[Federal Register Volume 63, Number 102 (Thursday, May 28, 1998)]
[Notices]
[Pages 29282-29285]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-14119]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40014; File No. SR-MSRB-98-1]


Self-Regulatory Organizations; Municipal Securities Rulemaking 
Board; Order Granting Approval of Proposed Rule Change and Notice of 
Filing and Order Granting Accelerated Approval of Amendment No. 1 
Relating to Interpretation of Rule G-38 on Consultants Concerning Bank 
Affiliates and the Definition of Payment

May 20, 1998.

I. Introduction

    On January 12, 1998,\1\ the Municipal Securities Rulemaking Board 
(``Board''

[[Page 29283]]

or ``MSRB'') submitted to the Securities and Exchange Commission 
(``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \2\ and Rule 19b-4 
thereunder,\3\ a proposed rule change to provide an interpretation of 
Rule G-38 on consultants relating to bank affiliates and the definition 
of payment. Notice of the proposed rule change appeared in the Federal 
Register on January 20, 1998.\4\
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    \1\ On November 13, 1997, the Board filed the same proposal as a 
Q&A under Section 19(b)(3)(A) of the Act, which rendered the 
proposal effective upon receipt of the filing by the Commission. See 
Securities Exchange Act Rel. No. 39391 (December 3, 1997), 62 FR 
65114 (December 10, 1997) (SR-MSRB-97-8). The Commission received 
four comment letters on the filing. See infra note 6. To provide 
additional time to fully air the concerns raised by the commenters, 
the Board agreed to withdraw this filing and resubmit it, pursuant 
to Section 19(b)(2). See letter from Diane G. Klinke, General 
Counsel, Municipal Securities Rulemaking Board, to Katherine A. 
England, Assistant Director, Division of Market Regulation, dated 
January 9, 1998.
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ 17 CFR 240.19b-4.
    \4\ See Securities Exchange Act Rel. No. 39541 (January 12, 
1998), 63 FR 3010.
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    The Commission received five comment letters specifically 
addressing the proposed rule change.\5\ The Commission, however, 
received ten comment letters in total which addressed either the 
proposed rule change or the proposed rule change that was withdrawn.\6\ 
All commenters opposed this interpretation, citing discriminatory 
effect against banks and bank-affiliated municipal securities dealers 
and focusing on the MSRB's jurisdiction concerning the banking 
industry. On March 3, 1998, the Board submitted Amendment No. 1 to the 
proposed rule change.\7\ This order approves the proposed rule change. 
Also, Amendment No. 1 is approved on an accelerated basis.
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    \5\ See letter from Sarah A. Miller, Senior Government Relations 
Counsel, Trust and Securities, American Bankers Association, to 
Jonathan G. Katz, Secretary, SEC, dated February 10, 1998 (``ABA 
Letter No. 2''); letter from Mae A. Cavoli, Senior Vice President, 
Senior Managing Counsel, KeyCorp Management Company, to Jonathan G. 
Katz, Secretary, SEC, dated February 10, 1998 (``KeyCorp Letter''); 
letter from William E. Marquis, Associate Counsel, Mellon Bank 
Corporation, to Jonathan G. Katz, Secretary, SEC, dated February 9, 
1998 (``Mellon Bank Letter No. 2''); letter from Robert J. Nagy, 
Senior Counsel, NationsBank, to Jonathan G. Katz, Secretary, SEC, 
dated February 10, 1998 (``NationsBank Letter No. 2''); letter from 
Victor M. DiBattista, Chief Regional Counsel, PNC Bank, N.A., dated 
February 10, 1998 (``PNC Letter No. 2'').
    \6\ These letters were resubmitted; they were originally 
submitted to address SR-MSRB-97-8. Letter from Sarah A. Miller, 
Senior Government Relations Counsel, Trust and Securities, American 
Bankers Association, to Jonathan G. Katz, Secretary, SEC, dated 
December 30, 1997 (``ABA Letter No. 1''); letter from Michael E. 
Bleier, General Counsel, Mellon Bank Corporation, to Jonathan G. 
Katz, Secretary, SEC, dated January 12, 1998 (``Mellon Bank Letter 
No. 1''); letter from Robert J. Nagy, Senior Counsel, NationsBank, 
to Jonathan G. Katz, Secretary, SEC, dated December 31, 1997 
(``NationsBank Letter No. 1''); letter from Victor M. DiBattista, 
Chief Regional Counsel, PNC Bank, N.A., to Jonathan G. Katz, 
Secretary, SEC, dated January 2, 1998 (``PNC Letter No. 1'').
    This letter, which was also initially submitted to address SR-
MSRB-97-8, was not resubmitted. Letter from Alan R. Leach, Senior 
Vice President and Manager, Dealer Bank Department, Deposit Guaranty 
National Bank, to Jonathan G. Katz, Secretary, SEC, dated January 5, 
1998 (``Deposit Guaranty Letter'').
    \7\ See infra note 13. The Board's response to the comment 
letters also included an amendment to the interpretation. The 
amended language clarifies that the consultant may be either the 
affiliate itself or an individual employed by the affiliate.
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II. Description of the Proposal

