with Christopher Taylor, Executive Director of the Municipal Securities Rulemaking Board

Municipal bond dealers asked plenty of questions about the proposed political contributions rule during a panel discussion last week at the fall conference of the National Association of Securities Dealers.

An overview of the proposed rule is contained in a separate speech, printed on page 9 of this edition, that was delivered at the conference by Christopher [Kit] Taylor, executive director of the Municipal Securities Rulemaking Board.

Following Taylor's speech, dealers asked many questions seeking further guidance on exactly how to apply the rule to their own situations.

Given the intense market interest in the rule generally -- and the views of Taylor and other panel participants specifically -- we are printing a transcript of the question-and-answer session.

Other participants on the panel were: Heather Ruth, president of the Public Securities Association; Richard Roberts, member of the Securities and Exchange Commission; and moderator John Pinto, executive representative of the compliance department for the NASD.

The NASD recorded the entire conferece; a tape of the fixed-income panel formed the basis for this transcript. The answers have been edited slightly for readability by Dennis Walters, The Bond Buyer's Los Angeles bureau chief, and many questions are paraphrased to better capture the essence of the remarks.

Q: Regarding the $250 contribution exemption, does that also apply for PACs and firms?

Taylor: Only for the individuals. There is a big fat zero exemption for the firms and the PACs.

Q: Is the $250 an aggregate figure per year?

Taylor: No. It is per election, so it is possible that you give $250 for a primary election, $250 for the main election, and if you should be unfortunate enough to live in a jurisdiction where they have a runoff, then you can give another $250. But it is per election.

Q: On the question of affiliates and the procedures for bank dealers, are you envisioning trying to control what the bank may be doing as well?

Taylor: No. The rule will refer to dealer-controlled PACs. The way we deal with affiliates and, how do I say, concerns that people might try to go around the edges of this rule by using affiliates or other parts of the firm, that's what the indirect provision is in there [for]. It is very clearly in there, and we would expect the regulators when they go into firms and have evidence that there has been extensive giving and, how do I say it, extensive awarding of business, I'd expect the [regulators] to ask some very, very hard questions, and I think you're going to have to have very, very good answers.

Q: So what you're saying is it's a review of the situation as opposed to record-keeping requirements?

Taylor: That's right. You're going to need in a bank -- you better have very good supervisory procedures in place. Although we cannot require it, I would suggest that you speak to senior management in the bank about trying to make sure that there's sufficient insulation from the other side, from the affiliates, that there be corporate policies that sort of, how do I say, insulate the muni department so that the muni department has a defense as well.

Q: We're a smaller firm. The senior officers basically manage the firm, and we do only municipal underwriting. Are you saying that I as president cannot donate $1,000 to the governor of the state of Iowa?

Taylor: Correct. You can give $250, assuming you're from Iowa. Because if you were from California and you give $250 in Iowa, you can't do business in Iowa. I've heard a lot of stories about, you know, wanting to contribute to good government 2,000 miles away from your home.

Q: In a small firm, that pretty much eliminates anyone from donating anything other than under the rule. You said it just applies on the municipal side?

Taylor: Yes, and it also goes up. The rule will make it very clear that the provisions of the rule go up the food chain to include the supervisors over the muni department, including on all the way up to the CEO.

Q: So the president of Merrill Lynch can't do it?

Taylor: That is correct; Merrill Lynch cannot do it. I'll pick on Dan Tulley. I have no clue where he lives. Let's assume he lives in Short Hills, New Jersey. He cannot give $250 -- he can't give a penny -- to somebody in New York City. He may work there but he's not entitled to vote there. So if he gives money in New York City, then the firm is out of the box in that jurisdiction.

Ruth: If I could add something there, I think this illustrates one of the dimensions on which our large members and small members have a somewhat different perspective. Because, for example, corporate finance or mortgage traders or whatever who work for Merrill Lynch can indeed contribute anything they want to in New York City or where they live or whatever. Whereas in a small firm you may not have the same options based on, you know, you basic core businesses. Certainly, the intent of the MSRB rule as currently drafted is to ensure that that not become an unlevel playing field sort of problem.

Taylor: Absolutely.

Ruth: I mean, if somebody's out there -- we'll use Merrill Lunch because we picked on Tulley -- but if somebody's marching around the mortgage trading desk saying, ~Hey, you know, why don't you write a check for ...'

