(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. 

Background

In the municipal securities markets, dealers[1] typically communicate with investors one-on-one, in person, or by telephone. These dealer/customer communications are made to provide the investor with information concerning the municipal securities the dealer wants to sell and to allow the dealer to find out about the customer’s investment objectives. Over the last few years there has been a dramatic increase in the use of the Internet for communication between dealers and their customers. Dealers are looking to the Internet as a mechanism for offering customers new and improved services and for enhancing the efficiency of delivering traditional services to customers. For example, dealers have developed online search tools that computerize the process by which customers can obtain and compare information on the availability of municipal securities of a specific type that are offered for sale by a particular dealer.[2] Technological advancements have provided many benefits to investors and the brokerage industry. These technological innovations, however, also have presented new regulatory challenges, including those arising from the application of the suitability rule to online activities. In consideration of this, the Municipal Securities Rulemaking Board (“MSRB”) is issuing this notice to provide dealers with guidance concerning their obligations under MSRB Rule G-19, relating to suitability of recommendations,[3] in the electronic environment.[4]

Rule G-19 prohibits a dealer from recommending transactions in municipal securities to a customer unless the dealer makes certain determinations with respect to the suitability of the transactions.[5] Specifically, the dealer must have reasonable grounds for believing that the recommendation is suitable based upon information available from the issuer of the security or otherwise and the facts disclosed by the customer or otherwise known about such customer.

As the rule states, a dealer's suitability obligation only applies to securities that the dealer recommends to a customer.[6] A dealer or associated person who simply effects a trade initiated by a customer without a related recommendation from the dealer or associated person is not required to perform a suitability analysis. However, under MSRB Rules, even when a dealer does not recommend a municipal security transaction to a customer but simply effects or executes the transaction, the dealer is obligated to fulfill certain other important fair practice obligations. For example, under Rule G-17, when effecting a municipal security transaction for a customer, a dealer is required to disclose all material facts about a municipal security that are known by the dealer and those that are reasonably accessible.[7] In addition, Rule G-18 requires that each dealer, when executing a municipal securities transaction for or on behalf of a customer as agent, make a reasonable effort to obtain a price for the customer that is fair and reasonable in relation to prevailing market conditions. Similarly, under Rule G-30, if a dealer engages in principal transactions with a customer, the dealer is responsible for ensuring that it is charging a fair and reasonable price. The MSRB wishes to emphasize the importance of these fair practice obligations even when a dealer effects a non-recommended transaction online.[8]

Applicability of the Suitability Rule to Electronic Communications—General Principles  

There has been much debate about the application of the suitability rule to online activities.[9]  Industry commentators and regulators have debated two questions: first, whether the current suitability rule should even apply to online activities, and second, if so, what types of online communications constitute recommendations for purposes of the rule. The NASD published NASD Notice to Members 01-23, Online Suitability-Suitability Rule and Online Communication (the “NASD Online Suitability Notice”) (April 2001) to provide guidance to its members in April 2001.[10] In answer to the first question, the MSRB, like the NASD, believes that the suitability rule applies to all recommendations made by dealers to customers—including those made via electronic means—to purchase, sell, or exchange a security. Electronic communications from dealers to their customers clearly can constitute recommendations. The suitability rule, therefore, remains fully applicable to online activities in those cases where the dealer recommends securities to its customers. 

With regard to the second question, the MSRB does not seek to identify in this notice all of the types of electronic communications that may constitute recommendations. As the MSRB has often emphasized, "[w]hether a particular transaction is in fact recommended depends on an analysis of all the relevant facts and circumstances."[11] That is, the test for determining whether any communication (electronic or traditional) constitutes a recommendation remains a "facts and circumstances" inquiry to be conducted on a case-by-case basis. 

