SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Release No. 61734/ March 18, 2010
Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: JP Morgan Securities, Inc.
The Division of Enforcement has investigated whether JP Morgan Securities Inc. ("JPMSI"), a broker-dealer registered with the Commission, violated MSRB Rule G-37 ("Rule G-37"). Rule G-37 prohibits a broker, dealer or municipal securities dealer from, among other things, underwriting municipal bonds for an issuer within two years after the broker, dealer or municipal securities dealer or one of its municipal finance professionals ("MFPs") makes a political contribution to an official of that issuer. JPMSI underwrote municipal bonds issued by the state of California within two years after the Vice Chairman of JPMSI's parent bank holding company, JP Morgan Chase & Co., Inc. ("JP Morgan Chase" or "the Company"), who also led JP Morgan Chase's investment banking business, gave a $1,000 contribution to the Treasurer of the State of California ("California Treasurer"). Although the Vice Chairman of JP Morgan Chase was not a director, officer or employee of JPMSI, he nevertheless was an MFP associated with JPMSI because he functionally supervised JPMSI and served on the executive committee that oversaw JPMSI.
The Commission deems it appropriate and in the public interest to issue this Report of Investigation ("Report") pursuant to Section 21(a) of the Securities Exchange Act of 1934 ("Exchange Act").1 The Report reaffirms guidance issued previously by the MSRB that a person associated with a broker, dealer or municipal securities dealer, as defined in Sections 3(a)(18) and (32) of the Exchange Act, but employed by an entity affiliated with a broker, dealer or municipal securities dealer, such as a parent bank holding company or an affiliated bank, is an MFP if by his or her activities, function, authority or responsibilities, such person meets the definition of MFP set forth in MSRB Rule G-37(g).
II. Background on MSRB Rule G-37
A. MSRB Rule G-37(b)
MSRB Rule G-37 has three substantive provisions-subparagraphs (b), (c) and (d)-that govern certain activities of brokers, dealers and municipal securities dealers to prohibit profiting from pay-to-play practices. MSRB Rule G-37(b) prohibits any broker, dealer, or municipal securities dealer from engaging in municipal securities business2 with an issuer within two years after any contribution to an official of the issuer3 made by the broker, dealer, or municipal securities dealer; or by any MFP associated with the broker, dealer, or municipal securities dealer; or by any political action committee controlled by the broker, dealer, municipal securities dealer or an MFP. A de minimus exception to Rule G-37(b) allows an MFP to contribute up to $250 per candidate per election if the MFP is entitled to vote for that issuer official.
Because Rule G-37 is a broad prophylactic measure, the Commission is not required to establish scienter or a quid pro quo in order to find a violation of Rule G-37(b). See In the Matter of Fifth Third Securities, Inc., Exchange Act Rel. No. 46087, n.4 (June 18, 2002). Instead, the prohibited act under Rule G-37(b) is engaging in municipal securities business within two years of a contribution to an official of the issuer, regardless of intent.4
As indicated above, a violation of Rule G-37(b) can occur as a result of a contribution by a broker, dealer, or a municipal securities dealer, an associated political action committee, or by certain associated persons who are MFPs. In basic terms, an MFP, as defined in Rule G-37(g), is any associated person who: (A) primarily engages in municipal securities representative activities; (B) solicits municipal securities business; (C) is a municipal securities principal or a municipal securities sales principal and supervises persons described in subparagraphs (A) and (B); (D) supervises any person described in subparagraph (C) up through and including, in the case of a broker, dealer or municipal securities dealer other than a bank dealer, the chief executive officer or similarly-situated official; or (E) is a member of the broker, dealer or municipal securities dealer executive or management committee or similarly situated officials. In addition, each person designated by a broker, dealer or municipal securities dealer as an MFP is deemed to be an MFP.
In evaluating the activities of an associated person to determine if he is an MFP as defined in MSRB Rule G-37(g), the Commission has previously noted that the definition includes "those individuals who have an economic interest in seeing that the dealer is awarded municipal securities business and who thus may be in a position to make political contributions for the purpose of influencing the awarding of such business by issuer officials." Notice of Filing of Proposed Rule Change by the MSRB Relating to Political Contributions and Prohibitions on Municipal Securities Business, Release No. 34-33482, 1994 SEC LEXIS 152 at *16 (Jan. 14, 1994). Thus, the definition of MFP not only includes those employees of a broker, dealer or municipal securities dealer primarily engaged in municipal securities business and their supervisors, but also certain other associated persons who might be solicited for contributions or might otherwise have an incentive to give a contribution in an effort to win underwriting business. Moreover, the MSRB has explained that whether someone is an MFP depends on "the activities of the individual and not his or her title." MSRB Additional Rule G-37 Q&As (Sept. 9, 1997, revised Oct. 30, 2003 and June 8, 2006).
