Delivery requirements: put option bonds. In a previous telephone conversation [name omitted] of your office had inquired whether any or all of the following deliveries of securities which are subject to a put option could be rejected:

(1) Certain securities are the subject of a "one time only" put option, exercisable by delivery of the securities to a designated trustee on or before a stated expiration date. An inter-dealer transaction in the securities—described as "puttable" securities—is effected for settlement prior to the expiration date. Delivery on the transaction is not made, however, until after the expiration date, and the recipient is accordingly unable to exercise the option, since it cannot deliver the securities to the trustee by the expiration date.

(2) Certain securities are the subject of a "one time only" put option, exercisable by delivery of the securities to a designated trustee on or before a stated expiration date. An inter-dealer transaction in the securities—described as "puttable" securities—is effected for settlement prior to the expiration date. Delivery on the transaction is made prior to the expiration date, but too late to permit the recipient to satisfy the conditions under which it can exercise the option (e.g., the trustee is located too far away for the recipient to be able to present the physical securities by the expiration date).

(3) Certain securities are the subject of a put option exercisable on a stated periodic basis (e.g., annually). An inter-dealer transaction in the securities—described as "puttable" securities—is effected for settlement shortly before the annual exercise date on the option. Delivery on the transaction, however, is not made until after the annual exercise date, so that the recipient is unable to exercise the option at the time it anticipated being able to do so.

I am writing to confirm my previous advice to him regarding the Board’s consideration of his inquiry.

As I informed him, his inquiry was referred to a Committee of the Board which has responsibility for interpreting the "delivery" provisions of the Board’s rules; that Committee has authorized my sending this response. In considering the inquiry, the Committee took note of the provisions of Board rule G-12(g), under which an inter-dealer delivery may be reclaimed for a period of eighteen months following the delivery date in the event that information pertaining to the description of the securities was inaccurate for either of the following reasons:

(i) information required by subparagraph (c)(v)(E) of this rule was omitted or erroneously noted on a confirmation, or

(ii) information material to the transaction but not required by subparagraph (c)(v)(E) of this rule was erroneously noted on a confirmation.

Under this provision, therefore, a delivery of securities described on the confirmation as being "puttable" securities could be reclaimed if the securities delivered are not, in fact, "puttable" securities.

The Committee is of the view that, in the first of the situations which he cited, the delivery could be rejected or reclaimed pursuant to the provisions of rule G-12(g). In this instance the securities were traded and described as being "puttable" securities; the securities delivered, however, are no longer "puttable" securities, since the put option has expired by the delivery date. Accordingly, the rule would permit rejection or reclamation of the delivery.

In the third case he put forth, however, this provision would not be applicable, since the securities delivered are as described. Accordingly, there would not be a basis under the rules to reject or reclaim this delivery, and a purchasing dealer who believed that it had incurred some loss as a result of the delivery would have to seek redress in an arbitration proceeding or in the courts. This may also be the result in the second case he cited, depending on the facts and circumstances of the delivery. MSRB interpretation of February 27, 1985.

Automated clearance: use of comparison systems. I am writing to confirm the substance of our conversations with you at our meeting on October 3 to discuss certain of the issues that have arisen since the August 1 effective date of the requirements of rule G-12(f) for the use of automated comparison services on certain inter-dealer transactions in municipal securities. In our meeting you explained certain problems that have become apparent since the implementation of these requirements, and you inquired as to our views concerning the application of Board rules to these difficulties or appropriate procedures to remedy them. The essential points of our responses are summarized below.

In particular, you indicated that the use of the "as of" (or "demand as of") feature of the automated comparison system has, in some cases, caused inappropriate rejections of deliveries of securities. This occurs, you explained, because the comparison system is currently programmed to display an alternative settlement date of two business days following the date of successful comparison of the transaction, if such comparison is accomplished through use of the "as of" or "demand as of" feature.[1] As a result, in certain cases involving transactions compared on an "as of" basis dealers have attempted to make delivery on the transaction on the contractual settlement date, and have had those deliveries rejected, since the receiving party recognizes only the later "alternative settlement date" assigned to the transaction by the comparison system. You inquire whether such rejections of deliveries are in accordance with Board rules.

I note that this "alternative settlement date" has significance for clearance purposes only, and does not result in a recomputation of the dollar price or accrued interest on the transaction.

As we advised in our conversation, the receiving dealer clearly cannot reject a good delivery of securities made on or after the contractual settlement date on the basis that the delivery is made prior to the "alternative settlement date" displayed by the comparison system. Both dealers have a contract involving the purchase of securities as of a specified settlement date, and a delivery tendered on or after that date in "good delivery" form must be accepted. A dealer rejecting such a delivery on the basis that it has been made prior to the "alternative settlement date" would be subject to the procedures for a "close-out by seller" due to the improper rejection of a delivery, as set forth in Board rule G-12(h)(ii).[2]

* * *

You also advised that some dealers who are using the automated comparison system are using their own delivery tickets, rather than the delivery tickets generated by the system, at the time they make delivery on the transaction. As a result, you indicated, there have been rejections of these deliveries, since the receiving dealer is unable to correlate these deliveries with its records of transactions compared through the system. You suggested that the inclusion of the "control numbers" generated by the comparison system on these self-generated delivery tickets would help to eliminate these unnecessary rejections and facilitate the correlation of receipts and deliveries with records of transactions compared through the system. As I indicated in our conversation, the Board concurs with your suggestion. The Board strongly encourages dealers who choose to use their own delivery tickets for transactions compared through the automated system to display on those tickets the control number or other number identifying the transaction in the system.[3] This would ensure that the receiving dealer can verify that it knows the transaction being delivered and that it was successfully compared through the system.

* * *

You also noted that many municipal securities dealers have continued the practice of sending physical confirmations of transactions, in addition to submitting such transactions for comparison through the automated system. You advised that this is causing significant problems for certain dealers, since they are required to maintain a duplicate system in order to provide for the review of these physical confirmations.

The Board is aware that certain municipal securities dealers chose to maintain parallel confirmation systems following implementation of the automated comparison requirements on August 1 in order to ensure that they maintained adequate control over their activities, and recognizes that for many such dealers this was an appropriate and prudent course of action.[4]  However, the Board wishes to emphasize that its rules do not require the sending of a physical confirmation on any transaction which has been submitted for comparison through the system. On the contrary, the continued use of unnecessary physical comparisons increases the risk of the duplication of trades and deliveries and substantially decreases the efficiencies and cost savings available from the use of the automated comparison system. The Board believes that all system participants must understand that the use of the automated comparison system is of primary importance. Accordingly, the Board strongly suggests that the mailing of unnecessary physical confirmations should be discontinued once a dealer is satisfied that it has adequate control over its comparison activities through the system.

You and others have suggested that it would be helpful if dealers which are unable to discontinue the mailing of physical confirmations would identify those transactions which have also been submitted for comparison through the system through some legend or stamp placed on the physical confirmation sent on the transaction. The Board concurs with your suggestion, and recommends that, during the short remaining interim when dealers are continuing to use duplicate physical confirmations, they include on physical confirmations of transactions submitted to the automated comparison system a stamp or legend in a prominent location which clearly indicates that the transaction has been submitted for automated comparison. MSRB interpretation of January 2, 1985.

[1] For example, a transaction of trade date October 19 for settlement October 25 fails to compare through the normal comparison cycle. Due to this failure to compare, the transaction is dropped from the comparison system on October 23; however, due to a resolution of the dispute, both parties resubmit the trade on an “as of” basis on October 24, and it is successfully compared on that date. Due to the delay in the comparison of the transaction, the system will display an “alternative settlement date” on this transaction of October 26 on the system-generated delivery tickets.