The MSRB also recognizes that many forms of electronic communications defy easy characterization. The MSRB believes this is especially true in the online municipal securities market, which is in a relatively early stage of development. Nevertheless, the MSRB offers as guidance the following general principles for dealers to use in determining whether a particular communication could be deemed a recommendation.[12] The "facts and circumstances" determination of whether a communication is a recommendation requires an analysis of the content, context, and presentation of the particular communication or set of communications. The determination of whether a recommendation has been made, moreover, is an objective rather than a subjective inquiry. An important factor in this regard is whether—given its content, context, and manner of presentation—a particular communication from a dealer to a customer reasonably would be viewed as a "call to action," or suggestion that the customer engage in a securities transaction. Dealers should bear in mind that an analysis of the content, context, and manner of presentation of a communication requires examination of the underlying substantive information transmitted to the customer and consideration of any other facts and circumstances, such as any accompanying explanatory message from the dealer.[13] Another principle that dealers should keep in mind is that, in general, the more individually tailored the communication is to a specific customer or a targeted group of customers about a security or group of securities, the greater the likelihood is that the communication may be viewed as a recommendation.

Scope of the Term Recommendation

As noted earlier, the MSRB agrees with and has in this guidance adopted the general principles enunciated in the NASD Online Suitability Notice as well as the NASD guidelines for evaluating suitability obligations discussed below. While the MSRB believes that the additional examples of communications that do not constitute recommendations provided by the NASD in its Online Suitability Notice are useful instruction for dealers who develop equity trading web sites, as the examples are based upon communications that exist with great regularity in the Nasdaq market, the MSRB believes that the examples have limited application to the types of information and electronic trading systems that are present in the municipal securities market. 

For example, the NASD’s third example of a communication that is not a recommendation describes a system that permits customer-directed searches of a “wide-universe” of securities and references all exchange-listed or Nasdaq securities, or externally recognized indexes.[14] The NASD example therefore applies to dealer web sites that effectively allow customers to request lists of securities that meet broad objective criteria from a list of all the securities available on an exchange or Nasdaq. These are examples of groups of securities in which the dealer does not exercise any discretion as to which securities are contained within the group of securities shown to customers. This example makes sense in the equity market where there are centralized exchanges and where electronic trading platforms routinely utilize databases that provide customer access to all of the approximately 7,300 listed securities on Nasdaq, the NYSE and Amex. However, no dealer in the municipal securities market has the ability to offer all of the approximately 1.3 million outstanding municipal securities for sale or purchase. The municipal securities market is a fragmented dealer market. Municipal securities do not trade through a centralized exchange and only a small number of securities (approximately 10,000) trade at all on any given day. Therefore, there is no comparable central exchange that could serve as a reference point for a database that is used in connection with municipal securities research engines. The databases used by dealer systems typically are limited to the municipal securities that a dealer, or a consortium of dealers, holds in inventory. In these types of systems the customer’s ability to search for desirable securities that meet the broad, objective criteria chosen by the customer (e.g., all insured investment grade general obligation bonds offered by a particular state) is limited. The concept of a wide universe of securities, which is central to all of the NASD’s examples, is thus difficult to define and has extremely limited, or no, application in the municipal securities market. 

Given the distinct features of the municipal securities market and the existing online trading systems, the MSRB believes it would be impractical to attempt to define the features of an electronic trading system that would have to be present for the system transactions to not be considered the result of a dealer recommendation. The online trading systems for municipal securities that are in place today limit customer choices to the inventory that the dealer or dealer consortium hold, and therefore, the dealer will always have a significant degree of discretion over the securities offered to the customer. A system that allows this degree of dealer discretion is a dramatic departure from the types of no recommendation examples provided by the NASD guidance, and thus, these communications must be carefully analyzed to determine whether or not a recommendation has been made.  

