Name Not Public
May 17, 2006
On May 10, 2006, NASD’s National Adjudicatory Council (“NAC”) considered the appeal of Firm 1 (or the “Firm”) of a November 30, 2005 decision of NASD’s Office of Regulation Policy (“Regulation Policy”) denying the Firm’s request for an exemption from Municipal Securities Rulemaking Board (“MSRB”) Rule G-37.1 For the reasons set forth below, the NAC affirms Regulation Policy’s denial of the exemption request.
MSRB Rule G-37 prohibits brokers, dealers, and municipal securities dealers (“dealers”) from engaging in municipal securities business2 with an issuer for two years following certain political contributions to an official of such issuer from the dealer, a municipal finance professional (“MFP”) associated with the dealer, or any political action committee controlled by the dealer or an MFP associated with the dealer.
Under subsection (i) of Rule G-37, NASD has authority to grant an exemption, conditionally or unconditionally, to a dealer who triggered the two-year ban because of a political contribution. Rule G-37 directs NASD, in connection with exemption requests, to consider many factors, including:
- Whether the exemption is consistent with the public interest, protection of investors, and purposes of the rule;
- Whether the dealer:
- Prior to the time that the political contribution was made, had developed and instituted procedures reasonably designed to ensure compliance with Rule G-37;
- Prior to or at the time that the political contribution was made, had no actual knowledge of the contribution;
- Has taken all reasonable steps to cause the contributor to obtain a return of the contribution;
- Has taken such other remedial or preventative measures as may be appropriate and the nature of the remedial or preventative measures;
- Whether, at the time of the contribution, the contributor was an MFP or otherwise an employee of the dealer, or was seeking such employment;
- The timing and amount of the contribution;
- The nature of the election; and
- The contributor’s apparent intent or motive in making the contribution, as evidenced by the facts and circumstances surrounding the contribution.
All Rule G-37 exemption opinions (whether issued by Regulation Policy or the NAC) are available in redacted form on NASD’s Website. The Firm requested confidential treatment of its exemption request. Because NASD publishes all Rule G-37 exemption decisions in redacted form only, The Firm’s request for confidentiality is unnecessary. The NAC’s decision in this matter will be published in redacted form on NASD’s Website.
The Firm is a State 1-based member firm with a history of underwriting debt issuances and providing underwriting services to State 1 and its agencies, school districts, and government utilities.
Officer A is Vice Chair of the Firm and relative of a founder of the Firm. He has managerial responsibility for the Firm’s private capital fund activities, and he serves as a Director of the Firm’s public holding company, Company 1. The Firm represents that Officer A is an MFP solely by virtue of his membership on the Firm’s Management Committee.3 The Firm represents that Officer A does not engage in the solicitation of any municipal securities business on behalf of the Firm; does not participate in any day-to-day activities related to the Firm’s public finance business; does not receive any compensation from the Firm based on the performance of the Firm’s public finance business; and has not received any such compensation since December 2003.
The Firm represents that, at the time of the contributions at issue, it maintained a detailed program to ensure compliance with MSRB Rule G-37, which included a pre-hire certification process for newly hired individuals, a quarterly political contributions certification for all MFPs, and a requirement that all political contributions be pre-approved in writing by Employee 1, the head of the Firm’s Public Finance Division. Employee 1 was responsible for day-to-day oversight of the Firm’s public finance underwriting and advisory business. The Firm states that, since enactment of Rule G-37 in 1994, Employee 1 has been the individual at the Firm responsible for reviewing and approving the Political Contribution Forms (“PCFs”) required of all MFPs for pre-approval of contributions to state or local officials.
