The MSRB reminds dealers of trade reporting procedures with respect to “step outs” and other inter-dealer deliveries that are not the result of inter-dealer transactions.

Rule G-14 requires that inter-dealer purchase-sale transactions eligible for comparison through the National Securities Clearing Corporation (NSCC) automated comparison system (RTTM) be reported to the MSRB Transaction Reporting System. For these inter-dealer transactions, trade reporting to the MSRB is accomplished by both the purchasing and selling dealers submitting the trade for comparison following NSCC’s procedures, and ensuring that the trade record includes certain additional data required by Rule G-14.  NSCC then forwards each dealer’s trade submission to the MSRB. In effect, the comparison submission to NSCC doubles as the trade report to the MSRB.

In certain situations, deliveries of securities occur between two dealers even though the two dealers did not effect a purchase-sale transaction with each other. Dealers using the comparison system to facilitate these deliveries must be careful not to report the deliveries as inter-dealer transactions. A frequent example of this situation occurs when an independent investment advisor effects a transaction with a dealer (the “executing dealer”) and instructs the executing dealer to deliver securities to another dealer (the “custody dealer”) for unnamed clients of the investment advisor. The resulting delivery between the executing dealer and the custody dealer may be handled through NSCC by submitting the delivery to RTTM for comparison, even though there was no purchase-sale transaction between the two dealers. However, in these cases, the executing dealer and the custody dealer each must indicate that the submissions are for RTTM Matching Only (Destination 01, see below) to ensure that the submissions do not also constitute trade reports under Rule G-14. Failure to do so by either party will result in a violation of Rule G-14.[1]

NSCC has published procedures for identifying comparison submissions as step outs, meaning comparison submissions that do not represent reportable inter-dealer transactions.[2] Although the full procedures are not repeated here, they basically require dealers using interactive messaging to submit data to NSCC with “DEST 01” (and no other “DEST”) in the destination indicator message field and dealers using RTTM Web to select the “RTTM” trade reporting indicator.[3] To avoid violations of Rule G-14, dealers also should be careful to use NSCC’s step out procedures only when applicable (i.e., when there is an inter-dealer delivery being compared, but there was no purchase-sale transaction between the dealers).[4]

It is worth noting that comparison submissions will compare against each other in RTTM regardless of whether their step out indicators match. When two dealers submit “mismatched” destination indicators and a comparison occurs, NSCC forwards data about both submissions to the MSRB, but the MSRB is unable to determine which dealer was correct as to whether the comparison represents a transaction or a step out. However, it is clear in such a case that at least one of the dealers has violated Rule G-14, either by reporting a true inter-dealer trade as a step out or by reporting an inter-dealer transaction that did not occur.

Questions about the procedure for processing step out deliveries should be directed to NSCC. Questions about whether a particular type of delivery is reportable as an inter-dealer purchase-sale transaction may be directed to MSRB staff.

[1] In this example, the executing dealer has an additional duty to report its execution of the investment advisor’s order to the MSRB as a dealer sale to a customer; the submission of the “step out” delivery to NSCC does not substitute for this customer trade report. See MSRB Notice 2003-20, “Notice on Reporting and Comparison of Certain Transactions Effected by Investment Advisors: Rules G-12(f) and G-14,” May 23, 2003.

[2] For NSCC’s complete procedure on comparing step out deliveries, see e.g., NSCC Important Notice A5943/P&S5513, “Changes to Municipal Bond ‘Step Out’ Processing,” December 2, 2004, on www.nscc.com.

[3] To further distinguish step out submissions, dealers also should include “STEP” in the Trader ID contra party field.

[4] Another example of a transfer of securities between dealers that is not the result of a purchase-sale transaction was described in MSRB Notice 2004-14, “Notice on Certain Inter-Dealer Transfers of Municipal Securities: Rules G-12(f) and G-14,” June 4, 2004.

Executive Summary

The Municipal Securities Rulemaking Board (“MSRB”) reminds brokers, dealers and municipal securities dealers (collectively “dealers”) of the need to report municipal securities transactions accurately and to minimize the submission of modifications and cancellations to the Real-Time Transaction Reporting System (“RTRS”). Each transaction initially should be reported correctly to RTRS. Thereafter, only changes necessary to achieve accurate and complete transaction reporting should be submitted to RTRS. Changes should be rare since properly reported transactions should not need to be corrected.

