Name Not Public

Exemptive relief is denied based on: Firm D was subject to a ban that was discernible via a review of publicly available Forms G-37 which disclosed that a PAC controlled by Firm D or a Firm D MFP made political contributions to the Issuer Officials; Firm D had a long history of making contributions to the Issuer Officials; the ban attached to Firm A upon completion of the acquisition of Firm D; neither Firm A nor Firm D attempted to obtain refunds of the contributions; Firm A’s proposed supervisory systems are not adequate to address regulatory concerns presented.


January 4, 2016

This serves as the Financial Industry Regulatory Authority’s (”FINRA”) response to your request dated August 18, 2015 and filed pursuant to FINRA Rule 9610 by Firm A (“Firm A”) seeking an exemption from subsection (b) of Rule G-37 (”the Rule”) of the Municipal Securities Rulemaking Board (MSRB) with respect to two municipal issuers: (1) City, State and (2) Authority (the “Issuers”). After careful consideration of your request and taking into account all relevant factors, FINRA has determined that, among other things, it would be inconsistent with the public interest, the protection of investors and the purposes of the Rule to grant Firm A an exemption from the Rule. Accordingly, Firm A’s request is denied. 

Background

In 20XX, Firm A's parent company (Firm B) acquired Firm C, the parent of Firm D (“Firm D”), a broker-dealer and member of FINRA. The broker-dealer business previously conducted by Firm D, including its municipal securities business, is now being conducted by Firm A. At the time of the acquisition, Firm D was subject to the provisions of the Rule including a two-year ban (the “Ban”) from engaging in a municipal securities business1 with the Issuers. The Ban resulted from contributions made (primarily to local Issuer officials2) by a political action committee, PAC (the “PAC”).  As a result of the acquisition, Firm A inherited the remainder of the Ban, thus prohibiting Firm A from conducting a municipal securities business with the Issuers for another five months. The PAC, which was created by Firm D’s former CEO (a municipal finance professionals)3 and funded by Firm D employee contributions, was used to make political contributions between Month 19XX and Month 20XX. A review of Form G-37 filings for the period Month 20XX to Month 20XX (the period cited in your exemption request letter) disclosed 11 contributions to officials of the Issuers ranging from $500 to $5,000 totaling $27,750. A review of prior G-37 filings, beginning 20XX, disclosed additional PAC contributions to officials of the Issuers totaling $27,000. Thus, contributions from the PAC to officials of the Issuers from 20XX through Month 20XX totaled $54,750. In addition, it should be noted that the PAC has a long history of political contributions to State officials, including 13 such contributions from 19XX through 20XX totaling $67,500. Further, Firm D’s G-37 filings reflect over 150 political contributions by municipal finance professionals to State officials from 19XX through 20XX totaling approximately $70,000.4

The Basis for Firm A's Request for an Exemption from the Ban

You have set forth four main arguments in support of Firm A's request for exemptive relief, as follows:

  • The PAC contributions that triggered the Ban were not dealer-controlled; rather, the contributions were directed by only Firm D’s former CEO and another Firm D employee for personal reasons, and were subject to adequate supervisory systems.
  • It would be inconsistent with the intent of the Rule and its interpretive guidance to penalize Firm A for political contributions made by Firm D's former CEO more than a year prior to the acquisition of Firm D since Firm A was not subject to the Rule at the time the contributions were made.
  • At the time Firm A decided to acquire Firm D, Firm A was not aware of contributions made by Firm D's former CEO and the PAC.
  • Firm A’s current and proposed supervisory systems are adequate to address any regulatory concerns going forward.

Further, Firm A has represented that the acquisition was not an attempt to circumvent the letter or spirit of Rule G-37.