Taylor: Soliciting is banned. That's the point. And you're going to have to have -- Merrill Lynch is going to have to have -- very strict procedures in place ot make sure there's nobody walking around for that reason.

Ruth: Absolutely. So that in some sense, the compensation may be that your supervisory procedures internally [in a smaller firm] may be a lot simpler than those that firm like Merrill Lynch is going to have to put in place. But I will tell you that lots of firms, including New York firms -- and I would include some of the CEOs who were originally approached by those who got this voluntary initiative started -- when they were told that they couldn't contribute $1,000 to the governor, or whatever, were sort of taken aback and didn't quite understand what the problem was.

But both for large New York firms and for smaller firms, regardless of whether you're municipal only or full service, this is a real change in behavior, and it has some civic cost to it. I think there's no question about it. And everyone's a little uncomfortable about that.

One of the regional dealers at our meeting yesterday gave a very poignant sort of presentation. He said he was a veteran of the civil rights movement, and he said, ~My father always told me you had three votes: You have the vote at the ballot, you have a vote with your feet, and you have avote with your wallet.' He said, ~I don't midn the $250 limit -- it's the feet that are bothering me right now. It means I can't do public service things. I can't, you know, be on this board. I can't write a position paper for a candidate or whatever.'

There is a cost associated with that, but against that is our concern, I think, that as a result of various revelations uncovered by the NASD staff -- but also a generally increased, aggressively increased demand for contributions on the part of politicians over the course of the last decade or so -- that things have really gotten out of hand, and we've simply got to do something drastic in order to change the nature of the business -- back, some would argue, to the way it used to be.

Q: So you couldn't write a position paper?

Taylor: That is giving something of value. The definition of contributions says that it is the obvious green stuff, whether it's a loan or actual. But it will be the same definition that is in the draft rule that went out in August, and it says anything of value. If you write a position paper solely for that candidate, then you are giving him something of value because otherwise he'd have to go out and hire somebody.

Q: What about your spouse's activities?

Taylor: Look, we don't cover spouses. You all chuckle, but let me tell you something...

Q: My spouse is very active politically so that's an honest question.

Taylor: And I know, and I'm trying to take it very seriously because there has been a lot of discussion at the board table about this. Spouses are not included in this rule now. But it does -- again it's the indirect. If your spouse is very active in the community and you underwrite the bonds, you are going to have to answer to that. And the pulbic perception right now, quite candidly, is that there's an all too close correlation between the amount of money or other things of value going to the people that are making the decisions. If you're going to write a position paper, I would suggest putting it in the op ed page of your local newspaper or something liek that. Give it to the community. That's who you're really trying to benefit. You give it to a single politician, you're giving him something of value.

Again, I would point out the indirect thing here. Today we're not requiring a lot of record keeping. And this is what I really wanted to say, following what Heather said, was look, this is why the principles [developed by the group of 17 Wall Street firms] are a good thing. Thi is why looking all those principles and signing on to them are a good thing.

Because I can sit here and if you want me to I'll write the most detailed, excruciating, difficult rule, and it'll close every loophole and you won't be buying and selling and trading and making a living -- you'll be filling out forms so that John can read them. Now if that's what you want, I'll be glad to do it. But I don't think writing rules is a good solution to problems. It's not the complete solution. I would much prefer to see people out there taking the high road on their own, and that's what the principles are designed to do.

Q: I'm a member of a bank holding company. does the rule apply just to the [municipal] subsidiary's PAC and insulate the bank holding company PACs?

Taylor: Right now, the rules say dealer-controlled PACs, which in a bank means the separately identifiable department. However, you better be real careful, and I would urge you when you go back you should be asking yourself, ~How can we avoid the perception of a conflict of interest in what were are doing and where we're underwriting business.' And I don't have a clear answer to you. It is very hard. And that's why I'm saying, if

you want me to write a rule, I'll do it. But I don't ... you know, that's my living. I mean give me a chance guys; I love to write rules. It's not really a good idea.

Ruth: There were a number of banks at our [PSA-sponsored] meeting yesterday. A representative from [a Southern bank] which does not have a subsidiary and in some sense therefore has an even more serious problem [and] is in three different states. To use as an example, [here are] some actions that they've taken.

