Background

Representatives of brokers, dealers and municipal securities dealers (collectively, “dealers”) have increasingly inquired about the application of certain Municipal Securities Rulemaking Board (MSRB) rules to managed accounts in which a registered investment adviser (“RIA”) is exercising discretion to buy and sell municipal securities on behalf of the account holder. Specifically, dealers have asked whether, with respect to these transactions, they are expected to:
 

1) Provide the time-of-trade disclosures required by MSRB Rule G-47 to the ultimate investor, who is the account holder (i.e., the RIA’s client), particularly if the dealer does not know the identity of the investor; and

2) Obtain a customer affirmation from such an investor for purposes of qualifying the person, separately, as a sophisticated municipal market professional (“SMMP”) under MSRB Rule D-15, and owing the modified obligations under MSRB Rule G-48, on transactions with SMMPs, if the RIA is itself an SMMP.[1]
 

This notice provides background information on the relevant rules, analyzes the questions presented and provides interpretive guidance in response.

Relevant Rules

The principal rules relevant to these interpretive questions are Rules G-47, D-15, and G‑48.

MSRB Rule G-47 – Time of Trade Disclosure

Rule G-47 sets forth the general time-of-trade disclosure obligation applicable to dealers. Specifically, pursuant to Rule G-47, a dealer cannot sell municipal securities to a customer, or purchase municipal securities from a customer, without disclosing to the customer, at or prior to the time of trade, all material information known about the transaction and material information about the security that is reasonably accessible to the market. The rule applies regardless of whether the transaction is unsolicited or recommended, occurs in a primary offering or the secondary market, and is a principal or agency transaction. The disclosure can be made orally or in writing.

Information is “material” if there is a substantial likelihood that the information would be considered important or significant by a reasonable investor in making an investment decision. The rule defines “reasonably accessible to the market” as information that is made available publicly through “established industry sources.”[2] Finally, the rule defines “established industry sources” as including EMMA, rating agency reports, and other sources of information generally used by dealers that effect transactions in the type of municipal securities at issue. Under these standards, “material information” encompasses a complete description of the security, which includes a description of the features that would likely be considered significant by a reasonable investor, and facts that are material to assessing potential risks of the investment.

MSRB Rule D-15 – Sophisticated Municipal Market Professional

Rule D-15 defines the set of customers that may be SMMPs” as (1) a bank, savings and loan association, insurance company, or registered investment company; (2) an RIA; or (3) any other person or entity with total assets of at least $50 million. To qualify as an SMMP under the rule, the dealer must have a reasonable basis to believe the customer is capable of independently evaluating investment risks and market value, in general and with respect to particular transactions and investment strategies in municipal securities. In addition, the customer is required to affirm that it is exercising independent judgment in evaluating the quality of execution of the customer’s transactions by the dealer. Further, the customer is required to affirm that it is exercising independent judgment in evaluating the transaction price in non-recommended agency secondary market transactions where the dealer’s services are explicitly limited to providing anonymity, communication, order matching and/or clearance functions, and the dealer does not exercise discretion as to how or when the transactions are executed. Finally, the customer is required to affirm that it has timely access to “material information” available publicly from “established industry sources” as those terms are defined in Rule G-47. The customer affirmation may be given orally or in writing, and may be given on a transaction-by-transaction basis, a type-of-municipal security basis, an account-wide basis or a type-of-transaction basis.

Importantly, the definition of SMMP under Rule D-15 is not self-executing, nor are the contingencies for its application solely controlled by the dealer. Rather, classification as an SMMP requires the customer to make the affirmation noted above. Consequently, any customer, even if otherwise qualifying as an SMMP, could choose not to make the affirmation in order to obtain the benefits of those obligations that otherwise would be modified (e.g., best execution). Overall, the customer affirmation requirement is designed to ensure that SMMPs have affirmatively and knowingly agreed to forgo certain protections under MSRB rules.

MSRB Rule G-48 – Transactions with Sophisticated Municipal Market Professionals

Rule G-48 addresses modified obligations of dealers when dealing with SMMPs. It relieves dealers of the time-of-trade disclosure obligation under Rule G-47 for information reasonably accessible to the market, the pricing obligations under MSRB Rule G-30 under certain circumstances,[3] the customer-specific suitability obligation under MSRB Rule G-19,[4] certain obligations with respect to the dissemination of quotations under MSRB Rule G-13,[5] and the best-execution obligation under Rule G-18.[6]

Interpretive Guidance

The rules referenced above, including Rule G-48 on certain modified obligations, are, or relate to the application of, various investor/customer protections. As such, a threshold approach to the interpretive questions is to focus on who the dealer’s customer is, and, thus, to whom the dealer owes these protections when an RIA has full discretion over investor clients’ accounts.

