Letters of Credit

Letters of credit. This is in response to your letter dated August 1, 1980, requesting the Board’s views on the application of rule G-25 to bank standby letters of credit issued in connection with new issues of securities which the dealer department of the bank intends to underwrite. Specifically, you have asked our views on whether such transactions would violate rule G-25(b), which generally prohibits a municipal securities dealer from guaranteeing a customer against loss in municipal securities transactions.

For the reasons discussed below, rule G-25(b) would not prohibit a municipal securities bank dealer from issuing a letter of credit which is publicly disclosed and for the benefit of all holders of the security.

Rule G-25(b) is an antimanipulation rule which is primarily designed to prevent a municipal securities dealer from artificially stimulating the market in a security, for example, by "parking" it with a customer who has assumed no market risk. It does not appear that the issuance of a fully disclosed letter of credit provided by a bank dealer for the benefit of all bondholders could be used to serve a market manipulative purpose, even though the letter would also serve to protect the bank’s own customers. Generally, such letters of credit protect bondholders from particular risks of loss, such as the inability of the issuer to make payments of principal or interest. Bondholders are not protected from general market risks, however, and, like all bona fide purchasers of securities, they incur gains or losses as the market price of the bonds fluctuates. Moreover, unlike the situation contemplated by rule G-25 which addresses guarantees made by dealers to their customers, the bondholders for whose benefit a letter of credit is issued would not necessarily have a customer relationship with the bank dealer issuing the letter. MSRB interpretation of March 6, 1981.