MSRB NOTICE 2012-16 (MARCH 26, 2012)


On March 26, 2012, the Municipal Securities Rulemaking Board (“Board” or “MSRB”) filed with the Securities and Exchange Commission (“SEC”) a proposed rule change consisting of a restatement of its 2002 interpretive notice concerning the application of MSRB Rule G-17 (on conduct of municipal securities and municipal advisory activities) to sophisticated municipal market professionals (“SMMPs”).[1]  The proposed rule change reflects the MSRB’s decision to streamline a dealer’s determination of whether a customer is an SMMP in view of the substantial changes in the municipal marketplace that have occurred since the 2002 interpretive notice was adopted.


Review of Electronic Trading Systems.  The MSRB is engaged in a review of the electronic trading systems[2] on which municipal securities may be traded to determine whether guidance it issued on such systems in 2001 and 2002 should be updated to reflect subsequent changes in the municipal securities market and such systems.  Each of the principal electronic trading systems has some institutional customers.  Accordingly, the MSRB decided to reconsider its 2002 guidance[3] on the institutional customers that use such systems (the “Existing SMMP Notice”).  Although the Existing SMMP Notice was developed in large part because of electronic trading systems, it is not limited in scope to electronic trading systems.

Increased Access to Information.  In 2002, the MSRB decided to adopt a definition of SMMP that differed from certain other regulatory definitions of investors considered sophisticated enough to receive special treatment under the federal securities laws.  The SMMP definition was closely modeled on a National Association of Securities Dealers (“NASD”) interpretation of its suitability rule,[4] which contained a list of factors found relevant to an investor’s independent evaluation of risk and independent investment decisions.  A notable difference was that the definition of SMMP also looked to whether the investor had access to material facts.  A key factor in the MSRB’s decision was the lack of information available about municipal securities at that time.  Since the adoption of the existing definition of SMMP, there has been a substantial increase in the availability of information about municipal securities reasonably accessible by institutional investors regardless of the amount of their holdings of municipal securities (e.g., on EMMA, from rating agencies, and from other information vendors).

New FINRA Suitability Rule.  Effective July 9, 2012, the NASD interpretation upon which the Existing SMMP Notice was based will no longer be in effect.  The existing NASD suitability rule will be replaced by Financial Industry Regulatory Authority (“FINRA”) Rule 2111, which adopts a different approach to a FINRA member’s customer-specific duty of suitability to an “institutional account.”  The MSRB generally considers it desirable from the standpoint of reducing the cost of dealer compliance to maintain consistency with FINRA rules, absent clear reasons for treating transactions in municipal securities differently.

Request for Comment.  On November 8, 2011, the MSRB requested comment on a draft restatement of the Existing SMMP Notice (the “Restated SMMP Notice”).[5] The MSRB received comment letters from (1) Alternative Regulatory Solutions, LLC; (2) Bond Dealers of America; (3) Securities Industry and Financial Markets Association; and (4) TMC Bonds L.L.C., formerly TheMuniCenter.  The MSRB’s response to those comments is contained in File No. SR-MSRB-2012-05.


Revised Definition of SMMP.  Because the quality and availability of information concerning municipal securities has improved substantially since 2002, and to maintain consistency with the revised FINRA suitability rule for institutional customers, the MSRB has proposed to retain the concept of an SMMP, but revise its definition so that it is consistent with the new FINRA suitability rule for institutional customers.  Specifically, the MSRB has proposed that an “SMMP” be defined as an “institutional customer of a dealer that: (1) the dealer has a reasonable basis to believe is capable of evaluating investment risks and market value independently, both in general and with regard to particular transactions in municipal securities, and (2) affirmatively indicates that it is exercising independent judgment in evaluating the recommendations of the dealer.”

The MSRB has also proposed to include the following statement in the Restated SMMP Notice’s discussion of the definition of SMMP: “As part of the reasonable basis analysis required by clause (1), the dealer should consider the amount and type of municipal securities owned or under management by the institutional customer.”  However, there would no longer be a threshold requirement that a customer own or manage a certain amount of municipal securities in order to be considered an SMMP.

The MSRB has also proposed that, in the case of the affirmation described in clause (2) of the revised definition of SMMP (i.e., “capable of evaluating investment risks and market value independently”), customers be allowed to make the affirmation orally or in writing and to provide the affirmation on a trade-by-trade basis, on a type-of-municipal-security basis (e.g., general obligation, revenue, VRDO, etc.), or for all potential transactions for the customer’s account.  This would be consistent with the affirmation requirement of FINRA Rule 2111, so the dealer’s receipt of the affirmation required by FINRA Rule 2111 would satisfy the affirmation requirement of the revised SMMP definition.

Application of Revised SMMP Definition.  The Restated SMMP Notice would change the application of Rule G-17 to SMMPs, under the assumption that institutional customers now have substantial access to material information about municipal securities.  The Existing SMMP Notice limits the exclusion from the duty to disclose all material facts to SMMPs to non-recommended transactions.  The Restated SMMP Notice would apply the exclusion to all transactions with SMMPs, whether recommended or self-directed.  The Restated SMMP Notice would also remove the lists of factors that were deemed by the Board in 2002 to be relevant to the components of the original definition of SMMP.  It would also update the Existing SMMP Notice to reflect developments in the MSRB’s interpretations of Rule G-17 since 2002 and remove endnote 9 to the Existing SMMP Notice, which has been construed by some to lessen the duty of a broker’s broker under Rule G-18 in a manner that is inconsistent with the Board’s proposed Rule G-43 (on broker’s brokers).   Furthermore, it would remove the language that suggests that transactions on alternative trading systems are done on an agency basis, because at least one major alternative trading system engages only in principal transactions.

Questions about this notice should be directed to Peg Henry, General Counsel, Market Regulation, at 703-797-6600.

March 26, 2012

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            The text of the proposed rule change may be found here.

[1] File No. SR-MSRB-2012-05.  Comments on the proposed rule change should be submitted to the SEC and should reference this file number.

[2] The term “electronic trading system” refers to multi-dealer platforms registered as brokers, dealers, or municipal securities dealers (“dealers”) and subject to regulation by the Securities and Exchange Commission (“SEC”) as alternative trading systems (“ATSs”).  Dealers and institutional customers are the principal users of such systems.  The term “electronic trading system” is to be contrasted with the term “electronic brokerage system,” which refers to single-dealer platforms owned by registered dealers to which retail customers are permitted access.

[3] Interpretive Notice Regarding the Application of MSRB Rules to Transactions with Sophisticated Municipal Market Professionals (April 30, 2002).

[4] See IM-2310-3.  Suitability Obligations to Institutional Customers.