 The MSRB, however, does believe that the examples of communications that are recommendations provided in the NASD Online Suitability Notice are communications that take place in the municipal securities market. Therefore, the MSRB has adopted these examples and generally would view the following communications as falling within the definition of recommendation:

• A dealer sends a customer-specific electronic communication (e.g., an e-mail or pop-up screen) to a targeted customer or targeted group of customers encouraging the particular customer(s) to purchase a municipal security.[15]
• A dealer sends its customers an e-mail stating that customers should be invested in municipal securities from a particular state or municipal securities backed by a particular sector (such as higher education) and urges customers to purchase one or more stocks from a list with "buy" recommendations.
• A dealer provides a portfolio analysis tool that allows a customer to indicate an investment goal and input personalized information such as age, financial condition, and risk tolerance. The dealer in this instance then sends (or displays to) the customer a list of specific municipal securities the customer could buy or sell to meet the investment goal the customer has indicated.[16]
• A dealer uses data-mining technology (the electronic collection of information on Web Site users) to analyze a customer's financial or online activity—whether or not known by the customer—and then, based on those observations, sends (or "pushes") specific investment suggestions that the customer purchase or sell a municipal security.

Dealers should keep in mind that these examples are meant only to provide guidance and are not an exhaustive list of communications that the MSRB does consider to be recommendations. As stated earlier, many other types of electronic communications are not easily characterized. In addition, changes to the factual predicates upon which these examples are based (or the existence of additional factors) could alter the determination of whether similar communications may or may not be viewed as recommendations. Dealers, therefore, should analyze all relevant facts and circumstances, bearing in mind the general principles noted earlier and discussed below, to determine whether a communication is a recommendation, and they should take the necessary steps to fulfill their suitability obligations. Furthermore, these examples are based on technological services that are currently used in the marketplace. They are not intended to direct or limit the future development of delivery methods or products and services provided online.  

Guidelines for Evaluating Suitability Obligations 

Dealers should consider, at a minimum, the following guidelines when evaluating their suitability obligations with respect to municipal securities transactions.[17] None of these guidelines is determinative of whether a recommendation exists. However, each should be considered in evaluating all of the facts and circumstances surrounding the communication and transaction.

• A dealer cannot avoid or discharge its suitability obligation through a disclaimer where the particular communication reasonably would be viewed as a recommendation given its content, context, and presentation.[18] The MSRB, however, encourages dealers to include on their web sites (and in other means of communication with their customers) clear explanations of the use and limitations of tools offered on those sites.[19]   
• Dealers should analyze any communication about a security that reasonably could be viewed as a "call to action" and that they direct, or appear to direct, to a particular individual or targeted group of individuals—as opposed to statements that are generally made available to all customers or the public at large—to determine whether a recommendation is being made.[20]
• Dealers should scrutinize any communication to a customer that suggests the purchase, sale, or exchange of a municipal security—as opposed to simply providing objective data about a security—to determine whether a recommendation is being made.[21] 
• A dealer's transmission of unrequested information will not necessarily constitute a recommendation. However, when a dealer decides to send a particular customer unrequested information about a security that is not of a generalized or administrative nature (e.g., notification of an official communication), the dealer should carefully review the circumstances under which the information is being provided, the manner in which the information is delivered to the customer, the content of the communication, and the original source of the information. The dealer should perform this review regardless of whether the decision to send the information is made by a representative employed by the dealer or by a computer software program used by the dealer.
• Dealers should be aware that the degree to which the communication reasonably would influence an investor to trade a particular municipal security or group of municipal securities—either through the context or manner of presentation or the language used in the communication—may be considered in determining whether a recommendation is being made to the customer.

The MSRB emphasizes that the factors listed above are guidelines that may assist dealers in complying with the suitability rule. Again, the presence or absence of any of these factors does not by itself control whether a recommendation has been made or whether the dealer has complied with the suitability rule. Such determinations can be made only on a case-by-case basis taking into account all of the relevant facts and circumstances.

