The Board requests comments on draft rule G-37 that would (1) prohibit municipal securities 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) require dealers to disclose, for a four-year period, all political contributions made, directly or indirectly, to officials of issuers with whom they have done business. The Board also requests comments on draft amendments to rules G-8 and G-9, on recordkeeping and record retention, respectively, requiring the recording of information regarding certain political contributions.
The Board believes that the municipal market is a fair and efficient market, and that market participants adhere to high standards of professionalism and integrity in conducting their municipal securities business. Over the last few years, however, the Board has become increasingly concerned about the opportunity for abuses and the perception of problems associated with political contributions in connection with the awarding of municipal securities business. The Board has, therefore, determined that regulatory action is necessary to carry out its statutory mandate to protect investors and the integrity of the market. Accordingly, the Board requests comments on draft rule G-37 concerning political contributions.
The draft rule would: (1) prohibit municipal securities 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) require dealers to disclose, for a four-year period, all political contributions made, directly or indirectly, to officials of issuers with whom they have done business./1/ In addition, the Board requests comments on draft amendments to rules G-8 and G-9, on recordkeeping and record retention, respectively, requiring the recording of information regarding certain political contributions.
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 that, since its August 1991 notice, there has been continuing concern by the Board, industry members and others regarding political contributions. The Board indicated that it would meet with issuer groups to discuss whether measures could be adopted by issuers or state legislatures to help ensure that political contributions do not influence the underwriter selection process. In addition, the Board stated that, during the next few months, it would review its authority and options for rule-making in this area.
Description of Draft Rule G-37
Draft rule G-37 is divided into five sections, and would apply to situations in which political contributions are made to officials of issuers who are responsible for, or can influence the outcome of, the awarding of certain types of of municipal securities business to dealers. "Municipal securities business" is defined in the proposed rule to encompass dealers acting as negotiated underwriters (either as managing underwriter or syndicate member), financial advisors and consultants, placement agents, and negotiated remarketing agents./2/ Paragraph (a) states the general purpose of the rule; paragraph (b) is the prohibition on contributions made for certain purposes; paragraph (c) sets forth the rule's disclosure requirements; paragraph (d) is the definitional section; and paragraph (e) provides for a phase-in of the disclosure requirements of paragraph (c).
General Purpose of the Draft Rule
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 these officials. The Board believes that the appearance of impropriety is as damaging as any actual improprieties that may have transpired. Such appearances can undermine investor confidence in the integrity of the market, which is essential to the long-term health of the market, both in terms of liquidity and capital-raising ability. In addition, just and equitable principles of trade require that dealers compete for the awarding of municipal securities business on merit rather than on political favoritism. Finally, the use of political contributions to obtain business creates artificial barriers to those not willing or able to make such payments, thereby harming investors and the public interest by stifling competition and increasing market costs. Thus, the Board has determined that a regulatory response is necessary to further the Board's statutory goals of, among other things, protecting investors and the public interest, preventing fraud, and promoting just and equitable principles of trade by ensuring that the high standards and integrity of the market are maintained.
Prohibition of Certain Contributions
Paragraph (b) of the draft rule would prohibit dealers, including associated persons/3/ and any political action committees (PACs) associated with such dealers, from, directly or indirectly, making political contributions to issuer officials for the purpose of obtaining or retaining the municipal securities business of such issuer./4/ This prohibition is intended to apply to any contribution that is given:
(i) to retain current business;
(ii) to obtain future business (whether in the near-term or at a later date);
(iii) in anticipation of some form of future business;
(iv) to gain political clout or favoritism which can be used as leverage to secure current or future business
(v) to create a quid pro quo financial arrangement in order to secure current or future business; or
(vi) to gain consideration for the awarding or current or future business, even if such business does not materalize.
The "contributions" contemplated by the draft rule include any gift, subscription, loan, advance, or deposit on money or anything of value made for the purpose of influencing the outcome of any candidacy, nomination, election, or appointment of any person for state or local office./5/ The term "issuer" means the governmental issuer specified in Section 3(a)(29) of the Act and the issuer of any separate security, including a separate security as defined in Rule 3b-5(a) under the Act. "Official of such issuer" or "official of an issuer" means any person who was, at the time of the contribution, an incumbent or announced candidate for any elective office of the issuer (including any election committee for such person) and who is directly or indirectly responsible for, or can influence the outcome of, the awarding of municipal securities business.
