distribution thereof. Since a sole underwriting does not involve a syndicate, rule G-8(a)(viii) does not apply to sole underwritings. Of course, the sole underwriter must maintain other required records for transactions in the new issue.  MSRB interpretation of May 12, 1989.

In 1986, several municipal securities dealers began selling ownership rights to discrete interest payments, principal payments or combinations of interest and principal payments on municipal securities. In 1987, the Board asked the Securities and Exchange Commission staff whether these "stripped coupon" instruments are municipal securities for purposes of the Securities Exchange Act and thus are subject to Board rules. On January 19, 1989, the staff of the Division of Market Regulation of the Commission issued a letter stating that, subject to certain conditions, these instruments are municipal securities for purposes of Board rules (SEC staff letter).

The Board is providing the following guidance on the application of its rules to transactions in stripped coupon instruments defined as municipal securities in the SEC staff letter (stripped coupon municipal securities). Questions whether other stripped coupon instruments are municipal securities and questions concerning the SEC staff letter should be directed to the Commission staff.

Background

A dealer sponsoring a stripped coupon municipal securities program typically deposits municipal securities (the underlying securities) with a barred custodian. Pursuant to a custody agreement, the custodian separately records the ownership of the various interest payments, principal payments, or specified combinations of interest and principal payments. One combination of interest and principal payments sometimes offered is the "annual payment security," which represents one principal payment, with alternate semi-annual interest payments. This results in an annual interest rate equal to one-half the original interest rate on the securities.[1] Stripped coupon municipal securities are marketed under trade names such as Municipal Tax Exempt Investment Growth Receipts (Municipal TIGRs), Municipal Receipts (MRs), and Municipal Receipts of Accrual on Exempt Securities (MUNI RAES).

Application of Board Rules

In general, the Board's rules apply to transactions in stripped coupon municipal securities in the same way as they apply to other municipal securities transactions. The Board's rules on professional qualifications and supervision, for example, apply to persons executing transactions in the securities the same as any other municipal security. The Board's rules on recordkeeping, quotations, advertising and arbitration also apply to transactions in the securities. Dealers should be aware that rule G-19, on suitability of recommendations, and rule G-30, on fair pricing, apply to transactions in such instruments.

The Board emphasizes that its rule on fair dealing, rule G-17, requires dealers to disclose to customers purchasing stripped coupon municipal securities all material facts about the securities at or before the time of trade. Any facts concerning the underlying securities which materially affect the stripped coupon instruments, of course, must be disclosed to the customer. The Board understands that some stripped coupon municipal securities are sold without any credit enhancement to the underlying municipal securities. As pointed out in the SEC staff letter, dealers must be particularly careful in these cases to disclose all material facts relevant to the creditworthiness of the underlying issue.

Confirmation Requirements

Dealers generally should confirm transactions in stripped coupon municipal securities as they would transactions in other municipal securities that do not pay periodic interest or which pay interest annually.[2] A review of the Board's confirmation requirements applicable to the securities follows.

Securities Descriptions. Rules G-12(c)(v)(E) and G-15(a)(i)(E)[*] require a complete securities description to be included on inter-dealer and customer confirmations, respectively, including the name of the issuer, interest rate and maturity date.[3] In addition to the name of the issuer of the underlying municipal securities, the trade name and series designation assigned to the stripped coupon municipal security by the dealer sponsoring the program must be included on the confirmation.[4] Of course, the interest rate actually paid by the stripped coupon security (e.g., zero percent or the actual, annual interest rate) must be stated on the confirmation rather than the interest rate on the underlying security.[†] Similarly, the maturity date listed on the confirmation must be the date of the final payment made by the stripped coupon municipal security rather than the maturity date of the underlying securities.[5]

Credit Enhancement Information. Rules G-12(c)(vi)(D) and G-15(a)(ii)(D)[‡] require confirmations of securities pre-refunded to a call date or escrowed to maturity to state this fact along with the date of maturity set by the advance refunding and the redemption price. If the underlying municipal securities are advance-refunded, confirmations of the stripped coupon municipal securities must note this. In addition, rules G-12(c)(v)(E) and G-15(c)(i)(E)[#] require that the name of any company or other person, in addition to the issuer, obligated directly or indirectly with respect to debt service on the underlying issue or the stripped coupon security be included on confirmations.[6]

Quantity of Securities and Denominations. For securities that mature in more than two years and pay investment return only at maturity, rules G-12(c)(v) and G-15(a)(v)[**] require the maturity value to be stated on confirmations in lieu of par value. This requirement is applicable to transactions in stripped coupon municipal securities over two years in maturity that pay investment return only at maturity, e.g., securities representing one interest payment or one principal payment. For securities that pay only principal and that are pre-refunded at a premium price, the principal amount may be stated as the transaction amount, but the maturity value must be clearly noted elsewhere on the confirmation. This will permit such securities to be sold in standard denominations and will facilitate the clearance and settlement of the securities.

