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Interpretive Guidance - Interpretive Notices
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Interpretive Notice Concerning the Application of MSRB Rule G-17 to Underwriters of Municipal Securities
Rule Number:

Rule G-17

Under Rule G-17 of the Municipal Securities Rulemaking Board (MSRB), brokers, dealers, and municipal securities dealers (“dealers”) must, in the conduct of their municipal securities activities, deal fairly with all persons and must not engage in any deceptive, dishonest, or unfair practice. This rule is most often cited in connection with duties owed by dealers to investors; however, it also applies to their interactions with other market participants, including municipal entities[1] such as states and their political subdivisions that are issuers of municipal securities (“issuers”).

The MSRB has previously observed that Rule G-17 requires dealers to deal fairly with issuers.[2] With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act,[3] the MSRB was expressly directed by Congress to protect municipal entities. Accordingly, in 2012, the MSRB provided additional interpretive guidance that addressed how Rule G-17 applies to dealers acting in the capacity of underwriters in the municipal securities transactions described therein (the “2012 Interpretive Notice”).[4]

This notice supersedes the MSRB’s 2012 Interpretive Notice, dated August 2, 2012, concerning the application of Rule G-17 to underwriters of municipal securities, as well as the related implementation guidance, dated July 18, 2012, and frequently-asked questions, dated March 25, 2013 (the “prior guidance”).[5] The prior guidance will remain applicable to underwriting relationships commencing prior to March 31, 2021. Underwriters will be subject to the amended guidance provided by this notice for all of their underwriting relationships beginning on or after that date. For purposes of this notice, an underwriting relationship is considered to have begun at the time the delivery of the first disclosure is triggered as described under “Timing and Manner of Disclosures” below (i.e., the earliest stages of an underwriter’s relationship with an issuer with respect to an issue, such as in a response to a request for proposal or in promotional materials provided to an issuer).

Applicability of the Notice

Except where a competitive underwriting is specifically mentioned, this notice applies to negotiated underwritings only.[6] This notice does not apply to a dealer acting as a primary distributor in a continuous offering of municipal fund securities, such as interests in 529 savings plans and Achieving a Better Life Experience (ABLE) programs. It does not apply to selling group members. This notice does not address a dealer’s duties when the dealer is serving as an advisor to a municipal entity. This notice applies to a primary offering of a new issue of municipal securities that is placed with investors by a dealer serving as placement agent, although certain disclosures may be omitted as described below.

The fair practice duties outlined in this notice are those duties that a dealer owes to a municipal entity when the dealer underwrites a new issue of municipal securities. This notice does not set out the underwriter’s fair-practice duties to other parties to a municipal securities financing (e.g., conduit borrowers). The MSRB notes, however, that Rule G-17 does require that an underwriter deal fairly with all persons in the course of the dealer’s municipal securities activities. What actions are considered fair will, of necessity, be dependent on the nature of the relationship between a dealer and such other parties, the particular actions undertaken, and all other relevant facts and circumstances. Although this notice does not address what an underwriter’s fair-dealing duties may be with respect to other parties, it may serve as one of many bases for an underwriter to consider how to establish appropriate policies and procedures for ensuring that it meets such fair-practice obligations, in light of its relationship with such other participants and their particular roles.

The examples discussed in this notice are illustrative only and are not meant to encompass all obligations of dealers to municipal entities under Rule G-17. Furthermore, when municipal entities are customers[7] of dealers, they are subject to the same protections under MSRB rules, including Rule G‑17, that apply to other customers.[8] The MSRB notes that an underwriter has a duty of fair dealing to investors in addition to its duty of fair dealing to issuers. An underwriter also has a duty to comply with other MSRB rules as well as other federal and state securities laws.

Basic Fair Dealing Principle

As noted above, Rule G-17 precludes a dealer, in the conduct of its municipal securities activities, from engaging in any deceptive, dishonest, or unfair practice with any person, including an issuer. The rule contains an anti-fraud prohibition. Thus, an underwriter must not misrepresent or omit the facts, risks, potential benefits, or other material information about municipal securities activities undertaken with a municipal issuer. However, Rule G-17 does not merely prohibit deceptive conduct on the part of the dealer; it also establishes a general duty of a dealer to deal fairly with all persons (including, but not limited to, issuers), even in the absence of fraud.

Role of Underwriters and Conflicts of Interest

In negotiated underwritings, underwriters’ Rule G-17 duty to deal fairly with an issuer requires certain disclosures to the issuer in connection with an issue or proposed issue of municipal securities, as provided below.[9]

  • The disclosures discussed under “Disclosures Concerning the Underwriters’ Role” and “Disclosures Concerning Underwriters’ Compensation” (the “standard disclosures”) must be provided by the sole underwriter or the syndicate manager[10] to the issuer as described below.
  • The disclosures discussed under “Required Disclosures to Issuers” (the “transaction-specific disclosures”) must be provided to the issuer by the underwriter who has recommended a financing structure or product to the issuer as described below.[11]
  • The disclosures discussed under “Other Conflicts Disclosures” (the “dealer-specific disclosures”) must be provided by the sole underwriter or each underwriter in a syndicate (as applicable) as described below.[12]

Disclosures Concerning the Underwriter’s Role.  The sole underwriter or the syndicate manager[13] must disclose to the issuer that:

   (i)    Municipal Securities Rulemaking Board Rule G-17 requires an underwriter to deal fairly at all times with both issuers and investors;
 
  (ii)   the underwriter’s primary role is to purchase securities with a view to distribution in an arm’s-length commercial transaction with the issuer and it has financial and other interests that differ from those of the issuer;[14]
 
  (iii)   unlike a municipal advisor, the underwriter does not have a fiduciary duty to the issuer under the federal securities laws and is, therefore, not required by federal law to act in the best interests of the issuer without regard to its own financial or other interests;[15]
 
  (iv)   the issuer may choose to engage the services of a municipal advisor with a fiduciary obligation to represent the issuer’s interests in the transaction;
 
  (v)   the underwriter has a duty to purchase securities from the issuer at a fair and reasonable price, but must balance that duty with its duty to sell municipal securities to investors at prices that are fair and reasonable; and
 
  (vi)   the underwriter will review the official statement for the issuer’s securities in accordance with, and as part of, its responsibilities to investors under the federal securities laws, as applied to the facts and circumstances of the transaction.[16]

Underwriters also must not recommend that issuers not retain a municipal advisor. Accordingly, underwriters may not discourage issuers from using a municipal advisor or otherwise imply that the hiring of a municipal advisor would be redundant because the sole underwriter or underwriting syndicate can provide the services that a municipal advisor would.

Disclosure Concerning the Underwriters’ Compensation. The sole underwriter or syndicate manager must disclose to issuers whether underwriting compensation will be contingent on the closing of a transaction. Sole underwriters or syndicate managers must also disclose that compensation that is contingent on the closing of a transaction or the size of a transaction presents a conflict of interest, because it may cause underwriters to recommend a transaction that is unnecessary or to recommend that the size of a transaction be larger than is necessary.

Other Conflicts Disclosures. The sole underwriter or each underwriter in a syndicate must also, when and if applicable, disclose other dealer-specific actual material conflicts of interest and potential material conflicts of interest,[17] including, but not limited to, the following:

   (i)    any payments described below under “Conflicts of Interest/Payments to or from Third Parties”;[18]
 
  (ii)   any arrangements described below under “Conflicts of Interest/Profit-Sharing with Investors”;
 
  (iii)   the credit default swap disclosures described below under “Conflicts of Interest/Credit Default Swaps”; and
 
  (iv)   any incentives for the underwriter to recommend a complex municipal securities financing and other associated conflicts of interest (as described below under “Required Disclosures to Issuers”).[19]

These categories of conflicts of interest are not mutually exclusive and, in some cases, a specific conflict may reasonably be viewed as falling into two or even more categories. An underwriter making disclosures of dealer-specific conflicts of interest to an issuer should concentrate on making them in a complete and understandable manner and need not necessarily organize them according to the categories listed above, particularly if adhering to a strict categorization process might interfere with the clarity and conciseness of disclosures.

Where there is a syndicate, each underwriter in the syndicate has a duty to provide its dealer-specific disclosures to the issuer. In general, dealer-specific disclosures for one dealer cannot be satisfied by disclosures made by another dealer (e.g., the syndicate manager) because such disclosures are, by their nature, not uniform, and must be prepared by each dealer. However, a syndicate manager may deliver each of the dealer-specific disclosures to the issuer as part of a single package of disclosures, as long as it is clear to which dealer each disclosure is attributed. An underwriter in the syndicate is not required to notify an issuer if it has determined that it does not have any dealer-specific disclosures to make. However, the obligation to provide dealer-specific disclosures includes material conflicts of interest arising after the time of engagement with the issuer, as noted below.

Timing and Manner of Disclosures.  The standard disclosures, transaction-specific disclosures, and dealer-specific disclosures must be made in writing to an official of the issuer identified by the issuer as a primary contact for that issuer for the receipt of the foregoing disclosures. In the absence of such identification, an underwriter may make such disclosures in writing to an official of the issuer that the underwriter reasonably believes has the authority to bind the issuer by contract with the underwriter and that, to the knowledge of the underwriter, is not a party to a disclosed conflict.[20] If provided within the same document as the dealer-specific disclosures and/or transaction-specific disclosures, the standard disclosures must be identified clearly as such and provided apart from the other disclosures (e.g., in an appendix).

Disclosures must be made in a clear and concise manner designed to make clear to such official the subject matter of such disclosures and their implications for the issuer in accordance with the following timelines.

  • A sole underwriter or syndicate manager must make the standard disclosure concerning the arm’s-length nature of the underwriter-issuer relationship at the earliest stages of the underwriter’s relationship with the issuer with respect to an issue (e.g., in a response to a request for proposals or in promotional materials provided to an issuer).[21]
  • A sole underwriter or syndicate manager must make the other standard disclosures regarding the underwriter’s role and compensation at or before the time the underwriter is engaged to perform underwriting services (e.g., in an engagement letter), not solely in a bond purchase agreement.
  • An underwriter must make the dealer-specific disclosures at or before the time the underwriter has been engaged to perform the underwriting services.[22] Thereafter, an underwriter must make any applicable dealer-specific disclosures discovered or arising after being engaged as an underwriter as soon as practicable after being discovered and with sufficient time for the issuer to fully evaluate any such conflict and its implications.[23]
  • An underwriter who recommends a financing structure or product to an issuer must make the transaction-specific disclosures in sufficient time before the execution of a commitment by an issuer (which may include a bond purchase agreement) relating to the financing, and with sufficient time to allow the issuer to fully evaluate the features of the financing.

Unless directed otherwise by an issuer, an underwriter may update selected portions of disclosures previously provided so long as such updates clearly identify the additions or deletions and are capable of being read independently of the prior disclosures.[24]

Acknowledgement of Disclosures. When delivering a disclosure, the underwriter must attempt to receive written acknowledgement[25] from an official of the issuer identified by the issuer as a primary contact for the issuer’s receipt of the foregoing disclosures.[26] In the absence of such identification, an underwriter may seek acknowledgement from an official of the issuer whom the underwriter reasonably believes has the authority to bind the issuer by contract with the underwriter and that, to the knowledge of the underwriter, is not party to a disclosed conflict. This notice does not specify the particular form of acknowledgement, but may include, for example, an e-mail read receipt.[27] An underwriter may proceed with a receipt of a written acknowledgement that includes an issuer’s reservation of rights or other self-protective language. If the official of the issuer agrees to proceed with the underwriting engagement after receipt of the disclosures but will not provide written acknowledgement of receipt, the underwriter responsible for making the requisite disclosure may proceed with the engagement after documenting with specificity why it was unable to obtain such written acknowledgement. Additionally, an underwriter must be able to produce evidence (including, for example, by automatic e-mail delivery receipt) that the disclosures were delivered with sufficient time for evaluation by the issuer before proceeding with the transaction. An issuer’s written acknowledgement of the receipt of disclosure is not dispositive of whether such disclosures were made with an appropriate amount of time. The analysis of whether disclosures were provided with sufficient time for an issuer’s review is based on the totality of the facts and circumstances.

Representations to Issuers

All representations made by underwriters to issuers in connection with municipal securities underwritings, whether written or oral, must be truthful and accurate and must not misrepresent or omit material facts. Underwriters must have a reasonable basis for the representations and other material information contained in documents they prepare and must refrain from including representations or other information they know or should know is inaccurate or misleading. For example, in connection with a certificate signed by the underwriter that will be relied upon by the issuer or other relevant parties to an underwriting (e.g., an issue price certificate), the dealer must have a reasonable basis for the representations and other material information contained therein.[28] In addition, an underwriter’s response to an issuer’s request for proposals or qualifications must fairly and accurately describe the underwriter’s capacity, resources, and knowledge to perform the proposed underwriting as of the time the proposal is submitted and must not contain any representations or other material information about such capacity, resources, or knowledge that the underwriter knows or should know to be inaccurate or misleading.[29] Matters not within the personal knowledge of those preparing the response (e.g., pending litigation) must be confirmed by those with knowledge of the subject matter. An underwriter must not represent that it has the requisite knowledge or expertise with respect to a particular financing if the personnel that it intends to work on the financing do not have the requisite knowledge or expertise.

Required Disclosures to Issuers

Many municipal securities are issued using financing structures that are routine and well understood by the typical municipal market professional, including most issuer personnel that have the lead responsibilities in connection with the issuance of municipal securities. For example, absent unusual circumstances or features, the typical fixed rate offering may be presumed to be well understood. Nevertheless, in the case of issuer personnel that the underwriter reasonably believes lack the requisite knowledge or experience to fully understand or assess the implications of a financing structures or products recommended by an underwriter, the underwriter making such recommendation must provide disclosures on the material aspects of such financing structures or product that it recommends (i.e., the “transaction-specific disclosures”).[30]

In some cases, issuer personnel responsible for the issuance of municipal securities would not be well positioned to fully understand or assess the implications of a recommended financing structure in its totality, because it is structured in a unique, atypical, or otherwise complex manner or incorporates unique, atypical, or otherwise complex features or products (a “complex municipal securities financing”).[31] Examples of complex municipal securities financings include, but are not limited to, variable rate demand obligations (“VRDOs”), financings involving derivatives (such as swaps), and financings in which interest rates are benchmarked to an index (such as LIBOR, SIFMA, or SOFR).[32] When a recommendation regarding a complex municipal securities financing structure has been made by an underwriter in a negotiated offering,[33] the underwriter making the recommendation has an obligation under Rule G-17 to communicate more particularized transaction-specific disclosures than those that may be required in the case of the recommendation of routine financing structures or products.[34] The underwriter making the recommendation must also disclose the material financial characteristics of the complex municipal securities financing, as well as the material financial risks of the financing that are known to the underwriter and reasonably foreseeable at the time of the disclosure.[35] It must also disclose any incentives for the recommendation of the complex municipal securities financing and other associated material conflicts of interest.[36] Such disclosures must be made in a fair and balanced manner based on principles of fair dealing and good faith.

The level of transaction-specific disclosure required may vary according to the issuer’s knowledge or experience with the proposed financing structure or similar structures, capability of evaluating the risks of the recommended financing structure or product, and financial ability to bear the risks of the recommended financing structure or product, in each case based on the reasonable belief of the underwriter.[37] Consequently, the level of transaction-specific disclosure to be provided to a particular issuer also can vary over time. In all events, the underwriter must disclose any incentives for the recommendation of the complex municipal securities financing and other associated conflicts of interest.

As previously mentioned, the transaction-specific disclosures must be made in writing to an official of the issuer identified by the issuer as a primary contact for the issuer for the receipt of such disclosures, or, in the absence of such identification, an underwriter may make such disclosures in writing to an issuer official whom the underwriter reasonably believes has the authority to bind the issuer by contract with the underwriter(s), and that, to the knowledge of the underwriter delivering the disclosure, is not a party to a disclosed conflict: (i) in sufficient time before the execution of a contract with the underwriter to allow the official to evaluate the recommendation (including consultation with any of its counsel or advisors) and (ii) in a manner designed to make clear to such official the subject matter of such disclosures and their implications for the issuer.

The disclosures concerning a complex municipal securities financing must address the specific elements of, and/or relevant products incorporated, into the recommended financing structure, rather than being general in nature.[38] An underwriter making a Complex Municipal Securities Financing Recommendation to an issuer cannot satisfy its fair dealing obligations by providing an issuer a single document setting out general descriptions of the various financing structures and/or products that may be recommended from time to time to various issuer clients that would effectively require issuer personnel to discover which disclosures apply to a particular recommendation and to the particular circumstances of that issuer. Underwriters can create, in anticipation of making such a recommendation, individualized descriptions, with appropriate levels of detail, of the material financial characteristics and risks for each of the various complex municipal securities financing structures and/or products (including any typical variations) they may recommend from time to time to various issuer clients, with such standardized descriptions serving as the base for more particularized disclosures for the specific complex financing the underwriter recommends to particular issuers.[39] In making a recommendation, an underwriter could incorporate, to the extent applicable, any refinements to the base description needed to fully describe the material financial features and risks unique to that financing.[40]

If the underwriter who has made a recommendation does not reasonably believe that the official to whom the disclosures are addressed is capable of independently evaluating the disclosures, the underwriter must make additional efforts reasonably designed to inform the official or its employees or agent. The underwriter also must make an independent assessment that such disclosures are appropriately tailored to the issuer’s level of sophistication.

Underwriter Duties in Connection with Issuer Disclosure Documents

Underwriters often play an important role in assisting issuers in the preparation of disclosure documents, such as preliminary official statements and official statements.[41] These documents are critical to the municipal securities transaction, because investors rely on the representations contained in such documents in making their investment decisions. Moreover, investment professionals, such as municipal securities analysts and ratings services, rely on the representations in forming an opinion regarding the credit. A dealer’s duty to have a reasonable basis for the representations it makes, and other material information it provides, to an issuer and to ensure that such representations and information are accurate and not misleading, as described above, extends to representations and information provided by the underwriter in connection with the preparation by the issuer of its disclosure documents (e.g., cash flows).

Underwriter Compensation and New Issue Pricing

Excessive Compensation. An underwriter’s compensation for a new issue (including both direct compensation paid by the issuer and other separate payments, values, or credits received by the underwriter from the issuer or any other party in connection with the underwriting), in certain cases and depending upon the specific facts and circumstances of the offering, may be so disproportionate to the nature of the underwriting and related services performed as to constitute an unfair practice with regard to the issuer that it is a violation of Rule G-17. Among the factors relevant to whether an underwriter’s compensation is disproportionate to the nature of the underwriting and related services performed, are the credit quality of the issue, the size of the issue, market conditions, the length of time spent structuring the issue, and whether the underwriter is paying the fee of the underwriter’s counsel or any other relevant costs related to the financing.

Fair Pricing. The duty of fair dealing under Rule G-17 includes an implied representation that the price an underwriter pays to an issuer is fair and reasonable, taking into consideration all relevant factors, including the best judgment of the underwriter as to the fair market value of the issue at the time it is priced.[42] In general, a dealer purchasing bonds in a competitive underwriting for which the issuer may reject any and all bids will be deemed to have satisfied its duty of fairness to the issuer with respect to the purchase price of the issue as long as the dealer’s bid is a bona fide bid (as defined in MSRB Rule G‑13)[43] that is based on the dealer’s best judgment of the fair market value of the securities that are the subject of the bid. In a negotiated underwriting, the underwriter has a duty under Rule G-17 to negotiate in good faith with the issuer. This duty includes the obligation of the dealer to ensure the accuracy of representations made during the course of such negotiations, including representations regarding the price negotiated and the nature of investor demand for the securities (e.g., the status of the order period and the order book). If, for example, the dealer represents to the issuer that it is providing the “best” market price available on the new issue, or that it will exert its best efforts to obtain the “most favorable” pricing, the dealer may violate Rule G-17 if its actions are inconsistent with such representations.[44]

Conflicts of Interest

Payments to or from Third Parties. In certain cases, compensation received by an underwriter from third parties, such as the providers of derivatives and investments (including affiliates of an underwriter), may color the underwriter’s judgment and cause it to recommend products, structures, and pricing levels to an issuer when it would not have done so absent such payments. The MSRB views the failure of an underwriter to disclose to the issuer the existence of payments, values, or credits received by an underwriter in connection with its underwriting of the new issue from parties other than the issuer, and payments made by the underwriter in connection with such new issue to parties other than the issuer (in either case including payments, values, or credits that relate directly or indirectly to collateral transactions integrally related to the issue being underwritten), to be a violation of an underwriter’s obligation to the issuer under Rule G-17.[45] For example, it would be a violation of Rule G-17 for an underwriter to compensate an undisclosed third party in order to secure municipal securities business. Similarly, it would be a violation of Rule G-17 for an underwriter to receive undisclosed compensation from a third party in exchange for recommending that third party’s services or product to an issuer, including business related to municipal securities derivative transactions. This notice does not require that the amount of such third-party payments be disclosed. The underwriter must also disclose to the issuer whether it has entered into any third-party arrangements for the marketing of the issuer’s securities.

Profit-Sharing with Investors. Arrangements between the underwriter and an investor purchasing new issue securities from the underwriter (including purchases that are contingent upon the delivery by the issuer to the underwriter of the securities) according to which profits realized from the resale by such investor of the securities are directly or indirectly split or otherwise shared with the underwriter also would, depending on the facts and circumstances (including in particular if such resale occurs reasonably close in time to the original sale by the underwriter to the investor), constitute a violation of the underwriter’s fair dealing obligation under Rule G-17.[46] Such arrangements could also constitute a violation of Rule G‑25(c), which precludes a dealer from sharing, directly or indirectly, in the profits or losses of a transaction in municipal securities with or for a customer. An underwriter should carefully consider whether any such arrangement, regardless of whether it constitutes a violation of Rule G-25(c), may evidence a potential failure of the underwriter’s duty with regard to new issue pricing described above.

Credit Default Swaps. The issuance or purchase by a dealer of credit default swaps for which the reference is the issuer for which the dealer is serving as underwriter, or an obligation of that issuer, may pose a conflict of interest, including a dealer-specific conflict of interest, because trading in such municipal credit default swaps has the potential to affect the pricing of the underlying reference obligations, as well as the pricing of other obligations brought to market by that issuer. Rule G-17 requires, therefore, that a dealer disclose the fact that it engages in such activities to the issuers for which it serves as underwriter. Activities with regard to credit default swaps based on baskets or indexes of municipal issuers that include the issuer or its obligation(s) need not be disclosed, unless the issuer or its obligation(s) represents more than 2% of the total notional amount of the credit default swap or the underwriter otherwise caused the issuer or its obligation(s) to be included in the basket or index.

Retail Order Periods

Rule G-17 requires an underwriter that has agreed to underwrite a transaction with a retail order period to, in fact, honor such agreement.[47]A dealer that wishes to allocate securities in a manner that is inconsistent with an issuer’s requirements must not do so without the issuer’s consent. In addition, Rule G-17 requires an underwriter that has agreed to underwrite a transaction with a retail order period to take reasonable measures to ensure that retail clients are bona fide. An underwriter that knowingly accepts an order that has been framed as a retail order when it is not (e.g., a number of small orders placed by an institutional investor that would otherwise not qualify as a retail customer) would violate Rule G-17 if its actions are inconsistent with the issuer’s expectations regarding retail orders. In addition, a dealer that places an order that is framed as a qualifying retail order but in fact represents an order that does not meet the qualification requirements to be treated as a retail order (e.g., an order by a retail dealer without “going away” orders[48] from retail customers, when such orders are not within the issuer’s definition of “retail”) violates its Rule G-17 duty of fair dealing. The MSRB will continue to review activities relating to retail order periods to ensure that they are conducted in a fair and orderly manner consistent with the intent of the issuer and the MSRB’s investor protection mandate.

Dealer Payments to Issuer Personnel

Dealers are reminded of the application of MSRB Rule G-20, on gifts, gratuities, and non-cash compensation, and Rule G-17, in connection with certain payments made to, and expenses reimbursed for, issuer personnel during the municipal bond issuance process.[49]  These rules are designed to avoid conflicts of interest and to promote fair practices in the municipal securities market.

Dealers should consider carefully whether payments they make in regard to expenses of issuer personnel in the course of the bond issuance process, including in particular, but not limited to, payments for which dealers seek reimbursement from bond proceeds or issuers, comport with the requirements of Rule G‑20. For example, a dealer acting as a financial advisor or underwriter may violate Rule G-20 by paying for excessive or lavish travel, meal, lodging and entertainment expenses in connection with an offering (such as may be incurred for rating agency trips, bond closing dinners, and other functions) that inure to the personal benefit of issuer personnel and that exceed the limits or otherwise violate the requirements of the rule.[50] 

 

[1] For purposes of this notice, the term “municipal entity” is used as defined by Section 15B(e)(8) of the Securities Exchange Act of 1934 (the “Exchange Act”), 17 CFR 240.15Ba1-1(g), and other rules and regulations thereunder.

[2] See Reminder Notice on Fair Practice Duties to Issuers of Municipal Securities, MSRB Notice 2009-54 (September 29, 2009); Rule G-17 Interpretive Letter – Purchase of new issue from issuer, MSRB interpretation of December 1, 1997, reprinted in MSRB Rule Book (“1997 Interpretation”).

[3] Pub. L. No. 111-203 § 975, 124 Stat. 1376 (2010).

[4] See Interpretive Notice Concerning the Application of MSRB Rule G-17 to Underwriters of Municipal Securities (Aug. 2, 2012) (superseded upon the effective date of this notice as described below).

[5] See MSRB Notice 2012-38 (July 18, 2012); MSRB Notice 2013-08 (Mar. 25, 2013).

[6] The MSRB has always viewed competitive offerings narrowly to mean new issues sold by the issuer to the underwriter on the basis of the lowest price bid by potential underwriters – that is, the fact that an issuer publishes a request for proposals and potential underwriters compete to be selected based on their professional qualifications, experience, financing ideas, and other subjective factors would not be viewed as representing a competitive offering for purposes of this notice. In light of this meaning of the term “competitive underwriting,” it should be clear that, although most of the examples relating to misrepresentations and fairness of financial aspects of an offering consist of situations that would only arise in a negotiated offering, Rule G-17 should not be viewed as allowing an underwriter in a competitive underwriting to make misrepresentations to the issuer or to act unfairly in regard to the financial aspects of the new issue.

[7] MSRB Rule D-9 defines the term “customer” as follows: “Except as otherwise specifically provided by rule of the Board, the term ‘Customer’ shall mean any person other than a broker, dealer, or municipal securities dealer acting in its capacity as such or an issuer in transactions involving the sale by the issuer of a new issue of its securities.”

[8] See MSRB Reminds Firms of Their Sales Practice and Due Diligence Obligations When Selling Municipal Securities in the Secondary Market, MSRB Notice 2010-37 (September 20, 2010).

[9] For purposes of this notice, underwriters are only required to provide written disclosure of their applicable conflicts and are not required to make any written disclosures on the part of issuer personnel or any other parties to the transaction as part of the standard disclosures, dealer-specific disclosures, or the transaction-specific disclosures.

[10] For purposes of this notice, the term “syndicate manager” refers to the lead manager, senior manager, or bookrunning manager of the syndicate. In circumstances where an underwriting syndicate is formed, only that single syndicate manager is obligated to make the standard disclosures under this notice. In the event that there are joint-bookrunning senior managers, only one of the joint-bookrunning senior managers would be obligated under this notice to make the standard disclosures. Unless otherwise agreed to, such as pursuant to an agreement among underwriters, the joint-bookrunning senior manager responsible for maintaining the order book of the syndicate would be responsible for providing the standard disclosures. Notwithstanding the fair dealing obligation of a syndicate manager to deliver the standard disclosures under this notice, nothing herein would prohibit an underwriter from making a disclosure in order to, for example, comply with another regulatory or statutory obligation.

[11] Where an underwriting syndicate is formed, the syndicate manager has the sole responsibility hereunder for providing the standard disclosures. Consistent with this obligation placed on the syndicate manager, only the syndicate manager must maintain and preserve records of the standard disclosures in accordance with MSRB rules. Further, the MSRB acknowledges that an underwriter may not know if a syndicate will form at the time that certain disclosures are sent. In instances in which an underwriter has provided a standard disclosure prior to or concurrent with the formation of a syndicate, it shall suffice that the then-underwriter (later syndicate manager) has delivered a standard disclosure, and no affirmative statement is necessary that a disclosure is being made on behalf of any existing or future syndicate members for the syndicate manager to have met its fair dealing obligations in this regard. Notwithstanding the obligation of a syndicate manager to deliver the standard disclosures, nothing herein would prohibit, or should be construed as prohibiting, another underwriter from delivering a standard disclosure in order to, for example, comply with another regulatory or statutory obligation.

[12] Each underwriter, whether a sole underwriter, syndicate manager, or other member of the underwriting syndicate, has a fair dealing obligation under this notice to deliver transaction-specific disclosures where such underwriter has made a recommendation to an issuer regarding a financing structure or product. The fair dealing obligation to deliver such a transaction-specific disclosure, includes, but is not limited to, determining the level of disclosure required based on the type of financing structure or product recommended and a reasonable belief of the issuer’s knowledge and experience regarding that particular type of financing structure or product. In such cases, as further discussed below, a sole underwriter, syndicate manager, or other member of the underwriting syndicate who has not made such a recommendation would not need to deliver transaction-specific disclosures in order to meet its fair dealing obligation under this notice.

[13] See also note 30 infra.

[14] As a threshold matter, the disclosures delivered by an underwriter to an issuer must not be inaccurate or misleading, and nothing in this notice should be construed as requiring an underwriter to make a disclosure to an issuer that is false. For example, in a private placement where a dealer acting as an agent to place securities on behalf of an issuer does not take a principal position (including not taking a “riskless principal” position) in the securities being placed, the standard disclosure relating to an “arm’s length” relationship may be inapplicable and in such case may be omitted due to the agent-principal relationship between the dealer and issuer that commonly gives rise to other duties as a matter of common law or another statutory or regulatory regime – whether termed as a fiduciary or other obligation of trust. See Exchange Act Release No. 66927 (May 4, 2012), 77 FR 27509 (May 10, 2012) (SR-MSRB-2011-09). In certain other contexts, depending on the specific facts and circumstances, a dealer acting as an underwriter may take on, either through an agency arrangement or other purposeful understanding, a fiduciary relationship with the issuer. In such case, it would be appropriate for an underwriter to omit those disclosures deemed inapplicable as a result of such relationship.

A dealer acting as a placement agent in the primary offering of a new issuance of municipal securities should also consider how the scope of its activities may interact with the registration and record-keeping requirements for municipal advisors adopted by the Securities and Exchange Commission (the “Commission”) under Section 15B of the Exchange Act (15 U.S.C. 78o-4), including the application of the exclusion from the definition of “municipal advisor” applicable to a dealer acting as an underwriter pursuant to Exchange Act Rule 15Ba1-1(d)(2)(i). See Registration of Municipal Advisors, Exchange Act Release No. 70462 (September 20, 2013), 78 FR 67467 (hereinafter, the “MA Rule Adopting Release”), at 67515 – 67516 (November 12, 2013) (available at http://www.sec.gov/rules/final/2013/34-70462.pdf) (stating: “The Commission does not believe that the underwriter exclusion should be limited to a particular type of underwriting or a particular type of offering. Therefore, if a registered broker-dealer, acting as a placement agent, performs municipal advisory activities that otherwise would be considered within the scope of the underwriting of a particular issuance of municipal securities as discussed [therein], the broker-dealer would not have to register as a municipal advisor.”); see also the MA Rule Adopting Release, 78 FR at 67513 – 67514 (discussing activities within and outside the scope of serving as an underwriter of a particular issuance of municipal securities for purposes of the underwriter exclusion).

[15] Id.

[16] In many private placements, as well as in certain other types of new issue offerings, no official statement may be produced, so that, to the extent that such an offering occurs without the production of an official statement, a dealer would not be required to disclose its role with regard to the review of an official statement.

[17] For purposes hereof, a potential material conflict of interest must be disclosed if, but only if, it is reasonably likely to mature into an actual material conflict of interest during the course of the transaction between the issuer and the underwriter.

[18] The third-party payments to which the disclosure standard would apply are those that give rise to actual material conflicts of interest or potential material conflicts of interest only.

[19] The specific standard with respect to complex financings does not obviate a dealer’s fair dealing obligation to disclose the existence of payments, values, or credits received by the underwriter or of other material conflicts of interest in connection with any negotiated underwriting, whether it be complex or routine.

[20] Absent red flags, an underwriter may reasonably rely on a written statement from an issuer official that he or she is not a party to a disclosed conflict. The reasonableness of an underwriter’s reliance on such a written statement will depend on all the relevant facts and circumstances, including the facts revealed in connection with the underwriter’s due diligence in regards to the transaction generally or in determining whether the underwriter itself has any actual material conflicts of interest or potential material conflicts of interest that must be disclosed.

[21] See also note 30 infra.

[22] In offerings where a syndicate is formed, the disclosure obligation for an underwriter to make its dealer-specific disclosures is triggered – if any such actual material conflicts of interest or potential material conflicts of interest must be so disclosed – when such underwriter becomes engaged as a member of the underwriting syndicate (except with regard to conflicts discovered or arising after such co-managing underwriter has been engaged). Consistent with the obligation of sole underwriters and syndicate managers, each underwriter in the syndicate must make any applicable dealer-specific disclosures discovered or arising after being engaged as an underwriter in the syndicate as soon as practicable after being discovered and with sufficient time for the issuer to fully evaluate such a conflict and its implications.

[23] For example, an actual material conflict of interest or potential material conflict of interest may not be present until an underwriter has recommended a particular financing structure. In that case, the disclosure must be provided in sufficient time before the execution of a contract with the underwriter to allow the issuer official to fully evaluate the recommendation, as described under “Required Disclosures to Issuers.”

[24] The MSRB acknowledges that not all transactions proceed along the same timeline or pathway. The timeframes expressed herein should be viewed in light of the overarching goals of Rule G-17 and the purposes that the disclosures are intended to serve as further described in this notice. The various timeframes set out in this notice are not intended to establish strict, hair-trigger tripwires resulting in mere technical rule violations, so long as an underwriter acts in substantial compliance with such timeframes and meets the key objectives for providing disclosure under the notice. Nevertheless, an underwriter’s fair dealing obligation to an issuer in particular facts and circumstances may demand prompt adherence to the timelines set out in this notice. Stated differently, if an underwriter does not timely deliver a disclosure and, as a result, the issuer: (i) does not have clarity throughout all substantive stages of a financing regarding the roles of its professionals, (ii) is not aware of conflicts of interest promptly after they arise and well before the issuer effectively becomes fully committed – either formally (e.g., through execution of a contract) or informally (e.g., due to having already expended substantial time and effort ) – to completing the transaction with the underwriter, and/or (iii) does not have the information required to be disclosed with sufficient time to take such information into consideration and, thereby, to make an informed decision about the key decisions on the financing, then the underwriter generally will have violated its fair-dealing obligations under Rule G-17, absent other mitigating facts and circumstances.

[25] An underwriter delivering a disclosure in order to meet a fair dealing obligation must obtain (or attempt to obtain) proper acknowledgement. When there is an underwriting syndicate, only the syndicate manager, as the dealer responsible for delivering the standard disclosures to the issuer, must obtain (or attempt to obtain) proper acknowledgement from the issuer for such disclosures.

[26] Absent red flags, and subject to an underwriter’s ability to reasonably rely on a representation from an issuer official that he or she has the authority to bind the issuer by contract with the underwriter, an underwriter may reasonably rely on a written delegation by an authorized issuer official in, among other things, the issuer’s request for proposals to another issuer official to receive and acknowledge receipt of a disclosure. The reasonableness of an underwriter’s reliance upon an issuer’s representation as to these matters will depend on all of the relevant facts and circumstances, including the facts revealed in connection with the underwriter’s due diligence in regards to the transaction generally.

[27] For purposes of this notice, the term “e-mail read receipt” means an automatic response generated by a recipient issuer official confirming that an e-mail has been opened. While an e-mail read receipt may generally be an acceptable form of an issuer’s written acknowledgement under this notice, an underwriter may not rely on such an e-mail read receipt as an issuer’s written acknowledgement where such reliance is unreasonable under all of the facts and circumstances, such as where the underwriter is on notice that the issuer official to whom the e-mail is addressed has not in fact received or opened the e-mail.

[28] The need for underwriters to have a reasonable basis for representations and other material information provided to issuers extends to the reasonableness of assumptions underlying the material information being provided. If an underwriter would not rely on any statements made or information provided for its own purposes, it should refrain from making the statement or providing the information to the issuer, or should provide any appropriate disclosures or other information that would allow the issuer to adequately assess the reliability of the statement or information before relying upon it. Further, underwriters should be careful to distinguish statements made to issuers that represent opinion rather than factual information and to ensure that the issuer is aware of this distinction.

[29] As a general matter, a response to a request for proposal should not be treated as merely a sales pitch without regulatory consequence, but instead should be treated with full seriousness that issuers have the expectation that representations made in such responses are true and accurate.

[30] In the circumstance where a dealer proposing to act as an underwriter in a negotiated offering recommends a financing structure or product prior to the time at which an underwriting syndicate is formed, such dealer shall have the same obligations to make any applicable standard disclosures, as if it were a sole underwriter or syndicate manager for purposes of the obligations described under “Required Disclosure to the Issuer” (e.g., to make the standard disclosure concerning the arm’s-length nature of the underwriter-issuer relationship at the earliest stages of the underwriter’s relationship with the issuer with respect to an issue), including complying with corresponding requirements to maintain and preserve records.

[31] If a complex municipal securities financing consists of an otherwise routine financing structure that incorporates a unique, atypical, or complex element or product and the issuer personnel have knowledge or experience with respect to the routine elements of the financing, the disclosure of material risks and characteristics may be limited to those relating to such specific element or product and any material impact such element or product may have on other features that would normally be viewed as routine.

[32] Respectively, the London Inter-bank Offered Rate (i.e., “LIBOR”), the SIFMA Municipal Swap Index (i.e., “SIFMA”), and Secured Overnight Financing Rate (“SOFR”). The MSRB notes that its references to LIBOR, SIFMA, and SOFR are illustrative only and non-exclusive. Any financings involving a benchmark interest rate index may be complex, particularly if an issuer is unlikely to fully understand the components of that index, its material risks, or its possible interaction with other indexes.

[33] For purposes of determining when an underwriter recommends a financing structure in a negotiated offering or recommends a complex municipal securities financing in a negotiated offering (a “Complex Municipal Securities Financing Recommendation”), the MSRB’s guidance on the meaning of “recommendation” for dealers in MSRB Notice 2014-07: SEC Approves MSRB Rule G-47 on Time-of-Trade Disclosure Obligations, MSRB Rules D-15 and G-48 on Sophisticated Municipal Market Professionals, and Revisions to MSRB Rule G-19 on Suitability of Recommendations and Transactions (March 12, 2014) is applicable by analogy. For example, whether an underwriter has made a Complex Municipal Securities Financing Recommendation is not susceptible to a bright line definition but turns on the facts and circumstances of the particular situation. An important factor in determining whether a Complex Municipal Securities Financing Recommendation has been made is whether – given its content, context, and manner of presentation— a particular communication from an underwriter to an issuer regarding a financing structure or product reasonably would be viewed as a call to action or reasonably would influence an issuer to engage in a such a financing structure or product deemed a complex municipal securities financing structure. In general, the more individually tailored the underwriter’s communication is to a specific issuer about a complex municipal securities financing structure, the greater the likelihood that the communication reasonably would be viewed as a Complex Municipal Securities Financing Recommendation.

[34] An underwriter must make reasonable judgments regarding whether it has recommended a financing structure or product to an issuer and whether a particular financing structure or product recommended by the underwriter to the issuer is complex, understanding that the fact that a structure or product has become relatively common in the market does not reduce its complexity. Not all negotiated offerings involve a recommendation by the underwriter(s), such as where a sole underwriter merely executes a transaction already structured by the issuer or its municipal advisor.

[35] For example, when a Complex Municipal Securities Financing Recommendation for a VRDO is made, the underwriter who recommends a VRDO should inform the issuer of the risk of interest rate fluctuations and material risks of any associated credit or liquidity facilities (e.g., the risk that the issuer might not be able to replace the facility upon its expiration and might be required to repay the facility provider over a short period of time). As an additional example, if the underwriter recommends that the issuer swap the floating rate interest payments on the VRDOs to fixed rate payments under a swap, the underwriter must disclose the material financial risks (including market, credit, operational, and liquidity risks) and material financial characteristics of the recommended swap (e.g., the material economic terms of the swap, the material terms relating to the operation of the swap, and the material rights and obligations of the parties during the term of the swap), as well as the material financial risks associated with the VRDO. Such disclosure should be sufficient to allow the issuer to assess the magnitude of its potential exposure as a result of the complex municipal securities financing. Such disclosures must also inform the issuer that there may be accounting, legal, and other risks associated with the swap and that the issuer should consult with other professionals concerning such risks. If the underwriter who has made a Complex Municipal Financing Securities Recommendation is affiliated with the swap dealer proposed to be the executing swap dealer, the underwriter may satisfy its disclosure obligation with respect to the swap if such disclosure has been provided to the issuer by the affiliated swap dealer or the issuer’s swap or other financial advisor that is independent of such underwriter and the swap dealer, as long as the underwriter has a reasonable basis for belief in the truthfulness and completeness of such disclosure. If the issuer decides to enter into a swap with another dealer, the underwriter is not required to make disclosures with regard to that swap product under this notice. The MSRB notes that a dealer who recommends a swap or security-based swap to a municipal entity may also be subject to rules of the Commodity Futures Trading Commission or those of the Securities and Exchange Commission (“SEC”).

[36] For example, a conflict of interest may exist when the underwriter who makes a Complex Municipal Securities Financing Recommendation to an issuer is also the provider, or an affiliate of the provider, of a swap used by an issuer to hedge a municipal securities offering or when an underwriter receives compensation from a swap provider for recommending the swap. See also “Conflicts of Interest/Payments to or from Third Parties” herein.

[37] Even a financing in which the interest rate is benchmarked to an index that is commonly used in the municipal marketplace (e.g., SIFMA) may be complex to an issuer that does not understand the components of that index or its possible interaction with other indexes.

[38] See note 19 supra.

[39] Page after page of complex legal jargon in small print would not be consistent with an underwriter’s fair dealing obligation under this notice.

[40] Underwriters should be able to leverage such materials for internal training and risk management purposes.

[41] Underwriters that assist issuers in preparing official statements must remain cognizant of their duties under federal securities laws. With respect to primary offerings of municipal securities, the SEC has noted, “By participating in an offering, an underwriter makes an implied recommendation about the securities.” See Exchange Act Release No. 26100 (Sept. 22, 1988) (proposing Exchange Act Rule 15c2-12) at text following fn. 70. The SEC has stated that “this recommendation itself implies that the underwriter has a reasonable basis for belief in the truthfulness and completeness of the key representations made in any disclosure documents used in the offerings.” Furthermore, pursuant to Exchange Act Rule 15c2-12(b)(5), an underwriter may not purchase or sell municipal securities in most primary offerings unless the underwriter has reasonably determined that the issuer or an obligated person has entered into a written undertaking to provide certain types of secondary market disclosure and has a reasonable basis for relying on the accuracy of the issuer’s ongoing disclosure representations. Exchange Act Release No. 34961 (Nov. 10, 1994) (adopting continuing disclosure provisions of Exchange Act Rule 15c2-12) at text following fn. 52.

[42]The MSRB has previously observed that whether an underwriter has dealt fairly with an issuer for purposes of Rule G-17 is dependent upon all of the facts and circumstances of an underwriting and is not dependent solely on the price of the issue. See MSRB Notice 2009-54 (Sept. 29, 2009) and the 1997 Interpretation (note 2 supra). See also “Retail Order Periods” herein.

[43] Rule G-13(b)(iii) provides: “For purposes of subparagraph (i), a quotation shall be deemed to represent a ‘bona fide bid for, or offer of, municipal securities’ if the broker, dealer or municipal securities dealer making the quotation is prepared to purchase or sell the security which is the subject of the quotation at the price stated in the quotation and under such conditions, if any, as are specified at the time the quotation is made.”

[44]See 1997 Interpretation (note 2 supra).

[45] See also “Required Disclosures to Issuers” herein.

[46] Underwriters should be mindful that, depending on the facts and circumstances, such an arrangement may be inferred from a purposeful but not otherwise justified pattern of transactions or other course of action, even without the existence of a formal written agreement.

[47]See MSRB Interpretation on Priority of Orders for Securities in a Primary Offering under Rule G-17, MSRB interpretation of October 12, 2010, reprinted in MSRB Rule Book. The MSRB also reminds underwriters of previous MSRB guidance on the pricing of securities sold to retail investors. See Guidance on Disclosure and Other Sales Practice Obligations to Individual and Other Retail Investors in Municipal Securities, MSRB Notice 2009-42 (July 14, 2009).

[48] In general, a “going away” order is an order for new issue securities for which a customer is already conditionally committed. See Exchange Act Release No. 62715, File No. SR-MSRB-2009-17 (August 13, 2010).

[50]See In the Matter of RBC Capital Markets Corporation, Exchange Act Release No. 59439 (Feb. 24, 2009) (settlement in connection with broker-dealer alleged to have violated MSRB Rules G-20 and G‑17 for payment of lavish travel and entertainment expenses of city officials and their families associated with rating agency trips, which expenditures were subsequently reimbursed from bond proceeds as costs of issuance); In the Matter of Merchant Capital, L.L.C., Exchange Act Release No. 60043 (June 4, 2009) (settlement in connection with broker-dealer alleged to have violated MSRB rules for payment of travel and entertainment expenses of family and friends of senior officials of issuer and reimbursement of the expenses from issuers and from proceeds of bond offerings).

Interpretive Guidance - Interpretive Notices
Publication date:
Confirmation Disclosure and Prevailing Market Price Guidance: Frequently Asked Questions
Rule Number:

(First published July 12, 2017)

Effective May 14, 2018, amendments to MSRB Rule G-15 require dealers to disclose additional information on retail customer confirmations for a specified class of principal transactions, including the dealer’s mark-up or mark-down as determined from the prevailing market price (PMP) of the security. Dealers generally also are required to disclose on retail customer confirmations the time of execution and a security-specific URL to the MSRB’s Electronic Municipal Market Access (EMMA®) website.[1] Related amendments to Rule G-30, on prices and commissions, provide guidance on determining the PMP for the purpose of calculating a dealer’s mark-up or mark-down and for other Rule G-30 determinations.

 

Also, effective May 14, 2018, amendments to Financial Industry Regulatory Authority (FINRA) Rule 2232 create similar confirmation disclosure requirements for other areas of the fixed income markets. Among other things, the FINRA amendments require dealers to determine their disclosed mark-ups and mark-downs from the PMP of the security that is traded, in accordance with existing guidance under FINRA Rule 2121.

 

Below are answers to frequently asked questions (FAQs) about the confirmation disclosure requirements under Rule G-15 and related PMP guidance under Rule G-30, Supplementary Material .06 (also referred to as the “waterfall” guidance or analysis). While these FAQs address MSRB rules only, FINRA has also issued guidance for the FINRA rules applicable to agency and corporate bonds. The MSRB and FINRA worked together to produce this guidance. While each has published its own version to refer to MSRB and FINRA rules and materials, respectively, the versions are materially the same and reflect the organizations’ coordinated approach to enhanced confirmation disclosure for debt securities. To the extent the MSRB and FINRA offer different guidance based on differences between the markets for corporate, agency and municipal securities, those differences are discussed in the context of the relevant question and answer.

 

During the implementation period, the MSRB will continue to work with dealers on questions related to the confirmation disclosure requirements and PMP guidance. Dealers are encouraged to contact the MSRB to suggest additional topics or questions for inclusion in the FAQs. Accordingly, the MSRB may add to, update or revise this guidance. The most recent date for the content of an answer will be clearly marked.

 

For ease of reference, unless otherwise noted, the term “mark-up” refers both to mark-ups applied to sales to customers and mark-downs applied to purchases from customers, and the term “contemporaneous cost” refers both to contemporaneous cost in the context of sales to customers and contemporaneous proceeds in the context of purchases from customers.

 

Section 1:  When Mark-Up Disclosure Is Required

1.1 When does Rule G-15 require mark-up disclosure?

A dealer is required to disclose on a customer confirmation the mark-up on a transaction in municipal securities with a non-institutional customer if the dealer also executes one or more offsetting principal transaction(s) on the same trading day as the customer transaction in an aggregate trading size that meets or exceeds the size of the customer trade. A non-institutional customer is a customer with an account that is not an institutional account, as defined in MSRB Rule G-8(a)(xi).

As noted during the MSRB’s confirmation disclosure rulemaking process, any intentional delay of a customer execution to avoid triggering the mark-up disclosure requirements may violate Rule G-18, on best execution, and Rule G-17, on conduct of municipal securities and municipal advisory activities.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 7 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 3-4 (November 14, 2016)

(July 12, 2017)

1.2  Is mark-up disclosure required only where the sizes of same-day customer and principal trades offset each other?

Yes. Mark-up disclosure is required only where a customer trade offsets a same-day principal trade in whole or in part. For example, if a dealer purchased 100 bonds at 9:30 a.m., and then, as principal, satisfied three non-institutional customer buy orders for 50 bonds each in the same security on the same trading day without making any other purchases of the bonds that day, mark-up disclosure would be required only on two of the three customer purchases, since one of the trades would need to be satisfied out of the dealer’s prior inventory rather than offset by the dealer’s same-day principal transaction.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 4; 7-8 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 3-4 (November 14, 2016); Amendment No. 1 to SR-MSRB-2016-12, at 4 (November 14, 2016)

(July 12, 2017)

1.2.1  Are position moves between separate desks within a firm considered “transactions” for purposes of determining whether a dealer has offsetting transactions that trigger a mark-up disclosure requirement?

No. Mark-up disclosure is triggered under Rule G-15 when a customer trade is offset by one or more “transactions.”  For purposes of the rule, the MSRB considers a “transaction” to entail a change of beneficial ownership between parties. Accordingly, if a retail desk within a dealer acquires bonds through a position move from another desk within the same firm and then sells those bonds to a non-institutional customer, the dealer is required to provide the customer with mark-up disclosure only if the dealer bought the bonds in one or more offsetting transactions on the same trading day as the sale to the customer (subject to the exceptions discussed in Question 1.7).

(March 19, 2018)

1.3  When are trades executed by a dealer’s affiliate relevant for determining whether the mark-up disclosure requirements are triggered?

If a dealer’s offsetting principal trade is executed with a dealer affiliate and did not occur at arm’s length, the dealer is required to “look through” to the time and terms of the affiliate’s trade with a third party to determine whether mark-up disclosure is triggered under Rule G-15. On the other hand, if the dealer’s transaction with its affiliate is an arms-length transaction, the dealer would treat that transaction as any other offsetting transaction (i.e., the dealer would not “look through” to the time and terms of the arms-length transaction).

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 9­‑10; 23; 26 (September 1, 2016)

(July 12, 2017)

1.4  What is considered an “arms-length transaction” when considering whether a dealer must “look through” to the time and terms of an affiliate’s trade?

