SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Release No. 39459 / December 17, 1997 Admin. Proc. File No. 3-9289 _________________________________________________ : In the Matter of the Application of : : MORGAN STANLEY & CO., INC. : : : OPINION OF THE COMMISSION REGISTERED SECURITIES ASSOCIATION -- REVIEW OF ASSOCIATION ACTION Jurisdiction to Review Action of Association Member firm of registered securities association was denied exemption from two-year prohibition on engaging in municipal securities business in state where associated person made prohibited contribution to state official. Held, the matter is not reviewable by the Commission because the denial of the exemption does not constitute any of the actions enumerated in Section 19(d) of the Securities Exchange Act of 1934, and application for review is dismissed. APPEARANCES: Kenneth A. Gross, of Skadden, Arps, Slate, Meagher & Flom LLP, for Morgan Stanley & Co., Inc. Alden S. Adkins, John Ramsay, and John Pilcher, for NASD Regulation, Inc. Diane G. Klinke and Ernesto A. Lanza, for the Municipal Securities Rulemaking Board, amicus curiae. Appeal lodged: March 31, 1997 Last brief filed: June 23, 1997 I. On September 9, 1996, the head of the Fixed Income Division of Morgan Stanley & Co., Inc. ("Morgan"), a member of the National Association of Securities Dealers, Inc. ("NASD"), contributed $1,000 to the United States Senate campaign of William Weld, then Governor of Massachusetts. As a result, Morgan became subject to a two-year prohibition from engaging in certain specified municipal securities business in Massachusetts, pursuant to Rule G-37 of the Municipal Securities Rulemaking Board ("MSRB"). Rule G-37 provides in pertinent part that "[n]o broker, dealer or municipal securities dealer shall engage in municipal securities business [as defined in the rule] with an issuer within two years after any contribution to an official of such issuer made by . . . any municipal finance professional associated with such broker, dealer or municipal securities dealer . . . ." On November 5, 1996, Morgan applied to the staff of NASD Regulation, Inc. ("NASDR") <(1)> for an exemption from the two-year prohibition under Rule G-37. That application was denied. On February 28, 1997, NASDR's Fixed Income Committee rejected Morgan's appeal of the denial. Morgan seeks review of the NASD's exemption denial before this Commission. On May 19, 1997, we issued an order granting an interim stay of the two- year prohibition and directing that the parties submit briefs addressing the issue of whether this Commission has jurisdiction to consider Morgan's appeal. As discussed below, we have determined that we do not have jurisdiction to consider this matter. <(2)> II. Rule G-37 serves a compelling government interest by addressing practices in the municipal securities market known as "pay to play." Such practices occur where a municipal securities firm makes contributions to, or solicits contributions for, officials of state and local issuers in order to be considered for an award of certain types of municipal securities business over which the officials have influence. When we approved Rule G-37, we stated that "[t]hese practices directly affect municipal securities markets by increasing costs borne by issuers, dealers and ultimately investors, by creating artificial barriers to competition, <(1)> On October 20, 1995, we approved NASD internal procedures whereby the NASD Board of Governors delegated authority to the staff of the NASDR Business Line to conduct an initial review of requests by NASD members for exemptions from the operation of Rule G-37. See Securities Exchange Act Rel. No. 36403 (Oct. 26, 1995), 60 SEC Docket 1668. <(2)> The MSRB has moved for leave to file an amicus brief in this matter. Morgan opposes the MSRB's motion, claiming that the MSRB lacks the required interest in the jurisdictional issue that the Commission directed the parties to address. In the alternative, Morgan asks this Commission to entertain only that portion of the MSRB's brief addressing the jurisdictional issue. We hereby grant the MSRB's request for leave to file an amicus brief to the extent it relates to the jurisdictional issue. We also grant Morgan's motion for leave to file a reply brief to the briefs of NASDR and the MSRB. ======END OF PAGE 2====== and by undermining underwriter and market integrity." <(3)> In considering Rule G-37, the United States Court of Appeals for the District of Columbia Circuit observed that "underwriters' campaign contributions self-evidently create a conflict of interest in state and local officials who have power over municipal securities contracts and a risk that they will award the contracts on the basis of benefit to their campaign chest rather than to the governmental entity." <(4)> The rule seeks to insulate the municipal securities industry from the potentially corrupting influence of political contributions that are made in close proximity to the awarding of municipal securities business. It does so by providing that a firm may not engage in municipal securities business with an issuer for a two-year period if an official of the firm has made a contribution covered by the