Legal Standard Applicable to a Request for an Exemption Pursuant to the Provisions of MSRB Rule G-37(i)

G-37(i) is designed to ensure that the high standards and integrity of the municipal securities industry are maintained, to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to perfect a free and open market and to protect investors and the public interest by: (i) prohibiting brokers, dealers and municipal securities dealers from engaging in municipal securities business with issuers if certain political contributions have been made to officials of such issuers; and (ii) requiring brokers, dealers and municipal securities dealers to disclose certain political contributions, as well as other information, to allow public scrutiny of political contributions and the municipal securities business of a broker, dealer or municipal securities dealer.5 The rule achieves its purpose by prohibiting any broker dealer or municipal securities dealer from engaging in any municipal securities business with an issuer within two years after certain contributions are made to any official of that issuer.6

As set forth in G-37(i), FINRA may grant an exemption from G-37(b), but first it MUST consider the following factors:

  1. whether such exemption is consistent with the public interest, the protection of investors and the purposes of this rule;
  2. whether such broker, dealer or municipal securities dealer:
    1. prior to the time the contribution(s) which resulted in such prohibition was made, had developed and instituted procedures reasonably designed to ensure compliance with this rule;
    2. prior to or at the time the contribution(s) which resulted in such prohibition was made, had no actual knowledge of the contribution(s);
    3. has taken all available steps to cause the contributor involved in making the contribution(s) which resulted in such prohibition to obtain a return of the contribution(s); and
    4. has taken such other remedial or preventive measures, as may be appropriate under the circumstances, and the nature of such other remedial or preventive measures directed specifically toward the contributor who made the relevant contribution and all employees of the broker, dealer or municipal securities dealer;
  3. whether, at the time of the contribution, the contributor was a municipal finance professional or otherwise an employee of the broker, dealer or municipal securities dealer, or was seeking such employment;
  4. the timing and amount of the contribution which resulted in the prohibition;
  5. the nature of the election (e.g., federal, state or local); and
  6. the contributor's apparent intent or motive in making the contribution which resulted in the prohibition, as evidenced by the facts and circumstances surrounding such contribution.

FINRA's Response

FINRA staff denies your request for exemptive relief based on the applicable standards. A paramount issue in rendering our determination is whether an exemption is consistent with the public interest, the protection of investors, and the purposes of MSRB Rule G-37. In reaching its determination, FINRA considered the following in response to your stated positions:

The PAC contributions that triggered the Ban were not dealer-controlled, were only directed by Firm D's former CEO and another Firm D employee, and were subject to adequate supervisory systems.

As an initial matter, it is important to point out that whether the contributions were made by a dealer-controlled PAC or a Municipal Finance Professional ("MFP")7 controlled PAC, the result would be the same (i.e., the Ban would be in effect). The Rule does not include a provision to ban MFPs individually from engaging in municipal securities business.

That said, one of Firm A’s central arguments in support of its request is that the PAC was not controlled by Firm D, and that “prior to the PAC and former CEO making contributions, Firm D had developed procedures reasonably designed to comply with the Rule…” The only evidence you provided in support of Firm D’s procedures in this regard is “the fact that all contributions were properly reported on Form G-37.” In this regard, it should be noted that the original Form G-37 disclosure filings for the timeframe you have cited (Month 20XX to Month 20XX) clearly indicate that the contributions were made “by [a] PAC controlled by the dealer.” You stated that subsequently, “certain Forms G-37” have been amended to reflect that the PAC “was only seemingly ‘dealer controlled.’” Interestingly, these amendments were not made until Date – more than 15 months after several of the contributions were made and shortly before Firm A’s purchase of Firm D. Further, only contributions made during your cited timeframe were amended. A review of the PAC’s contributions prior to the cited timeframe still indicate dealer control over the PAC’s contributions to officials of the Issuers, including a contribution in the first quarter of 20XX and three contributions in the second quarter of 20XX.8

In further support of your argument that the PAC contributions were not dealer controlled, you stated that the CEO was the only person “making contributions” through the PAC; however, it is critical to point out your acknowledgement that the PAC was “funded by Firm D employees' contributions.” Thus it is of concern that you have provided no information whatsoever with respect to the nature of this funding arrangement, such as the number of employee contributors, their positions within Firm D, the amount of their contributions, their motivation for making such contributions, or any procedures employed to monitor or supervise the arrangement. Thus, FINRA staff cannot make an informed determination regarding how wide-spread or deeply imbedded the arrangement was within Firm D (although its very existence significantly undermines any argument that the PAC contributions resulted from actions taken by the CEO and another Firm D employee in isolation). Accordingly, their subsequent disassociation from Firm D does not fully eradicate the regulatory concerns Rule G-37 was intended to address. 

