affiliated business entities; compensation arrangements; and
proprietary interests in municipal advisor client transactions.\63\
While some overlap could exist, the MSRB believes that the SEC forms do
not solicit all of the information that would be required by the
proposed rule change and, thus, would not serve as a sufficient
substitute. Specifically, the SEC forms would not be a viable proxy for
disclosing potential conflicts of interest that the municipal advisor
could have, nor would the forms contain an explanation of how they
intend to mitigate the material conflicts of interest that they
disclose. The MSRB expects that the written disclosure of material
conflicts of interest will be a useful tool to municipal advisor
clients that will allow them to readily assess the impact of actual or
potential conflicts of interest of potential or ongoing municipal
advisory activities.
---------------------------------------------------------------------------

    \63\ See SEC Form MA, Items 1.K., 4.H.-4.J. and 7.A.-7.F.,
respectively.
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    In response to the Second Request for Comment, SIFMA requested
clarification regarding the standard for determining the materiality of
the conflicts of interest described in paragraphs (b)(i)(A) and (G),
and when disclosure is required. Under the Revised Draft Rule,
paragraphs (b)(i)(A) and (G) required municipal advisors to disclose
``any . . . potential conflicts of interest . . . that might impair'' a
municipal advisor's advice or its ability to provide advice in
accordance with section (a) of Proposed Rule G-42. The language in
these paragraphs concerned certain commenters, such as SIFMA, because
they believed that such a standard would include nearly all imaginable
conflicts of interest and result in overly broad disclosure that could
distract from the provision's purpose. Therefore, to clarify, the MSRB
has amended these paragraphs to state that disclosure is required, in
paragraph (A) for ``any actual or potential conflicts of interest,''
and, in paragraph (G), for ``any other engagements or relationships.''
The MSRB believes that this revised language would more clearly
establish a limiting, objective standard for disclosing certain
conflicts of interest that would be relevant to a municipal advisor's
client.
    Further, paragraphs (b)(i)(A) and (G), as proposed, are revised to
limit the disclosure of conflicts required under paragraphs (b)(i)(A)
and (G) to those that potentially impact the advisor's ability to
provide ``advice to or on behalf of the client in accordance with the
standards of conduct of section (a) of this rule, as applicable.''
Previously, under the Revised Draft Rule, paragraphs (b)(i)(A) and (G)
required a municipal advisor to provide disclosure of conflicts of
interest that ``might impair its ability either to render unbiased and
competent advice to'' its clients. This revision was made after re-
evaluation of the phrasing used in the paragraphs and consideration of
comments received from Sanchez. Sanchez stated that the use of the
phrase ``unbiased and competent advice'' in the Revised Draft Rule ``.
. . appear[s] to import the duty of loyalty and duty of care into the
representations of obligated persons. . . .'' The MSRB agrees that the
use of the phrasing ``unbiased and competent advice'' does not
encompass all of the duties municipal advisors owe their clients, nor
would it sufficiently differentiate between the standards of conduct
owed by municipal advisors to their municipal entity clients and
obligated person clients. The MSRB believes that the revised standard
for identifying material conflicts of interest under proposed
paragraphs (b)(i)(A) and (G) will more clearly reflect the standards of
conduct in proposed section (a) and appropriately differentiate between
municipal entity and obligated person clients.
    In response to the Second Request for Comment, Sanchez also
suggested a revision to clarify the last sentence of subsection (b)(i)
of the Revised Draft Rule. Sanchez suggested deleting the term
``written documentation'' and using ``written statement'' instead to
clarify for municipal advisors the action required to comply with
subsection (b)(i). To remove any ambiguity, the MSRB has revised
proposed subsection (b)(i) to clarify that, when appropriate, a
municipal advisor must provide a ``written statement'' that the
municipal advisor has no known material conflicts of interest.
    Columbia Capital requested clarification regarding whether the
disclosures required by the Revised Draft Rule may be made in more than
one document. The required disclosures indeed may be provided to
clients in more than one document, as long as the document and its
delivery otherwise comply with the proposed rule. Because the language
of the proposed rule is not to the contrary, the MSRB has not made any
revisions in response to this comment.
    FSR commented that use of the term ``indirectly'' in paragraph
(b)(i)(B) in the Revised Draft Rule, which required disclosure of ``any
affiliate of the municipal advisor that provides any advice, service,
or product to or on behalf of the client that is directly or indirectly
related to the municipal advisory activities to be performed by the
disclosing municipal advisor,'' expanded the scope of the required
disclosures unnecessarily and would make compliance difficult for a
municipal advisor that is part of a large multi-service financial
conglomerate. FSR believed that the Revised Draft Rule did not provide
municipal advisors with sufficient guidance to identify activity that
could be indirectly related to municipal advisory activities, and,
taken in its plain meaning, could lead to a substantial burden on firms
having numerous affiliates that provide a wide array of services. After
further consideration of the purpose and intent of the proposed
paragraph, the MSRB has removed the clause ``or indirectly.'' The MSRB
believes revised proposed paragraph (b)(i)(B) will provide the

appropriate notice to clients of the relationships of any affiliates of
the municipal advisor that are likely to present material conflicts of
interest.
Disclosure of Legal or Disciplinary Events
    Several commenters addressed the draft requirements to disclose
legal or disciplinary events. FSR commented that subsection (b)(ii) of
the Revised Draft Rule would require a separate written disclosure of
legal or disciplinary events that is redundant of the requirements of
subsection (c)(iii) of the Revised Draft Rule. FSR requested that
``these disclosure requirements be deemed satisfied if an advisor
provides information about where clients may access electronically the
advisor's most recent [SEC] Forms MA and MA-I, along with the date of
the last material amendment to any legal or disciplinary event
disclosure on such forms.'' SIFMA, in response to the Second Request
for Comment, similarly stated that requiring ``[duplicative] disclosure
of specific events that are already disclosed in [SEC] Forms MA and MA-
I provides little, if any, benefit to municipal entities or obligated
persons, while it imposes unnecessary additional burdens on municipal
advisors.'' SIFMA suggested that providing clients with the information
regarding how to obtain electronic access to a municipal advisor's
legal and disciplinary history on SEC Forms MA and MA-I should suffice.
Sanchez stated, regarding the Revised Draft Rule, that ``[t]his
requirement appears to be overly burdensome . . . , [and] it should be
sufficient for purposes of this rule that a municipal advisor be
required to direct clients to their EDGAR filings by providing clients
with sufficiently specific information to locate their EDGAR filings.''
\64\
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    \64\ In response to the First Request for Comment, Sutherland
suggested that there is sufficient disclosure about disciplinary
history provided in a municipal advisor's SEC Forms MA and MA-I
filed with the SEC, and Parsons stated that disclosure should not be
required in the rule given such public disclosure on those forms.
Similarly, Lewis Young and NAIPFA believed the disclosure of legal
or disciplinary events would be duplicative and unnecessarily
burdensome and also suggested that municipal advisors should be able
to satisfy the requirement by referencing SEC Forms MA or MA-I.
---------------------------------------------------------------------------

    The MSRB contemplated that municipal advisors would be able to
satisfy their disclosure of legal and disciplinary events under
sections (b) and (c) of the Revised Draft Rule with specific reference
to the relevant portions of their most recent SEC Forms MA or MA-I
filed with the Commission. Proposed Rule G-42(b)(ii) further clarifies
this intention, and requires the municipal advisor to provide detailed
information specifying where the client may electronically access such
forms. The MSRB believes this approach will address the issue of
duplicative disclosure of the disciplinary and other legal events
contained in SEC Forms MA and MA-I. This revision also clarifies that
municipal advisors may satisfy the disclosure requirements of
subsections (b)(ii) and (c)(iii) in a similar fashion.
    A municipal advisor could, conceivably, simultaneously satisfy the
requirements of proposed subsections (b)(ii) and (c)(iii) in one
document if it were provided to the client prior to or upon engaging in
municipal advisory activities for the client. However, if combined
written disclosure and relationship documentation were made after a
municipal advisor engages in municipal advisory activities, the
municipal advisor would only be in compliance with proposed subsection
(c)(iii) and not subsection (b)(ii).
    SIFMA also suggested that subsection (c)(iv) of the Revised Draft
Rule should be removed. The subsection would require municipal advisors
to document the date of the last material change, including any
addition, to the legal or disciplinary event disclosures on any SEC
Form MA or MA-I filed with the Commission. Specifically, SIFMA believed
that requiring municipal advisors to update their written disclosures
and documentation with each of their municipal advisory clients
whenever a material change to a legal or disciplinary event was made to
any SEC Forms MA or MA-I would be unjustified.
    Proposed section (c) requires the documentation of the municipal
advisory relationship to be promptly amended or supplemented to reflect
any material changes or additions, and requires the amended
documentation or supplement to be promptly delivered to the municipal
entity or obligated person client. However, the MSRB does not believe
the update requirement under proposed section (c) is overly burdensome
because municipal advisors need only provide the date of the last
material change, including any addition, to their legal or disciplinary
event disclosure to their clients, as they would be permitted to
reference their SEC Forms MA and MA-I for the details of such material
changes. Additionally, the required documentation of the municipal
advisory relationship could be satisfied through the use of more than
one writing and updates or amendments to such documents could be
additional, separate writings that either amend or supplement earlier
writings. The MSRB believes these accommodations sufficiently address
the concern that municipal advisors would be required to amend and
redistribute a single writing every time a material change or addition
needed to be included. Further, the MSRB believes that, by requiring
municipal advisors to update the written documentation relating to
legal or disciplinary event disclosures provided to municipal entities
and obligated persons, proposed subsection (c)(iv) would help ensure
that those clients have sufficient, accurate and current information to
better inform their decisions to engage and/or continue engaging a
municipal advisor. The MSRB notes that the requirements of proposed
section (c) must be made in writing and delivered to the municipal
advisor's client in accordance with the duty of care and, as
applicable, the duty of loyalty.
    Coastal, Kutak and Parsons objected to the Initial Draft Rule's
requirement to disclose the legal and disciplinary events for all
individuals at a municipal advisory firm for which the firm is required
to submit an SEC Form MA-I. They suggested that municipal advisors
should not be required to disclose to a client legal and disciplinary
events that relate to an individual that is employed by the municipal
advisor, if that individual is not a part of (or reasonably expected to
be a part of) the advisor's team working for the client. Although there
could be numerous municipal advisors with large numbers of employees,
as Coastal indicated, the MSRB believes there is insufficient cause to
narrow the requirement of this disclosure obligation. Specifically, the
MSRB notes that, although all of a municipal advisor's employees might
not be a part of the team working on a particular client matter, the
number of employees with legal or disciplinary events that a municipal
advisor employs and the nature of any past legal or disciplinary events
related to those employees could be material to the client's evaluation
of the municipal advisor or the integrity of its management or advisory
personnel. In any event, since a municipal advisor could satisfy
Proposed Rule G-42(b)(ii) and (c)(iii) by providing information
specifying where the client can electronically access SEC Forms MA and
MA-I, there would be little additional burden imposed on municipal
advisors by leaving the scope of these requirements unchanged.