    Recently, the Board has received inquiries from market participants 
concerning the definition of payment, as used in Rule G-38, and whether 
bank affiliates and their employees may, under certain circumstances, 
be deemed consultants for purposes of the rule.\8\ Specifically, a bank 
and its employees communicate with an issuer on behalf of an affiliated 
dealer to obtain municipal securities business. The affiliated dealer 
issues credits to identify, for internal purposes, the source of 
business referrals; however, these credits do not involve any direct or 
indirect cash payments from the dealer to the bank or its employees. 
The issue is whether the credits received by a bank and its employees 
from an affiliated dealer qualify as ``payment'' under Rule G-38, thus 
requiring the dealer to designate the bank or its employees as 
consultants and comply with the requirements of Rule G-38.
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    \8\ To assist brokers, dealers, and municipal securities dealers 
in understanding and complying with its rules, the Board publishes 
notices of interpretation, in question-and-answer format, when 
warranted. Two sets of Q&A's have previously been published 
providing the Board's interpretation of the application of Rule G-
38. See Securities Exchange Act Release No. 36950 (March 11, 1996); 
61 FR 10828 (March 15, 1996) and Securities Exchange Act Release No. 
37997 (Nov. 29, 1996); 61 FR 64781 (Dec. 6, 1996).
    See also MSRB Reports Vol. 16, No. 2 (June 1996) at 3-5; and 
Vol. 17, No. 1 (Jan. 1997) at 15.
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    Rule G-38 defines a consultant as any person used by a dealer to 
obtain or retain municipal securities business through direct or 
indirect communication by such person with an issuer on behalf of the 
dealer where the communication is undertaken by the person in exchange 
for, or with the understanding of receiving, payment from the dealer or 
any other person.\9\ The term payment, as used in Rule G-38, means any 
gift, subscription, loan, advance, or deposit of money or anything of 
value.\10\ Under the Board's interpretation of payment in this proposed 
rule change, the absence of an immediate transfer of funds or anything 
of value, such as credits, to an affiliate or individual employed by 
the affiliate would not exclude the credits from the definition of 
payment if such credits eventually (e.g., at the end of the fiscal 
year) result in compensation to the affiliate or individual employed by 
the affiliate for referring municipal securities business to the 
dealer. In this regard, the compensation may be in the form of cash 
(e.g., a bonus) or non-cash. In either case, if the dealer or any other 
person \11\ eventually gives anything of value (i.e., makes a 
``payment'') to the affiliate or individual, based even in part on the 
referral, then the affiliate or individual is a consultant for purposes 
of Rule G-38 and the dealer must comply with the various requirements 
of the rule.
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    \9\ Municipal finance professionals and any person whose sole 
basis of compensation is the actual provision of legal, accounting 
or engineering advice, services or assistance are exempted from the 
definition of consultant.
    \10\ MSRB Manual, General Rules, Rule G-38(a)(v) (CCH) para. 
3686.
    \11\ The Act defines the term ``person'' as a ``natural person, 
company, government, or political subdivision, agency, or 
instrumentality of a government.'' Board Rule D-1 provides that 
unless the context otherwise specifically requires, the terms used 
in Board rules shall have the same meanings as set forth in the Act.
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III. Summary of Comments

    All of the comment letters addressing the proposed rule change 
opposed the proposed rule change, raising several issues.\12\ At the 
Commission's request, the Board submitted a response which addresses 
these issues.\13\
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    \12\ See supra notes 5 and 6.
    \13\ See letter from Diane G. Klinke, General Counsel, MSRB, to 
Katherine A. England, Esq., Assistant Director, Division of Market 
Regulation, SEC, dated March 2, 1998 (``MSRB Letter'' and 
``Amendment No. 1'').
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    Most commenters contend that the Board's interpretation is an 
impermissible extension of rule G-38 to banks' soft dollar compensation 
programs.\14\ These commenters are concerned that this interpretation 
would infringe upon the most effective method used by financial 
institutions to cross-sell their various products and services to a 
wide range of customers.\15\ According to the MSRB, this interpretation 
merely clarifies what is already required and is reasonably and fairly 
implied by the rule; it does not reflect a change in MSRB policy.\16\ 
The rule requires disclosure of the ``compensation arrangement'' of any 
consultant used by a dealer to obtain or