You also argued that the former CEO, through the PAC, made contributions “for personal reasons that were unrelated to Firm D's very limited municipal securities business and were made apparently without regard to potential future municipal business opportunities.” However, you provided no basis to substantiate what the CEO’s motivations were, or whether municipal securities business was sought. With respect to your reference to “Firm D’s very limited municipal securities business,” it should be noted that a review of Forms G-37 submitted by Firm D for the first quarter 20XX through the first quarter 20XX disclosed that Firm D had participated in negotiated underwriting and financial advisory activities related to municipal offerings in a number of different states totaling well over $XX in principal amount. Thus, while Firm D’s revenue from this business line may not be comparable to other revenue sources, this information indicates that Firm D had indeed been actively involved in public finance.

You noted that “Firm D did not engage in municipal securities business in jurisdictions where the PAC and former CEO made contributions, nor had Firm D engaged in such business with issuers with officials who received contributions.” While this representation may support the position that Firm D complied with the ban that was triggered when the PAC’s contributions were made,9 it does not provide a basis for seeking an exemption from such ban (which Firm D apparently fully accepted). Indeed, as you have correctly stated, Rule G-37 “was designed to ensure high standards of integrity and prevent political contributions from coloring interactions between brokers and issuers.” The two-year ban is an integral component of the Rule to ensure this goal is achieved.  The contributions in question were deliberate, coordinated, ongoing, and relatively large, particularly in light of the fact that the contributions were made primarily to local municipal issuer officials and candidates; large contributions to candidates running in small local elections are likely to be influential or, at the very least, have the appearance of being influential.10

It would be inconsistent with the intent of the Rule and its interpretive guidance to penalize Firm A for political contributions made by Firm D's former CEO more than a year prior to the acquisition of Firm D since Firm A was not subject to the Rule at the time the contributions were made.

You contended that it would be inconsistent with the intent of the Rule and its interpretive guidance “to penalize Firm A for political contributions made by Firm D's former CEO more than a year prior to the acquisition since Firm A was not in fact subject to the Rule at the time the contribution was actually made.” In support of this statement you cite an instance in 1999 wherein a firm sought and received (from FINRA’s predecessor, the National Association of Securities Dealers (“NASD”)) exemptive relief from an inherited G-37 ban that attached due to the firm’s acquisition of certain assets from another firm.11 You do not, however, discuss the particulars of that case which are, in fact, clearly distinguishable from the present request in several substantive regards. You also noted a reference made by NASD in its response letter that Rule G-37 “was not intended to prevent acquisitions and mergers or, upon consummation of a transaction, to hinder the surviving dealer’s municipal securities business” and cited to the source of this quote, an MSRB Q&A.12 However, you did not include the entirety of the MSRB’s Q&A which addressed a scenario which is also clearly distinguishable from Firm A’s exemptive request. Specifically, the Q&A addressed an instance wherein a person associated with a dealer in a non-municipal finance professional capacity makes a political contribution to an official of an issuer for whom such person is not entitled to vote. Less than two years after such person made the contribution, the dealer merges with another dealer and, solely as a result of the merger, that person becomes a municipal finance professional of the surviving dealer. In contrast to this scenario, Firm D’s CEO was an MFP at the time the contributions were made and possibly during the entirety of his tenure at Firm D. Further, in contrast to the single, isolated contribution addressed in the Q&A, there were (as discussed above) several substantial contributions made to Issuer officials via a PAC controlled by Firm D, and the PAC was funded by several employees of Firm D, many of whom may well currently be employed by Firm A. Consideration also must be given, in this regard, to the long history of political contributions to other State officials by Firm D.

It should also be noted that, as provided for in the Q &A, the Rule did not prevent the Firm D acquisition, and your request for exemptive relief from the resulting Ban was carefully considered according to its unique facts and circumstances to ensure that both the letter and spirit of Rule G-37 are upheld.

At the time Firm A decided to acquire Firm D, Firm A was not aware of contributions made by Firm D's former CEO and the PAC.