With respect to subparagraph (E) of the definition-covering executive or management committee MFPs-the Commission previously explained in a 1996 order approving certain changes to Rule G-37 that the subparagraph is
. . . the only part of the definition of municipal finance professional that does not depend upon the municipal securities activities of the person or the supervision of persons engaged in municipal securities activities. This provision was intended to prevent issuer officials from seeking contributions from dealers' senior executives once Rule G-37 precluded municipal finance professionals from contributing to those officials.
Order Granting Approval of Proposed Rule Change by the MSRB Relating to Political Contributions and Prohibitions on Municipal Securities Business, Release No. 34-37928, 1996 SEC LEXIS 3127 at *3 (Nov. 6, 1996).
A. The Role of the Former Vice Chairman of JP Morgan Chase
After joining JP Morgan Chase in 2000 with responsibility for JP Morgan's retail and consumer banking business, the Vice Chairman relinquished those roles in July 2002 and assumed responsibility for JP Morgan Chase's global investment banking, asset management and private wealth businesses. The Vice Chairman reported exclusively to JP Morgan Chase's Chairman and CEO at the time. In press releases after the change, JP Morgan Chase often referred to the Vice Chairman as the "CEO" of JP Morgan Chase's Investment Bank. The Investment Bank included a number of legal entities. JPMSI, the registered broker-dealer, was the primary U.S.-based legal entity, and it conducted its business on a fully integrated basis. JPMSI operated seamlessly within the Investment Bank.
From July 2002 through September 2004, the Vice Chairman supervised the entire global investment banking business, which included municipal securities underwriting in the United States by JPMSI. During that time period, JPMSI was an important component of the business units under the Vice Chairman's supervision, generating significant operating revenues for the global investment bank. The Vice Chairman had full authority to hire or fire employees of the Investment Bank, including employees of JPMSI; he set the compensation pools for the various business lines within the Investment Bank that operated through JPMSI; resolved disputes within the Investment Bank that involved JPMSI; and oversaw transactions involving JPMSI's municipal finance department.
The Vice Chairman was the only JP Morgan Chase officer with responsibility for all businesses under the JPMSI umbrella. During the Vice Chairman's tenure as CEO of the JP Morgan Chase's Investment Bank, the head of JPMSI's public finance business reported indirectly to the Vice Chairman; periodically met with the Vice Chairman to brief him on public finance deals, and arranged for the Vice Chairman to participate in meetings with important public finance clients. While the Vice Chairman did not directly supervise managers in the public finance business, his direct reports, who were responsible for that line of business, regularly reported to him on the public finance business' performance.5
JPMSI did not have a chief executive officer or similarly situated official. While JPMSI had its own board of directors, the Board did not manage or control the business, but only met annually to address regulatory and perfunctory operational matters. Although JPMSI also had an executive committee, it never met. Therefore, it never functioned as a management subcommittee of the board. In fact, an officer in the Investment Bank who, for a period, served as "president" of JPMSI, testified that he "didn't remember the [JPMSI executive] committee ever doing anything or what the function of the committee was." JPMSI's "chairman and president" occupied a regulatory function, with no real authority over the various businesses conducted by JPMSI, and he served no functional role overseeing the public finance business.
The Vice Chairman did play a functional role in the public finance business by, among other things, actively promoting its services. For example, in October 2002, the Vice Chairman sent a pitch letter to JPMSI's public finance customers, who included, among others, state and municipal bond issuers. The letter also was subsequently included by the public finance department in at least eight responses to Requests for Qualifications ("RFQs") from municipal securities issuers between November 2002 and October 2003.
By virtue of his senior position within JP Morgan Chase, the Vice Chairman was a member of JP Morgan Chase's executive committee. According to the Vice Chairman, JP Morgan Chase's executive committee met one to three times a month to discuss JP Morgan Chase's "annual plan, the overall strategy, regular performance reviews, risk management activities, positioning in the markets in general, in communities in particular, and global functions throughout the organization." The executive committee provided "broad-banded oversight of the entire organization."
B. Political Contributions to the California Treasurer
In August 2002, a few months after he became CEO of JP Morgan Chase's Investment Bank, the Vice Chairman received a call from the California Treasurer, who was in the middle of his 2002 re-election campaign. The California Treasurer called about fundraising. Soon after the call, on August 20, 2002, the California Treasurer' re-election campaign sent the Vice Chairman a facsimile inviting him to co-chair an upcoming New York event.
The invitation indicated that the Vice Chairman would be required to raise $10,000 for the California Treasurer's campaign in order to serve as co-chair of the event. The Vice Chairman did not agree to co-chair the event, but subsequently solicited $10,000 for the California Treasurer. On September 10, 2002, the Vice Chairman forwarded an invitation for the California Treasurer's New York fundraising event to JP Morgan Chase's executive committee and to its Vice President for Government Relations with a handwritten note stating that the California Treasurer is an important client and soliciting their help in raising $10,000 for the event.