[[Page 29284]]

retain municipal securities business.\17\ The Board is aware that 
consultants are sometimes paid in non-cash compensation, and thus 
specifically chose the term ``compensation arrangement'' because it did 
not want to limit the disclosure to cash payments.\18\ Thus, the 
interpretation is not an unwarranted extension to soft dollar 
compensation arrangements, because the rule already applied to such 
arrangements.\19\ The Commission agrees with the MSRB'S explanation 
that the dealer's disclosure requirements are specifically delineated 
in the rule, and that the interpretation is consonant with these 
requirements.
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    \14\ ABA Letter No. 2, p. 1, Deposit Guaranty Letter, p. 2, 
Nationsbank Letter No. 2, p. 2, Mellon Bank Letter, p. 2, and PNC 
Letter No. 2, p. 2.
    \15\ Id.
    \16\ MSRB Letter, p. 2.
    \17\ MSRB Manual, General Rules, Rule G-38(c) (CCH) para.3686.
    \18\ MSRB Letter, p. 2.
    \19\ Id.
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    The commenters also suggest that the interpretation is unworkable 
when applied to non-traditional compensation programs, given the 
subjective nature of the calculations, and would significantly 
discourage traditional banking referral programs.\20\ According to 
these commenters, most compensation programs are based on factors other 
than the initial credit allocation. Thus, translating credits allocated 
by the affiliated dealer into a specific dollar amount of the 
employees' compensation would be difficult because the reports are due 
quarterly; referral compensation, however, is usually awarded in the 
form of a year end bonus.\21\ The MSRB notes that Rule G-38 requires, 
among other things, that each broker, dealer, and municipal securities 
dealer disclose to the Board certain information relating to each 
consultant used by the dealer during the reporting period to obtain or 
retain municipal securities business.\22\ This definition also includes 
bank dealers.\23\ Furthermore, the Board notes that based on a review 
of reports submitted, several bank dealers and bank-affiliated dealers 
have been disclosing the information required by Rule G-38.\24\ These 
dealers have listed as consultants their bank affiliates and bank 
employees, and have disclosed the compensation arrangements for such 
consultants (either in dollar or as a formula), as well as dollar 
amounts paid to consultants.\25\
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    \20\ ABA Letter pp. 2-3, Deposit Guaranty Letter, p. 2, 
Nationsbank Letter No. 2, p. 2, Mellon Bank Letter No. 2, pp. 3-4 
and PNC Letter No. 2, p. 1.
    \21\ Id.
    \22\ MSRB Letter, p. 2.
    \23\ Id. See also 15 U.S.C. 78c(a)(30) (defining the term 
``municipal securities dealer'' pursuant to the Act).
    \24\ MSRB Letter, p. 3.
    \25\ See, e.g., reports submitted by Sun Trust Bank, Atlanta (3Q 
1997); SunTrust Capital Markets, Inc. (3Q 1997); and Norwest 
Investment Services, Inc. (2Q and 3Q `997) and available for public 
inspection at the Board's Public Access Facility in Alexandria, 
Virginia and on the Board's web site at www,msrb.org.
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    The commenters contend that rule G-38 should not apply to banks' 
referral programs because the intent of the rule is to capture 
traditional cash payments made by municipal dealers to independent 
consultants (i.e., professionals in the municipal securities arena) 
whose primary activity is to obtain or retain municipal securities 
business for the dealer.\26\ Moreover, they contend that, as the 
employee receives no ``payment'' or ``anything of value'' from the 
dealer, but rather from the financial institution itself, the employee 
cannot be deemed a consultant for purposes of the rule.\27\ The MSRB 
states that these assertions are erroneous. Under Rule G-38, a 
consultant is defined as any person used by the dealer to obtain or 
retain municipal securities business through direct or indirect 
communication with an issuer on the dealer's behalf where the 
communication is undertaken by such person in exchange for, or with the 
understanding of receiving, payment from the dealer or any other 