The term “arms-length transaction” is defined in Rule G-15(a)(vi)(I) to mean a transaction that was conducted through a competitive process in which non-affiliate firms could also participate, and where the affiliate relationship did not influence the price paid or proceeds received by the dealer. The MSRB has noted that as a general matter, it expects the competitive process used in an arms-length transaction to be one in which non-affiliates have frequently participated. In other words, the MSRB would not view a process, like a request for pricing protocol or posting of bids and offers, as competitive if non-affiliates responded to requests or otherwise participated in only isolated or limited circumstances.

Factors that may be relevant to a dealer’s determination that a transaction with an affiliate was conducted at arm’s length include, but are not limited to: counterparty anonymity during the competitive process to the time of execution; the presence of other competitive bids or offers, in addition to the affiliate's, in the competitive process; contemporaneous market activity in the same or a similar security (or securities) which is used to evaluate the relative competitiveness of bids or offers received during a competitive process; and a lack of preferential arrangements between the affiliates concerning, or based on, the handling of orders between them. The MSRB notes that no one of these factors is necessarily determinative on its own.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 9 (September 1, 2016)

(July 12, 2017)

(Updated March 19, 2018)

1.5  If a dealer has an exclusive agreement with a non-affiliated dealer under which it always purchases its securities from, or always sells its securities to, that non-affiliate, would the “look through” requirements apply when the dealer transacts with the non-affiliate?

No. The “look through” applies only to certain transactions between affiliated dealers. Under Rule G-15, a “look through” is required when the dealer’s offsetting transaction is with an affiliate and is not an “arms-length transaction.” A transaction with a non-affiliate would not meet these conditions, so a “look through” would not be required. The MSRB notes that dealers should continue to evaluate the terms and circumstances of any such arrangements in light of other MSRB rules and guidance, including best execution. In evaluating these terms and circumstances, dealers should consider whether they diminish the reliability and utility of mark-up disclosure to investors.

(July 12, 2017)

1.6  Does the mark-up disclosure requirement in Rule G-15 apply to transactions that involve a dealer and a registered investment adviser?

No. To trigger the mark-up disclosure requirement in Rule G-15, a dealer must execute a trade with a non-institutional customer. Under the rule, registered investment advisers are institutional customers; accordingly, mark-up disclosure is not required when dealers transact with registered investment advisers. This is the case even where the registered investment adviser with whom the dealer transacted later allocates all or a portion of the securities to a retail account or where the transaction is executed directly for a retail account if the investment adviser has discretion over the transaction. The MSRB notes that this answer is specific to the mark-up disclosure requirement in Rule G-15; it is not intended to alter any other obligations.

(July 12, 2017)

1.7  Are there any exceptions to the mark-up disclosure trigger requirements?

Yes. There are three exceptions. First, disclosure is not required for transactions in municipal fund securities. Second, mark-up disclosure is not necessarily triggered by principal trades that a dealer executes on a trading desk that is functionally separate from a trading desk that executes customer trades, provided the dealer maintains policies and procedures reasonably designed to ensure that the functionally separate trading desk had no knowledge of the customer trades. For example, the exception allows an institutional desk within a dealer to service an institutional customer without necessarily triggering the disclosure requirement for an unrelated trade performed by a separate retail desk within the dealer. Third, disclosure is not required for transactions that are list offering price transactions, as defined in paragraph (d)(vii)(A) of Rule G-14 RTRS Procedures.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 10 (September 1, 2016)

(July 12, 2017)

1.8  May dealers voluntarily provide mark-up disclosure on additional transactions that do not trigger mandatory disclosure?

Yes. In disclosing this information on a voluntary basis, dealers should be mindful of any applicable MSRB rules. For example, while mark-up disclosure is voluntary for trades that are not triggered by the relevant provisions of Rule G-15, the process for determining the PMP according to Rule G-30 applies in all cases. In addition, to avoid customer confusion, voluntary disclosure should also follow the same format and labeling requirements applicable to mandatory disclosure.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 13 n. 27 (September 1, 2016)

(July 12, 2017)

1.9  In arrangements involving clearing dealers and introducing or correspondent dealers, who is responsible for mark-up disclosure?

The introducing or correspondent dealer bears the ultimate responsibility for compliance with the disclosure requirements under Rule G-15. Although an introducing or correspondent dealer may use the assistance of a clearing dealer, as it may use other third-party service providers subject to due diligence and oversight, the introducing or correspondent dealer remains ultimately responsible for compliance.

(July 12, 2017)

Section 2:  Content and Format of Mark-Up Disclosure

2.1  What information must be included when dealers provide mark-up disclosure on a confirmation?

When mark-up disclosure is provided on a customer confirmation, Rule G-15 requires firms to express the disclosed mark-up as both a total dollar amount and a percentage amount of PMP. The mark-up should be calculated and disclosed as the total amount per transaction; disclosure of the per bond dollar amount of mark-up (e.g., $9.45 per bond) would not satisfy the requirement to disclose the total dollar amount of the transaction mark-up.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 12 (September 1, 2016)

(July 12, 2017)

2.2  Where is mark-up disclosure required to be located on a confirmation?

For printed confirmations, Rule G-15(a)(i)(E) requires the mark-up disclosure to be located on the front of the customer confirmation. For electronic confirmations, the disclosure should appear in a naturally visible place. Because the rule requires mark-up disclosure to be on the confirmation itself, the inclusion of a link on the customer confirmation that a customer could click to obtain his or her mark-up disclosure would not satisfy the requirements of Rule G-15.

(July 12, 2017)

2.3  May dealers use explanatory language to provide context for mark-up disclosure?

Yes. Dealers may include accompanying language to explain mark-up related concepts, or a dealer’s particular methodology for calculating mark-ups according to MSRB guidance (or to note the availability of information about the methodology upon request), provided such statements are accurate and not misleading. However, dealers may not label mark-ups as “estimated” or “approximate” figures, or use other such labels. These types of qualifiers risk diminishing the utility of the disclosure and of the dealer’s own determination of the security’s PMP and mark-up charged, and otherwise risk diminishing the value to retail investors of the disclosure.

MSRB Response to Comments on SR-MSRB-2016-12, at 11-12 (November 14, 2016)

(July 12, 2017)

2.4  If a dealer encounters a situation where a mark-up is negative (i.e., the dealer sold to the customer at a price lower than the PMP), may it choose to disclose a mark-up of zero instead?

The MSRB believes that negative mark-ups will be very infrequent; however, if such a case arises, a dealer may not disclose a mark-up of zero where the mark-up is not, in fact, zero. Dealers should disclose the mark-up that they calculate based on their determination of PMP consistent with Rule G-30. As an alternative to disclosing a negative mark-up, dealers are permitted to disclose “N/A” in the mark-up/mark-down field if the confirmation also includes a brief explanation of the “N/A” disclosure and the reason it has been provided. Dealers also have the flexibility to provide an explanation for trades with disclosed negative or zero mark-ups as well, consistent with Question 2.3 above.

(July 12, 2017)

2.5  How many decimal places should dealers use when disclosing the mark-up as a percentage amount?

Dealers should disclose the percentage amount rounded to at least two decimal places (e.g., hundredths of a percent). For example, if a dealer charged a $120 mark-up on a 10-bond transaction where the PMP was 99, the mark-up percentage should be disclosed to at least the hundredth of a percentage point, as 1.21% (as opposed to 1.2% or 1%). However, if a dealer charged a $100 mark-up on a 10-bond transaction where the PMP was 100, the mark-up percentage could be disclosed as 1.00% or 1%.

(March 19, 2018)

Section 3:  Determining Prevailing Market Price

3.1  How should dealers determine PMP to calculate mark-ups?

Dealers must calculate mark-ups from a municipal security’s PMP, consistent with Rule G-30 and the supplementary material thereunder, particularly Supplementary Material .06 (sometimes referred to as the “waterfall” guidance or analysis). Under the applicable standard of “reasonable diligence” (discussed below), dealers may rely on reasonable policies and procedures to facilitate PMP determination, provided the policies and procedures are consistent with Rule G-30 and are consistently applied.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 12 (September 1, 2016)

(July 12, 2017)

3.2  Does the PMP guidance in Rule G-30, Supplementary Material .06 apply for mark-up (and mark-down) disclosure purposes under Rule G-15 and for fair pricing purposes under Rule G-30?

Yes. Dealers should read the guidance in Supplementary Material .06 together with Rule G-30 and all the other supplementary material thereto. For example, while Supplementary Material .06 provides guidance in determining the PMP, Supplementary Material .01(a) explains that dealers must exercise “reasonable diligence” in establishing the market value of a security, and Supplementary Material .01(d) states that dealer compensation on a principal transaction with a customer is determined from the PMP of the security, as described in Supplementary Material .06. Read as a whole, Rule G-30 requires dealers to use reasonable diligence to determine the PMP of a municipal security in accordance with Supplementary Material .06.[2] This standard applies for mark-up disclosure purposes under Rule G-15 and for fair pricing purposes under Rule G-30.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 25; 28 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 9-11 (November 14, 2016)

(July 12, 2017)

(Updated March 19, 2018)

3.2.1  Does the functionally separate trading desk exception apply for purposes of determining the PMP of a security?

No. As explained in the rule filing, this exception “would only apply to determine whether or not the [mark-up] disclosure requirement has been triggered; it does not change the dealer’s requirements relating to the calculation of its mark-up or mark-down under Rule G-30.”

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at n. 20 (September 1, 2016)

(March 19, 2018)

3.3  When reading the PMP guidance in Rule G-30, Supplementary Material .06, what does the language in parentheses mean?

Unless the context requires otherwise, language in parentheses that is not preceded by an “i.e.,” or “e.g.,” within sentences refers to scenarios where a dealer is charging a customer a mark-down. Thus, for example, in the phrase, “contemporaneous dealer purchases (sales) in the municipal security in question from (to) institutional accounts,” the terms “(sales)” and “(to)” apply where a dealer is charging a customer a mark-down.

(July 12, 2017)

3.4  When should dealers determine PMP and calculate the mark-up to be disclosed on a confirmation?

The MSRB recognizes that dealers may employ different processes for generating customer confirmations such that this may occur at the end of the day, or during the day for firms that use real-time, intra-day confirmation generation processes. Therefore, although the objective must always be to determine the price prevailing at the time of the customer transaction, different dealers may consistently conduct the analysis to make that determination at different times. Specifically, dealers may base their mark-up calculations for confirmation disclosure purposes on the information they have available to them (based on the exercise of reasonable diligence) at the time they systematically input relevant transaction information into the systems they use to generate confirmations.

This means that a dealer that systematically inputs the information at the time of trade may determine the PMP—and therefore, the mark-up—at the same time (even if the confirmation itself is not printed until the end of day). On the other hand, if a dealer systematically inputs such information at the end of the day, the dealer must use the information available to the dealer at that time to determine the price prevailing at the time of the customer transaction—and, therefore, the mark-up.

The timing of the determination must be applied consistently across all transactions in municipal securities (e.g., the dealer may not enter information into its systems at the time of trade and determine the PMP at the time of trade for some trades but at the end of the day for others).

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 24 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 10 (November 14, 2016)

(July 12, 2017)

3.4.1  May a dealer determine PMP between the time of trade and the end of the day? 

Yes. The MSRB recognizes that firms may employ different processes for generating customer confirmations, and dealers are not limited to determining PMP for purposes of confirmation disclosure only at the times provided as examples in Question 3.4 (i.e., the time of trade or the end of the day). While the objective must always be to determine the price prevailing at the time of the customer transaction, as noted above in Question 3.4, PMP may be determined for disclosure purposes when a firm systematically enters the information into its confirmation generation system, based on information that is reasonably available to it at that time. Accordingly, a dealer may determine PMP at various times, including at the time of the trade, at the end of the day, or at times in between, provided the dealer does so according to reasonable, consistently applied policies and procedures and does not “cherry pick” favorable data.

(March 19, 2018)

3.4.2  May a dealer determine PMP at the time of trade (or at some other time before the end of the day) and wait until later in the day to analyze which trades triggered the disclosure requirement?

Yes. A dealer may determine PMP, enter the PMP information into a confirmation generation system, and later populate the mark-up field only on confirmations of trades that trigger disclosure. The MSRB would expect in such cases that the PMP determination would not be subject to change when the dealer performs the trigger analysis later in the day, other than for a reasonable exception review process (as discussed in Question 3.8.1). In all cases, dealers must follow consistently applied policies and procedures and may not “cherry pick” favorable data. Dealers are reminded that when determining PMP, they must use the information reasonably available to them at the time of the PMP determination and that the objective is always to determine the price prevailing at the time of the customer transaction.

(March 19, 2018)

3.4.3  What is considered a confirmation generation system, for purposes of the guidance on when dealers may determine PMP for disclosure purposes?

As noted above in Question 3.4, the MSRB recognizes that dealers may employ different processes for generating customer confirmations. For purposes of this guidance, the MSRB would consider a dealer to enter information systematically into a confirmation generation system when it stores the information in a location that is part of the confirmation generation process. The MSRB expects that the stored PMP information would not be subject to change, other than for a reasonable exception review process (as discussed in Question 3.8.1). The MSRB also expects that a dealer will clearly explain in its policies and procedures its confirmation generation process, including the timing and role of each material step in the process.

(March 19, 2018)

3.5  Once dealers determine PMP and input relevant information into their confirmation generation systems, would they be required to cancel and correct a confirmation to revise a disclosed mark-up if later events might contribute to a different PMP determination?

No. The disclosure must be accurate, based on the dealer’s exercise of reasonable diligence, as of the time the dealer systematically inputs the information into its systems to generate the disclosure. Once the dealer has input the information into its confirmation generation systems, the MSRB does not expect dealers to send revised confirmations solely based on the occurrence of a subsequent transaction or event that would otherwise be relevant to PMP determination under Rule G-30. On a voluntary basis, dealers may correct a confirmation, pursuant to reasonable and consistently applied policies and procedures.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 24 (September 1, 2016)

(July 12, 2017)

3.5.1 If a dealer corrects the price to a customer or determines that, at the time the dealer systematically entered the information into its systems to generate the mark-up disclosure, the PMP was inaccurate, must the dealer send a corrected confirmation that reflects a corrected mark-up disclosure and price?

Yes. Consistent with Question 3.5, dealers are not required to cancel and correct a confirmation to revise a disclosed mark-up solely based on the occurrence of a subsequent transaction or event that would otherwise be relevant to PMP determination under Rule G-30. However, if the dealer corrects the price to the customer or determines that a PMP was inaccurate at the time it was systematically entered into the dealer’s confirmation generation system, the dealer must send a confirmation that reflects an accurate mark-up and price.

(March 19, 2018)

3.6  May dealers engage third-party vendors to perform some or all of the steps required to fulfill the mark-up disclosure requirements?

Yes. Dealers may engage third-party service providers to facilitate mark-up disclosure consistent with Rules G-15 and G-30. For example, dealers that wish to perform most of the steps of the waterfall internally may choose to use the services of a vendor at the economic models level of the waterfall. Other dealers may wish to use the services of a vendor to perform most or all of the steps of the waterfall. In either case, the dealers retain the responsibility for ensuring the PMP is determined in accordance with Rule G-30 and that the mark-up is disclosed in compliance with Rule G-15 and must exercise due diligence and oversight over their third-party relationships.

As a policy matter, the MSRB does not endorse or approve the use of any specific vendors.

MSRB Response to Comments on SR-MSRB-2016-12, at 8 (November 14, 2016)

(July 12, 2017)

3.7  May dealers use a third-party evaluated pricing service as an economic model at the final step of the waterfall?

Yes. However, before doing so, the dealer should have a reasonable basis for believing the third-party pricing service’s pricing methodologies produce evaluated prices that reflect actual prevailing market prices. A dealer would not have a reasonable basis for such a belief, for example, where a periodic review of the evaluated prices provided by the pricing service frequently (over the course of multiple trades) reveals a substantial difference between the evaluated prices and the prices at which actual transactions in the relevant securities occurred. In choosing to use evaluated prices from any pricing service, a dealer should assess, among other things, the quality of the evaluated prices provided by the service and the extent to which the service determines its evaluated prices on an intra-day basis.

To be clear, dealers are not required to use such pricing services at this stage of the waterfall analysis. Rather, third-party evaluated pricing services are only one type of economic model. Other types of economic models may include internally developed models such as a discounted cash flow model or a reasonable and consistent methodology to be used in connection with an applicable index or benchmark. Dealers are reminded that when using an internally developed model, the dealer must be able to provide information that the dealer used on the day of the transaction to develop the pricing information (i.e., the data that was input and the data that the model generated and the dealer used to arrive at the PMP).

MSRB Response to Comments on SR-MSRB-2016-12, at 8 (November 14, 2016)

(July 12, 2017)

(Updated March 19, 2018)

3.8  May dealers use or rely on automated systems to determine PMP?

Yes. While dealers are not required to automate the PMP determination and mark-up disclosure, they may choose to do so, provided they (and/or their vendors) do so consistent with Rule G-30 and Rule G-15, and all other applicable rules. The MSRB has provided guidance in several areas during the rulemaking process to facilitate automation for firms that choose to employ it. First, as noted above in Question 3.4, dealers are permitted on certain conditions to determine PMP on an intra-day basis (e.g., at the time of trade), allowing dealers that generate confirmations intra-day to continue to do so. Second, as noted in Question 3.1 and discussed throughout this guidance, the MSRB has acknowledged that dealers may develop policies and procedures that rely on reasonable, objective criteria to apply the PMP guidance in Supplementary Material .06 at a systematic level. Consistent with the reasonable policies and procedures approach, the MSRB further recognized during the rulemaking process that reasonable policies and procedures could result in different firms making different PMP determinations for the same security. (The MSRB would expect, however, that the consistent application of policies and procedures within a dealer would result in different traders or desks arriving at PMP determinations that are substantially the same under comparable facts and circumstances.)

MSRB Response to Comments on SR-MSRB-2016-12, at 7-8 (November 14, 2016)

(July 12, 2017)

3.8.1 May dealers adopt a reasonable exception review process to evaluate PMP determinations?

Yes. As a general matter, the MSRB expects that dealers will employ supervisory review processes that consider, among other things, the reliability of their (or their vendors’) PMP determinations. To review reliability, a dealer might review PMP determinations that result in mark-ups that exceed pre-determined thresholds, and it also might compare PMP determinations with some other measure of market value to ascertain whether the PMP determinations fall outside pre-established ranges.

In cases where a dealer reviews PMP determinations before the associated trade confirmations are sent, dealers may correct PMP determinations to promote more accurate mark-up calculations, provided they do so according to reasonable and consistently applied policies and procedures. As a general matter, however, the MSRB expects that it will be rare for a dealer to correct the PMP of a security based on exception reporting, and documentation in such situations will be paramount. To prevent “cherry picking,” the dealer’s policies and procedures should be specific in describing the PMP review process and the conditions under which the dealer may show that a PMP was erroneous (e.g., the PMP determination was based on an isolated transaction, or a PMP determined through the use of an economic model did not reflect recent news about the security). If a dealer determines that a PMP is erroneous, it must correct it consistent with Rule G-30, and it must do so using the information reasonably available to it at the time it makes the correction.

There may also be cases where a dealer’s exception review process results in corrected customer trade prices. For example, a dealer may review a trade where the mark-up exceeded a pre-determined threshold and the PMP was determined correctly. Dealers may refer to Question 3.5.1 in these cases.

(March 19, 2018)

3.9  May dealers develop objective criteria to automatically determine whether a trade is “contemporaneous” for purposes of establishing a presumptive PMP at the first step of the waterfall analysis?

Yes. Dealers may establish an objective set of criteria to determine whether a trade is contemporaneous, provided the objective criteria are established based on the exercise of reasonable diligence. For example, dealers could define an objective period of time as a default proxy for determining whether the trade is contemporaneous. Dealers could also define criteria to consider other relevant factors, such as whether intervening trades by other firms occurred at prices sufficiently different than the dealer’s trade to suggest that the dealer’s trade no longer reasonably reflects the current market price for the security, or whether changes in interest rates or the credit quality of the security, or news reports were significant enough to reasonably change the PMP of the security.

Given the different trading characteristics of different municipal securities, and relevant court and SEC case law applicable to debt securities in general, it likely would not be reasonable for a dealer’s policies and procedures to determine categorically that all transactions that occur outside of a specified time frame are not “contemporaneous.” Accordingly, dealers should include in their policies and procedures an opportunity to review and override the automatic application of default proxies (e.g., by reconsidering the application for transactions identified through reasonable exception reporting and specifying designated time intervals (or market events) after which such proxies will be reviewed).

(July 12, 2017)

3.10  Since Rule G-15 adopts a same-day trigger standard for mark-up disclosure, would it be reasonable to assume a same-day standard for determining whether trades are contemporaneous for purposes of determining PMP under Rule G-30?

The MSRB notes that the determination of whether mark-up disclosure is required under Rule G-15 is distinct from the determination of whether a transaction is contemporaneous under the waterfall analysis. The PMP guidance under Rule G-30 provides that a dealer’s cost is considered contemporaneous if the transaction occurs close enough in time to the subject transaction that it would reasonably be expected to reflect the current market price for the municipal security. While same-day transactions may often be contemporaneous according to this meaning, the MSRB has not set forth a specific time-period that is categorically contemporaneous. As noted above in Question 3.9, the MSRB would expect that dealers developing objective criteria for this purpose would base the determination of such criteria on the exercise of reasonable diligence.

(July 12, 2017)

3.11  How should dealers determine their contemporaneous cost if they have multiple contemporaneous purchases?

Dealers may rely on reasonable and consistently applied policies and procedures that employ methodologies to establish PMP where they have multiple contemporaneous principal trades. For example, a dealer could employ consistently an average weighted price or a last price methodology. Such methodologies could further account for the type of principal trade, giving greater weight to principal trades with other dealers than to principal trades with customers.

MSRB Response to Comments on SR-MSRB-2016-12, at 12-13 (November 14, 2016)

(July 12, 2017)

3.12  What is the next step in the analysis, when determining contemporaneous cost or proceeds, if a dealer has no contemporaneous transactions with another dealer?

Where the dealer has no contemporaneous cost or proceeds, as applicable, from an inter-dealer transaction, the dealer must then consider whether it has contemporaneous cost or proceeds, as applicable, from a customer transaction. Note that, because the dealer’s contemporaneous cost or proceeds from a customer transaction will also include the mark-up or mark-down charged in that transaction, the dealer should adjust its contemporaneous cost or proceeds from that customer transaction to account for the mark-up or mark-down included in the price. In these instances, the difference between the dealer’s “adjusted contemporaneous cost or proceeds” (the dealer’s contemporaneous cost or proceeds in the customer transaction, adjusted by the mark-up or mark-down) and the price to its customer is equal to the mark-up (or mark-down) to be disclosed on customer confirmations under Rule G-15. The MSRB has noted that this approach allows the dealer to avoid “double counting” in the mark-up and mark-down it discloses to each customer. For example, if a dealer buys 100 bonds from Customer A at a price of 98 and immediately sells 100 of the same bonds to Customer B at a price of 100, the dealer may apportion the mark-up and mark-down paid by each customer. Assuming for illustration that the dealer determines the PMP in accordance with the waterfall guidance to be 99, then the dealer would disclose to Customer A a total dollar amount mark-down of $1,000, also expressed as 1.01% of PMP, and it would disclose to Customer B a total dollar amount mark-up of $1,000, also expressed as 1.01% of PMP.[3]

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 21 (September 1, 2016)

(July 12, 2017)

(Updated March 19, 2018)

3.12.1  May dealers adopt a reasonable default proxy or process to apportion the mark-up and mark-down on contemporaneous customer buy and sell transactions, as contemplated in Question 3.12? 
Yes. As explained in Question 3.12, the purpose of adjusting a dealer’s contemporaneous cost or proceeds in the case of contemporaneous customer buy and sell transactions is to arrive at a more accurate indication of the PMP of the securities, for example, by avoiding “double counting” in the mark-up and mark-down disclosed. Consistent with this goal, as an alternative to the process described in Question 3.12, dealers may adopt a reasonable default proxy or process to apportion the amount of the total mark-up and mark-down charged on contemporaneous customer transactions. Such proxy or process should be based upon and not inconsistent with a reasonable review of the typical mark-ups and mark-downs actually charged in the dealer’s municipal securities transactions. For example, assume that, based upon a review of the actual mark-ups and mark-downs charged on a dealer’s municipal securities transactions, a dealer determines that its mark-ups on municipal securities transactions are typically larger than its mark-downs by a quantifiable amount. The dealer may use such information to develop a consistently applied apportionment methodology—for example, by consistently apportioning x% of the total mark-up and mark-down to the customer buy transaction and y% of the total mark-up and mark-down to the sale transaction. If such a default proxy or process is adopted, a dealer should be mindful to review its continued appropriateness over time in a manner that is consistent with the dealer’s ongoing supervisory and compliance obligations.

(June 10, 2020)

3.13  May dealers adjust their contemporaneous cost to reflect what they believe to be a more accurate PMP, or their role taking risk to provide liquidity?

Dealers may adjust their contemporaneous cost only in one case: where a dealer’s offsetting trades that trigger disclosure under Rule G-15 are both customer transactions (discussed above at Question 3.12). Other adjustments to reflect the size or side of market for a dealer’s contemporaneous cost are not permitted.

(July 12, 2017)

3.14  May dealers apportion their expected aggregate monthly fees—for example to access an alternative trading system (ATS) or other trading platform—to individual contemporaneous transactions to be included in their contemporaneous costs?

No. For any given mark-up on a transaction, Supplementary Material .06 requires dealers to look first to their contemporaneous cost as incurred. The MSRB does not believe it would be consistent with Rule G-30 for dealers to consider an estimated apportionment of a future charge to be part of the specific cost they incurred in a contemporaneous transaction.

(July 12, 2017)

3.15  In determining contemporaneous cost, may dealers include transaction fees—for example to access an ATS or other trading platform—that were included in the price they paid?

Yes, provided the transaction fee is reflected in the price of the contemporaneous trade that is reported to EMMA, consistent with MSRB rules and guidance on pricing, trade reporting and fees. The MSRB will monitor and adjust this guidance as needed if it determines that pricing practices change in a way that diminishes the utility and reliability of mark-up disclosure.

(July 12, 2017)

3.16  May a dealer treat its own contemporaneous transaction as “isolated” and therefore disregard it when determining PMP?

No. Under Supplementary Material .06, isolated transactions or isolated quotations generally will have little or no weight or relevance in establishing PMP. The guidance also specifically provides that, in the municipal market, an “off-market” transaction may qualify as an isolated transaction. Through cross-references, Supplementary Material .06 makes clear that a dealer may deem a transaction or quotation at the hierarchy of pricing factors or similar-securities level of the waterfall to be isolated. However, the concept of “isolated” transactions or quotations does not apply to a dealer’s contemporaneous cost, which presumptively determines PMP.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 19; 21 (September 1, 2016)

(July 12, 2017)

3.17  Supplementary Material .06 notes that changes in interest rates may allow a dealer to overcome the presumption that its own contemporaneous cost is the best measure of PMP. Does this refer only to formal policy interest rate changes, or does it also contemplate market changes in interest rates?

It refers to any change in interest rates, whether the change is caused by formal policy decisions or market events. However, Supplementary Material .06 notes that a dealer may overcome the presumption that its contemporaneous cost is the best measure of PMP based on a change in interest rates only in instances where they have changed after the dealer’s transaction to a degree that such change would reasonably cause a change in municipal securities pricing.

(July 12, 2017)

3.18  Supplementary Material .06 notes that changes in the credit quality of the municipal security may allow a dealer to overcome the presumption that its own contemporaneous cost is the best measure of PMP. Does this refer only to formal credit rating changes, or does it also contemplate market changes in implied or observed credit spreads such as those due to market-wide credit spread volatility or anticipated changes in the credit quality of the individual issuer?

It refers to any changes to credit quality, with respect to that particular security or the particular issuer of that security, whether the change is caused by a formal ratings announcement or market events. Thus, for example, this could include changes in the guarantee or collateral supporting repayment as well as significant recent information concerning the issuer that is not yet incorporated in credit ratings (e.g., changes to ratings outlooks). However, Supplementary Material .06 notes that a dealer may overcome the presumption that its contemporaneous cost is the best measure of PMP based on a change in credit quality only in instances where it has changed significantly after the dealer’s transaction.

(July 12, 2017)

3.18.1 When considering inter-dealer trades at the hierarchy of pricing factors level of the waterfall analysis, if the only contemporaneous inter-dealer trades in the security are executed at the same time and involve a broker’s broker or an ATS, may a dealer choose to determine PMP by reference to the inter-dealer trade price which is reasonably likely to be on the opposite side of the market from the dealer seeking to determine PMP?

Yes. Consistent with the standard of reasonable diligence, dealers may adopt a reasonable approach to consistently choosing between or referring to multiple contemporaneous inter-dealer trades. If the only contemporaneous inter-dealer trades in the security are executed at the same time and involve a broker’s broker or an ATS in the security, it may be reasonable for the dealer seeking to determine PMP to do so by reference to the trade price which is reasonably likely to be on the opposite side of the market from the dealer seeking to determine PMP.

For example, assume that Dealer XYZ is selling a municipal security to a retail customer. Also, assume that the dealer lacks contemporaneous cost and that there are only two contemporaneous inter-dealer transactions in the security, and that both of those transactions occur at the exact same time and in the exact same trade amount. Additionally, both inter-dealer transactions are identified by an ATS special condition indicator on EMMA. One transaction is executed at a price of 113.618 and the other is executed at a price of 113.868. Assume further that the difference between these two ATS transaction prices is in the customary and typical range of the fee an ATS would charge for its services. In this case, it may be reasonable for Dealer XYZ to conclude that the transaction at 113.618 reflects a sale from a dealer to an ATS taking a principal position in the security, and that the transaction at 113.868 reflects a sale from that ATS to another dealer. Under these circumstances, Dealer XYZ may reasonably determine the PMP by reference to the transaction at 113.868, because the counterparty to the ATS in that transaction was purchasing the security and thus on the opposite side of the market from the side of Dealer XYZ in its customer trade.

(March 19, 2018)

3.19 May dealers adopt a reasonable default proxy where the waterfall guidance refers to trades between dealers and institutional accounts with which any dealer regularly effects transactions in the same security, if such information cannot be ascertained through reasonable diligence?

Yes. Consistent with the Rule G-30 standard of “reasonable diligence” in establishing the PMP of a municipal security, dealers reasonably may use objective criteria as a proxy for the elements of these steps of the waterfall that they cannot reasonably ascertain, such as whether a customer transaction involves an institutional customer and whether that institutional customer regularly trades in the same security with any dealer. A reasonable approach might assume that transactions at or above a $1,000,000 par amount involve institutional customers, since that size transaction is conventionally considered to be an institutional-sized transaction. In addition, because institutional investors transacting at or above this size threshold are typically sophisticated investors, the same size proxy might be used to assume that the institutional customer regularly transacts with a dealer in the same security.

(July 12, 2017)

3.19.1 May a dealer reasonably determine that new issue trade prices executed at list offering/takedown prices are not reflective of the PMP at the time of their execution?

Yes. Because new issues may be priced days before the transactions are executed and reported to RTRS, a dealer may, but is not required to, determine that new issue trades executed at list offering or takedown prices are not reflective of the PMP at the time of their execution. These transactions generally are denoted by a list offering price/takedown indicator on EMMA and in the MSRB Transaction Subscription Service. Market participants may also determine the list offering price by viewing the security’s home page (i.e., the Security Details page) on EMMA.

(March 19, 2018)

3.20  Can an “all-to-all” platform (i.e., one that allows non-dealers to participate) qualify as an inter-dealer mechanism at the step of the waterfall that refers to bids and offers for actively traded securities?

Yes, provided that the dealer determines that the prices available on an “all-to-all” platform are generally consistent with inter-dealer prices. Dealers should include in their policies and procedures how they will periodically review a platform’s activity to make such a determination.

(July 12, 2017)

3.21  When considering bid and offer quotations from an inter-dealer mechanism, how many inter-dealer mechanisms must a dealer check before considering the next category of factors under the waterfall analysis?

The obligation to determine PMP requires a dealer to use reasonable diligence. It does not require a dealer to seek out and consider every potentially relevant data point available in the market. With respect to this factor in the waterfall analysis, a dealer must only seek out and consider enough information to reasonably determine that there is no probative information to determine PMP before proceeding to the next category of factors.

(July 12, 2017)

3.22  In considering bids and offers for actively traded securities made through an inter-dealer mechanism, how can a dealer determine that transactions generally occur at the displayed quotations on the inter-dealer mechanism?

Consistent with the Rule G-30 standard of reasonable diligence and a reasonable policies and procedures approach, a dealer could request and assess from the platform relevant statistics and relevant information reasonably sufficient to conclude that the inter-dealer mechanism meets the applicable requirements under Supplementary Material .06. A dealer could then periodically request and assess updated statistics and relevant information to confirm that the inter-dealer mechanism continues to satisfy the requirements.

(July 12, 2017)

3.23  At the similar securities stage of the waterfall analysis, how can a dealer determine on a systematic basis that an inter-dealer quotation is “validated”?

Consistent with the standard of reasonable diligence and a reasonable and consistently applied policies and procedures approach to the PMP determination, for example, a dealer could determine that a bid (offer) quotation is validated if it is quoted on an “inter-dealer mechanism” (including the all-to-all platforms that qualify, as discussed above). With respect to a dealer’s own bids or offers, dealers are reminded of their existing regulatory obligations under applicable MSRB rules regarding bona fide bids or offers and the requirement that any published quotations must be based on the dealer’s best judgment of the fair market value of the securities. See, e.g., Rule G-13 and MSRB Notice to Dealers That Use the Services of Broker’s Brokers (December 22, 2012). Dealers are also reminded that under Rule G-30, Supplementary Material .06, isolated transactions or isolated quotations (including those that are off-market) generally will have little or no weight or relevance in establishing the PMP of a security.

Due to the lack of bid (offer) quotations for many municipal securities, under the waterfall analysis, dealers in the municipal securities market may not often find information from contemporaneous bid (offer) quotations in the municipal securities market.

(July 12, 2017)

(Updated March 19, 2018)

3.24  May a dealer use the same process it uses to identify a “similar” security for best-execution purposes to identify “similar” securities for PMP purposes?

Yes. Assuming the dealer’s process for identifying “similar” securities for Rule G-18 best-execution purposes is reasonable and in compliance with Rule G-18, a dealer may rely on the same process in connection with identifying similar securities under Rule G-30, Supplementary Material .06.

Alternatively, due to the different purposes of the “similar” security analysis for best-execution purposes as compared to PMP determination purposes, dealers reasonably may adopt a more restrictive approach to identifying “similar” securities for Rule G-30 than they may for Rule G-18. While the relevant part of the best-execution analysis under Rule G-18 seeks to identify the best market to address a customer’s order or inquiry by reference to another security, the relevant part of the waterfall analysis seeks to identify the PMP of one security by reference to another security. Further, Rule G-30 Supplementary Material .06 provides that, in order to qualify as a “similar” security, at a minimum, the municipal security should be sufficiently similar that a market yield for the subject security can be fairly estimated from the yield of the “similar” security. Due to the large number and diversity of municipal securities, the MSRB is of the view that, generally, if the prices or yields of a security would require an adjustment in order to account for differences between the security and the subject security, it would be reasonable for a dealer to determine that that security is not sufficiently “similar” to the subject security for purposes of Supplementary Material .06. To be clear, dealers have the flexibility to determine that a security that requires an immaterial adjustment in order to account for differences is sufficiently “similar” for these purposes, but they are not required to do so. This approach also is consistent with the MSRB’s view that, in order for a security to qualify as sufficiently “similar,” the security must be at least highly similar to the subject security with respect to nearly all the “similar” security factors listed in Rule G-30 Supplementary Material .06(b)(ii) that are relevant to the subject security.

Whichever approach a dealer chooses to apply, the dealer must apply that approach consistently across all municipal securities.

Due to the lack of active trading in many municipal securities and the above discussion regarding the identification of “similar” securities in the municipal securities market, under the waterfall analysis, dealers in the municipal securities market may not often find information from sufficiently similar securities as compared to dealers in other fixed income markets.

Because of the unique characteristics of the municipal securities market, the MSRB response to this question may differ from the FINRA interpretation under FINRA Rule 2121.

(July 12, 2017)

3.24.1 How many “similar” securities must a dealer consider at the “similar” securities stage of the waterfall analysis?

The obligation to determine PMP requires a dealer to use reasonable diligence. It does not require a dealer to seek out and consider every potentially relevant data point available in the market. At this point in the waterfall analysis, a dealer must only seek out and consider enough information to reasonably determine that it has identified the prevailing market price of the security (or that there is no probative information to determine PMP before proceeding to the next level). A dealer’s policies and procedures should explain the process for identifying similar securities (and, if relevant, how the dealer may adjust the prices or yields of identified similar securities). Because the reasonable diligence standard is often guided by industry norms, dealers should periodically revisit their policies and procedures to ensure that their established processes continue to remain reasonable.

Due to the unique characteristics of the municipal securities market, including the large number of issuers and the bespoke nature of many municipal securities, it is unlikely that the dealer will identify a substantial number of “similar” securities for many municipal securities. For example, it would be reasonable for a dealer to determine that a comparison security is not sufficiently “similar” to the subject security for purposes of Supplementary Material .06 if the prices or yields of the comparison security would require an adjustment in order to account for differences between that security and the subject security.

(March 19, 2018)

3.25  How is the “relative weight” provision in paragraphs (a)(v) (regarding the hierarchy of pricing factors) and (a)(vi) (regarding similar securities) of Supplementary Material .06 meant to be used in operation?

This provision is meant to be used when there is more than one comparison transaction or quotation within the categories specified in the hierarchy of pricing factors and when there is more than one comparison transaction or quotation within the similar securities level of the waterfall analysis. In these cases, a dealer may consider the facts and circumstances of the comparison transactions or quotations to determine the weight or degree of influence to attribute to a particular transaction or quotation. For example, a dealer might give greater weight to more recent (timely) comparison transactions or quotations. Similarly, to the extent a dealer considers comparison transactions or quotations in which the dealer is on the same side of the market as the dealer in the subject transaction (if known from dealer customer trade reports),[4] a dealer might give relatively less weight or influence to such information in determining PMP than information from transactions or quotations in which the dealer was on the opposite side of the market from the dealer in the subject transaction.

Consistent with the standard of reasonable diligence and a reasonable policies and procedures approach to the PMP determination, a dealer may adopt a reasonable methodology that it will consistently apply when considering the facts and circumstances of comparison transactions or quotations and assigning relative weight to such transactions or quotations. For example, a dealer might employ an average weighted price methodology (if all relevant trade sizes are publicly available) or last price methodology, provided its policies and procedures called for the reasonable and consistent use of the methodology and did not ignore potentially relevant facts and circumstances, such as side of the market.

Due to the unique characteristics of the municipal securities market, the MSRB response to this question may differ from the FINRA interpretation under FINRA Rule 2121.

(July 12, 2017)

(Updated March 19, 2018)

3.26  When dealers consider the hierarchy of pricing factors under Supplementary Material .06(a)(v), or similar securities factors under paragraph (a)(vi), may they consider the size of comparison transactions to determine their relative weight?

Yes. Paragraphs (a)(v) and (a)(vi) include a non-exhaustive list of facts and circumstances that may impact the “relative weight” of comparison transactions or quotations that may be considered at that point in the waterfall analysis. The MSRB believes it would be reasonable to consider the size of a comparison transaction when considering its relative weight.

(July 12, 2017)

3.27  What is an “applicable index” as that term is used at the “similar securities” level of Supplementary Material .06?

Supplementary Material .06 lists a number of non-exclusive factors that a dealer can look to in determining whether a security is sufficiently “similar” to the subject security. One of these factors is how comparably they trade over an applicable index or U.S. Treasury securities of a similar duration. The inclusion of the more general term “applicable index,” is intended to give dealers flexibility to consider, for example, commonly used municipal market bond indices, yield curves and benchmarks as these may be more relevant than data on Treasury securities (especially for tax-exempt bonds).

Amendment No. 1 to SR-MSRB-2016-12, at 5 (November 14, 2016)

(July 12, 2017)

3.28  Must dealers keep their PMP determination for each trade in their books and records?

The MSRB believes that dealers should keep records to demonstrate their compliance with Rule G-30, particularly where they have the evidentiary burden to demonstrate why a contemporaneous transaction was not the best measure of PMP for a given trade. The MSRB further notes that it would expect PMP documentation to be an important component of a firm’s system to supervise compliance with Rules G-15 and G-30.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 20 n. 39 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 8 (November 14, 2016)

(July 12, 2017)

(Updated March 19, 2018)

3.29  Is there a difference between the PMP that is determined for mark-up disclosure purposes under Rule G-15 and for fair pricing purposes under Rule G-30?

As noted during the rulemaking process, the MSRB recognizes that by allowing dealers to determine PMP for mark-up disclosure purposes at the time of entry of information into systems for confirmation generation, a mark-up disclosed on a confirmation may not reflect subsequent trades that could be considered “contemporaneous” under Supplementary Material .06. However, the MSRB does not believe it is necessary to make a formal distinction between a PMP determined for disclosure purposes and a PMP determined for other regulatory purposes. Still, in connection with any post-transaction fair pricing review process, dealers should not disregard any new information relevant under Supplementary Material .06 that occurs after the mark-up determination (e.g., contemporaneous proceeds obtained after the customer transaction).

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 14; 25; 28 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 10 (November 14, 2016)

(July 12, 2017)

Section 4:  Time of Execution and Security-Specific URL Disclosures

4.1  When must dealers disclose the time of execution on a customer confirmation?

Under Rule G-15, dealers must disclose the time of execution for all transactions, including principal and agency transactions. However, for transactions in municipal fund securities and transactions for an institutional account, as defined in Rule G-8(a)(xi), in lieu of disclosing the time of execution, dealers may instead include on the confirmation a statement that the time of execution will be furnished upon written request of the customer. This time-of-execution disclosure requirement is not limited to circumstances where mark-up disclosure is triggered; therefore, it is required even where mark-up disclosure is not.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 13-14 (September 1, 2016); Amendment No. 1 to SR-MSRB-2016-12, at 4-5 (November 14, 2016)

(July 12, 2017)

4.2  How should the time of execution be disclosed?

Dealers have an obligation under Rule G-14, on reports of sales or purchases of municipal securities, to report the “time of trade” to the MSRB’s Real-Time Transaction Reporting System. In addition, dealers have an obligation under Rule G-8(a)(vii) to make and keep records of the time of execution of principal transactions in municipal securities. The time of execution for confirmation disclosure purposes is the same as the time of trade for Rule G-14 reporting purposes and the time of execution for purposes of Rule G-8(a)(vii), except that dealers should omit all seconds, without rounding to the minute, from the time-of-execution disclosure because the trade data displayed on EMMA does not include seconds.

Alternatively, if disclosure in this format is operationally challenging or burdensome for a dealer, a dealer may choose to disclose the seconds, again without rounding to the minute (e.g., a time of trade of 10:00:59 may be disclosed as 10:00:59 or 10:00). Additionally, because EMMA displays the time of trade in eastern standard time (EST), dealers may disclose on the customer confirmation the time of execution in either military time (as reported to RTRS under Rule G-14) or in traditional EST with an AM or PM indicator (e.g., a time of trade of 14:00:59 may be disclosed on a confirmation as 14:00:59, 14:00, 2:00:59 PM or 02:00 PM). The time-of-execution disclosure format used by a dealer should be consistent for all municipal securities transaction confirmations on which the disclosure is provided.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 14 n. 29 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 6 n. 11 (November 14, 2016)

(July 12, 2017)

(Updated March 19, 2018)

4.3  When must dealers disclose a security-specific URL on a customer confirmation?

Under Rule G-15, dealers must disclose a security-specific URL, in a format specified by the MSRB as discussed below, for all non-institutional customer trades other than transactions in municipal fund securities, even where mark-up disclosure is not required. In the rare situations where there is no CUSIP assigned for a security that is subject to Rule G-15 at the time the dealer trades the security with a customer, the dealer is not required to include the security-specific URL on the customer confirmation.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 13-14; 27; 35 (September 1, 2016); Amendment No. 1 to SR-MSRB-2016-12, at 4 (November 14, 2016)

(July 12, 2017)

(Updated March 19, 2018)

4.4  What is the security-specific URL that must be disclosed?

The template for the URL that must be disclosed under Rule G-15 is:  https://emma.msrb.org/cusip/[insert CUSIP number]. [5] The URL is currently live and operational. Paper confirmations must include this URL with the security-specific CUSIP in print form; electronic confirmations must include the security-specific URL as a hyperlink to the web page.

MSRB Response to Comments on SR-MSRB-2016-12, at 6 (November 14, 2016)

FINRA has provided its own security-specific URL template in its guidance.

(July 12, 2017)

(Updated March 19, 2018)

4.5  Do dealers need to provide any other disclosure concerning the security-specific URL?

Yes. Dealers must include a brief description of the type of information that is available on the security-specific web page for the subject security, such as information about the prices of other transactions in the same security, the official statement and other disclosures for the security, ratings and other market data and educational material. To be clear, the disclosure does not need to describe with specificity all of the information available on the relevant web page. As described above, the description should be brief. Additionally, it only needs to describe enough information about the relevant web page that a reasonable investor would understand the type of information available on that page. For example, the following language would satisfy this obligation: “For more information about this security (including the official statement and trade and price history), visit [insert link]."[6]  Because this language is an example only, dealers may use other language to describe the content of the web page.

As a reminder, Rule G-15(a)(i)(E) requires all requirements to be clearly and specifically indicated on the front of the confirmation, subject to limited exceptions. Because the description of the type of information available on the security-specific web page is not listed as an exception, it must be on the front of the confirmation.

SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 13; 27 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 6 n. 9 (November 14, 2016)

(July 12, 2017)

(Updated March 19, 2018)

4.6 Is disclosure of the time of execution or security-specific URL required for transactions that involve a dealer and a registered investment adviser?

No. Disclosure of the time of execution and security-specific URL is not required for transactions with an institutional customer. Under Rule G-15, a registered investment adviser is an institutional accountholder; accordingly, disclosure is not required for these transactions. This is the case even if the registered investment adviser with whom the dealer transacted later allocates all or a portion of the securities to a retail account or where the transaction is executed directly for a retail account if the investment adviser has discretion over the transaction. The MSRB notes that this answer is specific to the time-of-execution and security-specific URL disclosure requirements in Rule G-15; it is not intended to alter any other obligations.

(July 12, 2017)


[1] EMMA is a registered trademark of the MSRB.

[2] Prior to May 14, 2018, Supplementary Material .01(d) provides that dealer compensation on a principal transaction is considered to be a mark-up or mark-down that is computed from the inter-dealer market price prevailing at the time of the customer transaction. As of May 14, 2018, the reference to the prevailing “inter-dealer” price is amended to instead, as noted above, reference the “prevailing market price,” as described in Supplementary Material .06. Supplementary Material .06, which applies to customer transactions and not internal position movements, generally embodies the principle that the PMP of a security is generally the price at which dealers trade with one another. This underlying principle does not mean that dealers may avoid following the steps of the waterfall analysis in the specific order prescribed in Supplementary Material .06. However, it remains a useful principle that dealers may wish to consider in approaching certain unspecified aspects of the waterfall analysis. The MSRB’s responses to Questions 3.11, 3.12, 3.20 and 3.23, in part, are reflective of this underlying principle. Other answers, including those in response to Questions 3.9, 3.10, 3.21 and 3.25 are reflective of the MSRB’s longstanding “reasonable diligence” standard, discussed above.

[3] This example assumes that the dealer has identified that it has contemporaneous cost and proceeds at the time that it is determining the mark-up and mark-down to each customer. If this is not the case, however, because the dealer systematically inputs information into its systems for the generation of PMP at the time of trade, then there is a different result. For example, assume that the trade at 98 occurs at 10:00 AM, the trade at 100 occurs at 3:00 PM and these trades are contemporaneous. If the dealer systematically determines PMP at the time of trade, consistent with Question 3.4, at the time of the 10:00 AM trade, the dealer may simply proceed down the waterfall to determine the PMP for the security without the need to adjust that PMP. At the time of the 3:00 PM trade, however, the dealer should adjust its contemporaneous cost as described above to account for the mark-down included in the price.

[4] At the institutional transactions and quotations categories in the hierarchy of pricing factors level of the waterfall, generally, dealers consider information from only one side of the market, depending on whether the dealer is charging a mark-up or mark-down. However, pursuant to reasonable and consistently applied policies and procedures, a dealer may consider information from transactions in which the dealer is on the other side of the market when reasonable to do so. For example, this may be reasonable where the dealer has identified no comparison transactions in which the dealer is on the opposite side of the market as the dealer in the subject transaction. In this case, the dealer may reasonably adjust the transaction price by an amount to account for the price at which that transaction might have occurred had it been a transaction in which the dealer was on the opposite side of the market from the dealer in the subject transaction. Also for example, where the dealer has identified comparison transactions on both sides of the market, the dealer reasonably may perform a similar adjustment (i.e., adjust a price from a transaction in which the dealer is on the same side of the market as the dealer in the subject transaction by an amount to account for the price at which that transaction might have occurred had it been a transaction in which the dealer was on the opposite side of the market from the dealer in the subject transaction). A dealer’s ability to consider such information may be particularly important in the municipal market in which securities often trade infrequently and in which dealers may often have such limited information available to them at the time of their PMP determination.

[5] The MSRB previously announced the URL template as: http://emma.msrb.org/cusip/[insert CUSIP number]. Accordingly, confirmations for dealers that began to program their confirmations in accordance with the previously announced URL template may begin with the http format, rather than the https format. The MSRB does not expect such dealers to reprogram the URLs provided on customer confirmations as the http format will continue to function and will automatically redirect to the more secure https site.

[6] As a reminder, for dealers that currently seek to satisfy their obligation to provide a copy of the official statement to customers under Rule G-32(a)(iii) by notifying customers of the availability of the official statement through EMMA, the provision of the link described in this set of FAQs would satisfy both the relevant Rule G-15 security-specific URL obligation and the Rule G-32(a)(iii), provided that, for purposes of Rule G-32(a)(iii), the URL address also is accompanied by the additional information described. For example, if a dealer included the sample description included in this question, the addition of the language “Copies of the official statement are also available from [insert dealer name] upon request” would satisfy both the Rule G-15 security-specific URL obligation and Rule G-32(a)(iii) obligations. 

Interpretive Guidance - Interpretive Notices
Publication date:
Obligations of Senior Syndicate Managers Utilizing Electronic Communications
Rule Number:

Background

In November 1998, the Municipal Securities Rulemaking Board (the “MSRB” or “Board”) published an interpretation about the use of electronic media to deliver and receive information by brokers, dealers and municipal securities dealers (collectively, “dealers”) under Board rules (the “1998 Interpretation”).[1] The 1998 Interpretation addresses how dealers may use electronic media to satisfy their delivery obligations under MSRB rules, including communications among dealers and between dealers and issuers. It states, “. . . a dealer that undertakes communications required under Board rules with other dealers and with issuers in a manner that conforms with the principles stated [in the 1998 Interpretation] relating to customer communications will have met its obligations with respect to such communications.”[2]

Discussion

The MSRB wishes to remind dealers of the 1998 Interpretation, particularly in light of the January 13, 2020 compliance date for certain amendments to MSRB Rule G-11, on primary offering practices.[3] Among other modifications, the amendments to Rule G-11 require senior syndicate managers to provide certain information to issuers regarding allocations and net designations.