[2] I understand that [Registered Clearing Agency] is taking steps to have the contractual settlement date reflected on delivery tickets produced with respect to transactions compared on an “as of” or “demand as of” basis. We believe that this will be most helpful in clarifying and receiving dealer’s contractual obligation to accept a proper delivery made on or after the date.

[3] I understand that proper utilization of the comparison system control number is a reliable method for identifying and referring to transactions.

[4] The Board is also aware that on certain transactions dealers will need to send physical confirmations to document the terms of a specific agreement concluded as the time of trade (e.g., a specification of a rating). In such circumstances the Board anticipates that physical confirmations will continue to be sent.

Confirmation disclosures: tender option bonds with adjustable tender fees. This is in response to your inquiry concerning the application of the Board’s rules to certain tender option bonds with adjustable tender fees issued as part of a recent [name of bond deleted] issue. Apparently, there is some uncertainty as to the interest rate which should be shown on the confirmation, and the appropriate yield disclosure required by rule G-15 with respect to customer confirmations in transactions involving these securities.

The securities in question are tender option bonds with a 2005 maturity which may be tendered during an annual tender period for purchase on an annual purchase date each year until the 2005 maturity date. To retain this tender option for the first year after issuance, the option bond owner must pay a tender fee of $27.50 per $1,000 in principal amount of the bonds. Beginning in the second year, however, the tender fee may vary each year and will be in an amount determined by the company granting the option (the "Company"), in its discretion, and approved by the bank which issued a letter of credit securing the obligations of the Company. The tender fee must, however, be in an amount which, in the judgment of the Company based upon consultation with not less than five institutional buyers of short term securities, would under normal market conditions permit the bonds to be remarketed at not less than par. If at any time these fees are not paid, the trustee will pay the fee to the Company on behalf of the owner and deduct that amount from the next interest payment sent to the owner unless the owner tenders the bonds prior to the fee payment date. While a system has been set up to receive payment of these tender fees, we understand that the trustee of the issue is assuming that most of the tender fees will be paid through a deduction from the interest payment.

You have advised us that confirmations of the original syndicate transactions in these securities stated the interest rate on the securities as 7-1/8%, which is the current effective rate on the bonds taking into account the tender fees during the first year after issuance (i.e., the 9-7/8% rate less the 2-6/8% fee) and which, because of the yearly tender fee adjustment, is fixed only for one year. The interest rate shown on the bond certificates, however, is the 9-7/8% total rate, and no reference is made to the 7-1/8% effective rate. In addition, the bonds are traded on a dollar price basis as fixed-rate securities and are sold as one year tender option bonds (although the 2005 maturity date is disclosed). The yield to the one year tender date is the only yield customer confirmations.

You inquire whether it is proper that the confirmation show the interest rate on these securities as 7-1/8% and whether the yield disclosure requirements of rule G-15 are met with the disclosure of the yield to the one year tender date. Your inquiry was referred to the Committee of the Board which has responsibility for interpreting the Board's confirmation rules. The Committee has authorized this reply.

Rules G-12(c)(v)(E) and G-15(a)(i)(E).[*] require that dealer and customer confirmations contain a description of the securities including, among, other things, the interest rate on the bonds. The Committee believes that the stated interest rate on these bonds of 9-7/8% should be shown as the interest rate in the securities description on confirmations to reduce the confusion that may arise when the bond certificates are delivered and to ensure that an outdated effective rate is not utilized. In order to fully describe the rate of return on these bonds, however, the Committee believes that immediately after the notation of the 9-7/8% rate on the confirmations, the following phrase must be added—"less fee for put." Thus, it will be the responsibility of the selling dealer to determine the current effective rate applicable to these bonds and to disclose this to purchasing dealers and customers at the time of trade.[1]

In regard to yield disclosure, rule G-15(a)(i)(I)[†] requires that the yield to maturity be disclosed because these securities are traded on the basis of a dollar price.[2] The Board has determined that, for purposes of making this computation, only "in whole" calls should be used. Thus, for these tender option bonds, the yield to maturity is required to be disclosed. It appears, however, that an accurate yield to maturity cannot be calculated for these securities. While it is possible to calculate a yield to maturity using the stated 9-7/8% interest rate, this figure might be misleading since the adjustable tender fees would not be taken into account. Similarly, a yield calculated from the current effective rate of return would not be meaningful since it would not reflect subsequent changes in the amounts of the tender fees deducted. In view of these difficulties, the Committee believes that confirmations of these securities need not disclose a "yield to maturity." The Committee is also of the view, however, that dealers must include the yield to the one year tender date on the confirmations as an alternative form of yield disclosure. MSRB interpretation of October 3, 1984.

[1] We understand that these tender option bonds are the first of a series of similar issues and on subsequent issues of this nature the phrase “Bond subject to the payment of tender fee” will be printed on the bond certificates next to the interest rate. This additional description on the bond certificates, although helpful, is not a substitute for complete confirmation disclosure and this interpretation applies to these subsequent issues as well.

[2] Rule G-15(a)(i)(I)[†] requires that on customer confirmations

for transactions effected on the basis of a dollar price…the lowest of the resulting yield to call, yield to par option, or yield to maturity shall be shown.

[*] [Currently codified at rule G-15(a)(i)(B)(4)(c)]

[†] [Currently codified at rule G-15(a)(i)(A)(5)(b)]

Callable securities: pricing transactions on construction loan notes. I am writing in response to your letter of February 3, 1984 concerning the application of certain of the confirmation requirements of Board rules G-12 and G-15 to transactions in construction loan notes. In your letter you note that both rules require that the confirmation of a transaction in callable securities effected on a yield basis set forth a dollar price that has been computed to the lowest of the price to the call, the price to the par option, or the price to maturity of the securities; rule G-15 requires that customer confirmations effected on a dollar price basis state the resulting yield computed to the lowest of the yield to call, to the par option, or to maturity. You inquire how these comparative calculation requirements would apply to a confirmation of a transaction in construction loan notes, which generally are callable "in whole" six months prior to the stated maturity date at par.

Your inquiry was referred to a committee of the Board which has responsibility for interpreting the Board's confirmation rules; that committee has authorized my sending you this response. The committee notes that a Board interpretive notice of December 1980, which discussed the types of call features which should be used for purposes of the comparative calculation requirements, stated clearly that these requirements would apply to a transaction in a callable security if the issue of which the security is a part is callable "in whole" and if there is no restriction on the source of the funds which may be used to exercise the call. Since the call feature applicable to issues of construction loan notes is this type of "in whole" call feature, the committee is of the view that the comparative calculation requirements would apply. The confirmation of a transaction in a construction loan note effected on a yield basis, therefore, should state a dollar price computed to the lower of the price to this call feature or the price to maturity. Similarly, a customer confirmation of a transaction in these securities effected on a dollar price basis should set forth a yield to the lower of the yield to this call feature or a yield to maturity. MSRB interpretation of March 5, 1984.

From time to time, industry members have asked the Board for guidance in situations in which municipal securities dealers have traded securities which either are different from those described ("misdescribed") or do not exist as described ("non-existent") and the parties involved were unaware of this fact at the time of trade. A sale of a misdescribed security may occur, for example, when a minor characteristic of the issue is misstated. A sale of a non-existent security may result, for example, from the sale of a "when, as and if issued" security which is never authorized or issued.