According to past guidance, there are facts and circumstances under which the MSRB considers the RIA, and not the underlying investors, to be the dealer’s customer. When an independent investment adviser (including an RIA) purchases securities from one dealer and instructs that dealer to make delivery of the securities to other dealers where the investment adviser’s clients have accounts, and the identities of individual account holders are not given to the delivering dealer, the investment adviser is the customer of the dealer and must be treated as such for recordkeeping and other regulatory purposes.[7] Accordingly, in those scenarios, the dealer does not have any customer obligations to the underlying investors.

Even if the underlying investors are, or are considered to be, customers of the dealer, the MSRB interprets Rule G-48 to mean, under certain circumstances, that the obligations modified by that rule are modified with respect to the underlying investors, as well as the RIA that is an SMMP. Specifically, when an investor has granted an RIA full discretion to act on the investor’s behalf for all transactions in an account, the RIA has effectively become that investor for purposes of the application of Rule G-48 when engaging in transactions with the dealer. Therefore, if that RIA is an SMMP, to whom the dealers’ obligations are modified under Rule G-48, then, for purposes of complying with the rules addressed in Rule G-48, the dealer should not be required to satisfy any greater or additional obligations with respect to the ultimate investor who holds that account. When the MSRB included RIAs in the set of customers that may be SMMPs, it was, of course, aware that RIAs typically act on behalf of third-party clients. It would have been anomalous for Rule G-48 to modify the dealers’ obligations to an RIA that is an SMMP, only essentially to re-impose them on the dealer with respect to the underlying investors who have given the RIA full discretion to act on their behalf.

This interpretation, under which dealer obligations to certain investors would be modified, is supported by the existence (where the conditions of the interpretation are met) of substantially similar federal and/or state obligations. For example, RIAs registered with the SEC are subject to the Investment Advisers Act of 1940 (“Advisers Act”) and the rules thereunder, including a fiduciary duty extending to all services undertaken on behalf of clients.[8] Obligations flowing from the fiduciary duty, include, but are not limited to, the requirements to: 

• Provide full disclosure of material facts, including conflicts of interest and disciplinary events and precarious financial condition;[9]
• Give suitable advice;[10]
• Have a reasonable basis for recommendations;[11] and
• Meet best-execution obligations.[12]

These and other investor protections provided by the regulatory regime under the Advisers Act reduce the need for the similar investor protections provided by time-of-trade disclosure, customer-specific suitability, best execution and the other obligations required by MSRB rules but modified under Rule G-48.[13] Additionally, where an investor has affirmatively and in writing authorized the RIA to exercise full discretion in the investor’s account, the investor has delegated decision-making authority over what to buy and sell in the account. Finally, the MSRB notes that, where the RIA is an SMMP, the RIA has affirmed and the dealer has a reasonable basis to believe that the RIA has the sophistication to obviate the need for the protections flowing from the obligations modified under Rule G-48, which the MSRB believes is also indicative of the RIA’s ability to provide similar protections to its clients when a dealer is not required to do so. When combining the investor protections afforded by substantially similar federal or state regulatory requirements for RIAs, the full discretionary power affirmatively provided to an RIA, and the RIA’s status as an SMMP, there is sufficient protection afforded to the account holders, who are the RIA’s clients, and, therefore, for purposes of the application of the rules modified by Rule G-48, dealers do not owe these underlying account holders any greater or additional obligations than those which apply to the RIA.[14]

Q: Dealers are required to include time of trade (along with trade date) on all transaction reports. What is “time of  trade?”

A: Transaction reporting procedures define “time of trade” as the time at which a contract is formed for a sale or purchase of municipal securities at a set quantity and set price.[1] For transaction reporting purposes, this is considered to be the same as the time that a trade is “executed.” The time that the trade is executed is not necessarily the time that the trade information is entered into the dealer’s processing system. For example, if a trade is executed on a trading desk but not entered for processing until later, the time of execution (not the time of entering the record into the processing system) is required to be reported as the “time of trade.” Similarly, when a dealer executes a transaction outside of the RTRS Business Day,[2] the time the trade was executed (rather than the time that the trade report is made) is the “time of trade” required to be reported.