Type of Writing(s) Required To Document the Municipal Advisory
Relationship
    Several commenters discussed the matter of documenting the
municipal advisory relationship and the type of writing that should be
required to evidence the municipal advisory relationship between the
municipal advisor and its client.
    FLA DBF, correctly recognizing that the Revised Draft Rule's
reference to a ``writing'' does not require a written contract,
suggested that the proposed rule change should be amended to require
municipal advisors to enter into written contracts with their municipal
entity clients regarding their municipal advisory relationships. In
contrast, GFOA, while also correctly recognizing that the Revised Draft
Rule does not require a written contract, supported the absence of a
contract requirement. GFOA noted that although entering into a
bilateral contract is a GFOA best practice, ``there may not always be a
need for a specific contract.'' GFOA agrees with the MSRB that the
municipal advisory relationship should be stated in writing as it would
allow the issuer to clearly delineate the scope of work it intends its
municipal advisor to provide.
    A number of other commenters, including ABA, BDA, ICI, Lewis Young,
MSA, NAIPFA and SIFMA, however, construed section (c) of the proposed
rule as requiring a written contract, leading them to raise various
concerns about the proposed rule applying to existing contracts that
might need to be revised. As a result, these commenters suggested the
inclusion of various kinds of transitional rule provisions to address
these issues. ABA and Lewis Young, for example, requested a
transitional provision to permit advisors to honor their existing
agreements with their clients until they expire. ICI recommended that
the MSRB clarify that, if approved, Proposed Rule G-42 would only apply
prospectively. SIFMA requested that the MSRB limit or eliminate the
need for municipal advisors to re-document their municipal advisory
relationships and apply the disclosure requirements of the proposed
rule only to future agreements. MSA requested guidance on whether the
obligations of section (c) of Proposed Rule G-42 could be satisfied by
a contract (such as a Master Services or Professional Services
Agreement) between the municipal advisor and its client.
    The documentation requirement of section (c) of Proposed Rule G-42,
as with the Revised Draft Rule, would not require the creation of new
contractual relationships or the modification of existing contracts or
agreements between municipal advisors and their clients. The purpose of
the requirement is to help ensure that certain terms of each municipal
advisory relationship would be reduced to writing and delivered to the
municipal advisor's municipal entity or obligated person client. So
long as the content of the documentation adheres to the requirements of
the proposed rule (including the standards of conduct in section (a)),
municipal advisors and their clients have some latitude in deciding the
exact form the documentation and writing might take. If municipal
advisors have already delivered documentation meeting some or all of
the requirements of proposed section (c), then municipal advisors would
be able to rely on such documents to satisfy some or all of their
obligations under section (c). While certainly permitted, the proposed
rule would not require municipal advisors to enter into written
contracts with their municipal entity or obligated person clients and
municipal advisors could satisfy the requirements of provision (c) by
providing separate or supplemental documents to any preexisting
contract, agreement or writing previously provided that might be in
place between the municipal advisor and its client. The relevant part
of proposed section (c) has been further revised to delete the phrase
``enter into'' (which could have connoted the formation of a contract)
and reads as follows: ``A municipal advisor must evidence each of its
municipal advisory relationships by a writing or writings created and
delivered to the municipal entity or obligated person client prior to,
upon or promptly after the establishment of the municipal advisory
relationship.'' The MSRB believes that requiring the documentation to
take the form of a bilateral contract would be unnecessary and could
lead to some of the burdensome consequences identified by commenters.
The amendments to the Revised Draft Rule should clarify that municipal
advisors would not be required to alter or re-execute any existing
contract and that, in the future, the documentation and disclosure
requirements could be satisfied in writings that are either included in
a contract or separate and independent of any contract entered into
between the municipal advisor and its municipal entity or obligated
person client.
    In response to the First Request for Comment, BDA and GKB stated
that they generally supported the documentation and disclosure
requirements of section (c) of the Initial Draft Rule but believed,
with respect to municipal financial products, that a ``written
agreement'' (as they believed was required by section (c)) should only
be required when municipal advisory activities are engaged in for
compensation. Based on their comments, it appears that BDA and GKB
understood section (c) to implicitly require the municipal advisor and
its client to evidence their municipal advisory relationship with a
bilateral contract. NAIPFA, in its response to the Initial Draft Rule,
asked the related question: ``Does this mean that the writing must be a
two party agreement?'' NAIPFA also suggested that the MSRB amend
section (c) to allow municipal advisors to satisfy the requirements of
the section through an engagement letter. As previously stated, section
(c) would not require, or preclude the use of a bilateral contract or
engagement letter to evidence the municipal advisory relationship. So
long as the content adheres to the requirements of Proposed Rule G-42
(including the standards of conduct of section (a)), municipal advisors
and their clients would have some latitude in deciding the exact form
the documentation and writings might take.
    NAIPFA expressed concerns regarding the amount of information that
would be required to be included in the documentation required by
section (c), stating that municipal advisors would be put at a
``significant competitive disadvantage to their [underwriting]
counterparts . . . [because] underwriters are not mandated to include
any particular contract-related terms within their engagement letter,
such as clauses relating to the termination of the relationship or
their obligations relating to certain aspects of the transaction . . .
.'' The MSRB does not believe the proposed documentation requirement
would result in the competitive disadvantages described by NAIPFA.
First, underwriters are required to make similar disclosures to issuers
of municipal securities under MSRB's fair dealing rule, Rule G-17,
which includes certain disclosures regarding the underwriter's
compensation. Second, to the extent any of the requirements of section
(c) are included in a written agreement, contract, engagement letter or
similar document already in possession of the client, such information
would not need to be included in a separate writing delivered to the
municipal advisor's client. Instead, municipal advisors would be

able to supplement existing writings to comply with section (c).
Finally, because a municipal advisor generally would be prohibited from
acting as an underwriter for a transaction directly related to the same
municipal securities transaction or municipal financial product as to
which the municipal advisor is providing or has provided advice, the
MSRB believes it would be unlikely that a municipal advisor would be in
direct competition with an underwriter as suggested by NAIPFA.
    In response to the Initial Draft Rule, ICI suggested that section
(c) be revised to specify that only material changes to the information
provided in the documentation required by section (c) would trigger the
updating requirement. The MSRB did not intend by section (c) to require
the supplementation of immaterial information and section (c) of the
proposed rule has been revised to provide this clarification.
Triggering the Documentation Required by Section (c)
    Under the Initial Draft Rule, a municipal advisor would have been
required to evidence each of its municipal advisory relationships by a
writing entered into prior to, upon or promptly after the inception of
the municipal advisory relationship. In response to the First Request
for Comment, Northland commented that section (c) of the Initial Draft
Rule should require that the documentation be in place prior to
engaging in municipal advisory activities rather than being permitted
to be created and provided subsequently (i.e., after the establishment
of a municipal advisory relationship (as defined by the Initial Draft
Rule)). Northland opined that its approach would align the proposed
rule change with analogous requirements and principles of the SEC Final
Rule. Northland also argued that earlier documentation of the municipal
advisory relationship is warranted for the same reasons it believes
justify the proposed rule change's requirement to disclose conflicts of
interest upon or prior to engaging in municipal advisory activities.
The MSRB has considered when municipal advisors should be required to
document their relationship with their clients and determined that
documentation should only be required after both parties have agreed
that the municipal advisor would engage in municipal advisory
activities for or on behalf of the client. It is understood by the MSRB
that a municipal advisor could engage in municipal advisory activities
while seeking an engagement to perform municipal advisory activities
but then might ultimately not be engaged by the client. Also, in some
instances, a municipal advisor could be called upon to engage in
municipal advisory activities on behalf of its client on short notice
for a time-sensitive matter. In such scenarios, the MSRB does not
believe it would be appropriate, or necessary, to require documentation
of the municipal advisory relationship because, as with the first case,
there is a reasonable possibility that no municipal advisory
relationship would materialize and, with regard to the second, the MSRB
does not want to inhibit a municipal advisor from performing its
municipal advisory activities for municipal entities and obligated
persons when time is short and documenting the municipal advisory
relationship might not be feasible. The MSRB believes that, when
balanced against the potential benefits of requiring earlier
documentation of the municipal advisory relationship, the timely
disclosure of material conflicts of interest (in accordance with
section (b) of Proposed Rule G-42) will sufficiently mitigate the
potential consequences identified by Northland and will serve as
sufficient protection to a municipal advisor's client to make an
informed decision about whether to accept the advice provided by the
municipal advisor until such time that documentation containing the
information required by section (c) can be created and delivered.
    On a separate but related matter, Northland stated that the use of
the term ``municipal advisory relationship'' would likely lead to
confusion between how Northland believes the term is used by municipal
advisors and other industry participants and how the term had been
defined for purposes of the Initial Draft Rule. Northland believed that
it would be difficult for municipal advisors to parse apart and
document ``municipal advisory relationships'' when some of those
relationships are ``historical and ongoing'' and are rarely thought of
as separate relationships. The MSRB believes that the definition
provided in Proposed Rule G-42(f)(vi) would provide sufficient guidance
to municipal advisors in this regard. That provision would state that a
municipal advisory relationship is deemed to exist when a municipal
advisor enters into an agreement to engage in municipal advisory
activities for a municipal entity or obligated person and ends on, the
earlier of, the date on which the municipal advisory relationship has
terminated pursuant to the terms of the documentation of the municipal
advisory relationship, or the date on which the municipal advisor
withdraws from the municipal advisory relationship.
    In response to the Second Request for Comment, Piper Jaffray, while
generally supportive of the documentation requirement of section (c) of
the Revised Draft Rule, expressed concern that it could require
premature documentation of a municipal advisory relationship.
Specifically, Piper Jaffray stated that section (c) could require
documentation when the municipal advisor has not been selected by its
client to be its municipal advisor and, instead, is, in fact, engaging
in municipal advisory activities as a means to obtain the engagement
with the client to perform municipal advisory activities. Section (c)
of the Revised Draft Rule, however, explicitly stated that the
documentation requirement would only be triggered ``prior to, upon or
promptly after the establishment of the municipal advisory
relationship'' (emphasis added). As defined in subsection (f)(vi), a
municipal advisory relationship would only be deemed to exist when the
``municipal advisor enters into an agreement to engage in municipal
advisory activities for a municipal entity or obligated person.'' Thus,
Proposed Rule G-42 would not necessarily require the provision of
relationship documentation during an early stage of municipal advisory
activities when the municipal advisor is still pursuing an engagement
to perform municipal advisory activities.
Other Comments Regarding the Documentation Requirement
    Consolidation. In response to the Revised Draft Rule, Piper Jaffray
suggested that the disclosure and documentation requirements of
sections (b) and (c) could be more clearly established if the sections
were merged. In particular, Piper Jaffray found it confusing that a
municipal advisor providing ``advice,'' but that has not yet been
engaged by an issuer, must provide disclosures related to its
compensation under paragraph (b)(i)(F). Piper Jaffray then posed the
question: ``[I]s the intention of the [MSRB] to assure that municipal
advisors must provide conflicts disclosure when providing information
that would constitute `advice' prior to [being] engaged[?]'' Piper
Jaffray suggested that the intention and purpose of the proposed rule
change could be better served if the required disclosures and
documentation of the municipal advisory relationship were provided when
the advisor is selected by the issuer to provide it with advice.
    The MSRB has considered Piper Jaffray's recommendation to merge