Conclusion

The foregoing discussion highlights some suggested principles and guidelines to assist in determining when electronic communications constitute recommendations, thereby triggering application of the MSRB's suitability rule. The MSRB acknowledges the numerous benefits that may be realized by dealers and their customers as a result of the Internet and online brokerage services. The MSRB emphasizes that it neither takes a position on, nor seeks to influence, any dealer's or customer's choice of a particular business model in this electronic environment. At the same time, however, the MSRB urges dealers both to consider carefully whether suitability requirements are adequately being addressed when implementing new services and to remember that customers' best interests must continue to be of paramount importance in any setting, traditional or online.

As new technologies and/or services evolve, the MSRB will continue to work with regulators, members of the industry and the public on these and other important issues that arise in the online trading environment.

[1] The term “dealer” is used in this notice as shorthand for “broker,” “dealer” or “municipal securities dealer,” as those terms are defined in the Securities Exchange Act of 1934. The use of the term in this notice does not imply that the entity is necessarily taking a principal position in a municipal security.

[2] The Bond Market Association’s (“TBMA”) 2001 Review of Electronic Transaction Systems found that at the end of 2001, there were at least 23 systems based in the United States that allow dealers or institutional investors to buy or sell municipal securities electronically compared to just 3 such systems in 1997. While dealers are also developing electronic trading platforms that allow retail customers to buy or sell municipal securities online, the development of online retail trading systems for municipal securities lags far behind that for equities.

[3] Rule G-19 provides in pertinent part:

(c) Suitability of Recommendations. In recommending to a customer any municipal security transaction, a [dealer] shall have reasonable grounds:

(i) based upon information available from the issuer of the security or otherwise, and

(ii) based upon the facts disclosed by such customer or otherwise known about such customer for believing that the recommendation is suitable.

[4] Although the focus of this notice is on the application of the suitability rule to electronic communications, much of the discussion is also relevant to more traditional communications, such as discussions made in person, over the telephone, or through postal mail.

[5] This notice focuses on customer-specific suitability under Rule G-19. Under Rule G-19, a dealer must also have a reasonable basis to believe that the recommendation could be suitable for at least some customers. See e.g., Rule G-19 Interpretation—Notice Concerning the Application of Suitability Requirements to Investment Seminars and Customer Inquiries Made in Response to a Dealer’s Advertisement, May 7, 1985, MSRB Rule Book (July 1, 2002) at 143; In re F.J. Kaufman and Company of Virginia, 50 S.E.C. 164, 168, 1989 SEC LEXIS 2376, *10 (1989) (the “reasonable basis” obligation relates only to the particular recommendation, rather than to any particular customer). The SEC, in its discussion of municipal underwriters’ responsibilities in a 1988 Release, noted that “a broker-dealer recommending securities to investors implies by its recommendation that it has an adequate basis for the recommendation.” Municipal Securities Disclosure, Securities Exchange Act Release No. 26100 (September 22, 1988) (the “1988 SEC Release”) at text accompanying note 72.

[6] Similarly, the suitability rule does not apply where a dealer merely gathers information on a particular customer, but does not make any recommendations. This is true even if the information is the type of information generally gathered to satisfy a suitability obligation. Dealers should nonetheless remember that regardless of any determination of whether the dealer is making a recommendation and subject to the suitability requirement, the dealer is required to make reasonable efforts to obtain certain customer specific information pursuant to rule G-8 (a)(xi) so that dealers can protect themselves and the integrity of the securities markets from customers who do not have the financial means to pay for transactions.

[7] See Rule G-17 Interpretation—Notice Regarding Rule G-17, on Disclosure of Material Facts, March 20, 2002, MSRB Rule Book (July 1, 2002) at 135.

