Supervisory procedures relating to indirect contributions: conference accounts and 527 organizations.  This is in response to your request for confirmation that donations to segregated conference accounts of organizations such as the Democratic Governors Association (DGA) and Republican Governors Association (RGA) do not constitute contributions to an official of an issuer within the meaning of Rule G-37(b) without an intent to use the conference accounts as a device for contributing to the election activities of individual governors or other officials of issuers.  You describe both organizations as independent, voluntary political organizations constituted under Section 527 of the Internal Revenue Code to raise money for political activities.  You note that the organizations’ activities have the primary purpose of influencing gubernatorial elections but also seek to conduct policy conferences and workshops to help their members and other interested parties to understand and participate in public policy questions that confront state governments.  You state that all Democratic governors are members of the DGA and all Republican governors are members of the RGA.

You further note that each organization has a wide variety of accounts into which it receives funds from individuals, organizations and other entities, with some accounts used to provide financial support to gubernatorial candidates and other accounts (including conference accounts) used exclusively to fund policy conferences.  You state that the conference accounts are segregated from accounts that provide financial support to gubernatorial candidates and that neither organization permits transfers of funds from their conference accounts to any of their other accounts, including their administrative accounts.  You represent that both organizations follow a standard practice of honoring any request by a donor to place donated funds in a conference account and that they have further committed to provide, upon a donor’s request, written confirmation prior to accepting a donation that the donated funds will be allocated to the conference account.

The MSRB cannot provide confirmation regarding the status under Rule G-37 of payments to any particular organization or account of such organization as such a determination requires an analysis of, among other things, the specific facts and circumstances of each individual payment, the written supervisory procedures of the broker, dealer or municipal securities dealer (“dealer”), and the efforts of the dealer to enforce such procedures.  However, this letter reviews guidance previously provided by the MSRB that may assist you in undertaking such an analysis.

Under Rule G-37, on political contributions and prohibitions on municipal securities business, contributions to officials of an issuer by a dealer, a municipal finance professional (“MFP”) of the dealer, or a political action committee (“PAC”) controlled by the dealer or an MFP can result in the dealer being banned from municipal securities business with such issuer for a period of two years.[1]  Section (d) of Rule G-37 provides, in part, that no dealer or MFP shall, directly or indirectly, through or by any other person or means, do any act which would result in a violation of the ban on municipal securities business.

The MSRB has previously provided guidance regarding the potential for payments made to political parties, PACs or others to constitute indirect contributions to issuer officials for purposes of Rule G-37(d).  In guidance published in 1996, the MSRB stated that a dealer would violate Rule G-37 by doing municipal securities 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 municipal securities business. Further, depending on the specific facts and circumstances, a payment to a PAC or political party that is soliciting funds for the purpose of supporting a limited number of issuer officials might result in the same prohibition on municipal securities business as would a contribution made directly to an issuer official.[2]  In such circumstances, dealers should inquire of the PAC or political party how any funds received from the dealer would be used.[3]

In 2005, the MSRB published guidance on dealers’ written supervisory procedures under Rule G-27, on supervision, relating to compliance with Rule G-37(d).  The MSRB noted that 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.[4]  Please note that the scope of Rule G-37(d) is not limited to the use of political parties and PACs as possible conduits for indirect contributions to issuer officials and, therefore, the need for such supervisory procedures would apply in connection with dealer and MFP payments to other types of political organizations as well, including but not limited to organizations constituted under Section 527 of the Internal Revenue Code.

The 2005 guidance on supervisory procedures included examples of certain provisions that dealers might include in their written supervisory procedures to ensure compliance with Rule G-37(d).  The MSRB stated that such examples are not exclusive and are only suggestions, and that each dealer is required 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(d).[5]  Thus, a dealer need not include the specific supervisory procedures described in the 2005 guidance in order to meet its obligation under Rule G-27(c) so long as the dealer in fact has, and enforces, other 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(d).