2. Q: What is “time of trade” for new issue securities?

A: For new issue securities, a transaction effected on a “when, as and if issued”[3] basis cannot be executed, confirmed and reported until the municipal security has been formally awarded by the issuer. For a negotiated issue, this “time of formal award” is defined as the time of the signing of the bond purchase agreement and for a competitive issue, it is the time of the official award by the issuer. While dealers may take orders for securities and make conditional trading commitments prior to the award, dealers cannot execute transactions, send confirmations or make a trade report prior to the time of formal award. Once a new issue of municipal securities has been formally awarded, trade executions can begin. The time of execution is then reported to the MSRB.[4]

3. Q: There is a non-transaction-based compensation special condition indicator (NTBC indicator) for customer transactions. Is the NTBC indicator to be used only on customer transactions executed in a wrap fee account?

A: No, while transactions that occur in a wrap fee account may be one example of a transaction that qualifies as a customer transaction with no transaction-based dealer compensation component, the NTBC indicator is intended to distinguish all customer transactions that do not include a transaction-based compensation component from those transactions that do include a mark-up, mark-down or commission. Dealers should carefully consider other transactions that may require this indicator, such as those in which the dealer receives a remarketing fee, or a transaction often referred to as an “accommodation” that does not include a transaction-based dealer compensation component.

4. Q: Is the NTBC indicator to be used only on customer trades executed on a principal basis?

A: No. The NTBC indicator applies to both principal and agency trades. It is important for dealers to affirmatively indicate the transactions where a principal transaction does not include a mark-up or mark-down and an agency trade does not include a commission.

5. Q: Is the NTBC indicator to be used only on retail customer accounts?

A: No. There is no exemption for transactions with Sophisticated Municipal Market Professionals (SMMPs). The NTBC indicator is determined on a transaction basis and is to be used on any customer transaction to which it applies.

6. Q: What is the purpose of identifying an inter-dealer trade executed with or using the services of an alternative trading system (ATS)?

A: The purpose of the indicator is to better ascertain the ex- tent to which ATSs are used in the municipal market and to indicate to market participants information that the services of an ATS were used in executing the inter-dealer transaction.

7. Q: If a counterparty does not use the ATS indicator, will the two dealers’ transaction submission still match on the NSCC Real-Time Trade Matching (RTTM)?

A: Yes. The ATS indicator is not a matching value for RTTM. As noted in the MSRB’s Specifications for Real-Time Reporting of Municipal Securities Transactions, a new error code (Q55A) will be noted when the seller’s and buyer’s trade reports differ with respect to the ATS special condition indicator. Incorrect submissions should be modified as necessary.

8. Q: Do transactions executed over the phone with an ATS (voice trades) require a special condition indicator?

A: As noted in MSRB Notice 2015-07, an inter-dealer trans- action executed with or using the services of an alternative trading system with Form ATS on file with the SEC is required to be reported with the ATS indicator regardless of the mode of the transaction. See the MSRB’s Specifications for Real-Time Reporting of Municipal Securities Transactions for more detail on the use of the ATS special condition indicator.

9. Q: As of July 18, 2016, dealers are no longer required to report yield on customer trade reports, but MSRB Rule G-15 still obligates a dealer to calculate yield for customer confirmations. If a dealer’s yield calculation used for customer confirmations to comply with Rule G-15 differs from the yield disseminated by the MSRB, how can the dealer determine the reason for the difference?

A: The EMMA website includes a column labeled “Calculation Date & Price (%)” that displays the date and price for which the yield was calculated, which provides transparency on the inputs used in MSRB yield calculations to explain any potential calculation differences.

[1] See MSRB Rule G-14 RTRS Procedures (d)(iii).

[2] Transactions effected during the RTRS Business Day (from 7:30 a.m. to 6:30 p.m. Eastern time) are required to be reported in real-time. Transactions effected outside of those hours are required to be reported within 15 minutes after the start of the next RTRS Business Day.

[3] See MSRB Glossary of Municipal Securities Terms, Third Edition, August 2013.

[4] For additional discussion of time of trade on transactions in new issue securities, see “Notice Requesting Comment on Draft Amendments to Rule G-34 to Facilitate Real-Time Transaction Reporting and Explaining Time of Trade for Reporting New Issue Trades,” MSRB Notice 2004-18 (June 18, 2004) and “Notice of Filing of Proposed Rule Changes to Extend the Expiration of the Three-Hour Exception and to Require Underwriter Participation with DTCC’s NIIDS System,” MSRB Notice 2007-36 (November 27, 2007) .