rule. Creating such a barrier removes the opportunity to benefit from such a contribution. As we previously have observed, Rule G-37 "represents a balanced response to allegations of corruption in the municipal securities market; it provides specific prohibitions to help ensure that underwriter selection is based on expertise, not on the amount of money given to a particular candidate for office." <(5)> The D.C. Circuit concluded that the rule is "closely drawn," restricting affected underwriters in a "narrow range of their activities for a relatively short period of time." <(6)> III. Our authority to review NASD actions is governed by the Securities Exchange Act of 1934 (the "Exchange Act"). Section 19(d) of the Exchange Act authorizes Commission review of an action of a self-regulatory organization ("SRO"), including the NASD, if that action: (i) imposes any final disciplinary sanction on any member or person associated with a member; (ii) denies membership to any applicant; (iii) prohibits or limits any person in respect to access to services offered by such organization or member thereof; or <(3)> Securities Exchange Act Rel. No. 33868 (April 7, 1994), 56 SEC Docket 1176. <(4)> Blount v. SEC, 61 F.3d 938, 944 (D.C. Cir. 1994), cert. denied, 116 S.Ct. 1351 (1996). <(5)> Securities Exchange Act Rel. No. 33868, 56 SEC Docket at 1183. <(6)> Blount, 61 F.3d at 947. ======END OF PAGE 3====== (iv) bars any person from becoming associated with a member. Although we have not previously considered the question of whether we can review actions involving the operation of Rule G-37, we have considered the extent of Commission jurisdiction to hear appeals from other types of SRO actions. Based on those earlier rulings, we conclude that we do not have jurisdiction here under any of the four prongs of Section 19(d). A.1. Section 19(d)(1) gives us the authority to review self- regulatory action that "imposes any final disciplinary sanction." We have determined that, in denying Morgan's application for an exemption from Rule G-37's two-year business disqualification, the NASD did not impose a sanction. The prohibition against engaging in municipal securities business was triggered automatically, pursuant to the operation of Rule G- 37. The NASD did not make any assessment of whether such contribution was wrongful or otherwise take any action to impose the ban. It was the action of Morgan's employee in making the contribution, not of the NASD, that automatically triggered the rule's two-year ban. When the Fixed Income Committee denied Morgan's request for an exemption from that automatic ban, the NASD was merely exercising the discretionary authority granted it under the rule. <(7)> 2. The NASD's denial of Morgan's request for an exemption from the operation of the rule was not a disciplinary action within the meaning of the Exchange Act because it did not impose "a punishment or sanction." <(8)> In a disciplinary action, a sanction is imposed following a determination of wrongdoing. Here, by contrast, there is no determination of wrongdoing. The NASD made no such finding. Nor does Rule G-37 characterize as wrongful the making of a political contribution. Rather, as discussed above, the rule seeks to protect the integrity of municipal securities markets by establishing an automatic, prophylactic time period between the making of potentially compromising political contributions and participation in municipal securities markets. <(7)> The release granting accelerated approval to the MSRB rule establishing the exemptive procedure stated that an exemption is to be granted only in "limited circumstances." The release further stated that the exemptive procedure is intended to "offer relief from the prohibition on business without sacrificing the rule's purpose and intent, i.e., to ensure that the high standards and integrity of the municipal securities industry are maintained. . . ." Securities Exchange Act Rel. No. 34160 (June 13, 1994), 56 SEC Docket 2676, 2677. <(8)> Tague Securities Corporation, 47 S.E.C. 743, 745 (1982) (quoting City of Newark v. Bellezza, 159 N.J. Super. 123, 387 A.2d 378, 380 (App. Div. 1978)). ======END OF PAGE 4====== The fact that Morgan was adversely affected by the NASD's exemption denial does not make the NASD's action disciplinary in nature. <(9)> In Tague Securities, for example, we refused to review the action of the Philadelphia Stock Exchange in directing one of its members to make trading adjustments with other members. We determined that the action did not have a disciplinary character, notwithstanding its adverse impact on the member. <(10)> Although we determined in Tague that we did not have jurisdiction to review the exchange's order that the trades be adjusted, we observed that, in the event Tague refused to make the directed trade adjustments and became subject to exchange disciplinary sanctions as a result, the subsequent disciplinary action would be reviewable. <(11)> The same reasoning applies here. If, for example, during a period when the prohibition was not stayed, Morgan were found by the NASD to have engaged in business in violation of the terms of Rule G-37 and sanctioned, Morgan could then seek Commission review of