The Vice Chairman gave $1,000 to the California Treasurer's campaign on September 30, 2002. The Vice Chairman also successfully solicited additional contributions totaling $8,000 from JP Morgan Chase Bank and three of JP Morgan Chase's senior officials.6
C. JPMSI's Municipal Securities Business in California — 2002-2004
Within two years after the Vice Chairman's contribution described above, JPMSI participated as senior manager or co-manager in more than 50 negotiated underwritings for California state agencies or instrumentalities for which the California Treasurer was an official of such issuers within the meaning of Rule G-37(g)(vi).7 The bonds underwritten sold for a total of more than $15.8 billion. For its roles in these underwritings and engagements, JPMSI received approximately $37 million in investment banking fees.
JPMSI underwrote certain California issues within two years after JP Morgan Chase's Vice Chairman contributed $1,000 to the California Treasurer. Although the Vice Chairman was not a director, officer or employee of JP Morgan Chase's broker-dealer subsidiary, JPMSI, the Vice Chairman was a person associated with JPMSI as that term is defined in the Exchange Act. Persons associated with brokers, dealers and municipal securities dealers are MFPs if by their activities, function, authority or responsibilities, they meet the definition of MFP set forth in Rule G-37(g).
In the Commission's 1994 Exchange Act Release approving Rule G-37, addressing a letter commenting on the MSRB's rule proposal, the Commission indicated that banks and bank holding companies affiliated with brokers, dealers and municipal securities dealers were excluded from the scope of MSRB Rule G-37.8 Since that time, the MSRB has stated in guidance first issued in 1997 that "one must review the activities of the individual and not his or her title[,]" when determining whether a person associated with the broker, dealer or municipal securities dealer, which by definition can include officers and employees of affiliated banks and bank holding companies, is an MFP and, thus, covered by the rule.9 Furthermore, in other guidance, the MSRB has described circumstances under which a person associated with a broker, dealer or municipal securities dealer but employed by an affiliated entity can be an MFP.10 The Commission, however, has never directly addressed whether directors, officers or employees of banks and bank holding companies affiliated with brokers, dealers or municipal securities dealers, who supervise the public finance activities of such brokers, dealers and municipal securities dealers, or who serve on executive committees that engage in such supervision, are MFPs.
We note that financial services firms cannot simply place executives managing a subsidiary broker, dealer, or municipal securities dealer, outside the broker, dealer, or municipal securities dealer's corporate structure as a means to avoid the limitations that Rule G-37 imposes on those executives' political contributions. We concur with the prior guidance by the MSRB that the rule looks to the activities, not merely the title, of an associated person in determining whether the person is an MFP. Today, many brokers, dealers and municipal securities dealers are subsidiaries of bank holding companies offering a broad array of financial services beyond municipal securities brokerage and investment banking. Given that commercial banks and other businesses within financial services companies are not directly subjected to pay-to-play prohibitions similar to Rule G-37, we underscore the limits imposed by Rule G-37 on executives who are the face of, and authority behind, brokers, dealers and municipal securities dealers within larger financial firms.
In this case, JPMSI, JP Morgan Chase's broker-dealer subsidiary, did not have an internal committee or other group overseeing the executive management and business operations of the broker-dealer. Accordingly, those responsibilities flowed outside the broker-dealer to executives at the Investment Bank, in particular, to the Vice Chairman, who essentially served as the de facto supervisor and executive officer of JPMSI. The Vice Chairman was the only executive within JP Morgan Chase to supervise and exercise authority over all of the businesses that operated through JPMSI. The Vice Chairman's active promotion of the public finance business is further evidence of his functional, supervisory role over that group. Moreover, JP Morgan Chase's executive committee, not JPMSI's, exercised management and supervisory functions with respect to JPMSI.11
This Report serves to remind the financial community that placing an executive who supervises the activities of a broker, dealer or municipal securities dealer outside of the corporate governance structure of such broker, dealer or municipal securities dealer does not prevent the application of MSRB Rule G-37 to that individual's conduct. Brokers, dealers and municipal securities dealers without distinct, active and functioning corporate governance structures may violate Rule G-37 when officers, directors or other individuals within affiliated entities who supervise the public finance activities of such brokers, dealers and municipal securities dealers, or who serve on executive committees that engage in such supervision, make political contributions to issuer officials. A proper application of the Rule requires a review of the activities, not merely the title, of an associated person of a broker, dealer or municipal securities dealer in determining whether the person is an MFP and, thus, subject to pay-to-play prohibitions set forth in Rule G-37.
By the Commission.