The Municipal Securities Rulemaking Board (the “Board”) has learned that sales of certain interests in accounts held by states, or agencies or instrumentalities thereof (the “state”), may be effected through brokers, dealers or municipal securities dealers (collectively, “dealers”). The Board understands that such accounts may be established by states to implement qualified ABLE programs under Section 529A of the Internal Revenue Code of 1986, as amended.[1] In response to a request of the Board, staff of the Office of Municipal Securities at the Securities and Exchange Commission (the “SEC”) has stated that “at least some interests in ABLE accounts . . . may be ‘municipal securities’ as defined in Section 3(a)(29) of the [Securities] Exchange Act [of 1934], depending on the facts and circumstances, including without limitation, the extent to which an ABLE account offered through an ABLE Program is a direct obligation of, or obligation guaranteed as to principal or interest by, a State or any agency or instrumentality thereof.”[2]

Any such interest may, in fact, constitute interests in municipal fund securities, as defined by MSRB Rule D-12. To the extent that dealers effect transactions in municipal fund securities, such transactions are subject to the jurisdiction of the Board pursuant to Section 15B of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).[3]

With respect to the applicability to municipal fund securities of Exchange Act Rule 15c2-12,[4] relating to municipal securities disclosure, staff of the Office of Municipal Securities has stated:

[W]e note that Rule 15c2-12(f)(7) under the Exchange Act defines a “primary offering” as including an offering of municipal securities directly or indirectly by or on behalf of an issuer of such securities.  Based upon your letter and communications with MSRB staff, it is our understanding that interests in ABLE Programs generally are offered only by direct purchase from the issuer.  Accordingly, we would view those interests as having been sold in a “primary offering” as that term is defined in Rule 15c2-12.  If a dealer is acting as an “underwriter” (as defined in Rule 15c2-12(f)(8)) in connection with that primary offering, the dealer may be subject to the requirements of Rule 15c2-12.[5]

Consistent with the SEC staff’s views, dealers effecting transactions in ABLE programs may be subject to all MSRB rules, unless such dealers are specifically exempted from any of those rules, because those dealers would be effecting transactions in municipal fund securities. In particular, dealers acting as underwriters with respect to the sale of interests in ABLE programs may be subject to the requirements of (i) MSRB Rule G-32, on disclosures in connection with primary offerings, and the requirement to submit official statements through the MSRB’s Electronic Municipal Market Access (EMMA®) system[6] pursuant to Rule G-32(b) and (ii) MSRB Rule G-45, on reporting of information on municipal fund securities, and the requirement to submit information on Form G-45 pursuant to Rule G-45(a).

Further, in 1999, the SEC staff provided guidance to the Board that (i) interests in higher education trusts established by states (“529 college savings plans”) may be municipal securities, depending on the facts and circumstances, under the Exchange Act and (ii) such interests appear to have been sold in a “primary offering” as defined under Rule 15c2-12 pursuant to the Exchange Act so that a dealer acting as an underwriter (defined in Rule 15c2-12(f)(8)) in connection with that primary offering may be subject to the requirements of Rule 15c2-12.[7] In addition, the SEC determined that interests offered by such 529 college savings plans are municipal securities under Section 3(a)(29) of the Exchange Act.[8] In response to the SEC staff’s guidance and the SEC’s determination, the Board published interpretive guidance relating to the sale of interests in 529 college savings plans by dealers.  All interpretive guidance under MSRB rules applicable to the sale of interests in 529 college savings plans also would apply to the sale of interests in ABLE programs, as relevant. 

The Board anticipates that it will publish guidance to address particular issues, including Rule G-45, applicable to the sale of interests in ABLE programs by dealers.

Rule G-33 generally requires that brokers, dealers, and municipal securities dealers (“dealers”) effecting transactions in municipal securities compute yields and dollar prices in accordance with the formulas prescribed.

Prior to an amendment effective February 23, 2016, Rule G-33(b)(i)(B)(2) and, by reference, (b)(ii)(B)(2), provided that, for interest-bearing municipal securities with periodic interest payments and more than six months to redemption, dealers compute the dollar price or yield using a formula that accounted for the present value of all future coupon payments and a semi-annual payment of interest. The formula in Rule G-33(b)(i)(B)(2) now provides a more precise pricing calculation when computing yields and dollar prices on securities with periodic interest payments and more than one coupon payment to redemption. Under the amended pricing formula, rather than presuming a semi-annual interest payment, the formula requires factoring in the actual interest payment frequency of the security (e.g., monthly, quarterly or annually).

The compliance date for Rule G-33, as amended, is July 18, 2016.  

Prior to July 18, 2016, a dealer will be deemed to be in compliance with Rules G-33(b)(i)(B)(2) and G-33(b)(ii)(B)(2) if calculating dollar price or yield for interest-bearing municipal securities with periodic interest payments and more than six months to redemption using the actual interest payment frequency rather than assuming a semi-annual payment. Beginning July 18, 2016, the compliance date for Rule G-33, as amended, all dealers will be required to factor in the actual interest payment frequency in calculating dollar price and yield for such securities.