The MSRB also has stated that payments to “housekeeping,” “conference” or “overhead” accounts of political parties are not safe harbors under Rule G-37 and that a dealer’s written supervisory procedures designed to ensure compliance with Rule G-37(d) must take into account such payments.  The MSRB noted that “preemptive” instructions accompanying payments to housekeeping accounts of political parties stating that such payments are not to be used for the benefit of one or a limited number of issuer officials are not considered sufficient to meet the dealer’s obligations with regard to ensuring that the payment is not being made to circumvent the requirements of Rule G-37.[6]  Although payments to housekeeping, conference or overhead accounts are not safe harbors and preemptive instructions are not by themselves sufficient to establish compliance with Rule G-37(d), procedures permitting payments to political parties and other political organizations only if made to these types of accounts and/or requiring preemptive instructions regarding the use of such payments may be elements in a supervisory program that, together with other appropriate procedures, could adequately ensure compliance with Rule G-37(d), depending on the specific facts and circumstances. MSRB Interpretation of December 21, 2006.
__________

[1] MFPs may make certain de minimis contributions to issuer officials without triggering the ban on business.

[2] See Rule G-37 Question and Answer No. III.4 (August 6, 1996), reprinted in MSRB Rule Book.

[3] See Rule G-37 Question and Answer No. III.5 (August 6, 1996), reprinted in MSRB Rule Book.

[4] See Rule G-37 Question and Answer No. III.7 (September 22, 2005) (“Q&A-III.7”), reprinted in MSRB Rule Book.

[5] See Q&A-III.7.

[6] See Rule G-37 Question and Answer No. III.8 (September 22, 2005), reprinted in MSRB Rule Book.

The Municipal Securities Rulemaking Board (“MSRB”) is publishing this interpretation to ensure that brokers, dealers and municipal securities dealers (“dealers”) effecting transactions in the 529 college savings plan market fully understand their fair practice and disclosure duties to their customers.[1]

Basic Customer Protection Obligation

At the core of the MSRB’s customer protection rules is Rule G-17, which provides that, in the conduct of its municipal securities activities, each dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest or unfair practice.  The rule encompasses two basic principles: an anti-fraud prohibition similar to the standard set forth in Rule 10b-5 adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (the “Exchange Act”), and a general duty to deal fairly even in the absence of fraud.  All activities of dealers must be viewed in light of these basic principles, regardless of whether other MSRB rules establish specific requirements applicable to such activities.

Disclosure

The MSRB has interpreted Rule G-17 to require a dealer, in connection with any transaction in municipal securities, to disclose to its customer, at or prior to the sale of the securities to the customer (the “time of trade”), all material facts about the transaction known by the dealer, as well as material facts about the security that are reasonably accessible to the market.[2]  This duty applies to any dealer transaction in a 529 college savings plan interest regardless of whether the transaction has been recommended by the dealer.

Many states offer favorable state tax treatment or other valuable benefits to their residents in connection with investments in their own 529 college savings plan.  In the case of sales of out-of-state 529 college savings plan interests to a customer, the MSRB views Rule G-17 as requiring a dealer to make, at or prior to the time of trade, additional disclosures that:

(i) depending upon the laws of the home state of the customer or designated beneficiary, favorable state tax treatment or other benefits offered by such home state for investing in 529 college savings plans may be available only if the customer invests in the home state’s 529 college savings plan;

(ii) any state-based benefit offered with respect to a particular 529 college savings plan should be one of many appropriately weighted factors to be considered in making an investment decision; and

(iii) the customer should consult with his or her financial, tax or other adviser to learn more about how state-based benefits (including any limitations) would apply to the customer’s specific circumstances and also may wish to contact his or her home state or any other 529 college savings plan to learn more about the features, benefits and limitations of that state’s 529 college savings plan.