* * *

Under Rule G-14, dealers are required to report all transactions to the MSRB and to report accurately and completely the information specified in the Rule G-14 RTRS Procedures (“Procedures”). Trades that are reported with errors affect the accuracy of the information published in price transparency reports as well as the audit trail information retained in the surveillance database.[1]

Dealers should not change trade reports when the transaction attribute that changes is not required to be reported by MSRB or NSCC. For example, if only the account representative associated with a transaction changes, the report to the MSRB should not be changed, as this information is not required to be reported to the MSRB under Rule G-14. Dealers should take care that, if a modification or cancellation is submitted that is not responding to an RTRS error message, the dealer is correcting or cancelling an erroneous report.[7]

RTRS counts the number of modifications and cancellations submitted by each dealer. The MSRB provides statistics to the NASD and other enforcement agencies that measure dealer performance in modifying and cancelling transactions, as well as error rates of original submissions. Dealers that excessively modify or cancel trade reports will have above-average rates in these statistical reports. Dealers therefore should change trade reports only when appropriate to attain accurate and complete reporting under Rule G-14 and the Procedures.

Dealers can monitor their reporting of transactions in compliance with Rule G-14 in several ways. The MSRB currently provides information to dealers about their reporting performance. Any error detected by RTRS is reported back to the submitter by electronic message and is shown to the submitter and the executing dealer on the RTRS Web screen.[8] RTRS also sends e-mail error messages to dealers on request. The RTRS Web screen lists all trades cancelled by the dealer, under its Advanced Search feature. In addition, beginning in March 2005, the MSRB plans to make available to dealers the same statistics provided to the enforcement agencies, in a report entitled “G-12(f)/G-14 Compliance Data from RTRS.” This will be available monthly on the first Monday after the 15th of the month. A dealer’s report will include its statistics for the most recent full month and for the previous month.[9] It will also include summary statistics for the municipal securities industry so that the dealer can compare its performance to the industry’s. Further information about how a dealer can obtain its compliance statistics will be posted in March on the MSRB web site, www.msrb.org.

[1] Transactions reported to the MSRB are made available to the NASD and other regulators for their market surveillance and enforcement activities

[2] See, e.g., “Reminder Regarding MSRB Rule G-14 Transaction Reporting Requirements” (March 3, 2003) on www.msrb.org.

[3] See Rule G-14 RTRS Procedures paragraph (a)(iv) and  “Reminder Regarding Accuracy of Information Submitted to the MSRB Transaction Reporting System: Rule G-14” (February 10, 2004) on www.msrb.org.

[4] Messages which indicate a trade report is “unsatisfactory” and which have an error code beginning with “U” require that the trade be modified or that it be cancelled and replaced. See “Specifications for Real-time Reporting of Municipal Securities Transactions,” especially the table and text after the table in section 2.9. This document is on www.msrb.org.

[5] Changes to inter-dealer trades are governed also by National Securities Clearing Corporation (“NSCC”) rules. See, e.g., “Interactive Messaging: NSCC Participant Specifications for Matching Input and Output” on www.nscc.com.

[6] Modification is preferred when changes are necessary because a modification is counted as a single change to a trade report. A cancellation and resubmission are counted as a change and (unless the resubmission is done within the original deadline for reporting the trade) also a late report of a trade. Methods for cancelling and modifying reports are described in Sections 1.3.3 and 2.9 of “Specifications for Real-time Reporting of Municipal Securities Transactions: Version 1.2” on www.msrb.org.

[7] Note that the MSRB does not require a dealer to report a change to the settlement date of a trade in  when-issued securities, if that is the only change.

[8] See “Real-Time Transaction Reporting Web User Manual” on www.msrb.org.

[9] The first report, planned for March 21, 2005, will include statistics only for February, since RTRS went into operation on January 31, 2005.

The MSRB is publishing this notice to remind dealers of their affirmative disclosure obligations when effecting transactions with customers in original issue discount bonds. An original issue discount bond, or O.I.D. bond, is a bond that was sold at the time of issue at a price that included an original issue discount. The original issue discount is the amount by which the par value of the bond exceeded its public offering price at the time of its original issuance. The original issue discount is amortized over the life of the security and, on a municipal security, is generally treated as tax-exempt interest. When the investor sells the security before maturity, any profit realized on such sale is calculated (for tax purposes) on the adjusted book value, which is calculated for each year the security is outstanding by adding the accretion value to the original offering price. The amount of the accretion value (and the existence and total amount of original issue discount) is determined in accordance with the provisions of the Internal Revenue Code and the rules and regulations of the Internal Revenue Service.[1]

Rule G-17, the MSRB’s fair dealing rule, encompasses two general principles. First, the rule imposes a duty on dealers not to engage in deceptive, dishonest, or unfair practices. This first prong of Rule G-17 is essentially an antifraud prohibition. In addition to the basic antifraud provisions in the rule, the rule imposes a duty to deal fairly with all persons. 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 the 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.[2] These obligations apply even when a dealer is effecting non-recommended secondary market transactions.

