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.

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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.

Municipal finance professional: supervisor.  This is in response to your inquiry seeking guidance regarding the possible classification as a municipal finance professional under rule G-37 of a Taxable Department Head at your firm. You stated that the Taxable Department Head is the direct supervisor of a Branch Manager and this Branch Manager manages a sales representative who has solicited municipal securities business from an issuer. You state that it is clear that the Branch Manager and the sales representative are both municipal finance professionals. However, you further state that the Taxable Department Head has delegated all Public Finance/Municipal oversight responsibilities to the Public Finance Department Head for the Taxable Department Head's personnel. You ask whether, under these circumstances, the Taxable Department Head would be considered a municipal finance professional under rule G-37 as a result of his or her supervisory position.

The term "municipal finance professional" is defined in rule G-37(g)(iv). Clauses (C) and (D) of the definition set forth the basis for considering an associated person of a dealer to be a municipal finance professional as a result of his or her supervisory position. Clause (C) includes any associated person who is both (i) either a municipal securities principal or municipal securities sales principal and (ii) a supervisor of any associated person either primarily engaged in municipal securities representative activities or who solicits municipal securities business (referred to herein as a "primary municipal securities supervisor"). Clause (D) includes any associated person who is a supervisor of a primary municipal securities supervisor up through and including (in the case of a non-bank dealer) the Chief Executive Officer or similarly situation official (referred to herein as a "secondary municipal securities supervisor").

Unlike in the case of a primary municipal securities supervisor, a secondary municipal securities supervisor is not required to be a municipal securities principal or municipal securities sales principal. The status of a secondary municipal securities supervisor as a municipal finance professional is not conditioned on the areas in which such supervisor has responsibility over a primary municipal securities supervisor, so long as such secondary municipal securities supervisor retains some degree of supervisory responsibility (whether or not relating to municipal securities activities) over the primary municipal securities supervisor.  MSRB interpretation of November 23, 1999.

Financial advisory relationship: private placements. This is in response to your letter in which you seek clarification on certain matters related to rules G-23, on activities of financial advisors, and G-37, on political contributions and prohibitions on municipal securities business.

You ask when it is "necessary in the process of commencing preliminary work with a potential financial advisory client to enter into a formal written financial advisory contract." Rule G-23(c) states that "[e]ach financial advisory relationship shall be evidenced by a writing entered into prior to, upon or promptly after the inception of the financial advisory relationship (or promptly after the creation or selection of the issuer if the issuer does not exist or has not been determined at the time the relationship commences)." Rule G-23(b) states that "...a financial advisory relationship shall be deemed to exist when a broker, dealer or municipal securities dealer renders or enters into an agreement to render financial advisory or consultant services to or on behalf of an issuer with respect to a new issue or issues of municipal securities, including advice with respect to the structure, timing, terms and other similar matters concerning such issue or issues, for a fee or other compensation or in expectation of such compensation for the rendering of such services."

You ask whether you are to advise the Board by means of reporting on Form G-37/G-38 or by any other means when you commence work on subsequent financing transactions with an issuer with which your firm has an ongoing financial advisory contract. The Instructions for Completing and Filing Form G-37/G-38 provide a guideline to use in determining when to report financial advisory services on Form G-37/G-38.[1] Pursuant to these Instructions, dealers should indicate financial advisory services when an agreement is reached to provide the services. In addition, the Instructions note that dealers also should indicate financial advisory services during a reporting period when the settlement date for a new issue on which the dealer acted as financial advisor occurred during such period. There are no other requirements for reporting financial advisory services to the Board.

Finally, you ask whether rules G-23 or G-37 contain requirements concerning private placement activities. The term "municipal securities business" is defined in rule G-37 to include "the offer or sale of a primary offering of municipal securities on behalf of any issuer ( e.g. , private placement)..." The Instructions for Completing and Filing Form G-37/G-38 provide that private placements should be indicated at least by the settlement date if within the reporting period.

With respect to rule G-23, section (d) of the rule states that no dealer that has a financial advisory relationship with respect to a new issue of municipal securities shall acquire as principal either alone or as a participant in a syndicate or other similar account formed for the purpose of purchasing, directly or indirectly, from the issuer all or any portion of such issue, or act as agent for the issuer in arranging the placement of such issue, unless various actions are taken.[2] In addition, rule G-23(g) states that each dealer subject to the provisions of sections (d), (e) or (f) of rule G-23 shall maintain a copy of the written disclosures, acknowledgments and consents required by these sections in a separate file and in accordance with the provisions of rule G-9, on preservation of records. Finally, rule G-23(h) states that, if a dealer acquires new issue municipal securities or participates in a syndicate or other account that acquires new issue municipal securities in accordance with section (d) of rule G-23, such dealer shall disclose the existence of the financial advisory relationship in writing to each customer who purchases such securities from such dealer, at or before the completion of the transaction with the customer. MSRB interpretation of October 5, 1999.

[1] I have enclosed a copy of the Instructions for Completing and Filing Form G-37/G-38 as contained in the MSRB Rule Book. The instructions are also contained on the Board's web site (www.msrb.org) under the link for rule G-37.

[2] These actions are: (i) if such issue is to be sold by the issuer on a negotiated basis, (A) the financial advisory relationship with respect to such issue has been terminated in writing and at or after such termination the issuer has expressly consented in writing to such acquisition or participation, as principal or agent, in the purchase of the securities on a negotiated basis; (B) the dealer has expressly disclosed in writing to the issuer at or before such termination that there may be a conflict of interest in changing from the capacity of financial advisor to purchaser of or placement agent for the securities with respect to which the financial advisory relationship exists and the issuer has expressly acknowledged in writing to the dealer receipt of such disclosure; and (C) the dealer has expressly disclosed in writing to the issuer at or before such termination the source and anticipated amount of all remuneration to the dealer with respect to such issue in addition to the compensation referred to in section (c) of rule G-23, and the issuer has expressly acknowledged in writing to the dealer receipt of such disclosure; or (ii) 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.