Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Municipal Securities Rulemaking Board Relating to Political Contributions and Prohibitions on Municipal Securities Business
Federal RegisterJan 21, 1994
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33482; File No. SR-MSRB-94-02]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Municipal Securities Rulemaking Board Relating to
Political Contributions and Prohibitions on Municipal Securities
Business
January 14, 1994.
On January 12, 1994, the Municipal Securities Rulemaking board
(``Board'' or ``MSRB'') filed with the Securities and Exchange
Commission (``Commission'' or ``SEC'') a proposed rule change (File No.
SR-MSRB-94-2), pursuant to Section 19(b)(1) of the Securities Exchange
Act of 1934 (``Act''), 15 U.S.C. 78s(b)(1), and Rule 19b-4 thereunder.
The MSRB filed the proposal to adopt rules relating to political
contributions and prohibitions on municipal securities business. The
proposed rule change is described in Items I, II, and III below, which
Items have been prepared by the Board. The Commission is publishing
this notice to solicit comments on the proposed rule change from
interested people.
Comments should be filed by February 11, 1994. The Commission
encourages interested persons to file their views promptly, recognizing
the statutory timeframe described in Section III below. The role of
political contributions in the municipal securities market and the
integrity of the underwriting process has been a matter of concern to
the MSRB for several years and has been the subject of extensive public
debate, even before the MSRB released its draft proposal in August
1993.
I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The Board is filing herewith proposed rule G-37 regarding political
contributions and prohibitions on municipal securities business, and
proposed amendments to existing rules G-8 and G-9 on recordkeeping and
record retention, respectively.
Proposed rule G-37 would prohibit brokers, dealers and municipal
securities dealers (hereafter referred to as ``dealers'') from engaging
in municipal securities business with an issuer within two years after
any contribution to an official of such issuer made by: (i) The dealer;
(ii) any municipal finance professional associated with such dealer; or
(iii) any political action committee (``PAC'') controlled by the dealer
or any municipal finance professional. The prohibition on business
would arise from contributions made on or after April 1, 1994. There is
one exception to this prohibition: contributions made by municipal
finance professionals to officials of issuers would not invoke
application of the prohibition on business, but only if the municipal
finance professional is entitled to vote for such official and provided
any contributions by such municipal finance professional do not exceed,
in total, $250 to each official, per election.
Proposed rule G-37 also would require dealers to disclose to the
Board certain political contributions, as well as other summary
information, to allow public scrutiny of political contributions and
the municipal securities business of a dealer. Contributions to be
reported would include those to officials of issuers and political
parties of states and political subdivisions made by the dealer, any
municipal finance professional, any executive officer, and any PAC
controlled by the dealer or by any municipal finance professional. Only
such contributions, over a de minimis amount, by municipal finance
professionals and executive officers would be disclosed. The names of
individual municipal finance professionals and executive officers would
not be disclosed. Such reports also would include a list of issuers
with which the dealer has engaged in municipal securities business
during the reporting period, along with the type of municipal
securities business and the name, company, role and compensation
arrangement of any person employed by the dealer to obtain or retain
municipal securities business with such issuers. The reports would be
made on proposed Form G-37 and would be submitted to the board in
accordance with rule G-37 filing procedures, quarterly, with due dates
determined by the Board.
The proposed amendment to rule G-8 would require a dealer to
maintain a list of: (i) Names, titles, city/county and state of
residence of every municipal finance professional; (ii) names, titles,
city/county and state of residence of all executive officers; (iii) the
states in which the dealer is engaging or is seeking to engage in
municipal securities business; (iv) every issuer with which municipal
securities business has been conducted during the current year, as well
as the previous two years and, where applicable, the name, company,
role and compensation arrangement of any person employed by the dealer
to obtain or retain municipal securities business with such issuer; and
(v) all contributions, direct or indirect, to officials of issuers and
to political parties of states and political subdivisions made by the
dealer, any dealer-controlled PAC, any municipal finance professional
or executive officer. The dealer would not, however, be required to
maintain a list of contributions by its municipal finance professionals
or executive officers that are made: (i) To officials for whom the
person is entitled to vote, provided such contributions do not exceed
$250 to each issuer official, per election; and (ii) to political
parties for the state and political subdivision in which the person is
entitled to vote, provided such contributions do not exceed $250 per
party, per year. In addition, dealers would not be required to maintain
a list of contributions by any other employees, affiliate companies and
their employees, spouses of covered employees, or any other person or
entity unless the contributions were directed by persons or entities
subject to proposed rule G-37. The required records pursuant to the
proposed amendment to rule G-8 would not have to be maintained for
contributions made or business engaged in prior to April 1, 1994.
The proposed amendment to rule G-9 would require dealers to
maintain, for a six-year period, those records required pursuant to the
proposed amendment to rule G-8.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Board included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Board has prepared summaries, set forth in Sections
(A), (B), and (C) below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
(a) Over the last few years, the Board has become increasingly
concerned about the opportunity for abuses and the problems associated
with political contributions in connection with the awarding of
municipal securities business. The Board believes, based on comment
letters and other information, that there have been numerous instances
in which dealers have been awarded municipal securities business based
on their political contributions. Even where such improprieties have
not transpired, political contributions create a potential conflict of
interest for issuers, or at the very least the appearance of a
conflict, when dealers make contributions to officials responsible for,
or capable of influencing the outcome of, the awarding of municipal
securities business and then are awarded business by issuers associated
with these officials. The problems associated with political
contributions undermine investor confidence in the municipal securities
market, which is crucial to the long-term health of the market, both in
terms of liquidity and capital-raising ability. In addition, in order
to promote just and equitable principles of trade, the awarding of
business should be based on merit, and not on political contributions.
The payment of such contributions to obtain business creates artificial
barriers to those dealers not willing or able to make such payments,
thereby harming investors and the public interest by stifling
competition and increasing market costs associated with doing municipal
securities business. Accordingly, the Board has determined that
regulatory action is necessary, among other things, to protect
investors and maintain the integrity of the market.
Background
The Board has monitored and discussed the issues surrounding
political contributions since its November 1990 meeting. In August
1991, the Board published a notice expressing its concern that the
process of selecting an underwriting team not be influenced by
political contributions. The Board stated that it is critical that the
market engender the highest degree of public confidence so that
investors will provide much needed capital to state and local
governments. Toward this end, the Board encouraged underwriters and
state and local governments to maintain the integrity of the
underwriter selection process. In May 1993, the Board published a press
release noting continuing concern by the Board, industry members and
others regarding political contributions. The Board indicated that it
planned to review its authority and options for rulemaking in this
area.
In August 1993, the Board published for comment draft rule G-37
(``August 1993 draft rule''), which would have (1) prohibited brokers,
dealers and municipal securities dealers (``dealers'') and their
associated persons from making political contributions, directly or
indirectly, to officials of issuers for the purpose of obtaining or
retaining municipal securities business, and (2) required dealers and
their associated persons to disclose, for a four-year period, all
political contributions to officials of such issuers with whom they
have done business. The Board also requested comments on draft
amendments to rule G-8 and G-9, on recordkeeping and record retention,
respectively, requiring the recording of information regarding certain
political contributions. The vast majority of commentators supported
the Board's efforts to alleviate the problems, both actual and
potential, associated with political contributions, and thereby
maintain the integrity of the market and protect investors and the
public interest. However, none gave unqualified support for the August
1993 draft rule; every commentator suggested modifications. At its
November and December 1993 meetings, the Board carefully considered the
commentators' concerns and suggestions, and adopted the proposed rule
change. The Board believes that the proposed rule change effectively
addresses the problems of political contributions and the awarding of
municipal securities business.
General Prohibition on Engaging in Municipal Securities Business
Proposed rule G-37 would prohibit any dealer from engaging in
municipal securities business with an issuer within two years after any
contribution to an official of such issuer made by: (i) The dealer;
(ii) any municipal finance professional associated with such dealer; or
(iii) any political action committee (``PAC'') controlled by the dealer
or any municipal finance professional. One exception to this
prohibition is discussed below.
The proposed rule change is not a ban on political contributions--
it is a ban on engaging in municipal securities business with an issuer
after certain contributions are made to officials of such issuer. The
term ``municipal securities business'' is defined in the proposed rule
to encompass certain activities of dealers, such as acting as
negotiated underwriters (as managing underwriter or as syndicate
member), financial advisors and consultants, placement agents, and
negotiated remarketing agents.\1\ Thus, a dealer could not provide any
of these services to an issuer within two years after the dealer, any
dealer-controlled PAC or any municipal finance professional made
contributions to an official of such issuer. This prohibition on
business also would result if a municipal finance professional
associated with a dealer made such a contribution prior to becoming
associated with the dealer (i.e., the two-year ban on business applies
to both the current and prior employer of the municipal finance
professional). This is intended to prohibit the new employer from
obtaining municipal securities business based on prior contributions by
its municipal finance professionals.
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\1\The proposed rule would not prohibit dealers from acting as
competitive underwriters or competitive remarketing agents.
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The prohibitions on business under the rule arise from
contributions made on or after April 1, 1994. This date was set so that
dealers could begin to monitor those political contributions that may
subject them to restrictions on engaging in municipal securities
business.
An ``official of an issuer'' is defined as any incumbent, candidate
or successful candidate for elective office of the issuer, which office
is directly or indirectly responsible for, or can influence the outcome
of, the hiring of a dealer for municipal securities business. The
definition includes any issuer official or candidate (or successful
candidate) who has influence over the awarding of municipal securities
business so that contributions to certain state-wide executive or
legislative officials (e.g., governors) would be included within the
proposed rule change's prohibition on engaging in municipal securities
business.
``Contributions'' which invoke application of the prohibition
include any gift, subscription, loan, advance, or deposit of money or
anything of value made: (i) For the purpose of influencing any election
for federal, state,\2\ or local office; (ii) for payment or reduction
of debt incurred in connection with any such election; or (iii) for
transition or inaugural expenses incurred by the successful candidate
for state or local office. The Board has decided to include all such
payments within the parameters of proposed rule G-37 because of concern
that such types of payments, in the past, have or may have been
connected to the awarding of municipal securities business. The Board
believes that the proposed rule's definition of contribution will cover
all circumstances in which political contributions are made to state
and local issuer officials and candidates who can influence the
awarding of municipal securities business, both before and after
election to state and local office. The Board wishes to sever any
connection between contributions and municipal securities business. Any
other payments to issuer officials are addressed in other Board rules,
such as rule G-20 on gifts and gratuities.
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\2\The term ``state'' is defined in Section 3(a)(16) of the Act
to mean any state of the United States, the District of Columbia,
Puerto Rico, the Virgin Islands, or any other possession of the
United States. Rule D-1 provides that, unless the context otherwise
requires, the terms used in the Board's rules shall have the same
meanings set forth in the Act.
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Finally, the Board does not seek, through its definition of
contribution, to restrict the personal volunteer work of municipal
finance professionals in political campaigns other than soliciting or
coordinating contributions.\3\ However, if resources of the dealer are
used (e.g., a political position paper is prepared by dealer personnel)
or expenses are incurred by the municipal finance professional in such
personal volunteer work, the value of such resources or expenses would
be included within the definition of contribution.
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\3\Restrictions on soliciting or coordinating contributions are
described below.
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Exception for Certain Contributions
The only exception to the proposed rule change's absolute
prohibition on business is for certain contributions made to issuer
officials by municipal finance professionals. Contributions by such
persons to officials of issuers would not invoke application of the
prohibition on business, but only if the municipal finance professional
is entitled to vote for such official and provided any contributions by
such municipal finance professional do not exceed, in total, $250 to
each official, per election.\4\ The Board believes that this exception
is appropriate because contributions of this nature present less
opportunity for a conflict of interest or the appearance of a conflict
of interest on the part of an issuer official in the awarding of
municipal securities business.