The MSRB understands that dealers acting as senior syndicate managers may use external third-party electronic systems or proprietary electronic systems to manage aspects of the primary offering process, such as the tracking of orders, the automated communication of certain information to syndicate members, and other electronic data sharing features (“electronic bookrunning systems”). With respect to certain information required to be delivered to other dealers and issuers under Rule G-11, the Board believes that such information may be provided by electronic means so long as the standards established in the 1998 Interpretation with respect to electronic communications are met, including providing timely and adequate notice that such information may be accessed electronically. For example, with respect to Rule G-11(g)(ii), within two business days following the date of sale, a senior syndicate manager can inform an issuer that allocation information is available electronically (e.g., on an electronic bookrunning system that an issuer has access to) by pushing notice to the issuer (e.g., email). Additionally, consistent with the 1998 Interpretation, a dealer should provide a paper version of the allocation information should an issuer request or object to receiving the information electronically.


[1] See Exchange Act Release No. 40848 (Dec. 28, 1998), 64 FR 544 (Jan. 5, 1999) (File No. SR-MSRB-98-12); see also Notice Regarding Electronic Delivery and Receipt of Information by Brokers, Dealers and Municipal Securities Dealers (Nov. 20, 1998).

[2] Id. 

[3] See MSRB Notice 2019-15 (June 28, 2019).

Interpretive Guidance - Interpretive Notices
Publication date:
"FAQs regarding the Use of Social Media under MSRB Rule G-21, on Advertising by Brokers, Dealers or Municipal Securities Dealers, and MSRB Rule G-40, on Advertising by Municipal Advisors"

 

The Municipal Securities Rulemaking Board (MSRB) provides these answers to frequently asked questions (FAQs) to enhance market participants’ understanding of permissible and impermissible uses of social media as part of their municipal securities business or municipal advisory activities under MSRB Rule G-21, on advertising by brokers, dealers or municipal securities dealers (collectively, “dealers”), and under MSRB Rule G-40, on advertising by municipal advisors (Rule G-21, together with Rule G-40, the “advertising rules”). These FAQs can assist dealers and municipal advisors (collectively, “regulated entities”) with their compliance with the MSRB’s advertising rules.

In developing these FAQs, the MSRB has been mindful of the potential burden on a regulated entity if there were to be unnecessary inconsistencies between any adopted MSRB social media guidance and similar guidance issued by other regulators that may be applicable to other aspects of the regulated entity’s business. To that end, and to the extent practicable, the MSRB has endeavored to align these FAQs with the social media guidance published by the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority, Inc. (FINRA).[1]

The FAQs discuss compliance with MSRB rules; regulated entities are reminded that they also may be subject to the rules of other financial regulators, including state regulators. Further, a regulated entity’s use of social media to conduct municipal securities or municipal advisory activities is optional, and the responsibilities that follow from that social media usage are not new here. In particular, a regulated entity should consider its ability to comply with the existing recordkeeping requirements under the federal securities laws and incorporated into MSRB rules when determining whether to use social media to conduct municipal securities or municipal advisory activities and whether to permit its associated persons to use social media to conduct municipal securities or municipal advisory activities.

Background

Amended Rule G-21 and new Rule G-40, effective as of the date of these FAQs, set forth general provisions, address professional advertisements by the relevant regulated entity and require principal approval, in writing, for advertisements by regulated entities before their first use.

During the development of the amendments to Rule G-21 and of new Rule G-40, the MSRB received requests for guidance regarding the use of social media by a regulated entity under those rules. These FAQs provide the requested guidance.

 

Consistent with MSRB Rule D-11, references in the FAQs to a dealer, municipal advisor or regulated entity generally include the associated persons of such dealer, municipal advisor or regulated entity.[2]

Use of Social Media

1.     Is social media use by a regulated entity relating to its municipal securities business or municipal advisory activities considered advertising under the MSRB’s advertising rules?

Yes, depending on the facts and circumstances. With limited exceptions, any material that relates to (i) the products or services of the dealer, (ii) the services of the municipal advisor, or (iii) the engagement of a municipal advisory client by the municipal advisor, may constitute an advertisement under the MSRB’s advertising rules, if it is:

 

  • published or used in any electronic or other public media; or
  • written or electronic promotional literature distributed or made generally available to either customers or municipal entities, obligated persons, municipal advisory clients or the public.

To the extent that the use of social media, including blogs, microblogs and social and professional networks, by a regulated entity is deemed advertising based on its content and distribution, that advertising would be subject to all applicable provisions of Rules G- 21 and G-40. Those provisions include content standards and a requirement that an advertisement be pre-approved by a principal before its first use.

Further, dealers and municipal advisors should bear in mind that “posts” or “chats” on social media, including those deemed advertising, are subject to all other applicable MSRB rules.

Those rules include:

 

  • MSRB Rule G-17, on conduct of municipal securities and municipal advisory activities;
  • MSRB Rule G-27, on supervision;
  • MSRB Rule G-44, on supervisory and compliance obligations of municipal advisors;
  • MSRB Rule G-8, on books and records to be made by brokers, dealers, municipal securities dealers, and municipal advisors; and
  • MSRB Rule G-9, on retention of records.    

2.     Can an associated person’s personal social media use be deemed “advertising” that is subject to the MSRB’s advertising rules?

Potentially, yes. An associated person’s personal social media use would not per se be advertising that is subject to the MSRB’s advertising rules. Whether an associated person’s personal social media use is advertising depends on whether the content of the social media relates to (i) the products or services of the dealer, (ii) the services of the municipal advisor, or (iii) the engagement of a municipal advisory client by the municipal advisor, as relevant.

 

  • For example, an associated person of a regulated entity “posts” the following on his personal social media that is viewable by the public rather than a selected audience:

Let’s help our children! ABC Youth Group is having a car wash to raise funds for a new basketball court on May 18th at 3:00 pm at XYZ address. Get your car washed and help out.

     

    The content in the “post” in the above example does not relate to (i) the products or services of the dealer, (ii) the services of the municipal advisor, or (iii) the engagement of a municipal advisory client by the municipal advisor. Even though the “post” is publicly available, the “post” would not be advertising that is subject to the MSRB’s advertising rules.

     

    Similarly, an associated person may hyperlink from his or her personal social media to content on his or her dealer’s or municipal advisor’s social media. The “hyperlinking” by the associated person to the regulated entity’s social media would not constitute an advertisement if that hyperlinked content does not relate to the matters referenced in the preceding paragraph.[3]

     

    • For example, a “post” from associated person FGH’s personal social media contains a hyperlink to an article on municipal advisor ABC’s website about an animal shelter rebuilding after recent flooding. The “post” is viewable by the public.

    The “post” would not be advertising that is subject to the MSRB’s advertising rules. The “post,” although it contains a hyperlink to a regulated entity’s website, links to content that does not relate to the services of the municipal advisor or the engagement of a municipal advisory client by a municipal advisor.

     

    By contrast, to the extent that an associated person of a municipal advisor engages in advertising, as defined by Rules G-21 and G-40, on his or her personal social media, that advertising would be subject to the requirements of the MSRB’s advertising rules.

     

    • For example, an associated person of ABC municipal advisor posts the following on his or her personal social networking page that is viewable by the general public:

    I’m happy to be part of the team! ABC municipal advisor was rated the best in XYZ state for airport financings during 2017 according to DEF rating service. ABC municipal advisor has great experience in airport financings, and can help you with your next project.

    The “post” would be an advertisement, as defined in Rule G-40(a)(i). The content of the electronically distributed “post” (i) promotes the expertise and experience of ABC municipal advisor and solicits inquiries about its services and (ii) is generally available to municipal entities, obligated persons, municipal advisory clients or the public. As such, even though the advertisement was “posted” on the associated person’s personal social networking page, the “post” would be subject to the requirements of Rule G-40 as well as all other applicable MSRB rules. See question 1.

     

    3.    Do the MSRB’s advertising rules apply to hyperlinked content on an independent third-party website from a regulated entity’s website?

    The MSRB’s advertising rules would apply to hyperlinked content on an independent third-party’s website from a regulated entity’s website in those instances where the regulated entity either:

    • involved itself in the preparation of content on that third-party website— this is known as entanglement;[4]; or
    • implicitly or explicitly approved or endorsed the content on that third-party website —this is known as adoption.[5]

    Accordingly, if a regulated entity either becomes entangled with or adopts the hyperlinked content, the regulated entity has obligations under MSRB’s advertising rules for that content.

    • For example, on its website, ABC dealer states that XYZ municipal entity has a great article about the financing for its new school (ABC dealer was the underwriter for that financing), and ABC dealer provides a hyperlink to that article.

    In this case, ABC dealer, by stating it was a great article, would have adopted the article on XYZ’s website, and the content of that article would be subject to Rule G-21. Further, depending on the facts and circumstances, ABC may have adopted the article by linking to its specific content even without stating that the article was a great article. See question 4. A regulated entity should consider whether the context of the hyperlink and the content of the hyperlinked information together create a reasonable inference that the regulated entity has approved or endorsed the hyperlinked information.[6]

    Similarly, a regulated entity may become entangled with hyperlinked content.

    • For example, CDE municipal advisor assists XYZ issuer with the preparation of a press release about a financing to build a new school. The press release discusses how the financing method will save taxpayer dollars, but does not mention CDE municipal advisor. CDE municipal advisor then posts a hyperlink on its website to the press release on XYZ issuer’s website.

    In this case, CDE municipal advisor, because it helped prepare the press release, would have become entangled with the press release, and the hyperlinked content would be an advertisement subject to Rule G-40.

    See Question 7 for discussion regarding third-party posts.

    4.    What factors are relevant for a regulated entity to consider as it determines whether it has adopted the hyperlinked content on an independent third-party’s website?

    While non-exclusive, some factors to consider are:[7]

    • Does the context suggest that the regulated entity has approved or endorsed the hyperlinked content? The regulated entity may want to consider its disclosure about the hyperlink and what a reader may imply by the location and presentation of the hyperlink. For example:
      • Does the regulated entity state that it approves or endorses the prominently-featured hyperlinked content (in which case, the regulated entity would have adopted the hyperlinked content), or does the regulated entity have a portion of its website that links to recent general news articles and provides hyperlinks to the websites of various newspapers or magazines (depending on the facts and circumstances, in most cases, the regulated entity would not have adopted such content)?[8]

      • Does the hyperlinked content indicate a degree of selective choice by the regulated entity, such as a hyperlink to a specific news article that is laudatory of the regulated entity, as compared to a hyperlink to the website of the newspaper?[9]

      • Does the regulated entity provide an explanation about the source of a hyperlinked article and why the regulated entity is hyperlinking to it in order to avoid the inference that the regulated entity is adopting the hyperlinked content?[10]

      Although a regulated entity’s hyperlink to specific independent third-party content may indicate adoption of that content, if the hyperlinked content itself is not an advertisement, the regulated entity’s hyperlink to that content would not be an advertisement under Rules G-21 and G-40.

      • For example, ABC dealer includes a hyperlink on its website to an article regarding the importance of saving for college on an independent third- party’s website. The article does not identify any particular 529 savings plan, any dealer, or any municipal security.

      In this case, ABC dealer hyperlinks to an article that is purely educational. Because the hyperlinked content does not address ABC dealer or a municipal security offered through ABC dealer, the hyperlinked content would not be an advertisement, and ABC dealer’s hyperlink to that content would not be an advertisement that is subject to Rule G-21.

    • Does the hyperlink create customer or municipal advisory client confusion? The regulated entity may want to consider whether a customer or municipal advisory client would be confused and not fully appreciate that the hyperlink is to third-party content. Does the regulated entity provide disclosure to explain that the hyperlink is to third-party content?[11]

    • Is the hyperlink to content that is not controlled by the regulated entity and is the hyperlink ongoing? When a regulated entity links to content that is hosted by an independent third-party that is not controlled or influenced by the regulated entity, that content may not be advertising subject to the MSRB’s advertising rules if the hyperlink is “ongoing.”

      An “ongoing” link is one which: (i) is continuously available to visitors to the regulated entity’s website; (ii) visitors to the regulated entity’s site have access to even though the independent third-party site may or may not contain favorable material about the regulated entity; and (iii) visitors to the regulated entity’s website have access to even though the independent third-party’s website may be revised.[12] A regulated entity may not have adopted the content on the independent third-party’s website if the link is “ongoing.”

    However, where a regulated entity has become entangled with the hyperlinked content on a third-party website (to the extent that hyperlinked content otherwise meets the definition of an advertisement), that hyperlinked content would be an advertisement under Rules G-21 and G-40 and the regulated entity must consider all applicable provisions of the MSRB’s advertising rules, including with respect to the hyperlinked content.[13] Therefore, a regulated entity should not include hyperlinked content on its website if there are any red flags that indicate that the hyperlinked content contains false or misleading material.[14]

    5.    May a regulated entity use a disclaimer alone to disclaim potential MSRB rule violations for hyperlinked content on an independent third-party website?

    No, the MSRB generally would not view a disclaimer alone as sufficient to insulate a regulated entity from potential MSRB rule violations related to hyperlinked content on an independent third-party website that the regulated entity knows or has reason to know is materially false or misleading. A regulated entity that hyperlinks to content that the regulated entity knows or has reason to know is materially false or misleading may violate Rules G-17, G-21 and/or G-40.[15]

    6.    Do the MSRB’s advertising rules apply to linked content within independent third- party content to which a regulated entity hyperlinked?

    No, Rules G-21 and G-40, in general, would not apply to linked content within content to which the regulated entity linked (“secondary links”). However, to avoid triggering the application of Rules G-21 and G-40:

    • The regulated entity must not have adopted or become entangled with the content in the secondary link – See question 3;
    • The regulated entity must have no influence or control over the content in the secondary links – See question 4;
    • The original linked content must not be a mere vehicle for the secondary links or not rely completely on the information available in the secondary links; and
    • The regulated entity must not know or have reason to know that the information contained in the secondary links contains any untrue statement of material fact or is otherwise false or misleading.[16] A regulated entity should not include a link on its website if there are any red flags that indicate that the hyperlinked website contains false or misleading content.[17]

    Third-Party Posts

    7.    Do Rules G-21 and G-40 apply to posts by a customer, municipal entity client or another third-party (collectively, “third-party posts”) on a regulated entity’s or its associated person’s social networking page?

    In general, no. Rules G-21 and G-40 generally would not apply to posts by a third-party on a regulated entity’s or its associated person’s social networking page. The post would not be considered material that is published, distributed or made available by the dealer or municipal advisor.

    Notwithstanding, Rules G-21 and G-40 may apply to such third-party posts under certain circumstances. For example, Rules G-21 and G-40 would apply to such posts if the dealer or municipal advisor becomes entangled with or adopts the content of such posts. See also question 3.

    • Entanglement. A regulated entity becomes entangled with a post by a third-party on the regulated entity’s social networking page if the regulated entity has involved itself with the preparation of the third-party content.[18] For example, a regulated entity or its associated person may become entangled with a third-party post if the regulated entity or its associated person pays for or solicits a third-party to post certain comments on the regulated entity’s social networking page.

    • Adoption. A regulated entity adopts the content of the third-party post if the regulated entity explicitly or implicitly approves or endorses the content.[19] A regulated entity or its associated person may adopt a third- party post if it “likes,” “shares,” or otherwise indicates approval or endorsement of the content.

    See question 3 above for a discussion of hyperlinked content on an independent third- party website; see question 4 above for a discussion of the non-exclusive factors to consider when determining whether a regulated entity or its associated person has adopted third-party content.

    8.    May a municipal advisory client post positive comments about its experience with the municipal advisor on the municipal advisor’s social media page without such post being a testimonial under Rule G-40?

    As with question 7 above, if a municipal advisory client posts positive comments on a municipal advisor’s social media page and the municipal advisor does not become entangled with or adopt that content, the municipal advisor could allow such content on its social media page. This would be true even if the municipal advisory client’s comments were to include a testimonial.

    However, if the municipal advisor paid for or solicited a municipal advisory client to post positive comments about its experience with the municipal advisor on the municipal advisor’s social media page, that post would be deemed to be an advertisement by the municipal advisor that contains a testimonial within Rule G-40.

    Specifically, by paying for or soliciting positive comments from a third-party, the municipal advisor would become entangled with those comments, and the posting of those third-party comments on the municipal advisor’s social media page would be deemed to be an advertisement by the municipal advisor that contains a testimonial within Rule G-40(a)(iv)(G). See question 7. As such, the municipal advisor’s use of that testimonial content would be prohibited.[20] Similar considerations would prohibit the municipal advisor from “liking” the municipal advisory client’s post or by forwarding the municipal advisory client’s post to others, thereby adopting the content.

    Recordkeeping

    9.    Must regulated entities retain records of “posts,” “chats,” text messages or messages sent through messaging applications related to the regulated entity’s business conducted through social media?

    Yes, the MSRB’s recordkeeping and record retention requirements apply to all written, including electronic, communications sent or received as well as records of advertisements under the MSRB’s advertising rules.

    Specifically, for dealers, Rule G-9(b)(viii)(C) requires that “all written and electronic communications received and sent, including inter-office memoranda, relating to the conduct of the activities of such municipal securities broker or municipal securities dealer with respect to municipal securities” be retained. Similarly, Rule G-9(h)(i) requires that a municipal advisor retain records, which include, among other things, originals or copies of all written and electronic communications received and sent, including inter-office memoranda, relating to municipal advisory activities.[21] Neither the technology used for the communication nor the distinction between a communication made through a device issued by the regulated entity or its associated person’s personal device is determinative for this analysis. See questions 10 and 11 regarding supervision.

    Supervision[22]

    10.    Should a regulated entity consider establishing policies and procedures as part of its supervisory system to address the use of social media by the regulated entity and its associated persons?

    Yes, given that recordkeeping requirements apply to electronic communications, a regulated entity should establish policies and procedures to address the use by the regulated entity and its associated persons of social media.[23] As a baseline, those policies and procedures would reflect the regulated entity’s permitted and/or prohibited practices. Such permitted practices may include restrictions on the use of certain technologies or the prohibition of the use of social media to engage in municipal securities business or municipal advisory activities. Further, the supervisory system for a regulated entity that permits the use of social media would address all applicable MSRB rules, including, but not limited to:

    • The MSRB’s advertising rules;
    • Rule G-17;
    • Rule G-8; and
    • Rule G-9.

    See question 1.

    11.    What are some factors that a regulated entity should consider as it develops policies and procedures about the use of social media?

    As with any policy and procedure, a regulated entity’s social media policies and procedures would be tailored to reflect, among other things, its size, organizational structure and the nature and scope of its municipal securities or municipal advisory activities. Social media policies and procedures are not expected to be “one size fits all.”

    Among the factors that a regulated entity should consider as it develops social media policies and procedures are:

    Usage Restrictions. While some regulated entities may prohibit an associated person from engaging in municipal securities business or municipal advisory activities through social media, other regulated entities may permit the use of social media for such purposes. A regulated entity that permits the use of social media by its associated persons, in whole or in part, should consider providing associated persons with a clear and concise list of permitted social media for the conduct of municipal securities business or municipal advisory activities. That list also may include any restrictions to the use of particular social media (for example, a regulated entity may permit certain messaging applications to be used only for internal communications among the regulated entity and its associated persons). If applicable, a regulated entity should consider making the list of permitted social media widely available and easily accessible to its associated persons.[24]

    Further, recognizing the need to have policies and procedures that are reasonably designed to ensure compliance with MSRB rules as well as with other applicable securities laws and regulations, and in light of the pace of technology innovations, a regulated entity that permits the use of social media should consider periodically reviewing its list of permitted social media. As part of that review, the regulated entity should determine whether any updates to the list of permitted social media would be warranted.[25]

    Along with the list of permitted social media, the regulated entity should consider addressing the consequences of non-compliance with its social media policies and procedures.[26]

    Training and Education. The regulated entity’s social media policies and procedures may address the training that the regulated entity will provide related to those policies and procedures. For example, will the training include an initial training as well as training that is required on a periodic basis? In addition, a regulated entity’s training on social media may address various topics likely to occur such as an explanation of the differences between business and personal social media use and how the lines between business and personal social media usage could be blurred. For example, an associated person could receive a request on his or her personal social media relating to municipal securities business or municipal advisory activities. A regulated entity may want to consider how the associated person should respond to such a request.

    Recordkeeping and Record Retention. As noted in question 1, it is possible that social media posts relating to the regulated entity’s municipal securities business or municipal advisory activities would be subject to the MSRB’s recordkeeping and record retention rules. A regulated entity should consider its recordkeeping and record retention obligations as it designs its social media compliance policies and procedures.[27]

    Monitoring. As a regulated entity develops its social media policies and procedures, the regulated entity should consider how it will monitor for compliance with those policies and procedures. For example, a regulated entity may determine to more frequently monitor various social media activities based on the potential risks that the regulated entity has determined may be associated with those activities. See question 12 below for a discussion of various factors that the regulated entity may want to consider as it develops its policies and procedures. As a reminder, a regulated entity’s supervisory procedures concerning social media should address not only the MSRB’s advertising rules, but all applicable MSRB rules and other applicable federal securities laws and regulations.

    12.    What factors may be important in determining the effectiveness of policies and procedures concerning social media?

    As noted in question 10, MSRB Rules G-27 and G-44 generally require that a regulated entity establish, implement and maintain a supervisory system that is reasonably designed to achieve compliance with MSRB rules as well as with other applicable federal securities laws and regulations. To help test whether that goal is being met with regard to its social media compliance policies and procedures, a regulated entity may want to consider the following non-exclusive factors:

    • Content standards. A regulated entity should consider whether there are certain risks associated with content created by the regulated entity for its social media and whether that content may create regulatory issues. For example, non-solicitor municipal advisors owe a fiduciary duty to their municipal entity clients. Is the social media content consistent with that duty (e.g., such as content that contains information on specific municipal advisory activity or a recommendation regarding that activity)? Further, is the social media content consistent with the testimonial restrictions set forth in the MSRB’s advertising rules?
    • Monitoring of third-party sites. To the extent that the regulated entity permits the use of social networking sites, a regulated entity should consider how it will monitor for compliance with the regulated entity’s social media policies and procedures on those sites.
    • Criteria for approving participation in social networking sites. A regulated entity should consider whether to develop standards relating to social networking participation. For example, at a minimum, a regulated entity must ensure compliance with record retention requirements. As the regulated entity develops its criteria for approving the use of certain sites, the regulated entity also should address whether it has a process in place for revoking approval to participate in a particular social networking site should certain circumstances change.
    • Personal social networking sites. A regulated entity should address whether the regulated entity or its associated persons may engage in municipal securities business or municipal advisory activities on personal social networking sites.
    • Enterprise-wide sites. A regulated entity that is a part of a larger financial services organization should consider whether it needs to develop usage guidelines reasonably designed to prevent the larger financial services organization in organizational-wide advertisements from violating the MSRB’s advertising rules including, for municipal advisors, the prohibition on the use of testimonials in municipal advisor advertising.

    Additional Resources

    SR-MSRB-2018-01 (January 24, 2018)

    Letter from Pamela K. Ellis, Associate General Counsel, Municipal Securities Rulemaking Board, dated April 30, 2018

    Self-Regulatory Organizations; Municipal Securities Rulemaking Board; Order Granting Approval of a Proposed Rule Change, Consisting to Amendments to Rule G-21, on Advertising, Proposed New Rule G-40, on Advertising by Municipal Advisors, and a Technical Amendment to Rule G-42, on Duties of Non-Solicitor Municipal Advisors

    MSRB Notice 2018-08 SEC Approves Advertising Rule Changes for Dealers and Municipal Advisors

    MSRB Notice 2018-32 Application of Content Standards to Advertisements by Municipal Advisors under MSRB Rule G-40

     

     

    [1] See, e.g., IM Guidance Update, No. 2014-04, Division of Investment Management, U.S. Securities and Exchange Commission (Mar. 2014) (“2014 IM Guidance Update”); National Examination Risk Alert, Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission (Jan. 4, 2012) (“2012 Risk Alert”); Exchange Act Release No. 58288 (Aug. 1, 2008); FINRA Regulatory Notice 17-18 (Apr. 2017). These materials are identified for reference and such reference is not intended to suggest that regulated entities that are not subject to the guidance issued by the SEC or FINRA are responsible for compliance with that guidance. In addition, the MSRB does not intend for the guidance provided by these FAQs to modify or otherwise affect the guidance contained in the any of the referenced materials published by the SEC or FINRA.

    [2] Rule D-11 provides that:

     

    Unless the context otherwise requires or a rule of the Board otherwise specifically provides, the terms “broker,” “dealer,” “municipal securities broker,” “municipal securities dealer,” “bank dealer,” and “municipal advisor” shall refer to and include their respective associated persons. Unless otherwise specified, persons whose functions are solely clerical or ministerial shall not be considered associated persons for purposes of the Board’s rules.

    [3] For example, such hyperlinked content may include information about a charity event sponsored by the dealer or municipal advisor, a human interest article, an employment opportunity, or employer information covered by state and federal fair employment laws. See, e.g., FINRA Regulatory Notice 17-18 (Apr. 2017) at 4.

    [4] See, e.g., Exchange Act Release No. 58288 (Aug. 1, 2008) at 32, 73 FR 45862 (Aug. 7. 2008) at 45870 (the “2008 release”); Exchange Act Release No. 42728 (Apr. 28, 2000), 65 FR 25843 (May 4, 2000) at 25848 (the “2000 release”).

    [5] Id.

    [6] 2008 release at 34.

    [7] See 2008 release at 33; 2000 release at 25849.

    [8] See 2008 release at 34; 2000 release at 25849.

    [9] See 2008 release at 35.

    [10] Id.

    [11] See 2008 release at 36; 2000 release at 25849.

    [12] See FINRA Regulatory Notice 17-18 (Apr. 2017) at 5.

    [13] See MSRB Notice 2018-14 (Jun. 27, 2018).

    [14] See FINRA Regulatory Notice 11-39 (Aug. 2011) at 3.

    [15] See 2008 Release at 36-37; 2000 Release at 25849.

    [16] See FINRA Regulatory Notice 17-18 at Q:4; see Q:5.

    [17] See FINRA Regulatory Notice 11-39 (Aug. 2011) at 3.

    [18] See 2008 release at 32; 2000 release at 25848-49; FINRA Regulatory Notice 10-06 (Jan. 2010) at 7-8. The MSRB’s definition of the entanglement and adoption theories is consistent with the definition of those theories set forth by the SEC and FINRA in those materials.

    [19] Id.

    [20] See 2014 IM Guidance Update at 3.

    [21] Rule G-8(h)(i) requires municipal advisors to make and keep current all books and records described in Rule 15Ba1-8(a) under the Exchange Act. Particularly, Rule 15Ba1- 8(a)(1) requires that municipal advisors make and keep true, accurate, and current “originals or copies of all written communications received, and originals or copies of all written communications sent, by such municipal advisor (including inter-office memoranda and communications) relating to municipal advisory activities, regardless of the format of such communications.”

    [22] While many regulated entities may find the guidance in these FAQs useful when establishing their supervisory systems, each regulated entity should develop a supervisory system that is tailored to its own business model, recognizing that some considerations may not apply in the same manner for every firm and others may not apply at all.

    [23] In part, Rules G-27(b) and Rule G-44(a) require that a regulated entity establish a supervisory system to supervise the municipal securities and municipal advisory activities of the regulated entity and its associated persons. In general, a supervisory system includes:

    1. compliance policies and procedures that describe the practices that associated persons must adhere to in order to meet the standards of conduct established by the regulated entity consistent with applicable securities laws and regulations, including MSRB rules; and
    2. written supervisory procedures that describe the practices that the supervisory personnel follow in order to reasonably ensure that associated persons meet the standards of conduct and the regulated entity can evidence a supervisory system.

    [24] See, e.g., 2012 Risk Alert at 3; FINRA Regulatory Notice 07-59 (Dec. 2007) at 7.

    [25] See, e.g., 2012 Risk Alert at 4.

    [26] See FINRA Regulatory Notice 07-59 (Dec.2007) at 7; see also National Exam Program Risk Alert, Observations from Investment Adviser Examinations Relating to Electronic Messaging, Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission (modified Dec. 14, 2018) available at https://www.sec.gov/ocie/announcement/ocie-risk-alert-electronic-messaging (“2018 Risk Alert”) at 4.

    [27] See FINRA Regulatory Notice 07-59 (Dec. 2007) at 6-7; 2018 Risk Alert at 3-4.

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Confirmation Disclosure and Prevailing Market Price Guidance: Frequently Asked Questions
    Rule Number:

    Rule G-15, Rule G-30

    (First published July 12, 2017)

     

    Effective May 14, 2018, amendments to MSRB Rule G-15 require dealers to disclose additional information on retail customer confirmations for a specified class of principal transactions, including the dealer’s mark-up or mark-down as determined from the prevailing market price (PMP) of the security. Dealers generally also are required to disclose on retail customer confirmations the time of execution and a security-specific URL to the MSRB’s Electronic Municipal Market Access (EMMA®) website.[1] Related amendments to Rule G-30, on prices and commissions, provide guidance on determining the PMP for the purpose of calculating a dealer’s mark-up or mark-down and for other Rule G-30 determinations.

     

    Also, effective May 14, 2018, amendments to Financial Industry Regulatory Authority (FINRA) Rule 2232 create similar confirmation disclosure requirements for other areas of the fixed income markets. Among other things, the FINRA amendments require dealers to determine their disclosed mark-ups and mark-downs from the PMP of the security that is traded, in accordance with existing guidance under FINRA Rule 2121.

     

    Below are answers to frequently asked questions (FAQs) about the confirmation disclosure requirements under Rule G-15 and related PMP guidance under Rule G-30, Supplementary Material .06 (also referred to as the “waterfall” guidance or analysis). While these FAQs address MSRB rules only, FINRA has also issued guidance for the FINRA rules applicable to agency and corporate bonds. The MSRB and FINRA worked together to produce this guidance. While each has published its own version to refer to MSRB and FINRA rules and materials, respectively, the versions are materially the same and reflect the organizations’ coordinated approach to enhanced confirmation disclosure for debt securities. To the extent the MSRB and FINRA offer different guidance based on differences between the markets for corporate, agency and municipal securities, those differences are discussed in the context of the relevant question and answer.

     

    During the implementation period, the MSRB will continue to work with dealers on questions related to the confirmation disclosure requirements and PMP guidance. Dealers are encouraged to contact the MSRB to suggest additional topics or questions for inclusion in the FAQs. Accordingly, the MSRB may add to, update or revise this guidance. The most recent date for the content of an answer will be clearly marked.

     

    For ease of reference, unless otherwise noted, the term “mark-up” refers both to mark-ups applied to sales to customers and mark-downs applied to purchases from customers, and the term “contemporaneous cost” refers both to contemporaneous cost in the context of sales to customers and contemporaneous proceeds in the context of purchases from customers.

     

     

    Section 1:  When Mark-Up Disclosure Is Required

    1.1 When does Rule G-15 require mark-up disclosure?

    A dealer is required to disclose on a customer confirmation the mark-up on a transaction in municipal securities with a non-institutional customer if the dealer also executes one or more offsetting principal transaction(s) on the same trading day as the customer transaction in an aggregate trading size that meets or exceeds the size of the customer trade. A non-institutional customer is a customer with an account that is not an institutional account, as defined in MSRB Rule G-8(a)(xi).

    As noted during the MSRB’s confirmation disclosure rulemaking process, any intentional delay of a customer execution to avoid triggering the mark-up disclosure requirements may violate Rule G-18, on best execution, and Rule G-17, on conduct of municipal securities and municipal advisory activities.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 7 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 3-4 (November 14, 2016)

    (July 12, 2017)

    1.2  Is mark-up disclosure required only where the sizes of same-day customer and principal trades offset each other?

    Yes. Mark-up disclosure is required only where a customer trade offsets a same-day principal trade in whole or in part. For example, if a dealer purchased 100 bonds at 9:30 a.m., and then, as principal, satisfied three non-institutional customer buy orders for 50 bonds each in the same security on the same trading day without making any other purchases of the bonds that day, mark-up disclosure would be required only on two of the three customer purchases, since one of the trades would need to be satisfied out of the dealer’s prior inventory rather than offset by the dealer’s same-day principal transaction.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 4; 7-8 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 3-4 (November 14, 2016); Amendment No. 1 to SR-MSRB-2016-12, at 4 (November 14, 2016)

    (July 12, 2017)

    1.2.1  Are position moves between separate desks within a firm considered “transactions” for purposes of determining whether a dealer has offsetting transactions that trigger a mark-up disclosure requirement?

    No. Mark-up disclosure is triggered under Rule G-15 when a customer trade is offset by one or more “transactions.”  For purposes of the rule, the MSRB considers a “transaction” to entail a change of beneficial ownership between parties. Accordingly, if a retail desk within a dealer acquires bonds through a position move from another desk within the same firm and then sells those bonds to a non-institutional customer, the dealer is required to provide the customer with mark-up disclosure only if the dealer bought the bonds in one or more offsetting transactions on the same trading day as the sale to the customer (subject to the exceptions discussed in Question 1.7).

    (March 19, 2018)

    1.3  When are trades executed by a dealer’s affiliate relevant for determining whether the mark-up disclosure requirements are triggered?

    If a dealer’s offsetting principal trade is executed with a dealer affiliate and did not occur at arm’s length, the dealer is required to “look through” to the time and terms of the affiliate’s trade with a third party to determine whether mark-up disclosure is triggered under Rule G-15. On the other hand, if the dealer’s transaction with its affiliate is an arms-length transaction, the dealer would treat that transaction as any other offsetting transaction (i.e., the dealer would not “look through” to the time and terms of the arms-length transaction).

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 9­‑10; 23; 26 (September 1, 2016)

    (July 12, 2017)

    1.4  What is considered an “arms-length transaction” when considering whether a dealer must “look through” to the time and terms of an affiliate’s trade?

    The term “arms-length transaction” is defined in Rule G-15(a)(vi)(I) to mean a transaction that was conducted through a competitive process in which non-affiliate firms could also participate, and where the affiliate relationship did not influence the price paid or proceeds received by the dealer. The MSRB has noted that as a general matter, it expects the competitive process used in an arms-length transaction to be one in which non-affiliates have frequently participated. In other words, the MSRB would not view a process, like a request for pricing protocol or posting of bids and offers, as competitive if non-affiliates responded to requests or otherwise participated in only isolated or limited circumstances.

    Factors that may be relevant to a dealer’s determination that a transaction with an affiliate was conducted at arm’s length include, but are not limited to: counterparty anonymity during the competitive process to the time of execution; the presence of other competitive bids or offers, in addition to the affiliate's, in the competitive process; contemporaneous market activity in the same or a similar security (or securities) which is used to evaluate the relative competitiveness of bids or offers received during a competitive process; and a lack of preferential arrangements between the affiliates concerning, or based on, the handling of orders between them. The MSRB notes that no one of these factors is necessarily determinative on its own.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 9 (September 1, 2016)

    (July 12, 2017)

    (Updated March 19, 2018)

     

    1.5  If a dealer has an exclusive agreement with a non-affiliated dealer under which it always purchases its securities from, or always sells its securities to, that non-affiliate, would the “look through” requirements apply when the dealer transacts with the non-affiliate?

    No. The “look through” applies only to certain transactions between affiliated dealers. Under Rule G-15, a “look through” is required when the dealer’s offsetting transaction is with an affiliate and is not an “arms-length transaction.” A transaction with a non-affiliate would not meet these conditions, so a “look through” would not be required. The MSRB notes that dealers should continue to evaluate the terms and circumstances of any such arrangements in light of other MSRB rules and guidance, including best execution. In evaluating these terms and circumstances, dealers should consider whether they diminish the reliability and utility of mark-up disclosure to investors.

    (July 12, 2017)

    1.6  Does the mark-up disclosure requirement in Rule G-15 apply to transactions that involve a dealer and a registered investment adviser?

    No. To trigger the mark-up disclosure requirement in Rule G-15, a dealer must execute a trade with a non-institutional customer. Under the rule, registered investment advisers are institutional customers; accordingly, mark-up disclosure is not required when dealers transact with registered investment advisers. This is the case even where the registered investment adviser with whom the dealer transacted later allocates all or a portion of the securities to a retail account or where the transaction is executed directly for a retail account if the investment adviser has discretion over the transaction. The MSRB notes that this answer is specific to the mark-up disclosure requirement in Rule G-15; it is not intended to alter any other obligations.

    (July 12, 2017)

    1.7  Are there any exceptions to the mark-up disclosure trigger requirements?

    Yes. There are three exceptions. First, disclosure is not required for transactions in municipal fund securities. Second, mark-up disclosure is not necessarily triggered by principal trades that a dealer executes on a trading desk that is functionally separate from a trading desk that executes customer trades, provided the dealer maintains policies and procedures reasonably designed to ensure that the functionally separate trading desk had no knowledge of the customer trades. For example, the exception allows an institutional desk within a dealer to service an institutional customer without necessarily triggering the disclosure requirement for an unrelated trade performed by a separate retail desk within the dealer. Third, disclosure is not required for transactions that are list offering price transactions, as defined in paragraph (d)(vii)(A) of Rule G-14 RTRS Procedures.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 10 (September 1, 2016)

    (July 12, 2017)

    1.8  May dealers voluntarily provide mark-up disclosure on additional transactions that do not trigger mandatory disclosure?

    Yes. In disclosing this information on a voluntary basis, dealers should be mindful of any applicable MSRB rules. For example, while mark-up disclosure is voluntary for trades that are not triggered by the relevant provisions of Rule G-15, the process for determining the PMP according to Rule G-30 applies in all cases. In addition, to avoid customer confusion, voluntary disclosure should also follow the same format and labeling requirements applicable to mandatory disclosure.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 13 n. 27 (September 1, 2016)

    (July 12, 2017)

    1.9  In arrangements involving clearing dealers and introducing or correspondent dealers, who is responsible for mark-up disclosure?

    The introducing or correspondent dealer bears the ultimate responsibility for compliance with the disclosure requirements under Rule G-15. Although an introducing or correspondent dealer may use the assistance of a clearing dealer, as it may use other third-party service providers subject to due diligence and oversight, the introducing or correspondent dealer remains ultimately responsible for compliance.

    (July 12, 2017)

    Section 2:  Content and Format of Mark-Up Disclosure

     

    2.1  What information must be included when dealers provide mark-up disclosure on a confirmation?

    When mark-up disclosure is provided on a customer confirmation, Rule G-15 requires firms to express the disclosed mark-up as both a total dollar amount and a percentage amount of PMP. The mark-up should be calculated and disclosed as the total amount per transaction; disclosure of the per bond dollar amount of mark-up (e.g., $9.45 per bond) would not satisfy the requirement to disclose the total dollar amount of the transaction mark-up.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 12 (September 1, 2016)

    (July 12, 2017)

    2.2  Where is mark-up disclosure required to be located on a confirmation?

    For printed confirmations, Rule G-15(a)(i)(E) requires the mark-up disclosure to be located on the front of the customer confirmation. For electronic confirmations, the disclosure should appear in a naturally visible place. Because the rule requires mark-up disclosure to be on the confirmation itself, the inclusion of a link on the customer confirmation that a customer could click to obtain his or her mark-up disclosure would not satisfy the requirements of Rule G-15.

    (July 12, 2017)

    2.3  May dealers use explanatory language to provide context for mark-up disclosure?

    Yes. Dealers may include accompanying language to explain mark-up related concepts, or a dealer’s particular methodology for calculating mark-ups according to MSRB guidance (or to note the availability of information about the methodology upon request), provided such statements are accurate and not misleading. However, dealers may not label mark-ups as “estimated” or “approximate” figures, or use other such labels. These types of qualifiers risk diminishing the utility of the disclosure and of the dealer’s own determination of the security’s PMP and mark-up charged, and otherwise risk diminishing the value to retail investors of the disclosure.

    MSRB Response to Comments on SR-MSRB-2016-12, at 11-12 (November 14, 2016)

    (July 12, 2017)

    2.4  If a dealer encounters a situation where a mark-up is negative (i.e., the dealer sold to the customer at a price lower than the PMP), may it choose to disclose a mark-up of zero instead?

    The MSRB believes that negative mark-ups will be very infrequent; however, if such a case arises, a dealer may not disclose a mark-up of zero where the mark-up is not, in fact, zero. Dealers should disclose the mark-up that they calculate based on their determination of PMP consistent with Rule G-30. As an alternative to disclosing a negative mark-up, dealers are permitted to disclose “N/A” in the mark-up/mark-down field if the confirmation also includes a brief explanation of the “N/A” disclosure and the reason it has been provided. Dealers also have the flexibility to provide an explanation for trades with disclosed negative or zero mark-ups as well, consistent with Question 2.3 above.

    (July 12, 2017)

    2.5  How many decimal places should dealers use when disclosing the mark-up as a percentage amount?

    Dealers should disclose the percentage amount rounded to at least two decimal places (e.g., hundredths of a percent). For example, if a dealer charged a $120 mark-up on a 10-bond transaction where the PMP was 99, the mark-up percentage should be disclosed to at least the hundredth of a percentage point, as 1.21% (as opposed to 1.2% or 1%). However, if a dealer charged a $100 mark-up on a 10-bond transaction where the PMP was 100, the mark-up percentage could be disclosed as 1.00% or 1%.

    (March 19, 2018)

    Section 3:  Determining Prevailing Market Price

     

    3.1  How should dealers determine PMP to calculate mark-ups?

    Dealers must calculate mark-ups from a municipal security’s PMP, consistent with Rule G-30 and the supplementary material thereunder, particularly Supplementary Material .06 (sometimes referred to as the “waterfall” guidance or analysis). Under the applicable standard of “reasonable diligence” (discussed below), dealers may rely on reasonable policies and procedures to facilitate PMP determination, provided the policies and procedures are consistent with Rule G-30 and are consistently applied.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 12 (September 1, 2016)

    (July 12, 2017)

    3.2  Does the PMP guidance in Rule G-30, Supplementary Material .06 apply for mark-up (and mark-down) disclosure purposes under Rule G-15 and for fair pricing purposes under Rule G-30?

    Yes. Dealers should read the guidance in Supplementary Material .06 together with Rule G-30 and all the other supplementary material thereto. For example, while Supplementary Material .06 provides guidance in determining the PMP, Supplementary Material .01(a) explains that dealers must exercise “reasonable diligence” in establishing the market value of a security, and Supplementary Material .01(d) states that dealer compensation on a principal transaction with a customer is determined from the PMP of the security, as described in Supplementary Material .06. Read as a whole, Rule G-30 requires dealers to use reasonable diligence to determine the PMP of a municipal security in accordance with Supplementary Material .06.[2] This standard applies for mark-up disclosure purposes under Rule G-15 and for fair pricing purposes under Rule G-30.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 25; 28 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 9-11 (November 14, 2016)

    (July 12, 2017)

    (Updated March 19, 2018)

     

    3.2.1  Does the functionally separate trading desk exception apply for purposes of determining the PMP of a security?

    No. As explained in the rule filing, this exception “would only apply to determine whether or not the [mark-up] disclosure requirement has been triggered; it does not change the dealer’s requirements relating to the calculation of its mark-up or mark-down under Rule G-30.”

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at n. 20 (September 1, 2016)

    (March 19, 2018)

    3.3  When reading the PMP guidance in Rule G-30, Supplementary Material .06, what does the language in parentheses mean?

    Unless the context requires otherwise, language in parentheses that is not preceded by an “i.e.,” or “e.g.,” within sentences refers to scenarios where a dealer is charging a customer a mark-down. Thus, for example, in the phrase, “contemporaneous dealer purchases (sales) in the municipal security in question from (to) institutional accounts,” the terms “(sales)” and “(to)” apply where a dealer is charging a customer a mark-down.

    (July 12, 2017)

    3.4  When should dealers determine PMP and calculate the mark-up to be disclosed on a confirmation?

    The MSRB recognizes that dealers may employ different processes for generating customer confirmations such that this may occur at the end of the day, or during the day for firms that use real-time, intra-day confirmation generation processes. Therefore, although the objective must always be to determine the price prevailing at the time of the customer transaction, different dealers may consistently conduct the analysis to make that determination at different times. Specifically, dealers may base their mark-up calculations for confirmation disclosure purposes on the information they have available to them (based on the exercise of reasonable diligence) at the time they systematically input relevant transaction information into the systems they use to generate confirmations.

    This means that a dealer that systematically inputs the information at the time of trade may determine the PMP—and therefore, the mark-up—at the same time (even if the confirmation itself is not printed until the end of day). On the other hand, if a dealer systematically inputs such information at the end of the day, the dealer must use the information available to the dealer at that time to determine the price prevailing at the time of the customer transaction—and, therefore, the mark-up.

    The timing of the determination must be applied consistently across all transactions in municipal securities (e.g., the dealer may not enter information into its systems at the time of trade and determine the PMP at the time of trade for some trades but at the end of the day for others).

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 24 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 10 (November 14, 2016)

    (July 12, 2017)

    3.4.1  May a dealer determine PMP between the time of trade and the end of the day? 

    Yes. The MSRB recognizes that firms may employ different processes for generating customer confirmations, and dealers are not limited to determining PMP for purposes of confirmation disclosure only at the times provided as examples in Question 3.4 (i.e., the time of trade or the end of the day). While the objective must always be to determine the price prevailing at the time of the customer transaction, as noted above in Question 3.4, PMP may be determined for disclosure purposes when a firm systematically enters the information into its confirmation generation system, based on information that is reasonably available to it at that time. Accordingly, a dealer may determine PMP at various times, including at the time of the trade, at the end of the day, or at times in between, provided the dealer does so according to reasonable, consistently applied policies and procedures and does not “cherry pick” favorable data.

    (March 19, 2018)

    3.4.2  May a dealer determine PMP at the time of trade (or at some other time before the end of the day) and wait until later in the day to analyze which trades triggered the disclosure requirement?

    Yes. A dealer may determine PMP, enter the PMP information into a confirmation generation system, and later populate the mark-up field only on confirmations of trades that trigger disclosure. The MSRB would expect in such cases that the PMP determination would not be subject to change when the dealer performs the trigger analysis later in the day, other than for a reasonable exception review process (as discussed in Question 3.8.1). In all cases, dealers must follow consistently applied policies and procedures and may not “cherry pick” favorable data. Dealers are reminded that when determining PMP, they must use the information reasonably available to them at the time of the PMP determination and that the objective is always to determine the price prevailing at the time of the customer transaction.

    (March 19, 2018)

    3.4.3  What is considered a confirmation generation system, for purposes of the guidance on when dealers may determine PMP for disclosure purposes?

    As noted above in Question 3.4, the MSRB recognizes that dealers may employ different processes for generating customer confirmations. For purposes of this guidance, the MSRB would consider a dealer to enter information systematically into a confirmation generation system when it stores the information in a location that is part of the confirmation generation process. The MSRB expects that the stored PMP information would not be subject to change, other than for a reasonable exception review process (as discussed in Question 3.8.1). The MSRB also expects that a dealer will clearly explain in its policies and procedures its confirmation generation process, including the timing and role of each material step in the process.

    (March 19, 2018)

    3.5  Once dealers determine PMP and input relevant information into their confirmation generation systems, would they be required to cancel and correct a confirmation to revise a disclosed mark-up if later events might contribute to a different PMP determination?

    No. The disclosure must be accurate, based on the dealer’s exercise of reasonable diligence, as of the time the dealer systematically inputs the information into its systems to generate the disclosure. Once the dealer has input the information into its confirmation generation systems, the MSRB does not expect dealers to send revised confirmations solely based on the occurrence of a subsequent transaction or event that would otherwise be relevant to PMP determination under Rule G-30. On a voluntary basis, dealers may correct a confirmation, pursuant to reasonable and consistently applied policies and procedures.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 24 (September 1, 2016)

    (July 12, 2017)

    3.5.1 If a dealer corrects the price to a customer or determines that, at the time the dealer systematically entered the information into its systems to generate the mark-up disclosure, the PMP was inaccurate, must the dealer send a corrected confirmation that reflects a corrected mark-up disclosure and price?

    Yes. Consistent with Question 3.5, dealers are not required to cancel and correct a confirmation to revise a disclosed mark-up solely based on the occurrence of a subsequent transaction or event that would otherwise be relevant to PMP determination under Rule G-30. However, if the dealer corrects the price to the customer or determines that a PMP was inaccurate at the time it was systematically entered into the dealer’s confirmation generation system, the dealer must send a confirmation that reflects an accurate mark-up and price.

    (March 19, 2018)

    3.6  May dealers engage third-party vendors to perform some or all of the steps required to fulfill the mark-up disclosure requirements?

    Yes. Dealers may engage third-party service providers to facilitate mark-up disclosure consistent with Rules G-15 and G-30. For example, dealers that wish to perform most of the steps of the waterfall internally may choose to use the services of a vendor at the economic models level of the waterfall. Other dealers may wish to use the services of a vendor to perform most or all of the steps of the waterfall. In either case, the dealers retain the responsibility for ensuring the PMP is determined in accordance with Rule G-30 and that the mark-up is disclosed in compliance with Rule G-15 and must exercise due diligence and oversight over their third-party relationships.

    As a policy matter, the MSRB does not endorse or approve the use of any specific vendors.

    MSRB Response to Comments on SR-MSRB-2016-12, at 8 (November 14, 2016)

    (July 12, 2017)

    3.7  May dealers use a third-party evaluated pricing service as an economic model at the final step of the waterfall?

    Yes. However, before doing so, the dealer should have a reasonable basis for believing the third-party pricing service’s pricing methodologies produce evaluated prices that reflect actual prevailing market prices. A dealer would not have a reasonable basis for such a belief, for example, where a periodic review of the evaluated prices provided by the pricing service frequently (over the course of multiple trades) reveals a substantial difference between the evaluated prices and the prices at which actual transactions in the relevant securities occurred. In choosing to use evaluated prices from any pricing service, a dealer should assess, among other things, the quality of the evaluated prices provided by the service and the extent to which the service determines its evaluated prices on an intra-day basis.

    To be clear, dealers are not required to use such pricing services at this stage of the waterfall analysis. Rather, third-party evaluated pricing services are only one type of economic model. Other types of economic models may include internally developed models such as a discounted cash flow model or a reasonable and consistent methodology to be used in connection with an applicable index or benchmark. Dealers are reminded that when using an internally developed model, the dealer must be able to provide information that the dealer used on the day of the transaction to develop the pricing information (i.e., the data that was input and the data that the model generated and the dealer used to arrive at the PMP).