sections (b) and (c) and modify the timing of the disclosure
requirement, but believes such amendments would conflict with the
intention of having municipal advisors disclose conflicts of interest
upon or prior to engaging in municipal advisory activities for the
client. Combining the paragraphs could cause municipal advisors to
delay making the proposed rule's required disclosures until the
municipal advisory relationship has been reduced to writing, which
could be a significant amount of time after the client has received,
and potentially acted on, advice from the municipal advisor. For these
reasons, the suggested changes are not included in Proposed Rule G-42.
    Indirect Compensation and Treatment of Incidental Informal Advice.
Regarding the documentation of the municipal advisory relationship,
SIFMA requested that Proposed Rule G-42 include a definition of
``indirect compensation'' as it is used in subsection (c)(i). On a
related topic, SIFMA requested that the MSRB ``clarify that informal
advice that is incidental to providing brokerage/securities [services]
would not, alone, trigger a written documentation requirement under
[section (c) of the Revised Draft Rule] . . . .''
    The MSRB believes that additional clarification within the proposed
rule change is not necessary because the phrase ``indirect
compensation'' is widely used and understood in the municipal advisory
and securities industry and is well established in securities statutes
and jurisprudence. Providing a definition of ``indirect compensation''
within Proposed Rule G-42 might reduce clarity regarding the general
understanding of the phrase and lead to unnecessary confusion in an
instance where sufficient guidance is already available.
    Regarding SIFMA's request pertaining to advice that is incidental
to providing brokerage/securities services, the MSRB notes that the
proposed rule change would apply to a scope of municipal advisory
activities as defined in the SEC Final Rule. Whether certain activities
constitute ``advice'' under the SEC Final Rule is a legal
interpretation within the authority of the SEC, and not the MSRB, to
make.
Recommendations and Review of Recommendations of Other Parties
    Section (d) of Proposed Rule G-42 would provide that if a municipal
advisor makes a recommendation of a municipal securities transaction or
municipal financial product to its client, the municipal advisor must
determine, based on the information obtained through reasonable
diligence, whether the transaction or product is suitable for the
client. Section (d) also would contemplate that a municipal advisor
could be asked to evaluate a recommendation made to its client by
another party, such as a recommendation by an underwriter of a new
financing structure or a new financial product. Section (d) would
require municipal advisors to conduct a suitability analysis--when
requested by the client and within the scope of the engagement--of the
recommendations of these third parties, guided by the requirements and
principles contained in relevant portions of the supplementary material
(such as paragraphs .01, .08 and .09).
    Commenters raised a number of issues with section (d) of Proposed
Rule G-42 (sections (d) and (e) of the Initial Draft Rule) and the
related paragraphs .01 (Duty of Care), .08 (Suitability) and .09 (Know
Your Client) of the Supplementary Material to Proposed Rule G-42. Below
is a summary of, and response to, these comments.
General Comments Regarding Section (d)
    In response to the Second Request for Comment, NAIPFA and GFOA
expressed their general support for the Revised Draft Rule's
suitability standard of section (d) of Proposed Rule G-42. NAIPFA
believed it appropriately reflects a municipal advisor's fiduciary
duties to its municipal entity clients.
    Compliance and Examination. BDA, in response to the Second Request
for Comment, expressed its support of the Revised Draft Rule's
requirement to have municipal advisors review recommendations of other
parties, but requested specific guidance on how municipal advisors
would develop reasonable policies to comply with section (d). BDA also
expressed concern about how FINRA examiners would test a dealer's
compliance with the requirements of section (d) when serving as a
municipal advisor.
    The MSRB believes it has provided sufficient guidance to municipal
advisors about the principles and requirements that should inform, and
be incorporated in, a municipal advisor's policies and procedures by
identifying the matters in the proposed rule text (such as in
subsections (d)(i)-(iii) and paragraphs .01, .08 and .09 of the
Supplementary Material) that a municipal advisor must, as applicable,
consider when forming its advice or recommendation. The MSRB recognizes
the diversity of the population of municipal advisors and the municipal
advisory activities in which they engage in and believes the primarily
principles-based approach taken by the proposed rule change will
accommodate that diversity. The MSRB also believes this approach will
clearly establish the minimum requirements and principles, which
financial regulators could then consistently apply in their examination
of municipal advisors.
    Updating Recommendations. In response to the Second Request for
Comment, SMA requested that the MSRB clarify that the suitability of a
recommendation would be determined by the facts and circumstances at
the time a client enters into the municipal securities transaction and
that the municipal advisor should not have continuing responsibility to
update its determination.
    The MSRB believes that whether advice given or recommendations made
by municipal advisors would need to be updated would depend on the
facts and circumstances surrounding the advice and recommendation,
including, but not limited to, the scope of the services that the
municipal advisor agreed to provide its client. The MSRB believes that
the reasonableness of a municipal advisor's recommendation or advice
would be determined by considering the information relied upon by, and
available to, the municipal advisor at the time the recommendation is
made or advice is given to its client. However, over the course of an
ongoing municipal advisory relationship, it is possible that a
municipal advisor would, as part of its duty of care, need to apprise
its client of changes to the suitability of the advice or
recommendation it had previously given. In such cases, a municipal
advisor's responsibilities would depend upon the facts and
circumstances and the parameters of its municipal advisory
relationship. The MSRB believes that the proposed rule change will
provide municipal advisors with the requisite guidance to comply with
its requirements.
    Third-Party Recommendations. Lamont and First Southwest, in
response to the First Request for Comment, requested clarification
regarding whether a municipal advisor must review any third-party
recommendation related to the advice that the municipal advisor has
agreed to provide.
    Proposed Rule G-42 would require municipal advisors to review a
third-party recommendation when such a review is within the scope of
the engagement between it and its client or if such a review would be
part of the reasonable diligence required to reasonably determine
whether a recommendation or advice is suitable

for its client. Therefore, a municipal advisor's obligation to review
third-party recommendations would depend on the facts and circumstances
of each particular instance. The MSRB believes that section (d) and the
relevant portions of the supplementary material of the proposed rule
change will provide sufficient guidance to municipal advisors presented
with such scenarios.
    Informing Client of Matters Related to Review of Recommendation. In
response to the First Request for Comment, Northland commented that the
Initial Draft Rule's requirement that municipal advisors must, under
section (d), discuss matters such as the material risks of a
recommendation and the basis upon which the municipal advisor
reasonably believes its recommendation is suitable for its client would
encourage written documentation of such discussions and create the
potential for conflict between the information provided by the
municipal advisor and the actions ultimately taken by the client. It
appears that Northland's concern is that a municipal advisor could be
exposed to liability in an ex post review of its suitability analysis.
    The MSRB received other comments related to the Initial Draft
Rule's requirement that municipal advisors must discuss these matters
with their clients. In response, the Revised Draft Rule included a
modification that required municipal advisors to inform their clients
of the matters specified in proposed section (d). The modification was
made to grant some flexibility to municipal advisors in the manner in
which the matters are delivered to their clients. The MSRB understands
that a municipal advisor's client could elect to engage in a course of
action that deviates from the municipal advisor's recommendation. For
purposes of compliance with section (d), however, a client's decision
to disregard its municipal advisor's recommendation would alone have no
bearing on whether the municipal advisor conducted an adequate analysis
of the recommendation it provided. An examination for compliance with
section (d) would focus on the adequacy of the suitability analysis
provided by the municipal advisor, not whether the client ultimately
pursued the municipal advisor's recommendation.
    Limiting Duty to Review Recommendations of Others. In response to
the First and Second Request for Comment, NAIPFA stated that, when a
municipal entity or obligated person has engaged an independent
registered municipal advisor \65\ and is also obtaining advice from a
third party that is relying upon the independent registered municipal
advisor exemption from the SEC registration requirement \66\ to provide
advice to the municipal entity or obligated person, the independent
registered municipal advisor should not be permitted to limit the scope
of the engagement with its client so as not to include the review of
recommendations made by the third-party.
---------------------------------------------------------------------------

    \65\ See SEC Rule 15Ba1-1(d)(3)(vi) (17 CFR 240.15Ba1-
1(d)(3)(vi)). ``Independent registered municipal advisor'' is
defined in SEC Rule 15Ba1-1(d)(3)(vi)(A) (17 CFR 240.15Ba1-
1(d)(3)(vi)(A)).
    \66\ See SEC Rule 15Ba1-1(d)(3)(iv) (17 CFR 240.15Ba1-
1(d)(3)(iv)).
---------------------------------------------------------------------------

    The MSRB has considered, yet disagrees with, NAIPFA's position. The
MSRB believes that municipal advisor clients, with the agreement of the
municipal advisor, should be able to define the scope of their
municipal advisory relationships and thus determine what services the
municipal advisor will provide. Furthermore, requiring municipal
advisors to review all third-party recommendations could result in a
costly burden to municipal entities and obligated persons that do not
expect to derive sufficient value from such review. However, the MSRB
acknowledges that limiting the scope of the engagement between a
municipal entity or obligated person and its independent registered
municipal advisor could affect a third party's ability to qualify and
make use of exemptions discussed in the SEC Final Rule, including the
exemption mentioned by NAIPFA.\67\
---------------------------------------------------------------------------

    \67\ 17 CFR 240.15Ba1-1.
---------------------------------------------------------------------------

Request for Definition of ``Independent'' as Used in Paragraph .03 of
the Supplementary Material
    BDA, in response to the First Request for Comment, requested that
the MSRB define the term ``independent'' for purposes of paragraph .03
of the Supplementary Material, action independent of or contrary to
advice, to the Initial Draft Rule. Proposed paragraph .03 states that a
municipal advisor would not be required to disengage from a municipal
advisory relationship if its client were to elect a course of action
that is ``independent or contrary'' to the advice provided by the
municipal advisor. BDA asked if ``independent'' would mean that the
municipal advisor's client is not relying on or considering the advice
of the municipal advisor; that the client is not seeking advice from
the municipal advisor; or, that the client is acting contrary to advice
given by the municipal advisor.
    Proposed paragraph .03 of the Supplementary Material was designed
to address instances when a municipal advisor's client has decided
either not to accept, rely on or consider the municipal advisor's
advice or to take an approach or position that varies (completely or
partially) from advice provided by the municipal advisor. In the event
of such occurrences, paragraph .03 would allow a municipal advisor to
continue in its advising capacity so long as doing so would not
otherwise be precluded by MSRB rules or federal, state or other laws,
as applicable.
    Scope of the Recommendations Analysis. Proposed section (d) and
paragraph .08 of the Supplementary Material address municipal advisors'
recommendations of municipal securities transactions or municipal
financial products. However, as part of the duty of care articulated
under proposed paragraph .01 of the Supplementary Material, a municipal
advisor would be required to have a reasonable basis for any advice
provided to its client.
    Northland requested clarification regarding whether section (d) of
the Initial Draft Rule would be applicable to all recommendations
provided by the municipal advisor or only when a recommendation is
related to entering into a municipal securities transaction or
municipal financial product. NABL stated, in response to the First
Request for Comment, that ``suitability,'' as a general matter, is a
regulatory concept that could not be appropriately applied to municipal
advisors in all instances. NABL suggested that a municipal advisor
should be permitted to make a recommendation as to a limited aspect of
the transaction, even if the municipal advisor does not agree that the
transaction is suitable.
    Section (d) of Proposed Rule G-42 would provide that a municipal
advisor must not recommend that its client enter into any municipal
securities transaction or municipal financial product unless the
municipal advisor has determined, based on the information obtained
through the reasonable diligence of the municipal advisor, whether the
transaction or product is suitable for the client. A municipal advisor
could provide advice regarding an aspect of a municipal securities
transaction or municipal financial product that the municipal advisor
believes to be unsuitable for its client so long as the municipal
advisor adhered to the duty of care, duty of loyalty, and all other
laws, as applicable, and either did not recommend the unsuitable
transaction

or product or informed the client of the basis on which the municipal
advisor reasonably believed the transaction or product to be
unsuitable.
    Documenting Recommendations. Lewis Young expressed concern that
section (d) of the Initial Draft Rule would require excessive and
``defensive'' recordkeeping and documentation in order to evidence
compliance with the section's requirement that municipal advisors
inform their clients of certain matters pertaining to their
recommendations. Lewis Young argued that such documentation would be a
``waste of time and resources'' because the client has already
determined to pursue a particular municipal securities transaction or
municipal financial product. Accordingly, Lewis Young believed
documenting such discussions ``so as to have a `good answer' for the
next regulatory audit'' would be overly and unnecessarily burdensome.
    The MSRB believes that the proposed rule change sufficiently
articulates that municipal advisors and their clients would have the
discretion to define the parameters of their municipal advisory
relationship and, thus, decide between them what municipal advisory
activities would be performed by the municipal advisor for its client,
including what matters for which a municipal advisor would be providing
advice. As such, regarding the scenario proffered by Lewis Young, a
municipal advisor that has not been engaged to provide advice about a
municipal securities transaction or municipal financial product that
was previously selected by its client would not be under an implicit
obligation to provide the client with the suitability analysis
described in proposed section (d) and the supplementary material. The
municipal advisor would remain subject to (among other provisions of
the proposed rule change) a duty of care, duty of loyalty (as
applicable) and relevant supplementary material such as paragraphs .04
(Limitations on the Scope of the Engagement) and .09 (Know Your
Client). Further, the MSRB believes that the documentation required by
proposed Rule G-8(h)(iv) is an appropriately tailored recordkeeping
requirement that will assist regulatory examiners in assessing the
compliance of municipal advisors with the proposed rule change. Also,
the MSRB believes the recordkeeping requirements will not be overly
burdensome because municipal advisors would only be required to
maintain documents created by the municipal advisor that were material
to its review of a recommendation by another party or that memorializes
the basis for any conclusions as to suitability.
    Recommendations of Investment Funds. NY State Bar requested the
MSRB to clarify the obligations owed by a municipal advisor to its
client when the recommendation is to invest in an investment fund that
is managed by a third-party advisor. NY State Bar's concern was that,
under the Initial Draft Rule, a municipal advisor would be obligated to
provide a recommendation, and therefore a suitability analysis, of the
investment choices made by the manager of the investment fund.
    Depending on the facts and circumstance of a particular scenario,
such as described by NY State Bar, a municipal advisor could have a
multitude of different obligations regarding its recommendation of an
investment fund to a client. While the proposed rule change would allow
municipal advisors and their clients to negotiate the municipal
advisory activities to be performed, the standards of conduct
articulated in section (a) and the relevant paragraphs of the
supplementary material would not be subject to alteration. Therefore, a
municipal advisor that has agreed to provide a recommendation regarding
the investment in an investment fund would be required to exercise a
duty of care that could, in turn, require the municipal advisor to
conduct a suitability analysis that might, depending on the relevant
facts and circumstance of a particular instance, require the municipal
advisor to conduct a suitability analysis of the investment choices
made by the manager of the investment funds. By establishing the
applicable standards of conduct for municipal advisors, and providing
additional guidance regarding those standards in the supplementary
material to Proposed Rule G-42, the MSRB believes that municipal
advisors will be able to make a determination regarding what actions
they must undertake when making recommendations to clients.
    Prescriptive Metrics for Suitability Analysis. In response to the
First Request for Comment, MSA asked whether the MSRB would provide the
``specific metrics (standard debt issuance options)'' that should be
used to determine the suitability of a recommendation. MSA also
inquired into whether ``there [will] be standards set for this
quantitative review or will it be the responsibility of the individual
[municipal advisor] to define the suitability metrics based on the
unique circumstances of each client or project?''
    In order to accommodate the diversity of the municipal securities
and municipal advisory marketplace, the MSRB has taken a primarily
principles-based approach regarding the required suitability analysis
so that municipal entities and obligated persons would receive
appropriately tailored and relevant advice and recommendations from
their municipal advisors. For this reason, the MSRB does not intend to
provide the specific metrics requested by MSA and instead will rely
upon the principles and requirements provided by the proposed rule
change.
Municipal Advisor Reliance on Information Provided by Client
    A number of commenters voiced apprehension regarding what they
believed to be the high standard set for providing recommendations to
their clients or reviewing the recommendation of a third party.
Specifically, commenters expressed concern with the portion of
paragraph .01 (which would be applicable to recommendations
contemplated under section (d)) that would require a municipal advisor
to ``undertake a reasonable investigation to determine that it is not
basing any recommendation on materially inaccurate or incomplete
information.'' Most commenters stated that a municipal advisor should
be able to rely on the accuracy and veracity of the information
provided by a client and not be required to validate such information.
    Sutherland asked, in response to the First Request for Comment, in
the context of 529 plans, what the Initial Draft Rule would require a
municipal advisor to do in order to satisfy the proposed obligation to
undertake a reasonable investigation to determine that it is not basing
any recommendation on materially inaccurate or incomplete information.
Sutherland also asked whether a municipal advisor must obtain a
representation from the issuer that the information it provides does
not contain any material misstatements or omissions.
    In response to the Second Request for Comment, ICI stated that
municipal advisors to 529 plans should not be required to verify the
veracity or completeness of the information provided to them by persons
who are authorized by the municipal entity client to act on behalf of a
state's 529 plan.
    NABL commented that a municipal advisor should be free to recommend
a transaction based on facts given to it by its client, without
exercising any diligence to check the facts, if consistent with the
scope of the engagement with