This interpretive notice was revoked on October 12, 2010. See Interpretation on Priority of Orders for Securities in a Primary Offering under Rule G-17 (October 12, 2010)

The Board is concerned about reports that senior syndicate managers may not always be mindful of principles of fair dealing in allocations of new issue securities. In particular, the Board believes that the principles of fair dealing require that customer orders should receive priority over similar dealer or certain dealer-related account[1] orders, to the extent that this is feasible and consistent with the orderly distribution of new issue securities.

Rule G-11(e) requires syndicates to establish priority provisions and, if such priority provisions may be changed, to specify the procedure for making changes. The rule also permits a syndicate to allow the senior manager, on a case-by-case basis, to allocate securities in a manner other than in accordance with the priority provisions if the senior manager determines in its discretion that it is in the best interests of the syndicate. Senior managers must furnish this information, in writing, to the syndicate members. Syndicate members must promptly furnish this information, in writing, to others upon request. This requirement was adopted to allow prospective purchasers to frame their orders to the syndicate in a manner that would enhance their ability to obtain securities since the syndicate’s allocation procedures would be known.

The Board understands that senior managers must balance a number of competing interests in allocating new issue securities. In addition, a senior manager must be able quickly to determine when it is appropriate to allocate away from the priority provisions and must be prepared to justify its actions to the syndicate and perhaps to the issuer. While it does not appear necessary or appropriate at this time to restrict the ability of syndicates to permit managers to allocate securities in a manner different from the priority provisions, the Board believes senior managers should ensure that all allocations, even those away from the priority provisions, are fair and reasonable and consistent with principles of fair dealing under rule G-17.[2] Thus, in the Board’s view, customer orders should have priority over similar dealer orders or certain dealer-related account orders to the extent that this is feasible and consistent with the orderly distribution of new issue securities. Moreover, the Board suggests that syndicate members alert their customers to the priority provisions adopted by the syndicate so that their customers are able to place their orders in a manner that increases the possibility of being allocated securities.

[1] A dealer-related account includes a municipal securities investment portfolio, arbitrage account or secondary trading account of a syndicate member, a municipal securities investment trust sponsored by a syndicate member, or an accumulation account established in connection with such a municipal securities investment trust.

[2] Rule G-17 provides that:

[i]n 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.

The Board is concerned that the market for escrowed-to-maturity securities has been disrupted by uncertainty whether these securities may be called pursuant to optional redemption provisions. Accordingly, the Board has issued the following interpretations of rule G-17, on fair dealing, and rules G-12(c) and G-15(a), on confirmation disclosure, concerning escrowed-to-maturity securities. The interpretations are effective immediately.

Background

Traditionally, the term escrowed-to-maturity has meant that such securities are not subject to optional redemption prior to maturity. Investors and market professionals have relied on this understanding in their purchases and sales of such securities. Recently, certain issuers have attempted to call escrowed-to-maturity securities. As a result, investors and market professionals considering transactions in escrowed-to-maturity securities must review the documents for the original issue, for any refunding issue, as well as the escrow agreement and state law, to determine whether any optional redemption provisions apply. In addition, the Board understands that there is uncertainly as to the fair market price of such securities which may cause harm to investors.

On March 17, 1987, the Board sent letters to the Public Securities Association, the Government Finance Officers Association and the National Association of Bond Lawyers expressing its concern. The Board stated that it is essential that issuers, when applicable, expressly note in official statements and defeasance notices relating to escrowed-to-maturity securities whether they have reserved the right to call such securities. It stated that the absence of such express disclosure would raise concerns whether the issuer’s disclosure documents adequately explain the material features of the issue and would severely damage investor confidence in the municipal securities market. Although the Board has no rulemaking authority over issuers, it advised brokers, dealers and municipal securities dealers (dealers) that assist issuers in preparing disclosure documents for escrowed-to-maturity securities to alert these issuers of the need to disclose whether they have reserved the right to call the securities since such information is material to a customer’s investment decision about the securities and to the efficient trading of such securities.

Application of Rule G-17 on Fair Dealing

In the intervening months since the Board’s letter, the Board has continued to receive inquiries from market participants concerning the callability of escrowed-to-maturity securities. Apparently, some dealers now are describing all escrowed-to-maturity securities as callable and there is confusion how to price such securities. In order to avoid confusion with respect to issues that might be escrowed-to-maturity in the future, the Board is interpreting rule G-17, on fair dealing,[1] to require that municipal securities dealers that assist in the preparation of refunding documents as underwriters or financial advisors alert issuers of the materiality of information relating to the callability of escrowed-to-maturity securities. Accordingly, such dealers must recommend that issuers clearly state when the refunded securities will be redeemed and whether the issuer reserves the option to redeem the securities prior to their maturity.