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\4\Thus, if an issuer official (i.e., incumbents and/or
candidates) for whom the municipal finance professional is entitled
to vote is involved in a primary prior to the general election, the
municipal finance professional could contribute up to $500 for each
such official (i.e., $250 per election).
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The term ``municipal finance professional'' means: (i) Any
associated person primarily engaged in municipal securities
representative activities, as defined in rule G-3(a)(i),\5\ (ii) any
associated person who solicits municipal securities business; (iii) any
direct supervisor of such persons up through and including, in the case
of a dealer other than a bank dealer, the Chief Executive Officer or
similarly situated official and, in the case of a bank dealer, the
officer or officers designated by the board of directors of the bank as
responsible for the day-to-day conduct of the bank's municipal
securities dealer activities, as required pursuant to rule G-1(a); or
(iv) any member of the dealer executive or management committee or
similarly situated officials, if any (or, in the case of a bank dealer,
similarly situated officials in the separately identifiable department
of division of the bank, as defined in rule G-1).
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\5\Rule G-3(a)(i) defines the term ``municipal securities
representative'' as a person associated with a dealer, other than a
person whose functions are solely clerical or ministerial, whose
activities include one or more of the following: (A) Underwriting,
trading or sales of municipal securities; (B) financial advisory or
consultant services for issuers in connection with the issuance of
municipal securities; (C) research or investment advice with respect
to municipal securities; or (D) any other activities which involve
communication, directly or indirectly, with pubic investors in
municipal securities; provided, however, that the activities
enumerated in subparagraphs (C) and (D) are limited to such
activities as they relate to the activities enumerated in
subparagraphs (A) and (B).
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Included within the definition of municipal finance professional is
any associated person of the dealer involved in the solicitation of
municipal securities business or bringing to market new issue municipal
securities. The definition also includes those individuals who have an
economic interest in seeing that the dealer is awarded municipal
securities business and who thus may be in a position to make political
contributions for the purpose of influencing the awarding of such
business by issuer officials. Such persons would include those in the
public finance department, as well as underwriters, traders and
institutional and retail sales persons primarily engaged in municipal
securities activities. The Board does not intend to include within the
definition of municipal finance professional retail sales persons who
primarily sell other products or associated persons employed in
departments other than the municipal securities department.
Direct and Indirect Contributions
In addition to the prohibition on business described above, the
proposed rule also would prohibit a dealer and any municipal finance
professional from doing any act indirectly which would result in a
violation of the proposed rule if done directly by the dealer or
municipal finance professional. This proscription was modeled after
Section 20(b) of the Act\6\ and is intended to prohibit those parties
subject to the proposed rule from using other persons or entities as
conduits in order to circumvent the proposed rule. A dealer would
violate the proposed rule by engaging in municipal securities business
with an issuer after directing a person to make a contribution to an
official of such issuer. For example, a violation would result if a
dealer does business with an issuer after directing contributions by
associated persons, family members of associated persons, consultants,
lobbyists, attorneys, other dealer affiliates, their employees or PACs,
or other persons or entities as a means to circumvent the rule.
Finally, the dealer would violate the rule by doing business with an
issuer after providing money to any person or entity when the dealer
knows that such money will be given to an official of an issuer who
could not receive such a contribution directly from the dealer without
triggering the rule's prohibition on business. For example, in certain
instances, a local political party may be soliciting contributions for
the purpose of supporting one issuer official. If this is the case,
contributions made to the political party would result in these same
prohibition on municipal securities business as would a contribution
made directly to the issuer official.
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\6\Section 20(b) provides that: ``It shall be unlawful for any
person, directly or indirectly, to do any act or thing which it
would be unlawful for such person to do under the provisions of this
title or any rule or regulation thereunder through or by means of
any other person.''
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Solicitation and Bundling Prohibition
The proposed rule also would prohibit a dealer and any municipal
finance professional from soliciting the parties described above, as
well as 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.\7\ Dealers may not engage in municipal securities
business with issuers if they or their municipal finance professionals
engage in any kind of fund-raising activities for officials of such
issuers. As noted previously, municipal finance professionals may
volunteer their personal services in other ways to political campaigns.
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\7\By the term ``seeking to engage in municipal securities
business'' the Board means dealer activities including responding to
Requests for Proposals, making presentations of public finance
capabilities, and other soliciting of business with issuer
officials.
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Recordkeeping Requirements
To facilitate compliance with, and enforcement of, proposed rule G-
37, the Board also proposes to amend existing rules G-8 and G-9,
concerning recordkeeping and record retention, respectively. The
amendment to rule G-8 is designed to assist dealers in determining
whether or not they may engage in business with a particular issuer.
These amendments would require a dealer to maintain a list of: (i)
Names, titles, city/county and state of residence of every municipal
finance professional; (ii) names, titles, city/county and state of
residence of all executive officers;\8\ (iii) the states in which the
dealer is engaging or is seeking to engage in municipal securities
business; (iv) every issuer with which municipal securities business
has been conducted during the current year, as well as the previous two
years and, where applicable, the name, company, role and compensation
arrangement of any person employed by the dealer to obtain or retain
municipal securities business with such issuer; and (v) all
contributions, direct or indirect, to officials of issuers and to
political parties of states and political subdivisions made by the
dealer, any dealer-controlled PAC, any municipal finance professional
or executive officer. The dealer would not, however, be required to
maintain a list of contributions by its municipal finance professionals
or executive officers that are made: (i) To officials for whom the
person is entitled to vote, provided such contributions do not exceed
$250 to each issuer official, per election; and (ii) to political
parties for the state and political subdivision in which the person is
entitled to vote, provided such contributions do not exceed $250 per
party, per year. In addition, dealers would not be required to maintain
a list of contributions by any other employees, affiliate companies and
their employees, spouses of covered employees, or any other person or
entity unless the contributions were directed by persons or entities
subject to the proposed rule.
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\8\An executive officer is defined in the proposed rule as any
associated person in charge of a principal business unit, division
or function or any other person who performs similar policy making
functions for the dealer, but does not include any municipal finance
professional.
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The Board determined to add a recordkeeping requirement for
contributions made by executive officers and contributions made to
political parties to help ensure that dealers, dealer-controlled PACs
and municipal finance professionals do not circumvent the prohibition
on business in the proposed rule by indirect contributions to issuer
officials through executive officers or to state or local political
parties. Upon review by the enforcement agencies of such information,
the Board may determine that further revisions to the proposed rule
change in this area would be appropriate.
In addition, a number of commentators expressed concern about the
use of consultants by dealers to obtain or retain municipal securities
business. Again, once the prohibition on business in the proposed rule
change is put into effect, the Board is concerned that use of
consultants who make contributions to issuer officials may increase.
Thus, the proposed rule change also would require dealers to record
every issuer with which municipal securities business has been
conducted, the type of business, and, where applicable, the name,
company, role and compensation arrangement of any person employed by
the dealer to obtain or retain municipal securities business with the
issuers listed.
The records would not have to be maintained for contributions made
or business engaged in prior to April 1, 1994. The amendment to rule G-
9 would require dealers to maintain these records, required pursuant to
the proposed amendments to rule G-8, for a six-year period.
Disclosure Requirements
Proposed rule G-37 would require dealers to report to the Board
certain summary information concerning contributions in order to allow
for public access to such information. Contributions to be reported
include those to officials of issuers and political parties of states
and political subdivisions made by: (i) the dealer; (ii) any municipal
finance professional; (iii) any executive officer; and (iv) any PAC
controlled by the dealer or by any municipal finance professional. Only
such contributions over a de minimis amount, i.e., those required to be
recorded under rule G-8, would be disclosed.
Reports, on Form G-37, would be submitted to the Board in
accordance with Board rule G-37 filing procedures, quarterly, with due
dates determined by the Board and would include, by state: (i) the
name, title (including any city/county/state or other political
subdivision) of each official of an issuer and political party
receiving contributions; (ii) total number and dollar amount of
contributions made by the persons and entities described above; and
(iii) such other identifying information as required by Form G-37. The
names of individual municipal finance professionals and executive
officer contributors would not be disclosed. Such reports also would
include a list of issuers with which the dealer has engaged in
municipal securities business during the reporting period, along with
the type of municipal securities business and the name, company, role
and compensation arrangement of any person employed by the dealer to
obtain or retain municipal securities business with such issuers.
The Board believes that it is important to provide certain summary
information on contributions to the public to help assure investors in
the municipal securities market that dealers are not engaging in
municipal securities business with issuers to whom contributions have
been made by the dealer, dealer-controlled PACs and municipal finance
principals. In addition, the Board is concerned that, once the
prohibition on business in the proposed rule change is put into effect,
dealers may seek to continue making contributions to obtain business
through contributions by executive officers or to political parties.
Thus, the proposed rule change requires disclosure of such
contributions. Finally, as noted above, to reduce the opportunity for
dealers to circumvent the rule's requirements through the use of
consultants and other persons, disclosure of the dealer's municipal
securities business activities and information about persons hired to
obtain or retain such business would be required.
The Board believes that public access to this information will help
to assure investors in the municipal securities market that dealers are
awarded business based on merit, not political contributions. Where
this is not the case, the information provided should assist state and
federal officials in detecting and correcting such situations.
In order to ensure equal public access to information provided on
Form G-37, the Board will include this information in its Municipal
Securities Information Library (``MSIL'') system, the Board's
electronic library. The Board is in the process of developing
appropriate rule G-37 filing procedures to allow for public access to
the information to be submitted on Form G-37, as well as indexing,
record storage, etc. It will seek information from a wide variety of
information submitters (i.e., dealers) and potential information users
(e.g., information services, newspapers, etc.) The Board's initial
filing procedures, of necessity, will be flexible and may allow for
many means of information submission (e.g., paper and electronic). Once
the Board gains experience with such submissions, it will seek to
modify its procedures to make searches easier and data collection and
storage more cost-effective.
Finally, the Board understands that a number of dealers have
offered voluntarily to submit additional information on contributions
to a repository for public access and dissemination. So too, certain
non-dealer municipal market participants also may wish voluntarily to
provide a central repository with contribution information. The
proposed rule notes that the Board will accept additional information
related to contributions voluntarily submitted by dealers or others as
long as such information is submitted in accordance with Board filing
procedures. The Board is considering whether it may have to charge a
filing fee to cover expenses associated with certain of this
voluntarily submitted information. It is also reviewing what kinds of
access fees to the forms filed, if any, would be appropriate.
Dealer Compliance Procedures
Pursuant to rule G-27, on supervision, each dealer must adopt,
maintain and enforce written supervisory procedures reasonably designed
to ensure compliance with Board rules. In regard to the proposed rule
change, effective compliance procedures are essential because the
proposed rule would require dealers to have information regarding each
contribution made by the dealer, dealer-controlled PACs and municipal
finance professionals so that it can determine where and with whom it
may or may not engage in municipal securities business. In addition, it
must have information on executive officer and political party
contributions and consultant hiring practices for disclosure purposes.
Moreover, because of the ``directly and indirectly'' provision in
section (d) of the proposed rule change, as well as the no solicitation
and no bundling provisions in section (c), dealers would have to take
measures to ensure that those persons and entities subject to the
proposed rule are not causing the dealer to be in violation.
Furthermore, the dealer must ensure that other people and entities
hired to assist in municipal securities activities (e.g., consultants)
are not being directed to make contributions that might result in a
violation of the proposed rule change.
Because dealer compliance procedures for the proposed rule change,
of necessity, will be quite extensive, dealers may wish to review the
work of a number of dealers and organizations that are seeking to
develop model compliance procedures in this area. While the Board
cannot specifically approve any such procedures, it believes that
dealers may benefit from these efforts.