its client. Regarding the review of recommendations of others, MSA
asked whether it would be necessary to obtain documentation or
information used by a third-party to make a recommendation that the
municipal advisor has been engaged to review. MSA believed that the
Initial Draft Rule should require the third party, who provided the
recommendation and that the municipal advisor has been engaged to
review, to disclose any documentation relied upon for that
recommendation.
    The duty of care is a core principle underlying many of the
obligations of the proposed rule and is included, among other reasons,
to ensure municipal entities and obligated persons are shielded from
the potential negative consequences that could result from not
receiving well-informed advice and expertly-executed services from
their municipal advisors. The MSRB believes that requiring municipal
advisors to conduct a reasonable investigation about the accuracy and
completeness of the information, including information pertaining to a
529 plan, on which they will be basing their advice is necessary to
ensure that clients will be able to make an informed decision based on
facts and choose a prudent course of action. As stated in section (d),
the municipal advisor would only need to exercise reasonable diligence,
thus obviating the need for a municipal advisor to go to impractical
lengths to determine the accuracy and completeness of the information
on which it will be basing its advice and/or recommendation. The MSRB
believes that obtaining a representation from the municipal advisor's
client that the information it has provided, with no or insufficient
diligence conducted by the municipal advisor, would not satisfy either
section (d) or paragraph .01 of the Supplementary Material of Proposed
Rule G-42 because such a representation would not sufficiently preclude
the potential for the risks associated with providing advice or
recommendations without a reasonable inquiry into the accuracy and
completeness of the information upon which such advice or
recommendations are based. While alone, such a representation would not
satisfy the requirements of the proposed rule change, a municipal
advisor would be free to seek and obtain such a representation as a
prudent part of its process for conducting a reasonable investigation
of the veracity and completeness of the information on which it is
basing its recommendation.
Applicability of Suitability Analysis to 529 Plans
    Several commenters raised concerns about how section (d) and the
related supplementary material that address suitability analysis would
generally apply to municipal advisors advising 529 plans.
    ICI stated, in response to the Second Request for Comment, that the
suitability standard set forth in paragraph .08 of the Supplementary
Material should recognize what ICI believes to be differences between
advice rendered in connection with municipal securities, generally, and
that rendered in connection with 529 plans. Sutherland voiced concerns
in its response to the First Request for Comment and stated that the
suitability factors listed in paragraph .08 and section (d) are not
workable with regard to 529 plans. ICI believed that some of the
factors for determining suitability included in paragraph .08 would be
``largely irrelevant in the context of rendering advice to a 529 plan''
and the MSRB should modify the Revised Draft Rule to explicitly state
that such factors would not apply to advice relating to 529 plans. In
the absence of exempting 529 plans from needing to consider such
factors, ICI asked the MSRB to clarify how it intends the listed
factors to apply to 529 plans.
    In consideration of these comments, the MSRB has modified proposed
paragraph .08 (formerly paragraph .09) of the Supplementary Material to
allow municipal advisors to base a suitability determination only on
the listed factors that are applicable to the particular type of client
being advised. The MSRB, accordingly, has inserted the phrase ``as
applicable to the particular type of client'' as a qualifier to the
list of factors in paragraph .08 that must be considered in a
suitability analysis. The modifications proposed should address the
commenters' concerns such as how factors such as ``financial capacity
to withstand changes in market conditions'' would apply given that 529
plans are not dependent on external sources of revenue or funding to
satisfy claims of investors. However, the listed factors in paragraph
.08, consistent with the regulation of recommendations in other
securities law contexts, are focused on the client and not the product
involved.
Request for Clarification of Documentation and Procedural Requirements
    In response to the Second Request for Comment, Piper Jaffray
requested additional clarification on what a municipal advisor would
need to do, and what documents would need to be created, to comply with
the Revised Draft Rule's suitability requirements. Specifically, Piper
Jaffray asked what the proposed rule change would require with regards
to decisions that Piper Jaffray refers to as ``smaller decisions''
(e.g., call features and whether to utilize a premium bond structure
that has a lower yield to call).
    The proposed rule change would require, pursuant to the duty of
care, a municipal advisor to have a reasonable basis for any advice it
provides to or on behalf of its client. Also, municipal advisors would
be required to conduct a suitability analysis of recommendations of
municipal securities transactions and municipal financial products that
would comport with the requirements of proposed paragraph .08 of the
Supplementary Material. Whether or not a suitability analysis would be
required would depend, as previously discussed in Item II.A., on the
facts and circumstances surrounding the communication made by the
municipal advisor and whether the communication was a recommendation of
a municipal securities transaction or municipal financial product.
Advice as to the ``smaller decisions'' asked about by Piper Jaffray
might, or might not, depending on the facts and circumstances of a
particular instance, rise to the level of being a recommendation that
would require a suitability analysis under the proposed rule change,
even though such advice may relate to a municipal securities
transaction or municipal financial product and therefore trigger other
provisions of the proposed rule, because the advice might not
reasonably be viewed as a ``call to action'' that would constitute a
recommendation of a municipal securities transaction or municipal
financial product. Note that even in the case of advice short of a
recommendation, a subsequent communication that does constitute a
recommendation requiring a suitability analysis might, depending on the
particular facts and circumstances, require analysis at that time of a
subject that was addressed in previous advice.
    With regard to the recordkeeping requirements that would be
required when providing a recommendation of a municipal securities
transaction or municipal financial product, proposed MSRB Rule G-
8(h)(iv) would require specifically that municipal advisors keep a copy
of any document created by a municipal advisor that was material to its
review of a recommendation by another party or that memorializes the

basis for any determination as to suitability for a period of not less
than five years. The MSRB believes that the proposed recordkeeping
requirements will allow regulatory examiners to efficiently assess a
municipal advisor's compliance with the suitability obligations of
Proposed Rule G-42. The MSRB also believes that the proposed
recordkeeping requirements will not overly burden municipal advisors
because the MSRB understands that these documents are routinely made
and retained by municipal advisors as a part of their normal business
operations.
Suitability and Policy Related Considerations
    In response to the First Request for Comment, BDA and Piper Jaffray
stated that the factors to be considered by municipal advisors when
determining whether a municipal securities transaction or municipal
financial product is suitable for its municipal entity or obligated
person client discussed in paragraph .08 (Suitability) of the
Supplementary Material overlooks the effect that ``policy and political
considerations'' could have on a suitability determination. Piper
Jaffray requested that the MSRB clarify whether the determination of
suitability should ``incorporate the policy directives and decisions of
the issuer at the time the issue is undertaken.'' BDA requested that
the MSRB clarify that, if a municipal advisor's client states its
objective, the municipal advisor, in making its recommendation, does
not need to assess the appropriateness of the client's stated objective
but could ``generally accept the [objective].''
    Section (a) and paragraph .01 of the Supplementary Material to
Proposed Rule G-42 would require that municipal advisors exercise due
care in performing their municipal advisory activities with respect to
all of their clients. This duty would require, among other things,
municipal advisors to provide their clients with informed advice. The
MSRB believes that informed advice regarding the suitability of a
municipal securities transaction or municipal financial product is the
result of a municipal advisor making a reasonable inquiry into certain
relevant information about the municipal advisor's client. For this
reason, the MSRB has included in proposed paragraph .08 the requirement
that a municipal advisor base its determination of suitability on any
material information known by the municipal advisor after reasonable
inquiry. Furthermore, proposed paragraph .09 of the Supplementary
Material would obligate a municipal advisor to know and retain the
essential facts concerning its client to allow the municipal advisor to
effectively service the client. The MSRB believes that policy
considerations could be materially relevant information under all of
the particular facts and circumstances that municipal advisors may
consider when determining the suitability of a municipal securities
transaction or municipal financial product. A stated objective of the
client as BDA posits could be made most clear by reducing it to writing
and including it in the relationship documentation on the scope of the
engagement.
Evidencing Evaluations and Delivery of Required Information Regarding
Recommendations
    Several commenters, including BDA, MSA, Northland and Lewis Young,
commented on records and documentation requirements of the proposed
rule change that would be applicable to municipal advisors.
    In response to the First Request for Comment, BDA requested
clarification regarding what books and records a municipal advisor
would need to maintain to evidence evaluations or recommendations made
by the municipal advisor. BDA commented that some evaluations or
recommendations could be delivered orally to a client and that
requiring a municipal advisor to memorialize each recommendation or
evaluation in writing could prove impractical and/or costly. MSA asked,
in response to the First Request for Comment, whether the information
regarding recommendations and evaluations of which a municipal advisor
is required to ``inform'' its client could be ``transmitted to the
client orally or will each alternative require empirical evidence
demonstrating the material risks, potential benefits, structure and
characteristics?'' If oral transmission is acceptable, MSA then asked
whether it would need to be documented by both parties. Also in
response to the First Request for Comment, Northland expressed concerns
regarding the Initial Draft Rule's requirement to discuss matters with
the client, because it believed there is an implicit need to document
these discussions therefore necessitating the use of written
communications. However, Northland argued that written communications
could result in a conflicting record that shows what the municipal
advisor recommended as possibly in opposition to the course of action
ultimately taken by its client. Northland was concerned that these
potential conflicts could result in some exposure to liability in the
event the justification of the decided upon course of action is
challenged. Lewis Young contended that requiring municipal advisors, in
section (d) of the Initial Draft Rule, to inform their clients of the
risks and benefits of a particular structure or product when the client
has already decided on a course of action (prior to engaging or seeking
the advice of the municipal advisor) would yield little, if any,
benefit. Lewis Young suggested only requiring the municipal advisor to
inform its client of the matters discussed in section (d) when the
client is considering, or presented with a recommendation of, a
financial product, transaction or mechanism that is ``novel to the
client.''
    Proposed Rule G-8(h)(iv) would require a municipal advisor to
maintain a copy of any document it created that was material to its
review of a recommendation by another party or that memorializes the
basis for any determination as to suitability. Section (d) of Proposed
Rule G-42 would require a municipal advisor to inform its clients of
the municipal advisor's evaluation of the material risks, potential
benefits, structure, and other characteristics of the recommended
municipal securities transaction or municipal financial product; the
basis upon which the municipal advisor reasonably believes that the
recommended municipal securities transaction or municipal financial
product is, or is not, suitable for the client; and whether the
municipal advisor has investigated or considered other reasonably
feasible alternatives to the recommended municipal securities
transaction or municipal financial product that might also or
alternatively serve the client's objectives. The MSRB notes that
municipal advisors, under Proposed Rule G-42, would be required to
``inform'' their clients of such matters, rather than ``discuss,'' as
previously required under the Initial Draft Rule. Under Proposed Rule
G-42, a municipal advisor would be allowed to choose the appropriate
method in which to communicate its evaluation of the material risks and
benefits attendant to the recommendation. The method selected and used
by the municipal advisor must, however, comport with the duty of care
and duty of loyalty (as applicable) that is owed to its client and
should, therefore, result in the municipal advisor's client receiving
timely, full and fair notification of the matters provided for in
proposed subsections (d)(i)-(iii) and that adhere to the guidance
provided in proposed paragraph .08 of the Supplementary Material.