This disclosure obligation is hereinafter referred to as the “out-of-state disclosure obligation.”[3]

The out-of-state disclosure obligation may be met if the disclosure appears in the program disclosure document, so long as the program disclosure document has been delivered to the customer at or prior to the time of trade and the disclosure appears in the program disclosure document in a manner that is reasonably likely to be noted by an investor.[4]  A presentation of this disclosure in the program disclosure document in close proximity and with equal prominence to the principal presentation of substantive information regarding other federal or state tax-related consequences of investing in the 529 college savings plan, and the inclusion of a reference to this disclosure in close proximity and with equal prominence to each other presentation of information regarding state tax-related consequences of investing in the 529 college savings plan, would be deemed to satisfy this requirement.[5]

The MSRB has no authority to mandate inclusion of any particular items in the issuer’s program disclosure document.[6]  Dealers who wish to rely on the program disclosure document for fulfillment of the out-of-state disclosure obligation are responsible for understanding what is included within the program disclosure document of any 529 college savings plan they market and for determining whether such information is sufficient to meet this disclosure obligation.  Notwithstanding any of the foregoing, disclosure through the program disclosure document as described above is not the sole manner in which a dealer may fulfill its out-of-state disclosure obligation.  Thus, if the issuer has not included this information in the program disclosure document in the manner described, inclusion in the program disclosure document in another manner may nonetheless fulfill the dealer’s out-of-state disclosure obligation so long as disclosure in such other manner is reasonably likely to be noted by an investor.  Otherwise, the dealer would remain obligated to disclose such information separately to the customer under Rule G-17 by no later than the time of trade.[7]

If the dealer proceeds to provide information to an out-of-state customer about the state tax or other benefits available through such customer’s home state, Rule G-17 requires that the dealer ensure that the information is not false or misleading.  For example, a dealer would violate Rule G-17 if it were to inform a customer that investment in the 529 college savings plan of the customer’s home state did not provide the customer with any state tax benefit even though such a state tax benefit is in fact available.  Furthermore, a dealer would violate Rule G-17 if it were to inform a customer that investment in the 529 college savings plan of another state would provide the customer with the same state tax benefits as would be available if the customer were to invest in his or her home state’s 529 college savings plan even though this is not the case.[8]  Dealers should make certain that information they provide to their customers, whether provided under an affirmative disclosure obligation imposed by MSRB rules or in response to questions from customers, is correct and not misleading.

Dealers are reminded that this out-of-state disclosure obligation is in addition to their general obligation under Rule G-17 to disclose to their customers at or prior to the time of trade all material facts known by dealers about the 529 college savings plan interests they are selling to their customers, as well as material facts about such 529 college savings plan that are reasonably accessible to the market.  Further, dealers are reminded that disclosures made to customers as required under MSRB rules with respect to 529 college savings plans do not relieve dealers of their suitability obligations—including the obligation to consider the customer’s financial status, tax status and investment objectives—if they have recommended investments in 529 college savings plans.

Suitability

Under Rule G-19, a dealer that recommends to a customer a transaction in a security must have reasonable grounds for believing that the recommendation is suitable, based upon information available from the issuer of the security or otherwise and the facts disclosed by or otherwise known about the customer.[9]  To assure that a dealer effecting a recommended transaction with a non-institutional customer has the information needed about the customer to make its suitability determination, the rule requires the dealer to make reasonable efforts to obtain information concerning the customer’s financial status, tax status and investment objectives, as well as any other information reasonable and necessary in making the recommendation.[10]  Dealers are reminded that the obligation arising under Rule G-19 in connection with a recommended transaction requires a meaningful analysis, taking into consideration the information obtained about the customer and the security, that establishes the reasonable grounds for believing that the recommendation is suitable.  Such suitability determinations should be based on the appropriately weighted factors that are relevant in any particular set of facts and circumstances, which factors may vary from transaction to transaction.[11]  Pursuant to Rule G-27(c), dealers must have written supervisory procedures in place that are reasonably designed to ensure compliance with this Rule G-19 obligation to undertake a suitability analysis in connection with every recommended transaction, and dealers must enforce these procedures to ensure that such meaningful analysis does in fact occur in connection with the dealer’s recommended transactions.