One is that they've stopped dealer-employee contributions to the PAC; they're making it a non-dealer PAC entirely. That only solves part of problem, obviously. And they're also contemplating rules associated with maximum political contributions on the other side of bank as well. We don't have any neat solutions for that, but clearly in the group of regional dealers we've been working with, we want to make sure that we come up with some creative ideas at least for the banks as well because they do have special problems. And, by the way, we're very appreciative that the MSRB made it absolutely clear that they recognize that problem. I mean, we would expect them to, but it's nice that they did by saying dealer-controlled PACs.

Q: Our firm is organized as a partnership, and one of our limited partners makes significant political contributions. I'm not sure what his duty is under the rule. What control I would have over his activities?

Taylor: That guy probably is covered because he is senior management of the firm or he is involved or he is an owner of the firm, and it is impossible to divorce his ownership of that firm or his participation in that firm from your activities in the firm. Look, the whole premise behind this -- let's back away from the rule a minute -- is to avoid the appearance of a conflict of interest. If your partner is making a $10,000 dollar contribution to XYZ official, and you are doing municipal securities business with that guy .. just think, it's my mother's rule of ethical conduct: ~Kit, don't do anything that you don't want to tell me about in the morning.' [Laughter.) Now my answer you is ...

Roberts: You live with your mother? [Laughter.]

Taylor: No. This is a shameless crew

Ruth: It gets, worse the longer it goes on.

Taylor: This shows you we're a little punchy after two days of this. No, don't live with my mother, but that's what she told me when I was a teenager. No, he's probably covered, an you can't do business where he is giving those contributions.

Q: I can appreciate the application the rule in this case if he was a full partner, and I can tell him how he affecting our business. But, I mean, h never had any day-to-day influence with the firm. He just put up some money so that we had some capital Taylor: I appreciate that. Look, this is the problem with rule writing: You throw babies out with the bath water. You do things that you wish you didn't have to do. But the fact of the matter is, I have to tell you, to me it is a clear conflict of interest and in violation of the spirit if not the letter o the rule.

Pinto: I think it also points out the importance of what you said earlier. If these are not complied with and you start writing more specific rules, you start throwing out, and including, far greater numbers of people that you don't really want to include in it.

Taylor: Look, it's public perception. And the public -- all you have to do is look at the last presidential election. There was a guy who got 20% of the vote because nobody liked the other fellows. And it really behooves us as an industry to really care about how people perceive the industry. You may say, and you can say to your dying day, there wasn't a conflict of interest, but there was certainly the appearance.

Q: First, are we only talking about the negotiated deals?

Taylor: It is negotiated deals, negotiated remarketings, anywhere where the issuer is selecting a firm. But by the way, let me just point out, it's not just the selection of the managing underwriter. If you are a member of the syndicate in a negotiated underwriting, you're covered by the rule. The issuer doesn't just have to pick you as senior manager. We're not just dealing with those cases. It's where you're in the syndicate.

Q: Second, how did you arrive at the $250?

Taylor: We felt that that was a sufficient amount of money to indicate support in your local jurisdiction. Beyond that it was the board's belief that it would begin to raise questions -- even in your local jurisdiction -- that there would be an attempt to buy the business. Now, we have people sit there and say, ~Well, $250 in New York City is a pittance.' Well, in other communities $250 to the local councilman is a heck of a lot of money. Again, you're writing a rule that is not based on the size of the jurisdiction you live in. We're trying to write a rule that is nationwide, and that's what we thought was the appropriate number.

Q: Does the rule cover a dealer selected as a financial adviser in a competitive deal?

Taylor: Yes. If the issuer is choosing you in a noncompetitive situation, then it is covered by the rule. Again, use your common sense. I cannot urge you enough, don't sit there and [say] ~Oh, how am I going to get around the edges of this rule.' Don't do that.

Ruth: If I could jump in, I might say that one of the things that's made us somewhat uncomfortable throughout this whole process is that financial advisers who are not dealers -- that is, so-called independent financial advisers -- bond counsel, engineers, architects, consultants, and so on, are not directly regulated by anybody and aren't covered by similar rules.

Now the chairman of the SEC has written to the organizations representing many of those groups and has urged them to come up with some voluntary principles that are similar to those that apply to dealers. And, of course, Kit and the MSRB have tried to do this through the indirect method -- that is, to make sure that dealers don't use their own influence to use these other folks as a conduit. But quite frankly, we wish there were some way of imposing identical or at least parallel rules on both the independent financial adviser and bond counsel, particularly on the bond counsel community. And unfortunately there doesn't seem to be a very large prospect that they're going to do that voluntarily themselves.