The Board has responded to these inquiries by advising that its rules do not address the resolution of any underlying contractual dispute arising from trades in such misdescribed or non-existent securities, and that the parties involved in the trade should work out an appropriate resolution. Board rule G-12(g) does permit reclamation of an inter-dealer delivery in certain instances in which information required to be included on a confirmation by rule G-12(c)(v)(E)[1] is omitted or erroneously noted on the confirmation or where other material information is erroneously noted on the confirmation. Rule G-12(g)(v) and (vi), however, make clear that a reclamation only reverses the act of delivery and reinstates the open contract on the terms and conditions of the original contract, requiring the parties to work out an appropriate resolution of the transaction.

The Board wishes to emphasize that general principles of fair dealing would seem to require that a seller of non-existent or misdescribed securities make particular effort to reach an agreement on some disposition of the open trade with the purchaser. The Board believes that this obligation arises since it is usually the seller's responsibility to determine the status of the municipal securities it is offering for sale. The extent to which the seller bears this responsibility, of course, may vary, depending on the facts of a trade.

The Board notes that the status of the underlying contract claim for trades in non-existent or misdescribed securities ultimately is a matter of state law, and each fact situation must be dealt with under applicable state law, and each fact situation must be dealt with under applicable contract principles. The Board believes that the position set forth above is consistent with general contract principles, which commonly hold that a seller is responsible to the purchaser in most instances for failing to deliver goods as identified in the contract, or for negligently contracting for goods which do not exist if the purchaser relied in good faith on the seller's representation that the goods existed.

Parties to trades in misdescribed or non-existent securities should attempt to work out an appropriate resolution of the contractual agreement. If no agreement is reached, the Board's close-out and arbitration procedures may be available.

[1] Rule G-12(c)(v)(E) requires that confirmations contain a description of the securities, including at a minimum the name of the issuer, interest rate, maturity date, and if the securities are limited tax, subject to redemption prior to maturity (callable), or revenue bonds, an indication to such effect, including in the case of revenue bonds the type of revenue, if necessary for a materially complete description of the securities and in the case of any securities, if necessary for a materially complete description of the securities, the name of any company or other person in addition to the issuer obligated, directly or indirectly, with respect to debt service or, if there is more than one such obligor, the statement "multiple obligors" may be shown.

Confirmation disclosure: advance refunded securities. I am writing in response to your recent letter concerning the confirmation description requirements of Board rules applicable to transactions in securities which have been advance refunded. In particular, you note that certain issues of securities have been advance refunded by specific certificate number, with securities of certain designated certificate numbers refunded to one redemption date and price and other securities of the same issue refunded to a different redemption date and price. You inquire whether a confirmation of a transaction in such securities should identify the securities as being advance refunded by certificate number.

Rules G-12(c)(vi)(C)[*] and G-15(a)(iii)(C)[†] require that confirmations include

if the securities [involved in the transaction] are "called" or "prerefunded," a designation to such effect, the date of maturity which has been fixed by the call notice, and the amount of the call price...

The rules therefore require, with respect to a transaction in securities which have been advance refunded by certificate number, that the confirmation state that the securities have been advance refunded, and the refunding redemption date and price. The rules do not require that the fact that only certain specific certificate numbers of the issue were advance refunded to that redemption date and price be stated on the confirmation. MSRB Interpretation of January 4, 1984.

[*] [Currently codified at rule G-12(c)(vi)(E)]

[†] [Currently codified at rule G-15(a)(i)(C)(3)(a)]

Delivery requirements: mutilated coupons. I am writing in response to your recent letter concerning the provisions of Board rule G-12(e) with respect to inter-dealer deliveries of securities with mutilated coupons attached. You indicate that your firm recently became involved in a dispute with another firm’s clearing agent concerning whether certain coupons attached to securities your firm had delivered to the agent were mutilated. You request guidance as to the standards set forth in rule G-12(e) for the identification of mutilated coupons.

As you are aware, rule G-12(e)(ix) indicates that a coupon will be considered to be mutilated if the coupon is damaged to the extent that any one of the following cannot be ascertained from the coupon:

(A) title of the issuer;

(B) certificate number;

(C) coupon number or payment date...;

or

(D) the fact that there is a signature... (emphasis added)

The standard set forth in the rule (that the information "cannot be ascertained") was deliberately chosen to make clear that minimal damage to a coupon is not sufficient to cause that coupon to be considered mutilated. For example, if the certificate number imprinted on a coupon is partially torn, but a sufficient portion of the coupon remains to permit identification of the number, the coupon would not be considered to be mutilated under the standard set forth in the rule, and a rejection of the delivery due to the damage to the coupon would not be permitted. In the case of the damaged coupon shown on the sample certificate enclosed with your letter, it seems clear that the certificate number can be identified, and confusion with another number would not be possible; therefore, this coupon would not be considered to be mutilated under the rule, and a rejection of a delivery due to the damage to this coupon would not be in accordance with the rule's provisions.

Your letter also inquires as to the means by which dealers can obtain redress in the event that a delivery is rejected due to damaged coupons which are not, in their view, mutilated under the standard set forth in the rule. I note that rule G-12(h)(ii) sets forth a procedure for a close-out by a selling dealer in the event that a delivery is improperly rejected by the purchaser; this procedure could be used in the circumstances you describe to obtain redress in this situation. Further, the arbitration procedure under Board rule G-35 could also be used in the event that the dealer incurs additional costs as a result of such an improper rejection of a delivery. MSRB interpretation of January 4, 1984.

Put option bonds: safekeeping, pricing. I am writing in response to your recent letter regarding issues of municipal securities with put option or tender option features, under which a holder of the securities may put the securities back to the issuer or an agent of the issuer at par on certain stated dates. In your letter you inquire generally as to the confirmation disclosure requirements applicable to such securities. You also raise several questions regarding a dealer’s obligation to advise customers of the existence of the put option provision at times other than the time of sale of the securities to the customer.

Your letter was referred to a committee of the Board which has responsibility for interpreting the  Board’s confirmation rules, among other matters. That committee has authorized my sending you the following response.

Both rules G-12(c) and G-15, applicable to inter-dealer and customer confirmations respectively, require that confirmations of transactions in securities which are subject to put option or tender option features must indicate that fact (e.g., through inclusion of the designation “puttable” on the confirmation). the date on which the put option feature first comes into effect need be stated on the confirmation only if the transaction is effected on a yield basis and the parties to the transaction specifically agree that the transaction dollar price should be computed to that date. In the absence of such an agreement, the put date need not be stated on the confirmation, and any yield disclosed should be a yield to maturity.

Of course, municipal securities brokers and dealers selling to customers securities with put option or tender option features are obligated to disclose adequately the special characteristics of these securities at the time of trade.  The customer therefore should be advised of information about the put option or tender option feature at this time.

In your letter you inquire whether a dealer who had previously sold securities with a put option or tender option feature to a customer would be obliged to contact that customer around the time the put option comes into effect to remind the customer that the put option is available. You also ask whether such an obligation would exist if the dealer held the securities in safekeeping for the customer. The committee can respond, of course, only in terms of the requirements of Board rules; the committee noted that no Board rule would impose such an obligation on the dealer.

Securities description: securities backed by letters of credit. I am writing in connection with our previous telephone conversation of last June regarding the confirmation of a transaction in a municipal issue secured by an irrevocable letter of credit issued by a bank. In our conversation you noted that both rules G-12 and G-15 require confirmations to contain a:

description of the securities including at a minimum..., if necessary for a materially complete description of the securities, the name of any company or other person in addition to the issuer obligated, directly or indirectly, with respect to debt service...

You inquired whether the name of the bank issuing a letter of credit securing principal and interest payments on an issue, or securing payments under the exercise of a put option or tender option feature, need be stated on the confirmation.