In the context of a recommended transaction relating to a 529 college savings plan, the MSRB believes that it is crucial for dealers to remain cognizant of the fact that these instruments are designed for a particular purpose and that this purpose generally should match the customer’s investment objective.  For example, dealers should bear in mind the potential tax consequences of a customer making an investment in a 529 college savings plan where the dealer understands that the customer’s investment objective may not involve use of such funds for qualified higher education expenses.[12]  Dealers also should consider whether a recommendation is consistent with the customer’s tax status and any customer investment objectives materially related to federal or state tax consequences of an investment.

Furthermore, investors generally are required to designate a specific beneficiary under a 529 college savings plan.  The MSRB believes that information known about the designated beneficiary generally would be relevant in weighing the investment objectives of the customer, including (among other things) information regarding the age of the beneficiary and the number of years until funds will be needed to pay qualified higher education expenses of the beneficiary.  The MSRB notes that, since the person making the investment in a 529 college savings plan retains significant control over the investment (e.g., may withdraw funds, change plans, or change beneficiary, etc.), this person is appropriately considered the customer for purposes of Rule G-19 and other MSRB rules.  As noted above, information regarding the designated beneficiary should be treated as information relating to the customer’s investment objective for purposes of Rule G-19.

In many cases, dealers may offer the same investment option in a 529 college savings plan sold with different commission structures.  For example, an A share may have a front-end load, a B share may have a contingent deferred sales charge or back-end load that reduces in amount depending upon the number of years that the investment is held, and a C share may have an annual asset-based charge.  A customer’s investment objective—particularly, the number of years until withdrawals are expected to be made—can be a significant factor in determining which share class would be suitable for the particular customer.

Rule G-19(e), on churning, prohibits a dealer from recommending transactions to a customer that are excessive in size or frequency, in view of information known to such dealer concerning the customer’s financial background, tax status and investment objectives.  Thus, for example, where the dealer knows that a customer is investing in a 529 college savings plan with the intention of receiving the available federal tax benefit, such dealer could, depending upon the facts and circumstances, violate rule G-19(e) if it were to recommend roll-overs from one 529 college savings plan to another with such frequency as to lose the federal tax benefit.  Even where the frequency does not imperil the federal tax benefit, roll-overs recommended year after year by a dealer could, depending upon the facts and circumstances (including consideration of legitimate investment and other purposes), be viewed as churning.  Similarly, depending upon the facts and circumstances, where a dealer recommends investments in one or more plans for a single beneficiary in amounts that far exceed the amount that could reasonably be used by such beneficiary to pay for qualified higher education expenses, a violation of rule G-19(e) could result.[13]

Other Sales Practice Principles

Dealers must keep in mind the requirements under Rule G-17—that they deal fairly with all persons and that they not engage in any deceptive, dishonest or unfair practice—when considering the appropriateness of day-to-day sales-related activities with respect to municipal fund securities, including 529 college savings plans.  In some cases, certain sales-related activities are governed in part by specific MSRB rules, such as Rule G-19 (as described above) and Rule G-30(b), on commissions.[14]  Other activities may not be explicitly addressed by a specific MSRB rule.  In either case, the general principles of Rule G-17 always apply.

In particular, dealers must ensure that they do not engage in transactions primarily designed to increase commission revenues in a manner that is unfair to customers under Rule G-17.  Thus, in addition to being a potential violation of Rule G-19 as discussed above, recommending a particular share class to a customer that is not suitable for that customer, or engaging in churning, may also constitute a violation of Rule G-17 if the recommendation was made for the purpose of generating higher commission revenues.  Also, where a dealer offers investments in multiple 529 college savings plans, consistently recommending that customers invest in the one 529 college savings plan that offers the dealer the highest compensation may, depending on the facts and circumstances, constitute a violation of Rule G-17 if the recommendation of such 529 college savings plan over the other 529 college savings plans offered by the dealer does not reflect a legitimate investment-based purpose.