    MSRB Response to Comments on SR-MSRB-2016-12, at 8 (November 14, 2016)

    (July 12, 2017)

    (Updated March 19, 2018)

     

    3.8  May dealers use or rely on automated systems to determine PMP?

    Yes. While dealers are not required to automate the PMP determination and mark-up disclosure, they may choose to do so, provided they (and/or their vendors) do so consistent with Rule G-30 and Rule G-15, and all other applicable rules. The MSRB has provided guidance in several areas during the rulemaking process to facilitate automation for firms that choose to employ it. First, as noted above in Question 3.4, dealers are permitted on certain conditions to determine PMP on an intra-day basis (e.g., at the time of trade), allowing dealers that generate confirmations intra-day to continue to do so. Second, as noted in Question 3.1 and discussed throughout this guidance, the MSRB has acknowledged that dealers may develop policies and procedures that rely on reasonable, objective criteria to apply the PMP guidance in Supplementary Material .06 at a systematic level. Consistent with the reasonable policies and procedures approach, the MSRB further recognized during the rulemaking process that reasonable policies and procedures could result in different firms making different PMP determinations for the same security. (The MSRB would expect, however, that the consistent application of policies and procedures within a dealer would result in different traders or desks arriving at PMP determinations that are substantially the same under comparable facts and circumstances.)

    MSRB Response to Comments on SR-MSRB-2016-12, at 7-8 (November 14, 2016)

    (July 12, 2017)

    3.8.1 May dealers adopt a reasonable exception review process to evaluate PMP determinations?

    Yes. As a general matter, the MSRB expects that dealers will employ supervisory review processes that consider, among other things, the reliability of their (or their vendors’) PMP determinations. To review reliability, a dealer might review PMP determinations that result in mark-ups that exceed pre-determined thresholds, and it also might compare PMP determinations with some other measure of market value to ascertain whether the PMP determinations fall outside pre-established ranges.

    In cases where a dealer reviews PMP determinations before the associated trade confirmations are sent, dealers may correct PMP determinations to promote more accurate mark-up calculations, provided they do so according to reasonable and consistently applied policies and procedures. As a general matter, however, the MSRB expects that it will be rare for a dealer to correct the PMP of a security based on exception reporting, and documentation in such situations will be paramount. To prevent “cherry picking,” the dealer’s policies and procedures should be specific in describing the PMP review process and the conditions under which the dealer may show that a PMP was erroneous (e.g., the PMP determination was based on an isolated transaction, or a PMP determined through the use of an economic model did not reflect recent news about the security). If a dealer determines that a PMP is erroneous, it must correct it consistent with Rule G-30, and it must do so using the information reasonably available to it at the time it makes the correction.

    There may also be cases where a dealer’s exception review process results in corrected customer trade prices. For example, a dealer may review a trade where the mark-up exceeded a pre-determined threshold and the PMP was determined correctly. Dealers may refer to Question 3.5.1 in these cases.

    (March 19, 2018)

    3.9  May dealers develop objective criteria to automatically determine whether a trade is “contemporaneous” for purposes of establishing a presumptive PMP at the first step of the waterfall analysis?

    Yes. Dealers may establish an objective set of criteria to determine whether a trade is contemporaneous, provided the objective criteria are established based on the exercise of reasonable diligence. For example, dealers could define an objective period of time as a default proxy for determining whether the trade is contemporaneous. Dealers could also define criteria to consider other relevant factors, such as whether intervening trades by other firms occurred at prices sufficiently different than the dealer’s trade to suggest that the dealer’s trade no longer reasonably reflects the current market price for the security, or whether changes in interest rates or the credit quality of the security, or news reports were significant enough to reasonably change the PMP of the security.

    Given the different trading characteristics of different municipal securities, and relevant court and SEC case law applicable to debt securities in general, it likely would not be reasonable for a dealer’s policies and procedures to determine categorically that all transactions that occur outside of a specified time frame are not “contemporaneous.” Accordingly, dealers should include in their policies and procedures an opportunity to review and override the automatic application of default proxies (e.g., by reconsidering the application for transactions identified through reasonable exception reporting and specifying designated time intervals (or market events) after which such proxies will be reviewed).

    (July 12, 2017)

    3.10  Since Rule G-15 adopts a same-day trigger standard for mark-up disclosure, would it be reasonable to assume a same-day standard for determining whether trades are contemporaneous for purposes of determining PMP under Rule G-30?

    The MSRB notes that the determination of whether mark-up disclosure is required under Rule G-15 is distinct from the determination of whether a transaction is contemporaneous under the waterfall analysis. The PMP guidance under Rule G-30 provides that a dealer’s cost is considered contemporaneous if the transaction occurs close enough in time to the subject transaction that it would reasonably be expected to reflect the current market price for the municipal security. While same-day transactions may often be contemporaneous according to this meaning, the MSRB has not set forth a specific time-period that is categorically contemporaneous. As noted above in Question 3.9, the MSRB would expect that dealers developing objective criteria for this purpose would base the determination of such criteria on the exercise of reasonable diligence.

    (July 12, 2017)

    3.11  How should dealers determine their contemporaneous cost if they have multiple contemporaneous purchases?

    Dealers may rely on reasonable and consistently applied policies and procedures that employ methodologies to establish PMP where they have multiple contemporaneous principal trades. For example, a dealer could employ consistently an average weighted price or a last price methodology. Such methodologies could further account for the type of principal trade, giving greater weight to principal trades with other dealers than to principal trades with customers.

    MSRB Response to Comments on SR-MSRB-2016-12, at 12-13 (November 14, 2016)

    (July 12, 2017)

    3.12  What is the next step in the analysis, when determining contemporaneous cost or proceeds, if a dealer has no contemporaneous transactions with another dealer?

    Where the dealer has no contemporaneous cost or proceeds, as applicable, from an inter-dealer transaction, the dealer must then consider whether it has contemporaneous cost or proceeds, as applicable, from a customer transaction. Note that, because the dealer’s contemporaneous cost or proceeds from a customer transaction will also include the mark-up or mark-down charged in that transaction, the dealer should adjust its contemporaneous cost or proceeds from that customer transaction to account for the mark-up or mark-down included in the price. In these instances, the difference between the dealer’s “adjusted contemporaneous cost or proceeds” (the dealer’s contemporaneous cost or proceeds in the customer transaction, adjusted by the mark-up or mark-down) and the price to its customer is equal to the mark-up (or mark-down) to be disclosed on customer confirmations under Rule G-15. The MSRB has noted that this approach allows the dealer to avoid “double counting” in the mark-up and mark-down it discloses to each customer. For example, if a dealer buys 100 bonds from Customer A at a price of 98 and immediately sells 100 of the same bonds to Customer B at a price of 100, the dealer may apportion the mark-up and mark-down paid by each customer. Assuming for illustration that the dealer determines the PMP in accordance with the waterfall guidance to be 99, then the dealer would disclose to Customer A a total dollar amount mark-down of $1,000, also expressed as 1.01% of PMP, and it would disclose to Customer B a total dollar amount mark-up of $1,000, also expressed as 1.01% of PMP.[3]

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 21 (September 1, 2016)

    (July 12, 2017)

    (Updated March 19, 2018)

     

    3.13  May dealers adjust their contemporaneous cost to reflect what they believe to be a more accurate PMP, or their role taking risk to provide liquidity?

    Dealers may adjust their contemporaneous cost only in one case: where a dealer’s offsetting trades that trigger disclosure under Rule G-15 are both customer transactions (discussed above at Question 3.12). Other adjustments to reflect the size or side of market for a dealer’s contemporaneous cost are not permitted.

    (July 12, 2017)

    3.14  May dealers apportion their expected aggregate monthly fees—for example to access an alternative trading system (ATS) or other trading platform—to individual contemporaneous transactions to be included in their contemporaneous costs?

    No. For any given mark-up on a transaction, Supplementary Material .06 requires dealers to look first to their contemporaneous cost as incurred. The MSRB does not believe it would be consistent with Rule G-30 for dealers to consider an estimated apportionment of a future charge to be part of the specific cost they incurred in a contemporaneous transaction.

    (July 12, 2017)

    3.15  In determining contemporaneous cost, may dealers include transaction fees—for example to access an ATS or other trading platform—that were included in the price they paid?

    Yes, provided the transaction fee is reflected in the price of the contemporaneous trade that is reported to EMMA, consistent with MSRB rules and guidance on pricing, trade reporting and fees. The MSRB will monitor and adjust this guidance as needed if it determines that pricing practices change in a way that diminishes the utility and reliability of mark-up disclosure.

    (July 12, 2017)

    3.16  May a dealer treat its own contemporaneous transaction as “isolated” and therefore disregard it when determining PMP?

    No. Under Supplementary Material .06, isolated transactions or isolated quotations generally will have little or no weight or relevance in establishing PMP. The guidance also specifically provides that, in the municipal market, an “off-market” transaction may qualify as an isolated transaction. Through cross-references, Supplementary Material .06 makes clear that a dealer may deem a transaction or quotation at the hierarchy of pricing factors or similar-securities level of the waterfall to be isolated. However, the concept of “isolated” transactions or quotations does not apply to a dealer’s contemporaneous cost, which presumptively determines PMP.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 19; 21 (September 1, 2016)

    (July 12, 2017)

    3.17  Supplementary Material .06 notes that changes in interest rates may allow a dealer to overcome the presumption that its own contemporaneous cost is the best measure of PMP. Does this refer only to formal policy interest rate changes, or does it also contemplate market changes in interest rates?

    It refers to any change in interest rates, whether the change is caused by formal policy decisions or market events. However, Supplementary Material .06 notes that a dealer may overcome the presumption that its contemporaneous cost is the best measure of PMP based on a change in interest rates only in instances where they have changed after the dealer’s transaction to a degree that such change would reasonably cause a change in municipal securities pricing.

    (July 12, 2017)

    3.18  Supplementary Material .06 notes that changes in the credit quality of the municipal security may allow a dealer to overcome the presumption that its own contemporaneous cost is the best measure of PMP. Does this refer only to formal credit rating changes, or does it also contemplate market changes in implied or observed credit spreads such as those due to market-wide credit spread volatility or anticipated changes in the credit quality of the individual issuer?

    It refers to any changes to credit quality, with respect to that particular security or the particular issuer of that security, whether the change is caused by a formal ratings announcement or market events. Thus, for example, this could include changes in the guarantee or collateral supporting repayment as well as significant recent information concerning the issuer that is not yet incorporated in credit ratings (e.g., changes to ratings outlooks). However, Supplementary Material .06 notes that a dealer may overcome the presumption that its contemporaneous cost is the best measure of PMP based on a change in credit quality only in instances where it has changed significantly after the dealer’s transaction.

    (July 12, 2017)

    3.18.1 When considering inter-dealer trades at the hierarchy of pricing factors level of the waterfall analysis, if the only contemporaneous inter-dealer trades in the security are executed at the same time and involve a broker’s broker or an ATS, may a dealer choose to determine PMP by reference to the inter-dealer trade price which is reasonably likely to be on the opposite side of the market from the dealer seeking to determine PMP?

    Yes. Consistent with the standard of reasonable diligence, dealers may adopt a reasonable approach to consistently choosing between or referring to multiple contemporaneous inter-dealer trades. If the only contemporaneous inter-dealer trades in the security are executed at the same time and involve a broker’s broker or an ATS in the security, it may be reasonable for the dealer seeking to determine PMP to do so by reference to the trade price which is reasonably likely to be on the opposite side of the market from the dealer seeking to determine PMP.

    For example, assume that Dealer XYZ is selling a municipal security to a retail customer. Also, assume that the dealer lacks contemporaneous cost and that there are only two contemporaneous inter-dealer transactions in the security, and that both of those transactions occur at the exact same time and in the exact same trade amount. Additionally, both inter-dealer transactions are identified by an ATS special condition indicator on EMMA. One transaction is executed at a price of 113.618 and the other is executed at a price of 113.868. Assume further that the difference between these two ATS transaction prices is in the customary and typical range of the fee an ATS would charge for its services. In this case, it may be reasonable for Dealer XYZ to conclude that the transaction at 113.618 reflects a sale from a dealer to an ATS taking a principal position in the security, and that the transaction at 113.868 reflects a sale from that ATS to another dealer. Under these circumstances, Dealer XYZ may reasonably determine the PMP by reference to the transaction at 113.868, because the counterparty to the ATS in that transaction was purchasing the security and thus on the opposite side of the market from the side of Dealer XYZ in its customer trade.

    (March 19, 2018)

    3.19 May dealers adopt a reasonable default proxy where the waterfall guidance refers to trades between dealers and institutional accounts with which any dealer regularly effects transactions in the same security, if such information cannot be ascertained through reasonable diligence?

    Yes. Consistent with the Rule G-30 standard of “reasonable diligence” in establishing the PMP of a municipal security, dealers reasonably may use objective criteria as a proxy for the elements of these steps of the waterfall that they cannot reasonably ascertain, such as whether a customer transaction involves an institutional customer and whether that institutional customer regularly trades in the same security with any dealer. A reasonable approach might assume that transactions at or above a $1,000,000 par amount involve institutional customers, since that size transaction is conventionally considered to be an institutional-sized transaction. In addition, because institutional investors transacting at or above this size threshold are typically sophisticated investors, the same size proxy might be used to assume that the institutional customer regularly transacts with a dealer in the same security.

    (July 12, 2017)

    3.19.1 May a dealer reasonably determine that new issue trade prices executed at list offering/takedown prices are not reflective of the PMP at the time of their execution?

    Yes. Because new issues may be priced days before the transactions are executed and reported to RTRS, a dealer may, but is not required to, determine that new issue trades executed at list offering or takedown prices are not reflective of the PMP at the time of their execution. These transactions generally are denoted by a list offering price/takedown indicator on EMMA and in the MSRB Transaction Subscription Service. Market participants may also determine the list offering price by viewing the security’s home page (i.e., the Security Details page) on EMMA.

    (March 19, 2018)

    3.20  Can an “all-to-all” platform (i.e., one that allows non-dealers to participate) qualify as an inter-dealer mechanism at the step of the waterfall that refers to bids and offers for actively traded securities?

    Yes, provided that the dealer determines that the prices available on an “all-to-all” platform are generally consistent with inter-dealer prices. Dealers should include in their policies and procedures how they will periodically review a platform’s activity to make such a determination.

    (July 12, 2017)

    3.21  When considering bid and offer quotations from an inter-dealer mechanism, how many inter-dealer mechanisms must a dealer check before considering the next category of factors under the waterfall analysis?

    The obligation to determine PMP requires a dealer to use reasonable diligence. It does not require a dealer to seek out and consider every potentially relevant data point available in the market. With respect to this factor in the waterfall analysis, a dealer must only seek out and consider enough information to reasonably determine that there is no probative information to determine PMP before proceeding to the next category of factors.

    (July 12, 2017)

    3.22  In considering bids and offers for actively traded securities made through an inter-dealer mechanism, how can a dealer determine that transactions generally occur at the displayed quotations on the inter-dealer mechanism?

    Consistent with the Rule G-30 standard of reasonable diligence and a reasonable policies and procedures approach, a dealer could request and assess from the platform relevant statistics and relevant information reasonably sufficient to conclude that the inter-dealer mechanism meets the applicable requirements under Supplementary Material .06. A dealer could then periodically request and assess updated statistics and relevant information to confirm that the inter-dealer mechanism continues to satisfy the requirements.

    (July 12, 2017)

    3.23  At the similar securities stage of the waterfall analysis, how can a dealer determine on a systematic basis that an inter-dealer quotation is “validated”?

    Consistent with the standard of reasonable diligence and a reasonable and consistently applied policies and procedures approach to the PMP determination, for example, a dealer could determine that a bid (offer) quotation is validated if it is quoted on an “inter-dealer mechanism” (including the all-to-all platforms that qualify, as discussed above). With respect to a dealer’s own bids or offers, dealers are reminded of their existing regulatory obligations under applicable MSRB rules regarding bona fide bids or offers and the requirement that any published quotations must be based on the dealer’s best judgment of the fair market value of the securities. See, e.g., Rule G-13 and MSRB Notice to Dealers That Use the Services of Broker’s Brokers (December 22, 2012). Dealers are also reminded that under Rule G-30, Supplementary Material .06, isolated transactions or isolated quotations (including those that are off-market) generally will have little or no weight or relevance in establishing the PMP of a security.

    Due to the lack of bid (offer) quotations for many municipal securities, under the waterfall analysis, dealers in the municipal securities market may not often find information from contemporaneous bid (offer) quotations in the municipal securities market.

    (July 12, 2017)

    (Updated March 19, 2018)

     

    3.24  May a dealer use the same process it uses to identify a “similar” security for best-execution purposes to identify “similar” securities for PMP purposes?

    Yes. Assuming the dealer’s process for identifying “similar” securities for Rule G-18 best-execution purposes is reasonable and in compliance with Rule G-18, a dealer may rely on the same process in connection with identifying similar securities under Rule G-30, Supplementary Material .06.

    Alternatively, due to the different purposes of the “similar” security analysis for best-execution purposes as compared to PMP determination purposes, dealers reasonably may adopt a more restrictive approach to identifying “similar” securities for Rule G-30 than they may for Rule G-18. While the relevant part of the best-execution analysis under Rule G-18 seeks to identify the best market to address a customer’s order or inquiry by reference to another security, the relevant part of the waterfall analysis seeks to identify the PMP of one security by reference to another security. Further, Rule G-30 Supplementary Material .06 provides that, in order to qualify as a “similar” security, at a minimum, the municipal security should be sufficiently similar that a market yield for the subject security can be fairly estimated from the yield of the “similar” security. Due to the large number and diversity of municipal securities, the MSRB is of the view that, generally, if the prices or yields of a security would require an adjustment in order to account for differences between the security and the subject security, it would be reasonable for a dealer to determine that that security is not sufficiently “similar” to the subject security for purposes of Supplementary Material .06. To be clear, dealers have the flexibility to determine that a security that requires an immaterial adjustment in order to account for differences is sufficiently “similar” for these purposes, but they are not required to do so. This approach also is consistent with the MSRB’s view that, in order for a security to qualify as sufficiently “similar,” the security must be at least highly similar to the subject security with respect to nearly all the “similar” security factors listed in Rule G-30 Supplementary Material .06(b)(ii) that are relevant to the subject security.

    Whichever approach a dealer chooses to apply, the dealer must apply that approach consistently across all municipal securities.

    Due to the lack of active trading in many municipal securities and the above discussion regarding the identification of “similar” securities in the municipal securities market, under the waterfall analysis, dealers in the municipal securities market may not often find information from sufficiently similar securities as compared to dealers in other fixed income markets.

    Because of the unique characteristics of the municipal securities market, the MSRB response to this question may differ from the FINRA interpretation under FINRA Rule 2121.

    (July 12, 2017)

    3.24.1 How many “similar” securities must a dealer consider at the “similar” securities stage of the waterfall analysis?

    The obligation to determine PMP requires a dealer to use reasonable diligence. It does not require a dealer to seek out and consider every potentially relevant data point available in the market. At this point in the waterfall analysis, a dealer must only seek out and consider enough information to reasonably determine that it has identified the prevailing market price of the security (or that there is no probative information to determine PMP before proceeding to the next level). A dealer’s policies and procedures should explain the process for identifying similar securities (and, if relevant, how the dealer may adjust the prices or yields of identified similar securities). Because the reasonable diligence standard is often guided by industry norms, dealers should periodically revisit their policies and procedures to ensure that their established processes continue to remain reasonable.

    Due to the unique characteristics of the municipal securities market, including the large number of issuers and the bespoke nature of many municipal securities, it is unlikely that the dealer will identify a substantial number of “similar” securities for many municipal securities. For example, it would be reasonable for a dealer to determine that a comparison security is not sufficiently “similar” to the subject security for purposes of Supplementary Material .06 if the prices or yields of the comparison security would require an adjustment in order to account for differences between that security and the subject security.

    (March 19, 2018)

    3.25  How is the “relative weight” provision in paragraphs (a)(v) (regarding the hierarchy of pricing factors) and (a)(vi) (regarding similar securities) of Supplementary Material .06 meant to be used in operation?

    This provision is meant to be used when there is more than one comparison transaction or quotation within the categories specified in the hierarchy of pricing factors and when there is more than one comparison transaction or quotation within the similar securities level of the waterfall analysis. In these cases, a dealer may consider the facts and circumstances of the comparison transactions or quotations to determine the weight or degree of influence to attribute to a particular transaction or quotation. For example, a dealer might give greater weight to more recent (timely) comparison transactions or quotations. Similarly, to the extent a dealer considers comparison transactions or quotations in which the dealer is on the same side of the market as the dealer in the subject transaction (if known from dealer customer trade reports),[4] a dealer might give relatively less weight or influence to such information in determining PMP than information from transactions or quotations in which the dealer was on the opposite side of the market from the dealer in the subject transaction.

    Consistent with the standard of reasonable diligence and a reasonable policies and procedures approach to the PMP determination, a dealer may adopt a reasonable methodology that it will consistently apply when considering the facts and circumstances of comparison transactions or quotations and assigning relative weight to such transactions or quotations. For example, a dealer might employ an average weighted price methodology (if all relevant trade sizes are publicly available) or last price methodology, provided its policies and procedures called for the reasonable and consistent use of the methodology and did not ignore potentially relevant facts and circumstances, such as side of the market.

    Due to the unique characteristics of the municipal securities market, the MSRB response to this question may differ from the FINRA interpretation under FINRA Rule 2121.

    (July 12, 2017)

    (Updated March 19, 2018)

     

    3.26  When dealers consider the hierarchy of pricing factors under Supplementary Material .06(a)(v), or similar securities factors under paragraph (a)(vi), may they consider the size of comparison transactions to determine their relative weight?

    Yes. Paragraphs (a)(v) and (a)(vi) include a non-exhaustive list of facts and circumstances that may impact the “relative weight” of comparison transactions or quotations that may be considered at that point in the waterfall analysis. The MSRB believes it would be reasonable to consider the size of a comparison transaction when considering its relative weight.

    (July 12, 2017)

    3.27  What is an “applicable index” as that term is used at the “similar securities” level of Supplementary Material .06?

    Supplementary Material .06 lists a number of non-exclusive factors that a dealer can look to in determining whether a security is sufficiently “similar” to the subject security. One of these factors is how comparably they trade over an applicable index or U.S. Treasury securities of a similar duration. The inclusion of the more general term “applicable index,” is intended to give dealers flexibility to consider, for example, commonly used municipal market bond indices, yield curves and benchmarks as these may be more relevant than data on Treasury securities (especially for tax-exempt bonds).

    Amendment No. 1 to SR-MSRB-2016-12, at 5 (November 14, 2016)

    (July 12, 2017)

    3.28  Must dealers keep their PMP determination for each trade in their books and records?

    The MSRB believes that dealers should keep records to demonstrate their compliance with Rule G-30, particularly where they have the evidentiary burden to demonstrate why a contemporaneous transaction was not the best measure of PMP for a given trade. The MSRB further notes that it would expect PMP documentation to be an important component of a firm’s system to supervise compliance with Rules G-15 and G-30.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 20 n. 39 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 8 (November 14, 2016)

    (July 12, 2017)

    (Updated March 19, 2018)

     

    3.29  Is there a difference between the PMP that is determined for mark-up disclosure purposes under Rule G-15 and for fair pricing purposes under Rule G-30?

    As noted during the rulemaking process, the MSRB recognizes that by allowing dealers to determine PMP for mark-up disclosure purposes at the time of entry of information into systems for confirmation generation, a mark-up disclosed on a confirmation may not reflect subsequent trades that could be considered “contemporaneous” under Supplementary Material .06. However, the MSRB does not believe it is necessary to make a formal distinction between a PMP determined for disclosure purposes and a PMP determined for other regulatory purposes. Still, in connection with any post-transaction fair pricing review process, dealers should not disregard any new information relevant under Supplementary Material .06 that occurs after the mark-up determination (e.g., contemporaneous proceeds obtained after the customer transaction).

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 14; 25; 28 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 10 (November 14, 2016)

    (July 12, 2017)

    Section 4:  Time of Execution and Security-Specific URL Disclosures

     

    4.1  When must dealers disclose the time of execution on a customer confirmation?

    Under Rule G-15, dealers must disclose the time of execution for all transactions, including principal and agency transactions. However, for transactions in municipal fund securities and transactions for an institutional account, as defined in Rule G-8(a)(xi), in lieu of disclosing the time of execution, dealers may instead include on the confirmation a statement that the time of execution will be furnished upon written request of the customer. This time-of-execution disclosure requirement is not limited to circumstances where mark-up disclosure is triggered; therefore, it is required even where mark-up disclosure is not.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 13-14 (September 1, 2016); Amendment No. 1 to SR-MSRB-2016-12, at 4-5 (November 14, 2016)

    (July 12, 2017)

    4.2  How should the time of execution be disclosed?

    Dealers have an obligation under Rule G-14, on reports of sales or purchases of municipal securities, to report the “time of trade” to the MSRB’s Real-Time Transaction Reporting System. In addition, dealers have an obligation under Rule G-8(a)(vii) to make and keep records of the time of execution of principal transactions in municipal securities. The time of execution for confirmation disclosure purposes is the same as the time of trade for Rule G-14 reporting purposes and the time of execution for purposes of Rule G-8(a)(vii), except that dealers should omit all seconds, without rounding to the minute, from the time-of-execution disclosure because the trade data displayed on EMMA does not include seconds.

    Alternatively, if disclosure in this format is operationally challenging or burdensome for a dealer, a dealer may choose to disclose the seconds, again without rounding to the minute (e.g., a time of trade of 10:00:59 may be disclosed as 10:00:59 or 10:00). Additionally, because EMMA displays the time of trade in eastern standard time (EST), dealers may disclose on the customer confirmation the time of execution in either military time (as reported to RTRS under Rule G-14) or in traditional EST with an AM or PM indicator (e.g., a time of trade of 14:00:59 may be disclosed on a confirmation as 14:00:59, 14:00, 2:00:59 PM or 02:00 PM). The time-of-execution disclosure format used by a dealer should be consistent for all municipal securities transaction confirmations on which the disclosure is provided.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 14 n. 29 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 6 n. 11 (November 14, 2016)

    (July 12, 2017)

    (Updated March 19, 2018)

     

    4.3  When must dealers disclose a security-specific URL on a customer confirmation?

    Under Rule G-15, dealers must disclose a security-specific URL, in a format specified by the MSRB as discussed below, for all non-institutional customer trades other than transactions in municipal fund securities, even where mark-up disclosure is not required. In the rare situations where there is no CUSIP assigned for a security that is subject to Rule G-15 at the time the dealer trades the security with a customer, the dealer is not required to include the security-specific URL on the customer confirmation.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 13-14; 27; 35 (September 1, 2016); Amendment No. 1 to SR-MSRB-2016-12, at 4 (November 14, 2016)

    (July 12, 2017)

    (Updated March 19, 2018)

     

    4.4  What is the security-specific URL that must be disclosed?

    The template for the URL that must be disclosed under Rule G-15 is:  https://emma.msrb.org/cusip/[insert CUSIP number]. [5] The URL is currently live and operational. Paper confirmations must include this URL with the security-specific CUSIP in print form; electronic confirmations must include the security-specific URL as a hyperlink to the web page.

    MSRB Response to Comments on SR-MSRB-2016-12, at 6 (November 14, 2016)

    FINRA has provided its own security-specific URL template in its guidance.

    (July 12, 2017)

    (Updated March 19, 2018)

     

    4.5  Do dealers need to provide any other disclosure concerning the security-specific URL?

    Yes. Dealers must include a brief description of the type of information that is available on the security-specific web page for the subject security, such as information about the prices of other transactions in the same security, the official statement and other disclosures for the security, ratings and other market data and educational material. To be clear, the disclosure does not need to describe with specificity all of the information available on the relevant web page. As described above, the description should be brief. Additionally, it only needs to describe enough information about the relevant web page that a reasonable investor would understand the type of information available on that page. For example, the following language would satisfy this obligation: “For more information about this security (including the official statement and trade and price history), visit [insert link]."[6]  Because this language is an example only, dealers may use other language to describe the content of the web page.

    As a reminder, Rule G-15(a)(i)(E) requires all requirements to be clearly and specifically indicated on the front of the confirmation, subject to limited exceptions. Because the description of the type of information available on the security-specific web page is not listed as an exception, it must be on the front of the confirmation.

    SR-MSRB-2016-12 Proposed Rule Change to MSRB Rules G-15 and G-30, at 13; 27 (September 1, 2016); MSRB Response to Comments on SR-MSRB-2016-12, at 6 n. 9 (November 14, 2016)

    (July 12, 2017)

    (Updated March 19, 2018)

     

    4.6 Is disclosure of the time of execution or security-specific URL required for transactions that involve a dealer and a registered investment adviser?

    No. Disclosure of the time of execution and security-specific URL is not required for transactions with an institutional customer. Under Rule G-15, a registered investment adviser is an institutional accountholder; accordingly, disclosure is not required for these transactions. This is the case even if the registered investment adviser with whom the dealer transacted later allocates all or a portion of the securities to a retail account or where the transaction is executed directly for a retail account if the investment adviser has discretion over the transaction. The MSRB notes that this answer is specific to the time-of-execution and security-specific URL disclosure requirements in Rule G-15; it is not intended to alter any other obligations.

    (July 12, 2017)

     


    [1] EMMA is a registered trademark of the MSRB.

     

    [2] Prior to May 14, 2018, Supplementary Material .01(d) provides that dealer compensation on a principal transaction is considered to be a mark-up or mark-down that is computed from the inter-dealer market price prevailing at the time of the customer transaction. As of May 14, 2018, the reference to the prevailing “inter-dealer” price is amended to instead, as noted above, reference the “prevailing market price,” as described in Supplementary Material .06. Supplementary Material .06, which applies to customer transactions and not internal position movements, generally embodies the principle that the PMP of a security is generally the price at which dealers trade with one another. This underlying principle does not mean that dealers may avoid following the steps of the waterfall analysis in the specific order prescribed in Supplementary Material .06. However, it remains a useful principle that dealers may wish to consider in approaching certain unspecified aspects of the waterfall analysis. The MSRB’s responses to Questions 3.11, 3.12, 3.20 and 3.23, in part, are reflective of this underlying principle. Other answers, including those in response to Questions 3.9, 3.10, 3.21 and 3.25 are reflective of the MSRB’s longstanding “reasonable diligence” standard, discussed above.

     

    [3] This example assumes that the dealer has identified that it has contemporaneous cost and proceeds at the time that it is determining the mark-up and mark-down to each customer. If this is not the case, however, because the dealer systematically inputs information into its systems for the generation of PMP at the time of trade, then there is a different result. For example, assume that the trade at 98 occurs at 10:00 AM, the trade at 100 occurs at 3:00 PM and these trades are contemporaneous. If the dealer systematically determines PMP at the time of trade, consistent with Question 3.4, at the time of the 10:00 AM trade, the dealer may simply proceed down the waterfall to determine the PMP for the security without the need to adjust that PMP. At the time of the 3:00 PM trade, however, the dealer should adjust its contemporaneous cost as described above to account for the mark-down included in the price.

     

    [4] At the institutional transactions and quotations categories in the hierarchy of pricing factors level of the waterfall, generally, dealers consider information from only one side of the market, depending on whether the dealer is charging a mark-up or mark-down. However, pursuant to reasonable and consistently applied policies and procedures, a dealer may consider information from transactions in which the dealer is on the other side of the market when reasonable to do so. For example, this may be reasonable where the dealer has identified no comparison transactions in which the dealer is on the opposite side of the market as the dealer in the subject transaction. In this case, the dealer may reasonably adjust the transaction price by an amount to account for the price at which that transaction might have occurred had it been a transaction in which the dealer was on the opposite side of the market from the dealer in the subject transaction. Also for example, where the dealer has identified comparison transactions on both sides of the market, the dealer reasonably may perform a similar adjustment (i.e., adjust a price from a transaction in which the dealer is on the same side of the market as the dealer in the subject transaction by an amount to account for the price at which that transaction might have occurred had it been a transaction in which the dealer was on the opposite side of the market from the dealer in the subject transaction). A dealer’s ability to consider such information may be particularly important in the municipal market in which securities often trade infrequently and in which dealers may often have such limited information available to them at the time of their PMP determination.

     

    [5] The MSRB previously announced the URL template as: http://emma.msrb.org/cusip/[insert CUSIP number]. Accordingly, confirmations for dealers that began to program their confirmations in accordance with the previously announced URL template may begin with the http format, rather than the https format. The MSRB does not expect such dealers to reprogram the URLs provided on customer confirmations as the http format will continue to function and will automatically redirect to the more secure https site.

     

    [6] As a reminder, for dealers that currently seek to satisfy their obligation to provide a copy of the official statement to customers under Rule G-32(a)(iii) by notifying customers of the availability of the official statement through EMMA, the provision of the link described in this set of FAQs would satisfy both the relevant Rule G-15 security-specific URL obligation and the Rule G-32(a)(iii), provided that, for purposes of Rule G-32(a)(iii), the URL address also is accompanied by the additional information described. For example, if a dealer included the sample description included in this question, the addition of the language “Copies of the official statement are also available from [insert dealer name] upon request” would satisfy both the Rule G-15 security-specific URL obligation and Rule G-32(a)(iii) obligations. 

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Notice Regarding Electronic Delivery and Receipt of Information by Municipal Advisors
    Rule Number:

    Rule G-32

     

    In November 1998, the MSRB published an interpretation about the use of electronic media to deliver and receive information by brokers, dealers and municipal securities dealers under Board rules (the “1998 interpretation”).  Since that time, the MSRB has been granted rulemaking authority over municipal advisors, and in the exercise of that authority, the MSRB has been developing a comprehensive regulatory framework for municipal advisors.

     

    The Board believes that the use of electronic media to deliver and receive information under Board rules also is important for municipal advisors, and extends the guidance provided in the 1998 interpretation, as relevant, to municipal advisors.  See Rule G-32 Interpretation – Notice Regarding Electronic Delivery and Receipt of Information by Brokers, Dealers and Municipal Securities Dealers (November 20, 1998).

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Duties of Non-Solicitor Municipal Advisors in Conduit Financing Scenarios
    Rule Number:

    Rule G-42

     

    The MSRB is providing interpretive guidance to address the applicability of Rule G-42, which establishes core standards of conduct for municipal advisors [1] that engage in municipal advisory activities,[2] other than municipal advisory solicitation activities (for purposes of this guidance and Rule G-42, “municipal advisors”), in the area of conduit financing. Using various scenarios, the guidance discusses a municipal advisor’s relationship(s) with, and duties and obligations owed to, a municipal entity issuer, an obligated person that is a conduit borrower,[3] or both, in connection with the issuance of municipal securities for the conduit borrower. For purposes of this guidance, the MSRB assumes that the conduit borrower is not a municipal entity, as defined in Section 15B(e)(8) of the Exchange Act, except in the final section of the guidance entitled, “When a Conduit Borrower is also a Municipal Entity.”

     

    A few broad principles should be noted. First, institutions that are often conduit borrowers, such as large universities, may choose to issue debt securities directly without the involvement of a municipal entity issuer. The exemption from registration under the Securities Act of 1933 (“Securities Act”)[4] may be based on Section 3(a)(4)[5] or Regulation D under the Securities Act,[6] rather than on Section 3(a)(2).[7] In such cases, there may be no municipal security, and Rule G-42 would not apply. In cases where there is a private placement “tail” (i.e., a non-municipal security) side-by-side with the issuance of a tax-exempt municipal security, the advice and the activities a municipal advisor engages in regarding the tax-exempt security, including any conduct or communication to fulfill the municipal advisor’s duties and obligations under Rule G-42, may have an impact or consequences for the municipal advisor with respect to its negotiations or other activities related to the non-municipal security (e.g., the disclosure to the client of a material conflict of interest as required under Rule G-42(b)).

     

    Second, the scenarios described below may involve advice given to both the municipal entity issuer and the conduit borrower. Rule G-42 provides that a fiduciary duty is owed only to a municipal entity, and a duty of care is owed to both the municipal entity and the conduit borrower. If an issue arises as to an activity that involves only the duty of care, such as inquiry as to the facts that provide the basis for advice provided to the client, the duty owed may be the same to both the municipal entity and the conduit borrower. Other issues, however, may involve the duty of loyalty owed the municipal entity as part of the municipal advisor’s fiduciary duty, and thus the municipal advisor’s obligation to the issuer may be higher (or different) than the duty owed the conduit borrower.

     

    Initially, the MSRB provides interpretive guidance regarding the applicability of Rule G-42 when an issuer hires a municipal advisor to provide advice directly to a conduit borrower (“First Scenario”). The MSRB then considers whether an issuer may retain a municipal advisor (either for a specific transaction, or on a long-term basis), and then provide advice that the issuer obtains from the municipal advisor, in connection with a specific issuance of municipal securities, indirectly through the issuer, to the conduit borrower in connection with the issuance (“Second Scenario”). In a third scenario, the MSRB considers whether a conduit borrower may retain a municipal advisor that, as a practical matter, will also provide advice to an issuer on which the issuer will rely, in cases where the issuer chooses not to retain a separate municipal advisor, and, in such circumstances, whether the municipal advisor must provide the issuer the disclosures set forth in Rule G-42 (“Third Scenario”). The MSRB also provides interpretive guidance regarding the application of Rule G-42 to an issuer and a conduit borrower when the issuer and the conduit borrower retain the same municipal advisor to provide advice regarding an issuance (“Fourth Scenario”). Finally, in a fifth scenario (“Fifth Scenario”), the MSRB interprets the applicability of Rule G-42 to a scenario involving two natural persons, A and B, who are employees or otherwise associated persons of a registered municipal advisor, where A is retained by the issuer to provide municipal advisory services to the issuer, and B is retained by the conduit borrower to provide municipal advisory services to the conduit borrower.

     

    Section 1: First Scenario

     

    In the First Scenario, the MSRB considers the applicability of Rule G-42, when, in connection with a specific issuance of municipal securities, an issuer hires a municipal advisor to provide advice directly to a conduit borrower. (For purposes of the First Scenario, the MSRB assumes that the municipal advisor does not provide municipal advisory services to the issuer. Instead, consistent with the issuer’s intent, the municipal advisor is retained for, and in fact, provides municipal advisory services solely to or on behalf of the conduit borrower.)

     

    Under Rule G-42, a municipal advisor may provide municipal advisory services directly to a conduit borrower, in connection with an issuance of municipal securities by an issuer, if the municipal advisor is retained and compensated by the issuer. Whether a person (in this case, the municipal advisor retained by the issuer) is a municipal advisor to the issuer, another person (in this case, the conduit borrower), or both and therefore is subject to Rule G-42, is activity-based and turns on whether the person is providing advice or otherwise engaging in municipal advisory activities for or on behalf of the recipient. Although the First Scenario focuses on the payment of compensation by the issuer, the existence or non-existence of compensation is not a factor in determining whether the municipal advisor is a municipal advisor to the issuer or to the conduit borrower.[8] In addition, the fact that, as to the conduit borrower, the municipal advisor is paid compensation by a third party is also not a factor in determining if the municipal advisor is a municipal advisor to the conduit borrower.

     

    In the First Scenario, the municipal advisor engages in municipal advisory activities solely for or on behalf of the conduit borrower, and is subject to the requirements of Rule G-42. The municipal advisor is required to comply with all the provisions of Rule G-42 as to the conduit borrower,[9] and the rule applies in all respects to the municipal advisor in its relationship with the conduit borrower, except provisions applicable solely to a municipal entity client.

     

    The threshold question regarding the application of Rule G-42 to the municipal advisor in its relationship to the issuer is whether the Securities and Exchange Commission (SEC) would interpret the facts and circumstances of the First Scenario – where the issuer does not receive the municipal advisory services, and the services are in fact provided solely to and on behalf of the conduit borrower – as the municipal advisor engaging (as a legal matter) in municipal advisory activities also to or on behalf of the issuer.

     

    The Exchange Act definition of municipal advisor includes a person that “[p]rovides advice[10] to or on behalf of [emphasis added] a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues.”[11] The SEC has stated that the determination of “whether a person provides advice to or on behalf of a municipal entity or an obligated person regarding municipal financial products or the issuance of municipal securities depends on all the relevant facts and circumstances.”[12] The meaning of the phrase “on behalf of” in the context of the First Scenario and more broadly, whether a person is engaged in municipal advisory activities for or on behalf of another person and is a municipal advisor to such person are interpretive issues that are solely within the jurisdiction of the SEC. Requests for interpretation regarding such issues should be directed to the SEC’s Office of Municipal Securities.

     

    If, in the First Scenario, the activities of the municipal advisor with the issuer are not interpreted by the SEC to mean that the municipal advisor is also a municipal advisor to the issuer, then the municipal advisor would not be required to comply with Rule G-42 with respect to the issuer. For example, the municipal advisor would not be required by Rule G-42 to provide disclosures of conflicts of interest, if any existed, to the issuer.

     

    Although compensation is not a factor in determining whether a person is a municipal advisor to a particular party (except as to a solicitor municipal advisor), the MSRB believes that, in the First Scenario, the compensation paid by the issuer to the municipal advisor for services for a conduit borrower may present a material conflict of interest, requiring the municipal advisor to make full and fair disclosure of such conflict in writing to the conduit borrower. Rule G-42 requires a municipal advisor to disclose all material conflicts of interest under Rule G-42(b)(i). (Such requirements are also incorporated in Rule G-42(c)). The requirement is not limited to actual material conflicts of interest. As provided in Rule G-42(b)(i)(F), for example, the municipal advisor must disclose potential material conflicts of interest that the municipal advisor becomes aware of after reasonable inquiry, that could reasonably be anticipated to impair the municipal advisor’s ability to provide advice to or on behalf of the client in accordance with the applicable standards of conduct under the Rule – the duty of care, and if applicable, the duty of loyalty. In this scenario, the client is the conduit borrower and the municipal advisor owes its client the duty of care as provided in Rule G‑42(a)(i) and SM .01.[13] Even if the compensation paid by the issuer to the municipal advisor is not viewed as an actual material conflict of interest by the municipal advisor, the municipal advisor must carefully consider if such payments give rise to a potential material conflict of interest. In the MSRB’s view, the payments from the issuer to the municipal advisor may create a relationship between the municipal advisor and the issuer, that even if not a municipal advisor-client relationship, generally would give rise to a potential material conflict of interest that could reasonably be anticipated to impair the municipal advisor’s ability to provide advice to or on behalf of the conduit borrower in accordance with the standards of Rule G-42(a). Before making any such disclosures to the conduit borrower, the municipal advisor should consider the guidance set forth in SM .05. Under SM .05, when a municipal advisor is required to make disclosures of material conflicts of interest, including those required under Rule G-42(b)(i)(F), the municipal advisor’s disclosures must be sufficiently detailed to inform the conduit borrower of the nature, implications and potential consequences of each conflict, and must also include an explanation of how the municipal advisor addresses or intends to manage or mitigate each conflict.

     

    Finally, the relationship between the issuer and the municipal advisor, however characterized or limited, may create other compliance concerns under Rule G-42. For example, in some cases, the issuer, although not the client, may wish to provide policy direction or instructions to the municipal advisor regarding the issuance of the municipal securities. If the issuer communicates, explicitly or implicitly, an instruction or direction which the municipal advisor follows and which inhibited or limited the municipal advisor’s ability to fulfill its duties and obligations to the conduit borrower client under Rule G-42, the municipal advisor would violate the rule.

     

    Section 2: Second Scenario

     

    The MSRB has been asked to provide guidance regarding a scenario where a municipal advisor is engaged in municipal advisory activities as directed by an issuer and for such issuer, pursuant to an explicit arrangement or agreement, and the municipal advisor “indirectly” also provides advice to a conduit borrower, because the issuer provides to the conduit borrower the advice the issuer receives from the municipal advisor. For purposes of this Second Scenario, the MSRB assumes that the municipal advisor is aware of the flow of information from the issuer to the conduit borrower.

     

    To assess whether the municipal advisor owes duties to the conduit borrower when the municipal advisor provides advice to the issuer that then flows through to the conduit borrower, again, a threshold question must be answered: Is the municipal advisor also engaged in municipal advisory activities for or on behalf of the conduit borrower because the conduit borrower is receiving, through the issuer, some or all of the advice that was provided by the municipal advisor to the issuer, establishing a municipal advisory relationship between the municipal advisor and the conduit borrower?

     

    As set forth above, the SEC has stated that the determination of “whether a person provides advice to or on behalf of a municipal entity or an obligated person regarding municipal financial products or the issuance of municipal securities depends on all the relevant facts and circumstances,”[14] and whether a person is engaged in municipal advisory activities for or on behalf of another person and is a municipal advisor to such person are interpretive issues that are solely within the jurisdiction of the SEC.[15] 

     

     

    If, in the Second Scenario, the transfer of advice from the issuer to the conduit borrower is interpreted by the SEC to mean that the municipal advisor is engaged in municipal advisory activities for or on behalf of the conduit borrower, the municipal advisor must comply with the requirements of Rule G-42 with respect to the issuer and the conduit borrower. This dual representation may raise several compliance issues.

     

    Rule G-42 distinguishes the duties and obligations that a municipal advisor owes to an issuer client (i.e., a municipal entity) from those owed to a conduit borrower client in two provisions. First, in the conduct of all municipal advisory activities for and on behalf of an issuer client, a municipal advisor is subject to a fiduciary duty as provided in Rule G-42(a)(ii). The fiduciary duty is more specifically described as a requirement to act in accordance with a duty of loyalty[16] and a duty of care,[17] as described in, respectively, SM .02 and SM .01. In contrast and as discussed above, when the municipal advisor’s client is a conduit borrower, the municipal advisor owes a duty of care to the client as provided in Rule G-42(a)(i) and SM .01, but not a duty of loyalty. Second, in connection with a municipal advisor’s municipal advisory activities for and on behalf of an issuer client, a municipal advisor, and any affiliate of the municipal advisor, is prohibited from engaging in certain principal transactions with the issuer, as provided in Rule G-42(e)(ii).[18] This specific prohibition does not apply to a municipal advisor when its client is a conduit borrower. However, all other provisions and protections in Rule G-42 apply in the same manner to a municipal advisor whether its client is an issuer (i.e., a municipal entity) or a conduit borrower. For example, municipal advisors must provide the same timely disclosures of material conflicts of interest and material legal and disciplinary events in the earliest stages of their dealings with their conduit borrower clients as they provide to their municipal entity clients (and supplement such disclosures as necessary during the relationship). Similarly, municipal advisors have the same obligations to an issuer client and a conduit borrower to provide written documentation of the municipal advisory relationship (and supplement such documentation as necessary during the relationship). Also, if a municipal advisor makes a recommendation of a municipal securities transaction to either type of client, the municipal advisor must have a reasonable basis to believe that the recommended municipal securities transaction is suitable for the client.

     

    The MSRB believes that a municipal advisor’s dual representation of an issuer and a conduit borrower with respect to the same issuance raises at least two types of compliance issues and concerns. First, the differing standards and other distinctions that Rule G-42 makes between issuer clients and conduit borrower clients will require a municipal advisor to consider whether, in every aspect of its conduct and representation, the municipal advisor acts in compliance with the more stringent standard applicable to its issuer client, and also fulfills its duties and obligations to its conduit borrower client. Moreover, under Rule G-42, compliance concerns and issues may require greater diligence to identify and address, because although certain duties and obligations are specified in Rule G-42(a)(i) and (ii) and SM. 01 and SM .02, generally, all of the specific duties or obligations that fall under the broad umbrella of the fiduciary duty cannot be specifically enumerated. Among other things, the MSRB cannot anticipate and identify all the situations that may arise in a particular offering, and, as a result, the rule cannot provide explicit instruction or guidance to a municipal advisor to an issuer, regarding what acts must be taken (or avoided) or what must be communicated (or not communicated) to an issuer to comply fully with the municipal advisor’s fiduciary duty. Similarly, all duties and obligations that a municipal advisor owes to a conduit borrower under the duty of care in a particular offering also cannot be specifically enumerated for the same reasons.

     

    Further, when compliance issues or concerns arise, whether the duty owed is a fiduciary duty (a duty of loyalty and a duty of care) or a duty of care, under Rule G-42 and SM .04, the standards of conduct applicable to the municipal advisor and, except as provided in SM .04, the duties and obligations owed to the municipal advisor’s client(s), cannot be eliminated, diminished or modified by disclosure, mutual agreement or otherwise. SM .04 makes clear that nothing in the rule shall be construed to permit a municipal advisor to alter the standards of conduct or impose limitations on any of the duties prescribed in Rule G-42. For example, in various requests for guidance, the MSRB was asked, regarding dual representations, if the MSRB could confirm a municipal advisor engaged in dual representations could continue its representation of both clients if full and fair disclosures of any conflicts of interest or other issues were made to both clients. Generally, disclosure alone would not be sufficient for a municipal advisor to ensure, in all facts and circumstances, that a municipal advisor would be in compliance with all the duties and obligations owed to one or both clients, including, as to a fiduciary, the obligation of a municipal advisor not to “engage in municipal advisory activities for a municipal entity client if it cannot manage or mitigate its conflicts of interest in a manner that will permit it to act in the municipal entity’s best interests.”[19] However, certain limitations may be placed on the scope of a municipal advisory relationship with a client, and the ability to do so is not limited to dual representation scenarios. Under SM .04, if requested or expressly consented to by a client, a municipal advisor may limit the scope of the municipal advisory activities to be performed to certain specified activities or services. (The effectiveness of any such specified limitation of the scope of municipal advisory activities may be negated, however, if the municipal advisor then engages in a course of conduct that is inconsistent with the specified limitations.)

     

    In the Second Scenario and any other scenario involving a dual representation, before entering into the dual representation, a municipal advisor must determine if it is possible to meet its duties and obligations to both clients under Rule G-42. The municipal advisor must determine it can comply with Rule G-42 when the duties and obligations owed to one client, the issuer, are more stringent and more difficult to fulfill, than those duties and obligations that the municipal advisor owes to the second client, the conduit borrower. Among other things, the duty of loyalty owed to the issuer requires a municipal advisor to act in the best interests of the issuer client without regard to the financial or other interests of the municipal advisor. The municipal advisor must consider whether it will be able to act consistently with this standard during the entire engagement while also providing municipal advisory services to the conduit borrower client, without putting its interests or the interests of the conduit borrower, before or above those of the issuer client, including not providing any advantages or benefits to itself or any other client to the loss or detriment of the issuer, including any financial loss or lost opportunity.

     

    In addition, as discussed above, in all municipal advisory relationships, a municipal advisor must identify and disclose to its client material conflicts of interest, after reasonable inquiry, and such disclosures must be sufficiently detailed to inform the client of the nature, implications and potential consequences of each conflict. In the MSRB’s view, conflicts of interest are, in most cases, inherent in a dual representation, although they may not always be material. In a dual representation, the MSRB believes that such conflicts of interest should be identified prior to or upon engaging in municipal advisory activities with each client. Further, in the MSRB’s view, the potential for an identified, but non-material conflict to become a material conflict of interest during the dual representation is great enough that the municipal advisor will have an obligation to make an initial disclosure pursuant to Rule G-42(b)(i)(F), of the facts and circumstances of the dual representation, how such dual representation is a potential material conflict of interest and the risk that such conflict could reasonably be anticipated to impair the municipal advisor’s ability to dually represent both clients in accordance with the standards of conduct under Rule G-42(a).[20] Further, for each client, the municipal advisor must include an explanation of how the municipal advisor addresses or intends to manage or mitigate each conflict, as provided in SM .05.