Exemption From Suitability Standard, ``Sophisticated'' Issuers
    In response to the First Request for Comment, First Southwest
expressed general support for a suitability standard for
recommendations by municipal advisors but stated that certain clients
of municipal advisors are capable of independently evaluating
recommendations of municipal advisors and these clients should be
exempt from the suitability standard in a manner similar to the
``sophisticated municipal market professional'' under MSRB Rule G-48.
Lamont voiced a similar concern stating that many of its ``large
sophisticated'' issuer clients do not want, or need, a review of the
transaction they have already decided to undertake. Lamont commented
that these types of clients are ``sufficiently capable of weighing the
risks in a transaction and making their own decision about whether to
proceed.''
    In response to the Second Request for Comment, SMA stated that when
a municipal securities transaction or municipal financial product has
been decided upon by a municipal advisor's client and: (a) Is related
to a project or event determined by the governing body of the municipal
entity or its citizens to be in its interest and consistent with its
goals; (b) is permitted by state statute as determined by municipal or
bond counsel; and (c) involves a transaction or product which the
municipality has employed in the past, then it seems suitability has
been determined and the advisor ought to be able to rely on these facts
and the closing documents as establishing a reasonable basis for
suitability. Southern MA suggested that a municipal advisor should not
be put in the position of substituting its judgment as to the
suitability of a municipal securities transaction or municipal
financial product for that of the municipal policy makers, citizens or
state lawmakers.
    The MSRB has determined that the requirements of section (d), and
the related paragraphs of the supplementary material, should be
applicable regardless of the municipal advisor's perception of the
sophistication of its client or the client's perception of its own
degree of sophistication. The proposed rule change is aimed at
protecting municipal entities, obligated persons and the public
interest and, as a result, the MSRB believes that exemptions such as
those described by these commenters would frustrate that objective.
However, in designing Proposed Rule G-42, the MSRB did incorporate many
of the concepts that commenters believed were indicia of the
sophistication of an issuer into the factors to be considered when
determining the suitability of a recommendation. Under those factors,
the considerations proffered by SMA could be relevant to, and therefore
be part of, a municipal advisor's suitability analysis depending on all
of the particular circumstances, though they might not alone be
sufficient to support a suitability determination under the proposed
rule change.
Specified Prohibitions
    Several commenters provided input on Proposed Rule G-42(e)(i),
which sets forth certain activities in which municipal advisors would
be prohibited from engaging.
General Comments
    In response to the First Request for Comment, NAIPFA and GFOA
expressed general support for the specified prohibitions, NAIPFA stated
that the section includes prohibitions that are ``important measures
that are needed to eliminate certain practices that often carry
unmanageable conflicts of interest inconsistent with Municipal Advisor
fiduciary duties,'' and the prohibitions are appropriately tailored and
would not impose undue regulatory burdens. Other commenters noted their
general support for the prohibitions, but suggested some revisions or
limitations, which are discussed in the section below.
    Cooperman commented that the MSRB should determine, after a
monitoring period since the passage of the Dodd-Frank Act, what, if
any, abuses or inappropriate conduct remain that would require the
regulation set forth in the proposed rule change. Alternatively,
Cooperman suggested that the MSRB consider, at least initially,
``limiting the [proposed rule] to an enumeration of prohibited forms of
conduct and practices'' rather than imposing extensive compliance,
supervision and other requirements. In response to the Second Request
for Comment, Lewis Young commented that the specified prohibitions
subsections (e)(i) and (ii) (on the ban of certain principal
transactions) are unnecessary because the matters addressed in those
sections are adequately attended to in section (a) and should be
intrinsic to a reputable municipal advisor's business practices. As
such, Lewis Young recommended that these prohibitions be set forth in
the supplementary material in order not to detract from the focus of
the proposed rule. In response to such comments, the MSRB notes that,
in many respects, Proposed Rule G-42 adopts a principles-based
approach, enumerating prohibited forms of conduct and practice.
However, regarding certain arrangements that the MSRB has identified as
particularly prone to conflict with, or risk of breach of, the
fiduciary duty and duty of care, the MSRB believes that the proposed
rule change appropriately incorporates more specific requirements and
prohibitions.
Excessive Compensation
    In response to the First Request for Comment, SIFMA, Lewis Young
and MSA commented that the provision that would prohibit receiving
compensation that is excessive in relation to the municipal advisory
activities actually performed (now Proposed Rule G-42(e)(i)(A)), did
not include a sufficiently clear standard for how excessive
compensation would be determined and failed to provide adequate amount
of guidance to facilitate compliance. SIFMA expressed concern that
without a clear standard or more guidance, such determinations would be
made in hindsight, presumably by financial regulatory examiners, and to
the detriment of municipal advisors. Lewis Young called the prohibition
unworkable, expressed concern that it would require advisors to
document all of their work and requested that the paragraph be deleted.
SIFMA and Lewis Young also commented that municipal advisor
compensation is subject to market forces, and therefore its
reasonableness should be determined by a negotiation between the client
and the municipal advisor. PRAG stated that the proposed rule change
fails to contemplate instances where transaction fees are included in a
municipal advisor's compensation to compensate the municipal advisor
for services that it has provided but that were unrelated to the
issuance of municipal securities. SIFMA and Lewis Young asked whether
the practice of including fees for services a municipal advisor
provided, if not related to the issuance of municipal securities, would
be permitted under the proposed rule change. Columbia Capital commented
that the MSRB should strike the phrase ``whether the fee is contingent
upon the closing of the municipal securities transaction or municipal
financial product,'' in paragraph .10 of the Supplementary Material of
Proposed Rule G-42, and add, as an additional factor to be considered
when determining whether compensation is excessive, a comparison of the
municipal advisor's compensation to other professionals providing
services on the transaction in question.

    After carefully considering the comments submitted in response to
the First Request for Comment, the MSRB incorporated guidance regarding
excessive compensation in paragraph .10 of the Supplementary Material
of the Revised Draft Rule and solicited further comment. Paragraph .10
of Proposed Rule G-42 sets forth various factors that municipal
advisors should consider when determining the reasonableness of their
compensation. These factors include: The municipal advisor's expertise,
the complexity of the municipal securities transaction or the financial
product, whether the fee is contingent upon the closing of the
transaction or financial product, the length of time spent on the
engagement and whether the advisor is paying any other costs related to
the transaction or financial product. Furthermore, Proposed Rule G-42
would prohibit receiving compensation that is excessive in relation to
the municipal advisory activities actually performed. Depending on the
facts and circumstances of a particular municipal advisory
relationship, either or both of these provisions could apply to a
scenario like that posited by PRAG. The proposed rule change, however,
would not prescribe the source of funds that could be used to pay the
municipal advisor for its services. Finally, the phrase regarding
contingent fees is not deleted from paragraph .10 of the Supplementary
Material as the MSRB believes it is a relevant factor and appropriately
included in a non-exhaustive list of other relevant factors.
Inaccurate Invoicing
    In response to the First Request for Comment, Wulff Hansen
commented that the prohibition on the delivery of inaccurate invoices
(now Proposed Rule G-42(e)(i)(B)) should be modified to clarify that it
would apply only to any overstatements of fees, expenses or activities,
and not to any fee discounting by a municipal advisor. SIFMA commented
that the prohibition should stand but should be modified to add
materiality and knowledge qualifiers (i.e., a municipal advisor may not
intentionally deliver a materially inaccurate invoice).
    The MSRB believes that the proposed rule change clearly implies
that offering a payment discount from the services actually performed
is a permissible activity because a municipal advisor would be able to
accurately describe such a discount on its invoice. In response to the
SIFMA comment, the MSRB notes that the scope of inaccuracy targeted by
the proposed provision is limited to the significant subjects of the
services performed and personnel who performed those services, and the
MSRB believes any inaccuracy in an invoice on those subjects should be
proscribed. In addition, the MSRB believes that the addition to the
proposed provision of the state-of-mind elements that SIFMA suggested
would not sufficiently protect municipal entity and obligated person
clients.
Prohibition on Fee-Splitting
    The Initial Draft Rule included a prohibition on making or
participating in any fee-splitting arrangement with underwriters, and
any undisclosed fee-splitting arrangement with providers of investments
or services to a municipal entity or obligated person client (now
Proposed Rule G-42(e)(i)(D)). In response to the First Request for
Comment, GFOA supported the fee-splitting prohibition in the Initial
Draft Rule, noting that it ``appears to be an inherent conflict, and
should be avoided.'' NAIPFA supported the prohibition, but asked the
MSRB to provide a definition of ``fee-splitting arrangements,'' under
which independent contractors and subcontractors would fall outside of
the prohibition. Lewis Young and Winters LLC stated that fee-splitting
arrangements should be disclosed but not prohibited. SIFMA commented
that fee-splitting arrangements with affiliates, if fully and fairly
disclosed, should be permissible. SIFMA stated that there could be
legitimate reasons for such arrangements, including fee structures
requested by clients of an affiliate, and, with such disclosure, the
parties should be free to engage in the fee arrangement believed to be
most economical and efficient under the circumstances. NABL commented
that the provision appears to apply to transactions even when the
advice provided is exempted or excluded from that which would cause one
to be a ``municipal advisor'' under the SEC Final Rule. Based on this
assumption, NABL argued that the prohibition should apply only when a
municipal advisor is giving ``non-exempt'' advice as part of the same
transaction, not when it is giving advice that is exempt under the SEC
Final Rule.
    Several commenters provided examples of fee-splitting arrangements
that they believed should not be prohibited. Cooperman stated that a
municipal advisor should not be prohibited from outsourcing certain
parts of its municipal advisory activities to independent contractors
and subcontractors, including those that may have advisors on their
staffs, when payment to those third parties is not dependent upon
successful conclusion of the financing or payment to the municipal
advisor of its fee. In addition, Cooperman stated the fee-splitting
prohibition should not prevent two advisor firms from contracting with
an issuer to perform services for a predetermined fee that is disclosed
to the issuer. Lewis Young, who favored disclosure of fee-splitting in
lieu of a complete prohibition, wrote that municipal advisors should be
permitted to enter into a fee-splitting arrangement with a structuring
agent that provides specific quantitative services on a transaction.
Winters LLC asserted that a municipal entity or obligated person should
be able to have its municipal advisor or other professionals (including
underwriters, if after the underwriting period) receive compensation
from investment providers or other service providers for providing
oversight and performing other services so long as there is full and
fair written disclosure of the fee-splitting or sharing arrangements.
Lamont stated that allowing an investment provider to pay fees related
to the solicitation of the investment by the municipal advisor, and
that are within the permitted limits of the Internal Revenue Service
rules, should be acceptable as long as the payments are disclosed to
the issuer and each investment provider on the bid list. Wulff Hansen
asked whether it would be permissible under the provision for a
municipal advisor to arrange for a routine purchase of services on
behalf of the advised client in a transaction with an entity in which
the advisor has an interest (e.g., a purchase of services from DTCC
when the advisor is also a DTCC Participant and thus a part owner of
DTCC). Finally, Piper Jaffray requested that the MSRB clarify that the
fee-splitting prohibition, with regards to underwriters, applies to
``any issue for which it is serving as municipal advisor'' because the
failure to link the prohibition to the actual advisory engagement could
lead to unintended and adverse consequences.
    The MSRB agrees with Piper Jaffray's comment and amended the
provision in the Revised Draft Rule (now Proposed Rule G-42(e)(i)(D))
to prohibit a municipal advisor from making or participating in any
fee-splitting arrangement with underwriters on any municipal securities
transaction as to which it has provided or is providing advice.
    The MSRB believes that the proposed rule change would help prevent
violations of fiduciary duties and the duty of care by clearly
identifying and prohibiting specific fee-splitting