In addition, the Board wishes to note that the proposed rule change
sets forth a minimum standard of conduct for dealers involved in
municipal securities business. The Board has sought to target the
proposed rule's requirements to the areas of abuse to which it has been
alerted, while reducing potentially burdensome requirements where
appropriate. Dealers are urged, where possible, to do even more to
sever any possible connection between political contributions and the
awarding of municipal securities business.
(b) The Board believes the proposed rule change is consistent with
Section 15B(b)(2)(C) of the Act which provides that the Board's rules
shall:
* * * be designed to prevent fraudulent and manipulative acts
and practices, to promote just and equitable principles of trade, to
foster cooperation and coordination with persons engaged in
regulating, clearing, settling, processing information with respect
to, and facilitating transactions in municipal securities, to remove
impediments to and perfect the mechanism of a free and open market
in municipal securities, and, in general, to protect investors and
the public interest.
The Board believes that the proposed rule change serves a number of
its enumerated purposes, and, as such, is properly within its authority
under the Act. The proposed rule is designed to prevent fraudulent and
manipulative acts and practices by prohibiting brokers, dealers and
municipal securities dealers from engaging in municipal securities
business with issuers if contributions have been made to officials of
such issuers and by requiring dealers to disclose contributions by
certain persons and entities to issuer officials and political parties
of states and political subdivisions, as well as certain other
information about their municipal securities business activities. The
Board believes that the proposed rule change would have many salutary
effects on the market, including eliminating, or at the very least
diminishing, the opportunity for abuses and the problems associated
with political contributions in connection with the awarding of
municipal securities business, thereby bolstering investor confidence
in the integrity of the market. In addition, the proposed rule change
is designed to promote just and equitable principles of trade by
ensuring that dealers compete for the awarding of municipal securities
business on merit rather than political contributions. Such healthy
competition would remove artificial barriers to those dealers not
willing or able to make such payments, thereby protecting investors and
the public interest by fostering competition and lowering costs
associated with doing municipal securities business.
The Board has adopted the proposed rule change as a first step
toward eliminating the problems associated with political contributions
in connection with the awarding of municipal securities business. It
believes the rule is targeted to the reported major problem areas and
should be an effective deterrent to activities which have called into
question the integrity of the market. Once the proposed rule is put
into place, the Board will closely monitor its effectiveness. If it
determines that compliance problems exist, or if dealers seek to
circumvent the proposed rule's requirements, the Board will not
hesitate to amend the proposed rule to make its prohibitions applicable
to a broader range of entities and individuals or to include other
prohibitions or disclosure requirements. The Board urges the dealer
community to put into place as soon as possible procedures designed to
comply effectively with the proposed rule so that the industry can move
past the allegations of impropriety and back to providing important
financing services, thereby effectively meeting the needs of state and
local governments.
B. Self-Regulatory Organization's Statement on Burden on Competition
The Board does not believe that the proposed rule change will
impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act since the proposed rule change
would apply equally to all brokers, dealers and municipal securities
dealers. In fact, the Board believes that the proposed rule change will
improve competition in the awarding of municipal securities business
because dealers now will compete for such business on the basis of
their abilities, not political contributions.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
The Board has received two sets of comment letters concerning
political contributions. The first set of comments, consisting of 40
letters and one oral comment, was received in response to the Board's
August 1993 draft rule. The second set of comments, consisting of nine
letters, was received in response to the Board's November 11, 1993
press release, regarding changes to the August 1993 draft rule.\9\
These comments are summarized and discussed below.
---------------------------------------------------------------------------
\9\Copies of the August 1993 notice and the Board's November 11,
1993 press release are included in Exhibit 2 to the filing, along
with the comment letters received.
---------------------------------------------------------------------------
Comments Received in Response to August 1993 Draft Rule
As previously noted, the vast majority of commentators supports the
Board's efforts to alleviate the problems associated with political
contributions, and thereby maintain the integrity of the market and
protect investors and the public interest. However, none gave
unqualified support for the draft rule; every commentator suggested
modifications. The commentators include the following:
A.G. Edwards & Sons, Inc.
Altman & Co.
American Bankers Association
Anonymous
Banc One Corporation
Central Bank of the South
Chemical Securities Inc.
Dain Bosworth, Inc.
D.A. Davidson & Co.
Dean Witter, Discover & Co.
Dupree & Company
Fenner, Joseph C.
First Securities Company of Kansas, Inc.
George K. Baum & Company
Goldman Sachs & Co.
Government Finance Officers Association
Grigsby Brandford & Co., Inc.
J.P. Morgan & Co., Inc.
Kane, KcKenna Capital, Inc.
Kidder Peabody (memorandum of oral comment)
Kiel, Frederick O.
Legg Mason Wood Walker, Inc.
Lehman Brothers Inc.
Morgan Stanley & Co., Inc.
National Association of Bond Lawyers
National Association of Independent Public Finance Advisors
National Association of State Treasurers
National League of Cities
NDB Bancorp, Inc.
Norwest Corporation
NYU Graduate School of Public Service
(The) Ohio Company
Protective Group Securities Corporation
Public Securities Association
Seasongood & Mayer
Securities Industry Association
Smith, Moore & Co.
Sonoma Securities
Trustmark National Bank
Wheat, First Securities, Inc.
William R. Hough & Co.
Summary and Discussion of Comments
Existence and Nature of the Problem. The vast majority of
commentators believe that problems exist in the municipal securities
market because of political contributions and that such problems should
be addressed. For example, many dealers commenting on the August 1993
draft rule express concern that the payment of political contributions
to issuer officials is a factor in the awarding of business and
undermines investor confidence in the integrity of the municipal
market.\10\ One dealer believes that ``[e]ven in the best of situations
where no discussion of a business award takes place there is always the
element of duress. Will this administration use my services, however,
beneficial, if I don't contribute?''\11\ And another commentator states
that the ``anti-competitive effects of political contributions are not
only unfair to industry members who do not play the game, but costly to
taxpayers and consumers for whose benefit state and local bonds are
issued.``\12\ The Public Securities Association (``PSA'') states that:
\10\See, e.g., letters from A.G. Edwards; Anonymous; Central
Bank of the South; Dain Bosworth; Dean Witter; Dupree & Company;
George K. Baum; Goldman Sachs; Grigsby Brandford; J.P. Morgan; Kane,
McKenna; Lehman Brothers; Morgan Stanley; and Wheat, First
Securities.
\11\Letter from Dupree & Company.
\12\Letter from Anonymous.
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Based upon our extensive consultation with PSA's membership,
including dealers headquartered in many regions throughout the
country, large national and smaller regional firms, brokers, dealers
and dealer banks, we believe that the vast majority of the dealer
community wants to see the end of political contributions to elected
officials as a factor, actual or apparent, in the selection of
underwriters, the maintenance of business relationships or any other
influence with respect to obtaining securities business from public
entities, including what has come to be called ``pay to play.''
Those active in the municipal finance business for some time have
become increasingly concerned about the escalation of pressure for
contributions from state and local officials and candidates for such
offices over the last decade and a half, continuing to this day. All
are concerned about the potential negative impact of political
contributions on the reputation of the industry, the public's
perception of the integrity of the business and the ability of state
and local issuers on behalf of their tax and rate payers to choose
the most cost-effective means of financing their projects and
programs in the tax-exempt market.\13\
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\13\Letter from PSA.
Other industry associations also believe that a problem exists. For
instance, the Securities Industry Association (``SIA'') ``share[s] the
Board's concern that some negative public perception has been created
by the potential, if not actual, problems associated with political
contributions connected to the awarding of municipal securities
business.'' The American Bankers Association (``ABA'') states that
``the appearance of such improprieties can only serve to undermine
investor confidence in the integrity of the market. Investor confidence
is essential to the continued liquidity and capital raising ability of
the municipal market.'' Similarly, the National Association of State
---------------------------------------------------------------------------
Treasurers (``NAST'') states that:
* * * recent reports of alleged abuses in the municipal
securities market have raised concerns in the investing public, and
the public generally, about the integrity of the public finance
marketplace. Allegations that certain municipal securities
underwriters have utilized campaign contributions to obtain or
retain underwriting business in municipal offerings, if proven,
undermine investor and public confidence in the integrity of market
participants and the overall cost and value of municipal securities.
Moreover, even if unfounded, such allegations create an appearance
of impropriety which may be just as damaging as actual impropriety.
The ABA further believes that the prohibition contained in the
draft rule ``will remove many of the existing barriers to full
participation in the business for those dealers unable or unwilling to
make political contributions to issuer officials. Removing these
artificial constraints will allow more competition * * * which will
result in lower prices which can only benefit investors, issuers and
taxpayers alike.'' Another commentator states that this issue ``is
vitally important to taxpayers and investors alike.''\14\ Other
commentators, however, believe that the problems associated with
political contributions are taxpayer--not investor--problems, and that
this subject is more appropriately regulated at the state and local
levels.\15\ For instance, although NAST acknowledges the deleterious
effects of political contributions on the municipal market, they are
``concerned about the myopic focus and approach of the proposed rule *
* * NAST believes that this subject can be better regulated by the
states.'' The Government Finance Officers Associations (``GFOA'')
states that they:
\14\Letter from Morgan Stanley; see also letter from Anonymous.
\15\See e.g., letters from Government Finance Officers
Association; NABL; National League of Cities; Seasongood & Mayer;
D.A. Davidson; NYU; and First Securities Company.
---------------------------------------------------------------------------
* * * do not share the view that the improper use of political
contributions is an investor protection problem * * * [that]
justifies a radical regulatory response * * *. It is the taxpayers
of a jurisdiction who are potentially harmed by improper practices
and it is the taxpayers, and not the SEC or the MSRB, who should
take action * * *. It is our view that political contributions are
best regulated at the state and local levels of government. We
believe that state and local laws governing political contributions
to elected officials are generally adequate. However, we recognize
that this regulatory system is not perfect and, in light of recent
allegations, we have generally supported the MSRB's attempt to
improve that system. Overall, we think the MSRB's suggested approach
is better than the other alternatives * * *.
The National League of Cities (``NLC'') similarly believes that
this is an issue of taxpayer concern and that state and local laws
``are generally adequate.'' The National Association of Bond Lawyers
(``NABL'') likewise, does not believe that problems associated with
political contributions are harmful to investors. Furthermore, NABL
believes that ``the publicity surrounding recent allegations of scandal
cannot be said to have materially impaired investor confidence to date.
Most states already require disclosure of political campaign
contributions, and such disclosure often results in local publicity
that informs local taxpayers and voters of the actions of their elected
officials. If such actions are viewed as improper by the voters, they
have the opportunity to remove the official at the next election.''\16\
However, NABL acknowledges that ``the MSRB's authority under Section
15B of the Securities Exchange Act of 1934 * * * is broad enough to
include the Rule * * *. Because it is a self-regulatory organization of
dealers, the MSRB is the appropriate body to determine `just and
equitable principles of trade' among municipal securities dealers.''
---------------------------------------------------------------------------
\16\See also letters from Seasongood & Mayer; D.A. Davidson &
Co.
---------------------------------------------------------------------------
Board Response. The Board believes that the problems, both actual
and potential, associated with political contributions are significant
problems that are adversely impacting investors as well as the
municipal market in general. As discussed above, the Board believes
that the proposed rule change is properly within its authority under
the Act. Nonetheless, some commentators erroneously believe that the
Board is attempting to regulate state and local campaign finance laws.
For example, NAST assumes that rule G-37 is aimed at ``preventing the
danger of corruption in the electoral process.'' However, the proposed
rule is not aimed at the electoral process, but rather at problems in
the municipal market, including the practice commonly known as ``pay to
play,'' which compels some dealers to make contributions not only to
gain business but also merely to be under consideration for the
awarding of business. The proposed rule would not prohibit dealers from
making contributions to issuers; rather, it would prohibit them from
engaging in municipal business with issuers under certain circumstances
and for a limited time.