The proscription of contributions given "directly or indirectly" by dealers was modeled after Section 20(b) of the Act/6/ and is intended to prohibit dealers from using other persons as conduits in order to circumvent the rule. For example, a dealer would violate the rule by using clerical personnel to make a prohibited contribution./7/ Similarly, a dealer would violate the rule by using family members, attorneys, or others as such conduits. A dealer also would violate the rule by giving a contribution to any person or entity when the dealer knows that the contribution ultimately is intended for an official of an issuer who can influence the awarding of municipal securities business.
The Board does not seek to prohibit dealers and their associated persons from making all political contributions. The Board does seek to prohibit those contributions made in connection with municipal securities business for the purpose of obtaining or retaining any such business. Accordingly, dealers must be prepared to establish that any contributions made are without the intent to obtain, retain or otherwise influence the awarding of municipal securities business. Pursuant to existing Board rule G-27, on supervision, dealers would be required to establish internal procedures to ensure that prohibited contributions are not made.
While the Board determined to propose rule G-37 to deal specifically with contributions made to officials of issuers by dealers with the intent to obtain, retain or otherwise influence the awarding of municipal securities business, the Board believes that general principles of fair dealing also would be applicable in such situations. Thus, the Board believes that, even prior to the approval and effectiveness of draft rule G-37, dealers should ensure that any payments or things of value given to officials of issuers comply with the fair dealing principles embodied in existing Board rule G-17./8/
To facilitate compliance with, and enforcement of, draft rule G-37, the Board also proposes to amend rules G-8 and G-9, concerning recordkeeping requirements and record retention, respectively. As indicated above, certain contributions would be permissible under the draft rule. The amendments to rules G-8 and G-9 would require a dealer that has been awarded municipal securities business by an issuer to maintain a record of all such contributions made to issuer officials by the dealer, any associated persons and any PAC associated with the dealer within the two years preceding and two years following the award of business. The "award" of business means the agreement between the issuer and the dealer that the dealer will perform municipal securities business, as defined above./9/ Dealers would be required to retain such records for a six-year period.
The recordkeeping requirements will assist enforcement agencies in their efforts to inspect for and enforce dealer compliance with all the provisions of the draft rule. It is important to note that the failure of a dealer to recognize and record contributions made to all officials of issuers with whom business is done would result in a violation of rule G-8, as well as a violation of the disclosure provisions of draft rule G-37 discussed below.
The disclosure requirements under paragraph (c) of the draft rule would require dealers to report the total dollar amount of contributions, and the total number of contributors, to issuer officials when the issuer awards the dealer municipal securities business. The disclosure would apply to contributions made two years preceding and two years following the date of the award. The Board chose this four-year period to correspond to many state and local election cycles. Paragraph (c) is intended to ensure that any possible conflicts of interest are disclosed and that this information is made available to the public. Thus, the draft rule would require dealers to send this information to the Board for inclusion in the Municipal Securities information Library/TM (MSIL/TM) system, the Board's electronic library through which such information will be made readily available to the public./10/
Under paragraph (c), if a dealer is awarded municipal securities business, that dealer would disclose, on Form G-37 (initial), the total dollar amount of contributions made (and the total number of contributors involved) to each official of the issuer within the two years preceding the awarding of such business. The triggering event for disclosure is the business awarded. Thus, the dealer would be required to submit a separate "Initial" report for each type and each instance of municipal securities business awarded. After submission of the initial report, the dealer would be required to submit an "Update" report for two more years, on a semiannual basis with due dates specified by the Board, disclosing any additional contributions (and number of contributors) made to any and every official of the issuer. While a separate initial report would be required for each type and each instance of municipal securities business received from a particular issuer, dealers would be permitted to include on Update reports all required information for any and all such business received f rom a particular issuer./11/
As noted above, the Board would specify due dates for Update reports. The Board is concerned that receiving Update reports from all dealers at or about the same time might create information processing problems. To process and disseminate the information as quickly as possible, the Board has determined to specify due dates for Update reports for each dealer that submits an initial report. This will ensure that the information will be readily available to the public through the MSIL system.
Finally, the Board has determined to phase-in the disclosure requirements of paragraph (c) so that only those contributions made on and after the effective date of the rule would be reported on Forms G-37 (Initial) and G-37 (Update).
