On August 5, 2011, Standard & Poor’s Ratings Service reduced the sovereign credit rating of the United States from “AAA” to “AA+.” On August 2, 2011, Moody’s Investors Service (“Moody’s”) confirmed its United States government bond rating at “Aaa,” although Moody’s assigned the rating a “negative outlook.” On August 2, 2011, Fitch Ratings announced that it has maintained its “AAA” U.S. sovereign debt rating but said that it continued to review the credit and expected that the review would be complete by the end of August 2011. Certain of these Nationally Recognized Statistical Rating Organizations (“Rating Agencies”) have also said that the securities of some states and municipalities are under review for possible downgrade as a result of their direct or indirect links to the credit of the United States. They had previously stated that, should they take negative rating actions on the debt of the United States, they also would likely downgrade debt directly or indirectly linked to the United States sovereign rating, as well as the ratings of certain municipal issuers that either have large numbers of federal employees in their jurisdiction or that are significantly reliant on federal government funding.
Although to date the Municipal Securities Rulemaking Board (“MSRB”) has observed no unusual municipal market activity, as a result of this continuing uncertainty concerning the ratings of such states and local governments the MSRB is publishing this reminder notice relating to the application of MSRB investor protection rules in the context of the potential impact of such ratings actions on the municipal securities market.
The MSRB reminds brokers, dealers, and municipal securities dealers (“dealers”) that, in spite of any market disruption that may result from such rating actions, all MSRB rules continue to apply, including rules on fair practice, trade pricing, suitability and disclosure. The MSRB is particularly concerned about the treatment of retail investors. MSRB Rule G-17 prohibits dealers from using a situation of market disruption to attempt to manipulate the pricing of municipal securities, either alone or in concert. Further, such situation does not negate a dealer’s duty under MSRB Rule G-30 (on prices and commissions) to purchase bonds from a customer or sell bonds to a customer as a principal at prices (including any markdown or markup) that are fair and reasonable based on prevailing market conditions.
As always, if the MSRB becomes aware of allegations that any dealer has attempted to take advantage of clients by trading in municipal securities at prices that are not fair and reasonable, the MSRB will notify the appropriate enforcement agencies and, if the allegations are true, recommend severe sanctions. One potential indication of such unfair behavior would be a purchase by a dealer at a low price followed by a resale shortly thereafter at a considerably higher price. While the MSRB recognizes that market disruption can present significant challenges to establishing a fair and reasonable price with precision, Rules G-17 and G-30 do not permit dealers to improperly take advantage of their clients by executing trades at prices that are not fair and reasonable. The MSRB encourages dealers that utilize computerized or other pricing models to review them carefully to determine that the prices they generate are fair and reasonable, particularly if such models were not designed to take into consideration the direct or indirect impact of a material downgrade in United States credit ratings.
The existence of a market disruption also does not negate a dealer’s duty to ensure that their recommendations are consistent with their obligations under MSRB Rule G-19 (on suitability of recommendations), which can be a significant concern in the context of retail investors who may rely on the recommendations of their dealers during this time of uncertainty. Further, dealers are reminded that all material facts concerning a transaction known to the dealer or available from established industry sources must be disclosed to the client at or prior to the time of sale, under MSRB Rule G-17.
The MSRB will continue to monitor developments in the marketplace and any potential concerns resulting from any ratings actions.
August 8, 2011