You stated that by purchasing another broker-dealer,Firm E,13Firm A “anticipated participating in key financings in the Geographic Region” and that, if unable to obtain an exemption, Firm A will be unable to pursue “major financings by both issuers” that Firm A understands to be “imminent.”  In support of your request, you stated that “[a]t the time Firm A decided to acquire Firm D, Firm A was not aware of contributions made by Firm D's former CEO and the PAC. FINRA staff does not view Firm A’s lack of due diligence in this regard to be supportive of its case. To the contrary, Firm A’s lack of attention to the implications of the Firm D acquisition undermines your representation that Firm A’s proposed policies and procedures would be sufficient to adequately address the regulatory concerns contemplated by Rule G-37. Indeed, a cursory review of the Forms G-37 submitted by Firm D would have put Firm A on notice of the Ban. Further, Firm A’s due diligence should have been heightened by the fact that Firm D’s former CEO was under investigation by both the Department of X and the Department of Y– an investigation that was disclosed in FINRA’s BrokerCheck system as well as in several widely available published accounts. It is also worth noting that nothing you have represented indicates that there are any current contracts between Firm A and the Issuers that would be disrupted by the Ban. 

You stated that “[p]rior to the final acquisition of Firm D, Firm A became aware of the political contributions and realized that the two-year ban could significantly impact its business.” As a result, you have represented that Firm A, through outside counsel, had communications with both FINRA and the MSRB about an exemption from the Ban and that “the MSRB was supportive of an exemption request.” FINRA followed up with the MSRB regarding this communication and was informed that the MSRB simply confirmed Firm A’s right to submit an exemption request, but in no way commented on the merits of Firm A’s argument.  You have also represented that FINRA “indicated it was not inclined to grant exemptive relief from the two-year ban because FINRA's position was that a dealer PAC had made the contributions and there was no precedent for such an exemption.” It should be clarified that this statement is, quite frankly, a reductionist simplification of the position FINRA staff had articulated, as the communications in question went well beyond a generic reliance on precedent; rather, several of the regulatory concerns addressed in this letter were discussed with prior counsel at length and in detail. Based on those concerns, FINRA staff notified prior counsel that it was unpersuaded that exemptive relief was warranted. 

Firm A's supervisory systems are adequate to address any regulatory concerns going forward.

You stated that “Firm A represents that Firm D's business operations relating to its previous municipal securities business have been integrated with Firm A’s operations and Firm D is no longer engaging in any new municipal securities business.” However, this ignores the fact that the exemption sought is on behalf of Firm A, which is the surviving broker-dealer entity of acquisition. You further stated that “Firm A has already put in place a mechanism to wall off all former Firm D employees from any municipal securities business that would otherwise be affected by the contributions…” However, you have provided no information whatsoever as to what this “mechanism” is.

You then stated that “Firm A agrees, if the exemption is granted, to institute the following procedures during the exemptive period to further ensure segregation of former Firm D employees from municipal securities business with issuers with officials who received contributions from the former CEO and/or PAC.”

  • Firm A professionals engaging in municipal securities business will be informed in writing that they may not have any discussion or communications (including e-mail or voice mail) with former employees of Firm D where such communication pertains to municipal securities business for an issuer with an official who received a contribution from the former CEO and/or PAC in the prior two years, without prior approval of Firm A’s legal department.
  • Firm A will provide notice to all MFPs doing business with issuers whose officials received the contributions regarding the segregation and all employees shall certify that they have received notice of this, understand and will comply with the notice, and acknowledge that they may be subject to sanctions, including potential dismissal, in the event they fail to comply.
  • Former Firm D employees now at Firm A will receive similar notice of the information restrictions and will be subject to the same obligation to provide written certification of compliance.
  • Firm A supervisors will undertake periodic inquiry to determine whether the specified procedures are being followed.

FINRA does not believe the proposed procedures are sufficient to overcome the regulatory concerns that Rule G-37 was designed to address given the fact that Firm D and Firm A are now a single firm. Taking into account the aforementioned political contributions engaged in by Firm D for over two decades, and the significant and widespread issues discussed in detail above, including a great many questions that remain unanswered as to the nature of the PAC’s funding and operation, you are asking FINRA to take an unprecedented and unwarranted “leap of faith” on Firm A’s behalf that would clearly be inconsistent with both the letter and spirit of the Rule. As discussed above, Rule G-37(i) is designed to ensure that the high standards and integrity of the municipal securities industry are maintained. The Rule serves its intended purpose only when it is administered in a manner that reinforces that purpose. FINRA cannot disregard legitimate regulatory concerns about Firm D simply because Firm D has been acquired by Firm A (which potentially stands to benefit from the political contributions that triggered the Ban). The Rule’s ban provision is a fundamental and critical means of ensuring that the high standards and integrity of the municipal securities industry are maintained by ensuring that there is not even a perception that political contributions can be used as a quid pro quo to direct business and derive economic benefit in contravention of a free and open market. In light of the presented circumstances, if the requested relief were to be granted, it would set a precedent far beyond any heretofore established and would effectively provide a means by which to circumvent the ban provision and, ultimately, the Rule’s purpose.14