In the context of the sale to customers of an original issue discount security, the MSRB’s customer confirmation rule, Rule G-15(a), provides that information regarding the status of bonds as original issue discount securities must be included on customer confirmations. Specifically, Rule G-15(a)(i)(C)(4)(c) provides that, “If the securities pay periodic interest and are sold by the underwriter as original issue discount securities, a designation that they are “original issue discount” securities and a statement of the initial public offering price of the securities, expressed as a dollar price” must be included on the customer’s confirmation.

The MSRB previously has alerted dealers of their obligation to make original issue discount disclosures to customers and has stated that, “The Board believes that the fact that a security bears an original issue discount is material information (since it may affect the tax treatment of the security); therefore, this fact should be disclosed to a customer prior to or at the time of trade.”[3] The MSRB is publishing this notice to remind dealers of their disclosure obligations under Rule G-17 because it remains concerned that, absent adequate disclosure of a security’s original issue discount status, an investor might not be aware that all or a portion of the component of his or her investment return represented by accretion of the discount is tax-exempt, and therefore might sell the securities at an inappropriately low price (i.e., at a price not reflecting the tax-exempt portion of the discount) or pay capital gains tax on the accreted discount amount. Without appropriate disclosure, an investor also might not be aware of how his or her transaction price compares to the initial public offering price of the security. Appropriate disclosure of a security’s original issue discount feature should assist customers in computing the market discount or premium on their transaction.

[1] See Glossary of Municipal Securities Terms, Second Edition (January 2004).

[2] See e.g., Rule G-17 Interpretation—Educational Notice on Bonds Subject to “Detachable” Call Features, May 13, 1993, MSRB Rule Book (July 2004) at 135.

[3] Rules G-12 and G-15, Comments Requested on Draft Amendments on Original Issue Discount Securities, MSRB Reports, Vol. 4, No. 6 (May 1994) at 7.

The Board has received an inquiry concerning a situation in which a municipal securities dealer that is acting as a syndicate manager sells bonds "short" for its own account to the detriment of the syndicate account. In particular, the Board has been made aware of allegations that certain syndicate managers, with knowledge that the syndicate account on a particular new issue of securities is not successful, have sold securities of the new issue "short" for their own accounts and then required syndicate members to take their allotments of unsold bonds. The syndicate managers allegedly have subsequently covered their short positions when the syndicate members attempt to sell their allotments at the lower market price.

Rule G-17, the Board’s fair dealing rule, provides:

In the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice.

Syndicate managers act in a fiduciary capacity in relation to syndicate accounts. Therefore they may not use proprietary information about the account obtained solely as a result of acting as manager to their personal advantage over the syndicate’s best interests. The Board is of the view that a syndicate manager that uses information on the status of the syndicate account which is not available to syndicate members to its own benefit and to the detriment of the syndicate account (e.g., by effecting "short sale" transactions for its own account against the interests of other syndicate members) appears to be acting in violation of the fair dealing provisions of rule G-17.

The Board has received inquiries whether individuals who solicit new account business on behalf of municipal securities dealers must be qualified under the Board’s rules. In particular, it has come to the Board’s attention that nonqualified individuals are making "cold calls" to individuals and, by reading from prepared scripts, introduce the services offered by a municipal securities dealer, prequalify potential customers, or suggest the purchase of specific securities currently being offered by a municipal securities dealer.

Board rule G-3(a) defines municipal securities representative activities to include any activity which involves communication with public investors regarding the sale of municipal securities but exempts activities that are solely clerical or ministerial. In the past, the Board has permitted nonqualified individuals, under the clerical or ministerial exemption, to contact existing customers in very limited circumstances. In an interpretive notice on rule G-3, the Board permitted certain ministerial and clerical functions to be performed by nonqualified individuals when municipal securities representatives and principals who normally handle the customers' accounts are unavailable, subject to strict supervisory requirements. These functions are: the recording and transmission in customary channels of orders, the reading of approved quotations, and the giving of reports of transactions. In this notice, the Board added that solicitation of orders by clerical personnel is not permitted. The Board is of the view that individuals who solicit new account business are not engaging in clerical or ministerial activities but rather are communicating with public investors regarding the sale of municipal securities and thus are engaging in municipal securities representative activities which require such individuals to be qualified as representatives under the Board’s rules.