person.\28\ (emphasis added) The Board drafted the rule language in 
this manner to ensure that dealers could not circumvent the rule's 
disclosure requirements by claiming that another party compensated a 
consultant that referred municipal securities business to the 
dealer.\29\ Furthermore, such compensation is not limited to cash 
payments; the term ``payment'' is defined as any gift, subscription, 
loan, advance, or deposit of money or anything of value.\30\
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    \26\ ABA Letter No. 2, pp. 3-5, KeyCorp Letter, Deposit Guaranty 
Letter, p. 1, NationsBank Letter No. 2, pp. 1-2, Mellon Bank Letter 
No. 2, p. 1, and PNC Letter No. 2, pp. 1-2.
    \27\ Id.
    \28\ MSRB Letter, p. 3. See supra note 11 for the definition of 
the term ``person.''
    \29\ MSRB Letter, p. 3.
    \30\ Rule G-38(a)(v) states that the term ``payment'' has the 
same meaning as in Rule G-37(g)(viii).
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    The Commission agrees with the MSRB's assessment. While these 
``credits'' may not be initially transmitted in monetary form, they are 
a factor in the calculations made to determine eventual monetary 
compensation, which is something of value. Moreover, a previous 
interpretation published by the MSRB directly addresses this issue.\31\ 
The MSRB has addressed Q&A No. 7, but Q&A No. 6 is also on point. If an 
employee of an affiliated company of a bank introduces one of its 
customers (i.e. a municipal issuer) to the bank's dealer department for 
purposes of engaging in municipal securities business, and that dealer 
pays the affiliated company for this activity, then that employee is 
considered a ``finder.'' Any person used by a dealer as a ``finder'' 
for municipal securities business would be considered a consultant 
under Rule G-38.
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    \31\ See Securities Exchange Act Release No. 36950 (March 11, 
1996), 61 FR 10828 (March 15, 1996) (Q&A No.'s 6 and 7).
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    Several commenters stated that the MSRB's proposal unfairly 
discriminates against bank-affiliated dealers, because it does not 
apply equally to incentive programs established and operated by 
financial service firms not affiliated with a bank.\32\ These 
commenters also contend that the MSRB's interpretation is an 
impermissible extension of its authority into an area exclusively 
reserved for bank regulators.\33\ Moreover, because the MSRB lacks 
jurisdiction over bank's compensation programs, banks would have to 
consent to their municipal securities dealer affiliates filing 
proprietary information with the MSRB, an unlikely occurrence, given 
the public availability of this information once submitted.\34\
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    \32\ ABA Letter No. 2, pp. 3-4, Deposit Guaranty Letter, p. 2, 
Mellon Bank Letter No. 2, p. 2, and PNC Letter, pp. 1-2.
    \33\ Id.
    \34\ Id.
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    In its response, the MSRB notes that bank dealers, like securities 
firms, are subject to federal securities laws.\35\ Further, all Board 
rules apply equally to bank dealers and securities firms. Prior Rule G-
38 interpretations clearly state that the rule applies to both dealer 
affiliates and bank affiliates.\36\ If a securities firm has an 
affiliate that refers municipal securities business to the dealer in 
exchange for ``credits,'' then the affiliate would be a consultant and 
the dealer must make the required disclosures under Rule G-38, 
including the consultant's compensation arrangement, even if the 
payment would be made by ``any other person'' and not by the 
dealer.\37\ The Board disagrees with the argument that the proposal 
unfairly discriminates against bank-affiliated dealers.\3\8 In fact, if 
bank dealers were allowed an exemption from Rule G-38 for referrals by 
bank affiliates and their employees, the rule would unfairly 
discriminate against non-bank affiliated dealers.\39\ The Commission 
agrees that the rule and its disclosure requirements apply equally to 
both dealer affiliates and bank