At that time I indicated to you that the identity of the bank issuing the letter of credit would have to be disclosed on the confirmation if the letter of credit could be drawn upon to cover scheduled interest and principal payments when due, since the bank would be "obligated ... with respect to debt service." I am writing to advise that the committee of the Board which reviewed a memorandum of our conversation has concluded that a bank issuing a letter of credit which secures a put option or tender option feature on an issue is similarly "obligated ... with respect to debt service" on such issue. The identity of the bank issuing the letter of credit securing the put option must therefore also be indicated on the confirmation. MSRB interpretation of December 2, 1982.

Securities description: revenue securities. I am writing in response to your letter of September 30, 1982 regarding the confirmation description of revenue securities. In your letter you note that the designation "revenue" is often not included in the title of the security, and you raise several questions concerning the method of deriving a proper confirmation description of revenue securities.

As you know, rule G-15(a)(v)[*] requires that customer confirmations set forth a description of the securities [involved in the transaction] including at a minimum the name of the issuer, interest rate, maturity date and if the securities are ... revenue bonds, an indication to such effect, including in the case of revenue bonds the type of revenue, if necessary for a materially complete description of the securities...[1] [emphasis added]

The rule requires, therefore, that revenue securities be designated as such, regardless of whether or not such designation appears in the formal title of the security. The dealer preparing the confirmation is responsible for ensuring that the designation is included in the securities description. In circumstances in which standard sources of descriptive information (e.g., official statements, rating agency and service bureau publications, and the like) do not include such a designation in the security title, therefore, the dealer must augment this title to include the requisite information.

In your letter you inquire as to who is responsible for providing this type of descriptive information to the facilities manager of the CUSIP system. Although the Board does not currently have any requirements concerning this matter, proposed rule G-34 will, when approved by the Securities and Exchange Commission, require that the managing underwriter of a new issue of municipal securities apply for the assignment of CUSIP numbers of such new issue if no other person (i.e., the issuer or a person acting on behalf of the issuer) has already applied for number assignment. In connection with such application, if one is necessary, the managing underwriter is required, under the proposed rule, to provide certain information about the new issue, including a designation of the "type of issue (e.g., general obligation, limited tax, or revenue)" and an indication of the "type of revenue, if the issue is a revenue issue."

In your letter you also ask for "the official definition of a 'revenue' issue." There is no "official definition" of what constitutes a revenue issue. Various publications include a definition of the term (e.g., the PSA's Fundamentals of Municipal Bonds, the State of Florida's Glossary of Municipal Securities Terms, etc.) and I would urge you to consult these for further information. MSRB interpretation of December 1, 1982.

[1] Rule G-12(c)(v)(E) sets forth the same requirement with respect to inter-dealer confirmations.

[*] [Currently codified at rules G-15(a)(i)(B) and G-15(a)(i)(C)]

Confirmation: Mailing of WAII, "all or none" confirmation. I understand that certain ... firms ... have raised questions concerning the application of a recent Board interpretive letter to certain types of municipal securities underwritings. I am writing to advise that these questions were recently reviewed by the Board which has authorized my sending you the following response.

The letter in question, reprinted in the Commerce Clearing House Municipal Securities Rulemaking Board Manual at ¶ 3556.55 [*], discusses the timing of the mailing of initial "when, as and if issued" confirmations on "pre-sale" orders to which new issue municipal securities have been allocated. Among other matters, the letter states that such confirmations may not be sent out prior to the date of award of the new issue, in the case of an issue purchased at competitive bid, or the date of execution of a bond purchase agreement on the new issue, in the case of a negotiated issue. [Certain] ... firms have questioned whether this interpretation ... is intended to apply to "all or none" underwritings, in which confirmations have been, at times, sent out prior to the execution of a formal purchase agreement.

As the Board understands it, an "all or none" underwriting of a new issue of municipal securities is an underwriting in which the municipal securities dealer agrees to accept liability for the issue at a given price only under a stated contingency, usually that the entire issue is sold within a stated period. The dealer typically "presettles" with the purchasers of the securities, with the customers receiving confirmations and paying for the securities while the underwriting is taking place. Pursuant to SEC rule 15c2-4 all customer funds must be held in a special escrow account for the issue until such time as the contingency is met (e.g., the entire issue is sold) and the funds are released to the issuer; if the contingency is not met, the funds are returned to the purchasers and the securities are not issued. [1]

The Board is of the view that an initial "when, as and if issued" confirmation of a transaction in a security which is the subject of an "all or none" underwriting may be sent out prior to the time a formal bond purchase agreement is executed. This would be permissible, however, only if two conditions are met: (1) that such confirmations clearly indicate the contingent nature of the transaction, through a statement that the securities are the subject of an "all or none" underwriting or otherwise; and (2) that the dealer has established, or has arranged to have established, the escrow account for the issue as required pursuant to rule 15c2-4. MSRB interpretation of October 7, 1982.

[1] I note also that SEC rule 10b-9 sets forth certain conditions which must be met before a dealer is permitted to represent an underwriting as an "all or none" underwriting.

[*] [See Rule G-12 Interpretive Letter - Confirmation: mailing of WAII confirmation, MSRB interpretation of April 30, 1982.]

Callable securities: disclosure. I am writing in response to your letter of August 17, 1982, concerning the requirements of Board rules G-12(c)(v)(E) and G-15(a)(v)[*] concerning securities descriptions set forth on confirmations. In your letter you note that certain descriptive details are required to be disclosed on the confirmation only "if necessary for a materially complete description of the securities," and you inquire whether information as to a security's callability is one of these details.

Rules G-12(c)(v)(E) and G-15(a)(v)[*] require confirmations to set forth a

description of the securities, including at a minimum the name of the issuer, interest rate, maturity date, and if the securities are limited tax, subject to redemption prior to maturity (callable) or revenue bonds, an indication to such effect, including in the case of revenue bonds the type of revenue, if necessary for a materially complete description of the securities, and in the case of any securities, if necessary for a materially complete description of the securities, the name of any company or other person in addition to the issuer obligated, directly or indirectly, with respect to debt service or, if there is more than one such obligor, the statement 'multiple obligators' may be shown." (emphasis added)

As you can see, the phrase "if necessary for a materially complete description of the securities" modifies only the requirements for disclosure of "the type of revenue," or ... disclosure of "the name of any company or other person obligated ... with respect to debt service...," and does not modify the requirements for disclosure of the other listed information. Both rules, therefore, deem information as to the "name of the issuer, interest rate, maturity date and if the securities are limited tax, subject to redemption prior to maturity (callable) or revenue bonds" to be necessarily material and subject to disclosure on the confirmation. In the specific case which you cite, that of a security with an "in-part" sinking fund call feature, the confirmation of a transaction in such security would be required to identify the security as "callable." MSRB interpretation of August 23, 1982.

[*] [Currently codified at rules G-15(a)(i)(B) and G-15(a)(i)(C)]

Original issue discount, zero coupon securities: disclosure of, pricing to call feature. I am writing in response to your inquiry in our recent telephone conversation regarding the application of Board rules to the recent original issue discount on "zero coupon" new issues of municipal securities. In particular, you indicated that these types of securities are often subject to somewhat unusual call provisions, and you inquired as to the application to these types of securities of Board rules concerning the disclosure of call provisions and the use of such call provisions in dollar price and yield computations.

Subsequent to our conversation, I obtained several examples of these call provisions, which were provided to the Board in connection with your inquiry. In the first of these examples, involving an original issue discount security, the call provision commences ten years after issuance, with the redemption price initially set at 90 and increasing by 2 points every three years, reaching a redemption price of 100 twenty-five years after issuance. In the second example, involving a "zero coupon" security, the call provision commences ten years after issuance; the redemption price is based on the compound accreted value of the security (plus a stated redemption premium for the first five years of the call provision), with certain of the securities initially redeemable at an approximate dollar price of 18.