Further, recommending transactions to customers in amounts designed to avoid commission discounts (i.e., sales below breakpoints where the customer would be entitled to lower commission charges) may also violate Rule G-17, depending upon the facts and circumstances.  For example, a recommendation that a customer make two smaller investments in separate but nearly identical 529 college savings plans for the purposes of avoiding a reduced commission rate that would be available upon investing the full amount in a single 529 college savings plan, or that a customer time his or her multiple investments in a 529 college savings plan so as to avoid being able to take advantage of a lower commission rate, in either case without a legitimate investment-based purpose, could violate Rule G-17.

With respect to sales incentives, the MSRB has previously interpreted Rule G-20, relating to gifts, gratuities and non-cash compensation, to require a dealer that sponsors a sales contest involving representatives who are not employed by the sponsoring dealer to have in place written agreements with these representatives.[15]  In addition, the general principles of Rule G-17 are applicable.  Thus, if a dealer or any of its associated persons engages in any marketing activities that result in a customer being treated unfairly, or if the dealer or any of its associated persons engages in any deceptive, dishonest or unfair practice in connection with such marketing activities, Rule G-17 could be violated.  The MSRB believes that, depending upon the specific facts and circumstances, a dealer may violate Rule G-17 if it acts in a manner that is reasonably likely to induce another dealer or such other dealer’s associated persons to violate the principles of Rule G-17 or other MSRB customer protection rules, such as Rule G-19 or Rule G-30.  Dealers are also reminded that Rule G-20 establishes standards regarding incentives for sales of municipal securities, including 529 college savings plan interests, that are substantially similar to those currently applicable to sales of mutual fund shares under NASD rules.

Municipal Securities Rulemaking Board ("MSRB") Rule G-38, on solicitation of municipal securities business, defines "solicitation" as any direct or indirect communication with an issuer for the purpose of obtaining or retaining municipal securities business. This definition is important for purposes of determining whether payments made by a broker, dealer or municipal securities dealer ("dealer") to persons who are not affiliated persons of the dealer are prohibited under Rule G-38.[1] In addition, the definition is central to determining whether communications by dealer personnel would result in such personnel being considered municipal finance professionals ("MFPs") of the dealer for purposes of Rule G-37, on political contributions and prohibitions on municipal securities business. This notice provides interpretive guidance relating to the status of certain types of communications as solicitations for purposes of Rules G-37 and G-38.

Purpose of Communication

The concept of solicitation under Rules G-37 and G-38 includes as a central element the notion that the communication occurs with the purpose of obtaining or retaining municipal securities business. The determination of whether a particular communication is a solicitation is dependent upon the specific facts and circumstances relating to such communication. As a general proposition, any communication made under circumstances reasonably calculated to obtain or retain municipal securities business for the dealer may be considered a solicitation unless the circumstances otherwise indicate that the communication does not have the purpose of obtaining or retaining municipal securities business. This notice provides examples of circumstances in which a communication may or may not be considered a solicitation. These examples are illustrative only and are not the only instances in which a solicitation may be deemed to have or have not occurred.

Limited Communications with Issuer Representative

If an issuer representative asks an affiliated person of a dealer whether the dealer has municipal securities capabilities, such affiliated person generally would not be viewed as having solicited municipal securities business if he or she provides a limited affirmative response, together with either providing the issuer representative with contact information for an MFP of the dealer or informing the issuer representative that dealer personnel who handle municipal securities business will contact him or her. Similarly, if an issuer representative is discussing governmental cash flow management issues with an affiliated person of a dealer who concludes, in his or her professional judgment, that an appropriate means of addressing the issuer's needs may be through an issue of municipal securities, the affiliated person generally would not be viewed as having solicited business if he or she provides a limited communication to the issuer representative that such alternative may be appropriate, together with either providing the issuer representative with contact information for an MFP or informing the issuer representative that dealer personnel who handle municipal securities business will contact him or her.