Rules G-12(c)(vi)(F) and G-15(a)(iii)(G)[††] require confirmations of securities that are sold or that will be delivered in denominations other than the standard denominations specified in rules G-12(e)(v) and G-15(a)(iii)(G)[††] to state the denominations on the confirmation. The standard denominations are $1,000 or $5,000 for bearer securities, and for registered securities, increments of $1,000 up to a maximum of $100,000. If stripped coupon municipal securities are sold or will be delivered in any other denominations, the denomination of the security must be stated on the confirmation.

Dated Date. Rules G-12(c)(vi)(A) and G-15(a)(iii)(A)[***] require that confirmations state the dated date of a security if it affects price or interest calculations, and the first interest payment date if other than semi-annual. The dated date for purposes of an interest-paying stripped coupon municipal security is the date that interest begins accruing to the custodian for payment to the beneficial owner. This date, along with the first date that interest will be paid to the owner, must be stated on the confirmation whenever it is necessary for calculation of price or accrued interest.

Original Issue Discount Disclosure. Rules G-12(c)(vi)(G) and G-15(a)(iii)(H)[†††] require that confirmations identify securities that pay periodic interest and that are sold by an underwriter or designated by the issuer as "original issue discount." This alerts purchasers that the periodic interest received on the securities is not the only source of tax-exempt return on investment. Under federal tax law, the purchaser of stripped coupon municipal securities is assumed to have purchased the securities at an "original issue discount," which determines the amount of investment income that will be tax-exempt to the purchaser. Thus, dealers should include the designation of "original issue discount" on confirmations of stripped coupon municipal securities, such as annual payment securities, which pay periodic interest.

Clearance and Settlement of Stripped Coupon Municipal Securities

Under rules G-12(e)(vi)(B) and G-15(a)(iv)(B), delivery of securities transferable only on the books of a custodian can be made only by the bookkeeping entry of the custodian.[7] Many dealers sponsoring stripped coupon programs provide customers with "certificates of accrual" or "receipts," which evidence the type and amount of the stripped coupon municipal securities that are held by the custodian on behalf of the beneficial owner. Some of these documents, which generally are referred to as "custodial receipts," include "assignment forms," which allow the beneficial owner to instruct the custodian to transfer the ownership of the securities on its books. Physical delivery of a custodial receipt is not a good delivery under rules G-12(e) and G-15(a) unless the parties specifically have agreed to the delivery of a custodial receipt. If such an agreement is reached, it should be noted on the confirmation of the transaction, as required by rules G-12(c)(v)(N) and G-15(a)(i)(N)[****].

The Board understands that some stripped coupon municipal securities that are assigned CUSIP numbers and sold in denominations which are multiples of $1,000 are eligible for automated comparison and automated confirmation/affirmation and that some of these instruments also are eligible for book-entry delivery through registered securities depositories. The Board reminds dealers that transactions in stripped coupon municipal securities are subject to the automated clearance requirements of rules G-12(f) and G-15(d) if they are eligible in the automated clearance systems. Dealers sponsoring stripped coupon programs also should note that rule G-34(b)(ii) requires CUSIP numbers to be assigned to stripped coupon municipal securities prior to the initial sale of the securities to facilitate clearance and settlement.

Written Disclosures in Connection with Sales of Stripped Coupon Municipal Securities

Dealers sponsoring stripped coupon municipal securities programs generally prepare "offering circulars" or "offering memoranda" describing the securities that have been placed on deposit with the custodian, the custody agreement under which the securities are held, and the tax treatment of transactions in the securities. These documents generally are provided to all customers purchasing the securities during the initial offering of the instruments. The Board strongly encourages all dealers selling stripped coupon municipal securities to provide these documents to their customers whether the securities are purchased during the initial distribution or at a later time.[8] Although the material information contained in these documents, under rule G-17, must be disclosed to customers orally if not provided in writing prior to the time of trade, the Board believes that the unusual nature of stripped coupon municipal securities and their tax treatment warrants special efforts to provide written disclosures. Moreover, if stripped coupon municipal securities are marketed during the underwriting period of the underlying issue, rule G-32 requires distribution of the official statement for the underlying issue prior to settlement of the transaction of the stripped coupon municipal securities.

[1] The Board understands that other types of stripped coupon municipal securities also may be offered with combinations of interest and principal payments providing an interest rate different than the original interest rate of the securities.