Taylor: Heather, I'll give you another perspective on the bond lawyers. And that is that there were a fair number of dealers who came up to me and said, ~Ha, we finally got those guys. Since we can't give, that means the politicians are going to hit them up to make up the difference.' Ruth: Right, right, I've heard that too.

Q: I just want to clarify a couple things to make sure I understand If you have a mortgage-backed business not involved in the municipal business, they could give anywhere?

Taylor: If that man or woman is giving a contribution and you happen to do business -- and by the way, in virtually every jurisdiction that I know of in the U.S., you have to disclose what your contributions were, so somebody's going to find out about it. God bless the newspapers. They go through these files, but if the guy in the mortgage-backed division is giving a lot of money and you do business there, you better be prepared to show these [regulators] at the end of the table that it wasn't for the purpose of gaining the business.

Q: If a bank holding company owns us, does that mean principals in the holding company are covered? Taylor: In the case of a bank, it does not. It does not go. It's not going to go into the ... no, it will not go past that group of people to the next group of people. We have the same problem in the securities industry in organizations like, just the most recent, the Travelers buying Shearson combination. You have the same kinds of questions.

Again, though, those people and those firms, they would be very wise to have very explicit procedures in place to show why they're giving contributions and where they're giving to insure and insulate the muni people from the appearance of a conflict of interest.

Q. I work for a bank -- how can a compliance officer make sure these rules get disseminated throughout a firm, especially when in New York City there are political contributions all over the place?

Taylor: I would urge you to send a copy of the rule to senior management of the bank and tell them that a violation of MSRB rules under federal banking law is considered a violation of, I mean, it's the kind of thing that goes directly to the board of directors.

Q: How far up does the rule go when you have a subsidiary in a bank?

Taylor: In that case, you're going to go up all the way through the sub and then the people above it are going to have to be very, very careful. You want to make sure that the muni department is isolated. I have to say it's true [as well] in a Goldman Sachs. I'll pick on my own chairman and apropos your question on mortgage bankers: You're going to have to make sure other people in your firm aren't winking and nodding and saying to their buddy on the underwriting desk, ~Who are you underwriting this week? Can I give a contribution?' You got to have some, you want to have very explicit procedures in place.

Q: So if a separate bank PAC gave to those in New York City government but we don't know about it and we have procedures in place, then we're all right if we're underwriting a New York City bond and can prove there was a solid wall?

Taylor: You're okay [but] let me tell you something. This problem has come about.

Roberts: You might want to look at Liz Holtzman's situation before you say you're okay. I'm not sure that Fleet thinks they're okay right now.

Taylor: That's the problem: The problem is Perception. And the problem is when you have a direct one-to-one correlation between the amount of money given by the organization, however you want to define it, the individuals, the PACs, the affiliates, whatever, and who got the business. And that's what you want to avoid. And unfortunately your friends, the politicians, aren't going to help you out.

I will relate to you a story about a man who I have a great deal of respect for who came to be the CEO of a firm here on the West Coast, and he was very active politically. And he would go to political fundraisers and finally the politicians kept coming up to him and saying, ~Why don't you go into the muni bond business so I can pay you back.' And he called me up, and he said, He had lunch with me in D.C., and he said, ~Should we do this?' And I said, ~This is a problem waiting to happen.' So I don't have, I can't control all aspects of a bank. I can't control all affiliates, but let me tell you this is an area where the bright lights are shining, and you want to make sure you're on the side of the angels.

Ruth: If I could add something there from the standpoint of an industry trade association that's trying to make it easier for firms who have not already been part of this group of 17 to figure out what they should do. I think our perspective is to help firms understand how they can really kind of change the culture of their institution. And in some cases it's going to be particularly difficult for banks. But we, in that process, are going to urge people to really sort of look at what they normally: do and try to figure out whether any of it stands up to the light of day.

Q: How about covering campaigns for national office?

Taylor: The rule presently does not apply to federal officials, people running for federal office. However, in response to questions yesterday, how do I say it, boy, I was I disabused real quickly. There was a chorus of people in the audience saying that they felt that congressmen had played an active role in the awarding of bond deals and that contributions were made to those congressmen for that purpose.