Finally, as noted above, a consideration that FINRA must take into account in connection with a requested exemption from the Rule’s requirements is whether all available steps have been taken to cause the contributor involved in making the contribution(s) which resulted in such prohibition to obtain a return of the contribution(s).15 There has apparently been no effort on the part of either Firm D or Firm A to request the return of any of the contributions. You noted that Firm A has “authorized former Firm D officials to request return of the contributions if the exemption is granted [emphasis added].” FINRA does not find it compelling that the mere act of requesting the return of the contributions is contingent upon Firm A first securing its requested exemption.  Further, you have provided no indication as to the likelihood of any of the contributions being returned. We note that in instances where FINRA has granted exemptions, one of the factors we have considered has been whether the firm obtained, or attempted to obtain, a refund of the subject contribution before the request was made.

Your request for relief asked that Firm A’s application for an exemption, the identity of Firm A, and the identity of the MFP remain confidential. To the extent feasible and permitted under law, FINRA grants that request. However, our determination to deny exemptive relief will be available, with identifying information redacted, on the FINRA website with other FINRA responses to requests for exemptive relief under MSRB Rule G-37. By publishing the FINRA responses in redacted form, FINRA is able to provide confidentiality while informing and educating firms, issuers, and investor communities of the factors that FINRA may consider in granting or denying exemptive relief under the Rule.

Please be advised that pursuant to FINRA Rule 9630 Firm A may file a written notice of appeal within 15 calendar days of the date of this letter. The notice of appeal should be filed with the Office of General Counsel of FINRA; 1735 K Street, NW; Washington, DC 20006-1500, with a copy to the undersigned. If Firm A does not want the appeal decision to be publicly available in whole or in part, please include a detailed statement, including supporting facts, showing good cause for treating the decision as confidential in whole or in part.

If you have any questions regarding the issues discussed herein, please contact me at 202-728-8133.

 

Sincerely,

Cynthia M. Friedlander
Director, Fixed Income Regulation

cc: FINRA XX District Office


1. See MSRB Rule G-37(g)(vii).

2. See MSRB Rule G-37(g)(vi).

3. See MSRB Rule G-37(g)(iv).

4. The referenced G-37 filings are available for viewing on the MSRB's EMMA website: emma.msrb.org.

5. See MSRB Rule G-37(a). 6. See MSRB Rule G-37(b).

7. See MSRB Rule G-37(g)(iv).

8. It is worth noting that several contributions reported by Firm C via Form G-37 indicate contributions "controlled by a municipal finance professional," so it is clear that Firm C was making this distinction and not automatically indicating dealer control.

9. See MSRB Rule G-37(b).

10. See MSRB Rule G-37(i)(iv), which requires FINRA to consider the timing and amount of the contribution(s)that resulted in the prohibition; and MSRB Rule G-37(i)(v), which requires FINRA to consider the nature of the elections at issue (e.g., federal, state or local).

11. NASD Notice to Members 99-14, Recent Decisions Regarding MSRB Rule G-37(i) Exemptive Relief, Letter 1: Exemptive Relief Granted, February 1999.

12. MSRB: Questions and Answers Concerning Political Contributions and Prohibitions on Municipal Securities Business: Rule G-37, Municipal Finance Professional II.16, (June 29, 1998), Revised October 30, 2003.

13. In 20XX, Firm B acquired Firm E, which was a public finance investment banking firm and registered broker-dealer located in City, State that engaged primarily in municipal securities business in the Geographic Region market. Firm E now conducts its business as a division of Firm A.

14. Rule G-37(d) states that "[n]o broker, dealer or municipal securities dealer or any municipal finance professional shall, directly or indirectly, through or by any other person or means, do any act which would result in a violation of sections (b) or (c) of this rule."

15. See Rule G-37(i)(ii)(C).