Finally, under rule G-3(i)[*], a person serving an apprenticeship period prior to qualification as a municipal securities representative may not communicate with public investors regarding the sale of municipal securities. The Board sees no reason to allow nonqualified individuals to contact public investors, except for the limited functions noted above, when persons training to become qualified municipal securities representatives may not do so.

[*] [Currently codified at rule G-3(a)(iii)]

Agency transactions: yield disclosures. I am writing in connection with your previous conversations with Christopher Taylor of the Board's staff concerning the application of the yield disclosure requirements of Board rule G-15 to certain types of transactions in municipal securities. In your conversations you noted that dealers occasionally effect transactions in municipal securities on an "agency" basis. In these transactions the customer's confirmation would typically show as the dollar price of the transaction the price paid by the dealer to the person from whom it acquired the securities; the dealer's remuneration, received in the form of a commission paid by the customer, is typically shown separately, as a charge included in the summing of the total dollar amount due from (or to) the customer in connection with the transaction. You inquired whether, in such a transaction, the yield to the customer disclosed on the confirmation should be derived from the price shown as the dollar price of the transaction or from the total dollar amount of the transaction (i.e., whether the yield should show the effect of the commission charged).

This will confirm Mr. Taylor's advice to you that the yield shown on the confirmation of such a transaction should be derived from the total dollar amount of the transaction, and therefore should show the effect of the commission charged to the customer on the transaction. As the Board has previously stated, the yield disclosure on customer confirmations is intended to provide customers with a means of assessing the merits of alternative investment strategies and the merits of the transaction being confirmed. The disclosure of the yield after giving effect to the commission charged the customer best serves these purposes. MSRB interpretation of July 13, 1984.

The Municipal Securities Rulemaking Board has recently received a number of inquiries from members of the municipal securities industry and others concerning certain of the provisions of rule G-33 on calculations. In particular, such persons have inquired concerning the acceptability under the rule of the practice of interpolation as a method of determining dollar price from yield. Such persons have also asked whether the rule permits a dealer effecting a transaction at a yield price equal to the interest rate on the securities to presume that the dollar price on the transaction is "100."

The Board wishes to remind members of the industry that both of these practices are no longer permissible. Board rule G-33 generally requires that yields and dollar prices on transactions effected by municipal securities brokers and dealers be computed in accordance with the formulas prescribed in the rule directly to the settlement date of the transaction. Subparagraph (b)(i)(C) of the rule permitted, until January 1, 1984, the use of the dollar price "100" as the presumed result on transactions in securities with a redemption value of par effected at a yield price equal to the interest rate on the securities. Subparagraph (b)(i)(D) of the rule permitted, until January 1, 1984, the use of interpolation as a method of deriving a dollar price. Since the effectiveness of both of these provisions lapsed as of January 1, 1984, therefore, these practices are no longer in compliance with the requirements of the rule; dollar prices on all transactions effected on a yield basis (including transactions effected on a yield basis equal to the interest rate) should therefore be computed directly to the settlement date of the transaction.

The Board notes that the rule continues to permit a municipal securities broker or dealer to effect a transaction in dollar price terms. Therefore, a dealer wishing to offer or sell a security at par may continue to effect the transaction on a direct dollar price basis at a price of "100."

Issuer consent: financial advisor participation in underwriting. This responds to your letter of March 6, 1984, regarding the application of rule G-23, concerning the activities of financial advisors to the following activities of [name deleted] (the "Company").

Your letter states that the Company serves as a financial advisor to a number of municipal entities with respect to the issuance and delivery of bonds. In the majority of circumstances in which bonds are to be marketed through a competitive bidding process, the Company is requested by the issuer either to bid for the bonds independently for its own account or as a participant with others in a syndicate organized to submit a bid. You state that the Company’s customary financial advisory contract, in almost all instances, specifically reserves to the Company the right to bid independently or in a syndicate with others for any bonds marketed through a competitive bid.