[2] Thus, for stripped coupon municipal securities that do not pay periodic interest, rules G-12(c)(v) and G-15(a)(v) require confirmations to state the interest rate as zero and, for customer confirmations, the inclusion of a legend indicating that the customer will not receive periodic interest payments. [See current rule G-15(a)(vi)(D), G-15(a)(i)(B)(4)(a) and G-15(a)(i)(D)(1).] Rules G-12(c)(vi)(H) and G-15(a)(iii)(l) [currently codified at rule G-15(a)(i)(C)(2)(e)] require confirmations of securities paying annual interest to note this fact.

[3] The complete description consists of all of the following information: 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 obligors" may be shown.

[4] Trade name and series designation is required under rules G-12(c)(vi)(l) and G-15(a)(iii)(J) [currently codified at rule G-15(a)(i)(A)(8)], which state that confirmations, must include all information necessary to ensure that the parties agree to the details of the transaction. [See also current rule G-15(a)(i)(B)(1)(a).]

[5] Therefore, the maturity date of a stripped coupon municipal security representing one interest payment is the date of the interest payment. [See current rule G-15(a)(i)(B)(3)(a).]

[6] It should be noted that the SEC staff letter is limited to instruments in which "neither the custodian nor sponsor additionally will guarantee or otherwise enhance the creditworthiness of the underlying municipal security or the stripped coupon security."

[7] Under rules G-12(c)(vi)(B) and G-15(a)(iii)(B) [currently codified at rule G-15(a)(i)(C)(2)(d)] the book-entry-only nature of the securities also must be noted on the confirmation.

[8] The Board understands that these documents generally are available from the dealers sponsoring the stripped coupon municipal securities program.

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

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

[‡] [Currently codified at rule G-15(a)(i)(C)(3)(c)]

[#] [Currently codified at rule G-15(a)(i)(C)(1)(b)]

[**] [Currently codified at rule G-15(a)(i)(A)(3)]

[††] [Currently codified at rule G-15(a)(i)(A)(7)(b)]

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

[†††] [Currently codified at rule G-15(a)(i)(C)(4)(c)]

[****] [Currently codified at rule G-15(a)(i)(A)(7)(c)]

Use of electronic signatures.  This is in response to your letter and a number of subsequent telephone conversations regarding your dealer department's proposed use of a bond trading system. The system is an online, realtime system that integrates all front and back office functions. The system features screen input of customer account and trading information which would allow the dealer department to eliminate the paper documents currently in use. The signature of the representative introducing a customer account, required to be recorded with customer account information by rule G-8, and the signature of the principal signifying approval of each municipal securities transaction, required by rule G-27, would be performed electronically, i.e., by input in a restricted datafield. The signature of the principal approving the opening of the account, required by rule G-8, will continue to be performed manually on a printout of the customer information.[1]

Rule G-8(a)(vi) and (vii) require dealers to make and keep records for each agency and principal transaction. The records may be in the form of trading tickets or similar documents. In addition, rule G-8(a)(xi), on recordkeeping of customer account information, requires, among other things, the signature of the representative introducing the account and the principal indicating acceptance of the account to be included on the customer account record. Rule G-27(c)(ii)[*] requires, among other things, the prompt review and written approval of each transaction in municipal securities. In addition, the rule requires the regular and frequent examination of customer accounts in which municipal securities transactions are effected in order to detect and prevent irregularities and abuses. The approvals and review must be made by the designated municipal securities principal or the municipal securities sales principal. Rule G-9(e), on preservation of records, allows records to be retained electronically provided that the dealer has adequate facilities for ready retrieval and inspection of any such record and for production of easily readable facsimile copies.

The Board recognizes that efficiencies would be obtained by the replacement of paper files with electronic data bases and filing systems and generally allows records to be retained in that form.[2] Moreover, as dealers increasingly automate, there will be more interest in deleting most physical records. Electronic trading tickets and automated customer account information satisfy the recordkeeping requirements of rule G-8 as long as such information is maintained in compliance with rule G-9(e).

The Board and your enforcement agency are concerned, however, that it may be difficult to verify a representative's signature on opening the account or a principal's signature approving municipal securities transactions or periodically reviewing customer accounts if the signatures are noted only electronically. Your enforcement agency has advised us of its discussions with you. Apparently, it is satisfied that appropriate security and audit procedures can be developed to permit the use of electronic signatures of representatives and principals and ensure that such signatures are verifiable. Thus, the Board has determined that rules G-8 and G-27 permit the use of electronic signatures when security and audit procedures are agreed upon by the dealer and its appropriate enforcement agency. Whatever procedures are agreed upon must be memorialized in the dealer's written supervisory procedures required by rule G-27. MSRB Interpretation of February 27, 1989.

[1] In addition, you noted in a telephone conversation that the periodic review of customer accounts required by rule G-27(c)(ii)[*] also will be handled electronically using the principal's electronic signature to signify approval.

[2] See rule G-9(e).

[*] [Currently codified at Rule G-27(c)(i)(G)(2)]