[[Page 29285]]

affiliates. As the MSRB explains, this proposal would also apply if the 
circumstance involved a securities firms and its affiliate. The 
Commission, therefore, supports the MSRB's assessment, as the 
interpretation ensures an evenhanded application of the rule.
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    \35\ See supra note 23.
    \36\ See supra note 31.
    \37\ MSRB Letter, p. 4.
    \38\ Id.
    \39\ Id.
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    In its letters, NationsBank suggests that the MSRB modify the 
proposal to clarify that a bank and its employees would only be 
consultants under circumstances where the bank receives credits for the 
referral of municipal securities business which are then allocated to 
employees based on a formulaic fashion.\40\ The MSRB disagrees with 
this interpretation and has, therefore, declined to adopt it.\41\ 
Alternatively, PNC Bank suggests that Rule G-38 be clarified to 
designate only the financial institution as the consultant in the case 
of soft dollar compensation programs.\42\ In response, the MSRB has 
amended Rule G-38 \43\ to say that the consultant may be either the 
affiliate or an individual employee of the affiliate.\44\ The dealer 
must make this determination and ensure proper compliance with the 
rule, including the contractual arrangements and requisite 
disclosures.\45\ Thus, the Board has amended the language of the 
interpretation to clarify that the consultant may be either the 
affiliate itself or an individual employed by the affiliate.\46\
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    \40\ NationsBank Letter No. 1 and NationsBank Letter No. 2, p. 2 
and its attached modified interpretation.
    \41\ MSRB Letter, p. 4.
    \42\ PNC Letter No. 2, p. 3.
    \43\ See supra notes 8 and 13.
    \44\ MSRB Letter, p. 4 and Amendment No. 1.
    \45\ Id.
    \46\ Id.
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    According to the MSRB, Amendment No. 1 clarifies who is deemed a 
consultant and the process of designation. The Commission agrees that 
the onus should be on the dealer to designate the consultant, whether 
affiliate or employee, and to ensure compliance with the rule. The 
Commission notes, however, that as amended, the dealer may designate 
either the bank affiliate or the employee as the consultant. As noted 
in their comments, most banks are reluctant to disclose what they deem 
to be proprietary information to the MSRB, and hence, the public.\47\ 
The Commission notes that both the employee and the affiliate benefit 
from referrals facilitated by these soft dollar compensation programs.
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    \47\ However, several banks are currently complying with Rule G-
38. See supra note 25.
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IV. Discussion

    The Commission believes the proposed rule change is consistent with 
the Act and the rules and regulations promulgated thereunder.\48\ 
Specifically, the Commission believes that approval of the proposed 
rule change is consistent with Section 15B(b)(2)(C) \49\ of the Act. 
This interpretation clarifies the rule's applicability to all broker-
dealers engaged in the municipal securities business. The 
interpretation is necessary to ensure that all persons hired by dealers 
to solicit municipal securities business will be covered by the rule. 
This interpretation will require that all consultant activity stemming 
from attendant soft dollar compensation arrangements, whether those of 
financial institutions or securities firms, be disclosed. The 
clarification of Rule G-38 regarding referrals by bank affiliates and 
their employees will improve the effectiveness of the rule by making 
explicit that it applies to all consultants and their political 
contribution activity.
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    \48\ The Commission has considered the proposed rule's impact on 
efficiency, competition and capital formation. The proposed rule 
change will add to the information available in the municipal 
securities market, and thus, competition, in the municipal 
securities markets because all municipal securities dealers will be 
required to disclose affiliations and compensation arrangements 
concerning their relationships with consultants. Efficiency and 
capital formation will be tangentially improved as enhanced 
disclosure will likely conserve both capital and personnel 
resources. 15 U.S.C. 78c(f).
    \49\ Section 15B(b)(2)(C) requires the Commission to determine 
that the Board's rules are designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
municipal securities, to remove impediments to and perfect the 
mechanism of a free and open market in municipal securities, and, in 
general, to protect investors and the public interest.
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    The Commission finds good cause for approving proposed Amendment 
No. 1 prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register. Amendment No. 1 
clarifies who is deemed a consultant and the process of designation. 
The Commission agrees that the onus should be on the dealer to 
designate the consultant, whether bank affiliate or employee thereof, 
and to ensure compliance with the rule, including contractual 
arrangements and required disclosures. The dealer's payment of credits 
to the consultant creates a strong incentive for the consultant to 
solicit an issuer and refer their business to the dealer. The dealer, 
therefore, should have the responsibility of documenting its 
relationship with the consultant and any compensation arrangements that 
result from or facilitate this relationship. For these reasons, the 
Commission finds good cause for accelerating approval of the proposed 
rule change, as amended.
    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether the amendment 
is consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of 
the submission, all subsequent amendments, all written statements with 
respect to the proposed rule change that are filed with the Commission, 
and all written communications relating to the proposed rule change 
between the Commission and any person, other than those that may be 
withheld from the public in accordance with the provisions of 5 U.S.C. 
552, will be available for inspection and copying in the Commission's 
Public Reference Room. Copies of the filing will also be available for 
inspection and copying at the Board's principal offices. Any 
submissions should refer to File No. SR-MSRB-98-1 and should be 
submitted by June 18, 1998.

V. Conclusion

    For the above reasons, the Commission believes that the proposed 
rule change is consistent with the provisions of the Act, and in 
particular with Section 15B(b)(2)(C).
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\50\ that the proposed rule change (SR-MSRB-98-1), be hereby 
approved including Amendment No. 1, on an accelerated basis.

    \50\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\51\
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    \51\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-14119 Filed 5-27-98; 8:45 am]
BILLING CODE 8010-01-M