As you know, the call provisions on "zero coupon" and original issue discount securities are one of the special characteristics of such securities, but are not, by any means, the sole special characteristic. The Board is of the view that municipal securities brokers and dealers selling such securities are obliged, under Board rule G-17 as well as under the anti-fraud rules under the Securities Exchange Act, to disclose to customers all material information regarding such special characteristics. As the Board stated in its April 27, 1982 "Notice Concerning 'Zero Coupon' and 'Stepped Coupon' Securities,"

persons selling such securities to the public have an obligation to adequately disclose the special characteristics of such securities so as to comply with the Board's fair practice rules.

Therefore, in selling an original issue discount or "zero coupon" security to a customer, a dealer would be obliged to disclose, among other matters, any material information with respect to the call provisions of such securities.

I note also that Rule G-15 requires customer confirmations of transactions in callable securities to indicate that the securities are "callable," and to contain a legend stating, in part, that information concerning the call provisions of such securities will be made available upon the customer's request. Customer confirmations of transactions in callable original issue discount or "zero coupon" securities would have to contain such a legend, in addition to the designation "callable," and the details of the call provisions of such securities would have to be provided to the customer in writing upon the customer's request.

The requirement under rules G-12 and G-15 for the computation of dollar price and (under rule G-15) yield to a call or option feature would apply to a transaction in an original issue discount or "zero coupon" security. Therefore, if the dollar price to the call on a transaction in such securities is lower than the price to maturity, such dollar price should be used. In the case of customer confirmations, if the yield to call on a transaction in such securities is lower, such yield must be shown. As you noted in our conversation, in view of the redemption price structure of the call provisions on such securities, the price or yield to call on a particular transaction might be lower than the price or yield to maturity, even though the transaction is effected at a price below par. Since heretofore the industry has been accustomed to call provisions at prices at or above par, industry members may wish to pay particular attention to the processing of transactions in original issue discount or "zero coupon" securities with these unusual types of call provisions, to ensure that the dollar price or yield of such transactions is not inadvertently overstated due to a failure to check the price or yield to call. MSRB interpretation of June 30, 1982.

Confirmation: Mailing of WAII confirmation. I am writing to confirm my recent telephone conversation with you regarding the requirements for mailing "when, as and if issued" confirmations of transactions in new issue municipal securities. Our recent conversation concerned your previous inquiry as to the time limit by which a municipal securities dealer must send out such confirmations in connection with allocations of securities to "pre-sale" orders, and the propriety of a dealer’s sending out such confirmations prior to the award of the new issue.

As we discussed, rule G-12(c)(iii) requires that,

[f] or transactions effected on a "when, as and if issued" basis, initial confirmations shall be sent within two business days following the trade date.

For purposes of this requirement the designation "trade date" should be understood to refer to, in the case of a competitive new issue, a date no earlier than the date of award of the new issue of municipal securities, and, in the case of a negotiated new issue, a date no earlier than the date of signing of the bond purchase agreement. Therefore, the rule would require that initial "when, as and if issued" confirmations reflecting the allocation of new issue securities to "pre-sale" orders be sent within [one] business day after the date of award or of signing of the bond purchase agreement. For example, if the bond purchase agreement on a negotiated new issue is signed on Monday, April 26, the initial "when, as and if issued" confirmations must be sent out not later than the close of business on Tuesday, April 27, one business day later.

Further, the Board is of the view that its rules prohibit a municipal securities dealer from sending out initial "when, as and if issued" confirmations prior to the trade date. In reaching this conclusion the Board does not intend to call into question the validity of a "pre-sale" order received for a syndicate’s securities or the practice of soliciting such orders. The Board recognizes that such orders are expressions of the purchasers’ firm intent to buy the new issue securities in accordance with the stated terms, and that such orders may be filled and confirmed immediately upon the award of the issue or the execution of a bond purchase agreement. The Board is of the view, however, that such orders cannot be deemed to be executed until the time of the award of the new issue, or the execution of a bond purchase agreement on the new issue. Mailing of confirmations on such orders prior to this time, therefore, is a representation that the orders have been filled before this actually occurs, and, as such, may be deceptive or misleading to the purchasers. MSRB interpretation of April 30, 1982.

NOTE: Revised to reflect subsequent amendments.

The Municipal Securities Rulemaking Board has recently received inquiries concerning the application of the confirmation disclosure requirements of Board rules G-12 and G-15 to transactions in municipal securities with "zero coupons" or "stepped coupons." Certain recent new issues of municipal securities have had several maturities paying 0% interest; securities of these maturities are sold at deep discounts, with the investor's return received in the form of an accretion of this discount to par. Other issues have been sold which have "stepped coupons;" that is, all outstanding bonds pay the same interest rate each year, with the interest rate periodically rising, on a pre-established schedule, on all securities yet to be redeemed. Interested persons have inquired concerning how the description requirements of the rules apply to such securities, and whether the yield disclosure requirements of rule G-15 apply to confirmations of transactions in such securities for the accounts of customers.

Rule G-12(c)(v)(E) requires a municipal securities dealer to set forth on an inter-dealer confirmation a description of the securities which are the subject of the transaction, including the interest rate. Rule G-15(a)(i)(E)[*] imposes the same requirement with respect to customer confirmations. Further, rule G-15(a)(i)(I)(2)[†] requires that customer confirmations of transactions effected at dollar prices (except for transactions at par) state the lowest of the resulting yield to call, yield to par option, or yield to maturity.

A confirmation of a transaction in a "zero coupon" security must state that the interest rate on the security is "0%." A customer confirmation of such a transaction must state the lowest of the yield to call or yield to maturity resulting from the dollar price of the transaction.[1] The Board believes that the disclosure of the resulting yield is particularly important on such transactions, since it provides the only indication to the investor of the return he or she can expect from the investment.

A confirmation of a transaction in a "stepped coupon" security must state the interest rate currently being paid on the securities, and must identify the securities as "stepped coupon" securities. A customer confirmation of such a transaction must also state the lowest of the yield to call, yield to par option, or yield to maturity resulting from the dollar price of the transaction.[2] In view of the wide variation in the coupon interest rates that will be received over the life of a "stepped coupon" security, the Board believes that the disclosure of yield will assist customers in determining the actual return to be received on the investment.

In addition to the specific confirmation disclosure requirements of Board rules G-12 and G-15 discussed above, the Board is of the view that persons selling such securities to the public have an obligation to adequately disclose the special characteristics of such securities so as to comply with the Board's fair practice rules. For example, although the details of the increases to the interest rates on "stepped coupon" securities need not be provided on confirmations, such information is, of course, material information regarding the securities, and municipal securities dealers would be obliged to inform customers about this feature of the securities at or before the time of trade.

[1] The Board notes that, upon the effectiveness of Board rule G-33, such yield must be computed on a basis that presumes semi-annual compounding.

[2] In the case of both "zero coupon" and "stepped coupon" securities, if the transaction is effected in a yield basis, the confirmation must show the yield price and the resulting dollar price, computed to the lowest of price to premium call, price to par option, or price to maturity.

[*] [Currently codified at rule G-15(a)(i)(B)(4)]

[†] [Currently codified at rule G-15(a)(i)(A)(5)]

The Municipal Securities Rulemaking Board has recently received complaints from certain municipal securities brokers and municipal securities dealers concerning problems with the documentation provided on rejections or reclamations of deliveries on municipal securities transactions. These brokers and dealers have alleged that other organizations, when rejecting or reclaiming deliveries, have failed to provide the requisite information regarding the return of the securities, thereby making it very difficult to accomplish prompt resolution of any delivery problems. In particular, these dealers indicate, notices of rejection or reclamation have often failed to state a reason for the rejection or reclamation, or to name a person who can be contacted regarding the delivery problem.

