MSRB NOTICE 2001-01 (JANUARY 9, 2001)

REMINDER OF APPROPRIATE TRANSACTION REPORTING PROCEDURES FOR TRANSACTIONS EFFECTED BY DEALERS USING CLEARING BROKERS

Customer transactions reported under rule G-14 must include the identity of the broker, dealer or municipal securities dealer (“dealer”) effecting the transaction with the customer. As noted in the User’s Manual for Transaction Reporting, the dealer’s identity shown must be “the dealer that actually effected the transaction with the customer (in contrast to the dealer that submitted the trade information or cleared the trade).”  Q&A No.  69, June 1998 Question and Answers TRS User’s Manual, found at www.msrb.org (emphasis added).   Accordingly, in customer transactions where there is an introducing/clearing broker arrangement, the introducing broker will be the dealer identified on the customer transaction report.  The introducing broker works directly with the customer, taking care of suitability considerations, disclosure of material facts, and any other time-of-trade customer protection requirements.  Because of the surveillance function of rule G-14 and the Transaction Reporting System, it is important to have the identity of that dealer in the record.  This is true even though the securities ultimately may be delivered to the customer, or safekept, by the clearing broker.

The MSRB from time to time receives questions about the proper way to report specific types of transactions involving introducing and clearing brokers.   The following Q and A’s provide additional clarification on some of the more frequent questions.

1.

Q:  My firm uses the services of a clearing broker to clear transactions.   My firm’s recordkeeping is set up such that we do take principal positions in municipal securities from time to time.  If I purchase bonds from my clearing broker’s inventory, and then sell the bonds to my customer on a riskless principal basis, how is the transaction reported?

A:  Anytime you purchase and sell bonds on a riskless principal basis, you report both trades as principal transactions.  In this case, the purchase from the clearing broker would be reported automatically by comparing the inter-dealer trade in the automated comparison system, using the proper “broker symbols” for both your firm and your clearing broker.  It is recognized in this case that the comparison record will have the same clearing number (your clearing broker’s) on each side of the trade record.  However, the sell-side will contain the “broker symbol” for your clearing broker, while the buy-side will have your own firm’s symbol. This indicates to the MSRB that a principal transaction occurred between the two dealers, with your firm as the buyer.  The customer transaction would be reported into the customer transaction reporting system, with your firm’s broker symbol.  It, of course, is reported as a principal sale to a customer.

2.

Q:   Same scenario, except that my clearing broker goes out to the street to find a bond at my request. I eventually sell that bond on a principal basis to my customer.  How many transactions are reported?

A:  There are three transactions that would be reported in this scenario: 1) the principal transaction between your clearing broker and the selling dealer, 2) the principal transaction between you and your clearing broker, and 3) the principal transaction between you and your customer.

3.

Q :  I have an arrangement with my clearing broker that I can trade municipal securities directly with other dealers.  What if I buy the bonds directly from another dealer on the street and the trading desk of my clearing broker is not involved?  Is this situation reported differently than in the question above?

A:  Yes, it is a different situation than the question directly above because you are doing a principal transaction with a dealer on the street rather than with your clearing broker.  Thus, an inter-dealer transaction is reported as occurring directly between your firm and the dealer you dealt with on the street.  That trade record, again reported via the comparison system, would show: 1) on the sell-side, the clearing number and broker symbol of your contra-party; and 2) on the buy-side, your clearing broker’s clearing number and your broker symbol.

4.

Q:  What about a different kind of clearing arrangement?   What if my firm is “fully disclosed” and never takes principal positions, even riskless ones?   Instead, we sell to our customers out of our clearing broker’s inventory.  How should these trades be reported?

A:  Since you do not take a principal position with regard to the trades you are effecting with your customers, all these customer transactions are reported to the MSRB by your firm as “agency” trades.  If the customer is buying bonds, then your trade record shows a “sale.”  If the customer is selling bonds through you (into your clearing broker’s inventory), your record shows a “buy.”  You can make the transaction reports directly to the MSRB using a dial-up facility, or you can make arrangements with your clearing broker to make the transaction reports on your behalf, but the transaction reports should identify your firm as the dealer that effected the transaction – not the clearing broker.

5.

Q :  Let me ask a different question about the same transaction.  Should my clearing broker report the trade as its own transaction -- as a principal sale by the clearing broker to my customer?

A:  No, it is reported as your transaction because you are the firm that dealt with the customer at the time of trade, presumably taking care of disclosure duties, suitability and other time-of-trade customer protection requirements.  In addition, the customer generally will consider you to be his or her broker – not the clearing/safekeeping entity.   In this situation, the clearing broker should not submit a trade report using its own identity.  The one transaction report with your firm’s identity is enough to establish the price of the transaction to the customer.  Since your relationship with your clearing broker already is known to regulators, the one transaction report also provides adequate surveillance data. 

6.

Q:  In the transaction described above, should my firm report an additional inter-dealer transaction between my firm and my clearing broker, just as in the first question concerning riskless principal trades?

A:   No.  When there is a transaction report of an agency trade by the introducing broker, there is no need for a separate transaction report of  a transaction between the introducing firm and its clearing broker.  Unlike the riskless principal scenario in the first question, there is no principal transaction between dealers in this case.  The surveillance database will have the record of your agency transaction and also has reference information identifying your clearing broker.

7.

Q :  Are there any other guiding principles I should know about reporting transactions correctly in these situations?

A:  Yes. Your transaction reports should be consistent with your recordkeeping required under MSRB rule G-8 and your confirmation disclosure required by rule G-15(a).  For example, if you are reporting principal transactions with customers, then your records should show principal transactions and the customer confirmations should show the trades as principal trades.  Conversely, if you are reporting agency transactions, your records and your confirmations should reflect that.

8.

Q :  How do I know whether a transaction is actually an agency transaction or a riskless principal one?

A:  That is not really a question that is answered by transaction reporting rules.  Whether your firm sets itself up to do agency or riskless principal transactions in a certain situation may depend on a variety of factors that are beyond the scope of this notice.  Net capital rules and the arrangements between clearing brokers and their correspondents are among the factors that enter into the decision. However, once it has been decided what kind of transactions will be done, you should be aware that confirmation disclosure and recordkeeping requirements will be affected by this decision, as well as transaction reporting.

Questions concerning this notice may be directed to John Baughman, Senior Data Analyst and Supervisor.

January 9, 2001