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.