In the examples above, if the affiliated person receives compensation such as a finder's or referral fee for such business or if the affiliated person engages in other activities that could be deemed a solicitation with respect to such business (for example, attending presentations of the dealer's municipal finance capabilities or responding to a request for proposals), the affiliated person generally would be viewed as having solicited the municipal securities business. The MSRB has long regarded receipt of a finder's fee for bringing municipal securities business to the dealer and activities such as attending presentations to issuer personnel of the dealer's municipal finance capabilities or responding to issuer requests for proposals as presumptively constituting solicitations of municipal securities business and does not view this notice as altering such presumption.

Promotional Communication

The MSRB understands that an affiliated person of a dealer may provide information to potential clients and others regarding the general capabilities of the dealer through either oral or written communications. Any such communication that is not made with the purpose of obtaining or retaining municipal securities business would not be considered a solicitation. Thus, depending upon the specific facts and circumstances, a communication that merely lists the significant business lines of a dealer without further descriptive information and which does not give the dealer's municipal securities practice a place of prominence within such listing generally would not be considered a solicitation unless the facts and circumstances indicate that it was aimed at obtaining or retaining municipal securities business. To the extent that a communication, such as a dealer brochure or other promotional materials, contains more than a mere listing of business lines, such as brief descriptions of each business line (including its municipal securities capabilities), determining whether such communication is a solicitation depends upon whether the facts and circumstances indicate that it was undertaken for the purpose of obtaining or retaining municipal securities business. The nature of the information provided and the manner in which it is presented are relevant factors to consider. Although no single factor is necessarily controlling in determining whether a communication was undertaken for the purpose of obtaining or retaining municipal securities business, the following considerations, among others, may often be relevant: (i) whether the municipal securities practice is the only business line included in the communication that would reasonably be of interest to an issuer representative; (ii) whether the portions of the communication describing the dealer's municipal securities capabilities are designed to garner more attention than other portions describing different business lines; (iii) whether the communication contains quantitative or qualitative information on the nature or extent of the dealer's municipal securities capabilities that is promotional in nature (e.g., quantitative or qualitative rankings, claims of expertise, identification of specific transactions, language associated with "puffery," etc.); and (iv) whether the dealer is currently seeking to obtain or retain municipal securities business from the issuer.

Work-Related Communications

Communications that are incidental to undertaking tasks to complete municipal securities business for which the dealer has already been engaged generally would not be solicitations. For example, if a dealer has engaged an independent contractor as a cash flow consultant to provide expert services on a negotiated underwriting for which the dealer has already been selected and the contractor communicates with the issuer on cash flow matters relevant to the financing, such communication would not be a solicitation under Rule G-38. Similarly, if a dealer has already been selected to serve as the underwriter for an airport financing and a non-MFP affiliated person of the dealer who normally works on airline corporate matters is used to provide his or her expertise to complete the financing, communications in this regard by the affiliated person with the issuer would not be a solicitation under Rule G-38. In addition, the fact that the work product of persons such as those described above may be used by MFPs of the dealer in their solicitation activities would not make the producer of the work product a solicitor unless such person personally presents his or her work to the issuer in connection with soliciting the municipal securities business.

Communications with Conduit Borrowers

The MSRB understands that dealers often work closely with private entities on their capital and other financing needs. In many cases, this work may evolve into a conduit borrowing through a conduit issuer. Although the ultimate obligor on such a financing is the private entity, if the dealer acts as underwriter for a financing undertaken through a conduit issuer on other than a competitive bid basis, it is engaging in municipal securities business for purposes of Rule G-37. The selection of the underwriter for such a financing frequently is made by the conduit borrower. While in many cases conduit issuers have either formal procedures or an informal historical practice of accepting the dealer selected by the conduit borrower, some conduit issuers may set minimum standards that dealers must meet to qualify to underwrite a conduit issue, and other conduit issuers may have a slate of dealers selected by the conduit issuer from which the conduit borrower chooses the underwriter for its issue. Still other conduit issuers may defer to the conduit borrower's selection of lead underwriter but may require the underwriting syndicate to include additional dealers selected by the issuer or selected by the conduit borrower from a slate of issuer-approved underwriters, often with the purpose of ensuring participation by local dealers or historically disadvantaged dealers. A smaller number of conduit issuers retain more significant control over which dealers act as underwriters, either by making the selection for the conduit borrower or by considering the conduit borrower's selection to be merely a suggestion which in some cases the conduit issuer does not follow. However, in virtually all cases, the conduit issuer will maintain ultimate power to control which dealer underwrites a conduit issue since the conduit issuer has discretion to withhold its agreement to issue the securities through any particular dealer.