     

    However, because the municipal advisor owes a fiduciary duty to one client but not the other, if any material conflict of interest is identified that the municipal advisor cannot manage or mitigate in a manner that will permit the municipal advisor to act in the issuer’s best interests, the municipal advisor must not engage in, or must cease engaging in, the municipal advisory activities for the issuer. Practically, this would require the municipal advisor to terminate the relationship with the issuer, or act to eliminate the material conflict of interest. For example, if such conflicts derive from the municipal advisor’s relationship with the conduit borrower, as an alternative to terminating its relationship with the issuer, the municipal advisor may be able to eliminate such material conflicts by amending or terminating its relationship with the conduit borrower. The MSRB notes that, in either scenario, the municipal advisor’s elimination of its conflicts of interest, by terminating its relationship with the issuer, or by amending or terminating its municipal advisory relationship with the conduit borrower, may create both legal and related business issues. If termination of the municipal advisory relationship with the issuer or the conduit borrower is required, among other things, the termination may have a detrimental impact on the schedule or costs of completing the issuance, or impair the terminated client’s ability to obtain informed advice. For these reasons, municipal advisors are cautioned to determine before or upon beginning a dual representation how either municipal advisory relationship would be modified or terminated if the municipal advisor is no longer able to comply with its Rule G-42 obligations in a dual representation. Among other things, a municipal advisor may wish to consider if, prior to finalizing the initial documentation of the municipal advisory relationship as required in Rule G-42(c), the municipal advisor should negotiate the specific terms and conditions that would apply to a future termination of a municipal advisory relationship with either of the clients. As required by Rule G-42(c), if specific terms regarding termination are agreed upon, such terms must be incorporated in the writing(s) that document the municipal advisory relationship.[21]

     

    An example of a difficult circumstance for the municipal advisor to resolve arises when, for example, a major university or hospital chain is engaged in multiple conduit financings in different jurisdictions around the country. The conduit borrower may have developed a certain type of financing to fit within its own broader financing plan, such as consistently structured variable rate securities. One state education authority, which is approached by the university conduit borrower, may, however, have a strong policy against the issuance of variable rate debt. The municipal advisor should bring the conflict to both parties at the earliest possible stage in the financing and make a determination whether it can advise both parties and fulfill its obligations under Rule G-42.

     

    The MSRB also cautions municipal advisors that neither the facts and circumstances characterizing an issuance involving an issuer and a conduit borrower, nor the duties and obligations under Rule G-42 as applied to a relationship, are static or fixed. The requirements of Rule G-42 apply at any time during which municipal advisory activities are engaged in for or on behalf of an issuer or a conduit borrower, and with equal rigor throughout the representation. For example, although the standards of conduct do not change, as facts and circumstances change, a municipal advisor must assess if, under such changed circumstances, there are specific acts, duties or obligations that are not enumerated under Rule G-42 that must be performed or attended to arising from the broad duty of care and, if applicable, duty of loyalty.[22] Rule G-42 also incorporates protections for municipal advisory clients in certain key provisions, which are based on the recognition that key facts and circumstances may change (i.e., the continuing obligation to provide promptly to a client amended or supplemental information in writing, regarding any changes and additions in the relationship documentation, such as amendments or supplements needed regarding the material conflicts of interest disclosures, or the disclosures regarding certain legal and disciplinary events).

     

    Changes in the facts and circumstances regarding the municipal securities issuance, or in the municipal advisory relationships with an issuer, a conduit borrower or both may require the municipal advisor to review if such changes may affect its ability to continue the dual representation and fully comply with Rule G-42. Even if an issuer, a conduit borrower and a municipal advisor believe at the beginning of the dual representation that the issuer and conduit borrower will be in agreement on all major issues that may arise during the course of the issuance, the interests and goals of each client may diverge later. Either the issuer, the conduit borrower, or both, may develop substantially divergent views on issues material to the issuance. Municipal advisors considering dual representation should assess initially the extent to which the interests and goals of the issuer and the conduit borrower are the same or substantially similar and make reassessments periodically thereafter.

     

    Although challenging, in certain circumstances, the MSRB believes that it may be possible for a municipal advisor to provide municipal advisory services to an issuer and, in the manner described in the Second Scenario, indirectly, to engage in municipal advisory activities for or on behalf of a conduit borrower and remain in compliance with Rule G-42. Specifically, the circumstances where dual representation as described in the Second Scenario may be most feasible are those where the interests of the issuer and the conduit borrower are aligned. This may occur when the issuer is created to finance a specific project for the benefit of a metropolitan area, or in instances where the issuer applies a policy-neutral or hands-off approach to proposed projects, provided that such projects and the related financings comply with fundamental legal requirements for issuance. In such circumstances where an issuer and a conduit borrower have a complete or substantially complete convergence of interests and goals, or where the issuer’s concerns are somewhat limited and related for the most part to determining that an issuance will fully comply with the applicable legal and regulatory requirements, it may be possible for the municipal advisor to deal honestly and with the utmost good faith and act in the best interests of the issuer without regard to the financial or other interests of the municipal advisor (including the municipal advisor’s financial or other interest arising from its relationship with the conduit borrower) as required under the duty of loyalty, and also meet its obligations to both clients under the duty of care. It also may be possible for the municipal advisor, which by the very status of its dual representation creates a potential material conflict of interest that must be disclosed in the initial disclosures made pursuant to Rule G-42(b), to manage or mitigate this and any other of “its conflicts of interest in a manner that will permit it to act in the municipal entity’s best interests,” as required under SM .02.

     

    Conversely, where there is not a substantially complete convergence of interests and goals of the issuer and the conduit borrower, or when the shared interests and goals of the issuer and the conduit borrower at the beginning of the issuance process diverge during the course of the issuance, it may not be possible for a municipal advisor to fulfill its duties of loyalty and care to its municipal entity client, and also provide, under the duty of care, the appropriate expert professional advice to the conduit borrower and otherwise fulfill its obligations to the conduit borrower that arise under the duty of care. Although dual representation is possible, for every action taken during an issuance, it is incumbent upon a municipal advisor to assess and determine, as to each client, if such actions comply with the standards of conduct and other requirements under Rule G-42.

     

    Given the broad scope of the duty of care and the broader and more strict obligations arising in a fiduciary relationship, the MSRB concludes that it may be possible for a municipal advisor in the Second Scenario to engage in dual representations for or on behalf of both an issuer and a conduit borrower, but the municipal advisor will face a number of challenges in such situations. Moreover, the challenges to fully and completely comply with its obligations to each client will be heightened in lengthier and more complex engagements.

     

    Section 3: Third, Fourth and Fifth Scenarios

     

    The Third, Fourth and Fifth Scenarios raise the same compliance issues and concerns under Rule G-42 as discussed in the First and Second Scenarios. In the Third Scenario, the municipal advisor, an issuer and a conduit borrower expressly recognize that the municipal advisor is retained by and provides municipal advisory services for the conduit borrower and, also, as a practical matter, provides advice to the issuer, on which the issuer relies.[23] Although in the Third Scenario, the conduit borrower, rather than the issuer compensates the municipal advisor, all the compliance and regulatory issues arising regarding Rule G-42 are the same as those discussed above regarding the Second Scenario.

     

    In relation to the Third Scenario, municipal advisors also have requested guidance regarding the municipal advisor’s responsibilities to the issuer when the municipal advisor is retained and compensated by the conduit borrower. For example, does the municipal advisor have a fiduciary responsibility to the issuer to whom advice is being provided, and is the municipal advisor required to provide disclosures of conflicts of interest to the issuer? If the provision of such advice to the issuer means, under SEC rules, that the provider is a municipal advisor to the issuer, then the municipal advisor would be a fiduciary to the issuer and subject to all the duties and obligations under Rule G-42. Thus, the municipal advisor would be required, among other things, to comply with the requirements to make disclosures of material conflicts of interest as provided in Rule G-42(b), and to provide such conflicts of interest disclosures as part of the relationship documentation as provided in Rule G-42(c).

     

    The Fourth Scenario is another scenario in which a municipal advisor is engaged in a dual representation of an issuer and a conduit borrower. Rule G-42 would apply in the Fourth Scenario in the same manner as it applies in the Second Scenario.

     

    The Fifth Scenario is also an example of dual representation by one municipal advisor of an issuer and a conduit borrower regarding the same issuance of municipal securities and, thus, raises the same issues regarding the municipal advisor’s compliance with Rule G-42 that are discussed for the Second Scenario. The duties and obligations of Rule G-42 run not only from a municipal advisor firm’s associated persons but also from the municipal advisor firm to the issuer and the conduit borrower. Although, in the Fifth Scenario, one employee is designated to act on behalf of the issuer and a second is designated to act on behalf of the conduit borrower, the employees are agents of their employer, a single municipal advisor firm. In the MSRB’s view, therefore, how Rule G-42 applies in the Fifth Scenario does not differ in any material respect from the Second, Third and Fourth Scenarios. In a dual representation, and, in particular, a dual representation purposefully established from the beginning of the issuance, a municipal advisor firm having the capacity to do so is likely to rely on the services of more than one of its associated persons, whether structured to work in coordination as one team, or separately.

     

    Section 4: When a Conduit Borrower is also a Municipal Entity

     

    In the discussion above regarding the five scenarios, the MSRB assumes that, in dual representations, the issuer client is a municipal entity, and the second client, the conduit borrower, is not. As discussed above, because under the Exchange Act and Rule G-42, a municipal advisor owes more rigorous obligations and duties to a municipal entity client – that is, a fiduciary duty – than are owed to a conduit borrower, in certain scenarios involving dual representation, a municipal advisor may find it difficult, or not possible, to fully comply with its obligations to both clients under Rule G-42.

     

    The MSRB recognizes that, at times, both the issuer and the conduit borrower are municipal entities, and, in this discussion, a conduit borrower that is a municipal entity is referred to as a municipal entity conduit borrower. In such cases, a municipal advisor that provides advice to or on behalf of the issuer and the municipal entity conduit borrower would owe the more rigorous duties required of a fiduciary to both clients equally (e.g., the municipal advisor would be required, in all contexts, to deal honestly and with the utmost good faith with the issuer and the municipal entity conduit borrower, and, as to each, to act in the client’s best interests without regard to the financial or other interests of the municipal advisor).

     

    Before undertaking such a dual engagement, the municipal advisor must assess its ability to comply with Rule G-42, including the proscription in Rule G-42, SM .02, which prohibits a municipal advisor from engaging in municipal advisory activities for a client if the municipal advisor could not manage or mitigate its conflicts of interest in a manner that would permit the municipal advisor to act in the best interests of the client. In addition, if the dual representation were undertaken, the municipal advisor’s assessment of its ability to fully comply with Rule G-42, including SM .02, should be carefully considered at the beginning of the dual representation and thoughtfully re-considered periodically during the course of the dual engagement. In the MSRB’s view, the facts and circumstances wherein a municipal advisor would be able to fully comply with Rule G-42, including all obligations as a fiduciary to each municipal entity, are not likely to occur frequently.

     

    This interpretive guidance is intended for use only as a resource. It does not describe all provisions of Rule G-42. In addition, the MSRB has adopted other rules and interpretations that may be applicable to the conduct described in the five scenarios.


    [1] This guidance is limited to persons that are municipal advisors as defined in Section 15B(e)(4) of the Securities Exchange Act of 1934 (“Exchange Act”), and the relevant rules and regulations promulgated pursuant to the Exchange Act (“Exchange Act rules”), but excludes municipal advisors engaged solely in the undertaking of a solicitation of a municipal entity or an obligated person, for compensation, on behalf of certain third parties (“solicitor municipal advisors”), because Rule G-42 does not apply to solicitor municipal advisors. See Exchange Act Release No. 70462 (September 20, 2013), 78 FR 67467 (November 12, 2013) (“Order Adopting SEC Final Rule”) (the Exchange Act rules and regulations referred to above include, but are not limited to, Exchange Act Rules 15Ba1-1 through 15Ba1-8. See also Section 15B(e)(4)(A)(ii); Exchange Act Rule 15Ba1-1(d)(1)(i) (the term “municipal advisor” includes solicitors of obligated persons); Section 15B(e)(9) of the Exchange Act (definition of “solicitation of a municipal entity or obligated person”); and Order Adopting SEC Final Rule, 78 FR 67467, at n. 138 and n. 408.

     

    [2] In Exchange Act Rule 15Ba1-1(e), the term “municipal advisory activities” means “(1) [p]roviding advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues; or (2) [s]olicitation of a municipal entity or an obligated person.” Further, the Rule provides that, in the absence of an exclusion or an exemption, these activities would cause a person to be a municipal advisor.

     

    [3] Although the term “conduit borrower” is not specifically defined in the Exchange Act, a conduit borrower in a municipal securities issuance, such as a private university, non-profit hospital, private corporation, or a public hospital or public university, is a type of “obligated person.” See Order Adopting SEC Final Rule, at 67483, n. 200 (the term obligated person can include entities acting as conduit borrowers, such as private universities and non-profit hospitals).

     

    The term, “obligated person,” is defined in Exchange Act Section 15B(e)(10) to mean:

     

    any person, including an issuer of municipal securities, who is either generally or through an enterprise, fund, or account of such person, committed by contract or other arrangement to support the payment of all or part of the obligations on the municipal securities to be sold in an offering of municipal securities.

     

    Generally, for purposes of this guidance, the terms “obligated person” and “conduit borrower” have the same meaning. In addition, for this guidance, both terms exclude a municipal entity acting as an issuer of municipal securities.

     

    [4] 15 U.S.C. 77a et seq.

     

    [5] 15 U.S.C. 77c(a)(4).

     

    [6] 17 CFR 230.500 – 508.

     

    [7] 15 U.S.C. 77c(a)(2).

     

    [8] See Order Adopting SEC Final Rule, at 67477 (the SEC concluded that compensation should not factor into a determination of whether a person must register (or be registered) as a municipal advisor, except in connection with solicitor municipal advisors; in such cases, the person must becompensated for such solicitation activity to be required to register (or be registered) as a municipal advisor).

     

    [9] These requirements include, but are not limited to: complying with the broad obligations under the duty of care under Rule G-42(a)(i) and Supplemental Material (“SM”) .01 under the rule in all aspects of the municipal advisor’s municipal advisory relationship with the conduit borrower; making the required disclosures to the conduit borrower regarding material conflicts of interest and material legal and disciplinary events (and updating them as necessary) as set forth in Rule G-42(b) and SM .05; providing relationship documentation to the conduit borrower (and updating the documentation as necessary) as provided in Rule G-42(c) and SM .05 and SM .06; if making a recommendation to the conduit borrower, or if reviewing a recommendation from the issuer or another party to the conduit borrower, following the requirements of Rule G-42(d) and SM .09 and SM .10; and not engaging in the specifically prohibited conduct as outlined in Rule G-42(e)(i) and SM .11.

     

    [10] In the Order Adopting SEC Final Rule, the SEC provided guidance to interpret “advice” as that term is used in the definition of municipal advisor and related terms. See Order Adopting SEC Final Rule, at 67471 (providing examples of communications that are excluded from the term “advice”) and 67478 - 80 (SEC guidance regarding the meaning of “advice,” statement that the SEC does not believe that the term “advice” is susceptible to a bright-line definition).

     

    Jurisdiction to resolve the interpretive issue of whether “advice” has been provided, based on the facts and circumstances, lies with the SEC.

     

    [11] See Exchange Act Section 15B(e)(4)(A)(i).

     

    [12] See Order Adopting SEC Final Rule, at 67479.

     

    [13] SM .01 of Rule G-42 sets forth core principles regarding the duty of care a municipal advisor owes to all clients, whether issuers or conduit borrowers. The duty of care includes, but is not limited to, the specific duties enumerated in the rule. For example, to fulfill its obligations under the duty of care, the municipal advisor must, among other things: possess the degree of knowledge and expertise needed to provide the client with informed advice; make a reasonable inquiry as to the facts that are relevant to a client’s determination as to whether to proceed with a course of action or that form the basis for advice provided to the client; and undertake a reasonable investigation to determine that it is not basing any recommendation on materially inaccurate or incomplete information. Also, a municipal advisor must have a reasonable basis for any advice provided to or on behalf of a client; any representations made in a certificate that it signs that will be reasonably foreseeably relied upon by the client, any other party involved in the municipal securities transaction, or investors in the issuer’s securities or municipal securities secured by payments from the conduit borrower client; and any information provided to the client or other parties involved in the municipal securities transaction in connection with the preparation of an official statement for any issue of municipal securities as to which the municipal advisor is advising. For example, to make a recommendation that complies with the duty of care, prior to making a recommendation, a municipal advisor is required to determine if the recommended municipal securities transaction is suitable, based on numerous factors, as applicable to the particular type of client. Various factors are set forth in SM .09 and include, but are not limited to: the client’s financial situation and needs, objectives, tax status, risk tolerance, liquidity needs, the client’s experience with, in this scenario, the issuance of municipal securities and related municipal securities transactions, the client’s experience with municipal securities issuance and related municipal securities transactions of the type and complexity being recommended, the client’s financial capacity to withstand changes in market conditions during the period that the municipal securities to be issued are reasonably expected to be outstanding and any other material information known by the municipal advisor about the client and the municipal securities issuance, after reasonable inquiry.

     

    [14] See Order Adopting SEC Final Rule, at 67479.

     

     

    [15] See supra notes 10-12, and accompanying text.

     

    [16] SM .02 of Rule G-42 sets forth core principles regarding the duty of loyalty owed to the issuer. Under SM .02, the duty of loyalty includes, but is not limited to, the duties and obligations to “deal honestly and with the utmost good faith with a municipal entity client and act in the client’s best interests without regard to the financial or other interests of the municipal advisor.” In addition, “[a] municipal advisor must not engage in municipal advisory activities for a municipal entity client if it cannot manage or mitigate its conflicts of interest in a manner that will permit it to act in the municipal entity’s best interests.”

     

    [17] See n. 13, supra.

     

    [18] Additional information and requirements regarding the specific prohibition in Rule G‑42(e)(ii) are set forth in SM .13, SM .14 and SM .15.

     

    [19] More specifically, requestors asked if the MSRB would confirm that full and fair disclosure of any conflicts of interest or other issues would address any concerns under the Rule with the result that there would be no unmanageable conflict of interest or issue that would prevent a municipal advisor from advising both an issuer and a conduit borrower (or two advisors from the same firm from representing, separately, an issuer and the related conduit borrower) as required under SM .02.

     

     

    [20] The MSRB believes that a conflict of interest arises in a dual representation described in the Second Scenario as it does in the First Scenario, when a municipal advisor provides municipal advisory services to a conduit borrower and the payment for such services is provided by a third-party, such as an issuer, in that such circumstances often can create or foster divided loyalties. In both cases, the MSRB believes that the potential that such conflicts of interest, which are present at the onset of such relationship(s), may later become material conflicts of interest requires, at a minimum, that such conflict(s) be disclosed initially to the client(s) pursuant to Rule G-42(b)(i)(F).

     

     

    [21] Rule G-42(c)(vi) requires that the written documentation of the municipal advisory relationship include, in writing, “the date, triggering event, or means for the termination of the municipal advisory relationship, or, if none, a statement that there is none.” Rule G‑42(c)(vii) requires that the written documentation include “any terms relating to withdrawal from the municipal advisory relationship.”

     

     

    [22] As noted above, all of the municipal advisor’s obligations and duties cannot be specifically enumerated or identified at the beginning of the dual representation. Instead, the duties and obligations under either standard of conduct will unfold during the dual representation.

     

     

    [23] The Third Scenario is limited to situations where an issuer chooses not to retain a separate municipal advisor. However, changing the facts and circumstances of the Third Scenario to include the retention of another municipal advisor by the issuer is not conclusive in determining if Rule G-42 would apply to the municipal advisor retained by the conduit borrower in its conduct with the issuer. If the municipal advisor retained by the conduit borrower provides municipal advisory services indirectly or, as a practical matter, to the issuer, and if the SEC interprets such conduct as engaging in municipal advisory activity for or on behalf of the issuer, the provision of such advice makes Rule G-42 applicable to the provider, except where the provider is subject to an exclusion or an exemption (from the definition of municipal advisor), such as the Independent Registered Municipal Advisor exemption provided under Exchange Act Rule 15Ba1-1(d)(3)(vi).

     

     
    Interpretive Guidance - Interpretive Notices
    Publication date:
    Excerpt from Notice of Application of MSRB Rules to Solicitor Municipal Advisors
    Rule Number:

    Rule G-17

    The MSRB amended Rule G-17, regarding fair dealing, to require that, in the conduct of their municipal advisory activities, municipal advisors, including solicitor municipal advisors, and their associated persons must deal fairly with all persons and not engage in any deceptive, dishonest, or unfair practice. (Previously, the rule applied only to dealers and their associated persons.) Rule G-17 became applicable to all municipal advisors, including solicitor municipal advisors, and their associated persons, on December 22, 2010.

    Rule G-17 contains an anti-fraud prohibition similar to the standard set forth in Rule 10b-5 adopted by the SEC under the Exchange Act. Thus, all municipal advisors must refrain from engaging in certain conduct and must not misrepresent or omit the facts, risks, or other material information about municipal advisory activities undertaken. However, Rule G-17 does not merely prohibit deceptive conduct on the part of a municipal advisor. The rule also establishes a general duty of a municipal advisor to deal fairly with all persons, even in the absence of fraud.

    Rule G-17 imposes a duty of fair dealing on solicitor municipal advisors when they are soliciting business from municipal entities and obligated persons on behalf of third parties. Again, municipal advisors are reminded that the term “municipal entity” also includes certain entities that do not issue municipal securities. Thus, in addition to owing the specific obligations discussed below to issuers of municipal securities, solicitor municipal advisors also owe such obligations to, for example, state and local government sponsored public pension plans and local government investment pools.

    The duty of fair dealing includes, but is not limited to, a duty to disclose to the municipal entity or obligated person being solicited material facts about the solicitation, such as the name of the solicitor’s client; the type of business being solicited; the amount and source of all of the solicitor’s compensation; payments (including in-kind) made by the solicitor to another solicitor municipal advisor (including an affiliate, but not an employee) to facilitate the solicitation regardless of characterization; and any relationships of the solicitor with any employees or board members of the municipal entity or obligated person being solicited or any other persons affiliated with the municipal entity or obligated person or its officials who may have influence over the selection of the solicitor’s client.

    Additionally, if a solicitor municipal advisor is engaged by its client to present information about a product or service offered by the third-party client to the municipal entity or obligated person, the solicitor municipal advisor must disclose all material risks and characteristics of the product or service. The solicitor municipal advisor must also advise the municipal entity or obligated person of any incentives received by the solicitor (that are not already disclosed as part of the solicitor municipal advisor’s compensation from its client) to recommend the product or service, as well as any other conflicts of interest regarding the product or service, and must not make material misstatements or omissions when discussing the product or service.

    Under the Exchange Act, municipal advisors and their associated persons are deemed to owe a fiduciary duty to their municipal entity clients.[*] Similarly, Rule G-42 (which applies only to non-solicitor municipal advisors) follows the Exchange Act in deeming municipal advisors to owe a fiduciary duty, for purposes of Rule G-42, to such municipal entity clients. However, because a solicitor municipal advisor’s clients are not the municipal entities that they solicit, but rather the third parties that retain or engage the solicitor municipal advisor to solicit such municipal entities, solicitor municipal advisors do not owe a fiduciary duty under the Exchange Act or MSRB rules to their clients (or the municipal entity) in connection with such activity. Nonetheless, as noted above, solicitor municipal advisors are subject to the fair dealing standards under Rule G-17 (including with respect to their clients and the entities that they solicit).


    [*] See Order Adopting SEC Final Rule [Release No. 34-70462 (September 20, 2013), 78 FR 67467 (November 12, 2013) (File No. S7-45-10)], at n. 100 (noting that the fiduciary duty of a municipal advisor, as set forth in Section 15B(c)(1) of the Exchange Act, extends only to its municipal entity clients).

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Application of MSRB Rules to Transactions in Managed Accounts
    Rule Number:

    Rule G-48, Rule D-15

    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]

     


    [1] Although the specific inquiries focused on the applicability of Rule G-47, MSRB Rule G-18, on best execution, and the exemption from Rule G-18 when executing transactions for or with an SMMP, this interpretive guidance applies to all the modified obligations under Rule G‑48, as discussed herein.

    [2] The public availability of material information through the MSRB’s Electronic Municipal Market Access (EMMA®) system, or other established industry sources, does not relieve dealers of their disclosure obligations, and dealers may not satisfy the disclosure obligation by directing customers to established industry sources or through disclosure in general advertising materials.

    [3] The pricing obligations under Rule G-30 are modified only when the transactions are non-recommended secondary market agency transactions; the dealer’s services with respect to the transactions have been 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.

    [4] The customer-specific suitability obligation requires that a dealer have a reasonable basis to believe that the recommendation is suitable for a particular customer based on that customer’s investment profile. See Supplementary Material .05(b) to Rule G-19. Rule G-48 does not relieve dealers of the obligations regarding reasonable-basis and quantitative suitability. See Supplementary Material .05(a) and (c) to Rule G-19.

    [5] As modified by Rule G‑48, if a dealer is disseminating a quotation on behalf of an SMMP, the dealer shall have no reason to believe the quotation does not represent a bona fide bid for, or offer of, municipal securities, or that the price stated in the quotation is not based on the best judgment of the fair market value of the securities of the SMMP, and no dealer shall knowingly misrepresent a quotation relating to municipal securities made by any SMMP.

    [6] Under Rule G-18, in any transaction for or with a customer or a customer of another dealer, a dealer must use reasonable diligence to ascertain the best market for the subject security and buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions.

    [7] See MSRB Notice 2003-20 (May 23, 2003); Interpretive Notice on Recordkeeping (Jul. 29, 1977).

    [8] See SEC Study on Investment Advisers and Broker-Dealers (January 2011) at 21 (“The Supreme Court has construed Advisers Act Section 206(1) and (2) as establishing a federal fiduciary standard governing the conduct of advisers.”) (“IA-BD Study”). See also SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963); Transamerica Mortgage Advisors, Inc., 444 U.S. 11, 17 (1979) (“[T]he Act’s legislative history leaves no doubt that Congress intended to impose enforceable fiduciary obligations.”).

    [9] See IA-BD Study at 22 (“[A]n adviser must fully disclose to its clients all material information that is intended ‘to eliminate, or at least expose, all conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested.’”).

    [10] “To fulfill the obligation, an adviser must make a reasonable determination that the investment advice provided is suitable for the client based on the client’s financial situation and investment objectives.” Id. at 27-28.

    [11] “[A]n investment adviser has ‘a duty of care requiring it to make a reasonable investigation to determine that it is not basing its recommendations on materially inaccurate or incomplete information.’” Id. at 28.

    [12] For accounts in which investment advisers exercise discretion, they generally have the responsibility to select dealers to execute client trades. Id. “In meeting this obligation, an adviser must seek to obtain the execution of transactions for each of its clients in such a manner that the client’s total cost or proceeds in each transaction are the most favorable under the circumstances.” Id. “An investment adviser should ‘periodically and systematically’ evaluate the execution it is receiving for clients.” Id. at 29.

    [13] The MSRB also believes that state rules and regulations for investment advisers offer similar protections that support the MSRB’s interpretations here. Although the requirements are not uniform, “[s]tates generally impose requirements upon state-registered investment advisers that are similar to those under the Advisers Act.” Id. at 85. See also Scott J. Lederman, Hedge Fund Regulation (2d Ed.), Ch. 17. State Advisory Regulation, 17-3 (Nov. 2012) (“State securities regulators generally impose requirements on state-registered advisers that are similar to those found in the Advisers Act. However, state regulation often contains additional requirements not found at the federal level.”).

    [14] The MSRB notes that implicit in this interpretation is the expectation of dealers’ compliance with all existing recordkeeping requirements associated with the various conditions for the interpretation’s applicability.

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Time of Trade Disclosure—Disclosure of Market Discount
    Rule Number:

    Rule G-47


    Overview

    MSRB Rule G-47, on time of trade disclosure, requires brokers, dealers and municipal securities dealers (collectively, “dealers”) to disclose to their customers, at or prior to the time of trade, all material information known about the transaction, as well as material information about the municipal security that is reasonably accessible to the market. The MSRB has previously provided interpretive guidance, now codified in supplementary material to Rule G-47, on specific types of information that is material where specific scenarios occur and requires time of trade disclosure. Rule G-47, however, emphasizes that this list of specific disclosures is not exhaustive, and that other information may be material to a customer and required to be disclosed. The MSRB is publishing this notice to state its interpretation that the fact that a municipal security bears market discount is material information that must be disclosed to a customer under Rule G-47.

    Market Discount

    When a municipal security is acquired in the secondary market for less than par value, the security may have “market discount.” The amount of market discount is equal to the excess, if any, of the stated redemption price at maturity over the basis of the security immediately after its purchase by the investor. Market discount occurs when the value of a municipal security declines after its issue date—which often may occur due to a rise in interest rates. The fact that a municipal security bears market discount may significantly affect its tax treatment. Under federal tax law, for bonds purchased after April 30, 1993, the market discount is taxed at the investor’s ordinary income tax rate, rather than the capital gains rate.[1]

    Original Issue Discount Bonds. Market discount is calculated differently for original issue discount (OID) bonds. An OID 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 bond’s stated redemption price at maturity exceeded its public offering price at the time of its original issuance and, for a tax-exempt municipal security, is generally treated as tax-exempt interest.[2]

    Market discount exists for an OID bond when the bond is acquired in the secondary market for less than its revised or adjusted issue price. The revised or adjusted issue price for an OID bond is equal to the bond’s original issue price plus the accrued OID up to the date of purchase. The amount of market discount is equal to the excess, if any, of the revised issue price over the basis of the bond immediately after its purchase by the investor.

    De Minimis Rule. Bonds with a de minimis amount of market discount are subject to more favorable tax treatment than bonds with a non-de minimis amount of market discount. Under the de minimis rule, if the amount of market discount is less than one-fourth of 1% (.0025) of the stated redemption price of the bond multiplied by the number of complete years from the date of purchase to the date of maturity, the market discount is de minimis and is generally taxed as a capital gain, rather than ordinary income.

    Market Discount Disclosure at or Prior to the Time of Trade

    As noted, Rule G-47 requires dealers to disclose to their customers, at or prior to the time of trade, “all material information known about the transaction, as well as material information about the security that is reasonably accessible to the market.”[3] This disclosure obligation applies whether the transaction is unsolicited or recommended, and whether it is a primary offering or secondary market transaction. Information is considered to be material under Rule G-47 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 MSRB has previously stated, and codified as supplementary material to Rule G-47, that the fact that a municipal security bears an original issue discount is material information that dealers are obligated to disclose, because it may affect the tax treatment of the security.[4] Significantly, in explaining this interpretation of the Board’s rules, the MSRB noted that appropriate disclosure of a security’s original issue discount feature should assist customers in computing the market discount or premium on their transaction. The MSRB also noted its concern that, absent adequate disclosure of a security’s original issue discount status, an investor might not be aware that all or a portion of his or her investment return represented by accretion of the discount is tax-exempt, and might therefore, for example, sell the security at an inappropriately low price (i.e., a price not reflecting the tax-exempt portion of the discount). 

    Similarly, the MSRB is concerned that, absent adequate disclosure that a security has market discount, an investor might not be aware that all or a portion of his or her investment return represented by accretion of the market discount is taxable as ordinary income, and therefore might, for example, purchase the securities at an inappropriately high price (i.e., a price not reflecting the potentially higher tax rate applicable to the discount). The existence of market discount may impact an investor’s decision to purchase or sell an affected bond or determination of what price to pay or accept for such bond. As a result, the MSRB believes that the fact that a security has market discount is material information that is required to be disclosed to a customer under Rule G-47 at or prior to the time of trade.


    [1] Tax treatment and the amount of market discount and original issue discount (if any) are determined in accordance with the provisions of the Internal Revenue Code and the rules and regulations of the Internal Revenue Service.

    [2] For more information about original issue discount bonds, see MSRB, About Original Issue Discount Bonds, available at: http://www.msrb.org/msrb1/pdfs/Original-Issue-Discount-Bonds.pdf.

    [3] MSRB Rule G-47(a). However, under MSRB Rule G-48, on transactions with sophisticated municipal market professionals, a dealer is relieved of the obligation to disclose to a sophisticated municipal market professional or SMMP material information that is reasonably accessible to the market. See Rule G-48(a). Accordingly, dealers do not have an obligation to disclose to SMMPs the existence of market discount.

    [4] See MSRB Rule G-47, Supplementary Material .03(f); see also Interpretive Reminder Notice Regarding Rule G-17, on Disclosure of Material Facts—Disclosure of Original Issue Discount Bonds (January 5, 2005); 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.

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Questions and Answers Notice Concerning Real-Time Reporting of Municipal Securities Transactions
    Rule Number:

    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) .

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Sales of Interests in ABLE Programs in the Primary Market
    Rule Number:


    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.


    [1] Section 529A of the Internal Revenue Code of 1986, as amended, was enacted pursuant to the Stephen Beck, Jr. Achieving a Better Life Experience Act of 2014 (the “ABLE Act”).

    [2] Letter dated March 31, 2016 from Jessica S. Kane, Director, Office of Municipal Securities, U.S. Securities and Exchange Commission to Robert A. Fippinger, Esq., Chief Legal Officer, Municipal Securities Rulemaking Board, in response to letter dated December 31, 2015 from Robert A. Fippinger to Jessica S. Kane available at http://www.sec.gov/info/municipal/msrb-letter-033116-interests-in-able-accounts.pdf [footnote omitted].

    [3] 15 U.S.C. §78o-4.

    [4] 17 CFR 240.15c2-12. 

    [5] See supra n.2.

    [6] EMMA is a registered trademark of the MSRB.

    [7] Letter dated February 26, 1999 from Catherine McGuire, Chief Counsel, Division of Market Regulation, U.S. Securities and Exchange Commission to Diane G. Klinke, General Counsel, Municipal Securities Rulemaking Board, in response to letter dated June 2, 1998 from Diane G. Klinke to Catherine McGuire, published as Municipal Securities Rulemaking Board, SEC No-Action Letter, Wash. Serv. Bur. (CCH) File No. 03229033 (Feb. 26, 1999).

    [8] Exchange Act Release No. 70462 (Sept. 20, 2013), 78 FR 67468, 67472-73 (Nov. 12, 2013).

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Calculations for Securities with Periodic Interest Payments
    Rule Number:

    Rule G-33

    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.

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Questions and Answers Concerning Political Contributions and Prohibitions on Municipal Securities Business: Rule G-37 (originally published on May 24, 1994)
    Rule Number:

    Rule G-37

    All Rule G-37 interpretive guidance for dealers shall apply to the analogous interpretive issues for municipal advisors, with the exception of interpretive guidance issued on February 21, 1997, and April 2, 2002. See Notice of Filing of Proposed Rule Change Consisting of Proposed Amendments to Rule G-37, on Political Contributions and Municipal Securities Business, Rule G-8, on Books and Records, Rule G-9 on Preservation of Records, and Form G-37 and G-37x, Release No. 34-76763 (December 16, 2015), 80 FR 81710, at 81718, 81735 (December 30, 2015) (File No. SR-MSRB-2015-14).

     


    I. PERSONS/ENTITIES SUBJECT TO THE RULE

    I.1
    Q: To whom does Rule G-37 apply?
    A: In general, Rule G-37 applies to brokers, dealers and municipal securities dealers (collectively referred to as dealers), municipal finance professionals, and PACs controlled by the dealer or any municipal finance professional. In addition, the recordkeeping and disclosure provisions apply to non-MFP executive officers of the dealer.

    (May 24, 1994)

    II. PROHIBITION ON ENGAGING IN MUNICIPAL SECURITIES BUSINESS (Rule G-37(b))

    II.1
    Q: What actions would cause a dealer to be prohibited from engaging in municipal securities business with an issuer?
    A:
    Rule G-37(b) prohibits a dealer from engaging in municipal securities business with an issuer within two years after any contribution to an official of such issuer made by: (i) the dealer, (ii) any municipal finance professional associated with such dealer; or (iii) any PAC controlled by the dealer or any municipal finance professional.

    (May 24, 1994)

    II.2
    Q: Is there an exception to this prohibition on engaging in municipal securities business?
    A: There is one exception to Rule G-37(b). The prohibition does not apply if the only contributions to officials of issuers are made by municipal finance professionals entitled to vote for such officials, and provided such contributions, in total, are not in excess of $250 by each such municipal finance professional to each official of such issuer, per election.

    (May 24, 1994)

    II.3
    Q: What is the municipal securities business that a dealer would be banned from engaging in with an issuer if certain political contributions are made to officials of such issuers?
    A: The term "municipal securities business" is defined in Rule G-37(g)(vii) to encompass certain activities of dealers, such as acting as negotiated underwriters (as managing underwriter or as syndicate member), financial advisors and consultants, placement agents, and negotiated remarketing agents. The rule does not prohibit a dealer from engaging in competitive underwritings or competitive remarketing services for the issuer.

    (May 24, 1994)

    II.4
    Q: If a non-MFP executive officer makes a contribution to an official of an issuer, is the dealer prohibited from engaging in municipal securities business with that issuer?
    A:
    No. The prohibition section applies only to contributions made by the dealer, its municipal finance professionals, or any PAC controlled by the dealer or any of its municipal finance professionals. The definition of non-MFP executive officer does not include any municipal finance professional. However, contributions by non-MFP executive officers are subject to the reporting/disclosure provisions of the rule. In addition, pursuant to section (d), dealers are prohibited from using non-MFP executive officers (as well as any other person or entity) as a conduit for making contributions to officials of issuers.

    (May 24, 1994)

    II.5
    Q: Would a dealer be prohibited from engaging in municipal securities business with a state agency, whose board members are appointed by the governor, if the dealer makes contributions to the governor?
    A: Yes, the definition of “official of an issuer” in Rule G-37(g)(vi) includes any person who was, at the time of the contribution, an incumbent, candidate or successful candidate for any elective office of a state or of any political subdivision, which office has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by an issuer.

    (May 24, 1994, revised October 30, 2003)

    II.6
    Q: May a municipal finance professional who is entitled to vote for an issuer official make contributions to pay for such official’s transition or inaugural expenses without causing a prohibition on municipal securities business with the issuer?
    A: Yes, under certain conditions. The de minimis exception allows a municipal finance professional to contribute up to $250 per candidate per election if the municipal finance professional is entitled to vote for that issuer official. The de minimis exception is keyed to an election cycle; therefore, if a municipal finance professional contributed $250 to the general election of an issuer official, the municipal finance professional would not be able to make any contributions to pay for transition or inaugural expenses without causing a prohibition on municipal securities business with the issuer. If a municipal finance professional made no contributions to an issuer official prior to the election, then the municipal finance professional may, if entitled to vote for the candidate, contribute up to $250 to pay for transition or inaugural expenses and payment of debt incurred in connection with the election without causing a prohibition on municipal securities business.

    (September 9, 1997)

    II.7
    Q: Are any payments made to issuer officials, other than political contributions, covered by the rule?
    A:
    No. However, any other payments may be subject to Rule G‑20 on gifts and gratuities.

    (May 24, 1994)

    Primary, State Caucus or Convention

    II.8
    Q: If an issuer official is involved in a primary election prior to the general election, may a municipal finance professional who is entitled to vote for such official contribute $250 to the issuer official's primary as well as general election?
    A:
    Yes, the municipal finance professional could contribute up to $500 to each such official (i.e., $250 per election).

    (May 24, 1994)

    II.9
    Q: If the locality in which the incumbent or candidate is seeking election as an issuer official holds a convention or caucus (instead of a primary election) prior to the general election, may a municipal finance professional entitled to vote in that locality contribute $250 to the incumbent or candidate's convention or caucus election campaign, as well as $250 to the incumbent or candidate's general election, without causing a ban on municipal securities business with the issuer?
    A: Yes, if the issuer official has been qualified to be considered at the state caucus or convention.

    (June 15, 1995)

    MFP as Incumbent or Candidate

    II.10
    Q: If a municipal finance professional also is an incumbent or candidate for political office in a municipality in which the municipal finance professional's employer (i.e., the dealer) conducts municipal securities business, must the dealer terminate the municipal finance professional or are there any restrictions on the kind of business a dealer can engage in with that issuer?
    A: No. However, the dealer, any municipal finance professional and any PAC controlled by the dealer or municipal finance professional must ensure that the dealer does not engage in municipal securities business with the issuer if contributions (other than the de minimis contributions allowed under section (b)) are made to an official of the issuer. The municipal finance professional who is an incumbent or candidate for office is not limited to contributing the de minimis amount to his or her own campaign in such instances.

    (May 24, 1994)

    Attendance at Fund-Raising Dinner

    II.11
    Q: May a dealer continue to engage in municipal securities business with an issuer if a municipal finance professional pays for and attends a fund-raising dinner for a candidate who is seeking election to a position as an official of such issuer?
    A: A municipal finance professional who contributes funds in this instance would subject the dealer to a prohibition on municipal securities business with the issuer unless the municipal finance professional is entitled to vote for such candidate and any contributions do not exceed $250 to such candidate per election. In addition, any municipal finance professional who attends the dinner for the purpose of soliciting contributions by others for the issuer official would violate Rule G-37's prohibition on soliciting contributions. See also Rule G-37(c).

    (May 24, 1994)

    Two-Year Look Back

    II.12
    Q: A municipal finance professional (i.e., a municipal investment banker subject to the two year look back) was associated with dealer X at the time he made a contribution which resulted in the dealer being prohibited from engaging in municipal securities business with the issuer. Then, less than two years after making the contribution, the municipal finance professional becomes associated with dealer Y. Is dealer Y also subject to the prohibition on business?
    A: Both dealers are subject to the prohibition for two years from the date the municipal finance professional made the contribution. Of course, dealer Y's prohibition on business only begins when the municipal finance professional becomes associated with that dealer.

    (May 24, 1994, revised October 30, 2003)

    II.13
    Q: Prior to becoming associated with any dealer, a person makes a contribution to an issuer official. Less than two years after making the contribution, that person becomes a municipal finance professional (i.e., a municipal investment banker subject to the two year look back). Would the hiring dealer be prohibited from engaging in municipal securities business with that issuer?
    A: Yes. Rule G-37 attempts to sever any connection between the making of contributions and the awarding of municipal securities business by prohibiting the dealer from engaging in municipal securities business with the issuer for two years from the date the contribution was made. As noted above, the dealer's prohibition on business would begin when the municipal finance professional becomes associated with that dealer. Thus, if the individual was hired, for example, six months after making the contribution, then the dealer's prohibition on business would extend for one and one half years.

    (May 24, 1994, revised October 30, 2003)

    II.14
    Q: If a dealer hires an individual as a retail sales person, would the contributions made by that person prior to being hired subject the dealer to the two-year prohibition on municipal securities business?
    A: The rule's two-year prohibition is triggered by contributions by dealers, municipal finance professionals, and political action committees controlled by a dealer or a municipal finance professional. If a retail sales person is not a municipal finance professional and does not become a municipal finance professional within two years after making a contribution to an issuer official, then such contributions will not trigger the ban on business. However, if the retail sales person is, or within two years becomes, a municipal finance professional (e.g., by solicitation of officials of an issuer), then contributions made by that person will subject the hiring dealer to the two-year ban on business. A retail sales person would not be considered to be a municipal finance professional solely because of his or her municipal securities retail sales activities. (See Rule G-37(g)(iv)).

    (December 7, 1994, revised October 30, 2003)

    II.15
    Q: A person is associated with a dealer in a non-municipal finance professional capacity, and makes a contribution to an issuer official. Less than two years after making the contribution, that person becomes a municipal finance professional (i.e., a municipal investment banker subject to the two year look back). Would the dealer be prohibited from engaging in a negotiated underwriting with that issuer?
    A: Yes, the dealer is subject to the prohibition for two years from the date the contribution was made.

    (May 24, 1994, revised October 30, 2003)

    II.16
    Q: A person is associated with a dealer in a non-municipal finance professional capacity and makes a political contribution to an official of an issuer for whom such person is not entitled to vote. Less than two years after such person made the contribution, the dealer merges with another dealer and, solely as a result of the merger, that person becomes a municipal finance professional of the surviving dealer. Would the surviving dealer be prohibited from engaging in municipal securities business with that issuer?
    A: Yes. Rule G-37 would prohibit the surviving dealer from engaging in municipal securities business with the issuer for two years from the date the contribution was made. Of course, the surviving dealer’s prohibition on business would only begin when the person who made the contribution becomes a municipal finance professional of the surviving dealer.

    The Board notes, however, that Rule G-37 was not intended to prevent mergers in the municipal securities industry or, once a merger is consummated, to seriously hinder the surviving dealer’s municipal securities business if the merger was not an attempt to circumvent the letter or spirit of rule G-37. Thus, the dealer may wish to seek an exemption from the ban on business pursuant to Rule G-37(i) from its appropriate regulatory authority.

    (June 29, 1998, revised October 30, 2003)

    Refund of Inadvertent Contribution

    II.17
    Q: A disgruntled municipal finance professional made a contribution purposely to subject the dealer to the two-year prohibition on business. When the contribution is discovered by the dealer, a refund of the contribution is requested and obtained. Is the dealer still banned from engaging in business with that issuer? In addition, does the contribution have to be disclosed on Form G-37?
    A: Rule G-37(b) prohibits a dealer from engaging in municipal securities business with an issuer within two years after any contribution to an official of such issuer by any municipal finance professional associated with such dealer if the contribution does not meet the de minimis exemption. Section (i) of the rule provides a procedure whereby dealers may seek relief from the appropriate enforcement agency of the rule G-37 prohibition on business. In determining whether to grant such an exemption, one of the factors the enforcement agency will consider is whether the dealer has taken all available steps to obtain a return of the contribution. Even if a refund of the contribution has been obtained, dealers are required to seek an exemption from the ban on business. In addition, dealers also must disclose the contribution on Form G-37. Dealers may wish to indicate on the form (and in their own records) that a refund of the contribution was obtained. See Rule G-37(i).

    (August 18, 1994)

    Volunteer Work

    II.18
    Q: Is a municipal finance professional prohibited from performing volunteer work on an issuer official's behalf?
    A: Rule G-37 is not intended to prohibit or restrict municipal finance professionals from engaging in personal volunteer work. However, soliciting and bundling of contributions would invoke application of the rule. In addition, if the municipal finance professional uses the dealer's resources (e.g., a political position paper prepared by dealer personnel) or incurs expenses in the conduct of such volunteer work (e.g., hosting a reception), then the value of such resources or expenses would constitute a contribution. Personal expenses incurred by the municipal finance professional in the conduct of such volunteer work, which expenses are purely incidental to such work and unreimbursed by the dealer (e.g., cab fares and personal meals), would not constitute a contribution.

    (May 24, 1994)

    Dealer Resources

    II.19
    Q: If an employee of a dealer is donating his or her time to an issuer official's campaign, does the dealer have to disclose this as a contribution to such official? In addition, would the fact that the employee is taking a leave of absence from the dealer cause a different result?
    A: An employee of a dealer generally can donate his or her time to an issuer official's campaign without this being viewed as a contribution by the dealer to the official, as long as the employee is volunteering his or her time during non-work hours, or is using previously accrued vacation time or the dealer is not otherwise paying the employee's salary (e.g., an unpaid leave of absence).

    (August 18, 1994)

    Making Contributions to Issuer Officials on Behalf of Other Persons

    II.20
    Q: A municipal finance professional signs a check drawn on a joint account, which is owned by the municipal finance professional and another person, and submits it to an issuer official as a contribution along with a writing which states that the contribution is being made solely by the other holder of the joint account. Would any portion of this contribution be attributable to the municipal finance professional under Rule G-37?
    A: If a municipal finance professional signs a check, whether the check was drawn on a joint account or not, and submits it as a contribution to an issuer official, then the municipal finance professional is deemed to have made the full contribution, regardless of any writing accompanying the check that provides or directs otherwise. Moreover, if this amount exceeds, or does not qualify for, the de minimis exception, then by making such a contribution the municipal finance professional will trigger the rule's ban on business thereby prohibiting his dealer/employer from engaging in municipal securities business with the particular issuer for two years.

    (February 16, 1996)

    II.21
    Q: If a municipal finance professional and another person (e.g., her spouse) both sign a check drawn on their joint account and submit the check to an issuer official as a contribution, would the contribution amount be attributable equally between them (i.e., 50% to each person) for purposes of Rule G-37?
    A: Yes. If a municipal finance professional and any other person both sign a check drawn on their joint account and submit it to an issuer official as a contribution, then each person is deemed to have made half of the contribution, regardless of any writing accompanying the check that provides or directs otherwise.

    (February 16, 1996)

    Making Contributions to a Candidate Who Later Loses the Election

    II.22
    Q: If a municipal finance professional made a political contribution which was not subject to the de minimis exception to an issuer official candidate who subsequently did not win the election, is the dealer banned from engaging in municipal securities business with that issuer (i.e., the governmental entity)?
    A: Yes. Rule G-37 defines the term "official of such issuer" or "official of an issuer" as "any person (including any election committee for such person) who was, at the time of the contribution, an incumbent, candidate or successful candidate: (A) for elective office of the issuer which office is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by the issuer; or (B) for any elective office of a state or of any political subdivision, which office has authority to appoint any official(s) of an issuer, as defined in subparagraph (A), above." It is clear from the rule that, at the time the contribution is made, if the recipient of that contribution is an "official of an issuer," then the dealer is subject to the two-year ban on business with the issuer, regardless of whether the candidate wins or loses the election. Any other result would mean that municipal finance professionals could make contributions to issuer officials, but the ban on business would not be triggered (if at all) until election results were known.

    (February 16, 1996)

    III. INDIRECT CONTRIBUTIONS (Rule G-37(d))

    Contributions by Spouses and Household Members

    III.1
    Q: Are contributions to issuer officials by municipal finance professionals’ spouses and household members covered by the rule?
    A: No, unless these contributions are directed by the municipal finance professional, which is prohibited by section (d) of the rule.

    (May 24, 1994)

    III.2
    Q: If a municipal finance professional directs a retail sales person (who is not a municipal finance professional) to make a political contribution to an issuer official, would this trigger the rule's two-year prohibition on business with that issuer?
    A: Yes. Section (d) of the rule prohibits municipal finance professionals (and dealers) from using any person or means to do, directly or indirectly, any act which would violate the rule. In other words, a municipal finance professional is prohibited from using a sales person (or any other person not otherwise subject to the rule) as a conduit to circumvent the rule. Thus, contributions made, directly or indirectly, by a municipal finance professional (or a dealer) to an issuer official will subject the dealer to the rule's two-year prohibition on municipal securities business with that issuer. In addition to triggering the prohibition, the municipal finance professional in this case has violated section (d) of the rule.