arrangements that are particularly prone to conflict with such duties.
Other fee-splitting arrangements would be permitted, provided they are
fully and fairly disclosed.
Payments To Obtain/Retain an Engagement To Perform Municipal Advisory
Activities
    In response to the First Request for Comment, NABL commented that
the Initial Draft Rule G-42 should not prohibit or require the
disclosure of payments made to obtain or retain municipal advisory
business, if those activities are engaged in by persons exempted from
registration as a municipal advisor under SEC Rule 15Ba1-1.\68\
Similarly, the NY State Bar commented that the prohibition on making
payments for the purpose of obtaining or retaining an engagement to
perform municipal advisory activities under subsection (g)(v) of the
Initial Draft Rule (now proposed Rule G-42(e)(i)(E)) is unnecessarily
restrictive with too narrow of an exemption. The NY State Bar stated
that the provision should also permit payments to persons subject to
comparable regulatory regimes (e.g., banks, trust companies, broker-
dealers and investment advisors) as well as to affiliates of the
municipal advisor so long as, in either case, the payments are
disclosed to the client. SIFMA commented that the proposed rule should
allow for reasonable fees to be paid to affiliates because soliciting
on behalf of affiliates does not trigger a requirement for a person to
register as a municipal advisor under the SEC Final Rule. In response
to the Second Request for Comment, Sanchez made a similar comment. In
addition, SIFMA commented that the prohibition should not cover
expenditures for normal business entertainment expenses as well as
marketing and sales activities.
---------------------------------------------------------------------------

    \68\ 17 CFR 240.15Ba1-1.
---------------------------------------------------------------------------

    In light of the comments received, the MSRB modified the provision
(now Proposed Rule G-42(e)(i)(E)(1)) so that it would not specifically
prohibit municipal advisors from making payments to an affiliate

for a direct or indirect communication with a municipal entity or
obligated person on behalf of the municipal advisor where such
communication is made for the purpose of obtaining or retaining an
engagement to perform municipal advisory activities. . . .

    The modification also would align the paragraph with Section
15B(e)(9) of the Exchange Act,\69\ which allows affiliates of the
municipal advisor to solicit on behalf of the municipal advisor without
triggering the municipal advisor registration requirement for the
affiliate. The MSRB would clarify, in proposed subparagraph
(e)(i)(E)(2), that a municipal advisor may pay reasonable fees to
another municipal advisor registered as such with the Commission and
the Board for making a similar communication on behalf of the municipal
advisor making such payments. The MSRB would also clarify, in proposed
subparagraph (e)(i)(E)(3), that payments that would qualify as
permissible normal business dealings under current MSRB Rule G-20 also
would not violate the prohibition. The revisions would harmonize the
proposed rule change with relevant federal securities laws and rules.
---------------------------------------------------------------------------

    \69\ 15 U.S.C. 78o-4(e)(9).
---------------------------------------------------------------------------

Additional Comments on Specified Prohibitions
    BDA and Piper Jaffray suggested adding two prohibitions to Proposed
Rule G-42. In response to the First and Second Requests for Comment,
Piper Jaffray suggested adding a specified prohibition that would
prohibit a municipal advisor from taking into account whether it
competes with other firms when the advisor makes a recommendation to
its client (e.g., a recommendation to the client regarding which
broker-dealer the client should hire as underwriter). In response to
the First Request for Comment, BDA and Piper Jaffray suggested a second
prohibition, which would prohibit a municipal advisor that is not also
registered as, or affiliated with, a dealer, from using the term
``independent,'' if used in a manner intended to convey to potential
clients that the municipal advisor is free from any potential conflicts
of interest, and imply that, in contrast to advisors also registered as
dealers, the municipal advisor would provide better advice. Piper
Jaffray also stated that continued use of the term ``independent'' to
connote an advisor free from conflicts should be specifically
prohibited in light of the issues its continued use could create if
market participants confused such advisors with a person acting as an
``independent registered municipal advisor'' as used in the SEC Final
Rule.\70\
---------------------------------------------------------------------------

    \70\ See, e.g., SEC Final Rule, 78 FR at 67471.
---------------------------------------------------------------------------

    The MSRB has not incorporated the prohibitions suggested by BDA and
Piper Jaffray. To the extent the described conduct constitutes a
material misrepresentation, the MSRB believes it is already
appropriately addressed by Proposed Rule G-42 and existing MSRB Rule G-
17, under which municipal advisors, in the conduct of their municipal
advisory activities, must not engage in any deceptive, dishonest or
unfair practice with any person.
Prohibition on Principal Transactions
    The MSRB received extensive comments on the proposed provision to
prohibit a municipal advisor (and its affiliates) from engaging in
certain principal transactions (as defined in the proposed rule) with a
municipal entity client of the municipal advisor (``prohibition on
principal transactions'' or ``ban''). Specifically, Proposed Rule G-
42(e)(ii) generally would prohibit a municipal advisor to a municipal
entity client, and any affiliate of such municipal advisor, from
engaging in a principal transaction directly related to the same
municipal securities transaction or municipal financial product as to
which the municipal advisor is providing, or has provided, advice.\71\
Three related provisions of the proposed rule, subsection (f)(i) and
paragraphs .07 and .11 of the Supplementary Material, would,
respectively, define the phrase, ``engaging in a principal
transaction,'' clarify the relationship between the proposed ban and
Rule G-23, and provide guidance regarding the term ``other similar
financial products'' in connection with principal transactions as
defined in subsection (f)(i). Comments regarding the ban and the
related provisions are discussed below.
---------------------------------------------------------------------------

    \71\ In the Initial Draft Rule, the ban is set forth in section
(f); in the Revised Draft Rule and the proposed rule change, the ban
is set forth in subsection (e)(ii).
---------------------------------------------------------------------------

General
    In response to the First Request for Comment, many commenters
raised concerns regarding: (1) The application of the ban to obligated
person clients of municipal advisors; (2) the scope of the ban; (3) the
meaning of ``principal transaction'' and ``principal capacity;'' (4)
the ban's application to transactions by affiliates of municipal
advisors; (5) the absence of an exception to the ban for an advisor or
its affiliate based upon full and fair disclosure and the written
consent of a client; and (6) the relationship between the ban and Rule
G-23. In response to the Second Request for Comment, most of the
comments focused on: (1) The scope of principal transactions that would
be considered ``directly related'' to the advised transaction and come
within the ban; (2) the ban's application to transactions by affiliates
of municipal advisors; and (3) the relationship between the ban and
Rule G-23.

Ban Does Not Apply to Obligated Person Clients
    In the Initial Draft Rule, the ban prohibited a municipal advisor
and its affiliates from engaging in principal transactions with
municipal entity and obligated person clients. The ban in Proposed Rule
G-42(e)(ii) no longer would apply to principal transactions with
obligated person clients. As a result, the comments urging that the ban
not apply to obligated persons are not incorporated in this discussion,
except to note that such comments were considered and the MSRB modified
the proposed ban such that it would not apply to principal transactions
with such persons.
Scope and ``Directly Related To''
    In Initial Draft Rule G-42, the prohibition on principal
transactions was significantly broader than the ban as modified in the
Revised Draft Rule and as further narrowed in this proposed rule
change. In the Initial Draft Rule, a municipal advisor (and its
affiliates) generally were prohibited from engaging in any transaction
in a principal capacity to which an obligated person client or a
municipal entity client of the municipal advisor would be the
counterparty. In response to the First Request for Comment, many
commenters \72\ interpreted the proposed prohibition quite broadly and
expressed concerns regarding the scope of the proposed prohibition on
principal transactions by municipal advisors (and their affiliates)
with the clients of such municipal advisors.\73\ Commenters, including
ABA, BDA, NABL and Piper Jaffray, interpreted the ban as covering
activities and transactions that were unrelated to the municipal
advisory relationship. The ABA commented that ``because banks almost
always provide banking products and services in a principal capacity,
the prohibition would prevent commercial banks and their affiliates
from providing any other banking products, such as deposit accounts,
loans, or cash management services . . . despite the fact that these
products and services are exempt from the municipal advisor regulatory
regime.'' BDA, Frost, SIFMA and Zion, among others, raised similar
concerns regarding the broad reach of the prohibition.
---------------------------------------------------------------------------

    \72\ Commenters that expressed such concerns include ABA, BDA,
Cape Cod Savings, Coastal, Frost, GFOA, GKB, JP Morgan, Kutak, NABL,
NY State Bar, Parsons, Piper Jaffray, SIFMA and Zion.
    \73\ SIFMA suggested narrowing the proposed provision to:
    A municipal advisor to a municipal entity client, and any
affiliate of such municipal advisor, is prohibited from engaging in
a principal transaction directly related to the advice rendered by
such municipal advisor (emphasis added).
    BDA suggested the following alternative:
    A municipal advisor, and any affiliate of such municipal
advisor, is prohibited from engaging in a principal transaction with
a municipal entity client if the structure, timing or terms of such
principal transaction was [sic] established on the advice of the
municipal advisor in connection with a municipal advisory
relationship with such municipal entity client.
---------------------------------------------------------------------------

    After carefully considering the comments, the prohibition on
principal transactions was significantly narrowed and clarified, as set
forth in Revised Draft Rule G-42(e)(ii). The MSRB limited the ban to
``a principal transaction directly related to the same municipal
securities transaction or municipal financial product as to which the
municipal advisor is providing advice'' (emphasis added). The Revised
Draft Rule would thus prohibit a municipal advisor (and its affiliates)
to a municipal entity client from engaging in a principal transaction
directly related to the same municipal securities transaction or
municipal financial product as to which the municipal advisor is
providing advice. The modification was designed to exclude many of the
transactions that some commenters read as potentially covered by the
Initial Draft Rule, including the taking of a cash deposit or the
payment by a client solely for professional services.
    In response to the Second Request for Comment, some commenters
supported the changes to the proposed rule text. Several other
commenters continued to raise concerns regarding what they believed to
be the overly broad scope of the ban. Conversely, one commenter stated
that the ban in Revised Draft Rule G-42(e)(ii) had become too narrow.
GFOA approved of the modification narrowing the proposed ban to ``a
principal transaction directly related to the same municipal securities
transaction or municipal financial product as to which the municipal
advisor is providing advice,'' and Wells Fargo noted that the
modification mitigated the impact of the proposed ban. ABA also
welcomed the revision, but suggested additional changes. In addition,
BDA, NY State Bar, Piper Jaffray and SIFMA suggested that the ban be
modified further to narrow or clarify the scope of the ban. ABA
recommended that the provision require the advice provided by the
municipal advisor be provided pursuant to a municipal advisory
relationship; NY State Bar recommended that the prohibition not apply
where the municipal advisor does not make a recommendation to the
municipal advisory client to enter into a transaction with the advisor
or its affiliate; and SIFMA recommended that the provision ban only
those principal transactions that are directly related to the advice
the municipal advisor is providing, not merely the same municipal
securities transaction or municipal financial product in connection
with which the advice is provided.\74\ BDA and Piper Jaffray commented
that the term ``directly related'' was unclear, and recommended
alternative language. In Piper Jaffray's view, the ban should be
limited to a transaction or issuance where a firm served as a municipal
advisor and about which advice was rendered. Alternatively, Piper
Jaffray suggested that the ban should cover transactions ``directly
related to the advice given rather than directly related to the
transaction itself.'' Applying the proposed ``directly related to''
standard to certain hypothetically paired transactions, BDA asked
whether one of each pair of such transactions would be considered
directly related to the second transaction and therefore subject to the
proposed prohibition, and also proposed a modification to the ban.\75\
Conversely, Lewis Young argued that, with the changes set forth in the
Revised Draft Rule, the scope of the prohibition on principal
transactions has gone from ``too broad to too narrow'' because the
definition of ``engaging in a principal transaction'' (discussed in
greater detail

below) does not extend fully to the variety of principal transactions
in which a municipal advisor could engage, which would be in conflict
with its municipal advisory role and fiduciary duty (e.g., a bank loan
as a substitute for an issuance of municipal securities).
---------------------------------------------------------------------------