However, to further accommodate these circumstances, you state that it is the Company’s practice to include in the official statement on any bond issue subject to competitive bids specific language, such as:

The Company is employed as Financial Advisor to the City in connection with the issuance of the Bonds. The Financial Advisor’s fee for services rendered with respect to the sale of the Bond is contingent upon the issuance and delivery of the Bonds. The Company may submit a bid for the Bonds, either independently or as a member of a syndicate organized to submit a bid for the Bonds.

In the notice of sale, the following language is included:

The Company, the City’s Financial Advisor, reserves the right to bid on the Bonds.

You add that these two documents, the official statement and the notice of sale, must be approved by formal resolution of the governing authority of the issuer, such as a city council or a board of directors, before bids are requested or on the date of sale. You ask whether the above language printed in the official statement and the notice of sale, which is approved by formal resolution of the governing authority of the issuer, constitutes compliance with rule G-23(d)(ii).

Rule G-23, concerning the activities of financial advisors, is designed to minimize the prima facie conflict of interest that exists when a municipal securities professional acts as both financial advisor and underwriter with respect to the same issue. Specifically, rule G-23(d)(ii) provides that a municipal securities dealer which is acting as a financial advisor may not acquire or participate in the distribution of a new issue unless,

if such issue is to be sold by the issuer at competitive bid, the issuer has expressly consented in writing prior to the bid to such acquisition or participation.

Compliance with the rule’s requirement that an issuer expressly consent in writing to the financial advisor’s participation in the underwriting cannot be inferred from its approval of the official statement and notice of sale. These documents are designed primarily to describe the new issue and a passing reference to the advisor’s possible participation in the underwriting of the bond issue cannot be construed as express approval of such activity since it is not clear that the issuer is provided with a sufficient opportunity to determine whether it is in its best interests to allow its financial advisor to participate in the competitive bidding.

While the Board does not mandate the form of the issuer’s consent, it understands that financial advisory contracts often may include consent language applicable to a specific new issue. Alternatively, financial advisors may obtain the consent of an issuer by means of a separate document. However, a financial advisory contract that reserves to the financial advisor the right to bid for any of the issuer’s bonds marketed through a competitive bid does not satisfy the requirements of rule G-23(d)(ii). The Board has stated that such "blanket consents" do not afford an issuer a sufficient opportunity to consider whether, under the particular circumstances of an offering, the financial advisor’s potential conflict of interest is sufficient to warrant not consenting to the financial advisor’s participation in the sale. MSRB interpretation of April 10, 1984.

Fixed-price offerings. This responds to your letter of February 17, 1984, requesting our view on the applicability of the Board's rules to the following situation:

[Name deleted] the ("Dealer") is an underwriter of industrial revenue bonds. It underwrites on average three or four issues per month and sells them almost entirely on a retail basis to individual investors. The coupon rates are fixed at current market levels. The bonds are then offered to the public at par. Official statements are provided to investors, fully disclosing all pertinent information and making clear note of the fact that the initial offering price of par may be changed without prior notice.

Recently, interest rates dropped significantly during the two or three-week time period needed for the Dealer to sell out a bond issue. This caused the offering price of the fixed rate municipal bonds to rise above the initial offering price stated in the official statement. All of this occurred before the closing of the syndicate account. You ask specifically whether, under the Board's rules, it is permissible to raise the offering price of municipal bonds which are part of a new issue above the initial price before the close of the underwriting period.

Board rule G-11 generally requires syndicates to establish priorities for different categories of orders and requires that certain disclosures be made to syndicate members which are intended to assure that allocations are made in accordance with those priorities. The rule also requires that the manager provide account information to syndicate members in writing. The Board has described rule G-11 as a "disclosure rule" designed to provide information to new issue participants so that they can understand and evaluate syndicate practices. The rule does not, however, dictate what those practices must be. Thus, rule G-11 does not require that the offering price of new issue municipal securities remain fixed through the underwriting period. The Board considered the issue of fixed-price offerings when it formulated rule G-11 and again when the Public Securities Association, in 1981, asked the Board to consider the adoption of rules governing the granting of concessions in new issues of municipal securities. Since the kind of fixed-price offering system developed for corporate securities has not been the primary means of distributing municipal securities and in light of industry concerns that any such proposed regulations could unnecessarily restrict prices and increase the borrowing costs for municipal issues, the Board determined not to adopt any rules addressing the issue. [1]

Finally, we know of no laws or regulations which purport to require fixed-price offerings for new issue municipal securities, and the NASD's rules in this area do not apply to transactions in municipal securities.[2] Of course, Board rule G-30, on prices and commissions, prohibits a dealer from buying municipal securities for its own account from a customer or selling municipal securities for its own account to a customer at an aggregate price unless that price is reasonable taking into consideration all relevant factors. MSRB interpretation of March 16, 1984.