Application of Rules G-12(c) and G-15(a) on Confirmation Disclosure of Escrowed-to-Maturity Securities

Rules G-12(c)(vi)(E) and G-15(a)(iii)(E)[*] require dealers to disclose on inter-dealer and customer confirmations, respectively, whether the securities are "called" or "prerefunded," the date of maturity which has been fixed by the call notice, and the call price. The Board has stated that this paragraph would require, in the case of escrowed-to-maturity securities, a statement to that effect (which would also meet the requirement to state "the date of maturity which has been fixed") and the amount to be paid at redemption. In addition, rules G-12(c)(v)(E) and G-15(a)(i)(E)[†] require dealers to note on confirmations if securities are subject to redemption prior to maturity (callable).

The Board understands that dealers traditionally have used the term escrowed-to-maturity only for non-callable advance refunded issues the proceeds of which are escrowed to original maturity date or for escrowed-to-maturity issues with mandatory sinking fund calls. To avoid confusion in the use of the term escrowed-to-maturity, the Board has determined that dealers should use the term escrowed-to-maturity to describe on confirmations only those issues with no optional redemption provisions expressly reserved in escrow and refunding documents. Escrowed-to-maturity issues with no optional or mandatory call features must be described as "escrowed-to-maturity." Escrowed-to-maturity issues subject to mandatory sinking fund calls must be described as "escrowed-to-maturity" and "callable." If an issue is advance refunded to the original maturity date, but the issuer expressly reserves optional redemption features, the security should be described on confirmations as "escrowed (or prerefunded) to [the actual maturity date]" and "callable."[2]

The Board believes that the use of different terminology to describe advance refunded issues expressly subject to optional calls will better alert dealers and customers to this important aspect of certain escrowed issues.[3]

[1] Rule G-17 states that "[i]n 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."

[2] This terminology also would be used for any issue prerefunded to a call date, with an earlier optional call expressly reserved.

[3] The Board believes that, because of the small number of advance refunded issues that expressly reserve the right of the issuer to call the issue pursuant to an optional redemption provision, confirmation systems should be able to be programmed for use of the new terminology without delay.

[*] [Currently codified at rule G-15(a)(i)(C)(3)(a). See also current rule G-15(a)(i)(C)(3)(b).]

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

Associated person on issuer governing body. This will respond to your letter to the Municipal Securities Rulemaking Board concerning rule G-22 on disclosure of control relationships. You ask whether the rule requires a dealer to disclose to customers that an associated person of the dealer is a member of a five-person town council that issued the securities.

Rule G-22(c) states that a dealer may not effect a customer transaction in a municipal security with respect to which the dealer has a control relationship, unless the dealer discloses to the customer the nature of the control relationship prior to executing the transaction. Section (a) of rule G-22 defines a control relationship to exist with respect to a security if the dealer controls, is controlled by, or is under common control with the issuer of the security. This includes any control relationship with an associated person of the dealer.1 Whether a control relationship exists in a particular case is a factual question. The Board, however, previously has stated that:

A control relationship with respect to a municipal security does not necessarily exist if an associated person of a securities professional is a member of the governing body or acts as an officer of the issuer of the security. However, if the associated person in fact controls the issuer, rule G-22 does apply. For example, rule G-22 applies if the associated person is the chairman of an issuing authority and, in that capacity, actually makes the decision on behalf of the issuing authority to issue securities. The rule does not apply if the associated person as chairman does not make that decision and does not have the authority alone to make the decision, or if the decision is made by a governing body of which he is only one of several members.2

MSRB interpretation of June 25, 1987.

1 Rule D-11 states that references to “brokers”, “dealers”, “municipal securities dealers”, and “municipal securities brokers” also mean associated persons, unless the context indicates otherwise.

2 Notice of Approval of Fair Practice Rules, October 24, 1978, at 6.

Contract sheets. This will respond to your letter of May 28, 1987, and confirm our telephone conversation of the same date concerning recordkeeping of “contract sheets.” You ask whether dealers are required by Board rules G-8 and G-9 to maintain records of “contract sheets” of municipal securities transactions.

Rule G-8(a)(ix) requires dealers to maintain records of all confirmations of purchases and sales of municipal securities, including inter-dealer transactions. Rule G-12(f), in certain instances, requires inter- dealer transactions to be compared through an automated comparison system operated by a clearing  agency registered with the Securities and Exchange Commission, rather than by physical confirmations.[1] These automated comparison systems generate “contract  sheets” to each party of a trade, which confirm the existence and the terms of the transaction.