The National League of Cities is ``concerned that hasty efforts to
devise and impose new requirements are raising doubt in the minds of
investors about the credibility and viability of the municipal
market.'' The Board believes that while such doubt may indeed exit, it
is in reaction to news reports of scandals and dubious market practices
involving political contributions and allegations of influence
peddling. The proposed rule change is a measured response to these
concerns and is intended, among other things, to bolster investor
confidence in the integrity of the market by eliminating the
opportunity for abuses in connection with the awarding of municipal
securities business.
Constitutional Concerns
First Amendment and Privacy Rights. As noted above, virtually all
commentators support the Board's goals in addressing the problems
associated with political contributions. Notwithstanding such support,
the commentators voiced constitutional concerns with The August 1993
draft rule. NAST states that:
Draft Rule G-37, like other rules of the MSRB, is promulgated
under the authority of section 15B(b)(2) of the Securities Exchange
Act of 1934. * * * and is enforced by the * * * NASD * * * the Act.
Thus, Draft Rule G-37 is a governmental regulation for the purpose
of First Amendment analysis. As such, to the extent that Draft Rule
G-37 imposes a burden on the exercise of political speech, including
any limitation on the use of funds to support a political candidate,
the draft rule must be narrowly tailored to serve a compelling
governmental interest. Even if the regulatory measure simply creates
a disincentive for the exercise of political speech, the measure
must be narrowly tailored * * *.
While NAST believes that the prohibition on certain contributions,
as set forth in the draft rule, ``can probably be justified by the
governmental interest in preventing the danger of corruption in the
electoral process * * *'' it argues that the rule is not narrowly
tailored. NAST is concerned that the rule will compel a dealer to
intrude on the protected political speech of its employees by requiring
them to divulge personal political contributions.
Like NAST, a number of other commentators are concerned that draft
rule G-37 will infringe upon employees' privacy rights and will
discourage participation in the political process.\17\ One commentator
states that ``the right to make political contributions has been
afforded the protections of the First Amendment. * * * [and that the
draft rule] would infringe upon our employees' First Amendment rights
of political expression.''\18\ Another commentator states that:
\17\See letters from Dean Witter; Chemical Securities; SIA;
Lehman Brothers; Norwest; and GFOA.
\18\Letter from Lehman Brothers.
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* * * the act of maintaining a record keeping system for
employee political contributions will unfairly interfere with the
exercise of political rights on the part of our employees * * *.
Employees who are active in what might be considered to be unpopular
causes might be discouraged from this activity by the knowledge that
their political contributions would have to be reported to the
company * * *. We are unconvinced that assurances from the company
that we would disregard this information would counteract the
negative effects of the proposed rule.\19\
---------------------------------------------------------------------------
\19\Letter from Dain Bosworth.
This commentator also notes that many of its employees regularly
participate in state and local campaigns, and that many run for office
---------------------------------------------------------------------------
and serve on various board and governing bodies.
All of this participation occurs in jurisdictions which may or
may not happen to be clients from time to time of the public finance
department * * *. We have a strong interest in the government of our
city [where our headquarters are located]. Our future is closely
tied to the success of governmental efforts to promote and maintain
the city and its economic base. Our employees have a long history of
civic activity in the [city], and we are proud of it * * *. We have
similar, if less extensive, relationships with every town, county or
state in which we have offices or in which our employees live.\20\
---------------------------------------------------------------------------
\20\Id.
Another commentator notes that it is a regional firm and that the
firm and its employees, ``have very strong local ties and have
historically supported candidates based on their positions on issues
which often have a direct effect on the firm and the community at
large. These issues may include tax policy, banking regulation, labor
laws and economic development policy to name a few.''\21\ Other
commentators also believe that firms```should have the right to be
involved in the political process when issues impact our business in
general or good government issues are in front of us. We should be free
to support candidates who address our concerns as a firm and also the
private concerns of our employee.''\22\ In this regard, one commentator
believes that the rule's ``chilling effect'' on individual
contributions would be removed if it contained an exemption for
individual contributions to candidates for office in the political
jurisdiction where the contribution lives.\23\
---------------------------------------------------------------------------
\21\Letter from Wheat First; see also letter from Public
Securities Association.
\22\Letter from The Ohio Company; see also letters from SIA;
PSA.
\23\Letter from Norwest Corporation.
---------------------------------------------------------------------------
A number of commentators are concerned that, in view of the
relevant privacy considerations, the draft rule will impose serious
compliance burdens on dealers, especially when employees are unwilling
to provide the necessary information to the dealer. One commentator
notes that:
* * * it is difficult to envision how municipal securities
dealers could lawfully compel employees to disclose, document and
obtain employer approval before they or their family members could
make political contributions, all of which would be necessary for
dealers to comply with the rule * * *. It is * * * unclear whether
dealers would be able to use an employee's failure to respond to
such inquiries fully as a lawful justification for terminating their
employment or imposing other sanctions. Without the ability to
impose sanctions, the reliability of the information-gathering
process is questionable.\24\
---------------------------------------------------------------------------
\24\Letter from Lehman Brothers.
Another commentator states that ``some of the firm's employees may
choose not to provide * * * information regarding their personal
political contributions, viewing this as a private matter that
transcends their employment relationship.''\25\ One dealer points out
that, while the rule would not apply to clerical and ministerial
employees, dealers could not comply with the rule ``without either
requiring a list of all contributions from clerical and ministerial
employees (contrary to the stated intent of the regulation) or by
prohibiting contributions by such employees.''\26\
---------------------------------------------------------------------------
\25\Letter from Dean Witter; see also letter from SIA.
\26\Letter from Dain Bosworth.
---------------------------------------------------------------------------
Finally, some commentators argue against extending the rule's
application to contributions made by family members. One commentator
``do[es] not believe that it is appropriate to regulate or investigate
the political activities of spouses or other family members of our
employees.* * * [T]here should be an explicit statement that political
contributions of family members are not the subject of this regulation,
and that the only activity which must be reported is an action by a
covered employee to direct a family member to make a prohibited
political contribution on their behalf.''\27\ Other commentators also
believe that the draft rule should contain a section to prohibit
covered parties from soliciting others to contribute.\28\
---------------------------------------------------------------------------
\27\Letter from Dain Bosworth; see also letter from SIA.
\28\See, e.g., letters from Dean Witter; Goldman Sachs.
---------------------------------------------------------------------------
Equal Protection. In addition to their First Amendment and state
sovereignty concerns, NAST believes that the draft rule would run afoul
of the Equal Protection Clause by regulating dealers but not other
market participants. NAST argues that these other market participants,
such as bond counsel, underwriter's counsel and independent financial
advisors, ``have an incentive and opportunity comparable to that of
dealers to engage in the unethical, uncompetitive and destructive
behavior regulated by Draft Rule G-37.'' Hence, the dealer
``classification is ultimately deficient * * * as it is underinclusive
(i.e., it impinges on the political speech of dealers and not others
who are comparably situated).'' NAST also argues that ``Draft Rule G-37
is, in fact, an attempt, however well-intentioned, to implement federal
regulation of state and local political speech and the regulation of
state and local elections in the guise of national economic
legislation. As such, it has serious constitutional deficiencies * *
*.''
Board Response. The proposed rule change would not prohibit a
dealer from making contributions to issuer officials, but rather would
prohibit a dealer, in certain situations and for a limited time, from
engaging in municipal securities business with a particular issuer if
certain contributions are made. In addition, it would require dealers
to record and disclose certain information regarding political
contributions made as well as municipal securities business engaged in
with issuers. In response to the constitutional concerns discussed
above, the Board notes that constitutional constraints and review apply
to actions by governmental actors. The Board is not a governmental
actor; it is not the federal government, and, unlike the Commission, it
is not an agency of the federal government. Thus, Board rules are not
subject to constitutional constraints or review.
In response to commentators' concerns that the draft rule would
discourage individuals from participating in the political process, the
Board has included in the proposed rule change a $250 de minimis
exemption, per election, for contributions by municipal finance
professionals to each issuer official for whom such individuals are
entitled to vote. Such contributions would not trigger the rule's
prohibition on engaging in business. The Board believes that this
exemption should adequately address the commentators' concerns in this
area. The proposed rule does not, however, provide a similar exemption
for contributions by dealers or dealer-controlled PACs. While the Board
is sensitive to commentators' concerns that the August 1993 draft rule
would have discouraged or inhibited individual participation in issues
which directly impact them and the community in which they live, it did
not find this argument as compelling when applied to dealers and
dealer-controlled PACs especially in light of the current municipal
business environment and its attendant problems. The Board is committed
to eradicating such problems, and does not believe that providing a de
minimis exemption for dealers and their PACs would further this
objective.
In response to concerns about the scope of the Board's proposed
rule, as discussed more fully below, the rule would apply only to
dealers, dealer-controlled PACs, municipal finance professionals, and
executive officers. The Board believes that narrowing the scope of the
rule in this regard will ensure that ``pay to play'' practices in the
municipal market will be halted without impacting every employee of the
dealer or his family members.
Comments on Specific Sections of August 1993 Draft Rule
(A) Prohibition Section
The rule will effectively ban all contributions.
The GFOA states that it is:
not able to provide unqualified support for the * * * [prohibition
section. They] believe that the rule is so broad it may effectively
ban contributions. * * * While [they] support banning those
contributions that are solely for the purpose of retaining or
obtaining business, the rule as proposed is more far-reaching and
may invite legal challenge from market participants or others who
have a legitimate interest in the political process, but who could
be prohibited under the rule from exercising their Constitutional
right to participate in that process. * * * [A]n effective ban * * *
is not warranted.
Other commentators also believe that the August 1993 draft rule
would have effectively banned all contributions and that such a result
is not desirable.\29\ However, the PSA believes that:
---------------------------------------------------------------------------
\29\See e.g., letters from George K. Baum; Lehman Brothers;
National League of Cities; NAST.
Many dealers have come to the conclusion, often reluctantly,
that an absolute ban on political contributions to state and local
officials who may affect public finance business decisions should be
imposed * * *. The principal advantage of an absolute ban would be
the removal of discretion which could lead to different
interpretations among competing firms, as well as a removal of the
need for internal procedures for making exceptions. Another
advantage is the speed with which such a program could be
implemented. Finally, any suggestion of an appearance of conflict of
---------------------------------------------------------------------------
interest would be removed.
Other commentators also favor a complete ban on all
contributions.\30\ One commentator states that the draft rule ``should
prohibit muni securities dealers from making political contributions to
issuers for any reason whatsoever. * * * It's about time that we put
ethics before commercial gain.'' [Emphasis included.]\31\ Another
commentator suggests that the Board ban all political contributions by
municipal department members, high ranking officers and PACs, including
the families of municipal department members and high ranking
officers.\32\ This commentator further suggests that the Board
``prohibit any individual covered by the ban from soliciting
contributions from any other employee of the firm or from third
parties.''\33\
---------------------------------------------------------------------------
\30\See e.g., letters from Dupree & Company; Goldman Sachs; Dain
Bosworth.
\31\Letter from Sonoma Securities.
\32\Letter from Goldman Sachs.
\33\Id.
---------------------------------------------------------------------------
The ``intent'' element of the rule will create compliance and
enforcement problems, as well as competitive problems.