[1] For a fuller explanation of the Board's review of G-11 in this area, See Notice Concerning Board Determination Not to Adopt Concession Rules, [MSRB Reports, Vol. 2, No. 5 (July 1982) at 7].

[2] See NASD Rules of Fair Practice, Article II, Section 1, subsection (m) [currently codified as NASD Rule 114].

The Board has received inquiries concerning the duty of municipal securities brokers and dealers to allocate partial calls fairly among customer securities held in safekeeping. In particular, it has come to the Board’s attention that certain municipal securities dealers use lottery systems that include only customer positions and exclude the dealer’s proprietary accounts when the call is exercised at a price below the current market value.

The Board recognizes that lottery systems are a proper method of allocating the results of a partial call. Principles of fair dealing require that all such lotteries treat dealer and customer account alike. The Board is of the view that a municipal securities dealer which uses a lottery that excludes the dealer’s proprietary accounts when the call is exercised at a price below the current market value is acting in violation of rule G-17, the Board’s fair dealing rule.[1]

[1] Rule G-17 provides:

In the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice.

Callable securities: pricing to call and extraordinary mandatory redemption features. This is in response to your November 16, 1983, letter concerning the application of the Board's rules to sales of municipal securities that are subject to extraordinary redemption features.

As a general matter, rule G-17 of the Board's rules of fair practice requires municipal securities brokers and dealers to deal fairly with all persons and prohibits them from engaging in any deceptive, dishonest, or unfair practice. The Board has interpreted this rule to require, in connection with the purchase from or sale of a municipal security to a customer, that a dealer must disclose, at or before the time the transaction occurs, all material facts concerning the transaction and not omit any material facts which would render other statements misleading. The fact that a security may be redeemed "in whole," "in part," or in extraordinary circumstances prior to maturity is essential to a customer's investment decision about the security and is one of the facts a dealer must disclose prior to the transaction. It should be noted that the Board has determined that certain items of information must, because of their materiality, be disclosed on confirmations of transactions. However, a confirmation is not received by a customer until after a transaction is effected and is not meant to take the place of oral disclosure prior to the time the trade occurs.

You ask whether, for an issue which has more than one call feature, the disclosure requirements of MSRB rule G-15 would be better served by merely stating on the confirmation that the bonds are callable, instead of disclosing the terms of one call feature and not another. Board rule G-15, among other things, prescribes what items of information must be disclosed on confirmations of transactions with customers.[1] Rule G-15(a)(i)(E)[*] requires that customer confirmations contain a materially complete description of the securities and specifically identifies the fact that securities are subject to redemption prior to maturity as one item that must be specified. The Board is of the view that the fact that a security may be subject to an "in whole" or "in part" call is a material fact for an individual making an investment decision about the securities and has further required in rule G-15a(iii)(D)[†] that confirmations of transactions in callable securities must state that the resulting yield may be affected by the exercise of a call provision, and that information relating to call provisions is available upon request.[2]

With respect to the computation of yields and dollar prices, rule G-15(a)(i)(I)[‡] requires that the yield and dollar price for the transaction be disclosed as the price (if the transaction is done on a yield basis) or yield (if the transaction is done on the basis of a dollar price) calculated to the lowest price or yield to call, to par option, or to maturity. The provision also requires, in cases in which the resulting dollar price or yield shown on the confirmation is calculated to call or par option, that this must be stated and the call or option date and price used in the calculation must be shown. The Board has determined that, for purposes of making this computation, only "in whole" calls should be used.[3] This requirement reflects the longstanding practice of the municipal securities industry and advises a purchaser what amount of return he can expect to realize from the investment and the terms under which such return would be realized.

You also ask whether it is reasonable to infer from the discharge of one call feature that no other call features exist. As discussed above, the Board requires a customer confirmation to disclose, when applicable, that a security is subject to redemption prior to maturity and that the call feature may affect the security's yield. This requirement applies to securities subject to either "in whole" or "in part" calls. Moreover, as noted earlier, because information concerning call features is material information, principles of fair dealing embodied by rule G-17 require that these details be disclosed orally at the time of trade.

By contrast, identification of the first "in-whole" call date and its price must be made only when they are used to compute the yield or resulting dollar price for a transaction. This disclosure is designed only to advise an investor what information was used in computing the lowest of yield or price to call, to par option, or to maturity and is not meant to describe the only call features of the municipal security.