This will confirm my advice to you that such contract sheets are deemed to be confirmations of transactions for purposes of rule G-8(a)(ix). Thus, dealers are required to include contract sheets in their records of confirmations and, under rule G-9(b)(v), are required to maintain these records for no less than three years.[2] MSRB interpretation of June 25, 1987.

[1] Rule G-12(c) governs the content of and procedures for sending physical confirmations.

[2] You also ask about the interpretation of rules 17a-3 and 17a-4 under the Securities Exchange Act. The Board is not authorized to interpret these Securities and Exchange Commission rules. You may wish to contact the SEC for guidance on this matter.

Time of receipt and execution of orders. This is in response to your March 3, 1987 letter regarding the application of rule G-8, on recordkeeping, to [name deleted]'s (the “Bank”) procedure on time stamping of municipal securities order tickets. You note that it is the Bank's policy to indicate on order tickets the date and time of receipt of the order and the date and time of execution of the order. You note, however, that when the order and execution occur simultaneously, it is your procedure to time stamp the order ticket once. You ask for Board approval of this policy.

Rule G-8(a)(vi) provides in pertinent part for a “memorandum of each agency order . . . showing the date and time of receipt of the order . . . and the date of execution and to the extent feasible, the time of execution . . .” Rule G-8(a)(vii) includes a similar requirement for principal transactions with customers. As noted in a Board interpretive notice on recordkeeping, the phrase “to the extent feasible” is intended to require municipal securities professionals to note the time of execution of each transaction except in extraordinary circumstances when it might be impossible to determine the exact time of execution. However, even in those unusual situations, the rule requires that at least the approximate time be noted.[1] This rule parallels SEC rule 17a-3(a)(6) and (7) on recordkeeping.

Thus, rule G-8(a)(vi) and (vii) required agency and principal orders to be time stamped upon receipt and upon execution. The requirement is designed to allow the dealer and the appropriate examining authority to determine whether the dealer has complied with rule G-18, on execution of transactions, and rule G-30, on pricing. Rule G-18 states that when a dealer is “executing a transaction in municipal securities for or on behalf of a customer as an agent, it shall make a reasonable effort to obtain a price for the customer that is fair and reasonable in relation to prevailing market conditions.”  Rule G-30(a) states that a dealer shall not effect a principal transaction with a customer except at a fair and reasonable price, taking into consideration all relevant factors including the fair market value of the securities at the time of the transaction. It is impossible to determine what the prevailing market conditions were at the time of the execution of the order if the date and time of execution are not recorded. In addition, it is important to time stamp the receipt and execution of an order so that a record can be maintained of when the order is executed.

Thus, even when the order and execution occur simultaneously, rule G-8 requires that two time stamps be included on order tickets. MSRB interpretation of April 20, 1987.

Supervisory structure.  This is in response to your letter of December 31, 1986 and our subsequent telephone conversation. You note that there has been a recent reorganization within your bank. As a consequence, you, as the head of the dealer department, now will report to the bank officer who also is in charge of the trust department and the bank's investment portfolio, rather than directly to the bank's president as had been the case. You ask whether this arrangement might constitute a conflict of interest under trust regulations or otherwise under Board rules.

Board rule G-27 places an obligation upon a dealer to supervise its municipal securities activities. It requires a dealer to accomplish this objective by designating individuals with supervisory responsibility for municipal securities activities and requires the dealer to adopt written supervisory procedures to this end. The rule does not specify how a dealer should structure its supervisory procedures, provided that the dealer adopts an organizational structure which meets the intent of the rule. You should review your dealer's written supervisory procedures to ensure that they provide for the appropriate delegation of supervisory responsibilities, given the reorganization within the bank.

You noted that the individual to whom you will be reporting is presently qualified as a municipal securities representative but not as a municipal securities principal. Board rule G-3(a)(i)^[*] defines a municipal securities principal as an associated person of a securities firm or bank dealer who is directly engaged in the management, direction or supervision of municipal securities activities. If, under the new reorganization, this individual will be designated with day-to-day responsibility for the management, direction or supervision of the municipal securities activities of the dealer, then he must be qualified as a municipal securities principal.

Finally, trust regulations are governed by the appropriate banking law and not by Board rules. Consequently, any concerns that you may have with respect to possible conflicts of interest with trust regulations should be directed to the appropriate bank regulatory agency. MSRB interpretation of March 11, 1987.

^[*] [Currently codified at rule G-3(b)(i).]