The Firm represents that, in the spring of 2004, Officer A received a solicitation from a personal acquaintance to attend a fund-raising event to support the 2006 re-election campaign of Candidate 1, the Elected Official of State 1. In lieu of attending, Officer A sent a $200 donation, which he correctly first submitted to Employee 1 on a PCF for pre-approval and which Employee 1 pre-approved.4 Approximately one year later, Officer A received a similar solicitation for a fund-raising event for Candidate 1’s 2006 re-election campaign. Officer A completed a PCF for approval of a $250 contribution to the re-election campaign and properly noted on the PCF that he previously had made a political contribution to Candidate 1’s 2006 campaign. Employee 1 failed to note that Officer A previously had made a contribution to the same campaign and approved the contribution. On April 19, 2005, Officer A issued Candidate 1’s re-election campaign a check for $250. (This contribution triggered the two-year ban.) Approximately three months later, on July 12, 2005, Officer A completed another PCF and sought approval to make another $250 contribution to Candidate 1’s 2006 re-election campaign. Officer A again noted on the PCF that he previously had made a contribution to the campaign, and Employee 1 again failed to note the previous contribution when he reviewed and approved the PCF. Officer A issued a second $250 check to the 2006 re-election campaign for Candidate 1. Officer A’s total contributions in excess of $250 were $450. The Firm became subject to the two-year ban on municipal securities business involving State 1 and its agencies, school districts, and utilities on April 19, 2005, when Officer A made the second contribution to Candidate 1’s 2006 re-election campaign.5
The Firm failed to detect that Officer A’s second and third contributions to Candidate 1’s campaign had exceeded $250 until NASD conducted a routine examination of the Firm in September 2005. The Firm concedes that it inadvertently conducted municipal securities business subsequent to the commencement on April 19 of the ban on the Firm’s municipal securities business with State 1.
In May, 2005, the Firm executed an Underwriting Agreement for a transaction with the City 1 Airport Commission.6 The Firm acknowledges that its entrance into this transaction violated the two-year ban on municipal securities business. In June 2005, the Firm signed a second Underwriting Agreement for a transaction with the State 1 Housing Finance Agency.7 The Firm contends that, because it was unaware that it had triggered the two-year ban, it violated the ban unwittingly, and states that it is ready to disgorge net revenues from both transactions as a conditional undertaking to the NAC’s granting an exemption.
The Firm contends that, when it learned that it had triggered the two-year ban in September 2005, it promptly took remedial and preventative action. The Firm states that it notified Officer A and instructed him to request a return of $450 (the amount of his contribution in excess of the G-37 $250 limit) from Candidate 1’s campaign.8 The Firm states that it conducted a five-year review of all PCFs approved by Employee 1 and did not find any other errors. The Firm also contends that it modified and improved its Rule G-37 pre-clearance procedures to require all PCFs to undergo pre-approval review by both Employee 1 and a member of the Firm’s Office of General Counsel. The Firm states that it also implemented an electronic database for tracking PCFs in connection with the pre-clearance process so that each review of a PCF now is accompanied by a review of the printed record from the electronic database of all MFP contributions. Additionally, the Firm states that it revised its Rule G-37 quarterly certification form to more clearly inform its employees of the limitations on political contributions. The Firm contends that it disciplined Employee 1 and Officer A by requiring that they sign internal compliance memoranda acknowledging their responsibility for triggering the two-year ban.
Regulation Policy’s Denial
Regulation Policy denied the Firm’s request based upon several determinations. Regulation Policy concluded that the Firm’s repeated failure to detect Officer A’s contributions in excess of $250 demonstrated that the Firm had not developed and instituted procedures reasonably designed to ensure compliance with Rule G-37. Regulation Policy also determined that the Firm had actual knowledge of all three of Officer A’s contributions and that the Firm violated the municipal securities ban on two separate ocassions. Finally, Regulation Policy concluded that the Firm’s failure to discover its own rule violations prior to NASD’s intervention indicated that the Firm’s supervisory procedures were inadequate. Regulation Policy also concluded that the Firm’s subsequent remedial measures were not sufficient to justify granting the Firm an exemption from the municipal securities ban.
Based on the factors outlined below, we affirm Regulation Policy’s decision to deny the Firm an exemption from the two-year ban under Rule G-37.
The overall purpose of MSRB Rule G-37 is to protect the municipal securities markets from potential conflicts of interest connected to political contributions. See Exchange Act Rel. No. 33482, 1994 SEC LEXIS 152, at *6-7 (Jan. 14, 1994). “[P]olitical 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.” Id. The SEC and the MSRB concluded that the awarding of municipal securities business should be based on merit, not political contributions, and that the best way to maintain the competitiveness of the municipal securities markets for the benefit of the investing public is to ensure that the payment of political contributions does not become an artificial barrier to participation in the municipal securities markets. Id. For this reason, the MSRB adopted Rule G-37.
Turning to the factors for consideration listed in Rule G-37(i), we find that the procedures that the Firm had in place at the time of the contributions were not reasonably designed and implemented to ensure compliance with the rule, and that the Firm, through Employee 1, had notice of the contributions and should have detected that the G-37 ban had been triggered prior to NASD intervention. Furthermore, given that the election at issue was for one of the highest offices in the state in which the Firm conducts significant municipal securities business and the prominent position of Officer A in the Firm, we find that an exemption is not consistent with the public interest, the protection of investors, and the purposes of the rule to avoid actual and perceived conflicts of interest.