In addition to the difficulty noted earlier concerning employee
compliance with the August 1993 draft rule, many commentators believe
that the ``intent'' element of the rule would have created serious
problems relating to dealer compliance. One commentator believes that
determining whether a violation of the rule occurred would require a
determination of intent, which would be difficult for enforcement
authorities to ascertain.\34\ Hence, the commentator does not believe
that the draft rule should be modeled after the Foreign Corrupt
Practices Act, which is based on intent. The commentator believes
``that the attempt by the MSRB to directly and so literally model the
Draft rule after the [FCPA] has resulted in difficulties that may cause
confusion and hamper enforcement.''\35\ Another commentator believes
that ``it is extremely impractical if not actually impossible to prove
such intent. * * * ''\36\ The PSA notes that many dealers are concerned
that the intent element gives dealers the discretion to determine
whether or not their contributions were made for the purpose of
obtaining or retaining business. Such discretion could lead to
different interpretations among competing firms. Another commentator
echoes this concern, noting that ``dealer firms might face internal
confusion in defining and implementing control procedures * * * [and
will be concerned] that their activity in this regard will be
significantly different than their competition which could result in a
competitive disadvantage.''\37\ Another commentator states that the
rule ``would likely foster unfair competition and a non-level playing
field. To the extent that political contributions might influence the
awarding of business * * * any firm that could justify contributions on
some basis other than obtaining or retaining business would have an
advantage over others.''\38\ However, this commentator also states that
``[i]t is the fact of making a contribution in conjunction with a
business interest, rather than the intention of the contributor, that
creates an appearance of impropriety.''\39\ NABL believes that
``[r]egulations that are subject to interpretive disputes over
subjective standards, such as the intent of an underwriter when making
a contribution, should be avoided.''
---------------------------------------------------------------------------
\34\Id.
\35\Id.
\36\Letter from National Association of Independent Public
Finance Advisors; see also letter from George K. Baum.
\37\Letter from Goldman Sachs.
\38\Letter from JP Morgan. See also letter from Grigsby
Brandford.
\39\Letter from JP Morgan.
---------------------------------------------------------------------------
The rule should provide a good faith defense for dealers for
certain violations by their employees.
A number of commentators are concerned that the intent element of
the August 1993 draft rule imposes a ``strict liability'' standard on
dealers. For example, a dealer would be in violation of the rule ``if
one of its employees * * * [made a] contribution without obtaining the
dealer's approval, successfully concealed a corrupt intent, or used a
friend or consultant to make a contribution that had been rejected by
the firm.''\40\ One dealer notes that:
---------------------------------------------------------------------------
\40\Letter from Lehman Brothers.
As presently drafted, dealers are subject to a strict liability
standard for any and all violations by the firms, as well as their
employees, who may decline to disclose the required information
pertaining to personal political contributions. Proposed rule G-37
also imposes strict liability on dealers for violations by any of
its ``associated persons,'' no matter how attenuated the associated
person's relationship to the firm, nor how commendable the firm's
good faith efforts to comply with its record-keeping and reporting
obligations. * * * [A] good faith defense would balance the
interests of the investing public with legitimate privacy concerns
and constitutional protections expected by employees.\41\
---------------------------------------------------------------------------
\41\Letter from Dean Witter; see also letter from George K.
Baum.
The SIA believes that a dealer's liability for violations by its
associated persons `` should be based on the reasonableness of their
supervision of their employees.''\42\ And NABL believes ``that if a
dealer establishes effective internal procedures for approval and
reporting of political contributions by employees, the dealer should be
saved from responsibility for the unauthorized act of its employees,
much like the controlling and controlled person concepts under Sections
15(f) and 20 of the 1934 Act.''
---------------------------------------------------------------------------
\42\See also letter from Wheat First.
---------------------------------------------------------------------------
The draft rule inappropriately imposes a ``burden of proof'' on
dealers.
Many commentators believe that the draft rule inappropriately
imposes a ``burden of proof'' on dealers to overcome a presumption that
their contributions were made with an impermissible intent, i.e., to
obtain, retain or otherwise influence the awarding of municipal
securities business. These commentators argue that such a burden should
be on the party challenging the legitimacy of the contribution (i.e.,
the NASD, SEC or other inspection/enforcement agency).\43\
---------------------------------------------------------------------------
\43\See e.g., letters from SIA; PSA; Wheat First NAST; George K.
Baum; Dain Bosworth; Lehman Brothers; Morgan Stanley; JP Morgan;
D.A. Davidson; Smith Moore; and Protective Group.
---------------------------------------------------------------------------
The Board should provide clear guidelines regarding permissible/
impermissible contributions.
Many commentators believe that compliance with, and enforcement of,
draft rule G-37 would be substantially improved if the Board provided
guidelines regarding permissible and impermissible contributions.\44\
One dealer notes that the Board ``provides no guidance as to what it
considers legitimate political activity. ``\45\ Another dealer states
that:
---------------------------------------------------------------------------
\44\See e.g., letters from NABL; The Ohio Company; SIA; Dain
Bosworth; George K. Baum; JP Morgan; Lehman Brothers.
\45\Letter from Dain Bosworth.
---------------------------------------------------------------------------
[w]ithout objective criteria to define what is prohibited, all
political contributions by municipal securities dealers and their
associated persons would be suspect. As a result, even those
contributions that were innocent and permissible under the rule
could subject municipal securities dealers and associated persons to
time-consuming and expensive harassment in the form of complaints to
regulators by suspicious competitors.\46\
---------------------------------------------------------------------------
\46\Letter from JP Morgan.
---------------------------------------------------------------------------
The SIA states that the rule ``lacks any requisite intent standards
for violations of its reporting provisions * * *. Consequently, dealers
would be subject to strict liability for violations * * *.'' And NABL
expresses its hope ``that any final Rule be sufficiently clear to serve
as a guide to dealers for developing internal procedures * * *.''
The rule should provide a de minimis exemption for contributions.
The SIA recommends that the rule contain a `'safe harbor'' from the
prohibition section which would provide that any contribution under,
for example, $200 per year per candidate would not violate the rule,
``unless otherwise proven.''\47\ The GFOA recommends that ``consistent
with MSRB rule G-20, certain exceptions should be identified that would
permit participation in the political process that do not threaten the
impartial or objective performance of an elected public official's
duties.''\48\ Other commentators similarly believe that the Board
should adopt a safe harbor for ``contributions which are sufficiently
small in size * * * that they pose little or no risk of undo [sic]
influence.''\49\ Some commentators recommend that municipal securities
dealers, their officers and employees be prohibited from soliciting
contributions from other officers and employees (who would not be
subject to the rule) in order to prevent evasion of established
limits.\50\
---------------------------------------------------------------------------
\47\See also letters from The Ohio Company; Kane McKenna; George
K. Baum.
\48\See also letters from Legg Mason; William R. Hough; and
Grigsby Brandford.
\49\Letter from NBD Bancorp. See also letter from JP Morgan.
\50\Letter from JP Morgan; See also letters from Frederick O.
Kiel; Smith, Moore & Co.
---------------------------------------------------------------------------
Board Response. As noted above, many commentators were concerned
that the ``intent'' element of the August 1993 draft rule would have
created a number of serious problems due to its subjective nature. The
Board was persuaded by the commentators' arguments that, in addition to
compliance and enforcement problems, the subjective nature of the draft
rule would have resulted in differing interpretations among dealers,
thereby providing a competitive advantage for some dealers and a
competitive disadvantage for others. In response to this and other
concerns, the Board determined to eliminate the intent element and
replace it with an objective standard by which dealers can judge their
compliance with the rule. Instead of proposing a prohibition on making
contributions, the Board has proposed a prohibition on engaging in
municipal business with issuers under certain circumstances and for a
limited time. Accordingly, dealers would be prohibited, for two years,
from engaging in municipal securities business with issuers if the
dealer or any municipal finance professional associated with the
dealer, or any PAC controlled by the dealer or any municipal finance
professional, made a contribution to an official of an issuer. The
Board believes that the proposed rule change provides objective
criteria by which dealers can determine permissible from impermissible
conduct, which should simplify compliance with, and enforcement of, the
proposed rule. The proposed rule also should eliminate concerns over
unfair competition, since all dealers will judge themselves, and be
judged, according to the same standard.
Furthermore, because the proposed rule is not intended as a ban, or
an effective ban, on making contributions, the Board believes that it
adequately addresses and should alleviate commentators' concerns that
the draft rule would have operated as an effective ban. Such concerns
were due in large part, if not completely, to the subjective nature of
the intent element and its accompanying interpretive problems. By
eliminating this element, the Board has obviated such concerns.
Likewise, the proposed rule change should allay concerns regarding
``burden of proof.''
A number of commentators were concerned that the August 1993 draft
rule would have imposed a ``strict liability'' standard on dealers,
such that the dealer would have been in violation of the draft rule for
any and all violations notwithstanding good-faith efforts to comply
with the rule. These commentators suggested that the rule include a
good-faith defense. The Board carefully considered this suggestion, but
determined not to adopt such a provision. As with all Board rules, the
relevant enforcement agencies are authorized to determine whether a
rule violation has occurred and what action should be taken as a result
of any such violation. The proposed amendments to rules G-8 and G-9, on
recordkeeping and retention, are designed to assist the enforcement
agencies (as well as dealers) in their efforts relating to compliance
with rule G-37, as well as rules G-8 and G-9, and rule G-27 on
supervision.
As discussed above, in response to commentators' concerns about an
individual's ability to participate in the political process, the Board
determined to provide a $250 de minimis exemption, per election, for
contributions by municipal finance professionals to each issuer
official for whom such individuals are entitled to vote.
(B) Recordkeeping & Disclosure Section
The rule will impose undue recordkeeping burdens on dealers.
The ABA ``fully supports the concept of public disclosure but would
urge the MSRB to consider other disclosure alternatives less burdensome
than those proposed.'' Specifically, the ABA is concerned about putting
additional burdens on banks which already ``are suffocating under
costly and burdensome regulatory requirements.'' The SIA states that
``[e]ven if fully achievable, compliance with the Rule would be
excessively and unnecessarily burdensome and costly * * *. The amount
of information which the MSRB would amass pursuant to the Rule would be
so overwhelming that the Rule's effectiveness would be limited.'' And
the PSA believes that ``compliance with draft rule G-37 would prove
costly and burdensome.''
The rule should provide a de minimis exemption before the
disclosure/reporting requirement applies.
In order to ameliorate some of the burdens of compliance associated
with the August 1993 draft recordkeeping requirements, a number of
commentators recommend that the draft rule provide a de minimis
exemption.\51\ One commentator states that ``[t]he abuses which the
Board is seeking to curb obviously have taken place in connection with
large contributions, therefore it is unreasonable and inefficient to
ask securities firms to track all contributions.''\52\ Thus, this
commentator recommends that the Board provide a dollar limit on
contributions that would be subject to the recordkeeping and reporting
requirements of rule G-37. This would create a presumption that
contributions at some level are not in violation of the draft rule.
Another commentator also recommends the adoption of reporting
thresholds, noting that ``[t]his would permit employees of a broker/
dealer to participate in the political process through contributions *
* * in amounts that, in our view, should not be deemed to influence the
recipient.''\53\ One commentator believes that such thresholds ``would
alleviate greatly the burden imposed by the disclosure and
recordkeeping requirements of the draft rule. Of course, such a de
minimis exception should apply only to the disclosure requirements, not
to the ban on improper contributions, and firms should be expressly
forbidden from bundling * * * contributions for the purpose of evading
the disclosure requirements.''\54\ The recommendations of those
commentators who favor a limit, in general, fall in the range of $100-
250 per official/candidate per year.\55\ However, some commentators
recommend higher limits.\56\ Some of the proposed limits would apply
only to firm contributions, some only to individual contributions, and
some limits would apply both to firm and individual contributions.
---------------------------------------------------------------------------
\51\See e.g. letters from Dean Witter; Chemical Securities.
\52\Letter from George K. Baum.