Section 2 of the Board’s Arbitration Code, rule G-35, requires all dealers to submit to arbitration at the instance of a customer or another dealer. From time to time, a dealer will refuse to submit to arbitration or will delay or even refuse to make payment of an award. Such acts constitute violations of rule G-35. The Board believes that it is a violation of rule G-17, on fair dealing, for a broker, dealer or municipal securities dealer or its associated persons to fail to submit to arbitration as required by Rule G-35, or to fail to comply with the procedures therein, including the production of documents, or to fail to honor an award of arbitrators unless a timely motion to vacate the award has been made according to applicable law.[1]

[1] A party typically has 90 days to seek judicial review of an arbitration award; after that the award cannot be challenged. Challenges to arbitration awards are heard only in limited, egregious circumstances such as fraud or collusion on the part of the arbitrators.

"Municipal Securities Principal" defined. This is in response to your letter of January 28, 1987, and subsequent telephone conversations with the Board's staff, requesting an interpretation of Board rule G-3(a)(i)[*], the definition of the term "Municipal Securities Principal". You ask whether an individual, who has day-to-day responsibility for directing the municipal underwriting activities of a firm, must be qualified as a municipal securities principal. You suggest that such activity seems to meet the definition of a municipal securities principal, namely, an individual who is "directly engaged in the management, direction or supervision of. . .underwriting . . .of municipal securities." You note that this individual has the authority to make underwriting commitments in the name of the firm, but that the firm's president is designated with supervisory responsibility for this individual's underwriting activity. Also, you indicated that this individual does not have supervisory responsibility for any other representative.

Your request for an interpretation was referred to a Committee of the Board which has responsibility for professional qualification matters. The Committee concluded that the individual you describe would not be required to qualify as a municipal securities principal, provided that her responsibilities are limited to directing the day-to-day underwriting activities of the dealer, and provided that these responsibilities are carried out within policy guidelines established by the dealer and under the direct supervision of a municipal securities principal. The Committee is also of the opinion that commitment authority alone is not indicative of principal activity, but rather is inherent in the underwriting activities of a municipal securities representative. MSRB interpretation of February 27, 1987.

[*][Currently codified at rule G-3(b)(i)]

Disqualification of municipal securities principals. In our recent telephone conversation you asked whether the Board has interpreted rule G-3(c)(iv)[*] as to the qualification status of a municipal securities principal in circumstances where the bank dealer, with which the individual is associated, fails to effect a municipal security transaction for a period of two or more years. You proposed that, if there are no municipal securities transactions for the principal to supervise, the individual would not be considered to be "acting as a municipal securities principal" and, consequently, the individual's qualification as a municipal securities principal would lapse after a two-year period of such inactivity.

The Board has considered a similar situation and given an interpretation in the matter. It reaffirmed the interpretation that an individual whose responsibilities no longer include supervision of municipal securities activities probably will not be able to remain adequately informed in the supervisory and compliance matters of concern to municipal securities principals, and that continuing association with a municipal securities dealer, in a capacity other than that of a municipal securities principal, is not sufficient to maintain qualification as a municipal securities principal. However, the Board also concluded that it did not intend this interpretation of rule G-3(c)(iv)[*] to mean that a dealer must necessarily effect transactions in municipal securities in order for its municipal securities principal to maintain such qualification. The Board noted that the definition of a municipal securities principal not only includes supervision of trading or sales, but of other municipal securities activities as well. Consequently, the Board determined that the qualification of a municipal securities principal should not automatically terminate because the individual is associated with a municipal securities broker or dealer which has not effected a municipal securities transaction in two or more years, but that to maintain such qualification the individual must demonstrate clearly that:

--the municipal securities broker or dealer was engaged in municipal securities activity during this period (e.g., determinations of suitability involving municipal securities, recommendations to customers, advertising, financial advisory activity with respect to municipal issuers); and

--the individual in question had been designated with supervisory responsibility for such municipal securities activities during this period.

MSRB interpretation of January 15, 1987

[*] [Currently codified at rule G-3(b)(ii)(C)]

Board rule G-3(a)(iii)[*] 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. As you noted, in December 1984, the Board issued an interpretation of rule G-3 which states 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. Examples of solicitation of new account business stated in the notice included “cold calls” to individuals during which the non-qualified individual introduces the services offered by the dealers, prequalified potential customers, or suggests the purchase of specific securities currently being offered by a municipal securities dealer. An individual who introduces the name of the municipal securities dealer and inquires as to the type of securities in which a portfolio manager invests would be communicating with the public in an attempt to prequalify potential customers and thus must be qualified as a municipal securities representative. MSRB interpretation of January 5, 1987.

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