    \74\ In response to the Second Request for Comment, ABA
recommended the provision be modified to read:
    A municipal advisor to a municipal entity client, and any
affiliate of such municipal advisor, is prohibited from engaging in
a principal transaction directly related to the same municipal
securities transaction or municipal financial product as to which
the municipal advisor is providing advice pursuant to a municipal
advisory relationship.
    SIFMA recommended the provision be modified to read:
    A municipal advisor to a municipal entity client, and any
affiliate of such municipal advisor, is prohibited from knowingly
engaging in a [prohibited] principal transaction.
    \75\ In connection with interpreting the scope of the ``directly
related to'' standard, BDA asked whether: (1) Selling securities as
a principal after winning a competitive bid for an open market
refunding escrow on a refunding bond issue for which the firm was a
municipal advisor would be a transaction ``directly related to'' the
refunded bond issue and therefore a prohibited principal
transaction; (2) acting as the underwriter on a series of variable
rate bonds would be directly related to acting as the municipal
advisor for a related swap, and be prohibited; and, (3) underwriting
a refunding issue years after serving as a municipal advisor for the
initial issue would be a transaction that would be considered
directly related to the initial issue and prohibited.
    BDA recommended the provision be modified to delete the
``directly related to'' standard and substitute: ``if the structure,
timing or terms of such principal transaction was established on the
advice of the municipal advisor in connection with a municipal
advisory relationship with such municipal entity client.''
---------------------------------------------------------------------------

    The principal transactions ban is incorporated in the proposed rule
change as Proposed Rule G-42(e)(ii). The MSRB has determined not to
narrow, broaden or otherwise modify the standard--``directly related to
the same municipal securities transaction or municipal financial
product as to which the municipal advisor is providing advice''--in
response to the comments received. The MSRB believes that the various
alternative rule texts proposed by commenters would not be more
effective or efficient means for achieving the stated objective of
Proposed Rule G-42(e)(ii), which is to eliminate a category of
particularly acute conflicts of interest that would arise in the
fiduciary relationship between a municipal advisor and its municipal
entity client. The alternatives offered by various commenters are
similar in that they would seek to limit the scope of prohibited
transactions to those pertaining to the advice rendered by the
municipal advisor. If adopted, such a change could leave transactions
that have a high risk of self-dealing insufficiently addressed. For
example, a municipal advisor that provided advice to a municipal entity
regarding the timing and structure of a new issuance arguably would not
be prohibited from acting as principal in entering into an interest
rate swap for the same issuance so long as the advisor refrained from
advising on the swap. In addition, in response to the comments that the
standard would continue to raise questions whether a transaction was
prohibited under Proposed Rule G-42(e)(ii) and the suggestion that the
MSRB further amend the provision to clarify the provision, the MSRB
does not believe it would be feasible or desirable, given the
principled nature of the provision, to specify in advance its
application in all circumstances. As noted above, the proposed
principal transactions ban is revised to clarify that the prohibition
applies both to principal transactions that occur while the municipal
advisor is providing advice with respect to a directly related
municipal securities transaction or municipal financial product, and
after the municipal advisor has provided such advice.
``Engaging in a Principal Transaction'' and ``Other Similar Financial
Products''
    In response to the First Request for Comment, certain commenters,
including GFOA, NAIPFA, SIFMA and Wulff Hansen, commented that the MSRB
should provide additional guidance regarding the meaning of various
terms (e.g., ``principal capacity'' and ``principal transaction'') for
purposes of interpreting the proposed prohibition on principal
transactions. Several commenters, including GFOA, Wulff Hansen and
First Southwest, sought clarification regarding the types of
transactions that would constitute principal transactions. For example,
the GFOA requested that the MSRB provide examples of prohibited and
acceptable practices; Wulff Hansen asked that the MSRB specify whether
the sale of other additional municipal advisory or related services
would constitute a prohibited principal transaction; and First
Southwest asked whether a municipal advisor that also facilitates
private placements would be engaged in a principal transaction.
    In response to comments, the Revised Draft Rule G-42(f)(i) added,
for purposes of the Revised Draft Rule, a defined term, ``engaging in a
principal transaction'' to mean: ``when acting as principal for one's
own account, selling to or purchasing from the municipal entity client
any security or entering into any derivative, guaranteed investment
contract, or other similar financial product with the municipal entity
client.''
    In response to the Second Request for Comment, ABA and GFOA
expressed support for the proposed defined term. Another commenter,
Sanchez, asked the MSRB to include a non-exhaustive list of specific
common roles (such as underwriter) in addition to the general
description. NY State Bar recommended two significant changes intended
to narrow the scope of the prohibition and the definition of principal
transaction: (1) The ``somewhat open-ended'' phrase ``other similar
financial product'' should be amended to refer exclusively to municipal
financial products, as defined in the Exchange Act; and (2) the
definition of ``engaging in a principal transaction'' should be amended
to make clear that the term does not include any of the banking
activities as to which a bank may provide advice without being
registered as a municipal advisor pursuant to the exemption in the SEC
Rule 15Ba1-1(d)(3)(iii),\76\ including holding investments in a deposit
or savings account, certificate of deposit or other deposit instrument
issued by a bank; extensions of credit by a bank to a municipal entity
or obligated person, including the issuance of a letter of credit; the
making of a direct loan, or the purchase of a municipal security by the
bank for its own account; holding funds in a sweep account; or
investments made by a bank acting in the capacity of an indenture
trustee or similar capacity.
---------------------------------------------------------------------------

    \76\ 17 CFR 240.15Ba1-1(d)(3)(iii).
---------------------------------------------------------------------------

    In response to comments filed regarding the Second Request for
Comment, including Lewis Young's, the proposed rule would provide
additional guidance regarding the term, ``other similar financial
products.'' Proposed Supplemental Material paragraph .11 would provide
that, as used in Proposed Rule G-42(f)(i), ``other similar financial
products,'' ``includes a bank loan, but only if it is in an aggregate
principal amount of $1,000,000 or more and it is economically
equivalent to the purchase of one or more municipal securities.'' The
MSRB notes that the term ``other similar financial products'' is not
limited to refer exclusively to municipal financial products, as
defined in the Exchange Act, in that a fiduciary's obligation to its
client--not to engage in principal transactions in which the
fiduciary's financial interests and concerns conflict with those of the
client--is not so limited. For the same reason, the MSRB has determined
not to limit the scope of banned transactions, which are covered based
generally on conflicts principles, to the category of transactions as
to which advising triggers a registration requirement as a municipal
advisor.
Exceptions to Ban
    In the First Request for Comment, the MSRB specifically sought
comments on whether a ban on principal transactions by municipal
advisors was the appropriate regulatory approach, or whether a
municipal advisor should be permitted to engage in certain types of
principal transactions with its client, with full and fair disclosure
and written client consent, and, if so, what types of principal
transactions should be allowed.
    In response to the First Request for Comment, several commenters,
including ABA, First Southwest, Frost, GKB, Kutak, JP Morgan, NABL and
SIFMA, expressed concerns regarding what they viewed as the overly
broad prohibition on principal transactions between municipal advisors
and their clients. Several commenters, including the ABA, Cape Cod
Savings, Frost, NABL, SIFMA and Zion, stated that the prohibition could
do a disservice to municipal entities by unnecessarily and

substantially restricting the choices available to municipal entities
that engage their municipal advisors (or their affiliates) in other
types of transactions that would be prohibited by the Initial Draft
Rule. In addition, several commenters, including ABA, Kutak, NABL,
Parsons, SIFMA, Sutherland and Wells Fargo, believed that a municipal
advisor should be permitted to engage in certain types of principal
transactions with its clients if the municipal advisor provides its
client with full and fair disclosure and then receives informed consent
from the client. NABL stated that the proposed ban would conflict with
common law, under which an agent's fiduciary duties of loyalty and care
could be waived or otherwise modified by the principal if the principal
is not legally incompetent. Kutak commented that the Initial Draft Rule
should not prohibit all principal transactions with municipal entities
when the client is sufficiently sophisticated to adequately assess the
risks of the transactions. Kutak believed transactions involving an
investment in an instrument where an established market exists and a
municipal entity client could readily ascertain the reasonableness and
fairness of the price should be allowed under the Initial Draft Rule.
    Also, multiple commenters, including ABA, Kutak, NABL and SIFMA (in
response to the First Request for Comment) and FSR and Zion (in
response to the Second Request for Comment), noted that under Section
206(3) of the Investment Advisers Act and other regulatory regimes,
certain principal transactions are permitted based upon full and fair
disclosure and client consent.\77\ The commenters suggested that a
similar mechanism should be included in the ban that would allow
municipal advisors to engage in principal transactions with their
municipal entity clients, subject to similar disclosure and consent
requirements. NABL also commented that, if the MSRB adopted a provision
that was consistent with the SEC's guidance under the Investment
Advisers Act regarding an exception to a ban based on disclosure and
informed consent, the MSRB should provide clear guidance to market
participants to avoid confusion.
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    \77\ See 15 U.S.C. 80b-6 and the rules adopted thereunder, which
prohibit an adviser, acting as a principal for its own account, from
knowingly selling any security to or purchasing any security from a
client for its own account, without disclosing to the client in
writing the capacity in which it (or an affiliate) is acting and
obtaining the client's consent before the completion of the
transaction.
    SIFMA also referred to the regulation of swap dealers and
security-based swap dealers that also serve as advisors to Special
Entities (which includes municipal entities) under the CEA. See 7
U.S.C. 1 et seq. According to SIFMA, the CEA does not preclude such
advisors from entering, in a principal capacity, into derivatives
transactions with the Special Entities that they advise, including
municipal entities, subject to the duty of the advisor to act in the
best interests of the Special Entity.
---------------------------------------------------------------------------

    In contrast, commenters Lewis Young and NAIPFA supported the
proposed ban on principal transactions and did not recommend creating
exceptions or narrowing its scope. Lewis Young commented that the ban
was appropriate, stating that a party cannot be both a fiduciary and a
principal party in a buyer/seller relationship if the sale is an asset,
financial product or something other than services that are compatible
with the fiduciary role.
    The MSRB carefully considered the comments received that urged the
MSRB to include one or more exceptions to the prohibition on principal
transactions. After considering the fiduciary duty of the municipal
advisor in its relationship to a municipal entity client and the
possibilities for self-dealing, the MSRB believes that the proposed
prohibition on principal transactions is sufficiently targeted and
should be retained. In addition, the MSRB believes that exceptions to
the prohibition based on disclosure and client consent, even if limited
to sophisticated municipal entities, would not sufficiently protect
municipal entity clients from potential self-dealing-related abuses.
The prohibition has been narrowed to ban only those transactions that
(1) are ``directly related'' to the same municipal securities
transaction or municipal financial product as to which the municipal
advisor is providing or has provided advice and (2) are purchases or
sales of a security or involve entering into a derivative, guaranteed
investment contract, or other similar financial product with the
municipal entity client (as discussed, supra). In the MSRB's view, the
prohibition on principal transactions should not at this juncture be
modified or narrowed, given the acute conflicts of interest presented
and the risk of self-dealing by a regulated entity (or its
affiliate).\78\
---------------------------------------------------------------------------