    (December 7, 1994)

    Political Parties

    III.3
    Q: Are contributions to national, state or local political parties covered by the rule?
    A: Any such contributions would not trigger the prohibition on business portion of the rule (section (b)) unless such entities are used as a conduit to indirectly contribute to an issuer official, which is prohibited by section (d) of the rule. However, contributions to state or local political parties must be recorded under Rule G-8(a)(xvi) and disclosed in summary form under Rule G‑37(e), except for those contributions which meet the de minimis exemption. See also Rule G-37(e).

    (May 24, 1994)

    Contributions to a Non-Dealer Associated PAC and Payments to a State or Local Political Party

    III.4
    Q: Could contributions to a non-dealer associated PAC or payments to a state or local political party lead to a ban on municipal securities business with an issuer under Rule G-37?
    A: Rule G-37(d) prohibits a dealer and any municipal finance professional from doing any act indirectly which would result in a violation of the rule if done directly by the dealer or municipal finance professional. A dealer would violate Rule G-37 by doing business with an issuer after providing money to any person or entity when the dealer knows that such money will be given to an official of an issuer who could not receive such a contribution directly from the dealer without triggering the rule’s prohibition on business. For example, in certain instances, a non-dealer associated PAC or a local political party may be soliciting funds for the purpose of supporting a limited number of issuer officials. Depending upon the facts and circumstances, contributions to the PAC or payments to the political party might well result in the same prohibition on municipal securities business as would a contribution made directly to the issuer official. (August 6, 1996)

    III.5
    Q: If a dealer receives a fund raising solicitation from a non-dealer associated PAC or a political party with no indication of how the collected funds will be used, can the dealer make contributions to the non-dealer associated PAC or payments to the political party without causing a ban on municipal securities business?
    A: Dealers should inquire of the non-dealer associated PAC or political party how any funds received from the dealer would be used. For example, if the non-dealer associated PAC or political party is soliciting funds for the purpose of supporting a limited number of issuer officials, then, depending upon the facts and circumstances, contributions to the PAC or payments to the political party might well result in the same prohibition on municipal securities business as would a contribution made directly to the issuer official.

    (August 6, 1996)

    Making Payments to a National Political Party for its Non-Federal Account (Rule G-37(e))

    III.6
    Q: If a national political party accepts payments in which contributors have designated that their payments be deposited into the account for a state or local political party, must the dealer record such payments and report them on Form G-37?
    A: Yes. Rule G-37 requires that dealers record and report payments made to state and local political parties and the ultimate recipient in the above scenario is a state or local political party so designated by the contributor.

    (February 16, 1996)

    Supervisory Procedures Relating to Indirect Contributions

    III.7
    Q: Is a broker, dealer or municipal securities dealer (“dealer”) required to have written supervisory procedures reasonably designed to ensure compliance with Rule G-37(d), on indirect contributions and solicitations, with regard to payments to political parties and PACs by a dealer or its municipal finance professionals (“MFPs”)?
    A: Yes. The relevant portion of the MSRB's supervision rule, Rule G-27(c), provides that, “Each dealer shall adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance [with MSRB rules].”

    Rule G-37(d) provides that: “No broker, dealer or municipal securities dealer or any municipal finance professional of the broker, dealer or municipal securities dealer shall, directly or indirectly, through or by any other person or means, do any act which would result in a violation of sections (b) or (c) of this rule.” While Rule G-37 was adopted to deal specifically with contributions made to officials of issuers by dealers and municipal finance professionals, and political action committees (“PACs”) controlled by dealers or MFPs, this section of the rule also prohibits MFPs and dealers from using conduits—such as, but not limited to parties, PACs, affiliates, consultants, lawyers or spouses—to contribute indirectly to an issuer official if such MFP or dealer can not give directly to the issuer without triggering the ban on business.

    In order to ensure compliance with Rule G-27(c) as it relates to payments to political parties or PACs and Rule G-37(d), each dealer must adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that neither the dealer nor its MFPs are using payments to political parties and non-dealer controlled PACs to contribute indirectly to an official of an issuer.[1] For example, a dealer's written supervisory procedures might provide that, if the dealer or any of its MFPs want to make payments to political parties or PACs, the dealer must perform adequate due diligence prior to allowing political party or PAC payments by the dealer or its MFPs to reasonably ensure that neither the dealer nor its MFPs are using payments to political parties or non-dealer controlled PACs to contribute indirectly to an official of an issuer. [2] Such due diligence also might include inquiring about and documenting the intent or motive in making the payment, whether the party payment or PAC contribution was solicited by anyone, and if so, the identification of the person soliciting the party payment and a record of written solicitations. This information will assist the dealer in determining whether the facts and circumstances surrounding the payment support the reason given for making the payment.

    In addition, to ensure compliance with Rule G-37(d) in connection with contributions by dealers or MFPs to non-controlled (but affiliated) PACs,[3]

    the dealer might adopt information barriers between any affiliated PACs and the dealer or its MFPs. Examples of such information barrier provisions might include such things as:

    • a prohibition on the dealer or MFPs from recommending, nominating, appointing or approving the management of affiliated PACs;

    • a prohibition on sharing the affiliated PAC's meeting agenda, meeting schedule, or meeting minutes;

    • a prohibition on identification of prior affiliated PAC contributions, planned PAC contributions or anticipated PAC contributions;

    • a prohibition on directly providing or coordinating information about prior negotiated municipal securities business, solicited municipal securities business, and planned solicitations of municipal securities business; and

    • other such information barriers as the firm deems appropriate to effectively monitor conflicting interests and prevent abuses.

    These examples are not exclusive and are only suggestions for supervisory procedures that dealers could consider. Each dealer is required under Rule G-27, on supervision, to evaluate its own circumstances and develop written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance with Rule G-37, on indirect violations.

    (September 22, 2005)


    [1] In addition, pursuant to MSRB Rule G-8(a)(xx), on Records Concerning Compliance with Rule G-27, each dealer must maintain and keep current the records required under Rules G-27(c) and G-27 (d).

    [2] See Rule G-37 Questions and Answers Nos. III. 4 and III.5, reprinted in MSRB Rule Book.

    [3] For the purposes of this guidance the term “affiliated PAC” means a PAC controlled by an affiliated entity of a dealer. An “affiliated entity” is an entity that controls, is controlled by or is under common control with the dealer.

    III.8
    Q: Is a dealer required to have written supervisory procedures in place to ensure compliance with Rule G-37(d) if the dealer only allows the dealer or its municipal finance professionals (“MFPs”) to make political party payments to “housekeeping”, “conference” or “overhead” type accounts of a political party?
    A: Yes. There is no safe harbor under Rule G-37 for payments to “housekeeping”, “conference” or “overhead” type political party accounts. The dealer must have adequate supervisory procedures reasonably designed to prevent a violation of Rule G-37(d), on indirect political contributions, even when the payments are being made to a “housekeeping”, “conference” or “overhead” type account. While the political party itself may prohibit direct contributions to issuer official candidates from “housekeeping” accounts, payments to these accounts might be used for political party events that are focused to benefit a specific candidate or a small number of candidates. Additionally, because money is fungible, a payment made to a fund earmarked for non-issuer official elections might “free up” other money to support the candidacy of specific issuer officials.

    The need for dealers to adopt adequate written supervisory procedures to prevent indirect violations via “housekeeping”, “conference” or “overhead” type political party accounts is especially important in light of media and other reports that issuer agents have informed dealers and MFPs that, if they are prohibited from contributing directly to an issuer official's campaign, they should contribute to an affiliated party's “housekeeping” account. In addition, NASD staff has informed the MSRB that some firms make contributions to “housekeeping” accounts or PAC's with explicit instructions accompanying the payment that the specific payment is not to be used for the benefit of one or a limited number of issuer officials. The MSRB does not consider such “preemptive” disclosures or instructions sufficient to meet the dealer's obligation to perform due diligence to reasonably ensure that the payment to the political party or PAC is not being made to circumvent the requirements of Rule G-37.

    (September 22, 2005)

    IV. DEFINITIONS (Rule G-37(g))

    Contribution

    IV.1
    Q: How is the term "contribution" defined in Rule G-37?
    A: The term "contribution" is defined in Rule G-37(g)(i) to mean any gift, subscription, loan, advance, or deposit of money or anything of value made: (i) for the purpose of influencing any election for federal, state or local office; (ii) for payment of debt incurred in connection with any such election; or (iii) for transition or inaugural expenses incurred by the successful candidate for state or local office.

    (May 24, 1994)

    IV.2
    Q: Is Rule G-37 applicable to contributions given to officials of issuers who are seeking election to federal office, such as the House of Representatives, the Senate or the Presidency?
    A: Yes. Rule G-37(g)(i) defines “contribution” as, among other things, any gift, subscription, loan, advance, or deposit of money or anything of value made for the purpose of influencing any election for federal, state or local office.

    (June 15, 1995)

    IV.3
    Q: Does Rule G-37 encompass all contributions to candidates for federal office?
    A: No. Rule G-37 encompasses, for federal offices, only those contributions to an official of an issuer who is seeking election to a federal office.

    (May 24, 1994)

    IV.4
    Q: Are contributions to bond ballot campaigns subject to the requirements of Rule G-37.
    A: Such political contributions are subject to the disclosure requirements of Rule G-37(e) (other than contributions made by a municipal finance professional or a non-MFP executive officer to a bond ballot campaign for a ballot initiative with respect to which such person is entitled to vote if all contributions by such person to such bond ballot campaign, in total, do not exceed $250 per ballot initiative). Although such contributions will not result in a ban on municipal securities business under Rule G-37(b), as with all MSRB rules, failure to comply with requirements of the rule (i.e., by failing to disclose such contributions) may subject dealers to fines and other disciplinary actions by the Securities and Exchange Commission, Financial Industry Regulatory Authority, or other appropriate regulatory agencies.

    (May 24, 1994, revised February 25, 2010)

    Charitable Donations

    IV.5
    Q: Would a charitable donation to an organization made by a dealer at the request of an issuer official meet the definition of "contribution" in Rule G-37?
    A: No. Charitable donations are not considered political contributions for purposes of Rule G‑37 and therefore are not covered by the rule.

    (May 24, 1994)

    Municipal Finance Professional

    IV.6
    Q: Who is considered a municipal finance professional?
    A: To determine if a particular person is a municipal finance professional, first determine whether the person is an "associated person" of a dealer (other than a bank dealer) under Section 3(a)(18) of the Securities Exchange Act of 1934 (Act), or an associated person of a bank dealer under Section 3(a)(32) of the Act. Then determine whether the associated person fits within one of the four categories listed in the definition of municipal finance professional under Rule G-37.

    Under Section 3(a)(18) of the Act, "associated person of a broker or dealer" is defined as:

    • Any partner, officer, director, or branch manager (or any person occupying a similar status or performing similar functions);
    • Any person directly or indirectly controlling, controlled by, or under common control with the dealer;
    • Or any employee of such broker or dealer, except those whose functions are solely clerical or ministerial.

    Under Section 3(a)(32) of the Act, "person associated with a municipal securities dealer" when used with respect to a municipal securities dealer which is a bank or a division or department of a bank means:

    • Any person directly engaged in the management, direction, supervision, or performance of any of the municipal securities dealer’s activities with respect to municipal securities; and
    • Any person directly or indirectly controlling such activities or controlled by the municipal securities dealer in connection with such activities.

    Under Rule G-37(g)(iv), a municipal finance professional is defined as:

    1. Any associated person primarily engaged in municipal representative activities pursuant to Rule G-3(a)(i) (such activities include underwriting, trading, sales, financial advisory and consultant services, research or investment advice on municipal securities, or any other activities which involve communication, directly or indirectly, with public investors relating to the activities listed in this paragraph), provided, however, that sales activities with natural persons shall not be considered to be municipal securities representative activities for purposes of Rule G-37(g)(iv);

    2. Any associated person who solicits "municipal securities business" as defined in Rule G-37 (which includes negotiated underwriting activities, private placement activities, negotiated remarketing services, financial advisory and consultant services);

    3. Any associated person who is both (i) a municipal securities principal or a municipal securities sales principal and (ii) a supervisor of any persons described in paragraphs 1 or 2 above;

    4. Any associated person who is a supervisor of the associated persons described in paragraph 3 above, up through and including: (i) for dealers that are not bank dealers, the CEO or similarly situated official; and (ii) for bank dealers, the officer or officers designated by the bank's board of directors as responsible for the day-to-day conduct of the bank's dealer activities.

    5. For dealers other than bank dealers: any associated person who is a member of the executive or management committee, or similarly situated officials, if any. For bank dealers: any member of the executive or management committee of the separately identifiable department or division of the bank, as defined in Rule G‑1, if any. However, if the only associated persons meeting the definition of municipal finance professional are those described in this paragraph 5, the broker, dealer or municipal securities dealer shall be deemed to have no municipal finance professionals.

    Each person listed by the dealer as a municipal finance professional is deemed to be such for purposes of Rule G-37.

    (May 24, 1994, revised October 30, 2003)

    IV.7
    Q: Does the definition of municipal finance professional include all registered representatives?
    A: No. The definition of municipal finance professional includes, among others, any associated person primarily engaged in municipal representative activities pursuant to Rule G-3(a)(i), but excludes sales activities with natural persons.

    (May 24, 1994, revised October 30, 2003)

    IV.8
    Q: Does the definition of municipal finance professional include any associated person who solicits municipal securities business, even if this solicitation activity is a very small portion of the associated person's work?
    A: Yes. Even if an associated person is not "primarily engaged in municipal representative activities," that associated person can be considered a municipal finance professional if he or she solicits municipal securities business, as defined in Rule G-37 (such business includes negotiated underwriting activities, private placement activities, negotiated remarketing services, financial advisory and consultant services).

    (May 24, 1994)

    IV.9
    Q: Does the definition of municipal finance professional include anyone other than an associated person of the dealer, for example, consultants, lawyers or spouses of municipal finance professionals?
    A: No. Municipal finance professionals must be associated persons of the dealer. Of course, if a dealer or a municipal finance professional seeks indirectly to make contributions to issuer officials through consultants, lawyers or spouses, such contributions would result in the dealer being prohibited from engaging in municipal securities business with the issuer for two years from the date of such contributions.

    (May 24, 1994)

    Finder’s Fee

    IV.10 & IV.11 Deleted

    IV.12
    Q: Is a "finder's fee" solely cash compensation?
    A: No. Such compensation, for example, may take the form of: (i) an unusually large allocation of bonds to a particular sales person; (ii) sales credits; or (iii) any other kind of remuneration.

    (December 7, 1994)

    IV. 13 Deleted

    Supervisors

    IV.14
    Q: A sales representative at a branch office solicits municipal securities business for the dealer. Such activity results in that person becoming a "municipal finance professional" under Rule G-37(g)(iv)(B). Would that person's branch manager also be considered a municipal finance professional?

    A: Yes. Rule G-37(g)(iv)(C) provides that the definition of municipal finance professional includes, among others, any associated person who is both a (i) municipal securities principal or a municipal securities sales principal and (ii) a supervisor of any associated person who solicits municipal securities business (or who is primarily engaged in municipal securities representative activities). If a sales person is soliciting municipal securities business, then the supervisor of that person (i.e., the branch manager) also is included within the definition of municipal finance professional. Branch managers are included within the definition of municipal finance professional in the circumstances described above.

    (March 22, 1995, revised October 30, 2003)

    Designation Period for Municipal Finance Professionals

    IV.15
    Q: Rule G-37(g)(iv) states that each person designated a municipal finance professional shall retain this designation for one year after the last activity or position which gave rise to the designation. If a dealer terminates a municipal finance professional’s employment, and that person is no longer associated in any way with the dealer (including any affiliated entities of the dealer), must the dealer continue to designate that person a “municipal finance professional” for recordkeeping and reporting purposes under Rules G-37(g)(iv) and G-8(a)(xvi)?
    A: No. If a municipal finance professional is no longer employed by the dealer, and is not an “associated person” of the dealer, then the dealer is not required to designate that person a municipal finance professional and the dealer may cease its recordkeeping and reporting obligations with respect to that person.

    (August 6, 1996, revised October 30, 2003)

    IV.16
    Q: If a municipal finance professional is transferred from a firm’s dealer department to another non-municipal department, such as the corporate department, must the dealer continue to designate this person a municipal finance professional for recordkeeping and reporting purposes?
    A: If a municipal finance professional is transferred to another department within the same firm (such as corporate, equities, etc.) and remains an “associated person” of the dealer, the dealer must continue to designate this person a municipal finance professional for one year from the date of the last activity or position which gave rise to this designation and must continue its recordkeeping and reporting obligations under Rules G-37 and G-8. It is incumbent upon each dealer to determine whether the person is an associated person pursuant to Section 3(a)(18) of the Securities Exchange Act of 1934. If so, then in addition to recordkeeping and reporting obligations, dealers should be mindful that any contributions made by this associated person during the one-year designation period (other than contributions that qualify for the rule’s $250 de minimis exception) will subject the dealer to the rule’s ban on municipal securities business for two years from the date of such contribution. Of course, the ban can only be triggered if the person previously was a municipal finance professional.

    (August 6, 1996, revised October 30, 2003)

    IV.17
    Q: A municipal finance professional resigns from a dealer, but still remains an associated person of the dealer (e.g., by retaining a position in the dealer’s holding company). May the dealer cease designating this person a municipal finance professional for purposes of the recordkeeping and reporting requirements under Rules G-37 and G-8? In addition, may this person make contributions to issuer officials without causing the dealer to be banned from municipal securities business with such issuers?
    A: If a person is no longer a municipal finance professional because he or she has left the dealer’s employ, but nevertheless remains an associated person of the dealer, then the dealer must continue to designate this person a municipal finance professional for one year from the last activity or position which gave rise to such designation. Moreover, any contributions by this associated person (other than those that qualify for the de minimis exception under Rule G-37(b)) will subject the dealer to the rule’s ban on municipal securities business for two years from the date of the contribution.

    (August 6, 1996, revised October 30, 2003)

    IV.18
    Q: In making the determination of which associated persons of a dealer meet the definitions of municipal finance professional and non-MFP executive officer, is it correct to designate all the executives of the dealer (e.g., President, Executive Vice Presidents) under the category of non-MFP executive officers?

    A: No. In making the determination of whether someone is a municipal finance professional or non-MFP executive officer, one must review the activities of the individual and not his or her title. Rule G-37(g)(iv) defines the term “municipal finance professional” as:

    (A) any associated person primarily engaged in municipal securities representative activities, as defined in Rule G-3(a)(i), provided, however, that sales activities with natural persons shall not be considered to be municipal securities representative activities for purposes of this subparagraph (A);

    (B) any associated person who solicits municipal securities business, as defined in paragraph (vii);

    (C) any associated person who is both (i) a municipal securities principal or a municipal securities sales principal and (ii) a supervisor of any persons described in subparagraphs (A) or (B);

    (D) any associated person who is a supervisor of any person described in subparagraph (C) up through and including, in the case of a broker, dealer or municipal securities dealer other than a bank dealer, the Chief Executive Officer or similarly situated official and, in the case of a bank dealer, the officer or officers designated by the board of directors of the bank as responsible for the day-to-day conduct of the bank’s municipal securities dealer activities, as required pursuant to Rule G-1(a); or

    (E) any associated person who is a member of the broker, dealer or municipal securities dealer (or, in the case of a bank dealer, the separately identifiable department or division of the bank, as defined in Rule G-1) executive or management committee or similarly situated officials, if any; provided, however, that, if the only associated persons meeting the definition of municipal finance professional are those described in this subparagraph (E), the broker, dealer or municipal securities dealer shall be deemed to have no municipal finance professionals.

    Rule G-37(g)(v) defines the term “non-MFP executive officer” as:

    an associated person in charge of a principal business unit, division or function or any other person who performs similar policy making functions for the broker, dealer or municipal securities dealer (or, in the case of a bank dealer, the separately identifiable department or division of the bank, as defined in Rule G-1), but does not include any municipal finance professional, as defined in paragraph (iv) of this section (g); provided, however, that, if no associated person of the broker, dealer or municipal securities dealer meets the definition of municipal finance professional, the broker, dealer or municipal securities dealer shall be deemed to have no non-MFP executive officers. [emphasis added]

    Dealers should first review the activities of their associated persons to determine whether they are municipal finance professionals, and then, once that list of individuals has been established, conduct a review of the remaining associated persons to determine whether they are non-MFP executive officers. Dealers should pay close attention to those associated persons who are soliciting municipal securities business and, thus, will be considered municipal finance professionals.

    (September 9, 1997, revised October 30, 2003 and June 8, 2006)

    Non-MFP Executive Officer

    IV.19
    Q: Who is a non-MFP "executive officer?"
    A: Pursuant to Rule G-37(g)(v), a non-MFP executive officer is defined as any associated person in charge of a principal business unit, division or function, or any other person who performs similar policy making functions for the dealer (or, in the case of a bank dealer, the separately identifiable department or division of the bank, as defined in Rule G-1), but does not include any municipal finance professional.

    (May 24, 1994)

    IV.20
    Q: In a bank with a separately identifiable dealer department, who would be considered a non-MFP executive officer?
    A: For most bank dealer departments which deal only in municipal securities, there are no individuals who meet the definition of non-MFP executive officer within Rule G-37.

    (August 18, 1994)

    Official of an Issuer

    IV.21
    Q: How is the term "official of an issuer" defined in Rule G-37?
    A: Rule G-37(g)(vi) defines the term "official of an issuer" to mean “any person (including any election committee for such person) who was, at the time of the contribution, an incumbent, candidate or successful candidate: (A) for elective office of the issuer which office is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by the issuer; or (B) for any elective office of a state or of any political subdivision, which office has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by an issuer. Thus, contributions to certain state-wide executive or legislative officials would be included within the prohibition on engaging in municipal securities business.

    (May 24, 1994, revised October 30, 2003)

    IV.22
    Q: How can a dealer determine whether an incumbent or candidate for a particular elective office will be able to award or influence the awarding of municipal securities business? For example, in many states, such influence is found in executive branch elected officials, not legislative branch officials.
    A: The dealer must review the scope of authority of the particular office at issue, whether executive or legislative branch, not the individual, to determine whether influence over the awarding of municipal securities business is present.

    (May 24, 1994)

    IV.23
    Q: An incumbent was seeking re-election as an issuer official but she lost the election. She is now soliciting money to pay for the debt incurred in connection with this election. Would there be a prohibition on engaging in municipal securities business with the issuer if a dealer or a municipal finance professional provides money for the payment of this debt?
    A: No, under certain conditions. If the incumbent is out of office at the time she is soliciting money to pay for the election debt, then she is no longer considered to be within the definition of “official of an issuer” and any monies given for the payment of debt incurred in connection with the election in this instance is not subject to Rule G-37. If the incumbent still holds her issuer official position at the time she is soliciting money to pay for the election debt, then, if a municipal finance professional contributed $250 to her during the general election, the municipal finance professional would not be able to make any contributions for the payment of debt without causing a prohibition on municipal securities business with the issuer. If a municipal finance professional made no contributions to the incumbent prior to the election, then the municipal finance professional may, if entitled to vote for the candidate, contribute up to $250 for the payment of debt incurred in connection with the election while the incumbent is still in office without causing a prohibition on municipal securities business. A dealer may not contribute any monies towards the payment of debt while the incumbent is still in office without causing a prohibition on municipal securities business with the issuer.

    (September 9, 1997)

    Dealer-Controlled PAC

    IV.24
    Q: What is a "dealer-controlled" PAC?
    A: Each dealer must determine whether a PAC is dealer controlled. For dealers, other than bank dealers, one may assume that any PAC of the dealer would be considered a dealer-controlled PAC for purposes of Rule G-37. For bank dealers, it will depend upon whether the dealer or anyone from the dealer department has the ability to direct or cause the direction of the management or the policies of the PAC.

    (May 24, 1994)

    V. SCOPE OF WAIVER PROVISION IN RULE G-37(i)

    V.1
    Q: If an enforcement agency grants an exemption from a ban on municipal securities business pursuant to Rule G-37(i), may this exemption be applied retroactively so that any municipal securities business engaged in after the ban had gone into effect but prior to the date on which the exemption was granted would not be viewed as a Rule G-37 violation?
    A: Rule G-37(i) allows the enforcement agencies to exempt a dealer from a ban on municipal securities business. It is the Board’s view that such an exemption is only effective as of the date of the exemption. Rule G-37(i) does not contain a provision allowing for the retroactive application of the exemption. Thus, a dealer would violate Rule G-37 if, prior to the date of the exemption, the dealer engaged in municipal securities business with an issuer while subject to a ban with this issuer because of a political contribution. As with any violation of a Board rule, the enforcement agencies have discretion in determining the type and extent of enforcement action appropriate for such violation, in light of the specific facts and circumstances. If an enforcement agency has granted an exemption to a dealer from the ban on municipal securities business, the facts and circumstances considered by such agency in granting the exemption could appropriately also be considered (together with any other relevant facts and circumstances) in determining what, if any, enforcement action should be taken against such dealer if it had engaged in municipal securities business after the ban on such business became effective but prior to the date on which the exemption was granted.

    (March 1, 2000)

    VI. RECORDKEEPING AND REPORTING (Rules G-37(e), G-8 and G-9)

    VI.1 

    Q: If a dealer has instituted an internal voluntary ban on political contributions, is the dealer still subject to the recordkeeping requirements?
    A: Yes. The Board amended Rule G-8 and G-9, on recordkeeping and record retention, respectively, to require each dealer to maintain records of certain information. This recordkeeping is designed to assist dealers in determining whether or not they may engage in business with a particular issuer, as well as to facilitate compliance with, and enforcement of, Rule G-37.

    (May 24, 1994)

    VI.2
    Q: Rule G-8 requires dealers to record all issuers with which the dealer has engaged in municipal securities business. The term "issuer" includes the issuer of a separate security as defined in SEC Rule 3b-5(a) under the Act. In the context of industrial revenue bond issues, for example, the issuer of a separate security is a private corporation, not a government entity. Must we record these "issuers"?
    A: No. Such private corporations, which are not an agency or instrumentality of a state or any political subdivision, need not be recorded. Of course, dealers are required to record the governmental issuer in these situations, for both taxable and tax-exempt municipal securities.

    (December 7, 1994)

    VI.3
    Q:
    What are the reporting requirements under rule G-37?
    A: Dealers are required to submit Form G-37/G-38 to the MSRB by the last day of the month following the end of each calendar quarter. These submission dates correspond to January 31, April 30, July 31 and October 31 of each year. There is no fixed time frame for submission of Form G-37x. However, if a dealer wishes to rely on the Form G-37x exemption from the Form G-37/G-38 submission requirement for a particular calendar quarter, Form G-37x must be submitted by no later than the submission deadline for such quarter.

    (May 24, 1994, revised October 30, 2003)

    VI.4
    Q: Under what circumstances must Form G-37/G-38 be filed with the Board?
    A: Form G-37/G-38 must be submitted to the Board for a calendar quarter if ANY one of the following occurred: (i) reportable political contributions or payments to political parties were made during the reporting period, unless the dealer has previously submitted Form G-37x and the submission remains effective; (ii) the dealer engaged in municipal securities business during the reporting period; or (iii) the dealer used consultants during the reporting period (i.e., new or continuing relationship with consultants).

    (May 24, 1994, revised October 30, 2003)

    VI.5
    Q: Does a dealer have to complete the section of Form G-37/G-38 concerning issuers with whom the dealer has engaged in municipal securities business if the only municipal securities related business engaged in during the reporting period was as a selling group member?
    A: No. Rule G-37 does not define "municipal securities business" to include selling group member activities.

    (May 24, 1994)

    VI.6
    Q: Which contributions must be disclosed to the Board on Form G-37/G-38?
    A: Those contributions which are required to be recorded pursuant to rule G-8(a)(xvi). These include (i) the contributions, direct or indirect, to officials of an issuer and to political parties of states and political subdivisions made by the dealer and each PAC controlled by the dealer (or controlled by any municipal finance professional of such dealer); (ii) the contributions, direct or indirect, to officials of an issuer made by each municipal finance professional and non-MFP executive officer, however, such records need not reflect any contribution made by a municipal finance professional or non-MFP executive officer to officials of an issuer for whom such person is entitled to vote if the contributions by each such person, in total, are not in excess of $250 to any official of an issuer, per election; (iii) the contributions, direct or indirect, to political parties of states and political subdivisions made by all municipal finance professionals and non-MFP executive officers, however, such records need not reflect those contributions made by any municipal finance professional or non-MFP executive officer to a political party of a state or political subdivision in which such persons are entitled to vote if the contributions by each such person, in total, are not in excess of $250 per political party, per year; (iv) the contributions, direct or indirect, to bond ballot campaigns made by the dealer and each PAC controlled by the dealer (or controlled by any municipal finance professional of such dealer); and (v) the contributions, direct or indirect, to bond ballot campaigns made by each municipal finance professional and non-MFP executive officer, however, such records need not reflect any contributions made by a municipal finance professional or non-MFP executive officer to a bond ballot campaign for a ballot initiative with respect to which such person is entitled to vote if the contributions by such person, in total, are not in excess of $250 to any bond ballot campaign, per ballot initiative.

    (May 24, 1994, revised February 25, 2010)

    VI.7

    Q: May non-dealers (e.g., attorneys, independent financial advisors) voluntarily submit information on political contributions and other activities to the Board?
    A:
    Yes, as long as the filing procedures are followed.

    (May 24, 1994)

    VI.8
    Q: Will the Forms G-37 submitted to the Board be available for public review?

    A: Yes. The Forms G-37/G-38 and Forms G-37x submitted to the Board are posted on the Board’s website for viewing (www.msrb.org).

    (May 24, 1994, revised June 14, 2010)

    VI.9
    Q: May a holding company submit to the Board one Form G-37/G-38 reflecting information for various dealers within the control of the holding company?

    A: No. A separate Form G-37/G-38 must be submitted for each dealer.

    (February 16, 1996)

    VI.10
    Q: Rule G-37(e) requires, among other things, that dealers submit information to the Board on Form G-37/G-38 about the municipal securities business in which they engaged. Is information about the municipal securities business engaged in required to be submitted by all syndicate and selling group members, or is it only the responsibility of the manager(s) to submit such information on behalf of the syndicate?
    A: All manager(s) and syndicate members (excluding selling group members) must separately report the municipal securities business in which they engaged.

    (September 9, 1997)

    VI.11
    Q: Are dealers required to identify the type of contributor (i.e. dealer, dealer controlled PAC, MFP, MFP controlled PAC, or non-MFP executive officer) when completing Form G-37/G-38?
    A: Yes. Rule G-37 (e)(i)(2) requires dealers to report to the Board on its Form G-37/G-38 the contribution or payment amount made and the contributor category of each of the following persons and entities making such contributions or payments during each calendar quarter: the broker, dealer or municipal securities dealer; each municipal finance professional; each non-MFP executive officer; and each political action committee controlled by the broker, dealer or municipal securities dealer or by any municipal finance professional. It is not sufficient to list contributors as “employee” or “registered representative.” For each contribution listed on the Form G-37/G-38, one of the specified contributor categories must be identified.

    (February 25, 2004)

    VI.12
    Q: How should contributions to officials of issuers who are seeking federal office be reported on Form G-37/G-38?
    A: Under Rule G-37, contributions given to officials of issuers who are seeking election to federal office, such as the U.S. House of Representatives, Senate or the Presidency, must be reported on the dealer's quarterly Form G-37/G-38 unless they meet the de minimis exception. When reporting these contributions, dealers must report information identifying the issuer official. Firms may additionally report information identifying the federal office sought. For example, if a sitting Governor of a state were running for a seat in the U.S. House of Representatives, and the Governor is an “official of an issuer,” the form must list the state where the official is serving as Governor, and the Governor's complete name and title. Dealers may also report the federal office sought by the issuer official.

    (February 25, 2004)

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Implementation Guidance on MSRB Rule G-18, on Best Execution
    Rule Number:

    Rule G-18

    (As updated February 7, 2019)

    Background

    MSRB Rule G-18, establishing the first best-execution rule for transactions in municipal securities, became effective March 21, 2016. The best-execution rule requires brokers, dealers and municipal securities dealers (dealers) to use reasonable diligence to ascertain the best market for the subject security and buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. Related amendments to MSRB Rule G‑48, on transactions with sophisticated municipal market professionals (SMMPs), and to MSRB Rule D-15, on the definition of an SMMP, exempt transactions with SMMPs from the best-execution rule. This implementation guidance provides answers to frequently asked questions about the best-execution rule and the SMMP exemption.

    Use of This Document

    The MSRB is providing in this document general implementation guidance on certain aspects of new Rule G-18 and amended Rules G-48 and D-15 (rules) in a question-and-answer format. This guidance is designed to support compliance with the best-execution rule and the SMMP exemption.[1] The answers are not considered rules and have neither been approved nor disapproved by the Securities and Exchange Commission (SEC).

    The MSRB may update these questions and answers periodically, and any updates will include appropriate references to dates of new or modified questions and answers.

    Questions and Answers Concerning Best Execution and the Exemption for Transactions with Sophisticated Municipal Market Professionals:  Rules G-18, G-48 and D-15

    I. Best-Execution Standard – General

    I.1: Reasonable Diligence

    Q: What do dealers need to do to use reasonable diligence when selling (purchasing) municipal securities out of (into) their inventory to (from) customers[2] who are not sophisticated municipal market professionals (SMMPs)?[3]

    A: Overview of Best-Execution Standard. Section (a) of MSRB Rule G-18, on best execution, requires dealers, in any transaction for or with a customer or a customer of another dealer, to use reasonable diligence to ascertain the best market for the subject security and to buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. This obligation applies to transactions in which the dealer is acting as agent and transactions in which the dealer is acting as principal.[4] Section (a) includes a non-exhaustive list of factors that dealers must consider when exercising this diligence, which includes: the character of the market for the security (e.g., price, volatility, and relative liquidity), the size and type of transaction, the number of markets checked, the information reviewed to determine the current market for the subject security or similar securities, the accessibility of quotations, and the terms and conditions of the customer’s inquiry or order, including any bids or offers, that result in the transaction, as communicated to the dealer. A dealer must make every effort to execute a customer transaction promptly,[5] but the determination as to whether a firm exercised reasonable diligence necessarily involves a “facts and circumstances” analysis, and actions that in one instance may meet a dealer’s best-execution obligation may not satisfy that obligation under another set of circumstances. The rule is designed to complement existing fair and reasonable pricing standards and improve execution quality for retail investors in municipal securities, while promoting fair competition among dealers and improving market efficiency.

    Policies and Procedures. As explained during the rulemaking process for the best-execution rule, dealers can use reasonable diligence in ascertaining the best market for a security by using sound policies and procedures and periodically reviewing and improving them. Indeed, paragraph .08 of the Supplementary Material requires the development of policies and procedures reasonably designed to achieve best execution. Paragraph .08 requires dealers to conduct, at a minimum, annual reviews of their policies and procedures for determining the best available market, assessing whether they are reasonably designed to achieve best execution, taking into account the quality of the executions the dealer is obtaining under its current policies and procedures, changes in market structure, new entrants, the availability of additional pre-trade and post-trade data, and the availability of new technologies, and to make promptly any necessary modifications of their policies and procedures in light of those reviews.[6] In short, a dealer can comply with the requirement to use reasonable diligence by developing, following and maintaining policies and procedures that are themselves reasonably designed.

    Rule G-18 is designed to provide sufficient flexibility to accommodate the diverse population of dealers, which can adopt policies and procedures to be reasonably related to the nature of their business, including the level of sales and trading activity and the type of customer transactions at issue, and to allow dealers to evidence that they had used reasonable diligence in a manner that is different than that used by other dealers. However, in developing policies and procedures, dealers should consider reviewing and including in their policies and procedures the existing practices of their trading operations, existing best practices within the municipal securities market (particularly those used by similarly-situated dealers), existing best practices in the corporate debt securities market with respect to compliance with FINRA Rule 5310, which requires, among other things, best execution for transactions in corporate debt securities, and any other practices they believe to be relevant. By way of example, if similarly-situated dealers in the municipal securities market typically take certain steps when purchasing municipal securities from a customer, dealers should consider whether their written policies and procedures should provide for those steps to be taken on a consistent and systematic basis.

    As explained during the rulemaking process for Rule G-18, the rule is generally substantively consistent with FINRA Rule 5310, with specific tailoring to the characteristics of the municipal securities market. This substantive consistency is in recognition of the efficiencies to be gained from harmonized regulation in similar areas of the fixed income markets. Significantly, the core standard of reasonable diligence in Rule G‑18(a) is stated in identical terms to the core standard in FINRA Rule 5310; however, portions of the list of factors that are considered in determining whether a firm has used reasonable diligence are different. As a result, and also in the interests of harmonized regulation, steps by a dealer that meet the reasonable diligence standard under FINRA Rule 5310 generally will be considered to meet the reasonable diligence standard under Rule G-18 in circumstances that are substantially the same. However, dealers should consider whether any additional or different steps may need to be taken to address provisions in Rule G-18 that are tailored specifically for transactions in municipal securities.

    (November 20, 2015) 

    I.2: Best Price

    Q: Does the term “best execution” (as it relates to municipal securities) mean every trade at a particular point in time must match the best price to have occurred within a short time thereafter?

    A: As stated in paragraph .01 of the Supplementary Material to MSRB Rule G-18, “[t]he principal purpose of [the] rule is to promote, for customer transactions, dealers’ use of reasonable diligence,” and a “failure to have actually obtained the most favorable price possible will not necessarily mean that the dealer failed to use reasonable diligence.” A trade occurring shortly after a transaction at a materially more favorable price with no significant change in market conditions or the credit worthiness of the security, however, could indicate a lack of reasonable diligence on the part of the dealer or the utilization of inadequate procedures. Such occurrences would suggest that dealers should consider, as part of their periodic review of their procedures, the inclusion of additional markets when handling future customer orders or inquiries.

    (November 20, 2015) 

    I.3: Documentation

    Q: How do dealers document reasonable diligence in compliance with the best-execution standard and does documentation need to be made for each and every transaction?

    A: The issue of documentation of dealers’ compliance with MSRB Rule G-18 arises in at least three areas. First, the rule requires dealers to have written policies and procedures for compliance with the rule. Second, dealers should consider documenting their periodic reviews of their written policies and procedures and the results of those reviews. Third, dealers should consider documenting their adherence to their policies and procedures generally, and paragraph .06 of the Supplementary Material specifically requires documentation of compliance with their policies and procedures with respect to securities with limited quotations or pricing information.[7] The documentation dealers should consider in the third area necessarily would depend on the content of the policies and procedures that the dealer determines to adopt. Only by way of example, recognizing this dependence on the content of the policies and procedures, a dealer could use records providing information displayed on an alternative trading system and reviewed by a trader prior to execution, records of periodic observation of traders, notations by traders and/or records of pre- and/or post-trade reviews.[8] However, these are, again, only examples of documentation methods, and Rule G-18 is designed to provide sufficient flexibility to accommodate the diverse population of dealers, which can adopt policies and procedures to be reasonably related to the nature of their business, including the level of sales and trading activity and the type of customer transactions at issue, and to allow dealers to demonstrate that they had used reasonable diligence in a manner that is different than that used by other dealers. Given this flexibility, some firms may choose to document their adherence to their policies and procedures on a transaction-by-transaction basis, but the MSRB recognizes that there may be reasonable alternative approaches that would satisfy the requirements of MSRB rules and be sufficient to demonstrate compliance.

    (November 20, 2015) 

    I.4: Extreme Market Conditions

    Q: How do extreme market conditions affect dealers’ best-execution obligations?

    A: In the potential event of extreme market conditions impacting the trading of municipal securities (e.g., a shortage of liquidity and divergent prices during periods of significant ratings changes, interest rate movements or other market-wide events) dealers should consider establishing and implementing procedures that are designed to preserve the continued execution of customers’ orders in a manner that is consistent with their best-execution obligations while also recognizing and limiting their exposure to extraordinary market risk. Dealers should consider the following guidelines when evaluating their best-execution procedures during extreme market conditions: 

    • The treatment of customer orders must remain fair, consistent and reasonable.
    • To the extent that a dealer’s order-handling procedures are different during extreme market conditions, it should disclose to its customers the differences in the procedures from normal market conditions and the circumstances in which it may generally activate these procedures.[9]
    • Activation of procedures designed to respond to extreme market conditions may be implemented only when warranted by market conditions. Excessive activation of modified procedures on the grounds of extreme market conditions could raise best-execution concerns. Accordingly, dealers should document the basis for activation of their modified procedures. 

    Ultimately, it necessarily involves a facts and circumstances analysis to determine whether actions taken by dealers during extreme market conditions are consistent with the duty of best execution, but the MSRB recognizes that market conditions are an important factor in dealers’ best-execution determinations.

    (November 20, 2015)

    II. Best-Execution Standard – Applicability

    II.1: Applicability to Introducing Dealers

    Q: Do introducing dealers that execute and clear trades through other dealers have best-execution obligations to their customers?

    A: Yes. MSRB Rule G-18 applies to any transaction in a municipal security for or with a customer or a customer of another dealer, without any exception for orders that are routed to another dealer. Paragraph .08(b) of the Supplementary Material to the rule, however, provides that “[a] dealer that routes its customers’ transactions to another dealer that has agreed to handle those transactions as agent or riskless principal for the customer (e.g., a clearing firm or other executing dealer) may rely on that other dealer’s periodic reviews [of its written policies and procedures] as long as the results and rationale of the review are fully disclosed to the dealer and the dealer periodically reviews how the other dealer’s review is conducted and the results of the review.” Under this provision, introducing dealers may rely on the best-execution policies and procedures of their clearing firms or other executing dealers, all of which are subject to their own best-execution obligations under the rule. An introducing dealer, however, is not relieved of its obligations to establish written policies and procedures of its own. For example, such an introducing dealer’s policies and procedures could provide for the reliance on another dealer’s policies and procedures and periodic reviews by the introducing dealer of the other dealer’s reviews of its policies and procedures.

    (November 20, 2015) 

    II.2: Inter-Dealer Trades

    Q: Do trades between broker-dealers have to comply with the best-execution standard?

    A: No. MSRB Rule G-18 applies to any transaction for or with a customer or a customer of another dealer. Paragraph .05 of the Supplementary Material to Rule G-18 provides that “[a] dealer’s duty to provide best execution in any transaction ‘for or with’ ‘a customer of another dealer’ does not apply in instances when the other dealer is simply executing a customer transaction against the dealer’s quote,”... and “[a] dealer’s duty to provide best execution to customer orders received from other dealers arises only when an order is routed from another dealer to the dealer for handling and execution.”

    (November 20, 2015)

    III. Reasonable Diligence Factors – Number of Markets Checked 

    III.1: General

    Q: When effecting a customer transaction in municipal securities, how many dealers and/or markets does a dealer need to check, and how much diligence does a dealer need to conduct in order to have confidence that all appropriate dealers and/or markets are included? 

    A: The duty of best execution requires a dealer to use reasonable diligence. It does not require a dealer to access every available market, especially given the differences in pricing information and execution functionality offered, and there is no set number of dealers making an offer or collecting bids on behalf of a customer order, or other markets, to check that categorically qualifies as reasonable diligence for compliance with the best-execution obligation. Accordingly, a dealer does not need to post a bid-wanted simultaneously on multiple fixed income alternative trading systems (ATSs) and/or with multiple broker’s brokers, though this may be warranted in some cases, or become a subscriber to every ATS. However, in general, dealers should check more than one market or expose customer orders to multiple offerings or bids, and show external offerings and bids to retail customers, which may be accomplished by the use of ATSs or broker’s brokers that expose orders to multiple dealers, each of which constitutes a “market,” as that term is broadly defined in paragraph .04 of the Supplementary Material.[10] For example, a dealer’s policies and procedures could require that, after receiving offers or bids, the dealer must evaluate the offer or bid price versus relevant market information to determine whether any additional markets, including, but not limited to, other dealers, should be checked to perform reasonable diligence. Each dealer should consider including in its written policies and procedures how and when its trading desk exposes retail customer orders to multiple offerings or bids and shows external offerings and bids to retail customers (directly or through financial advisors). Some dealers may employ “filters,” which generally refer to automated tools that allow the dealer to limit its trading, with, for example, specific parties or parties with specified attributes with which it does not want to interact. If a dealer uses filters on counterparties or filters on specific securities intended to limit accessing bids or offers in those securities, they may be used only for a legitimate purpose consistent with obtaining the most favorable executions for non-SMMP customers, and should be reviewed on a periodic basis and adjusted as needed. The dealer, accordingly, should have policies and procedures in place that govern when and how to: reasonably use filters without negatively impacting the quality of execution of non-SMMP customer transactions; periodically reevaluate their use; and determine whether to lift them upon request.[11]  

    Given that the rule is designed, in part, to promote fair competition among dealers, generally, a dealer’s policies and procedures should facilitate competition for its customer order flow, including by eliminating practices that discourage other dealers from offering (bidding on) securities to (from) its clients. However, exposing customer order flow to other dealers, alone, is not sufficient to satisfy reasonable diligence, and dealers must also consider the non-exhaustive list of factors identified in Rule G‑18(a).  

    (November 20, 2015)

    (Updated February 7, 2019)

    III.2: Use of Broker’s Brokers and ATSs

    Q: Under what circumstances must a dealer use a broker’s broker or ATS to demonstrate reasonable diligence in ascertaining the best market? 

    A: There is no categorical requirement in MSRB Rule G-18 for dealers to use a broker’s broker or an ATS, and the rule is designed specifically not to favor any particular type of venue over another for dealers to meet their best-execution obligations. Paragraph .04 of the Supplementary Material construes the term “market” broadly for purposes of Rule G-18, including the rule’s core provision, section (a), requiring the exercise of reasonable diligence in ascertaining the “best market” for the security. Paragraph .04 of the Supplementary Material states: “This expansive interpretation is meant both to inform dealers as to the breadth of the scope of venues that must be considered in the furtherance of their best-execution obligations and to promote fair competition among dealers (including broker’s brokers), alternative trading systems and platforms, and any other venue that may emerge, by not mandating that certain trading venues have less relevance than others in the course of determining a dealer’s best-execution obligations.” A principal purpose of this broad and even-handed language is to tailor the definition of the critical term “market” to the characteristics of the municipal securities market and provide flexibility for future developments in both market structure and applied technology. For example, the language expressly recognizes a characteristic of the municipal securities market (i.e., the role of dealer inventories in providing liquidity) by providing that the executing dealer itself, acting in a principal capacity, may be the best market for the security. Additionally, while an ATS or a broker’s broker, individually, can be considered a market, each can also be a mechanism to expose customer orders to multiple dealers and, therefore, multiple markets. 

    As the availability of electronic systems that facilitate trading in municipal securities increases, dealers need to determine whether these systems might provide benefits to their customer order flow, particularly retail order flow, and help ensure they are meeting their obligations under Rule G-18(a) with respect to ascertaining the best market for their customer transactions. Similarly, pre-trade transparency, such as through electronic trading platforms, is also increasing in the municipal securities market, and dealers need to periodically analyze and determine whether incorporating pricing information available from these systems should be incorporated into their best-execution policies and procedures. 

    The MSRB recognizes that different markets provide different levels of price information and execution functionality, and that a dealer’s analysis of the available pricing information offered by different systems may take these differences into account. Some systems, including auto-execution systems, both display prices and provide execution functionality, while other systems display prices but provide no execution functionality. Still other systems, such as request-for-quotation systems, may provide indications of interest but not display prices or provide execution functionality. As such, it is the dealers’ responsibility to evaluate various markets (e.g., ATSs, inter-dealer brokers, other dealers) and to establish and periodically review reasonably designed written policies and procedures addressing when and how certain markets should be checked to satisfy the requirements of the rule. Pursuant to paragraph .08(a) of the Supplementary Material, “[i]n conducting its periodic reviews, a dealer must assess whether its policies and procedures are reasonably designed to achieve best execution, taking into account the quality of the executions the dealer is obtaining under its current policies and procedures, changes in market structure, new entrants, the availability of additional pre-trade and post-trade data, and the availability of new technologies, and to make promptly any necessary modification(s) to such policies and procedures as may be appropriate in light of such reviews.” As an aspect of this periodic review, dealers should review the execution quality provided by the various markets they choose to use (including the internalization of order flow), and, to the extent information is reasonably available, the execution quality of new markets or markets they do not use to determine whether to use them.[12] This review could include, for example, reviewing EMMA® data for previous executions in the subject security or similar securities. 

    Additionally, Rule G-18(a) provides a non-exhaustive list of factors that will be considered in determining whether a dealer has used reasonable diligence, with no single factor being determinative, including: (1) the character of the market for the security (e.g., price, volatility and relative liquidity); (2) the size and type of transaction; (3) the number of markets checked; (4) the information reviewed to determine the current market for the subject security or similar securities; (5) the accessibility of quotations; and (6) the terms and conditions of the customer’s inquiry or order, including any bids or offers, that result in the transaction, as communicated to the dealer. Accordingly, a dealer’s policies and procedures for best execution should address how these factors will affect the dealer’s municipal securities transactions with customers under various conditions. 

    (November 20, 2015)

    (Updated February 7, 2019)

    III.3: Reliance on Broker’s Brokers for Pricing

    Q: Is a dealer in compliance with MSRB Rule G-18 if it uses the best bid or offer obtained by a broker’s broker as the only basis for the price at which the dealer executes a customer order? 

    A: Use of the best bid or offer obtained by a broker’s broker for a particular security as the only basis for the price at which a dealer executes a customer order will not qualify categorically as reasonable diligence in compliance with Rule G-18. To the extent a dealer uses such practice alone, the dealer’s policies and procedures should establish what facts and circumstances should be considered to allow the dealer to do so (e.g., length of collection period used, number of offers/bids received, accessibility of quotations). 

    (November 20, 2015) 

    III.4: One ATS/Broker’s Broker

    Q: Can a dealer comply with MSRB Rule G-18 by exposing customer orders to an ATS or broker’s broker that captures offers/bids from multiple markets? 

    A: The market for municipal securities has evolved significantly in recent years. Some dealers have reduced their inventory positions in response to market and regulatory influences and the use of electronic trading systems, including ATSs, continues to grow. In addition, transaction prices for most municipal securities are now widely available to market participants and investors. Although the amount of pre-trade pricing information (e.g., bids and offers) available also has increased, it is still relatively limited as compared to equity securities and generally not readily accessible by the investing public. While new technology and communications in the municipal securities market have advanced, the market remains decentralized, with much trading still occurring primarily through individual dealers.  

    In light of this evolution of the municipal securities market, the MSRB encourages the use of broker’s brokers, ATSs and other markets that typically provide exposure to offers/bids from multiple dealers, each of which could constitute a separate market, and it recognizes there may be facts and circumstances under which it may be sufficient for a dealer to check only one such market and satisfy the best-execution obligation. However, utilizing one ATS, one broker’s broker or other similar market will not qualify categorically as reasonable diligence in compliance with Rule G-18. To the extent a dealer checks only one ATS, broker’s broker or other similar market when executing customer orders, the dealer’s policies and procedures should establish what facts and circumstances may allow for the checking of only one such market (e.g., competitiveness of the ATS; the number of dealers, offerings or bids an order is generally exposed to through the ATS or broker’s broker; accessibility of quotations) and what steps would be required to be taken in those situations. 