Ruth: It was really fascinating. This was not a reaction that was just, if you'll forgive the use of the word, ~pissiness,' -- [to wit], ~Well, if the MSRB is going to regulate local and state contributions, why not take on Congress as well?

It was genuine concern. One, that it happens now, and two, that it would be the ultimate loophole. That is, where hypothetically your mayor comes to you and says, ~I know you can't give a contribution to me any longer, but give it to congressman X, and he'll take care of me.' Now I have a feeling that a certain chairman of a subcommittee of the energy and commerce committee might go bananas and beyond if a pattern of this type emerged and the MSRB felt it had to deal with it. But it is a tricky issue.

Q: Are there model compliance-procedures and rules and the like being put together?

Taylor: That's part of what the group of 17 is doing. Yesterday, in response to a request from members of the audience, PSA will be doing it for its members, I gather.

Ruth: Yes, that's subject to the approval of committees and budget resources and so on, but we're taking the request very seriously.

Q: On the other side of the fence, what are the politicians' thoughts about this?

Roberts: Some of them aren't very happy.

Taylor: Oh, really.? [Laughter.]

Ruth: Actually, we had two public officials on the panel yesterday in Chicago. One of whom -- Sam Shapiro, who's the treasurer of the state of Maine -- came out rather early this year and said, ~Okay, I'm going to quit. I'm not going to take contributions from these guys any longer.' And another of whom had not decided what to do yet. They were both very, very supportive. They both were concerned, and I don't blame them actually, sort of saying, ~Hey, this is really politician bashing. It's not dealer bashing, and I resent being called a corrupt official.' I should say, by the way, Kathleen Brown in this state recently, rather belatedly, but nevertheless came out and said she was going to stop taking contributions ... as well.

I think everybody understands that part of the problem here is the cost of political campaigns. That is the problem -- the escalating cost of political campaigns. And quite frankly, in yesterday's meeting, a number of our members came up and said, ~You know, PSA really ought to get on the bandwagon of political campaign finance reform,' which is an amazing statement. Because as a trade association we tend to define what we ought to get involved in quite narrowly to make sure that everybody in the association really believes it's our business to be involved in those things. Heck, we didn't even have a position on Nafta, despite the fact that everybody I could think of in the trade association was very much in favor of it. But to have our members king of voluntarily say, ~This is just ridiculous, now that we've seen what it's done to our industry, we ought just sort of for public policy purposes get involved in trying to solve this problem at all levels of government.' I found that fascinating.

I will say, however, that there are politicians who are incensed, and I would say that minority politicians and woman politicians are particularly upset about this. Because they view it, many of them view it, as in effect saying, ~Well now that I'm successful as a politician and now that there are women and minority investment bankers and securities people who are successful who have money who can give ... only now has somebody figured out that this is bad.'

And I must say, personally, I am extremely sympathetic with that kind of reaction. But quite frankly, something has to be done about the problem. And it's a pity it's come to this, but it's really a very dangerous thing that's happened.

Taylor: I would really like to echo those remarks. It is a pity that it has come to this. It is not. fun to write rules like this. It is not something that I think anyone who cares about the political process and the way in which things are done in this country -- and I think this is a great place to live -- but I want to keep it that way. And I think the board members feel very, very strongly that this is an industry that's come under attack, and very forceful action has to be taken and this rule, we believe, is the first step in doing that.

Ruth: If I could make one other comment. Someone yesterday remarked that there is a strong correlation -- not a perfect correlation, but a strong correlation -- in this business for people who are engaged in public finance in particular to have come from the public sector. That is sort of the ultimate pity, it seems to me. Because the problem is such that precisely the people who are most likely in a typical firm to be the most interested in local politics, state politics, national politics, and so on, are in public finance rather than somewhere else because they wanted to build public infrastructure. You know, they ~wanted to deal with public officials as clients. So that's, it seems to me, the ultimate irony, but also possibly part of the cause of the problem.

Pinto: Well, I told you this was not a controversial issue [Laughter.] If I could just say, though, as the self-regulatory organization that's going to be responsible for examining and enforcing this rule in whatever the final format is, I can assure you that it's something that we're going to take very seriously and aggressively go out and examine for compliance.

And it really is incumbent, Kit and Heather mentioned this, it really is incumbent on you to take a look at your supervisory systems and not just write down something but to really -- not only to put into place procedures -- but to carry out these procedures in order to ensure that you've got the safeguards in place to ensure compliance with the rule.

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