MSRB NOTICE 2002-10 (MARCH 25, 2002)


On March 18, 2002, the Securities and Exchange Commission approved an interpretive notice regarding rule G-17, on disclosure of material facts (Rel. 34-45591).  The text of the interpretive notice is provided below:

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Rule G-17, the MSRB’s fair dealing rule, encompasses two general principles.  First, the rule imposes a duty on dealers[1] not to engage in deceptive, dishonest, or unfair practices. This first prong of rule G-17 is essentially an antifraud prohibition. 

Second, the rule imposes a duty to deal fairly.  Statements in the MSRB’s filing for approval of rule G-17 and the SEC’s order approving the rule note that rule G-17 was implemented to establish a minimum standard of fair conduct by dealers in municipal securities.  In addition to the basic antifraud prohibitions in the rule, the duty to “deal fairly” is intended to “refer to the customs and practices of the municipal securities markets, which may, in many instances differ from the corporate securities markets.”[2]  As part of a dealer’s obligation to deal fairly, the MSRB has interpreted the rule to create affirmative disclosure obligations for dealers.  The MSRB has stated that dealer’s affirmative disclosure obligations require that a dealer disclose, at or before the sale of municipal securities to a customer, all material facts concerning the transaction, including a complete description of the security. [3]  These obligations apply even when a dealer is acting as an order taker and effecting non-recommended secondary market transactions.

Rule G-17 was adopted many years prior to the adoption of SEC Rule 15c2-12.  The development of the NRMSIR system,[4] the MSRB’s Municipal Securities Information Library® (MSIL®) system[5] and Transaction Reporting System (“TRS”),[6] rating agencies and indicative data sources in the post-Rule 15c2-12 era have created much more readily available information sources.  Recently, the market has made progress and market professionals (including institutional investors) can, and do, go to these industry sources to find securities descriptive information, official statements, rating agency ratings and reports, and ongoing disclosure information.  These developments suggest a need for further explanation of what “disclosure of all material facts” means in today’s market.

Rule G-17 requires that dealers disclose to a customer at the time of trade all material facts about a transaction known by the dealer.  In addition, a dealer is required to disclose material facts about a security when such facts are reasonably accessible to the market.  Thus, a dealer would be responsible for disclosing to a customer any material fact concerning a municipal security transaction made publicly available through sources such as the NRMSIR system, the MSIL® system, TRS, rating agency reports and other sources of information relating to the municipal securities transaction generally used by dealers that effect transactions in the type of municipal securities at issue (collectively, “established industry sources”). [7]

The customs and practices of the industry suggest that the sources of information generally used by a dealer that effects transactions in municipal securities may vary with the type of municipal security.  For example, a dealer might have to draw on fewer industry sources to disclose all material facts about an insured “triple-A” rated general obligation bond than for a non-rated conduit issue.  In addition, to the extent that a security is more complex, for example because of complex structure or where credit quality is changing rapidly, a dealer might need to take into account a broader range of information sources prior to executing a transaction. 

With respect to primary offerings of municipal securities, the SEC has noted, “By participating in an offering, an underwriter makes an implied recommendation about the securities.”  The SEC stated, “This recommendation itself implies that the underwriter has a reasonable basis for belief in the truthfulness and completeness of the key representations made in any disclosure documents used in the offerings.”[8] Similarly, if a dealer recommends a secondary market municipal security transaction, rule G-19 requires a dealer to “have reasonable grounds for the recommendation in light of information available from the issuer or otherwise.”[9]  If this “reasonable basis” suitability cannot be obtained from the established industry sources, then further review may be necessary before making a recommendation.  To the extent that such review elicits material information that would not have become known through a review of established industry sources, dealers recommending transactions would be obligated to disclose such information in addition to information available from established industry sources.

March 18, 2002

[1] The term “dealer” is used in this interpretive notice as shorthand for “broker,” “dealer” or “municipal securities dealer,” as those terms are defined in the Securities Exchange Act of 1934.  The use of the term in this interpretive notice does not imply that the entity is necessarily taking a principal position in a municipal security.

[2] See Exchange Act Release No. 13987 (Sept. 22, 1977).

[3] See e.g., Rule G-17 Interpretation—Educational Notice on Bonds Subject to “Detachable” Call Features, May 13, 1993, MSRB Rule Book (July 2001) at 129-130.  The SEC described material facts as those “facts which a prudent investor should know in order to evaluate the offering before reaching an investment decision.” Municipal Securities Disclosure, Securities Exchange Act Release No. 26100 (September 22, 1988) (the “1988 SEC Release”) at note 76, quoting In re Walston & Co. Inc., and Harrington, Securities Exchange Act Release No. 8165 (September 22, 1967).  Furthermore, the United States Supreme Court has stated that a fact is material if there is a substantial likelihood that its disclosure would have been considered significant by a reasonable investor. TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976).

[4] For purposes of this notice, the “NRMSIR system” refers to the disclosure dissemination system adopted by the SEC in SEC Rule 15c2-12.  Under Rule 15c2-12, as adopted in 1989, participating underwriters provide a copy of the final official statement to Nationally Recognized Municipal Securities Information Repositories (“NRMSIRs”) to reduce their obligation to provide a final official statement to customers.  In the 1994 amendments to Rule 15c2-12 the SEC determined to require that annual financial information and audited financial statements submitted in accordance with issuer undertakings must be delivered to each NRMSIR and to the State Information Depository (“SID”) in the issuer’s state, if such depository has been established.  The requirement to have annual financial information and audited financial statements delivered to all NRMSIRs and the appropriate SID was included in Rule 15c2-12 to ensure that all NRMSIRs receive disclosure information directly.  Under the 1994 amendments, notices of material events, as well as notices of a failure by an issuer or other obligated person to provide annual financial information, must be delivered to each NRMSIR or the MSRB, and the appropriate SID. 

[5] The MSIL® system collects and makes available to the marketplace official statements and advance refunding documents submitted under MSRB rule G-36, as well as certain secondary market material event disclosures provided by issuers under SEC Rule 15c2-12.  Municipal Securities Information Library® and MSIL® are registered trademarks of the MSRB.

[6] The MSRB’s TRS collects and makes available to the marketplace information regarding inter-dealer and dealer-customer transactions in municipal securities.

[7] Dealers operating electronic trading platforms have inquired whether providing electronic access to material information is consistent with the obligation to disclose information under rule G-17.  The MSRB believes that the provision of electronic access to material information to customers who elect to transact in municipal securities on an electronic platform is generally consistent with a dealer’s obligation to disclose such information, but that whether such access is effective disclosure ultimately depends upon the particular facts and circumstances present.

[8] 1988 SEC Release at text following note 70.  The SEC also stated that an underwriter must review the issuer’s disclosure documents for possible inaccuracies and omissions. In the case of a negotiated offering, the SEC expects the underwriter to make an inquiry into the key representations included in the disclosure materials. In the case of a competitive offering, the SEC acknowledges that the underwriter may have more limited opportunities to undertake such a review and investigation but nonetheless is obligated to take appropriate actions under the particular facts and circumstances of such offering. 

[9] See e.g., Rule G-19 Interpretation—Notice Concerning the Application of Suitability Requirements to Investment Seminars and Customer Inquiries Made in Response to a Dealer’s Advertisement, May 7, 1985 MSRB Rule Book (July 2001) at 134; In re F.J. Kaufman and Company of Virginia, 50 S.E.C. 164, 168, 1989 SEC LEXIS 2376, *10 (1989) (discussing “reasonable basis” suitability).