Rule G-12(g)(iv) requires that a dealer rejecting or reclaiming a delivery of securities must provide a notice or other document with the rejected or reclaimed securities, which notice shall include the following information:

(A) the name of the party rejecting or reclaiming the securities;

(B) the name of the party to whom the securities are being rejected or reclaimed;

(C) a description of the securities;

(D) the date the securities were delivered;

(E) the date of rejection or reclamation;

(F) the par value of the securities which are being rejected or reclaimed;

(G) in the case of a reclamation, the amount of money the securities are reclaimed for;

(H) the reason for rejection or reclamation; and

(I) the name and telephone number of the person to contact concerning the rejection or reclamation.

The Uniform Reclamation Form may be used for this purpose.

The Board believes that the required information is the minimum necessary to permit prompt resolution of the problem, and does not view the requirement to provide this information as burdensome. The Board is concerned that failure to provide this information may contribute to inefficiencies in the clearance process, and strongly urges municipal securities brokers and dealers to take steps to ensure that the requirements of the rule are complied with. The Board notes that, in the case of reclaimed securities, failure to provide this information may result in, at minimum, a refusal on the part of the receiving party to honor the reclamation.

Close-out procedures: mandatory repurchase. You recently inquired concerning the use of the "mandatory repurchase" option provided under Board rule G-12(h)(i)(D) for execution of a close-out notice. In the situation you presented, a municipal securities dealer executing a notice was requiring, under the provisions of this option, a repurchase at the original contract price. Since the transaction was originally effected on the basis of a yield price, you inquired whether the repurchase should be effected at this yield price (with the dollar price computed to the settlement date of the repurchase transaction), or at the dollar price computed from this yield price at the time of the original transaction.

At the time of your telephone call I responded that, while the Board would have to consider this inquiry, the Board’s response to somewhat similar inquiries in the past suggested that the dollar price of the original contract should be used. I am writing to advise you that the Board did not adopt this position. With respect to the specific circumstances presented in your inquiry, the Board has concluded that the purchasing dealer does have the right, in the appropriate circumstances, to execute a close-out by requiring the seller to repurchase the securities at the yield price of the original contract, with the resulting dollar price computed to the settlement date of the repurchase transaction. The Board notes that, in these circumstances, the selling dealer has failed to fulfill its contractual obligations, and believes that permitting the use of the yield price of the original contract, with the resulting dollar price computed to the settlement date of the repurchase transaction, will in the majority of cases most fairly compensate the purchaser for the time value of the investment for the period from the original execution to the mandatory repurchase.[1]

The Board also is generally of the view that purchasers executing mandatory repurchase transactions may require a mandatory repurchase at the yield basis of the original transaction, with the resulting dollar price computed to the settlement date of the repurchase transaction, except in the case where both parties to the transaction agree that the original transaction was, and the repurchase transaction should be, effected on the basis of a dollar price, or where the terms of the transaction and/or the trading characteristics of the security (e.g., issues with an active sinking fund or tender program) suggest that dollar price rather than yield was the dominant consideration in the original transaction. MSRB interpretation of March 4, 1982.

[1] The Board notes, for example, that, in the case of a security purchased at a discount, the purchaser and the purchaser’s customer would realize the accretion of the discount for the period the security was owned. In the case of a security purchased at a premium, the premium would be amortized for the period the purchaser owned the security.

Settlement of syndicate accounts. This is in response to your letter of July 28, 1981, suggesting that requirements analogous to those placed on syndicate managers in rule G-12(j) be imposed on syndicate members who must remit their share of syndicate losses to their syndicate managers. You state that syndicate members frequently do not remit their losses to the manager in a timely fashion and that such a requirement would establish an "equitable balance between the interests of syndicate members and syndicate managers."

Rule G-12(j) provides:

Final settlement of a syndicate or similar account formed for the purchase of securities shall be made within 60 days following the date all securities have been delivered by the syndicate or account manager to the syndicate or account members.

The rule is not expressly limited to money payments by syndicate managers, but broadly requires that final settlement shall be made within 60 days following the date the manager delivers the securities to the syndicate members. Thus, the rule requires syndicate members to remit their share of syndicate losses to the syndicate manager within the 60-day period set forth in the rule. Since a syndicate member cannot remit his share of losses until he is apprised by the syndicate manager of the amount of his share, a member should remit his share of the losses to the manager within a reasonable period of time after receiving the syndicate accounting required by rule G-11(h). MSRB interpretation of September 28, 1981.

The Municipal Securities Rulemaking Board has recently received inquiries concerning the provisions of rule G-12(h)(iii) regarding close-out procedures in the event of a firm's liquidation. The Board has been advised that a SIPC trustee has been appointed in connection with the liquidation of a general securities firm with which certain municipal securities brokers and dealers have uncompleted transactions in municipal securities, and that the New York Stock Exchange and the National Association of Securities Dealers, Inc., have notified their respective members that they may institute "immediate" close-out procedures on open transactions with the firm in liquidation. In accordance with a previous understanding between the Board and the NASD, the NASD has also advised municipal securities brokers and dealers that, pursuant to rule G-12(h)(iii), they may execute "immediate" close-outs on open transactions in municipal securities.

Rule G-12(h)(iii) provides:

Nothing herein contained shall be construed to prevent brokers, dealers or municipal securities dealers from closing out transactions as directed by a ruling of a national securities exchange, a registered securities by a ruling of a national securities exchange, a registered securities association or an appropriate regulatory agency issued in connection with the liquidation of a broker, dealer or municipal securities dealer.

Therefore, in the event that a national securities exchange or registered securities association makes a ruling that close-outs may be effected "immediately" on transactions with a firm in liquidation, municipal securities brokers and dealers may take such action. In these circumstances, a purchasing dealer seeking to execute such a close-out need not follow the procedures for initiation of a close-out procedure, nor is the dealer required to wait the prescribed time periods prior to executing the close-out notice. Similarly, a selling dealer need not attempt delivery prior to using the procedure for close-outs by sellers. In both cases dealers may proceed to execute the close-out immediately--that is, the purchasing dealer may immediately "buy in" the securities in question for the account and liability of the firm in liquidation (or utilize one of the other options available for execution of the close-out), and a selling dealer may immediately "sell out" the subject securities. Notification of the execution of the close-out should be provided in accordance with the normal procedure.

Dealers executing close-outs in these circumstances should advise the trustee of the firm in liquidation of their actions in closing out these transactions. If proceeds from the close-out execution are due to the firm in liquidation, they should be remitted to the trustee. Requests for payment of amounts due on close-out executions should also be sent to the trustee; the trustee will resolve these claims in the course of the liquidation.

The Board also notes that dealers having open transactions with a firm in liquidation may, but are not required to, execute "immediate" close-outs in these circumstances. If individual dealers wish to attempt some other means of completing these transactions, such as seeking to complete a transaction with the liquidated firm's other contra-side, they may do so.

The Board continues to be concerned about industry compliance with certain of the requirements of Board rules G-11, "Sales of New Issue Municipal Securities During the Underwriting Period," and G-12, "Uniform Practice," with respect to the settlement of syndicate accounts. Board rule G-11(g)[*] requires, among other matters, that syndicate managers provide to members at the time of settlement of a syndicate account a detailed statement of the expenses incurred by the syndicate.[1] Rule G-12(j) requires that settlement of a syndicate account and distribution of any profit due to members be made within 60 days of delivery of the syndicate's securities. In addition, rule G-12(i) requires that good faith deposits be returned within two business days of settlement with an issuer, and rule G-12(k) requires that sales credits designated by a customer be distributed within 30 days following delivery of the securities [by the issuer to the syndicate]. 