\53\Letter from Norwest Corporation.
\54\Letter from Morgan Stanley. See also letters from Dean
Witter; A.G. Edwards.
\55\See e.g., letters from PSA; Dean Witter; Dain Bosworth;
Norwest Corporation; Chemical Securities; Kiel; A.G. Edwards.
\56\See, e.g., Grigsby Brandford; D.A. Davidson; George K. Baum.
---------------------------------------------------------------------------
The rule should require dealers to disclose all contributions on a
periodic basis; such reporting should not be tied to the awarding of
business.
One dealer recommends that the Board not key the August 1993 draft
rule's disclosure requirements to the awarding of municipal
business.\57\ Instead, this commentator recommends ``full, periodic and
open disclosure of all political contributions from dealers and
associated persons to all state, local and special district officials
and candidates for such offices.''\58\ The commentator also suggests
that quarterly reporting to the Board's MSIL system would be
appropriate. Another dealer states that, while it supports the
disclosure requirements, ``the method and type of disclosure called for
by the draft rule is not an optimal means of accomplishing the MSRB's
objectives. * * * [B]rokers and dealers [should] periodically provide
the MSRB with a chronological list of all municipal securities business
it has performed in each state, along with a chronological list of all
contributions made in that state * * *. Such ongoing disclosure will be
more effective in deterring improper political contributions.''\59\
Another commentator is similarly concerned about linking the disclosure
requirement to the award of business since this ``is unnecessarily
burdensome and creates significant potential for inadvertent
violations. Alternatively, we suggest that periodic reporting of all
political contributions by dealers and/or their associated persons
could achieve the same purpose while substantially mitigating the
compliance burden.''\60\
---------------------------------------------------------------------------
\57\Letter from Goldman Sachs.
\58\Id.
\59\Letter from Morgan Stanley.
\60\Letter from NBD Bancorp. See also letters from National
Association of Independent Public Finance Advisors; NYU; Chemical
Securities; Dain Bosworth; Morgan Stanley; William R. Hough; and
A.G. Edwards.
---------------------------------------------------------------------------
The disclosure obligation should be on the recipient rather than
the donor.
Some commentators believe that the disclosure obligation concerning
political contributions should be imposed on the recipient rather than
the donor of such contributions.\61\ The PSA states that ``the most
comprehensive and appropriate source of information about political
contributions is the recipient who solicited the contribution, not the
donor.'' Wheat First favors a rule which requires disclosure by both
the issuer and dealer. Norwest ``urge[s] the Board to withdraw this
proposal and urge state and local governments to adopt recipient
disclosure.''
---------------------------------------------------------------------------
\61\See e.g., letters from Norwest Corporation; Legg Mason; The
Ohio Company.
---------------------------------------------------------------------------
Board Response. While the Board is sensitive to commentators'
concerns that the recordkeeping and disclosure requirements would
impose a burden on dealers, it believes that any such burden is
necessary and appropriate in furtherance of the purposes of the Board's
mandate to, among other things, protect investors and the public
interest, and remove impediments to and perfect a free and open market
in municipal securities. Moreover, the Board believes that the proposed
rule change represents a measured response to the problems noted. The
Board has attempted to minimize any burden by:
--requiring disclosure on a periodic basis (i.e., quarterly) rather
than linking it to the award of business;
--making the recordkeeping and disclosure requirements applicable
only to: (i) contributions made, directly and indirectly, by dealers
and any PAC controlled by the dealer (or a municipal finance
professional) to officials of an issuer and to political parties;
and (ii) contributions over the de minimis exemption made, directly
and indirectly, by municipal finance professionals and executive
officers to officials of an issuer and to political parties.
The Board determined to add a recordkeeping/disclosure requirement
for contributions by executive officers to issuer officials, and a
recordkeeping/disclosure requirement for contributions by dealers,
dealer-controlled PSACs, and municipal finance professionals and
executive officers to political parties, but not to include such
contributions as triggering events for the prohibition on business.
These requirements will permit enforcement agencies, as well as the
public, to examine the nature of such contributions. The information
disclosed to the public will consist of summary information and will
not include the names or titles of individual contributors. In
addition, the rule's proscriptions on indirect violations, soliciting
and bundling are intended to prohibit covered parties from
circumventing the rule by using any other person or means, including
executive officers and political parties, as conduits. For instance, a
dealer may violate the rule, as well as trigger the prohibition on
business, by making a contribution to a political party when the dealer
knows that a contribution will be provided by the political party to a
specific issuer official with which the dealer engages or is seeking to
engage in business. Similarly, a dealer may violate the rule and
trigger its prohibition by using an executive officer as a conduit for
making contributions. Thus, dealers should ensure that their
supervisory procedures, pursuant to rule G-27, adequately guard against
such violations. The Board believes that the rule's prohibitions, in
conjunction with the recordkeeping/disclosure requirements, should
adequately protect against abuses in connection with contributions to
political parties. However, the Board will not hesitate to impose more
stringent requirements in this area if it becomes aware of significant
abuses.
(C) Definitions
The Board should narrow the definition of ``associated person''.
Many commentators are concerned that the definition of ``associated
person'' in draft rule G-37 is too broad and that it should be limited
to dealers, their officers and employees who participate in the process
of obtaining or retaining municipal securities business for their
firm.\62\ These commentators are concerned that the scope of the rule
would extend to holding companies, subsidiaries and affiliates of
dealers regardless of their lack of direct or indirect involvement in
the dealer's municipal securities business. One commentator believes
that by narrowing the definition of associated persons, the Board ``can
effectuate its stated purpose of seeking to prohibit only those
political contributions made solely for the purpose of obtaining or
retaining municipal securities business, without imposing on municipal
securities dealers and their other employees unnecessary and unworkable
compliance responsibilities or invading the privacy, or interfering
with the constitutionally protected rights of those employees.''\63\
Another commentator also believes it is unnecessary and overly broad to
impose the prohibition on parents and affiliates of dealers, and
recommends that the scope of the rule be narrowed to cover ``brokers,
dealers, municipal securities dealers, and their registered employees
and immediate family members who reside with them, as well as
contributions made by the dealer's affiliated political action
committee.''\64\ Another commentator notes that it is ``a large
organization with a great number of employees and [is] part of a large
holding company structure * * * and [that] the reporting and
recordkeeping requirements * * * would be an administrative
nightmare.''\65\ This commentator states that the definition is broad
and could be interpreted to apply to people as far removed from the
dealer as the chairman, the chief executive office, and the chief
operating officer of the holding company that owns the dealer. At the
same time, this commentator acknowledges that ``the reports
contemplated by the Draft Rule may be the only, or at the least the
best, way for the relevant enforcement authority to become aware of a
possible violation * * *.''\66\ The PSA notes that a ``meaningful but
narrow definition is particularly important in order to preserve a
`level playing field' for different types of municipal securities
dealers. * * * [T]he limitations and reporting requirements should
apply to municipal finance professionals engaged in the solicitation
and conduct of municipal finance business and their direct supervisors,
up to and including the CEO of the firm.'' And another commentator
believes that a ``firm's municipal finance professionals are an
identifiable group whose activities can be effectively supervised and
monitored for compliance and enforcement purposes. The firm itself, any
employee political action committee and the firm's municipal finance
professionals and their supervisors should constitute the specific
group subject to the Rule.''\67\
---------------------------------------------------------------------------
\62\See, e.g., letters from Dean Witter; Chemical Securities;
Dain Bosworth; Wheat First; George K. Baum; Norwest Corporation.
\63\Letter from Dean Witter.
\64\Letter from Lehman Brothers.
\65\Letter from Chemical Securities. See also letters from SIA;
Dain Bosworth.
\66\Letter from Chemical Securities.
\67\Letter from A.G. Edwards.
---------------------------------------------------------------------------
The SIA states that by applying the ``directly or indirectly''
language of the draft rule, dealers would be required to record and
report contribution information from ``family members, attorneys and
other potential third-party conduits, as well as dealers' and their
affiliated entities' clerical personnel * * *. The amount of
information which the MSRB would amass pursuant to the Rule would be so
overwhelming that the Rule's effectiveness would be limited. If the
Rule is narrowed * * * the MSRB would receive much more usable and
meaningful information.'' NAST also is concerned that this language
``effectively compels a dealer to require employees to report all
personal political contributions to the employer/dealer as well as
contributions made by employees on behalf of the dealer.''
Board Response. In response to commentators' concerns that the
definition of ``associated person'' was too broad and would result in
costly and burdensome compliance with the rule, the Board determined to
limit the prohibition section of the proposed rule to individuals
defined as ``municipal finance professionals.'' This term encompasses
any associated person: (i) Primarily engaged in municipal securities
activities, as defined in rule G-3(a)(i) (including bankers, traders,
institutional salespeople , and retail salespeople);\68\ (ii) who
solicits municipal securities business; (iii) direct supervisors of
such persons up through and including, in the case of a dealer other
than a bank dealer, the Chief Executive Officer or similarly situated
official and, in the case of a bank dealer, the officer or officers
designated by the board of directors of the bank as responsible for the
day-to-day conduct of the bank's municipal securities dealer
activities, as required pursuant to rule G-1(a); and (iv) members of
the dealer's executive or management committee or similarly situated
officials, if any (or, in the case of a bank dealer, similarly situated
officials in the bank's separately identifiable department or division,
as defined in rule G-1). Each person designated by the dealer as a
``municipal finance professional'' shall be deemed as such for purposes
of the proposed rule change.
---------------------------------------------------------------------------
\68\Pursuant to rule G-3(a)(i), such activities include: (i)
Underwriting, trading or sales of municipal securities; (ii)
financial advisory or consultant services for issuers in connection
with the issuance of municipal securities; (iii) research or
investment advice with respect to municipal securities; or (iv) any
other activities which involve communication, directly or
indirectly, with public investors in municipal securities.
---------------------------------------------------------------------------
The definition of municipal finance professional includes any
associated person of the dealer primarily involved in the solicitation
of municipal securities business or bringing to market new issue
municipal securities. This includes those individuals who have an
economic interest in seeing that the dealer is awarded municipal
securities business and thus may be in a position to make political
contributions for the purpose of influencing the awarding of such
business by issuer officials. Such persons would include those in the
public finance department, as well as underwriters, traders and
institutional and retail sales persons primarily engaged in municipal
securities activities. The Board does not, however, intend to include
within the definition of municipal finance professional those persons
who activities do not primarily involve municipal securities, such as
those retail sales persons who primarily sell other products or
associated persons employed in departments other than the municipal
securities department.
It should be noted that contributions by executive officers would
be subject to the recordkeeping and disclosure requirements, but
contributions by such persons would not trigger the rule's prohibition
on business. The Board has defined ``executive officer'' as any
associated person in charge of a principal business unit, division, or
function or any other person who performs similar policymaking
functions for the dealer, but does not include anyone already covered
by the definition of municipal finance professional.\69\
---------------------------------------------------------------------------
\69\This definition was adapted from Section 16 of the Act.
---------------------------------------------------------------------------
The proposed rule would prohibit municipal finance professionals
(as well as dealers) from doing any act, directly or indirectly, which
would be a violation of the proposed rule. This proscription is
intended to prohibit such persons from circumventing the proposed rule
by using any other person or means as conduits, including, but not
limited to, family members, consultants, lawyers, lobbyists, non-
covered associated persons, and political parties. Some commentators
argued against extending the August 1993 draft rule's application to
contributions by family members. The Board determined not to
specifically include family members within the term ``municipal finance
professional,'' since the proscription on indirect violations
contemplates such persons in situations in which their contributions
are directed by municipal finance professionals. Furthermore, the
proposed rule contains a prohibition on soliciting contributions in
connection with the awarding of business. This prohibition is intended
to prohibit dealers and municipal finance professionals from soliciting
others, including family members, to make contributions to issuer
officials in order to influence the awarding of municipal securities
business. Finally, the proposed rule contains a prohibition on
coordinating (i.e., bundling) contributions, which is intended to
prevent dealers and municipal finance professionals from aggregating,
or soliciting others to aggregate, contributions to issuer officials in
order to influence the awarding of municipal securities business.