In addition, in the case of the sale of new issue securities during the underwriting period, Board rule G-32 requires that ... a copy of the final official statement, if any, must be provided to the customer.[4] While the official statement would describe all call features of an issue, it must be emphasized that delivery of this document does not relieve a dealer of its obligation to advise a customer of material characteristics and facts concerning the security at the time of trade.

Finally, you ask whether the omission of this or other call features on the confirmation is a material omission of the kind which would be actionable under SEC rule 10b-5. The Board is not empowered to interpret the Securities Exchange Act or rules thereunder; that responsibility has been delegated to the Securities and Exchange Commission. We note, however, that the failure to disclose the existence of a call feature would violate rule G-15 and, in egregious situations, also may violate rule G-17, the Board's fair dealing rule. MSRB interpretation of February 10 1984.

[1] Similar requirements are specified in rule G-12 for confirmations of inter-dealer transactions.

[2] The rule states that this requirement will be satisfied by placing in footnote or otherwise the statement:

"[Additional] call features ... exist [that may] affect yield; complete information will be provided upon request."

[3] See [Rule G-15 Interpretation - Notice concerning pricing to call], December 10, 1980 ... at ¶ 3571.

[4] The term underwriting period is defined in rule G-11 as:

the period commencing with the first submission to a syndicate of an order for the purchase of new issue municipal securities or the purchase of such securities from the issuer, whichever first occurs, and ending at such time as the issuer delivers the securities to the syndicate or the syndicate no longer retains an unsold balance of securities, whichever last occurs.

[*] [Currently codified at rule G-15(a)(i)(C)]

[†] [Currently codified at rule G-15(a)(i)(C)(2)(a)]

[‡] [Currently codified at rule G-15(a)(i)(A)(5)]

NOTE: Revised to reflect subsequent amendments.

From time to time, industry members have asked the Board for guidance in situations in which municipal securities dealers have traded securities which either are different from those described ("misdescribed") or do not exist as described ("non-existent") and the parties involved were unaware of this fact at the time of trade. A sale of a misdescribed security may occur, for example, when a minor characteristic of the issue is misstated. A sale of a non-existent security may result, for example, from the sale of a "when, as and if issued" security which is never authorized or issued.

The Board has responded to these inquiries by advising that its rules do not address the resolution of any underlying contractual dispute arising from trades in such misdescribed or non-existent securities, and that the parties involved in the trade should work out an appropriate resolution. Board rule G-12(g) does permit reclamation of an inter-dealer delivery in certain instances in which information required to be included on a confirmation by rule G-12(c)(v)(E)[1] is omitted or erroneously noted on the confirmation or where other material information is erroneously noted on the confirmation. Rule G-12(g)(v) and (vi), however, make clear that a reclamation only reverses the act of delivery and reinstates the open contract on the terms and conditions of the original contract, requiring the parties to work out an appropriate resolution of the transaction.

The Board wishes to emphasize that general principles of fair dealing would seem to require that a seller of non-existent or misdescribed securities make particular effort to reach an agreement on some disposition of the open trade with the purchaser. The Board believes that this obligation arises since it is usually the seller's responsibility to determine the status of the municipal securities it is offering for sale. The extent to which the seller bears this responsibility, of course, may vary, depending on the facts of a trade.

The Board notes that the status of the underlying contract claim for trades in non-existent or misdescribed securities ultimately is a matter of state law, and each fact situation must be dealt with under applicable state law, and each fact situation must be dealt with under applicable contract principles. The Board believes that the position set forth above is consistent with general contract principles, which commonly hold that a seller is responsible to the purchaser in most instances for failing to deliver goods as identified in the contract, or for negligently contracting for goods which do not exist if the purchaser relied in good faith on the seller's representation that the goods existed.

Parties to trades in misdescribed or non-existent securities should attempt to work out an appropriate resolution of the contractual agreement. If no agreement is reached, the Board's close-out and arbitration procedures may be available.

[1] Rule G-12(c)(v)(E) requires that confirmations contain a description of the securities, including at a minimum the name of the issuer, interest rate, maturity date, and if the securities are limited tax, subject to redemption prior to maturity (callable), or revenue bonds, an indication to such effect, including in the case of revenue bonds the type of revenue, if necessary for a materially complete description of the securities and in the case of any securities, if necessary for a materially complete description of the securities, the name of any company or other person in addition to the issuer obligated, directly or indirectly, with respect to debt service or, if there is more than one such obligor, the statement "multiple obligors" may be shown.