From a literal perspective, any communication by a dealer with a conduit borrower that is intended to cause the borrower to select the dealer to serve as underwriter for a conduit issue could be considered a solicitation of municipal securities business. This is because the conduit borrower eventually communicates its selection of the dealer to act as underwriter to the conduit issuer for approval. This series of communications would, by its terms, constitute an indirect communication by the dealer through the conduit borrower to the conduit issuer for the purpose of obtaining or retaining municipal securities business.

However, the MSRB believes that a dealer's communication with a conduit borrower generally should not be deemed an indirect solicitation of the issuer unless a reasonable nexus can be established between the making of contributions to officials of the conduit issuer within the meaning of Rule G-37 and the selection of the underwriter for such conduit financing. A determination of whether such a reasonable nexus could exist depends on the specific facts and circumstances.

Further, if an affiliated person of a dealer who is providing investment banking services and corporate financing advice to a private company concludes, in his or her professional judgment, that an appropriate financing alternative may be a conduit financing, a limited communication to the company by the affiliated person that such financing alternative may be appropriate, together with the provision to the company of contact information for an MFP of the dealer, generally would not be presumed to be a solicitation. Alternatively, the affiliated person could inform the company that dealer personnel who handle municipal securities business will contact it. In addition, if a dealer has already been selected by the conduit borrower to serve as the underwriter for a conduit financing and a non-MFP affiliated person of the dealer communicates with the conduit borrower in furtherance of the financing, such communications by the affiliated person would not be a solicitation under Rule G-38.

Communications by Non-Affiliated Professionals

So long as non-affiliated persons providing legal, accounting, engineering or other professional services in connection with specific municipal securities business are not being paid directly or indirectly by a dealer for communicating with an issuer for the purpose of obtaining or retaining municipal securities business for the dealer (i.e., they are paid solely for their provision of legal, accounting, engineering or other professional services with respect to the business), they would not become subject to Rule G-38. Dealers are reminded that the term "payment" as used in Rules G-37 and G-38 refers to anything of value and can, depending on the specific facts and circumstances, include quid pro quo arrangements whereby a non-affiliated person solicits municipal securities business for the dealer in exchange for being hired by the dealer to provide other unrelated services.

529 college savings plan advertisements.  Thank you for your letter of April 21, 2006 in which you request interpretive guidance on the application of Rule G-21, on advertising, with respect to advertisements of 529 college savings plans.  Rule G-21 was amended in 2005 by adding new section (e) relating to advertisements by brokers, dealers and municipal securities dealers (“dealers”) of interests in 529 college savings plans and other municipal fund securities (collectively referred to as “municipal fund securities”).  These new provisions were modeled after the provisions of Securities Act Rules 482 and 135a relating to mutual fund advertisements, with certain modifications.

The Board expects to undertake a detailed review of issues relating to the implementation of section (e) of its advertising rule in the coming months and your views will be instrumental in that review.  We appreciate your interest in the operation of the rule and the commitment of your organization and your individual members to assure that investors receive appropriate disclosures.  As you are aware, MSRB rules apply solely to dealers, not to issuers or other parties.  The MSRB has previously stated that Rule G-21 does not govern advertisements published by issuers but that an advertisement produced by a dealer as agent for an issuer must comply with Rule G-21.  Similarly, a dealer cannot avoid application of Rule G-21 merely by hiring a third party to produce and publish advertisements on its behalf.[1]  Pending our detailed review of section (e) of Rule G-21, I would like to address certain basic principles under the current rule language and existing interpretive guidance that may prove helpful in the context of some of the issues you raise in your letter.[2]