[8] On April 30, 2002, the Securities and Exchange Commission (“SEC”) approved a proposed rule change relating to the manner in which dealers fulfill their fair practice obligations to certain institutional customers.  Release No. 34-45849 (April 30, 2002), 67 FR 30743.  See Rule G-17 Interpretation—Notice Regarding the Application of MSRB Rules to Transactions With Sophisticated Municipal Market Professionals (“SMMPs”) (the “SMMP Notice”), MSRB Rule Book (July 1, 2002) at 136. The SMMP Notice recognizes the different capabilities of SMMPs and retail or non-sophisticated institutional customers and provides that dealers may consider the nature of the institutional customer when determining what specific actions are necessary to meet the dealer’s fair practice obligations to such customers. The SMMP Notice provides that, while it is difficult to define in advance the scope of a dealer’s fair practice obligations with respect to a particular transaction, by making a reasonable determination that an institutional customer is an SMMP, then certain of the dealer’s fair practice obligations remain applicable but are deemed fulfilled.

[9] See generally Report of Commissioner Laura S. Unger to the SEC, On-Line Brokerage: Keeping Apace of Cyberspace, at n. 64 (Nov. 1999) (“Unger Report”) (discussing various views espoused by online brokerage firms, regulators and academics on the topic of online suitability); Developments in the Law—The Law of Cyberspace, 112 Harv. L. Rev. 1574, 1582-83 (1999) (The article highlights the broader debate by academics and judges over whether "to apply conventional models of regulation to the Internet.").

[10] The guidance contained in this notice is intended to be consistent with the general statements and guidelines contained in the NASD Online Suitability Notice. 

[11] See e.g., Rule G-19 Interpretive Letter dated February 17, 1998, MSRB Rule Book (July 1, 2002) at 144.

[12] These general principles were first enunciated in the NASD Online Suitability Notice.

[13] For example, if a dealer transmitted a rating agency research report to a customer at the customer's request, that communication may not be subject to the suitability rule; whereas, if the same dealer transmitted the very same research report with an accompanying message, either oral or written, that the customer should act on the report, the suitability analysis would be different.

[14] NASD Online Suitability Notice at 3.

[15] Note that there are instances where sending a customer an electronic communication that highlights a particular municipal security (or securities) will not be viewed as a recommendation. For instance, while each case requires an analysis of the particular facts and circumstances, a dealer generally would not be viewed as making a recommendation when, pursuant to a customer's request, it sends the customer (1) electronic "alerts" (such as account activity alerts, market alerts, or rating agency changes) or (2) research announcements (e.g., sector reports) that are not tailored to the individual customer, as long as neither—given their content, context, and manner of presentation—would lead a customer reasonably to believe that the dealer is suggesting that the customer take action in response to the communication.

[16] Note, however, that a portfolio analysis tool that merely generates a suggested mix of general classes of financial assets (e.g., 60 percent equities, 20 percent bonds, and 20 percent cash equivalents), without an accompanying list of securities that the customer could purchase to achieve that allocation, would not trigger a suitability obligation. On the other hand, a series of actions which may not constitute recommendations when considered individually, may amount to a recommendation when considered in the aggregate. For example, a portfolio allocator's suggestion that a customer could alter his or her current mix of investments followed by provision of a list of municipal securities that could be purchased or sold to accomplish the alteration could be a recommendation. Again, however, the determination of whether a portfolio analysis tool's communication constitutes a recommendation will depend on the content, context, and presentation of the communication or series of communications.

[17] These guidelines were originally set forth in the NASD Online Suitability Notice.

[18] Although a dealer cannot disclaim away its suitability obligation, informing customers that generalized information provided is not based on the customer's particular financial situation or needs may help clarify that the information provided is not meant to be a recommendation to the customer. Whether the communication is in fact a recommendation would still depend on the content, context, and presentation of the communication. Accordingly, a dealer that sends a customer or group of customers information about a security might include a statement that the dealer is not providing the information based on the customers' particular financial situation or needs. Dealers may properly disclose to customers that the opinions or recommendations expressed in research do not take into account individual investors' circumstances and are not intended to represent recommendations by the dealer of particular municipal securities to particular customers. Dealers, however, should refer to previous guidelines issued by the SEC that may be relevant to these and/or related topics. For instance, the SEC has issued guidelines regarding whether and under what circumstances third-party information is attributable to an issuer, and the SEC noted that the guidance also may be relevant regarding the responsibilities of dealers. See SEC Guidance on the Use of Electronic Media, Release Nos. 34-7856, 34-42728, IC-24426, 65 Fed. Reg. 25843 at 25848-25849 (April 28, 2000).