    \78\ Similar concerns regarding conflicts of interests arising
when a regulated entity would provide financial advice to a
municipal issuer and also serve as underwriter were raised by the
MSRB and commenters in connection with SR-MSRB-2011-03, a proposed
rule change to amend MSRB Rule G-23 relating to the activities of
financial advisors, which was approved by the Commission. See
Exchange Act Release No. 64564 (May 27, 2011), 76 FR 32248, 32249
(June 3, 2011) (order approving File No. SR-MSRB-2011-03) (``[T]he
proposed rule change resulted from a concern that a dealer financial
advisor's ability to underwrite the same issue of municipal
securities, on which it acted as financial advisor, presented a
conflict that is too significant for the existing disclosure and
consent provisions of Rule G-23 to cure. Even in the case of a
competitive underwriting, the perception on the part of issuers and
investors that such a conflict might exist was sufficient to cause
concern that permitting such role switching was not consistent with
`a free and open market in municipal securities' '' (emphasis
added)).
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Affiliates
    In response to the First Request for Comment, a number of
commenters commented on the ban's coverage of principal transactions by
affiliates of a municipal advisor, including ABA, Frost, JP Morgan,
Parsons, Piper Jaffray, SIFMA, Wells Fargo and Zion.
    The ABA, SIFMA and other commenters commented generally that other
fiduciary regimes do not prohibit all affiliates of a fiduciary from
engaging in principal transactions with the party owed the fiduciary
duty. Wells Fargo also sought to limit the coverage of the ban,
commenting that the ban should not apply to certain affiliates. In
Wells Fargo's view, affiliates of large financial institutions often
offer substantially different services, operate with distinct
governance structures and employ information barriers, and, in such
instances, if a non-municipal advisor affiliate is not connected to the
municipal advisor relationship, the risk of a conflict of interest in a
principal transaction between a municipal advisor client and the non-
municipal advisor affiliate is significantly diminished. Wells Fargo
suggested that the MSRB not apply the ban to affiliates or, at a
minimum, limit the ban to principal transactions of affiliates that are
directly related to the municipal advisory relationship that the
municipal advisor affiliate has with the client. ABA, NABL, SIFMA,
Wells Fargo, Zion and other commenters generally expressed concerns
related to regulating conduct of affiliates of municipal advisors,
specifically the imposition of compliance burdens on the affiliates and
possible unintended consequences to clients if certain products and
services offered by affiliates of the municipal advisor were no longer
available to clients. ABA and NABL commented that the MSRB does not
have apparent authority to regulate the conduct of affiliates of
municipal advisors that are not brokers, dealers or municipal
securities dealers, and thus, any ban should be narrowly-tailored and
addressed to the municipal advisor's right to advise, rather than its
affiliates' rights to engage in unrelated transactions.
    In response to the Second Request for Comment, ABA, FSR, SIFMA and
Wells

Fargo included significant comments that focused on the ban's
application to transactions by affiliates. With respect to affiliates,
among the concerns raised was the difficulty that municipal advisors
and their affiliates might have in identifying transactions that are
related to an advised transaction, particularly within large
organizations, and the likely significant cost of compliance.
    Commenters, such as SIFMA and Wells Fargo, also questioned the
value of extending the prohibition to affiliates of a municipal
advisor, stating that, in scenarios where the affiliate has no
knowledge of the municipal advisory relationship, or where the
municipal advisor has no knowledge of an affiliate's contemplated
principal transaction, the parties would not be likely to engage in
self-dealing or profit from the affiliation.
    SIFMA suggested that the MSRB include the emphasized modifier in
subsection (e)(ii) as follows: ``A municipal advisor to a municipal
entity client, and any affiliate of such municipal advisor, is
prohibited from knowingly engaging in a principal transaction. . . .''
(emphasis added), which is the same modifier contained in the provision
on principal transactions in the Investment Advisers Act.\79\ Wells
Fargo suggested a modification to exempt municipal advisor affiliates
operating with information barriers, stating that such entities are
unlikely to engage in the self-dealing that the rule is aimed at
preventing.
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    \79\ See 15 U.S.C. 80b-6(3).
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    After considering the fiduciary duty of the municipal advisor in
its relationship to a municipal entity client and the risk of self-
dealing, the MSRB believes that the proposed prohibition on principal
transactions, including its application to affiliates, is sufficiently
targeted. In the MSRB's view, the proposed prohibition should be
retained without exceptions, including one based on disclosure and
consent, for the reasons set forth above, given the acute nature of the
conflicts of interest presented and the risks of self-dealing by
affiliates in transactions that are ``directly related'' to the same
municipal securities transaction or municipal financial product as to
which the affiliated municipal advisor is providing or has provided
advice. Significantly, the prohibition is limited to certain types of
transactions (i.e., purchases or sales of a security or those involving
entering into a derivative, guaranteed investment contract, or other
similar financial product). Finally, in connection with affiliates, if
the prohibition on principal transactions were modified by
``knowingly,'' the MSRB believes the standard would be overly
stringent, which could hinder regulatory examinations and enforcement.
Relationship Between the Ban and Rule G-23
    In the First Request for Comment, the ban prohibiting municipal
advisors (and their affiliates) from engaging in principal transactions
with the municipal advisor's clients included the exception: ``Except
for an activity that is expressly permitted under [MSRB] Rule G-23''
(``Rule G-23 exception''). The Rule G-23 exception was included to
address the interrelationship between the proposed specific prohibition
on principal transactions in Initial Draft Rule G-42 and principal
transactions that are permitted by underwriters under Rule G-23.
    Commenters sought clarity regarding the relationship between Rule
G-23 and the prohibition on principal transactions in the Initial Draft
Rule. In response to the First Request for Comment, commenters asked
whether the prohibition on principal transactions was in conflict with
principal transactions discussed in Rule G-23, under which a municipal
advisor could acquire, as a principal, all or any portion of an
issuance of municipal securities for which the municipal advisor had
provided advice, as long as the municipal advisor complied with Rule G-
23. BDA and GKB noted that, although the provision in the proposed ban
referenced an exception for activities that are expressly permitted
under Rule G-23, it was unclear what principal transactions would be
permitted. Lamont commented that MSRB rules applicable to municipal
advisors should not conflict with MSRB rules applicable to dealers
regarding principal transactions, observing that, in its view, a
fiduciary duty to the issuer will require additional steps to ensure
that the pricing has been at least as favorable as having a third party
in the transaction.
    After careful consideration of the comments, the MSRB developed the
Revised Draft Rule to clarify the relationship between the proposed ban
on principal transactions and those principal transactions currently
permitted under Rule G-23. Specifically, paragraph .07 to the
Supplementary Material of the Revised Draft Rule described the Rule G-
23 exception to the ban, providing that subsection (e)(ii) would not
apply to an acquisition as principal, either alone or as a participant
in a syndicate or other similar account formed for the purpose of
purchasing, directly or indirectly, from an issuer all or any portion
of an issuance of municipal securities, provided that the municipal
advisor complied with the requirements of Rule G-23. Thus, the Rule G-
23 exception was more clearly described using the particular
terminology in Rule G-23, rather than solely cross-referencing Rule G-
23.
    Several of the comments received in response to the Second Request
for Comment continued to seek clarification regarding the Rule G-23
exception, desiring to avoid confusion regarding any express and direct
conflict between the ban and Rule G-23. GFOA sought additional
amendments to paragraph .07 of the Supplementary Material, seeking to
``ensure that no component of a final Rule on G-42 removes the
authority of issuers to decide for themselves how they utilize a
[municipal advisor] or underwriter on a transaction so long as
compliance with MSRB Rule G-23, MSRB Rule G-42 and the SEC's Municipal
Advisor Rule are maintained.'' In BDA's view, the Revised Draft Rule
language did not clarify the provision compared with the prior language
regarding when a municipal advisor could act as a principal on the same
transaction for which it is providing advice.
    Sanchez appeared to interpret the provision to mean that a
transaction permitted by Rule G-23 would be deemed in all cases to be
lawful vis-a-vis other requirements under proposed Rule G-42 (such as
the duty of loyalty) and under other laws (such as the statutory
fiduciary duty). Columbia Capital commented that the sentence regarding
the Rule G-23 exception in paragraph .07 of the Supplementary Material
should be deleted because it ``contemplates a situation where an MA
could serve as a principal in a transaction for which it provides MA
services, creating a conflict'' with the proposed prohibition on
principal transactions. Finally, ABA commented that the clarification
regarding the conflict between Rule G-23 and draft Rule G-42(e)(ii) is
unnecessary, or, if the clarification is retained, the phrase,
``provided that the municipal advisor complies with all of the
provisions of Rule G-23,'' should be deleted and the phrase, ``provided
that such a transaction is not prohibited by the provisions of Rule G-
23,'' should be incorporated.
    The MSRB notes that the purpose of the sentence regarding the Rule
G-23 exception in paragraph .07 of the Supplementary Material is to
avoid a potential inconsistency in the MSRB's

rules by providing specifically in Proposed Rule G-42, until such time
as the MSRB may further review and potentially revise Rule G-23, that
the specific ban on principal transactions in proposed subsection
(e)(ii) does not prohibit a type of principal transaction that is
already addressed and prohibited to a certain extent by Rule G-23. To
further clarify this point, and respond to the comment by ABA, the MSRB
has deleted the phrase ``provided that the municipal advisor complies
with all the provisions of Rule G-23'' from the end of paragraph .07,
and substituted the phrase ``that is a type of transaction that is
addressed by Rule G-23.'' Also, in response to the comments requesting
additional clarification, the MSRB has included the phrase ``on the
basis that the municipal advisor provided advice as to the issuance.''
Proposed paragraph .07 of the Supplementary Material, as revised, would
provide:

    In addition, the specific prohibition in subsection (e)(ii) . .
. shall not apply to an acquisition as principal, either alone or as
a participant in a syndicate or other similar account formed for the
purpose of purchasing, directly or indirectly, from an issuer all or
any portion of an issuance of municipal securities on the basis that
the municipal advisor provided advice as to the issuance because
that is a type of transaction that is addressed and prohibited in
certain circumstances by Rule G-23 (emphasis added).

    The MSRB cautions that this provision is quite limited, providing
an exception only to the specific prohibition in subsection G-
42(e)(ii); and it would not mean, for example, that a transaction not
prohibited by Rule G-23 is deemed in all cases to be lawful vis-a-vis
all other requirements under Proposed Rule G-42 (such as the duty of
loyalty) and under other laws (such as the statutory fiduciary duty).
Inadvertent Advice--Supplementary Material .06
    In response to the Second Request for Comment, several commenters
expressed concerns and suggested changes to the inadvertent advice
exclusion in paragraph .06 of the Supplementary Material to the Revised
Draft Rule. First, NAIPFA believed the paragraph impermissibly creates
an additional exemption from the Commission's definition of the term
``municipal advisor'' and is inconsistent with Rule G-23, allowing
broker-dealers to provide advice to municipal entities and obligated
persons as municipal advisors without becoming subject to corresponding
fiduciary responsibilities and ultimately allowing such municipal
advisors to serve as underwriters of the securities being issued.
Similarly, WM Financial believed paragraph .06 negated Rule G-23 and
effectively allowed broker-dealers to serve as municipal advisors and
then switch to serving as underwriters, undermining the definition of
``municipal advisor'' and the exemptions thereto provided by the SEC.
Contrary to NAIPFA and WM Financial, Sanchez stated that ``it appears
reasonably clear at the moment that Supplementary Material .06 is only
intended to provide relief from subsections (b) and (c) of Proposed
Rule G-42;'' however, he believed it would be useful for the MSRB to
also include an affirmative statement that even inadvertent advice is
subject to all other rules and requirements applicable to municipal
advisory activities and financial advisory relationships entered into
by broker-dealers under Rule G-23, Commission rules, and the fiduciary
duty set forth in the Exchange Act.
    NAIPFA and WM Financial misinterpreted the safe harbor provided by
paragraph .06 as broadly relieving a municipal advisor of other
regulatory requirements. To address such confusion, the MSRB has
revised paragraph .06 of the Supplementary Material to include a
clarifying statement that the relief the paragraph provides ``has no
effect on the applicability of any provisions'' of Proposed Rule G-42,
other than sections (b) and (c) (relating to documentation of the
municipal advisory relationship and the disclosure of conflicts of
interest, respectively) or any other legal requirements applicable to
municipal advisory activities, which would include, but are not limited
to, SEC rules and Rule G-23.
    Second, SIFMA suggested that the MSRB broaden the limited safe
harbor provided by paragraph .06 to relieve municipal advisors that
inadvertently engage in municipal advisory activities from compliance
with section (d) and subsection (e)(ii) of the Revised Draft Rule.
Section (d) would require a suitability analysis of recommendations
made by the municipal advisor or by a third party while subsection
(e)(ii) would prohibit principal transactions directly related to the
same municipal securities transaction or municipal financial product as
to which the municipal advisor is providing or has provided advice. The
MSRB believes that, despite inadvertently engaging in municipal
securities activities, a municipal advisor should not be relieved of
complying with the suitability analysis requirement to the extent the
municipal advisor made or reviewed a recommendation as contemplated by
Proposed Rule G-42(d). Further, the MSRB does not believe, as SIFMA
suggested, that firms would be less likely to perform the disclaimer
process under paragraph .06 because doing so would not permit them to
engage in a principal transaction prohibited under Proposed Rule G-