Section (a) of the rule provides a broad definition of “advertisement.”[3]  Sections (b) through (e) of the rule establish requirements with respect to specific types of advertisements.  Section (b) establishes standards for professional advertisements, which are advertisements concerning the dealer’s facilities, services or skills with respect to municipal securities.  Section (c) establishes general standards for product advertisements, with additional specific standards relating to advertisements for new issue debt securities set forth in Section (d) and specific standards relating to advertisements for municipal fund securities set forth in Section (e).  In addition, all advertisements are subject to the MSRB’s basic fair dealing rule, Rule G-17,[4] and are subject to approval by a principal pursuant to Section (f) of Rule G-21.

Where an advertisement does not identify specific securities, specific issuers of securities or specific features of securities, but merely refers to one or more broad categories of securities with respect to which the dealer provides services, the MSRB would generally view such advertisement as a professional advertisement under Section (b) rather than as a product advertisement.  For example, if an advertisement simply states that the dealer provides investment services with respect to 529 college savings plans – without identifying any specific 529 college savings plan, specific municipal fund securities issued through a 529 college savings plan, or specific features of any such municipal fund securities – the advertisement would be subject to Section (b) of Rule G-21, rather than to Sections (c) and (e).

On the other hand, advertisements that identify specific securities, specific issuers of securities or specific features of securities generally are viewed as product advertisements under Rule G-21 and therefore would be subject to Section (c), as well as Section (d) or (e), if applicable.  However, in some circumstances, an advertisement that identifies an issuer of securities without identifying its securities or specific features of such securities effectively may not constitute an advertisement of such issuer’s securities and therefore would not be treated as a product advertisement under the rule, particularly if the dealer or any of its affiliates is not identified.  For example, if an advertisement identifies the state or other governmental entity that operates a 529 college savings plan without identifying its municipal fund securities, the specific features of such securities or the dealer and its affiliates that may participate in the marketing of its municipal fund securities, the MSRB generally would not view such advertisement as a product advertisement subject to Sections (c) and (e) of Rule G-21.[5] MSRB Interpretation of May 12, 2006.

[1] The MSRB expresses no opinion at this time as to the applicability of MSRB rules to advertisements relating to municipal fund securities produced and published by issuers with funds provided directly or indirectly by a dealer.

[2] Other issues you raise in your letter will be considered during the upcoming review of Rule G-21.

[3] An advertisement is defined as any material (other than listings of offerings) published or designed for use in the public, including electronic, media, or any promotional literature designed for dissemination to the public, including any notice, circular, report, market letter, form letter, telemarketing script or reprint or excerpt of the foregoing. The term does not apply to preliminary official statements or official statements (including program disclosure documents), but does apply to abstracts or summaries of official statements, offering circulars and other such similar documents prepared by dealers.  The MSRB expresses no opinion at this time as to whether the specific communications or promotional materials described in your letter would constitute advertisements under this definition.

[4] Rule G-17 requires each dealer, in the conduct of its municipal securities activities, to deal fairly with all persons and prohibits the dealer from engaging in any deceptive, dishonest or unfair practice.

[5] The advertisement may, in addition to or instead of identifying the state or other governmental entity that operates the 529 college savings plan, include the state’s marketing name for such plan so long as such name does not identify the dealer or any dealer affiliates that may participate in the marketing of its municipal fund securities.  Further, any contact information (such as a telephone number or Internet address) included in the advertisement should be for the state or other governmental entity and must not be for the dealer or its affiliates.

Background

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

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

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

Applicability of the Suitability Rule to Electronic Communications—General Principles  

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

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

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

Scope of the Term Recommendation

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

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

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

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

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

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

Guidelines for Evaluating Suitability Obligations 

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

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

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

Conclusion

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

[14] NASD Online Suitability Notice at 3.

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

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

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

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

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

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

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

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

ENDNOTES

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

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

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

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

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

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

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

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

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