The Firm’s procedures, prior to and at the time of the contributions, were not reasonably designed and implemented to achieve compliance with Rule G-37. The Firm’s procedures essentially were to require all MFPs in the Firm to obtain pre-approval of all political contributions and to file quarterly reports regarding their political contributions. The Firm argues that its procedures were reasonably designed to ensure compliance with the rule and that the mere fact that there was one circumstance under which the Firm’s system failed does not translate necessarily into a finding that the Firm’s system was faulty. We disagree. We find that the Firm’s procedures and the Firm’s implementation of those procedures fell short of the minimum needed to ensure compliance with Rule G-37. The Firm’s system was deficient in large part because it relied on the assumption that the one individual responsible for reviewing all PCFs (Employee 1) would not err. The system included no back up plan or follow-up procedure to ensure that Employee 1’s review was accurate and complete. The record indicates that Officer A followed the Firm’s procedures and disclosed on the PCFs that he had made prior political contributions to the same candidate. Employee 1 nonetheless twice failed to detect that Officer A previously had donated to Candidate 1’s campaign and erroneously approved donations that triggered G-37’s ban. In a system such as the Firm’s in which the only stopgap is Employee 1’s review of the Firm’s PCFs, it would have been reasonable for the Firm to provide for a contingent review by another individual or some other form of secondary review that would have protected against human error. The Firm’s only supplemental review was quarterly reporting. Quarterly reporting, however, was not a satisfactory back up given that one MFP could contribute to one campaign several times during different quarters, thereby making it difficult for the Firm to rely on quarterly reporting as a secondary method for detecting contributions that trigger Rule G-37’s two-year ban.9 We find that the Firm’s procedures and its implementation of the procedures were deficient.
We also considered that the Firm, through Employee 1, the head of the Firm’s Public Finance Division, had notice of the contributions that triggered Rule G-37’s ban. The Firm nonetheless failed to discover the ban prior to NASD intervention and, on two occasions, violated the ban. The Firm argues that its failure to detect the implementation of the ban does not necessarily demonstrate that the Firm’s procedure were inadequate. We find that the Firm’s failure in this regard highlights the need for the Firm to have buttressed its compliance procedures by providing for some review in addition to Employee 1’s review of the Firm’s PCFs. A firm’s ability to discover on its own contributions that result in a ban is a key aspect of a firm’s overall diligence in complying with Rule G-37. In our view, the Firm’s system should have been more robust and should have included alternative methods of detection to ensure the Firm’s compliance with Rule G-37.
We also considered the position of the MFP making the contribution. The Firm argues that Officer A’s motivation in making these donations was not to benefit the Firm but was based solely on personal political beliefs. We accept the Firm’s explanation. We find, however, that Officer A’s lack of malevolent motivation is outweighed by the overriding regulatory interest in ensuring that the Firm prudently adheres to the requirements of Rule G-37. The Firm is a major figure in State 1’s municipal securities business and in the business community of the region. Officer A has been a prominent executive of the Firm for an extended period. Both the Firm and Officer A should have been keenly aware of the pay-to-play restrictions in Rule G-37 and the possible economic hardship that could result to the Firm from anyone triggering a ban on the Firm’s municipal business with State 1. Officer A should have established a high standard for Firm employees to follow. Rather, he personally contributed donations that exceeded the $250 limit.
Employee 1 also held a high profile position at the Firm as the head of the Firm’s Public Finance Division since 1994. He too should have appreciated the importance of carefully reviewing the Firm’s PCFs to ensure Rule G-37 compliance. Lapses by two senior officials, Officer A in contributing more than $250 to Candidate 1’s campaign in one election cycle and Employee 1 in failing to review Officer A’s PCFs carefully, are significant. As senior members of management, their conduct should have set an example for other members of the Firm. Instead, they demonstrated a lackadaisical approach to an important MSRB rule. This supports our determination to deny the Firm’s exemption request.