The Board has from time to time received complaints from industry members concerning certain managers' non-compliance with these requirements. These persons allege that certain managers unduly delay the sending of syndicate settlement checks and other disbursements, and furnish settlement statements that provide little or no detail about the nature of the expenses incurred by the syndicate. These persons have also, on occasion, furnished to the Board copies of syndicate statements which illustrate clearly these managers' failure to provide the requisite information and to meet the time requirement for these disbursements. The Board has referred each of these complaints to the appropriate regulatory agency for investigation and appropriate action.

The Board wishes to emphasize strongly the need for compliance with these provisions. The Board continues to be of the view that the time periods and other requirements of the rules, which were arrived at after considerable deliberation, are fair and reasonable. The Board believes that failure to comply with these provisions is inexcusable. The Board does not accept the rationale offered by some, that the difficulties in obtaining bills for syndicate expenses justify these undue delays; the Board believes that it is incumbent upon managers to assure that such bills are received and processed in timely fashion, to permit compliance with the rule. The Board strongly urges syndicate managers who have failed to comply with these requirements to bring their practices into compliance with the requirements of the rules.

The Board also is communicating these views to the enforcement organizations and stressing its concern with respect to compliance with these provisions. It strongly urges all syndicate members to notify the appropriate enforcement organization of any violations by managers of these provisions.

[1] The rule contemplates that the statement will set forth a detailed breakdown of expenses into specified categories, such as advertising, printing, legal, computer services, packaging and handling, etc. The statement may include an item for miscellaneous expenses, provided that the amount shown under such an item is not disproportionately large in relation to other items of expense shown and includes only items of expense which cannot be easily categorized elsewhere in the statement.

[*] [Currently codified at rule G-11(h)]

NOTE: Revised to reflect subsequent amendments.

Confirmation disclosure: put option bonds. This will acknowledge receipt of your letter of May 6, 1981, requesting further clarification of the application of Board rules to municipal securities with "put option" or "tender option" features. In your letter you note that I had previously indicated that, in some circumstances, Board rules would require inter-dealer and customer confirmations to set forth a yield to the "put option" date, designated as such. You suggest that presentation of this information on confirmations would require reprogramming of many computerized confirmation-processing systems, and you inquire whether the Board intends that

dealers should possess the capability to "price to the put" and [to] indicate the appropriate yield in their confirmation systems[.]

In my previous letter of April 24, 1981, I advised that Board rules G-12(c), on inter-dealer confirmations, and G-15, on customer confirmations, would require the following with respect to transactions in securities with "put option" features:

(1) If the transaction is effected on the basis of a yield price, the confirmation must state the yield at which the transaction was effected and the resulting dollar price. The dollar price must be computed to the maturity date, since, in most instances, these securities will not have call features. If the securities do have a refunding call feature, the requirement for pricing to the lowest of the premium call, par option, or maturity would obtain.

(2) If the transaction is effected on the basis of a dollar price, the confirmation must state the dollar price, and, in the case of a customer confirmation, the resulting yield to maturity. If the securities have a call feature, the customer confirmation would state the yield to premium call or the yield to par option in lieu of the yield to maturity, if either is lower than the yield to maturity.

In neither case does the rule require the presentation of a yield or a dollar price computed to the "put option" date as a part of the standard confirmation processing. Further, the Board does not at this time plan to adopt any requirement for a calculation of yield or dollar price to the lower of the put option or maturity dates, comparable to the calculation requirement involving call features. I would therefore have to respond to your inquiry by stating that the Board does not at this time intend to require, as an aspect of standard confirmation processing, that dealers have the capability to "price to the put."

In your May 6 letter you quote a paragraph from my previous correspondence, which stated the following:

If the parties explicitly agree that the transaction is effected at a yield to the "put option" date, then such yield may be shown on the confirmation, together with a statement that it is a yield to the (date) put option, and an indication of the date the option first becomes available to the holder.

As this paragraph indicates, in some circumstances the parties to a particular transaction may agree between themselves that the transaction is effected on the basis of a yield to the "put option" date, and that the dollar price will be computed in that fashion. In such circumstances, the yield to the "put option" date is the "yield at which [the] transaction was effected" and must be disclosed as such; it must also be identified in order to evidence the agreement of the parties that the transaction is priced in this fashion. However, since the sale of securities on the basis of a yield to the "put option" is at the discretion of the parties to the transaction, and is a special circumstance requiring a mutual agreement of such parties, I suggest that the reprogramming you mention would be necessary only if your bank elects to treat securities with "put option" features in this special fashion. Further, given the fact that these would be exceptional transactions, and would require special handling at the time of trade itself (viz., the conclusion of the mutual agreement concerning the pricing), I suggest that manual processing of these transactions on an "exception" basis appears to be a viable alternative to the reprogramming. MSRB interpretation of May 11, 1981.

Confirmation disclosure: put option bonds. This will acknowledge receipt of your letter of March 17, 1981, with respect to "put option" or "tender option" features on certain new issues of municipal securities. In your letter you note that an increasing number of issues with "put option" features are being brought to market, and you inquire concerning the application of the Board’s rules to these securities.

The issues of this type with which we are familiar have a "put option" or "tender option" feature permitting the holder of securities of an issue to sell the securities back to the trustee of the issue at par. The "put" or "tender option" privilege normally becomes available a stated number of years (e.g., six years) after issuance, and is available on stated dates thereafter (e.g., once annually, on an interest payment date). The holder of the securities must usually give several months prior notice to the trustee of his intention to exercise the "put option."

Most Board rules will, of course, apply to "put option" issues as they would to any other municipal security. As you recognize in your letter, the only requirements raising interpretive questions appear to be the requirements of rules G-12 and G-15 concerning confirmations. These present two interpretive issues: (1) does the existence of the "put option" have to be disclosed and if so, how, and (2) should the "put option" be used in the computation of yield and dollar price.

Both rules require confirmations to set forth a

description of the securities, including ... if the securities are ... subject to redemption prior to maturity ..., an indication to such effect

Confirmations of transactions in "put option" securities would therefore have to indicate the existence of the "put option," much as confirmations concerning callable securities must indicate the existence of the call feature. The confirmation need not set forth the specific details of the "put option" feature.

The requirements of the rules differ with respect to disclosure of yields and dollar prices. Rule G-12, which governs inter-dealer confirmations, requires such confirmations to set forth the

yield at which transaction was effected and resulting dollar price, except in the case of securities which are traded on the basis of dollar price or securities sold at par, in which event only dollar price need be shown (in cases in which securities are priced to premium call or to par option, this must be stated and the call or option date and price used in the calculation must be shown, and where a transaction is effected on a yield basis, the dollar price shall be calculated to the lowest of price to premium call, price to par option, or price to maturity)

Rule G-15 requires customer confirmations to contain yield and dollar price as follows:

(A) for transactions effected on a yield basis, the yield at which transaction was effected and the resulting dollar price shall be shown. Such dollar price shall be calculated to the lowest of price to premium call, price to par option, or price to maturity. In cases in which the dollar price is calculated to premium call or par option, this must be stated, and the call or option date and price used in the calculation must be shown.