Delivery requirements: mutilated coupons. I am writing in response to your recent letter concerning the provisions of Board rule G-12(e) with respect to inter-dealer deliveries of securities with mutilated coupons attached. You indicate that your firm recently became involved in a dispute with another firm’s clearing agent concerning whether certain coupons attached to securities your firm had delivered to the agent were mutilated. You request guidance as to the standards set forth in rule G-12(e) for the identification of mutilated coupons.

As you are aware, rule G-12(e)(ix) indicates that a coupon will be considered to be mutilated if the coupon is damaged to the extent that any one of the following cannot be ascertained from the coupon:

(A) title of the issuer;

(B) certificate number;

(C) coupon number or payment date...;

or

(D) the fact that there is a signature... (emphasis added)

The standard set forth in the rule (that the information "cannot be ascertained") was deliberately chosen to make clear that minimal damage to a coupon is not sufficient to cause that coupon to be considered mutilated. For example, if the certificate number imprinted on a coupon is partially torn, but a sufficient portion of the coupon remains to permit identification of the number, the coupon would not be considered to be mutilated under the standard set forth in the rule, and a rejection of the delivery due to the damage to the coupon would not be permitted. In the case of the damaged coupon shown on the sample certificate enclosed with your letter, it seems clear that the certificate number can be identified, and confusion with another number would not be possible; therefore, this coupon would not be considered to be mutilated under the rule, and a rejection of a delivery due to the damage to this coupon would not be in accordance with the rule's provisions.

Your letter also inquires as to the means by which dealers can obtain redress in the event that a delivery is rejected due to damaged coupons which are not, in their view, mutilated under the standard set forth in the rule. I note that rule G-12(h)(ii) sets forth a procedure for a close-out by a selling dealer in the event that a delivery is improperly rejected by the purchaser; this procedure could be used in the circumstances you describe to obtain redress in this situation. Further, the arbitration procedure under Board rule G-35 could also be used in the event that the dealer incurs additional costs as a result of such an improper rejection of a delivery. MSRB interpretation of January 4, 1984.

Yield disclosures: yields to call on zero coupon bonds. I am writing in response to your letter of October 18, 1983 concerning the appropriate method of disclosing on a confirmation a call price used in the computation of a dollar price or yield on a transaction in a zero coupon, compound interest, multiplier, or other similar type of security. In your letter you indicate that the call features on these types of securities often express the call prices in terms of a percentage of the compound accreted value of the security as of the call date.[1] You note that, in computing a price or yield to such a call feature, it is necessary for the computing dealer to convert such a call price into its equivalent in terms of a percentage of maturity value (i.e., into a standard dollar price), and use this figure in the computation. You inquire whether, in circumstances where the confirmation of a transaction is required to disclose a yield or dollar price computed to such a call feature, the call price used in the calculation should be stated on the confirmation in terms of the percentage of the compound accreted value or in terms of the equivalent percentage of maturity value.

The requirement which is the subject of your inquiry is set forth in Board rule G-15(a)(i)(I)[*] as follows:

In cases in which the resulting dollar price or yield shown on the confirmation is calculated to call or par option, this must be stated, and the call or option date and price used in the calculation must be shown...[2]

The Board is of the view that, in the case of a computation of a yield or dollar price to a call or option feature on a transaction in a zero coupon or similar security, the call price shown on the confirmation should be expressed in terms of a percentage of the security's maturity value. The Board believes that the disclosure of the call price in terms of the security's maturity value would provide more meaningful information to the purchaser, since other confirmation disclosure on these types of securities are also expressed in terms of the security's maturity value. This form of disclosure therefore presents the information to a purchaser in a consistent format, thereby facilitating the purchaser's understanding of the information shown on the confirmation. The Board notes also that this form of disclosure is simpler and requires less confirmation space to present. MSRB interpretation of January 4, 1984.

[1] For example, the selected portions of an official statement describing one of these types of issues enclosed with your letter indicate that the security in question is callable on October 1, 1993 at 108% of the security's compound accreted value on that date (which is indicated elsewhere in the official statement to be $146.02 per $1,000 of maturity value).

[2] Comparable requirements with respect to inter-dealer confirmations are set forth in Board rule G-12(c)(v)(I).

[*] [Currently codified at rule G-15(a)(i)(A)(5)]