Furthermore, we considered the nature of the election at issue. Officer A contributed to the incumbent for one of the highest offices in State 1. It should be apparent that this elected official of this state would most likely be considered to be an officer of the issuer for debt issuances of the state and its agencies, school districts, and utilities. Given the Firm’s connections to State 1, the potential repercussions to the Firm of donations to the Elected Official’s campaign should have been obvious to Officer A and Employee 1. Yet neither ensured the Firm’s compliance with Rule G-37. In our view, the nature of the election at issue further supports our determination to deny the Firm’s exemption request.
We find that, although several factors weigh in favor of granting the Firm an exemption, overall the Firm has not carried its burden of satisfying the requirements for an exemption from Rule G-37. For example, the Firm represents that, upon discovery of the G-37 ban, it took prompt, remedial action. We agree that the Firm’s enhanced procedures are an improvement over the prior procedures that the Firm had in place and qualify as prompt, remedial action. In addition, the Firm also represents that Officer A obtained a refund of his contributions from Candidate 1’s campaign. We acknowledge that this factor weighs in favor of granting an exemption. We do not conclude, however, that these factors outweigh the overriding regulatory importance of prudent adherence to the requirements of Rule G-37.
MSRB Rule G-37’s two-year prohibition serves the public interest by attempting to ameliorate actual and perceived conflicts of interest that may arise when MFPs make political contributions to officials who can direct an issuer’s municipal finance business to the MFP’s firm. The appearance of a potential conflict of interest is particularly germane here given the high profile of Officer A, the Firm’s history in the public debt market for State 1, and the fact that the donations at issue were to one of the highest offices of the state. Furthermore, the Firm had in place at the time of the donations procedures that were not reasonably designed to ensure compliance with Rule G-37, and the Firm failed on its own to detect the contributions that triggered the ban. For these reasons, we affirm Regulation Policy’s denial of the Firm’s Rule G-37 exemption request.
Very truly yours,
Barbara Z. Sweeney
1 Pursuant to MSRB Rule G-37, the Firm currently is subject to a two-year ban on certain municipal securities business. The Firm seeks an exemption from the ban.
2 MSRB Rule G-37(g) defines municipal securities business as: (A) the purchase of a primary offering of municipal securities from the issuer on other than a competitive bid basis; (B) the offer or sale of a primary offering of municipal securities on behalf of any issuer; (C) the provision of financial advisory or consultant services to or on behalf of an issuer with respect to a primary offering of municipal securities in which the dealer was chosen to provide such services on other than a competitive bid basis; or (D) the provision of remarketing agent services to or on behalf of an issuer with respect to a primary offering of municipal securities in which the dealer was chosen to provide such services on other than a competitive bid basis.
3 MSRB Rule G-37 defines MFP to include: (1) an associated person primarily engaged in municipal securities representative activities; (2) an associated person who solicits municipal securities business; (3) an associated person who is both a municipal securities principal or sales principal and a supervisor of individuals identified in parts (1) and (2); (4) an associated person who is a supervisor of any person described in part (3); and (5) an associated person who is a member of the dealer’s executive or management committee or similarly situated officials.
4 Officer A was eligible to vote for Candidate 1. This initial $200 contribution therefore did not trigger MSRB Rule G-37’s two-year ban on the Firm’s municipal securities business involving State 1.
5 MSRB Rule G-37(g) defines the term “official of an issuer” as any person (including any election committee for such person) who was, at the time of the contribution, an incumbent, candidate or successful candidate: (A) for elective office of the issuer which office is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by the issuer; or (B) for any elective office of a state or of any political subdivision, which office has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by an issuer. The Firm does not dispute that Candidate 1 was an official of State 1 and its agencies, school districts, and government utilities.
6 The City 1 Airport Commission is not an agency of State 1, but the Elected Official of State 1 has appointment authority for certain members of the Board of Directors of the Airport Commission. The Firm therefore does not dispute that the Elected Official of State 1 would be considered an “official of the issuer,” as that term is defined in Rule G-37.
7 The State 1 Housing Finance Agency is an agency of State 1, and the Firm did not dispute that the Elected Official of State 1 would be considered an “official of the issuer,” as that term is defined in Rule G-37.
8 Officer A complied, and Candidate 1’s campaign returned $500 to Officer A in October 2005.
9 In this case, Employee 1 improperly approved Officer A’s second and third $250 donations to Candidate 1’s campaign because he failed to note that Officer A had indicated on the PCF that he previously had donated to the campaign. Employee 1’s errors were compounded by the fact that the three donations, none of which exceeded $250, occurred in three different quarters. Thus, the quarterly reports did not help the Firm to detect that Officer A had triggered Rule G-37.