The effect of the proscription on indirect violations and the anti-
solicitation provision would be to subject a dealer to the rule's
prohibition on business if the dealer or a municipal finance
professional uses other non-covered parties to make or solicit
contributions. The recordkeeping and disclosure requirements would
apply to contributions by dealers, dealer-controlled PACs, municipal
finance professionals, and executive officers, as well as contributions
made by any other person or entity if such contributions were directed
by a dealer, dealer-controlled PAC, or municipal finance professional.
PACs associated with bank dealers should be exempt from the rule.
A few commentators express concern about inclusion of bank PACs in
the draft rule, especially when the dealer is owned by an organization
(i.e., a bank or bank holding company) whose primary focus is outside
the securities business. One commentator notes that ``the draft rule is
based on the assumption that the dealer has the ability to control or
influence the actions of all associated PACs to obtain the favor of
municipal issuers. This assumption is incorrect for PACs established by
large bank holding companies whose major focus is banking and not
securities underwriting and distribution.``\70\ This commentator notes
that another significant concern for dealers owned by bank holding
companies is the acquisition of new subsidiaries by the dealer's
parent. ``The rule is unclear as to what responsibility the dealer has
with respect to contributions made by a subsidiary in the two years
immediately preceding the subsidiary's acquisition. * * * [T]he draft
rule should not apply to PACs in cases where a dealer is owned by an
organization whose primary focus is not investment banking. * * * [We
recommend that the Board] exclude PACs which are not under the direct
control of the dealer and removing the burden of compliance as to the
political contributions that predate acquisition of a subsidiary of a
dealer's parent.''\71\
---------------------------------------------------------------------------
\70\Letter from Banc One. See also from Central Bank of the
South.
\71\Letter from Banc One.
---------------------------------------------------------------------------
One commentator notes that PACs are required by various laws to
report periodically all contributions and other disbursements that they
make. These reports include individual contributions by bank officers
(including associated persons of the dealer department) above de
minimis thresholds.\72\ Thus, this commentator recommends that ``the
reporting scheme set forth in the proposed rule as it applies to PACs
is duplicative and unnecessarily burdensome.''\73\ In addition, the
commentator believes that there is a significant potential for
inadvertent violations of the rule's reporting requirements, since ``a
PAC associated with a diversified financial institution will make a
large number of contributions without knowledge of the potential role
that the recipient may play in the awarding of municipal securities
business * * *. Accordingly, we suggest that PACs be exempted from the
* * * reporting requirements * * *. As an alternative, the Board may
wish to consider requiring associated PACs to file copies of federal
and/or state disbursement reports with [the MSIL system].''\74\
---------------------------------------------------------------------------
\72\Letter From NBD Bancorp.
\73\Id.
\74\Id.
---------------------------------------------------------------------------
Board Response. The August 1993 draft rule would have applied to
``dealer-associated'' PACs, which, for dealers that are departments of
banks or subsidiaries of banks or bank holding companies, would have
included bank PACs. The Board recognizes that, in many instances, such
bank PACs receive contributions from bank employees who have no
connection of the securities business. The Board has, therefore,
attempted to address commentators' concerns over the inclusion of bank
PACs by changing the proposed rule's terminology to ``dealer-
controlled'' PACs. Thus, if a bank PAC is not a ``dealer-controlled''
PAC, then its contributions would not trigger the rule's prohibition on
business.
The definition of ``official of the issuer'' is too broad.
Several commentators are concerned that the definition of
``official of an issuer'' is too broad. The Ohio Company believes that
``[i]t is impossible to ascertain, with total certainty in some cases
or with even an educated guess in others, which elected official of the
issuer is actually in a position to influence the awarding of municipal
securities business.'' NAST asks, ``how is a dealer to know when a non-
issuer official is likely to become an issuer official? Does the draft
rule cover an official who has the power to appoint issuer officials,
but is not an issuer official himself or herself? * * * How does a
dealer meet the supervision and reporting requirements when it is
unclear who is considered to be an official of an issuer?'' Lehman
Brothers notes that ``one may interpret the rule as also applying to
elected officials at the federal level who may be in a position to
influence local officials in their states. * * *'' And NBD Bancorp
states that ``the inclusion of any elected officer who `can influence
the outcome' of the award of business is potentially broad enough to
effectively disenfranchise associated persons of municipal securities
dealers from any political activities with respect to candidates for
local office.'' However, Kane McKenna states that:
contributions are often given to an office holder who, although not
an ``official of the issuer,'' clearly has the ability to informally
influence the issuer. * * * [I]n our experience, it can be one of
the most important methods of contributing to a political campaign
for purposes of business generation.
Board Response. The Board considered the commentators' suggestions
to narrow the definition of ``official of the issuer,'' but determined
that its definition is appropriate. The term includes any incumbent,
candidate or successful candidate for elective office of the issuer,
which office is directly or indirectly responsible for, or can
influence the outcome of, the hiring of a dealer for municipal
securities business. The definition is intended to include any issuer
official, candidate or successful candidate which has influence over
the awarding of municipal securities business so that contributions to
certain state-wide executive or legislative officials, such as
governors, would trigger the proposed rule's prohibition on business.
The Board should clarify the definition of ``contributions''
regarding volunteer work and charitable contributions.
Some commentators note that the definition of ``contribution,''
which includes ``anything of value,'' could have the unintended effect
of regulating an employee's volunteer work on political campaigns
during non-business hours. These commentators ask that the Board
clarify this definition with respect to such volunteer work.\75\ Other
commentators seek further clarification of the definition with respect
to charitable contributions that are solicited by officials of
issuers.\76\ Another commentator suggests that the definition
specifically include ```in kind''' contributions, such as secretarial
help, free rent, etc. * * * Politicians understand the phrase, and
making the prohibition of in-kind contributions explicit would help
protect dealers against the request for such contributions by
politicians.''\77\ An anonymous commentator recommends expanding the
definition of contributions ``to include any financial or economic
benefit bestowed upon or requested by or for any person who is in a
position to select or influence the selection of underwriters,
financial advisors, bond lawyers, etc.'' And NAST is concerned that the
August 1993 draft rule could be interpreted as prohibiting independent
political expenditures.
---------------------------------------------------------------------------
\75\See e.g., letters from PSA; Dain Bosworth; Morgan Stanley;
Lehman Brothers; Fenner; anonymous; Kane McKenna.
\76\See letters from PSA; Morgan Stanley.
\77\Letter from Fenner.
---------------------------------------------------------------------------
Board Response. The Board does not seek to regulate personal
volunteer work on political campaigns by municipal finance
professionals. However, if any entity or person subject to the rule
utilizes the dealer's resources (such as a political position paper
drafted by dealer personnel), or incurs expenses in connection with
such activity, then the value of any such resources used or expenses
incurred would come under the proposed rule's requirements. Other types
of payments to issuer officials may be subject to other Board rules,
including rule G-20, on gifts and gratuities. Finally, the Board does
not seek to regulate independent political expenditures.\78\
---------------------------------------------------------------------------
\78\The Federal Election Campaign Act, 2 U.S.C. Section
431(17)(1988), defines an ``independent expenditure'' as: ``an
expenditure by a person expressly advocating the election or defeat
of a clearly identified candidate which is made without cooperation
or consultation with any candidate, or any authorized committee or
agent of such candidate, and which is not made in concert with, or
at the request or suggestion of, any candidate, or any authorized
committee or agent of such candidate.''
---------------------------------------------------------------------------
Other Comments and Suggestions
A number of commentators are concerned that the draft rule creates
an opportunity for abuse by not addressing the practice of hiring
consultants or other third parties to solicit business on behalf of
dealers. The GFOA states that if ```politics' is to be taken out of the
underwriter selection process, this practice must be reviewed.'' One
dealer describes this practice as ``arguably the most serious area in
need of regulation with respect to political interference in the
selection of municipal finance professionals * * *. These relationships
and lobbying efforts take a variety of forms.''\79\ And some
commentators are concerned that brokers and dealers will find more
creative ways of influencing officials, such as:
---------------------------------------------------------------------------
\79\Letter from William R. Hough.
[retaining] consultants who in turn regularly make large political
contributions so that the consultants are in a position to influence
the selection of an underwriter or financial advisor by an issuer.
Firms may also make donations to charitable organizations at the
request of governmental officials. Contributions to political
parties and organizations, rather than directly to candidates, may
also increase. * * * [Our] principal concern with the proposed rule
is that as drafted it will result in a continuation of ``pay to
play'' practices by some firms who will act in a more circuitous
fashion.\80\
---------------------------------------------------------------------------
\80\Letter from Morgan Stanley; see also letter from Kane
McKenna.
One commentator believes that the draft rule ``is not a
comprehensive solution to the problems relating to the selection of
underwriters and financial advisors.''\81\ This commentator suggests
that, in addition to banning improper contributions by brokers and
dealers, the Board should specifically prohibit such contributions by
consultants, lawyers and other persons who seek municipal securities
business on behalf of brokers and dealers. Furthermore, ``brokers and
dealers should be required to disclose all consulting, lobbying and
third party contracts relating to obtaining or retaining municipal
securities business, whether or not those contracts involve political
contributions. This disclosure requirement in and of itself is likely
to act as a prophylactic measure that will discourage firms from asking
third parties to engage in such efforts on their behalf.''\82\ Another
commentator recommends prohibiting any individual covered by the rule
from soliciting contributions from any other employee or from third
parties.\83\ Another commentator is concerned that the draft rule does
not address contributions by an associated person who may have a
financial interest or gain income from an independent financial
advisory or consulting firm, and that such an associated person may be
able to circumvent the rule by funneling contributions through these
firms.\84\ Thus, the commentator suggests that the Board require any
associated person with a pecuniary interest in an independent firm to
also report that firm's contributions. And the PSA ``urges the MSRB to
consider prohibiting explicitly certain practices * * * [such as] the
retention of consultants for the purpose of obtaining business who
concurrently serve as public officials of the state in which
jurisdictions are to be influenced.''
---------------------------------------------------------------------------
\81\Letter from Morgan Stanley.
\82\Id.
\83\Letter from Goldman Sachs. See also letter from Trustmark.
\84\Letter from Trustmark.
---------------------------------------------------------------------------
One commentator is concerned that the draft rule does not apply to
interest rate swaps, and notes that ``[s]uch transactions are becoming
more common, can be very profitable, and are subject to the same
intense competition which exists for municipal securities
offerings.``\85\ This commentator is similarly concerned that the draft
rule would not apply to U.S. Treasury Securities or other similar
securities, regardless of whether such transactions are associated with
a municipal offering.
---------------------------------------------------------------------------
\85\Letter from William R. Hough.
---------------------------------------------------------------------------
Board Response. To reduce the possibility and opportunity for
circumvention of the proposed rule, the Board included language
prohibiting dealers from acting ``directly or indirectly'' through any
other person or means. This proscription was modeled after Section
20(b) of the Act\86\ and is intended to prohibit dealers (as well as
municipal finance professionals) from using, for example, family
members, consultants, attorneys, finders, lobbyists, etc., as conduits.
Again, dealers should ensure that their supervisory procedures,
pursuant to rule G-27, adequately guard against such violations.
---------------------------------------------------------------------------
\86\Supra note 6.