    (November 20, 2015) 

    (Updated February 7, 2019)

    III.5: Only One Market

    Q: How does the best-execution obligation apply when there is only one dealer (i.e., only one market) offering or bidding on the subject security? 

    A: There is no set number of dealers making an offer or collecting bids on behalf of a customer order the checking of which categorically qualifies as reasonable diligence for compliance with the best-execution obligation, and, in general, dealers’ procedures should provide for the checking of more than one market or the exposure of customer orders to multiple offers or bids (e.g., use of an ATS or broker’s broker). However, the MSRB recognizes there may be facts and circumstances under which it may be sufficient for a dealer to check only one market, including internal inventory only, and satisfy the best-execution obligation. In order to comply with the best-execution obligation, each dealer’s written policies and procedures should address such facts and circumstances and the steps required to be taken in those scenarios. At a minimum, dealers must also consider the other factors identified in MSRB Rule G-18(a), including, but not limited to, information to determine the current market for the subject security (e.g., recent trade history) and information on similar securities (e.g., offerings of similar securities). If a dealer has policies and procedures in place that are reasonably designed and otherwise comply with applicable rules and follows them, it could execute an order for which there is only one available market, as long as such handling and execution also are consistent with the terms of the customer’s order or inquiry as communicated to the dealer. 

    (November 20, 2015)

    IV. Reasonable Diligence Factors – Information Reviewed to Determine the Current Market for the Subject Security or Similar Securities 

    IV.1: Similar Securities

    Q: What constitutes a similar security? 

    A: The municipal securities market differs significantly from the market for equity securities and options and also can vary significantly depending on the specific municipal security at issue. For example, some municipal securities may trade frequently, be relatively more liquid and have transparent, accessible and firm quotations available. Other municipal securities do not have public quotations or frequent pricing information available, and may trade infrequently; however, some municipal securities that are less liquid also are fungible, meaning that they trade like other, similar securities, and the pricing in these similar securities can be used as a basis for determining prices in a subject security.   

    Given the wide variety of municipal securities, it is impracticable for the MSRB to provide an exhaustive list of characteristics that qualify a bond as a “similar security” for purposes of MSRB Rule G-18. By way of example, however, issuer, source of repayment, credit rating, coupon, maturity, redemption features, sector, geographical region and tax status are some factors a dealer could use to identify municipal bonds as similar. If a dealer uses a similar securities analysis, its written policies and procedures should establish how the dealer identifies similar securities, as well as how and when to consider the market for them for the purposes of complying with the best-execution rule. 

    (November 20, 2015) 

    IV.2: Trade Review

    Q: In the absence of a market and the absence of previous trade history with other dealers in the subject security, how should dealers use reasonable diligence in compliance with their best-execution obligations? 

    A: The MSRB encourages dealers to incorporate pre- and/or post-trade review(s) into their written policies and procedures for compliance with MSRB Rule G-18, but Rule G-18 does not mandate any specific trade review process and the MSRB recognizes that multiple approaches to trade reviews could satisfy a dealer’s best-execution obligations. Rule G-18 is designed to provide sufficient flexibility to accommodate the diverse population of dealers, which can adopt policies and procedures to be reasonably related to the nature of their business, including the level of sales and trading activity and the type of customer transactions at issue, and to allow dealers to evidence that they have used reasonable diligence in compliance with the rule in a manner different than that used by other dealers. Accordingly, dealers can use a variety of data, such as comparisons to similar securities, internal models for assessing the quality of execution or potential execution and/or other tools or measurements of quality of execution, as part of their policies and procedures for best execution or the evaluation thereof. To fully inform themselves when determining what procedures to use for customer transactions, dealers should consider what procedures they use or would use for executing the same or similar transactions for their own accounts, although such procedures are not absolutely required to be the same. 

    (November 20, 2015) 

    IV.3: Evaluated Pricing

    Q: Can dealers use evaluated pricing as a component of their procedures to comply with the best-execution obligation? 

    A: Yes. MSRB Rule G-18(a) requires dealers to use reasonable diligence to ascertain the best market for the subject security and to buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. Section (a) includes a non-exhaustive list of factors that a dealer must consider when exercising this diligence, including the information reviewed to determine the current market for the subject security or similar securities. Accordingly, dealers can use a variety of data, which is not required to include, but can include, evaluated pricing as part of their written policies and procedures for best execution or the evaluation of their policies and procedures; however, such use would not categorically make those policies and procedures sufficient for compliance with Rule G-18. 

    (November 20, 2015)

    V. Maintenance of Adequate Resources 

    V.1: Appropriate Level of Resources

    Q: How does a firm establish that it has the appropriate level of resources? 

    A: Paragraph .02 of the Supplementary Material to MSRB Rule G-18 states that “[a] dealer’s failure to maintain adequate resources (e.g., staff or technology) is not a justification for executing away from the best available market.” Additionally, paragraph .02 states that “[t]he level of resources that a dealer maintains should take into account the nature of the dealer’s municipal securities business, including its level of sales and trading activity.” This provision was designed to provide flexibility to accommodate the diverse population of dealers. Accordingly, an appropriate level of resources will depend on many factors, including, but not limited to, a firm’s amount of business, and dealers need to employ enough resources to assure that they can establish, implement, follow and periodically review and improve written policies and procedures reasonably designed to achieve best execution. 

    (November 20, 2015)

    VI. Securities with Limited Quotations or Pricing Information 

    VI.1: Execution Timing

    Q: Are there municipal bonds that require more time for a dealer to use reasonable diligence when effecting a customer transaction, and how does a dealer demonstrate such diligence? 

    A: Paragraph .03 of the Supplementary Material to MSRB Rule G-18 requires dealers to make every effort to execute a customer transaction promptly, taking into account prevailing market conditions. Taking a relatively shorter time can suggest a lack of reasonable diligence to ascertain the best market, while taking a relatively longer time can suggest a failure to execute promptly. There is no specific amount of time that is too short or too long to effect a customer transaction; it necessarily will depend on the particular facts and circumstances. Paragraph .03, which is tailored for the municipal securities market and varies from the language of FINRA Rule 5310, therefore, goes on to recognize that, in certain market conditions, dealers may need more time to use reasonable diligence to ascertain the best market for the subject security. This provision clarifies that a dealer should not be considered to have failed to execute promptly in market conditions that are beyond the dealer’s control that cause reasonable diligence to be more time-consuming. This provision, at the same time, is designed to temper the promptness requirement so that it does not undermine the goal of the rule to promote reasonable diligence. By way of example, such market conditions could be illiquidity or infrequent trading of the subject security, low demand for lower-rated bonds, low demand for distressed bonds and low demand for bonds with uncommon structural characteristics.  

    The absence or limitation of accessible quotations or pricing information is not uncommon for many municipal securities, but does not relieve a dealer of its best-execution obligations. Indeed, paragraph .06 of the Supplementary Material to Rule G-18 specifically requires dealers to have written policies and procedures in place that address how the dealer will make its best-execution determinations with respect to securities with limited quotations or pricing information and to document its compliance with those policies and procedures. Such policies and procedures could establish what bonds/market conditions are subject to any variance in the dealer’s other order-handling procedures, including establishing what it means to have limited quotations or pricing information, what additional procedures, if any, are required to be followed by dealer personnel, and how such steps are to be documented. For example, these securities may require dealers to take additional steps in order to satisfy the best-execution standard, including, but not limited to, seeking out other sources of pricing information and potential liquidity, including, but not limited to, directly contacting dealers with which they previously have traded the security or that are otherwise known to trade in the security.

    The MSRB recognizes that, in some instances, obtaining quotations from multiple markets could adversely affect execution quality due to delays in execution or other factors.[13] Therefore, a dealer generally should analyze other data to which it reasonably has access to determine whether it has ascertained the best market for the subject security, but its policies and procedures should also establish under what facts and circumstances it would be appropriate to obtain quotations or other pricing information from multiple markets. Additionally, if pricing information related to the subject security, such as a dealer’s previous trades in the security, or other pricing information, such as a quotation from another market, is limited or unavailable, a dealer may also consider previous trades in a similar security, if that security and those previous trades constitute a reasonable basis for comparison. As with all policies and procedures related to best execution, paragraph .08 of the Supplementary Material to Rule G-18 requires dealers to periodically review these specific policies and procedures, assess whether they are reasonably designed to achieve best execution, and make promptly any necessary modifications in light of such reviews. 

    (November 20, 2015)

    VII. Relationship To Fair Pricing 

    VII.1: MSRB Rule G-30

    Q: How does MSRB Rule G-18, on best execution, relate to MSRB Rule G-30, on prices and commissions? 

    A: Rule G-18 is intended to complement, support and foster compliance with the MSRB’s established substantive pricing standards, which are governed by Rule G-30, by improving execution quality for customers and promoting fair competition among dealers resulting in increased market efficiency. However, the rule makes clear that its obligations are distinct from, for example, the fairness and reasonableness of commissions, markups or markdowns.  

    Rule G-30 requires dealers to trade with customers at fair and reasonable prices, and to exercise diligence in establishing the market value of municipal securities and the reasonableness of their compensation. Rule G-18, on the other hand, does not contain any substantive pricing standard; it is an order-handling and transaction-execution standard, under which the goal of the dealer’s reasonable diligence is to provide the customer the most favorable price possible under prevailing market conditions. Paragraph .01 of the Supplementary Material makes explicit that Rule G-18 is not an absolute “best-price” standard. The rule requires dealers to exercise reasonable diligence with the goal of obtaining the most favorable price possible under prevailing market conditions, which is accomplished through the use and periodic improvement of policies and procedures; it does not require the dealer to actually obtain the most favorable price possible in each transaction (although it frequently will do so through the use of reasonable diligence), and a failure to obtain the most favorable price possible in a transaction will not necessarily mean that the dealer failed to use reasonable diligence under the circumstances.  

    Despite the different purposes of Rules G-18 and G-30, some of the relevant factors in determining the fairness and reasonableness of prices and commissions or service charges, such as the availability of the securities and the nature of the dealer’s business, may also be relevant to the application of the best-execution requirement. Further, although the best-execution rule does not itself contain any substantive standard by which the transaction price itself is to be or could be evaluated, the requirement to use reasonable diligence in the order-handling and transaction-execution process is expected to increase the probability that customers receive fair-and-reasonable prices.  

    (November 20, 2015)

    VIII. SMMP Eexemption – General 

    VIII.1: Qualification

    Q:  Does the best-execution obligation apply to all customer transactions? 

    A: No. However, the only variance in the requirements of MSRB Rule G-18, according to the characteristics of the customer, is codified in MSRB Rules G-48 and D-15 in the form of the SMMP exemption. Section (e) of Rule G-48, which is the consolidated MSRB rule under which all modified obligations of dealers when dealing with SMMPs are addressed, provides that the best-execution obligation under Rule G-18 does not apply to transactions with customers that are SMMPs as defined in Rule D-15.  

    (November 20, 2015) 

    VIII.2: Applicability to Non-Recommended Transactions

    Q: Will the SMMP exemption from the best-execution rule apply to non-recommended transactions? 

    A: Yes. The applicability of the SMMP exemption to MSRB Rule G-18 is triggered by a customer’s status as an SMMP, not whether or not a transaction is recommended by the dealer. However, the applicability of the exemption for any particular SMMP is controlled by the scope of the customer affirmation required by MSRB Rule D-15(c) and provided to the dealer. Specifically, paragraph .02 of the Supplementary Material to Rule D-15 provides that “[t]he customer affirmation may be given either orally or in writing, and may be given on a trade-by-trade basis, a type-of-transaction basis, a type-of-municipal-security basis (e.g., general obligation, revenue, variable rate), or an account-wide basis.” As such, any transaction not covered by a customer’s affirmation would remain subject to the best-execution obligation. 

    (November 20, 2015) 

    VIII.3: Applicability to Transactions with Other Broker-Dealers

    Q: Do dealers need to rely on the SMMP exemption to be relieved of the best-execution obligation for transactions for or with broker-dealer clients? 

    A: No. MSRB Rule G-18’s best-execution obligation only applies to transactions for or with a customer or a customer of another dealer, and the MSRB’s definition of “customer” in Rule D-9 does not include broker-dealers acting in their capacity as broker-dealers.[14] Accordingly, there is no need for dealers to rely on the SMMP exemption when executing transactions for or with other broker-dealers, and, therefore, no need for customer affirmations for those broker-dealers to qualify as SMMPs. 

    (November 20, 2015) 

    VIII.4: Existing Customer Affirmations

    Q: Can dealers rely on customer affirmations based on existing MSRB Rule D-15? 

    A: No. As of the effective date of MSRB Rule G-18 and the amendments to MSRB Rules G-48 and D-15, a customer will not qualify as an SMMP unless it makes the broader affirmation required by Rule D-15, as amended, which addresses all of the modified dealer obligations provided in Rule G-48, including the exemption from the best-execution obligation. Accordingly, any customer affirmations based on existing Rule D-15 would be ineffective to qualify for the SMMP exemption. 

    (November 20, 2015) 

    VIII.5: Piecemeal Customer Affirmations and Waiver of Dealer Obligations

    Q: Can an SMMP waive time-of-trade disclosures, but still have its trades subject to the best-execution rule? 

    A: No. A customer cannot waive, and a dealer is not exempt from the time-of-trade disclosure obligation, unless the customer qualifies as an SMMP.[15] In order to qualify as an SMMP, the customer’s affirmation, according to MSRB Rule D-15, must be unified and speak to all of the modified dealer obligations provided in MSRB Rule G-48, including the modified obligations with respect to both time-of-trade disclosure and best execution. The MSRB has determined that, if a customer is not prepared to forgo all of the legal protections afforded by the dealer obligations that would be modified under Rule G-48 if they were an SMMP, then the customer likely does not have the sophistication necessary to qualify as an SMMP. However, the exemption from the best-execution obligation provided by Rules G-48 and D-15 does not preclude a dealer from following its best-execution policies and procedures when handling SMMP orders. 

    (November 20, 2015) 

    VIII.6: Customer Affirmation Updates

    Q: If a dealer reasonably concludes a customer is an SMMP, is the initial affirmation sufficient for all future trades for that customer, or is there a periodic update requirement for customer affirmations? 

    A: Although there is no explicit periodic update requirement for customer affirmations, MSRB Rule G‑48 requires that dealers “reasonably conclude” a customer is an SMMP. After a certain lapse of time, it will become unreasonable for the dealer to continue to rely on the stale affirmation, and the dealer, therefore, could no longer “reasonably conclude,” as required, that the customer is an SMMP. 

    (November 20, 2015) 

    VIII.7: FINRA Rule 2111

    Q: Will an institutional investor’s suitability form/letter in compliance with FINRA Rule 2111 satisfy the affirmation requirement to qualify as an SMMP pursuant to MSRB Rule D-15? 

    A: No. FINRA Rule 2111(b) and paragraph .07 of the Supplementary Material thereto provide that one element of the suitability obligation of member firms under that rule is fulfilled if the institution affirmatively indicates that it is exercising independent judgment in evaluating the member's or associated person's recommendations. This is similar to the existing exemption dealers have from the suitability requirement of MSRB Rule G-19 under MSRB Rule G-48(c). But neither FINRA Rule 2111 nor any other FINRA rule provides a similar exemption from best execution or any other obligations for its member firms comparable to those included in Rule G-48. Accordingly, a suitability form/letter limited in its terms to comply with FINRA Rule 2111 would not address the full scope of obligations that dealers would be relieved of fulfilling under the exemptions provided by Rules G-48 and D-15. Therefore, a customer will not qualify as an SMMP unless it makes the affirmation required by Rule D-15, which does address all of the modified dealer obligations provided in Rule G-48.

    (November 20, 2015)


    [1] The MSRB believes the guidance in this Notice is consistent in all material respects with guidance on best execution obligations on transactions in corporate fixed income securities published by the Financial Industry Regulatory Authority (FINRA) on November 20, 2016, except where the rule or context otherwise specifically requires. The two instances where material differences exist with the FINRA guidance are with respect to (1) the review of policies and procedures and execution quality by dealers, and (2) the timeliness of executions consistent with reasonable diligence. See note 12 and accompanying text; VI.1 infra; Section 1 (The Duty of Best Execution) and Section 2 (Regular and Rigorous Review for Best Execution) of FINRA Notice to Members 15-46 (November 2015). The MSRB and FINRA will continue to work together with the goal of ensuring that their guidance on best-execution obligations remains consistent in all material respects, unless differentiation is necessary due to differences in the markets for municipal or corporate fixed income securities or their respective rules.

    [2] MSRB Rule D-9 states that, “[e]xcept as otherwise specifically provided by rule of the [MSRB], the term ‘customer’ shall mean any person other than a broker, dealer, or municipal securities dealer acting in its capacity as such or an issuer in transactions involving the sale by the issuer of a new issue of its securities.”

    [3] See MSRB Rule D-15.

    [4] See MSRB Rule G-18(c).

    [5] See paragraph .03 of the Supplementary Material to Rule G-18.

    [6] Additionally, paragraph .06 of the Supplementary Material specifically requires dealers to have written policies and procedures in place that address how they will make best-execution determinations with respect to securities with limited quotations or pricing information (and document their compliance with those policies and procedures), but dealers should consider establishing and implementing policies and procedures that address other potential market conditions or variables, such as volatility. See, e.g., I.4 infra.

    [7] See note 6 supra. The MSRB also notes that, pursuant to MSRB Rules G-8(a)(xx) and G-27(c), dealers are required to maintain records of written supervisory procedures reasonably designed to ensure that the conduct of their municipal securities activities and those of their associated persons are in compliance with MSRB rules and the applicable provisions of the Securities Exchange Act of 1934 (Exchange Act) and rules thereunder.

    [8] See IV.2 infra.

    [9] However, the disclosure of alternative order handling procedures that are unfair or otherwise inconsistent with the firm’s best-execution obligations would neither correct the deficiencies with such procedures nor absolve the firm of potential best execution violations.

    [10] See III.5 infra.

    [11] The scope of a dealer’s policies and procedures on the use of filters, as well as the periodic review and adjustment of their use, should be appropriate to the nature of the dealer’s municipal securities business and, therefore, may be different than the policies and procedures used by other dealers.

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    [12] In adopting Rule G-18, and paragraph .08 of the Supplementary Material specifically, the MSRB did not include provisions that are contained in FINRA Rule 5310 pertaining to “regular and rigorous review of execution quality,” to tailor the rule to the characteristics of the municipal securities market. Accordingly, the implementation guidance provided herein on dealers’ review of execution quality differs from guidance on regular and rigorous review that has been published by FINRA.

    [13] The MSRB notes that a dealer providing a price in response to a bid request or bid list presented to the dealer or other competitive bidding process would not be subject to a best-execution obligation since the dealer has not accepted a customer order for the purpose of facilitating the handling and execution of such order.  This situation is analogous to paragraph .05 of the Supplementary Material to Rule G-18, which draws a distinction between those situations in which a dealer acts solely as the buyer or seller in connection with an order presented against its quote as opposed to accepting an order for handling and execution.

    [14] See note 2 supra.

    [15] See 15 U.S.C. 78cc(a) (“Any condition, stipulation, or provision binding any person to waive compliance with any provision of [the Exchange Act] or of any rule or regulation thereunder, or of any rule of a self-regulatory organization, shall be void.”).

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Notice to Dealers That Use the Services of Broker’s Brokers
    Rule Number:

    Rule G-13, Rule G-43

    Introduction 

    In view of the important role that broker’s brokers play in the provision of secondary market liquidity for municipal securities owned by retail investors, MSRB Rule G-43 sets forth particular rules to which broker’s brokers are subject.  Rule G-43(a)(i) provides:

    Each dealer acting as a "broker’s broker"[1] with respect to the execution of a transaction in municipal securities for or on behalf of another dealer shall make a reasonable effort to obtain a price for the dealer that is fair and reasonable in relation to prevailing market conditions.  The broker’s broker must employ the same care and diligence in doing so as if the transaction were being done for its own account.[2]

    In guidance on broker’s brokers issued in 2004,[3] the MSRB noted the role of some broker’s brokers in large intra-day price differentials of infrequently traded municipal securities with credits that were relatively unknown to most market participants, especially in the case of “retail” size blocks of $5,000 to $100,000.  In certain cases, differences between the prices received by the selling customers as a result of a broker’s broker bid-wanted and the prices paid by the ultimate purchasing customers on the same day were 10% or more.  After the securities were purchased from the broker’s broker, they were sold to other dealers in a series of transactions until they eventually were purchased by other customers.  The abnormally large intra-day price differentials were attributed in major part to the price increases found in the inter-dealer market occurring after the broker’s brokers’ trades.

    Rule G-43 addresses the role of broker’s brokers, including their role in such a series of transactions.  It is the role of the broker’s broker to conduct a properly run bid-wanted or offering and thereby satisfy its duty to make a reasonable effort to obtain a price for the dealer that is fair and reasonable in relation to prevailing market conditions.  The MSRB believes that a bid-wanted or offering conducted in the manner provided in Rule G-43 will be an important element in the establishment of a fair and reasonable price for municipal securities in the secondary market.  This notice addresses the roles of other transaction participants, specifically the brokers, dealers, and municipal securities dealers (“dealers”) that sell, and bid for, municipal securities in bid-wanteds and offerings conducted by broker’s brokers.  Those selling dealers (“sellers”) and bidding dealers (“bidders”) also have pricing duties under MSRB rules and their failure to satisfy those duties could negate the reasonable efforts of a broker’s broker to achieve fair pricing.

    Duties of Bidders

    Rule G-13(b)(i) provides that, in general, “no broker, dealer or municipal securities dealer shall distribute or publish, or cause to be distributed or published, any quotation relating to municipal securities, unless the quotation represents a bona fide bid[4] for, or offer of, municipal securities by such broker, dealer or municipal securities dealer.”  Rule G-13(b)(ii) provides that “[n]o broker, dealer or municipal securities dealer shall distribute or publish, or cause to be distributed or published, any quotation relating to municipal securities, unless the price stated in the quotation is based on the best judgment of such broker, dealer or municipal securities dealer of the fair market value of the securities which are the subject of the quotation at the time the quotation is made.”

    Dealers that submit bids to broker’s brokers that they believe are below the fair market value of the securities or that submit “throw-away” bids to broker’s brokers do so in violation of Rule G-13.  While bidders are entitled to make a profit, Rule G-13 does not permit them to do so by “picking off” other dealers at off-market prices.  Throw-away bids, by definition, violate Rule G-13, because throw-away bids are arrived at without an analysis by the bidder of the fair market value of the municipal security that is the subject of the bid.  A conclusion by the bidder that a security must be worth “at least that much,” without any knowledge of the security or comparable securities and without any effort to analyze the security’s value is not based on the best judgment of such bidder of the fair market value of the securities within the meaning of Rule G-13(b)(ii).  When the MSRB first proposed Rule G-13, it explained in a February 24, 1977 letter from Frieda Wallison, Executive Director and General Counsel, MSRB, to Lee Pickard, Director, Division of Market Regulation, Securities and Exchange Commission that, among the activities that Rule G-13 was designed to prevent was the placing of a bid that is “pulled out of the air,” which is another way to describe a throw-away bid.

    Furthermore, when a dealer’s bid is accepted and a transaction in the securities is executed, that transaction price (and accordingly the bid itself) will be disseminated within the meaning of Rule G-13(a)(i) on the MSRB’s Electronic Municipal Market Access (EMMA®) platform within 15 minutes after the time of trade.  At that point, if the bid is off-market, it will create a misperception in the municipal marketplace of the true fair market value of the security.  The fact that the bid price that wins a bid-wanted or offering may well not represent the true fair market value of the security is evidenced by the trade activity observed by enforcement agencies following such auctions.  Enforcement agencies have informed the MSRB that they continue to observe the same kinds of series of transactions in municipal securities that prompted the MSRB’s 2004 pricing guidance.  They have also informed the MSRB about their observations of other trading patterns that indicate some market participants may misuse the role of the broker’s broker in the provision of secondary market liquidity and may cause retail customers who liquidate their municipal securities by means of broker’s brokers to receive unfair prices.

    Duties of Sellers

    Dealers that use the services of broker’s brokers to sell municipal securities for their customers also have significant fair pricing duties under Rule G-30 when they act as a principal.  As the MSRB noted in its request for comment on Draft Rule G-43,[5]

    the information about the value of municipal securities provided to a selling dealer by a broker’s broker is only one factor that the dealer must take into account in determining a fair and reasonable price for its customer.  In fact, in 2004, the National Association of Securities Dealers (“NASD”) announced that it had fined eight dealers for relying solely on prices obtained in bid-wanteds conducted by broker’s brokers, which the NASD found to be significantly below fair market value.[6]  In that same year, the MSRB said that “particularly when the market value of an issue is not known, a dealer . . . may need to check the results of the bid wanted process against other objective data to fulfill its fair pricing obligations . . . .”

    Under those circumstances where broker’s brokers seeks to satisfy their fair pricing obligations in bid-wanteds conducted pursuant to Rule G-43(b), Rule G-43(b)(v) provides for notice by broker’s brokers to sellers when bids in bid-wanteds are below predetermined parameters that are designed to identify possible off-market bids (e.g., those based on yield curves, pricing services, recent trades reported to the MSRB’s RTRS System, or bids received by broker’s brokers in prior bid-wanteds or offerings).  Once a seller has received such notice, it must direct the broker’s broker as to whether to execute the trade at that price.  That notice by the broker’s broker and required action on the part of the seller should put the seller on notice that it must take additional steps to ascertain whether the high bid provided to it by the broker’s broker is, in fact, a fair and reasonable price for the securities.  Rule G-30 mandates that the seller, if acting as a principal, must not buy municipal securities from its customer at a price that is not fair and reasonable (taking any mark-down into account), taking into consideration all relevant factors, including those listed in the rule.

    The MSRB notes that Rule G-8(a)(xxv)(E) requires broker’s brokers to keep records when they have provided the seller with the notice described in Rule G-43(b)(v).  Among the required records are the full name of the person at the seller who received the notice, the direction given by the seller firm following the notice, and the full name of the person at the seller who provided that direction.

    Rule G-43(b)(i) permits a broker’s broker to limit the audience for a bid-wanted at the selling dealer’s direction, a practice sometimes referred to as “screening” or “filtering,” because the MSRB recognizes that there may be legitimate reasons for this practice.  However, the MSRB notes that such screening may reduce the likelihood that the high bid represents a fair and reasonable price.  Selling dealers should, therefore, be able to demonstrate a reason that is not anti-competitive (e.g., credit, legal, or regulatory concerns), rather than trying to eliminate access by a competitor, for directing broker’s brokers to screen certain bidders from the receipt of bid-wanteds or offerings.  For example, a selling dealer might maintain a list of the firms it would be unwilling to accept as a counterparty and the reasons why.

    The MSRB recognizes that there may be circumstances under which customers may need to liquidate their municipal securities quickly and that there are limitations on the ability of a bid-wanted or offering to achieve a price that is comparable to recent trade prices under certain circumstances, particularly in view of its timing and the presence or absence of regular buyers in the marketplace.  Nevertheless, the MSRB urges sellers not to assume that their customers need to liquidate their securities immediately without inquiring as to their customers’ particular circumstances and discussing with their customers the possible improved pricing benefit associated with taking additional time to liquidate the securities.

    Rule G-17 requires dealers, in the conduct of their municipal securities activities, to deal fairly with all persons and to not engage in any deceptive, dishonest, or unfair practice.  Broker’s brokers have informed the MSRB that many dealers place bid-wanteds and offerings with broker’s brokers with no intention of selling the securities through the broker’s brokers.  Some have noted that shortly thereafter they see the same securities purchased by dealers for their own accounts at prices that exceed the high bid obtained by the broker’s brokers by only a very small amount.  Other dealers have told the MSRB that they are skeptical of many of the bid-wanteds they see, because they think the bid-wanteds are only being used for price discovery by the selling dealers and are not real.  Accordingly, in many cases, they do not bid.  This use of broker’s brokers solely for price discovery purposes harms the bid-wanted and offering process by reducing bidders, thereby reducing the likelihood that the high bid in a bid-wanted will represent the fair market value of the securities.  Additionally, it causes broker’s brokers to work without reasonable expectation of compensation.  For those reasons, depending upon the facts and circumstances, the use of bid-wanteds solely for price discovery purposes may be an unfair practice within the meaning of Rule G-17.


    [1] Rule G-43(d)(iii) defines a “broker’s broker” as “a dealer, or a separately operated and supervised division or unit of a dealer, that principally effects transactions for other dealers or that holds itself out as a broker’s broker.” Certain alternative trading systems are excepted from the definition of “broker’s broker.”
     
    [2] A bid-wanted conducted in accordance with Rule G-43(b) will satisfy the pricing obligation of a broker’s broker.
     
     
    [4] Rule G-13(b)(iii) provides that:

    a quotation shall be deemed to represent a "bona fide bid for, or offer of, municipal securities" if the broker, dealer or municipal securities dealer making the quotation is prepared to purchase or sell the security which is the subject of the quotation at the price stated in the quotation and under such conditions, if any, as are specified at the time the quotation is made.

    [5] MSRB Notice 2011-18 (February 24, 2011).

    [6] See http://www.finra.org/Newsroom/NewsReleases/2004/P011465.

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Interpretive Notice Concerning the Application of MSRB Rule G-17 to Underwriters of Municipal Securities
    Rule Number:

    Rule G-17

    Under Rule G-17 of the Municipal Securities Rulemaking Board (the “MSRB”), brokers, dealers, and municipal securities dealers (“dealers”) must, in the conduct of their municipal securities activities, deal fairly with all persons and must not engage in any deceptive, dishonest, or unfair practice.  This rule is most often cited in connection with duties owed by dealers to investors; however, it also applies to their interactions with other market participants, including municipal entities[1] such as states and their political subdivisions that are issuers of municipal securities (“issuers”).

    The MSRB has previously observed that Rule G-17 requires dealers to deal fairly with issuers in connection with the underwriting of their municipal securities.[2]  More recently, with the passage of the Dodd-Frank Act,[3] the MSRB was expressly directed by Congress to protect municipal entities.  Accordingly, the MSRB is providing additional interpretive guidance that addresses how Rule G-17 applies to dealers acting in the capacity of underwriters in the municipal securities transactions described below.  Except where a competitive underwriting is specifically mentioned, this notice applies to negotiated underwritings only.  Furthermore, it does not apply to selling group members.

    The examples discussed in this notice are illustrative only and are not meant to encompass all obligations of dealers to municipal entities under Rule G-17.  The notice also does not address a dealer’s duties when the dealer is serving as an advisor to a municipal entity.  Furthermore, when municipal entities are customers[4] of dealers they are subject to the same protections under MSRB rules, including Rule G-17, that apply to other customers.[5]  The MSRB notes that an underwriter has a duty of fair dealing to investors in addition to its duty of fair dealing to issuers.  An underwriter also has a duty to comply with other MSRB rules as well as other federal and state securities laws.

    Basic Fair Dealing Principle

    As noted above, Rule G-17 precludes a dealer, in the conduct of its municipal securities activities, from engaging in any deceptive, dishonest, or unfair practice with any person, including an issuer of municipal securities.  The rule contains an anti-fraud prohibition. Thus, an underwriter must not misrepresent or omit the facts, risks, potential benefits, or other material information about municipal securities activities undertaken with a municipal issuer.  However, Rule G-17 does not merely prohibit deceptive conduct on the part of the dealer.  It also establishes a general duty of a dealer to deal fairly with all persons (including, but not limited to, issuers of municipal securities), even in the absence of fraud.

    Role of the Underwriter/Conflicts of Interest

    In a negotiated underwriting, the underwriter’s Rule G-17 duty to deal fairly with an issuer of municipal securities requires the underwriter to make certain disclosures to the issuer to clarify its role in an issuance of municipal securities and its actual or potential material conflicts of interest with respect to such issuance.

    Disclosures Concerning the Underwriter’s Role.  The underwriter must disclose to the issuer that:

    (i)         Municipal Securities Rulemaking Board Rule G-17 requires an underwriter to deal fairly at all times with both municipal issuers and investors;

    (ii)        the underwriter’s primary role is to purchase securities with a view to distribution in an arm’s-length commercial transaction with the issuer and it has financial and other interests that differ from those of the issuer;

    (iii)       unlike a municipal advisor, the underwriter does not have a fiduciary duty to the issuer under the federal securities laws and is, therefore, not required by federal law to act in the best interests of the issuer without regard to its own financial or other interests;

    (iv)       the underwriter has a duty to purchase securities from the issuer at a fair and reasonable price, but must balance that duty with its duty to sell municipal securities to investors at prices that are fair and reasonable; and

    (v)        the underwriter will review the official statement for the issuer’s securities in accordance with, and as part of, its responsibilities to investors under the federal securities laws, as applied to the facts and circumstances of the transaction.

    The underwriter also must not recommend that the issuer not retain a municipal advisor.

    Disclosure Concerning the Underwriter’s Compensation.  The underwriter must disclose to the issuer whether its underwriting compensation will be contingent on the closing of a transaction.  It must also disclose that compensation that is contingent on the closing of a transaction or the size of a transaction presents a conflict of interest, because it may cause the underwriter to recommend a transaction that it is unnecessary or to recommend that the size of the transaction be larger than is necessary.

    Other Conflicts Disclosures.  The underwriter must also disclose other potential or actual material conflicts of interest, including, but not limited to, the following:

    (i)         any payments described below under “Conflicts of Interest/ Payments to or from Third Parties”;

    (ii)        any arrangements described below under “Conflicts of Interest/Profit-Sharing with Investors”;

    (iii)       the credit default swap disclosures described below under “Conflicts of Interest/Credit Default Swaps”; and

    (iv)       any incentives for the underwriter to recommend a complex municipal securities financing and other associated conflicts of interest (as described below under “Required Disclosures to Issuer”).

    Disclosures concerning the role of the underwriter and the underwriter’s compensation may be made by a syndicate manager on behalf of other syndicate members.  Other conflicts disclosures must be made by the particular underwriters subject to such conflicts.

    Timing and Manner of Disclosures.  All of the foregoing disclosures must be made in writing to an official of the issuer that the underwriter reasonably believes has the authority to bind the issuer by contract with the underwriter and that, to the knowledge of the underwriter, is not a party to a disclosed conflict.  Disclosures must be made in a manner designed to make clear to such official the subject matter of such disclosures and their implications for the issuer.  The disclosure concerning the arm’s-length nature of the underwriter-issuer relationship must be made in the earliest stages of the underwriter’s relationship with the issuer with respect to an issue (e.g., in a response to a request for proposals or in promotional materials provided to an issuer).  Other disclosures concerning the role of the underwriter and the underwriter’s compensation generally must be made when the underwriter is engaged to perform underwriting services (e.g., in an engagement letter), not solely in a bond purchase agreement.  Other conflicts disclosures must be made at the same time, except with regard to conflicts discovered or arising after the underwriter has been engaged.  For example, a conflict may not be present until an underwriter has recommended a particular financing.  In that case, the disclosure must be provided in sufficient time before the execution of a contract with the underwriter to allow the official to evaluate the recommendation, as described below under “Required Disclosures to Issuers.”

    Acknowledgement of Disclosures.  The underwriter must attempt to receive written acknowledgement (other than by automatic e-mail receipt) by the official of the issuer of receipt of the foregoing disclosures.  If the official of the issuer agrees to proceed with the underwriting engagement after receipt of the disclosures but will not provide written acknowledgement of receipt, the underwriter may proceed with the engagement after documenting with specificity why it was unable to obtain such written acknowledgement.

    Representations to Issuers

    All representations made by underwriters to issuers of municipal securities in connection with municipal securities underwritings, whether written or oral, must be truthful and accurate and must not misrepresent or omit material facts.  Underwriters must have a reasonable basis for the representations and other material information contained in documents they prepare and must refrain from including representations or other information they know or should know is inaccurate or misleading.  For example, in connection with a certificate signed by the underwriter that will be relied upon by the issuer or other relevant parties to an underwriting (e.g., an issue price certificate), the dealer must have a reasonable basis for the representations and other material information contained therein.  In addition, an underwriter’s response to an issuer’s request for proposals or qualifications must fairly and accurately describe the underwriter’s capacity, resources, and knowledge to perform the proposed underwriting as of the time the proposal is submitted and must not contain any representations or other material information about such capacity, resources, or knowledge that the underwriter knows or should know to be inaccurate or misleading.  Matters not within the personal knowledge of those preparing the response (e.g., pending litigation) must be confirmed by those with knowledge of the subject matter.  An underwriter must not represent that it has the requisite knowledge or expertise with respect to a particular financing if the personnel that it intends to work on the financing do not have the requisite knowledge or expertise.

    Required Disclosures to Issuers

    Many municipal securities are issued using financing structures that are routine and well understood by the typical municipal market professional, including most issuer personnel that have the lead responsibilities in connection with the issuance of municipal securities.  For example, absent unusual circumstances or features, the typical fixed rate offering may be presumed to be well understood.  Nevertheless, in the case of issuer personnel that the underwriter reasonably believes lack knowledge or experience with such structures, the underwriter must provide disclosures on the material aspects of such structures that it recommends.

    However, in some cases, issuer personnel responsible for the issuance of municipal securities would not be well positioned to fully understand or assess the implications of a financing in its totality, because the financing is structured in a unique, atypical, or otherwise complex manner (a “complex municipal securities financing”).[6]  Examples of complex municipal securities financings include variable rate demand obligations (“VRDOs”) and financings involving derivatives (such as swaps).  An underwriter in a negotiated offering that recommends a complex municipal securities financing to an issuer has an obligation under Rule G-17 to make more particularized disclosures than those that may be required in the case of routine financing structures.  The underwriter must disclose the material financial characteristics of the complex municipal securities financing, as well as the material financial risks of the financing that are known to the underwriter and reasonably foreseeable at the time of the disclosure.[7]  It must also disclose any incentives for the underwriter to recommend the financing and other associated conflicts of interest.[8]  Such disclosures must be made in a fair and balanced manner based on principles of fair dealing and good faith.

    The level of disclosure required may vary according to the issuer’s knowledge or experience with the proposed financing structure or similar structures, capability of evaluating the risks of the recommended financing, and financial ability to bear the risks of the recommended financing, in each case based on the reasonable belief of the underwriter.[9]  In all events, the underwriter must disclose any incentives for the underwriter to recommend the complex municipal securities financing and other associated conflicts of interest.

    The disclosures described in this section of this notice must be made in writing to an official of the issuer whom the underwriter reasonably believes has the authority to bind the issuer by contract with the underwriter (i) in sufficient time before the execution of a contract with the underwriter to allow the official to evaluate the recommendation and (ii) in a manner designed to make clear to such official the subject matter of such disclosures and their implications for the issuer.  The disclosures concerning a complex municipal securities financing must address the specific elements of the financing, rather than being general in nature.  If the underwriter does not reasonably believe that the official to whom the disclosures are addressed is capable of independently evaluating the disclosures, the underwriter must make additional efforts reasonably designed to inform the official or its employees or agent.

    Underwriter Duties in Connection with Issuer Disclosure Documents

    Underwriters often play an important role in assisting issuers in the preparation of disclosure documents, such as preliminary official statements and official statements.[10]  These documents are critical to the municipal securities transaction, in that investors rely on the representations contained in such documents in making their investment decisions.  Moreover, investment professionals, such as municipal securities analysts and ratings services, rely on the representations in forming an opinion regarding the credit.  A dealer’s duty to have a reasonable basis for the representations it makes, and other material information it provides, to an issuer and to ensure that such representations and information are accurate and not misleading, as described above, extends to representations and information provided by the underwriter in connection with the preparation by the issuer of its disclosure documents (e.g., cash flows).

    Underwriter Compensation and New Issue Pricing

    Excessive Compensation.  An underwriter’s compensation for a new issue (including both direct compensation paid by the issuer and other separate payments, values, or credits received by the underwriter from the issuer or any other party in connection with the underwriting), in certain cases and depending upon the specific facts and circumstances of the offering, may be so disproportionate to the nature of the underwriting and related services performed as to constitute an unfair practice with regard to the issuer that it is a violation of Rule G-17.  Among the factors relevant to whether an underwriter’s compensation is disproportionate to the nature of the underwriting and related services performed, are the credit quality of the issue, the size of the issue, market conditions, the length of time spent structuring the issue, and whether the underwriter is paying the fee of the underwriter’s counsel or any other relevant costs related to the financing.

    Fair Pricing.  The duty of fair dealing under Rule G-17 includes an implied representation that the price an underwriter pays to an issuer is fair and reasonable, taking into consideration all relevant factors, including the best judgment of the underwriter as to the fair market value of the issue at the time it is priced.[11]  In general, a dealer purchasing bonds in a competitive underwriting for which the issuer may reject any and all bids will be deemed to have satisfied its duty of fairness to the issuer with respect to the purchase price of the issue as long as the dealer’s bid is a bona fide bid (as defined in Rule G-13)[12] that is based on the dealer’s best judgment of the fair market value of the securities that are the subject of the bid.  In a negotiated underwriting, the underwriter has a duty under Rule G-17 to negotiate in good faith with the issuer.  This duty includes the obligation of the dealer to ensure the accuracy of representations made during the course of such negotiations, including representations regarding the price negotiated and the nature of investor demand for the securities (e.g., the status of the order period and the order book).  If, for example, the dealer represents to the issuer that it is providing the “best” market price available on the new issue, or that it will exert its best efforts to obtain the “most favorable” pricing, the dealer may violate Rule G-17 if its actions are inconsistent with such representations.[13]

    Conflicts of Interest

    Payments to or from Third Parties.  In certain cases, compensation received by the underwriter from third parties, such as the providers of derivatives and investments (including affiliates of the underwriter), may color the underwriter’s judgment and cause it to recommend products, structures, and pricing levels to an issuer when it would not have done so absent such payments.  The MSRB views the failure of an underwriter to disclose to the issuer the existence of payments, values, or credits received by the underwriter in connection with its underwriting of the new issue from parties other than the issuer, and payments made by the underwriter in connection with such new issue to parties other than the issuer (in either case including payments, values, or credits that relate directly or indirectly to collateral transactions integrally related to the issue being underwritten), to be a violation of the underwriter’s obligation to the issuer under Rule G-17.[14]  For example, it would be a violation of Rule G-17 for an underwriter to compensate an undisclosed third party in order to secure municipal securities business.  Similarly, it would be a violation of Rule G-17 for an underwriter to receive undisclosed compensation from a third party in exchange for recommending that third party’s services or product to an issuer, including business related to municipal securities derivative transactions.  This notice does not require that the amount of such third-party payments be disclosed.  The underwriter must also disclose to the issuer whether it has entered into any third-party arrangements for the marketing of the issuer’s securities.

    Profit-Sharing with Investors.  Arrangements between the underwriter and an investor purchasing new issue securities from the underwriter (including purchases that are contingent upon the delivery by the issuer to the underwriter of the securities) according to which profits realized from the resale by such investor of the securities are directly or indirectly split or otherwise shared with the underwriter also would, depending on the facts and circumstances (including in particular if such resale occurs reasonably close in time to the original sale by the underwriter to the investor), constitute a violation of the underwriter’s fair dealing obligation under Rule G-17.  Such arrangements could also constitute a violation of Rule G-25(c), which precludes a dealer from sharing, directly or indirectly, in the profits or losses of a transaction in municipal securities with or for a customer.

    Credit Default Swaps.  The issuance or purchase by a dealer of credit default swaps for which the reference is the issuer for which the dealer is serving as underwriter, or an obligation of that issuer, may pose a conflict of interest, because trading in such municipal credit default swaps has the potential to affect the pricing of the underlying reference obligations, as well as the pricing of other obligations brought to market by that issuer.  Rule G-17 requires, therefore, that a dealer disclose the fact that it engages in such activities to the issuers for which it serves as underwriter.  Activities with regard to credit default swaps based on baskets or indexes of municipal issuers that include the issuer or its obligation(s) need not be disclosed, unless the issuer or its obligation(s) represents more than 2% of the total notional amount of the credit default swap or the underwriter otherwise caused the issuer or its obligation(s) to be included in the basket or index.

    Retail Order Periods

    Rule G-17 requires an underwriter that has agreed to underwrite a transaction with a retail order period to, in fact, honor such agreement.[15]  A dealer that wishes to allocate securities in a manner that is inconsistent with an issuer’s requirements must not do so without the issuer’s consent.  In addition, Rule G-17 requires an underwriter that has agreed to underwrite a transaction with a retail order period to take reasonable measures to ensure that retail clients are bona fide.  An underwriter that knowingly accepts an order that has been framed as a retail order when it is not (e.g., a number of small orders placed by an institutional investor that would otherwise not qualify as a retail customer) would violate Rule G-17 if its actions are inconsistent with the issuer’s expectations regarding retail orders.  In addition, a dealer that places an order that is framed as a qualifying retail order but in fact represents an order that does not meet the qualification requirements to be treated as a retail order (e.g., an order by a retail dealer without “going away” orders[16] from retail customers, when such orders are not within the issuer’s definition of “retail”) violates its Rule G-17 duty of fair dealing.  The MSRB will continue to review activities relating to retail order periods to ensure that they are conducted in a fair and orderly manner consistent with the intent of the issuer and the MSRB’s investor protection mandate.

    Dealer Payments to Issuer Personnel

    Dealers are reminded of the application of MSRB Rule G-20, on gifts, gratuities, and non-cash compensation, and Rule G-17, in connection with certain payments made to, and expenses reimbursed for, issuer personnel during the municipal bond issuance process.[17]  These rules are designed to avoid conflicts of interest and to promote fair practices in the municipal securities market.

    Dealers should consider carefully whether payments they make in regard to expenses of issuer personnel in the course of the bond issuance process, including in particular, but not limited to, payments for which dealers seek reimbursement from bond proceeds or issuers, comport with the requirements of Rule G-20.  For example, a dealer acting as a financial advisor or underwriter may violate Rule G-20 by paying for excessive or lavish travel, meal, lodging and entertainment expenses in connection with an offering (such as may be incurred for rating agency trips, bond closing dinners, and other functions) that inure to the personal benefit of issuer personnel and that exceed the limits or otherwise violate the requirements of the rule.[18]

    August 2, 2012


    [1] The term “municipal entity” is defined by Section 15B(e)(8) of the Securities Exchange Act (the “Exchange Act”) to mean: “any State, political subdivision of a State, or municipal corporate instrumentality of a State, including—(A) any agency, authority, or instrumentality of the State, political subdivision, or municipal corporate instrumentality; (B) any plan, program, or pool of assets sponsored or established by the State, political subdivision, or municipal corporate instrumentality or any agency, authority, or instrumentality thereof; and (C) any other issuer of municipal securities.”

    [2] See Reminder Notice on Fair Practice Duties to Issuers of Municipal Securities, MSRB Notice 2009-54 (September 29, 2009); Rule G-17 Interpretive Letter – Purchase of new issue from issuer, MSRB interpretation of December 1, 1997, reprinted in MSRB Rule Book (“1997 Interpretation”).

    [3] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203 § 975, 124 Stat. 1376 (2010).

    [4] MSRB Rule D-9 defines the term “customer” as follows: “Except as otherwise specifically provided by rule of the Board, the term “Customer” shall mean any person other than a broker, dealer, or municipal securities dealer acting in its capacity as such or an issuer in transactions involving the sale by the issuer of a new issue of its securities.”

    [5] See MSRB Reminds Firms of Their Sales Practice and Due Diligence Obligations When Selling Municipal Securities in the Secondary Market, MSRB Notice 2010-37 (September 20, 2010).

    [6] If a complex municipal securities financing consists of an otherwise routine financing structure that incorporates a unique, atypical or complex element and the issuer personnel have knowledge or experience with respect to the routine elements of the financing, the disclosure of material risks and characteristics may be limited to those relating to such specific element and any material impact such element may have on other features that would normally be viewed as routine.

    [7] For example, an underwriter that recommends a VRDO should inform the issuer of the risk of interest rate fluctuations and material risks of any associated credit or liquidity facilities (e.g., the risk that the issuer might not be able to replace the facility upon its expiration and might be required to repay the facility provider over a short period of time).  As an additional example, if the underwriter recommends that the issuer swap the floating rate interest payments on the VRDOs to fixed rate payments under a swap, the underwriter must disclose the material financial risks (including market, credit, operational, and liquidity risks) and material financial characteristics of the recommended swap (e.g., the material economic terms of the swap, the material terms relating to the operation of the swap, and the material rights and obligations of the parties during the term of the swap), as well as the material financial risks associated with the VRDO.  Such disclosure should be sufficient to allow the issuer to assess the magnitude of its potential exposure as a result of the complex municipal securities financing.  The underwriter must also inform the issuer that there may be accounting, legal, and other risks associated with the swap and that the issuer should consult with other professionals concerning such risks.  If the underwriter’s affiliated swap dealer is proposed to be the executing swap dealer, the underwriter may satisfy its disclosure obligation with respect to the swap if such disclosure has been provided to the issuer by the affiliated swap dealer or the issuer’s swap or other financial advisor that is independent of the underwriter and the swap dealer, as long as the underwriter has a reasonable basis for belief in the truthfulness and completeness of such disclosure.  If the issuer decides to enter into a swap with another dealer, the underwriter is not required to make disclosures with regard to that swap.  The MSRB notes that dealers that recommend swaps or security-based swaps to municipal entities may also be subject to rules of the Commodity Futures Trading Commission or those of the Securities and Exchange Commission (“SEC”).

    [8] For example, a conflict of interest may exist when the underwriter is also the provider of a swap used by an issuer to hedge a municipal securities offering or when the underwriter receives compensation from a swap provider for recommending the swap provider to the issuer.  See also “Conflicts of Interest/Payments to or from Third Parties” herein.

    [9] Even a financing in which the interest rate is benchmarked to an index that is commonly used in the municipal marketplace (e.g., LIBOR or SIFMA) may be complex to an issuer that does not understand the components of that index or its possible interaction with other indexes.

    [10] Underwriters that assist issuers in preparing official statements must remain cognizant of their duties under federal securities laws.  With respect to primary offerings of municipal securities, the SEC has noted, “By participating in an offering, an underwriter makes an implied recommendation about the securities.” See SEC Rel. No. 34-26100 (Sept. 22, 1988) (proposing Exchange Act Rule 15c2-12) at text following note 70.  The SEC has stated that “this recommendation itself implies that the underwriter has a reasonable basis for belief in the truthfulness and completeness of the key representations made in any disclosure documents used in the offerings.”  Furthermore, pursuant to SEC Rule 15c2-12(b)(5), an underwriter may not purchase or sell municipal securities in most primary offerings unless the underwriter has reasonably determined that the issuer or an obligated person has entered into a written undertaking to provide certain types of secondary market disclosure and has a reasonable basis for relying on the accuracy of the issuer’s ongoing disclosure representations.  SEC Rel. No. 34-34961 (Nov. 10, 1994) (adopting continuing disclosure provisions of Exchange Act Rule 15c2-12) at text following note 52.

    [11] The MSRB has previously observed that whether an underwriter has dealt fairly with an issuer for purposes of Rule G-17 is dependent upon all of the facts and circumstances of an underwriting and is not dependent solely on the price of the issue.  See MSRB Notice 2009-54 and the 1997 Interpretation.  See also “Retail Order Periods” herein.