Board Rule G-20, on Gifts and Gratuities
Draft rule G-37 would apply to political contributions by dealers. Existing Board rule G-20, on gifts and gratuities, applies to all other payments and gifts./12/ Rule G-20 was intended to prevent commercial bribery, and prohibits dealers from, directly or indirectly, giving or permitting to be given any thing or service of value in excess of $100 per year to anyone in relation to its municipal securities activities (other than to an employee or partner of the dealer). Certain items are exempt from this prohibition, including occasional gifts of meals or tickets to theatrical, sporting, and other entertainment, as well as the sponsoring of other legitimate business functions that are recognized by the IRS as deductible business expenses. Gifts of reminder advertising are also exempt from rule G-20. However, the rule provides that such exempt gifts can not be so frequent or so expensive as to raise a suggestion of unethical conduct. The Board notes that rule G-20 is not intended to proscribe legitimate compensation for services rendered, or to restrict social relationships or legitimate business functions that do not suggest impropriety.
Request for Comments
The Board specifically requests comment on the following:
1. Does the definition of "municipal securities business," under paragraph (d) of the draft rule, address all relevant areas where issuers may have responsibility or influence in awarding business to dealers?
2. Are there other situations, not covered by the draft rule, in which contributions by dealers play a role in the awarding of municipal securities business? For instance, do dealers have relationships with parties (other than issuers) that could result in the awarding of municipal securities business to dealers?
3. In defining the "awarding of municipal securities business," the draft rule does not (unless otherwise required) require evidence of a written agreement to trigger the rule's requirements, since in many instances there may not be any such writing. Does this present any timing problems from a compliance perspective?
4. Are the requirements of the draft reporting forms clear? Will it be possible for dealers to consolidate information, by issuer, on the Update forms?
5. In specifying due dates for Update reports, would semiannual reporting pose any particular problems for dealers?
Comments on the draft rule should be submitted no later than Sept. 30, 1993, and may be directed to Jill C. Finder, assistant general counsel. Written comments will be available for public inspection after Board review.
/1/ Like all Board rules, draft rule G-37 would apply only to brokers, dealers and municipal securities dealers. As more fully discussed [in the text], the draft rule would apply to such entities when acting as negotiated underwriters (either as managing underwriter or syndicate member), financial advisers and consultants, placement agents and negotiated remarketing agents. However, the Board's authority does not extend to the activities of independent financial advisors or other nondealers. /2/ The draft rule would not apply to situations in which dealers act as competitive underwriters or competitive remarketing agents. /3/ The term "dealer" used in Board rules also encompasses associated persons of such dealer, as defined in the Securities Exchange Act of 1934 ("Act"). See Board rule D-1. Under Section 3(a)(18) of the act, the term "person associated with a broker or dealer" or "associated person of a broker or dealer" means any partner, officer, director, or branch manager of such broker or dealer (or any person occupying a similar status or performing similar functions), any person directly or indirectly controlling, controlled by, or under common control with such broker or dealer, or any employee of such broker or dealer except those whose functions are solely clerical or ministerial. Although a person associated with a bank dealer is defined somewhat differently from a non-bank dealer, the definition covers essentially the same persons (any person "engaged in the management, direction, supervision or performance of any of the municipal securities dealers's activities with respect to municipal securities" and persons in a control relationship.) See Section 3(a)(32) of the Act. /4/ The proposed rule is modeled after the Foreign Corrupt Practices Act -- Section 30A of the act -- which prohibits corporate issuers from making certain payments to foreign officials in order to obtain or retain business overseas. /5/ This definition was adapted from a provision in the Public Utility Holding Company Act. Section 12(h), 15 U.S.C. Section 791(h). /6/ Section 20(b) provides that: It shall be unlawful for any person, directly or indirectly, to do any act or thing which 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. /7/ As stated in note 3, above, the definition of associated person under the Act does not include clerical or ministerial personnel. /8/ Rule G-17 provides that in the conduct of its municipal securities business, each broker, dealer and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice. /9/ Such agreements could be written or oral agreements, unless otherwise required by Board rules to be in writing (eg., rule G-23(c), concerning financial advisory relationships.) /10/ Municipal Securities information Library and MSIL are trademarks of the Board. /11/ Draft forms G-37 (initial) and G-37 (Update) are included at the end of this notice. /12/ The Board has never interpreted rule G-20 to apply to the contributions encompassed by proposed rule G-37.