(B) for transactions effected on the basis of dollar price, the dollar price at which transaction was effected, and the lowest of the resulting yield to premium call, yield to par option, or yield to maturity shall be shown; provided, however, that yield information for transactions in callable securities effected at a dollar price in excess of par, other than transactions in securities which have been called or prerefunded, is not required to be shown until October 1, 1981.

(C) for transactions at par, the dollar price shall be shown[.]

Therefore, with respect to transactions in "put option" securities effected on the basis of dollar price, rule G-12 requires that confirmations simply set forth the dollar price. Rule G-15 requires that confirmations of such transactions set forth the dollar price and the yield to maturity resulting from such dollar price. With respect to transactions effected on the basis of yield, both rules require that the confirmations set forth the yield at which the transaction was effected and the resulting dollar price. Unless the parties otherwise agree, the yield should be computed to the maturity date when deriving the dollar price. If the parties explicitly agree that the transaction is effected at a yield to the "put option" date, then such yield may be shown on the confirmation, together with a statement that it is a "yield to the [date] put option," and an indication of the date the option first becomes available to the holder.

Since the exercise of the "put option" is at the discretion of the holder of the securities, and not, as in the case of a call feature, at the discretion of someone other than the holder, the Board concludes that the presentation of a yield to maturity on the confirmation, and the computation of yield prices to the maturity date, is appropriate, and accords with the goal of advising the purchaser of the minimum assured yield on the transaction. The Board further believes that the ability of the two parties to a transaction to agree to price the transaction to the "put option" date, should they so desire, provides sufficient additional flexibility in applying the rules to transactions in "put option" securities. MSRB interpretation of April 24, 1981.

The Municipal Securities Rulemaking Board has recently received inquiries concerning the application of the Board’s confirmation disclosure requirements, which are contained in Board rules G-12 and G-15, to municipal securities with variable or "floating" interest rates.

Rule G-12(c)(v)(E)[*] requires a municipal securities dealer to set forth on an inter-dealer confirmation a description of the securities which are the subject of the transaction, including the interest rate. Rule G-15(a)(i)(E)[*] imposes the same requirement with respect to customer confirmations. The Board is of the view that these provisions require that the security description appearing on customer and inter-dealer confirmations for securities with variable interest rates include a clear indication that the interest rates are variable or "floating."

The Board also notes that due to the variability of the interest rates on these securities, it is not possible to derive a yield to a future call or maturity date. Therefore, the Board has concluded that the provision of rule G-15 which requires that customer confirmations for transactions effected at a dollar price set forth the yield resulting from such dollar price is not applicable to transactions in variable-rate municipal securities.

[*] [Currently codified at rule G-15(a)(1)(B)(4)]

Board rules G-12 on uniform practice and G-15 on customer confirmations set forth certain requirements concerning the computations of yields and dollar prices to premium call or par option features. Both rules currently require that, in the case of a transaction in callable securities effected on the basis of a yield price, the dollar price should be calculated to the lowest of the price to premium call, price to par option, or price to maturity. Further, confirmations of transactions on which the dollar price has been computed to a call or option feature must state the call date and price used in the computation. Amendments to rule G-15 which will become effective on October 1, 1981, generally require that confirmations of transactions in callable securities effected at a dollar price in excess of par must set forth the lowest of the yield to premium call, yield to par option, or yield to maturity resulting from such dollar price.[1]

Since the December 1977 effective dates of rule G-12 and G-15, the Board has received numerous inquiries concerning these provisions and their application to different issues of municipal securities. In view of the general interest in this subject, the Board is issuing this notice to provide guidance with respect to the general criteria to be used in selecting the appropriate call feature for yield or dollar price computations.

The requirement for the computation of dollar price to the lowest of price to premium call, par option, or maturity reflects the long-established practice of the industry in pricing transactions. This practice assures a customer that he or she will realize, at a minimum, the stated yield, even in the event that a call provision is exercised. The pending amendment to rule G-15, which requires the presentation of information concerning the lowest yield on confirmations of dollar price transactions, will provide investors with the equivalent information on these types of transactions.

In view of the variety of call provisions applicable to different kinds of municipal securities, there is often uncertainty concerning the selection of the appropriate call feature for use in the computation of yield or dollar price. Issues of municipal securities often have several different call features, ranging from calls associated with mandatory sinking fund requirements to optional calls from the proceeds of a refunding or funds in excess of debt service requirements. Certain issues have additional call provisions in the event that funds designated for specific purposes are not expended or obligations securing the issue are prepaid.[2] Most of the inquiries which the Board has received concerning the provisions of rules G-12 and G-15 focus on this question of selection of the call provisions to be used for computation purposes.

The Board is of the view that a distinction should be drawn between "in whole" call provisions, (i.e., those under which all outstanding securities of a particular issue may be called) and "in part" call provisions (i.e., those under which part of an issue, usually selected by lot or in inverse maturity or numerical order, may be called for redemption). The Board is of the view that for computation purposes only "in whole" calls should be used; sinking fund calls and other "in part" calls should not be used in making the computations required by rules G-12 and G-15.

Several inquiries have raised the question of which "in whole" call should be used in the case of issues which have more than one such call. The earlier call features of such issues are often subject to restrictions on the proceeds which may be used to redeem securities (e.g., a restriction that only unexpended funds from the original issue may be used for redemption purposes). Since such call features operate as a practical matter as "in part" calls, the Board is of the view that the "in whole" call feature which would be exercised in the event of a refunding is the call feature which should generally be used for purposes of the computation of yields and dollar prices.

Other concerned persons have inquired regarding the application of the "pricing to call" requirements in the case of an issue with a sequence of call dates at gradually declining premiums. The Board believes that, as a general matter, a trial computation to the first date on which a security is callable "in whole" at a premium will be sufficient to determine whether the price to the premium call is the lowest dollar price. However, in the rare instance where the price to an intermediate premium call (i.e., a call in the "middle" of a sequence of calls at declining premiums) is the lowest dollar price, such price should be used. The Board notes that, in such cases, the structure of the call schedule is sufficiently unusual (e.g., with sharp declines in the premium amount over a very short period of time) that dealers should be alerted to the need to take the intermediate calls into consideration.

[1] Effective December 1, 1980, customer confirmations of transactions in callable securities effected at a dollar price less than par must set forth the yield to maturity resulting from such dollar price. Confirmations of dollar-price transactions in non-callable securities, or securities which have been called or prerefunded, must set forth the resulting yield to maturity (or to the date for redemption of the securities, in the case of called or prerefunded securities).

[2] Other issues are also callable in the event that the financed project is damaged or destroyed, or the tax exempt status of the issue is revoked. Since the possibility of such a call being exercised is extremely remote, and beyond the control of the issuer of the securities, the Board does not believe that these "catastrophe" calls need be considered for computation purposes.

Rule G-12(c)(v)(E) requires a municipal securities dealer to set forth on an inter-dealer confirmation a description of the securities which are the subject of the transaction, including "…in the case of revenue bonds the type of revenue, if necessary for a materially complete description of the securities…."

Rule G-15(a)(v) [*] imposes the identical requirement with respect to customer confirmations. The Board has recently received an inquiry regarding whether these provisions require confirmations of transactions in Los Angeles Department of Water and Power bonds to distinguish between bonds secured by revenues of the electric power system and bonds secured by revenues of the waterworks system.

The Board is of the view that, if securities of a particular issuer are secured by separate sources of revenue, the source of revenue of the securities involved in a transaction is a material element of the description of the securities which should be set forth on customer and inter-dealer confirmations. Confirmations of transactions in Los Angeles Department of Water and Power bonds must therefore indicate whether the securities are "electric revenue" or "water revenue" bonds.

[*] [Currently codified at rule G-15 (a)(i)(C)(1)(a)]