    [12] Rule G-13(b)(iii) provides: “For purposes of subparagraph (i), a quotation shall be deemed to represent a "bona fide bid for, or offer of, municipal securities" if the broker, dealer or municipal securities dealer making the quotation is prepared to purchase or sell the security which is the subject of the quotation at the price stated in the quotation and under such conditions, if any, as are specified at the time the quotation is made.”

    [13] See 1997 Interpretation.

    [14] See also “Required Disclosures to Issuers” herein.

    [15] See MSRB Interpretation on Priority of Orders for Securities in a Primary Offering under Rule G-17, MSRB interpretation of October 12, 2010, reprinted in MSRB Rule Book.  The MSRB also reminds underwriters of previous MSRB guidance on the pricing of securities sold to retail investors.  See Guidance on Disclosure and Other Sales Practice Obligations to Individual and Other Retail Investors in Municipal Securities, MSRB Notice 2009-42 (July 14, 2009).

     

    [16] In general, a “going away” order is an order for new issue securities for which a customer is already conditionally committed.  See SEC Release No. 34-62715, File No. SR-MSRB-2009-17 (August 13, 2010).

    [17] See MSRB Rule G-20 Interpretation — Dealer Payments in Connection With the Municipal Securities Issuance Process, MSRB interpretation of January 29, 2007, reprinted in MSRB Rule Book.

    [18] See In the Matter of RBC Capital Markets Corporation, SEC Rel. No. 34-59439 (Feb. 24, 2009) (settlement in connection with broker-dealer alleged to have violated MSRB Rules G-20 and G-17 for payment of lavish travel and entertainment expenses of city officials and their families associated with rating agency trips, which expenditures were subsequently reimbursed from bond proceeds as costs of issuance); In the Matter of Merchant Capital, L.L.C., SEC Rel. No. 34-60043 (June 4, 2009) (settlement in connection with broker-dealer alleged to have violated MSRB rules for payment of travel and entertainment expenses of family and friends of senior officials of issuer and reimbursement of the expenses from issuers and from proceeds of bond offerings).

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Guidance on the Prohibition on Underwriting Issues of Municipal Securities for Which a Financial Advisory Relationship Exists Under Rule G-23
    Rule Number:

    Rule G-23

    MSRB Rule G-23 establishes certain basic requirements applicable to a broker, dealer, or municipal securities dealer (“dealer”) acting as a financial advisor with respect to the issuance of municipal securities.  MSRB Rule G-23(d) provides that a dealer that has a financial advisory relationship with respect to the issuance of municipal securities is precluded from acquiring all or any portion of such issue, directly or indirectly, from the issuer as principal, either alone or as a participant in a syndicate or other similar account formed for that purpose.  A dealer is also precluded from arranging the placement of an issue with respect to which it has a financial advisory relationship.  This notice refers to both of these activities as “underwritings” and provides interpretive guidance on when a dealer may be precluded by Rule G-23(d) from underwriting an issue of municipal securities due to having served as financial advisor with respect to that issue.  Rule G-23 is solely a conflicts rule.  Accordingly, this notice does not address whether provision of the advice permitted by Rule G-23 would cause the dealer to be considered a “municipal advisor” under the Exchange Act and the rules promulgated thereunder.

    Rule G-23(b) provides, among other things, that a financial advisory relationship shall be deemed to exist for purposes of Rule G-23 when a dealer renders or enters into an agreement to provide financial advisory or consultant services to or on behalf of an issuer with respect to the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such issue or issues.  Rule G-23(b) also provides, however, that a financial advisory relationship shall not be deemed to exist when, in the course of acting as an underwriter and not as a financial advisor, a dealer provides advice to an issuer, including advice with respect to the structure, timing, terms, and other similar matters concerning the issuance of municipal securities.

    Although Rule G-23(c) requires a financial advisory relationship to be evidenced by a writing, a financial advisory relationship will be deemed to exist whenever a dealer renders the types of advice provided for in Rule G-23(b), regardless of the existence of a written agreement.  However, a dealer that clearly identifies itself in writing as an underwriter and not as a financial advisor from the earliest stages of its relationship with the issuer with respect to that issue (e.g., in a response to a request for proposals or in promotional materials provided to an issuer) will be considered to be “acting as an underwriter” under Rule G-23(b) with respect to that issue.  The writing must make clear that the primary role of an underwriter is to purchase, or arrange for the placement of, securities in an arm’s-length commercial transaction between the issuer and the underwriter and that the underwriter has financial and other interests that differ from those of the issuer.  The dealer must not engage in a course of conduct that is inconsistent with an arm’s-length relationship with the issuer in connection with such issue of municipal securities or the dealer will be deemed to be a financial advisor with respect to that issue and precluded from underwriting that issue by Rule G-23(d).  Thus, a dealer providing advice to an issuer with respect to the issuance of municipal securities (including the structure, timing, and terms of the issue and other similar matters, when integrally related to the issue being underwritten) will not be viewed as a financial advisor for purposes of Rule G-23, if such advice is rendered in its capacity as underwriter for such issue.  In addition to engaging in underwriting activities, it shall not be a violation of Rule G-23(d) for a dealer that states that it is acting as an underwriter with respect to the issuance of municipal securities to provide advice with respect to the investment of the proceeds of the issue, municipal derivatives integrally related to the issue, or other similar matters concerning the issue.

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Reminder Regarding the Application of Rule G-37 to Federal Election Campaigns of Issuer Officials
    Rule Number:

    In 1999, the MSRB published a notice on the application of Rule G-37, on political contributions and prohibitions on municipal securities business, to Presidential campaigns of issuer officials.[1]  In general, the notice described a 1995 interpretive letter[2] in which the Board noted that Rule G-37 is applicable to contributions given to an official of an issuer[3] who seeks election to federal office, such as the Presidency.  The Board also explained that the only exception to Rule G-37’s absolute prohibition on business is for certain contributions made to issuer officials by municipal finance professionals.  Specifically, contributions by such persons to an official of an issuer would not invoke application of the prohibition if the municipal finance professional is entitled to vote for such official, and provided that any contributions by such municipal finance professional do not exceed, in total, $250 to each official, per election.  In the example of an issuer official running for President, any municipal finance professional in the country can contribute the de minimis amount to the official’s Presidential campaign without causing a ban on municipal securities business with that issuer.  Finally, the Board noted that a Presidential candidate who has accepted public funding for the general election is prohibited under federal law from accepting any contributions to further his or her general election campaign.  In these circumstances, federal law allows individuals to contribute to the candidate’s compliance fund, which uses the contributions solely for legal and accounting services to ensure compliance with federal law and not for campaign activities.  Thus, any municipal finance professional in the country can contribute the de minimis amount to an issuer official’s compliance fund without causing a ban on municipal securities business with that issuer.  This would apply if the issuer official runs for President or Vice President.

    The MSRB wishes to remind dealers that these concepts also apply to an issuer official who campaigns for any federal office.  For example, any municipal finance professional residing in a state in which an issuer official is campaigning for a state-wide federal office may contribute the de minimis amount to the official’s campaign without causing a ban on municipal securities business with that issuer.  The MSRB does not opine whether any particular individual is or is not an issuer official. 

    The MSRB also wishes to remind dealers to be aware of the Rule G-37 issues involving indirect rule violations and contributions to non-dealer associated political action committees and payments to political parties, which issues have been the subjects of previous notices and interpretive Questions and Answers.[4]

    September 28, 2011


    [1] See Application of Rule G-37 to Presidential Campaigns of Issuer Officials reprinted in MSRB Rule Book (January 1, 2011) at 299-300.  The notice is also available from the MSRB Rules/Interpretive Notices section of the MSRB’s website at www.msrb.org.

    [2] See MSRB Interpretation of May 31, 1995, reprinted in MSRB Rule Book (January 1, 2011) at 309-311.  The letter is also available from the MSRB Rules/Interpretive Letters section of the MSRB’s website at www.msrb.org.

    [3] The term “official of an issuer” is defined in Rule G-37(g)(vi) as any person (including any election committee for such person) who was, at the time of the contribution, an incumbent, candidate or successful candidate: (A) for elective office of the issuer which office is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by the issuer; or (B) for any elective office of a state or of any political subdivision, which office has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for municipal securities business by an issuer.

    [4] See Notice Concerning Indirect Rule Violations: Rules G-37 and G-38, reprinted in MSRB Rule Book (January 1, 2011) at 302-303; Rule G-37 Questions and Answers Nos.  III.4 and III.5 regarding contributions to a non-dealer associated PAC and payments to a state or local political party, reprinted in MSRB Rule Book (January 1, 2011) at 290; and Rule G-37 Question and Answer No. III.7 regarding supervisory procedures relating to indirect contributions, reprinted in MSRB Rule Book (January 1, 2011) at 291.  The notice and Questions and Answers are also available on the MSRB’s website at www.msrb.org.

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Guidance on Dealer-Affiliated Political Action Committees Under Rule G-37
    Rule Number:

    Rule G-37, Rule D-11

    Since 1994, the Municipal Securities Rulemaking Board (“MSRB”) has sought to eliminate pay-to-play practices in the municipal securities market through its Rule G-37, on political contributions and prohibitions on municipal securities business.[1]  Under the rule, certain contributions to elected officials of municipal securities issuers made by brokers, dealers and municipal securities dealers (“dealers”), municipal finance professionals (“MFPs”) associated with dealers, and political action committees (“PACs”) controlled by dealers and their MFPs (“dealer-controlled PACs”)[2] may result in prohibitions on dealers from engaging in municipal securities business with such issuers for a period of two years from the date of any triggering contributions.

    Rule G-37 requires dealers to record and disclose certain contributions to issuer officials, state or local political parties, and bond ballot campaigns, as well as other information, on Form G-37 to allow public scrutiny of such contributions and the municipal securities business of a dealer. In addition, dealers and MFPs generally are prohibited from soliciting others (including affiliates of the dealer or any PACs) to make contributions to officials of issuers with which the dealer is engaging or seeking to engage in municipal securities business, or to political parties of a state or locality where the dealer is engaging or seeking to engage in municipal securities business. Dealers and MFPs also are prohibited from circumventing Rule G-37 by direct or indirect actions through any other persons or means.[3]

    Due to changes in the financial markets since the adoption of Rule G-37, many dealers and MFPs have become affiliated with a broad range of other entities in increasingly diverse organizational structures.  Some of these affiliated entities (including but not limited to banks, bank holding companies, insurance companies and investment management companies) have formed or otherwise maintain relationships with PACs (“affiliated PACs”) and other political organizations, many of which may make contributions to issuer officials.  Such relationships raise questions regarding the extent to which affiliated PACs may effectively be controlled by dealers or their MFPs and thereby constitute dealer-controlled PACs whose contributions are subject to Rule G-37.  Further, such relationships raise concerns regarding whether the contributions of such affiliated PACs, even if not viewed as dealer-controlled PACs, may be used by dealers or their MFPs to circumvent Rule G-37 as indirect contributions for the purpose of obtaining or retaining municipal securities business.

    The MSRB remains concerned that individuals and firms subject to Rule G-37 may seek ways around the rule through payments to and contributions by affiliated PACs that benefit issuer officials. When evaluating whether contributions made by affiliated PACs may be subject to the provisions of Rule G-37, the MSRB emphasizes that dealers should first determine whether such affiliated PAC would be viewed as a dealer-controlled PAC. If an affiliated PAC is determined to be a dealer-controlled PAC, then its contributions to issuer officials would subject the dealer to the ban on municipal securities business and its contributions to issuer officials, state or local political parties, and bond ballot campaigns would be subject to disclosure under Rule G-37. Even if the affiliated PAC is determined not to be a dealer-controlled PAC, the dealer still must consider whether payments made by the dealer or its MFPs to such affiliated PAC could ultimately be viewed as an indirect contribution under Rule G-37(d) if, for example, the affiliated PAC is being used as a conduit for making a contribution to an issuer official.

    The MSRB wishes to provide guidance regarding the factors that may result in an affiliated PAC being viewed as controlled by the dealer or an MFP of the dealer and thereby being treated as a dealer-controlled PAC for purposes of Rule G-37. The MSRB also wishes to ensure that the industry is cognizant of prior MSRB guidance regarding the potential for payments to and contributions by affiliated PACs to constitute indirect contributions under the rule.

    Indicators of Control by Dealers and MFPs

    Soon after adoption of Rule G-37, the MSRB stated that each dealer must determine whether a PAC is dealer controlled, with any PAC of a non-bank dealer assumed to be a dealer-controlled PAC.[4]  The MSRB has also stated that the determination of whether a PAC of a bank dealer[5] is a dealer-controlled PAC would depend upon whether the bank dealer or anyone from the bank dealer department has the ability to direct or cause the direction of the management or the policies of the PAC.[6]  Such ability to direct or cause the direction of the management or the policies of a PAC also would be indicative of control of such PAC by a non-bank dealer or any of its MFPs, although it would not be the exclusive indicator of such control. While this guidance establishes basic principles with regard to making a determination of control, it does not set out an exhaustive list of circumstances under which a PAC may or may not be viewed as dealer or MFP controlled.  The specific facts and circumstances regarding the creation, management, operation and control of a particular PAC must be considered in making a determination of control with respect to such PAC.

    Creation of PAC. In general, a dealer or MFP involved in the creation of a PAC would continue to be viewed as controlling such PAC unless and until such dealer or MFP becomes wholly disassociated in any direct or indirect manner with the PAC. Thus, any PAC created by a dealer, acting either in a sole capacity or together with other entities or individuals, would be presumed to be a dealer-controlled PAC.  This presumption continues at least as long as the dealer or any MFP of the dealer retains any formal or informal role in connection with such PAC, regardless of whether such dealer or MFP has the ability to direct or cause the direction of the management or policies of the PAC. This presumption also would continue for so long as any associated person of the dealer (either an individual, whether or not an MFP, or an affiliated company directly or indirectly controlling, controlled by or under common control with the dealer) has the ability to direct or cause the direction of the management or policies of the PAC. In effect, a dealer could not attempt to treat a PAC it created and then spun off to the control of an affiliated company as not being a dealer-controlled PAC. However, depending on the totality of the facts and circumstances, a PAC originally created by a dealer in which the dealer or its MFPs no longer retain any role, and with respect to which any other affiliates retain only very limited non-control roles, could be viewed as no longer controlled by the dealer.

    Similarly, a PAC created by any person associated with the dealer at the time the PAC was created, acting either in a sole capacity or together with other entities or individuals, would be presumed to be controlled by such person.  Such presumption continues at least for so long as such person retains any formal or informal role in connection with such PAC, regardless of whether any such person has the ability to direct or cause the direction of the management or policies of the PAC.  This presumption also would continue for so long as any other person associated with the same dealer as the creator of the PAC has the ability to direct or cause the direction of the management or policies of the PAC. Although such PAC may not be viewed as being subject to Rule G-37 as an MFP-controlled PAC when originally created if such person was not then an MFP, if the person creating the PAC, or any other associated person with the ability to direct or cause the direction of the management or policies of such PAC, is or later becomes an MFP, such PAC would be deemed an MFP-controlled PAC.[7]

    Management, Funding and Control of PAC. Beyond the role of the dealer, MFP or other person in creating a PAC and maintaining an ongoing association with such PAC, the ability to direct or cause the direction of the management or the policies of a PAC is also important. Strong indicators of management and control are not mitigated by the fact that such dealer, MFP or other person does not have exclusive, predominant or “majority” control of the PAC, its management, its policies, or its decisions with regard to making contributions.  For example, the fact that a dealer or MFP may only have a single vote on a governing board or other decision-making or advisory board or committee of a PAC, and therefore does not have sole power to cause the PAC to take any action, would not obviate the status of such dealer or MFP as having control of the PAC, so long as the dealer or MFP has the ability, alone or in conjunction with other similarly empowered entities or individuals, to direct or cause the direction of the management or the policies of the PAC.  In essence, it is possible for a single PAC to be viewed as controlled by multiple different dealers if the control of such PAC is shared among such dealers, although the presumption of control may be rebutted as described below.

    The level of funding provided by dealers and their MFPs to a PAC may also be indicative of control. A PAC that receives a majority of its funding from a single dealer (including the collective contributions of its MFPs and employees) or a single MFP is conclusively presumed to be controlled by such dealer or MFP, regardless of the lack of any of the other indicia of control described in this notice.  Another important factor is the size or frequency of contributions by a dealer or MFP,[8] viewed in light of the size and frequency of contributions made by other contributors not affiliated in any way with such dealer or MFP. For example, a limited number of small contributions freely made by employees of a dealer to an affiliated PAC (i.e., not directed by the dealer and not part of an automated or otherwise dealer-organized program of contributions) would not, by itself, automatically raise a presumption of dealer control so long as the collective contributions by the dealer or its employees is not significant as compared to the total funding of the affiliated PAC, subject to consideration of the other relevant facts and circumstances. In addition, contributions made by a dealer or MFP to an affiliated PAC could raise a stronger inference of de facto dealer or MFP control than when such contributions were made to non-affiliated PACs.

    However, even where a dealer or MFP is not viewed as controlling a PAC under the principles described above, dealers should remain mindful of the potential for leveraging the contribution activities of affiliated PACs in soliciting municipal securities business in a way that could raise a presumption of dealer or MFP control.  For example, an MFP’s references to the contributions made by an affiliated PAC during solicitations of municipal securities business could, depending on the facts and circumstances, serve as evidence of coordination of such PAC’s activities with the dealer or MFP that could, together with other facts, be indicative of direct or indirect control of the PAC by such dealer or MFP.  Such control could be found even in circumstances where the dealer or its MFPs have not made contributions to the affiliated PAC.[9]

    Of course, the presumptions described above may be rebutted, depending upon the totality of facts and circumstances. Considerations that may serve to rebut such presumptions may include whether the dealer or person creating the PAC:  (i) participates with a broad-based group of other entities and/or individuals in creating the PAC, (ii) at no time undertakes any direct or indirect role (and, in the case of a dealer, no person associated with the dealer undertakes any direct or indirect role) in leading the creation of the PAC or in directing or causing the direction of the management or the policies of the PAC, and/or (iii) provides funding for such PAC (and, in the case of a dealer, its associated persons collectively provide funding for such PAC) that is not substantially greater than the typical funding levels of other participants in the PAC who do not undertake a direct or indirect role in leading the creation of the PAC or in directing or causing the direction of the management or the policies of the PAC.

    Indirect Contributions Through Bank PACs or Other Affiliated PACs

    As noted above, if an affiliated PAC is determined not to be a dealer-controlled PAC, a dealer must still consider whether payments made by the dealer or its MFPs to such affiliated PAC could be viewed as an indirect contribution that would become subject to Rule G-37 pursuant to section (d) thereof. The MSRB has provided extensive guidance on such indirect contributions, noting in 1996 that, depending on the facts and circumstances, contributions to a non-dealer associated PAC that is soliciting funds for the purpose of supporting a limited number of issuer officials might result in the same prohibition on municipal securities business as would contributions made directly to the issuer official.[10]  The MSRB also noted that dealers should make inquiries of a non-dealer associated PAC that is soliciting contributions in order to ensure that contributions to such a PAC would not be treated as an indirect contribution.[11]

    The MSRB also has previously provided guidance in 2005 with regard to supervisory procedures [12] that dealers should have in place in connection with payments to a non-dealer associated PAC or a political party to avoid indirect rule violations of Rule G-37(d).  In such guidance, the MSRB stated that, in order to ensure compliance with Rule G-27(c) as it relates to payments to political parties or PACs and Rule G-37(d), each dealer must adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that neither the dealer nor its MFPs are using payments to political parties or non-dealer controlled PACs to contribute indirectly to an official of an issuer.[13]  Among other things, dealers might seek to establish procedures requiring that, prior to the making of any contribution to a PAC, the dealer undertake certain due diligence inquiries regarding the intended use of such contributions, the motive for making the contribution and whether the contribution was solicited. Further, in order to ensure compliance with Rule G-37(d), dealers could consider establishing certain information barriers between any affiliated PACs and the dealer and its MFPs.[14]  Dealers that have established such information barriers should review their adequacy to ensure that the affiliated entities’ contributions, payments or PAC disbursement decisions are neither influenced by the dealer or its MFPs, nor communicated to the dealers and the MFPs.

    The MSRB subsequently noted that the 2005 guidance did not establish an obligation to put in place the specific procedures and information barriers described in the guidance so long as the dealer in fact has and enforces other written supervisory procedures reasonably designed to ensure that the conduct of the dealer and its MFPs are in compliance with Rule G-37(d).[15]  Thus, for example, when information regarding past or planned contributions of an affiliated PAC is or may be available to or known by the dealer or its MFPs, the dealer might establish and enforce written supervisory procedures that prohibit the dealer or MFP from providing information to issuer personnel regarding past or anticipated affiliated PAC contributions.

    _______________________________________

    [1] Rule G-37 defines municipal securities business as: (i) the purchase of a primary offering of municipal securities from an issuer on other than a competitive bid basis; (ii) the offer or sale of a primary offering of municipal securities on behalf of an issuer; (iii) the provision of financial advisory or consultant services to or on behalf of an issuer with respect to a primary offering of municipal securities in which the dealer was chosen to provide such services on other than a competitive bid basis; or (iv) the provision of remarketing agent services to or on behalf of an issuer with respect to a primary offering of municipal securities in which the dealer was chosen to provide such services on other than a competitive bid basis.

    [2] The MSRB has previously stated that the matter of control depends upon whether or not the dealer or the MFP has the ability to direct or cause the direction of the management or policies of the PAC (MSRB Question & Answer No. IV. 24 – Dealer Controlled PAC).

    [3] Rule G-37(d) provides that no broker, dealer or municipal securities dealer or any municipal finance professional shall, directly or indirectly, through or by any other person or means, do any act which would result in a violation of sections (b) or (c) of the rule. Section (b) relates to the ban on business and Section (c) relates to the prohibition on soliciting and coordinating contributions.

    [4] See Rule G-37 Question & Answer No. IV.24 (May 24, 1994).

    [5] MSRB Rule D-8 defines a bank dealer as a municipal securities dealer which is a bank or a separately identifiable department or division of a bank.

    [6] See Rule G-37 Question & Answer No. IV.24 (May 24, 1994).

    [7] However, a PAC created by an individual acting in his or her formal capacity as an officer, employee, director or other representative of a dealer, regardless of whether such individual is an MFP, would be deemed a dealer-controlled PAC rather than a PAC controlled by the individual.

    [8] A dealer or an MFP may make sufficiently large or frequent contributions to a PAC so as to obtain effective control over the PAC, depending on the totality of facts and circumstances.

    [9] See Rule G-37 Question & Answer No. III.7 (September 22, 2005) for a discussion of potential indirect contributions through affiliated PACs.

    [10] See Rule G-37 Question & Answer No. III.4 (August 6, 1996).

    [11] See Rule G-37 Question & Answer No. III.5 (August 6, 1996).

    [12] Rule G-27, on supervision, provides in section (c) that each dealer shall adopt, maintain and enforce written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance with MSRB rules.

    [13] See Rule G-37 Question & Answer No. III.7 (September 22, 2005).

    [14] The potential information barriers described in the guidance include: i) a prohibition on the dealer or MFP from recommending, nominating, appointing or approving the management of affiliated PACs; ii) a prohibition on sharing the affiliated PAC’s meeting agenda, meeting schedule, or meeting minutes; iii) a prohibition on identification of prior affiliated PAC contributions, planned PAC contributions or anticipated PAC contributions; iv) a prohibition on directly providing or coordinating information about prior negotiated municipal securities businesses, solicited municipal securities business, and planned solicitations of municipal securities business; and v) other such information barriers as the firms deems appropriate to monitor conflicting interest and prevent abuses effectively.

    [15] See Rule G-37 Interpretive Letter – Supervisory procedures relating to indirect contributions; conference accounts and 527 organizations (December 21, 2006).

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Interpretation on Priority of Orders for Securities in a Primary Offering under Rule G-17
    Rule Number:

    Rule G-11, Rule G-17

    On December 22, 1987, the MSRB published a notice[1] interpreting the fair practice principles of Rule G-17 as they apply to the priority of orders for new issue securities (the “1987 notice”). The MSRB wishes to update the guidance provided in the 1987 notice due to changes in the marketplace and subsequent amendments to Rule G-11.

    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 syndicate manager, on a case-by-case basis, to allocate securities in a manner other than in accordance with the priority provisions if the syndicate manager determines in its discretion that it is in the best interests of the syndicate. Under Rule G-11(f), syndicate managers must furnish information, in writing, to the syndicate members about terms and conditions required by the issuer,[2] priority provisions and the ability of the syndicate manager to allocate away from the priority provisions, among other things. 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.

    In addition to traditional priority provisions found in syndicate agreements, municipal securities underwriters frequently agree to other terms and conditions specified by the issuer of the securities relating to the distribution of the issuer’s securities. Such provisions include, but are not limited to, requirements concerning retail order periods. MSRB Rule G-17 states that, in the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer (“dealer”) shall deal fairly with all persons and shall not engage in any deceptive, dishonest or unfair practice. These requirements specifically apply to an underwriter’s activities conducted with a municipal securities issuer, including any commitments that the underwriter makes regarding the distribution of the issuer’s securities. An underwriter may violate the duty of fair dealing by making such commitments to the issuer and then failing to honor them. This could happen, for example, if an underwriter fails to accept, give priority to, or allocate to retail orders in conformance with the provisions agreed to in an undertaking to provide a retail order period. A dealer who wishes to allocate securities in a manner that is inconsistent with an issuer’s requirements must not do so without the issuer’s consent.

    Except as otherwise provided in this notice, principles of fair dealing will require the syndicate manager to give priority to customer orders over orders for its own account, orders by other members of the syndicate for their own accounts, orders from persons controlling, controlled by, or under common control with any syndicate member (“affiliates”) for their own accounts, or orders for their respective related accounts,[3] to the extent feasible and consistent with the orderly distribution of securities in a primary offering. This principle may affect a wide range of dealers and their related accounts given changes in organizational structures due to consolidations, acquisitions, and other corporate actions that have, in many cases, resulted in increasing numbers of dealers, and their related dealer accounts, becoming affiliated with one another.

    Rule G-17 does not require the syndicate manager to accord greater priority to customer orders over orders submitted by non-syndicate dealers (including selling group members). However, prioritization of customer orders over orders of non-syndicate dealers may be necessary to honor terms and conditions agreed to with issuers, such as requirements relating to retail orders.

    The MSRB understands that syndicate managers must balance a number of competing interests in allocating securities in a primary offering and must be able quickly to determine when it is appropriate to allocate away from the priority provisions, to the extent consistent with the issuer’s requirements. Thus, Rule G-17 does not preclude the syndicate manager or managers from according equal or greater priority to orders by syndicate members for their own accounts, affiliates for their own accounts, or their respective related accounts if, on a case-by-case basis, the syndicate manager determines in its discretion that it is in the best interests of the syndicate. However, the syndicate manager shall have the burden of justifying that such allocation was in the best interests of the syndicate. Syndicate 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.

    It should be noted that all of the principles of fair dealing articulated in this notice extend to any underwriter of a primary offering, whether a sole underwriter, a syndicate manager, or a syndicate member.


    [1] MSRB Notice of Interpretation Concerning Priority of Orders for New Issue Securities: Rule G-17 (December 22, 1987).

    [2] The requirements of Rule G-11(f) with respect to issuer requirements were adopted by the MSRB in 1998. See Exchange Act Release No. 40717 (November 27, 1998) (File No. SR-MSRB-97-15).

    [3] “Related account” has the meaning set forth in Rule G-11(a)(xi).
     
    Interpretive Guidance - Interpretive Notices
    Publication date:
    MSRB Reminds Firms of Their Sales Practice and Due Diligence Obligations when Selling Municipal Securities in the Secondary Market

    Executive Summary

    Brokers, dealers and municipal securities dealers (dealers or firms) must fully understand the bonds they sell in order to meet their disclosure, suitability and pricing obligations under the rules of the Municipal Securities Rulemaking Board (MSRB) and federal securities laws. These obligations are not limited to firms involved in primary offerings. Dealers must also obtain, analyze and disclose all material facts about secondary market transactions that are known to the dealer, or that are reasonably accessible to the market through established industry sources.

    Those sources include, among other things, official statements, continuing disclosures, trade data, and other information made available through the MSRB’s Electronic Municipal Market Access system (EMMA). Firms may also have a duty to obtain and disclose information that is not available through EMMA, if it is material and available through other public sources. The public availability of material information, through EMMA or otherwise, does not relieve a firm of its duty to disclose that information. Firms must also have reasonable grounds for determining that a recommendation is suitable based on information available from the issuer of the security or otherwise. Firms must also use this information to determine the prevailing market price of a security as the basis for establishing a fair price in a transaction with a customer. To meet these requirements, firms must perform an independent analysis of the bonds they sell, and may not rely solely on a bond’s credit rating.

    Continuing disclosures made by issuers to the MSRB via EMMA are part of the information that dealers must obtain, disclose and consider in meeting their regulatory obligations. The Securities and Exchange Commission (SEC) has recently approved amendments to Securities Exchange Act Rule 15c2-12, governing continuing disclosures. Firms that sell municipal securities should review and, if necessary, update their procedures to reflect the amendments, which have a compliance date of December 1, 2010.  

    Background and Discussion

    MSRB Disclosure, Suitability and Pricing Rules

    MSRB Rule G-17 provides that, in the conduct of its municipal securities activities, each dealer must deal fairly with all persons and may not engage in any deceptive, dishonest or unfair practice. The MSRB has interpreted Rule G-17 to require a dealer, in connection with any transaction in municipal securities, to disclose to its customer, at or prior to the sale, all material facts about the transaction known by the dealer, as well as material facts about the security that are reasonably accessible to the market.[1] This includes the obligation to give customers a complete description of the security, including a description of the features that likely would be considered significant by a reasonable investor and facts that are material to assessing the potential risks of the investment.

    Such disclosures must be made at the “time of trade,” which the MSRB defines as at or before the point at which the investor and the dealer agree to make the trade. Rule G-17 applies to all sales of municipal securities, whether or not a transaction was recommended by a broker-dealer.[2] This means that municipal securities dealers must disclose all information required to be disclosed by the rule even if the trade is self-directed.[3]

    MSRB Rule G-19 requires that a dealer that recommends a municipal securities transaction have reasonable grounds for believing that the recommendation is suitable for the customer based upon information available from the issuer of the security or otherwise and the facts disclosed by, or otherwise known about, the customer.[4]

    MSRB Rule G-30 requires that dealers trade with customers at prices that are fair and reasonable, taking into consideration all relevant factors.[5] The MSRB has stated that the concept of a “fair and reasonable” price includes the concept that the price must “bear a reasonable relationship to the prevailing market price of the security.” The impetus for the MSRB’s Real-time Transaction Reporting System (RTRS), which was implemented in January 2005, was to allow market participants to monitor market price levels on a real-time basis and thus assist them in identifying changes in market prices that may have been caused by news or market events.[6] The MSRB now makes the transaction data reported to RTRS available to the public through EMMA.

    In meeting these disclosure, suitability and pricing obligations, firms must take into account all material information that is known to the firm or that is available through “established industry sources,” including official statements, continuing disclosures, and trade data, much of which is now available through EMMA. Resources outside of EMMA may include press releases, research reports and other data provided by independent sources. Established industry sources can also include material event notices and other data filed with former nationally recognized municipal securities information repositories (NRMSIRs) before July 1, 2009.[7] Therefore, firms should review their policies and procedures for obtaining material information about the bonds they sell to make sure they are reasonably designed to access all material information that is available, whether through EMMA or other established industry sources. The MSRB has also noted that the fact that material information is publicly available through EMMA does not relieve a firm of its duty to specifically disclose it to the customer at the time of trade, or to consider it in determining the suitability of a bond for a specific customer.[8] Importantly, the dealer may not simply direct the customer to EMMA to fulfill its time-of-trade disclosure obligations under Rule G-17.[9]

    Amendments to Rule 15c2-12 Concerning Continuing Disclosure

    Securities Exchange Act Rule 15c2-12 requires underwriters participating in municipal bond offerings that are subject to that rule[10] to receive, review, and distribute official statements of issuers of primary municipal securities offerings, and prohibits underwriters from purchasing or selling municipal securities covered by the rule unless they have first reasonably determined that the issuer or an obligated person[11] has contractually agreed to make certain continuing disclosures to the MSRB, including certain financial information and notice of certain events. The MSRB makes such disclosure public via EMMA.

    Financial information to be disclosed under the rule consists of the following:

    • Annual financial information updating the financial information in the official statement;
    • Audited financial statements, if available and not included within the annual financial information; and
    • Notices of failure to provide such financial information on a timely basis.

    Currently, the rule enumerates the following as notice events, if material:

    • Principal and interest payment delinquencies;
    • Non-payment related defaults;
    • Unscheduled draws on debt service reserves reflecting financial difficulties;
    • Unscheduled draws on credit enhancements reflecting financial difficulties;
    • Substitution of credit or liquidity providers or their failure to perform;
    • Adverse tax opinions or events affecting the tax-exempt status of the security;
    • Modifications to rights of security holders;
    • Bond calls;
    • Defeasances;
    • Release, substitution or sale of property securing repayment of the securities; and
    • Rating changes.

    Rule 15c2-12(c) also prohibits any dealer from recommending the purchase or sale of a municipal security unless it has procedures in place that provide reasonable assurance that it will receive prompt notice of any event notice reported pursuant to the rule. Firms should review any applicable continuing disclosures made available through EMMA and other established industry sources and take such disclosures into account in undertaking its suitability and pricing determinations. 

    On May 26, 2010, the SEC amended the rule’s disclosure obligations, with a compliance date of December 1, 2010, to: (1) apply continuing disclosure requirements to new primary offerings of certain variable rate demand obligations (VRDOs); (2) add four new notice events;[12] (3) remove the materiality standard for certain notice events;[13] and (4) require that event notices be filed in a timely manner but no later than 10 business days after their occurrence. With respect to the tax status of the security, the rule has been broadened to require disclosure of adverse tax opinions, issuance by the IRS of proposed or final determinations of taxability and other material notices, and determinations or events affecting the tax status of the bonds (including a Notice of Proposed Issue). Firms that deal in municipal securities should familiarize themselves with these amendments, and, if necessary, modify their policies and procedures to incorporate this additional disclosure accordingly. 

    The Financial Industry Regulatory Authority (FINRA) noted in its Regulatory Notice 09-35 that, if a firm discovers through its Rule 15c2-12 procedures or otherwise that an issuer has failed to make filings required under its continuing disclosure agreements, the firm must take this information into consideration in meeting its disclosure obligations under MSRB Rule G-17 and in assessing the suitability of the issuer’s bonds under MSRB Rule G-19.

    Credit Ratings

    In order to meet their obligations under MSRB Rules G-17 and G-19, firms must analyze and disclose to customers the risks associated with the bonds they sell, including, but not limited to, the bond’s credit risk. A credit rating is a third-party opinion of the of the credit quality of a municipal security. While the MSRB generally considers credit ratings and rating changes to be material information for purposes of disclosure, suitability and pricing, they are only one factor to be considered, and dealers should not solely rely on credit ratings as a substitute for their own assessment of a bond’s credit risk. [14]  Moreover, different agencies use different quantitative and qualitative criteria and methodologies to determine their rating opinions.  Dealers should familiarize themselves with the rating systems used by rating agencies in order to understand and assess the relevance of a particular rating to the firm’s overall assessment of the bond.[15]. With respect to credit or liquidity enhanced securities, the MSRB has stated that material information includes the following, if known to the dealer or if reasonably available from established industry sources: (i) the credit rating of the issue or lack thereof; (ii) the underlying credit rating or lack thereof, (iii) the identity of any credit enhancer or liquidity provider; and (iv) the credit rating of the credit provider and liquidity provider, including potential rating actions (e.g., downgrade).[16]  Additionally, material terms of the credit facility or liquidity facility should be disclosed (e.g., any circumstances under which a standby bond purchase agreement would terminate without a mandatory tender).

    Other Material Information 

    In addition to a bond’s credit quality, firms must obtain, analyze and disclose other material information about a bond, including but not limited to whether the bond may be redeemed prior to maturity in-whole, in-part or in extraordinary circumstances,[17] whether the bond has non-standard features that may affect price or yield calculations,[18] whether the bond was issued with original issue discount or has other features that would affect its tax status,[19] and other key features likely to be considered significant by a reasonable investor.  For example, for VRDOs, auction rate securities or other securities for which interest payments may fluctuate, firms should explain to customers the basis on which periodic interest rate resets are determined.[20] The MSRB has stated that firms should take particular care with respect to new products that may be introduced into the municipal securities market, existing products that may have complex structures that can differ materially from issue to issue, and outstanding securities that may trade infrequently, may be issued by less well-known issuers, or may have unusual features.[21]

    Supervision

    Firms are reminded that MSRB Rule G-27 requires firms to supervise their municipal securities business, and to ensure that they have adequate policies and procedures in place for monitoring the effectiveness of their supervisory systems. Specifically, firms must:

    • Supervise the conduct of the municipal securities activities of the firm and associated persons to ensure compliance with all MSRB rules, the Exchange Act and the rules there under;
    • Have adequate written supervisory procedures; and
    • Implement supervisory controls to ensure that their supervisory procedures are adequate.

    Rule G-27 requires that a firm’s supervisory procedures provide for the regular and frequent review and approval by a designated principal of customer accounts introduced or carried by the dealer in which transactions in municipal securities are effected, with such review being designed to ensure that transactions are in accordance with all applicable rules and to detect and prevent irregularities and abuses. Although the rule does not establish a specific procedure for ensuring compliance with the requirement to provide disclosures to customers pursuant to Rule G-17, firms should consider including in their procedures for reviewing accounts and transactions specific processes for documenting or otherwise ascertaining that such disclosures have been made.  

    Questions to Consider

    Before selling any municipal bond, dealers should make sure that they fully understand the bonds they are selling in order to make adequate disclosure to customers under Rule G-17, to ensure that recommendations are suitable under Rule G-19, and to ensure that they are fairly priced under Rule G-30. Among other things, dealers should ask and be able to answer the following questions: 

    • What are the bond’s key terms and features and structural characteristics, including but not limited to its issuer, source of funding (e.g., general obligation or revenue bond), repayment priority, and scheduled repayment rate? (Much of this information will be in the Official Statement, which for many municipal bonds can be obtained by entering the CUSIP number in the MuniSearch box at www.emma.msrb.org). Be aware, however, data in the Official Statement may have been superseded by the issuer’s on-going disclosures.
    • Does information available through EMMA or other established industry sources indicate that an issuer is delinquent in  its material event notice and other continuing disclosure filings?  Delinquencies should be viewed as a red flag.
    • What other public material information about the bond or its issuer is available through established industry sources other than EMMA?
    • What is the bond’s rating? Has the issuer of the bond recently been downgraded? Has the issuer filed any recent default or other event notices, or has any other information become available through established industry sources that might call into question whether the published rating has been revised to take such event into consideration?
    • Is the bond insured, or does it benefit from liquidity support, a letter of credit or is it otherwise supported by a third party? If so, check the credit rating of the bond insurer or other backing, and the bond’s underlying rating (without third party support). If supported by a third party, review the terms and conditions under which the third party support may terminate.
    • How is it priced? Be aware that the price of a bond can be priced above or below its par value for many reasons, including changes in the creditworthiness of a bond's issuer and a host of other factors, including prevailing interest rates.
    • How and when will interest on the bond be paid? Most municipal bonds pay semiannually, but zero coupon municipal bonds pay all interest at the time the bond matures. Variable rate bonds typically will pay interest more frequently, usually on a monthly basis in variable amounts.
    • What is the bond’s tax status, under both state and federal laws? Is it subject to the Federal Alternate Minimum Tax? Is it fully taxable (e.g., Build America Bonds)?
    • What are its call provisions? Call provisions allow the issuer to retire the bond before it matures. How would a call affect expected future income?

    [1] MSRB Rule G-17 applies to all transactions in municipal securities, including those in both the primary and secondary market. MSRB Rule G-32 specifically addresses the delivery of the official statement in connection with primary offerings.

    [2] See MSRB Notice 2009-42 (July 14, 2009).

    [3] A dealer’s specific investor protection obligations, including its disclosure, fair practice and suitability obligations under Rules G-17 and G-19, may be affected by the status of an institutional investor as a Sophisticated Municipal Market Professional (“SMMP”). See Rule G-17 Interpretation – Notice Regarding the Application of MSRB Rules to Transactions with Sophisticated Municipal Market Professionals (April 30, 2002).

    [4] See MSRB Notice 2009-42, supra n.2.

    [5] Rule G-18 requires that a dealer effecting an agency trade with a customer make a reasonable effort to obtain a price for the customer that is fair and reasonable in relation to prevailing market conditions.

    [6] See MSRB Notice 2004-3 (January 26, 2004).

    [7] Since July 1, 2009, material event notices are required to be filed through EMMA, which has replaced Bloomberg Municipal Repository; DPC DATA Inc.; Interactive Data Pricing and Reference Data, Inc.; and Standard & Poor’s Securities Evaluations, Inc. as the sole NRMSIR.

    [8] The MSRB has also stated that providing adequate disclosure does not relieve a firm of its suitability obligations. See MSRB Notice 2007-17 (March 30, 2007).

    [9] Rule G-32 does allow a dealer to satisfy its obligation to deliver an official statement to its customer during the primary offering disclosure period no later than the settlement of the transaction by advising the customer of how to obtain it on EMMA, unless the customer requests a paper copy.  The delivery obligation under Rule G-32 is distinct from the duty to disclose material information under Rule G-17, which applies to all primary and secondary market transactions.

    [10] Certain limited offerings, variable rate demand obligations, and small issues are exempt from Rule 15c2-12.

    [11] “Obligated person” is defined as “any person, including an issuer of municipal securities, who is either generally or through an enterprise, fund or account of such person committed by contract or other arrangement to support payment of all, or part of the obligations of the municipal securities to be sold in the offering (other than providers of municipal bond insurance, letters of credit, or other liquidity facilities).”

    [12] The new notice events are (1) tender offers, (2) bankruptcy, insolvency, receivership, or similar events, (3) consummation of mergers, consolidations, acquisitions, or asset sales, or entry into or termination of a definitive agreement related to do the same, if material, and (4) appointment of a successor or additional trustee or a change in the name of the trustee, if material.

    [13] The amendments removed the materiality standard and require notices for the following events: (1) principal and interest payment delinquencies with respect to the securities being offered ; (2) unscheduled draws on debt service reserves reflecting financial difficulties; (3) unscheduled draws on credit enhancements reflecting financial difficulties; (4) substitution of credit or liquidity providers, or their failure to perform; (5) defeasances: and (6) rating changes. The amendments retained the materiality standard for the following events: (1) non-payment related defaults; (2) modifications to rights of security holders; (3) bond calls; and (4) release, substitution, or sale of property securing repayment of the securities.

    [14] See MSRB Notice 2009-42, supra n.2. Ratings changes are reportable events under Rule 15c2-12.

    [15] Not all municipal bonds are rated. While an absence of a credit rating is not, by itself, a determinant of low credit quality, it is a factor that the dealers should consider, and may warrant additional due diligence of the bond and its issuer by the dealer. In addition, MSRB Rule G-15 requires confirmation statements for customer trades in unrated municipal securities to disclose that the securities are not rated.

    [16] See MSRB Notice 2009-42.  The SEC has approved the MSRB’s proposal to require dealers to submit copies of credit enhancement and liquidity facility documents to EMMA pursuant to amended MSRB Rule G-34(c), which may increase the availability of such information to dealers.  See Securities Exchange Act Release No. 62755, August 20, 2010 (File No. SR-MSRB-2010-02).

    [17] See Notice Concerning Disclosure of Call Information to Customers of Municipal Securities, MSRB Interpretation of March 4, 1986.

    [18] See Transactions in Municipal Securities With Non-Standard Features Affecting Price/Yield Calculations, MSRB Interpretation of June 12, 1995.

    [19] See MSRB Notice 2005-01 (January 5, 2005); MSRB Notice 2009-41 (July 10, 2009).

    [20] See MSRB Notice 2008-09 (February 19, 2008).

    [21] See MSRB Notice 2009-42, supra n.2.
    Interpretive Guidance - Interpretive Notices
    Publication date:
    Reminder Notice on Fair Practice Duties to Issuers of Municipal Securities
    Rule Number:

    Rule G-17

    The Municipal Securities Rulemaking Board (“MSRB”) has recently provided guidance regarding the fair practice and related obligations of brokers, dealers and municipal securities dealers (“dealers”) to investors.[1] Specifically, MSRB Rule G-17, on conduct of municipal securities activities, states that, in the conduct of its municipal securities business, each dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice.  The MSRB is publishing this notice to remind dealers that the fair practice requirements of Rule G-17 also apply to their municipal securities activities with issuers of municipal securities.

    Thus, the rule requires dealers to deal fairly with issuers in connection with all aspects of the underwriting of their municipal securities, including representations regarding investors made by the dealer.  As the MSRB has previously stated, whether or not an underwriter has dealt fairly with an issuer is dependent upon the facts and circumstances of an underwriting and cannot be addressed simply by virtue of the price of the issue.[2] The MSRB has also previously noted that Rule G-17 may apply in connection with certain payments made and expenses reimbursed during the municipal bond issuance process for excessive or lavish entertainment or travel expenses.[3]

    As noted above, the fair practice requirements of Rule G-17 apply to all municipal securities activities of dealers with issuers.  In particular, even where other MSRB rules provide for specific disclosures or other actions by, or establish specific standards of behavior for, dealers with respect to or on behalf of issuers, such disclosures, actions or behavior must also comport with the fair practice principles of Rule G-17.  The MSRB will continue to review practices with respect to dealer activities with issuers.


    [1] See MSRB Notice 2009-42 (July 14, 2009).

     

    [2] See Rule G-17 Interpretive Letter – Purchase of new issue from issuer, MSRB interpretation of December 1, 1997, reprinted in MSRB Rule Book.

    [3] See MSRB Rule G-20 Interpretation — Dealer payments in connection with the municipal securities issuance process, MSRB interpretation of January 29, 2007, reprinted in MSRB Rule Book.

    Interpretive Guidance - Interpretive Notices
    Publication date:
    Notice Concerning Use of Electronic Confirmations Produced By a Clearing Agency or Qualified Vendor to Satisfy the Requirements of Rule G-15(a)
    Rule Number:

    Rule G-15

    MSRB Rule G-15 provides confirmation, clearance, settlement and other uniform practice requirements with respect to transactions with customers.  Rule G-15(a) requires that, at or before the completion of a transaction in municipal securities with or for the account of a customer, each broker, dealer or municipal securities dealer (collectively “dealer”) give or send to the customer “a written confirmation of the transaction” containing the information specified by the rule.  Rule 15(d) provides additional uniform practice requirements for transactions executed with customers on a payment for securities received (“RVP”) or delivery against payment of securities sold (“DVP”) basis (collectively, “DVP/RVP”).  In addition to the specific uniform practice requirements of this section, Rule G-15(d)(i)(c) expressly provides that dealers executing DVP/RVP transactions must comply with the requirements of section (a) of the rule pertaining to customer confirmations.  Rule G-15(d) also requires dealers that transact with customers on a DVP/RVP basis to use the facilities of a Clearing Agency or Qualified Vendor, as defined in Rule G-15(d)(ii)(B), for automated confirmation and acknowledgement of the transaction. 

    Securities Exchange Act Rule 10b-10, on customer confirmations of non-municipal securities transactions, provides for confirmation requirements that are similar to Rule G-15(a).  Several providers of automated confirmation and acknowledgement services have received no-action letters from the Securities and Exchange Commission (“SEC”) staff that allow their dealer clients to rely on the confirmations they produce to satisfy dealer confirmation delivery obligations to certain customers under SEC Rule 10b-10 where the disclosures customarily provided on the back of paper confirmations are provided electronically using a uniform resource locator (“URL”) link.[1]  One of the service providers that received a no-action letter, as described above, permitting it to use URL links for its dealer clients, has requested an interpretation of Rule G-15(a) to allow dealers to rely on confirmations produced by this service provider to the same extent as dealers are allowed to use the confirmations produced by the service providers to comply with SEC Rule 10b-10.

    In a 1994 Interpretive Notice, the MSRB recognized that the speed and efficiencies offered by electronic confirmation delivery are of benefit to the municipal securities industry.[2]  Therefore, the MSRB has interpreted the requirement in Rule G-15(a) to provide a customer with a written confirmation to be satisfied by an electronic confirmation for DVP/RVP transactions sent by a Clearing Agency or Qualified Vendor, as defined in MSRB Rule G-15(d)(ii)(B), where disclosures customarily provided on the back of paper confirmations are provided electronically using a URL link when the following conditions are met: (i) the confirmation sent includes all of the information required by Rule G-15(a); and (ii) all of the requirements and conditions concerning the use of the electronic confirmation service expressed in applicable SEC no-action letters concerning SEC Rule 10b-10 continue to be met.

     


     

    [1] See, e.g., letter from Paula R. Jenson, Deputy Chief Counsel, SEC, to Norman Reed, General Counsel, Omgeo LLC (March 12, 2008).
     
    Interpretive Guidance - Interpretive Notices
    Publication date:
    Build America Bonds: Reminder of Customer Confirmation Yield Disclosure Requirement
    Rule Number:

    Rule G-15

    On April 24, 2009, the Municipal Securities Rulemaking Board (MSRB) published a notice clarifying that “Build America Bonds” and other tax credit bonds are municipal securities and, therefore, subject to MSRB rules.[1]  The MSRB understands that many of these securities contain certain redemption provisions, such as mandatory pro rata sinking funds, and that brokers, dealers and municipal securities dealers (collectively “dealers”) frequently effect transactions on a basis of “yield to average life.”  The MSRB reminds dealers that, for transactions effected on the basis of “yield to average life,” Rule G-15(a), on customer confirmations, requires the confirmation to display that yield as well as the yield computed to the lower of an “in whole” call or maturity.

    Rule G-15(a)(i)(A)(5) states requirements for dealers to calculate and display yields and dollar prices on customer confirmations.  For transactions effected on the basis of yield to maturity, call or put date, the yield at which the transaction was effected as well as a dollar price computed to the lower of an “in whole” call or maturity are required to be shown on a confirmation.  Similarly, for transactions effected on the basis of a dollar price, the dollar price at which the transaction was effected along with a yield computed to the lower of an “in whole” call or maturity are required to be shown on a confirmation. 

    Sinking funds do not represent “in whole” call features.  Accordingly, MSRB confirmation requirements do not require dealers to compute yield or dollar price to a sinking fund call date or to compute a “yield to average life” using multiple sinking fund dates.  However, dealers should note that if the computed yield otherwise required by Rule G-15(a)(i)(A)(5) is different than the yield at which the transaction was effected, Rule G-15(a)(i)(A)(5)(vii) provides that both the computed yield and the yield at which the transaction was effected must be shown on the confirmation.  Therefore, when a transaction is effected on the basis of “yield to average life,” such yield must be displayed on a customer confirmation.