---------------------------------------------------------------------------
In addition to the prohibition on indirect violations, the proposed
rule would require dealers to record and disclose a list of all
parties, including consultants, hired to obtain or retain municipal
securities business, as well as the compensation arrangements with such
parties. These requirements, in conjunction with the rule's other
recordkeeping/disclosure requirements, will permit the enforcement
agencies, as well as the public, to examine whether the hiring of such
parties involves any impropriety in connection with business awarded to
the dealer based on political contributions. As noted previously,
information disclosed to the public would be in summary form.
Finally, by requiring the recording and disclosure of all political
contributions, the proposed rule should assist enforcement agencies in
determining whether such contributions influence the awarding of other
business from issuers to dealers, such as interest rate swaps or
reinvestment of bond proceeds.
The rule should apply to all market participants.
A number of commentators believe that a rule concerning political
contributions should apply to all municipal market participants.\87\
The commentators recognize the Board's limited authority in this
regard, and believe that the SEC should promulgate rules in this area.
For instance, the PSA ``strongly urge[s] the MSRB to request the
Securities and Exchange Commission * * * to use its existing authority
(and seek legislation if necessary) to effect this result.''\88\ At the
same time, however, PSA believes ``that the dealer community cannot
wait for an ideal solution to the more general problem of financing
political campaigns for elective office, but must rather do something
for itself.'' One commentator is concerned that independent financial
advisors will ``still be able to curry favor with political
contributions. * * * [A]ny individual can name themselves a financial
advisor and employ inappropriate practices * * *. These people are not
licensed and not regulated * * * [and] will now have a competitive
advantage * * *.''\89\ NAST states that bond counsel, underwriter's
counsel and independent financial advisors ``have an incentive and
opportunity comparable to that of dealers to engage in unethical,
anticompetitive and destructive behavior * * *.''
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\87\See e.g., letters from PSA; SIA; Wheat First; The Ohio
Company; George K. Baum; Lehman Brothers; Norwest Corporation;
Morgan Stanley; Altman & Co.
\88\See also letters from Lehman Brothers; The Ohio Company.
\89\Letter from Altman & Co.
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Board Response. The Board has adopted the proposed rule change as a
first step toward eliminating the problems associated with political
contributions in connection with the awarding of municipal securities
business. It believes the rule is targeted to the reported major
problem areas and should be an effective deterrent to activities which
have called into question the integrity of the market. Once the
proposed rule change is put into place, the Board will closely monitor
its effectiveness. If it determines that compliance problems exist, or
if dealers seek to circumvent the proposed rule change's requirements,
the Board will not hesitate to amend the proposed rule change to make
its prohibitions applicable to a broader range of entities and
individuals or to include other prohibitions or disclosure
requirements.
The Board should conduct a cost/benefit analysis before adopting a
rule on political contributions.
The National League of Cities (``NLC'') believes ``that any
proposal to mandate changes in the workings of the municipal market
should only be imposed after the most careful analysis, including a
cost-benefit and risk analysis about the impact of any proposed
changes.'' NLC notes that ``[w]e are unaware of any detailed analysis
of the costs and benefits to investors * * *. Nor have we discovered
any analysis of the impact of these costs on municipal investors.''
Similarly, the GFOA states that the ``reservation we have about this
new system of reporting is the lack of serious analysis to assess the
specific nature or extent of improper practices. As a consequence,
there is no way to determine if the costs of new regulation, which will
inevitably be passed on to state and local government issuers, justify
the benefits to be derived.''
Board Response. The Board has attempted to respond appropriately to
commentators' concerns over regulatory burdens, without sacrificing the
proposed rule's overall effectiveness in eradicating the problems
noted. The Board has submitted the proposed rule change because it
believes that a significant problem exists, that this problem is
adversely impacting investors as well as the integrity of the municipal
market, and that it is incumbent upon the Board to seek to rectify
known problems in the municipal market. Moreover, the Board believes
that the proposed rule change is a measured response to the problems
noted.
The proposed rule change would foster competition for municipal
securities business by removing artificial barriers to dealers who may
have been unwilling or unable to make contributions in order to be
considered for the awarding of business. Dealers will now compete on a
level playing field and be awarded municipal securities business on the
basis of merit, not political contributions. Such competition would
lower market costs and restore investor confidence in the integrity of
the market.
Any reporting of information to the Board should take place on an
annual basis.
Two commentators believe that reporting should be on an annual
(rather than semiannual) basis.\90\
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\90\Letters from Dain Bosworth and Morgan Stanley.
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Board Response. The Board believes that, for information on
political contributions and consultants to be useful in correcting the
problems noted, the disclosure of such information must be timely in
relation to municipal business awarded to dealers. At the same time,
the Board has attempted to reduce the compliance burden on dealers.
Thus, the Board determined to adopt a quarterly disclosure requirement,
and believes that this requirement strikes an appropriate balance of
the competing concerns noted.
Comments Received in Response to November 1993 Press Release
Since its November 1993 meeting, the Board has received nine
additional comment letters on proposed rule G-37, bringing the total
comments received to 49 letters and one oral comment.\91\ The
additional letters were provided by the following: Anonymous (investing
banker), Anonymous (registered principal), The Argentarius Group, Ltd.,
The City of Novato, CA, Griffin, Kubik, Stephens & Thompson, Inc., J.P.
Morgan Securities, Inc., Public Securities Association, Seasongood &
Mayer (two letters).
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\91\The nine additional letters are included in Exhibit 2 to the
filing.
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De Minimis Exemption. One commentator is concerned that the $250 de
minimis exemption will be abused.\92\ This commentator believes that
the municipal industry is plagued by ``a prevalent practice for hiding
contributions'' noting that:
\92\Letter from The Argentarius Group.
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Bankers, salespeople, their spouses, their * * * adult children
as well as clerical and secretarial staff are ``encouraged'' to each
give a certain amount of money to a candidate. The amount is usually
$200 or less, since our [state] laws * * * do not require reporting
contributions of that amount or less. Individual checks are then
presented en masse by a banker for the firm to the candidate.\93\
\93\Id.
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Board Response. As previously described, the Board determined to
provide a $250 de minimis exemption, per election, for contributions by
municipal finance professionals to each issuer official for whom such
individuals are entitled to vote. Such contributions would not trigger
the rule's prohibition on engaging in business. The Board believes that
this exemption is a measured response to concerns over an individual's
ability to participate in the political process, recognizing the
Board's statutory mandate to address known problems in the municipal
market. Furthermore, the Board believes that its prohibitions on
indirect activities, soliciting and bundling contributions, as well as
the various recordkeeping/disclosure requirements will prevent
circumvention of the proposed rule.
Scope of Rule. One commentator is concerned that the rule's scope
is too narrow.\94\ This commentator notes that (in addition to elected
officials) political appointees, employees, and financial advisors act
as decision makers in the underwriter selection process, and that
financial advisors, in particular, have great influence, and usually
complete control, over this process and others. The commentator also
believes that the scope of the rule should extend beyond political
contributions to encompass any monetary or economic benefit conferred
upon the decision maker, noting that financial advisors commonly
structure deals for their own pecuniary benefit, while causing issuers
to bear additional and unnecessary costs and higher interest rates.\95\
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\94\Letter from Anonymous (investment banker).
\95\Id.
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Another commentator also is concerned that the rule will be abused,
and states that the Board should not provide exemptions for any
affiliates, lobbyists, or related parties, and that contributions by
such parties should trigger the rule's prohibition on business.\96\ In
addition, this commentator believes that an issuer official's
``transition costs'' should be addressed by the rule.\97\
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\96\Letter from Seasongood & Mayer.
\97\Id.
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PSA seeks guidance from the Board on a number of issues relating to
political contributions so that it may assist its membership in this
area. PSA poses questions concerning the following:
--Volunteer work and charitable contributions.
--Transition and inaugural expenses.
--Contributions by spouses and other household members.
--The effect of the proposed rule on ``partisan versus non-partisan
associations or PACs of state or local officials.''\98\
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\98\Letter from PSA.
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Board Response. In response to concerns about the scope of the
proposed rule, the Board believes that the narrow scope of the rule
will ensure that ``pay to play'' practices in the municipal market will
be halted without impacting every employee of the dealer or his or her
family members. As discussed, the rule would apply only to dealers,
dealer-controlled PACs, municipal finance professionals, and executive
officers.
In response to concerns regarding the use of consultants and other
parties, the proposed rule would require dealers to record and disclose
a list of all such parties hired to obtain or retain municipal
securities business, as well as the compensation arrangements with such
parties. These requirements, in conjunction with the rule's other
recordkeeping/disclosure requirements, will permit the enforcement
agencies, as well as the public, to examine whether the hiring of such
parties involves any impropriety in connection with business awarded to
the dealer.
In response to PSA's questions, the Board, as discussed above, does
not seek to prohibit or to regulate personal volunteer work by
municipal finance professionals so long as the professional does not
utilize the dealer's resources or incur expenses in connection with
such activity. The Board is in the process of reviewing its rule G-20,
on gifts and gratuities, and will consider, among other things,
contributions to charities in connection with this review. However, the
proposed rule's definition of ``contributions'' would encompass
transition and inaugural expenses. Thus, such payments would be subject
to the proposed rule.
As previously described, the proposed rule would prohibit covered
parties from doing indirectly any act which would constitute a
violation of the rule. This section is intended to prohibit covered
parties from circumventing the proposed rule by using as conduits any
other person or means, including, but no limited to, spouses and other
family members. In addition, the proposed 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.
Finally, it is not clear what organizations the PSA is referring to
as ``partisan versus non-partisan associations or PACs'' and,
accordingly, the Board cannot provide any guidance with respect to this
question.
Ballot Referenda. One commentator expressed concern over a practice
whereby dealers, who are seeking underwriter or financial advisory
positions, are asked to contribute to bond election committees
supporting ballot measures for bonds and tax levies.\99\ The
commentator notes that such requests are made by the election committee
or by public officials who play a role in the underwriter selection
process, and believes ``that this practice undermines the integrity of
our industry. * * * [and] is another example of money influencing the
selection process.''\100\
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\99\Letter from Anonymous (registered principal).
\100\Id.
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Board Response. Contributions to ballot measures, and other
independent expenditures, would not be subject to the proposed rule.
However, contributions to election committees for incumbents and
candidates would be covered by the rule, since the term ``official of
such issuer'' or ``official of an issuer'' means any person who was, at
the time of the contribution, an incumbent, candidate or successful
candidate for elective office of the issuer, including any election
committee for such person, which office is directly or indirectly
responsible for, or can influence the outcome of, the hiring of a
dealer for municipal securities business. In addition, a dealer may
violate the rule's proscription on indirect violations by using any
other person or means as a conduit to contribute to an issuer official.
Dissemination of Information on Political Contributions. One
commentator believes that disclosure of information on political
contributions is ``essential . . . and should be strongly
encouraged.''\101\ The commentator is concerned, however, that there is
no mechanism by which such information will be ``routinely
disseminated,'' and believes that such a mechanism should provide for
continuous, ongoing disclosure.\102\
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\101\Letter from J.P. Morgan.
\102\Id.
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Board Response. In order to ensure equal public access to
information about political contributions and parties hired by dealers
in connection with municipal securities business, the proposed rule
change will require dealers to submit this and other information to the
Board on a quarterly basis. The Board will utilize its existing MSIL
system to accept and disseminate such information, and is in the
process of developing appropriate filing procedures to accomplish such
purposes.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) by order approve such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other those that may
be withheld from the public in accordance with the provisions of 5
U.S.C. Sec. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of the filing will also be
available for inspection and copying at the principal office of the
MSRB. All submissions should refer to the file number in the caption
above and should be submitted by February 11, 1994.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority, 17 CFR 200.30-3(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-1454 Filed 1-19-94; 4:15 pm]
BILLING CODE 8010-01-M
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.