that sanction. B. We also conclude that the NASD's action does not constitute a denial of membership. The operation of Rule G-37 and the NASD's exemption denial have no bearing on Morgan's membership in the NASD, which continues unchanged whether or not an exemption is granted. Morgan's inability to <(9)> Morgan seems to concede, in its May 30, 1997 Motion for Clarification, that the two-year prohibition did not constitute a "penalty." <(10)> See also New York Stock Exchange, Inc., Securities Exchange Act Rel. No. 15827 (May 15, 1979), 17 SEC Docket 589 (Commission considered exchange's determination to treat proposed procedures as "non- disciplinary" to be appropriate because the "primary purpose of the [procedures was] to assure adequate specialist performance . . . rather than to sanction individual specialists for substandard performance."). We also noted in Tague, 47 S.E.C. at 745, that the exchange had not employed its disciplinary procedures in its consideration of the exemption request there presented. At the time of the NASD's consideration of Morgan's exemption request, the NASD's rules provided that disciplinary proceedings were considered first before one of the NASD's district business conduct committees (or its Market Surveillance Committee) and then, on appeal, before its National Business Conduct Committee. Disciplinary proceedings were governed by the Rule 9200 Series of the NASD's Code of Procedure. Here, by contrast, Morgan's exemption request was initially considered by NASDR's Business Line and then by its Fixed Income Committee. <(11)> Id. ======END OF PAGE 5====== engage in certain aspects of the municipal securities business results, as indicated, from the action of Morgan's own employee and the automatic operation of Rule G-37, not from any condition imposed by the NASD. Morgan is seeking relief from the operation of the rule, not from any condition imposed on its membership by the NASD. <(12)> This conclusion is underscored by the instances in which, pursuant to Section 19(d) of the Exchange Act, we have reviewed the NASD's imposition of or refusal to modify a restriction agreement, under which a firm agrees to certain restrictions on its business activities as a condition of NASD membership. <(13)> Section 19(d) authorizes review of such NASD action because it relates to the NASD's membership process. C. The NASD's action in denying Morgan an exemption does not constitute a denial of access to services offered by the NASD because it has no impact on Morgan's access to any service offered by the NASD. Morgan did not seek access to any NASD service, but rather relief from the automatic operation of Rule G-37's prohibition, which its employee's actions triggered. In those cases in which we have found a denial of access, an SRO had denied or limited the applicant's ability to utilize one of the fundamentally important services offered by the SRO. The services at issue were not merely important to the applicant but were central to the function of the SRO. In Scattered Corporation, <(14)> for example, we determined that we had jurisdiction to review the refusal by the Chicago Stock Exchange to process a firm's request for registration as a market <(12)> Compare Beatrice J. Feins, 51 S.E.C. 918, 921 (1993). In Feins, we dismissed an application where the applicant had not been permitted to transfer his exchange membership to a family member, observing that he "retained his membership and all privileges thereto, including his ability to transfer and lease the membership." We also observed that he had not been denied access to services of the exchange nor subject to disciplinary action. <(13)> Domestic Securities, Inc., Securities Exchange Act Rel. No. 37559 (August 13, 1996), 62 SEC Docket 1647 (jurisdiction found where requested modification of restrictive agreement to increase number of securities in which applicant could make markets was denied by NASD); First Potomac Investment Services, Inc., 50 S.E.C. 848 (1992) (jurisdiction found where requested modification of restriction agreement to permit the trading of uncovered put options under certain conditions was denied by NASD). <(14)> Securities Exchange Act Rel. No. 37249 (May 29, 1996), 62 SEC Docket 12. ======END OF PAGE 6====== maker in certain issues because such action "limit[ed] the firm's access to the CHX's services." Similarly, in William J. Higgins, <(15)> we granted review where the New York Stock Exchange denied a member's request to install telephone link-ups to permit direct communication between the exchange's trading floor and non-member customers. In determining that the exchange's actions constituted a prohibition of, or limitation on, access to services of a member, we found that "[t]he operation of a trading floor is the principal service offered by a national securities exchange to its members, and by its members to investors." <(16)> D. We turn finally to the fourth prong of Section 19(d), which bases jurisdiction on an SRO's barring any person from becoming associated with a member. Morgan cites our decision in Exchange Services, Inc. <(17)> asserting that, where NASD action has "had a negative `impact on applicant's business,'" the firm has been "aggrieved" within the meaning of Section 19(d)(2) and is, therefore, entitled to Commission review. Contrary to Morgan's assertion, however, the basis for our jurisdiction in Exchange Services was not that the NASD's action had a negative impact on that firm's business, but that the NASD had effectively barred from association certain of the firm's employees. <(18)> The issue in Exchange Services was whether the NASD had acted properly in denying licensing exemptions for employees of an NASD member who took unsolicited securities orders over the phone. The NASD had determined that, because the employees' duties were not merely "clerical or ministerial," they did not qualify for an NASD licensing exemption and had to pass the requisite registered representative examination. The NASD further denied the employees a waiver from the NASD's examination requirement because it concluded that they were engaged in the firm's securities business. We stated in the Exchange Services opinion that, "[i]n reviewing the NASD's decision not to grant the specific waivers requested in this proceeding, we take no position on the general question of whether the determinations of self-regulatory organizations to grant or deny waivers <(15)> 48 S.E.C. 713 (1987). <(16)> Id. at 718-19. See also Creative Medical Dev., Inc., Securities Exchange Act Rel. No. 37611 (August 27, 1996), 62 SEC Docket 1954 (Commission granted review of NASD action denying issuer temporary exception from automatic quotation system's inclusion standards); Biorelease Corporation, Securities Exchange Act Rel. No. 35575 (April 6, 1995), 59 SEC Docket 84 (Commission granted review of NASD action delisting securities from its automatic quotation system). <(17)> 48 S.E.C. 210 (1985). <(18)> Id. at 214. ======END OF PAGE 7====== are reviewable." <(19)> Although the case involved an exemption denial, it was the consequence of that denial -- i.e., that certain persons were barred from association with the firm -- that provided the jurisdictional basis for Commission review. As indicated, however, the NASD's exemption denial at issue here had no similar effect on Morgan or any of its associated persons. IV. On June 2, 1997, Morgan asked us to "clarify" our order granting its stay request by "confirm[ing]" that our order "does not have the effect of extending or tolling the application of Rule G-37's two year ban." We decline to do so. In its motion requesting a stay, Morgan stated that, "[i]f a stay is not granted, the damage to the firm would be substantial and irreparable in that it stands to lose a substantial amount of business opportunities in Massachusetts as well as lose the good will that it has developed with issuers in the State." When we granted Morgan's stay request, we stated that, "in light of the time-limited nature of the ban, if we determine that we do have jurisdiction, much of the value of any appeal would be lost if a stay is not granted." Thus we were seeking to preserve the status quo ante pending our determination of the jurisdictional issue. The issuance of a stay eliminated the legal impediment to Morgan engaging in municipal securities business in Massachusetts during the pendency of its appeal. Morgan has now informed us, however, that, as a "precautionary measure, [it] has not availed itself of the stay . . . ." Nevertheless, Morgan never sought dissolution of the stay, and it was free while the stay was in effect to pursue business opportunities that Rule G- 37 would otherwise have prohibited. As discussed, Rule G-37's prohibition serves a compelling governmental interest by establishing a two-year barrier between the making of a proscribed contribution and engaging in municipal securities business. Were we to grant Morgan's request, we would be reducing that barrier and, thereby, undermining the rule's "prophylactic" purpose. <(20)> Morgan has advanced no compelling reason why the granting of that stay should result in a reduction in the period of prohibition imposed by the rule. V. For the reasons discussed above, we have concluded that the NASD's decision to deny Morgan an exemption from the two-year prohibition under Rule G-37 is not reviewable by this Commission <(19)> Id. at 215 n.14. <(20)> Blount, 61 F.3d at 945. ======END OF PAGE 8====== pursuant to the Exchange Act. We accordingly dismiss Morgan's petition. An appropriate order will issue. By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT, CAREY, and UNGER). Jonathan G. Katz Secretary ======END OF PAGE 9====== UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. Admin. Proc. File No. 3-9289 _________________________________________________ : In the Matter of the Application of : : MORGAN STANLEY & CO., INC. : : : ORDER DISMISSING APPLICATION FOR REVIEW OF EXEMPTION DENIAL BY REGISTERED SECURITIES ASSOCIATION On the basis of the Commission's opinion issued this day, it is ORDERED that Morgan Stanley & Co., Inc.'s petition for review of the denial by the National Association of Securities Dealers, Inc. of an exemption from a two-year prohibition under Rule G-37 of the Municipal Securities Rulemaking Board be, and it hereby is, dismissed for want of jurisdiction. By the Commission. Jonathan G. Katz Secretary