[19] The MSRB believes that a dealer should, at a minimum, clearly explain the limitations of its search engine and the decentralized nature of the municipal securities market. The dealer should also clearly explain that securities that meet the customer’s search criteria might be available from other sources.

[20] The MSRB notes that there are circumstances where the act of sending a communication to a specific group of customers will not necessarily implicate the suitability rule. For instance, a dealer's business decision to provide only certain types of investment information (e.g., research reports) to a category of "premium" customers would not, without more, trigger application of the suitability rule. Conversely, dealers may incur suitability obligations when they send a communication to a large group of customers urging those customers to invest in a municipal security.

[21] As with the other general guidelines discussed in this notice, the presence of this factor alone does not automatically mean that a recommendation has been made. 

The MSRB understands that an issuer [of municipal fund securities] may make minor modifications to the official statement in order to correct typographical or grammatical errors, or to make such other modifications that the issuer may deem to be immaterial.  If the issuer has acknowledged in writing to the primary distributor that it does not consider such modification to be material to investors and does not believe that such modification is required to make the statements in the official statement not misleading, then the modification need not be sent by a dealer to a customer that has previously received the official statement, notwithstanding the provisions of Rule G-32(a)(i).[1]  The primary distributor must maintain the issuer’s written acknowledgement under Rule G-8(a)(xiii), relating to records concerning deliveries of official statements.  The primary distributor must send all amendments, regardless of materiality, to the MSRB under Rule G-36.

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ENDNOTES

[*] [This interpretation is an excerpt from “Application of Fair Practice and Advertising Rules to Municipal Fund Securities,” May 14, 2002.  The remaining portions of the 2002 interpretation have been superseded by other interpretations and rule changes.]

[1] Rule G-32(a)(i) requires delivery of an official statement to a customer purchasing municipal fund securities by settlement of the transaction.  In the case of a repeat purchaser who has already received the official statement, dealers generally are required to deliver any amendments or supplements to the official statement in connection with subsequent purchases of the securities. [footnote has been renumbered]

Rule G-37, on political contributions and prohibitions on municipal securities business, prohibits any broker, dealer or municipal securities dealer (a "dealer") from engaging in municipal securities business with an issuer within two years after any contribution (other than certain de minimis contributions) to an official of such issuer made by: (i) the dealer; (ii) any municipal finance professional associated with such dealer; or (iii) any political action committee controlled by the dealer or any municipal finance professional. The Municipal Securities Rulemaking Board ("MSRB") has received inquiries regarding the effect of a ban on municipal securities business with an issuer arising from a contribution made after a dealer has entered into a long-term contract to serve as the primary distributor of the issuer's municipal fund securities.

In an interpretive notice published in 1997 (the "1997 Interpretation"), the MSRB stated that a dealer subject to a prohibition on municipal securities business with an issuer is allowed to continue to execute certain issue-specific contractual obligations in effect prior to the date of the contribution that caused the prohibition.[1] For example, dealers that had already executed a contract with the issuer to serve as underwriter or financial advisor for a new issue of debt securities prior to the contribution could continue in these capacities.

The 1997 Interpretation also addressed certain types of on-going, non-issue-specific municipal securities business that a dealer may have contracted with an issuer to perform prior to the making of a contribution that causes a prohibition on municipal securities business with the issuer. For example, the MSRB noted that a dealer may act as remarketing agent for an outstanding issue of municipal securities or may continue to underwrite a specific commercial paper program so long as the contract for such services was in effect prior to the contribution. The MSRB stated that these activities are not considered new municipal securities business and may be performed by dealers that are banned from municipal securities business with an issuer. The MSRB further stated, however, that provisions in existing contracts that allow for changes in the services provided by the dealer or compensation paid by the issuer would be viewed by the MSRB as new municipal securities business and, therefore, rule G-37 would preclude a dealer subject to a ban on municipal securities business from performing such additional functions or receiving additional compensation. The MSRB cited two examples of these types of provisions. The first involved a contract to serve as remarketing agent for a variable rate issue that might permit a fixed rate conversion, with a concomitant increase in the per bond compensation. The second example involved an agreement to underwrite a commercial paper program that might include terms for increasing the size of the program, with no increase in per bond fees but an increase in overall compensation resulting from the larger outstanding balance of commercial paper. In both cases, the MSRB viewed the exercise of these provisions as new municipal securities business that would be banned under the rule.

In the 1997 Interpretation, the MSRB recognized that there is great variety in the terms of agreements regarding municipal securities business and that its guidance in the 1997 Interpretation may not adequately deal with all such agreements. The MSRB sought input on other situations where contracts obligate dealers to perform various types of activities after the date of a contribution that triggers a ban on municipal securities business and stated that additional interpretations might be issued based upon such input.

The MSRB understands that dealers typically are selected by issuers to serve as primary distributors of municipal fund securities on terms that differ significantly from those of a dealer selected to underwrite an issue of debt securities. Issuers generally enter into long-term agreements (in many cases with terms of ten years or longer) with the primary distributor of municipal fund securities for services that include the sale in a continuous primary offering of one or more categories or classes of the securities issued within the framework of a single program of investments.[2] In addition, an issuer may often engage a particular dealer to serve as the primary distributor of its municipal fund securities as part of a team of professionals that includes the dealer's affiliated investment management firm, which is charged with managing the investment of the underlying portfolios.

The MSRB believes that the guidance provided in the 1997 Interpretation, although appropriate for the circumstances discussed therein, may not be adequate to address the unique features of municipal fund securities programs. For example, so long as a program realizes net in-flows of investor cash, the size of an offering of municipal fund securities will necessarily increase over time. Under most compensation arrangements in the market, any net in-flow of cash generally would result in an increase in total compensation, causing any new sales of municipal fund securities that exceed redemptions to be considered new municipal securities business under the 1997 Interpretation. Also, the addition by the issuer of a new category of investments (e.g., a new portfolio in an aged-based Section 529 college savings plan created for children born in the most recent year) could be considered a new offering from which such dealer might be banned, even where such new category may have been clearly contemplated at the outset of the dealer's engagement. Further, the MSRB understands that the repercussions to an issuer of municipal fund securities or investors in such securities of a sudden change in the primary distributor (and possible concurrent change in the investment manager) resulting from a ban on municipal securities business arising during the term of an existing arrangement often will be significantly greater than in the case of an underwriting or other primary market activity relating to the typical debt offering. Issuers could be faced with redesigning existing programs and investors may need to establish new relationships with different dealers in order to maintain their investments.

As a result, the MSRB believes that further interpretive guidance is necessary in this area. The MSRB is of the view that, where a dealer has become subject to a ban on municipal securities business with an issuer of municipal fund securities with which it is currently serving as primary distributor, any continued sales of existing categories of municipal fund securities for such issuer during the duration of the ban would not be considered new municipal securities business if the basis for determining compensation does not change during that period, even if total compensation increases as a result of net in-flows of cash. Further, the MSRB believes that any changes in the services to be provided by the dealer to the issuer throughout the duration of the ban that are contemplated under the pre-existing contractual arrangement (e.g., the addition of new categories of securities within the framework of the existing program) would not be considered new municipal securities business so long as such changes do not result in: (1) an increase in total compensation received by the dealer for services performed for the duration of the ban (whether paid during the ban or as a deferred payment after the ban); or (2) in an extension of the term of the dealer in its current role.

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