Request for Comment on Proposed Rule Amendments and Interpretive Notice on Retail Order Periods

The Municipal Securities Rulemaking Board (“MSRB”) is requesting comment on proposed amendments concerning retail order periods to MSRB Rules G-11 (on primary offering practices), G-8 (on books and records), and G-32 (on disclosures in connection with primary offerings), and a proposed interpretive notice concerning the application of MSRB Rules G-17 and G-30 to retail order periods.  If the MSRB subsequently files the proposed amendments and the proposed interpretive notice with the Securities and Exchange Commission, the MSRB will request that it be given prospective application.

Comments should be submitted no later than April 13, 2012, and may be submitted in electronic or paper form.  Comments may be submitted electronically by clicking here.  Comments submitted in paper form should be sent to Ronald W. Smith, Corporate Secretary, Municipal Securities Rulemaking Board, 1900 Duke Street, Suite 600, Alexandria, VA 22314.  All comments will be available for public inspection on the MSRB’s website.[1]

Questions about this notice should be directed to Kathleen Miles, Associate General Counsel, at 703-797-6600.

BACKGROUND

The MSRB is proposing the amendments and the interpretive notice as part of its mandate to protect municipal entities and investors and in consideration of the prevalence of retail order periods.  Over the last two years, the MSRB has been made aware of various concerns related to retail order periods from issuers, dealers, and municipal advisors.  Those concerns have ranged from concerns about disregard by brokers, dealers, and municipal securities dealers (“dealers”) of terms and conditions required by issuers for retail order periods, to failure of syndicate managers to disseminate timely notice of issuer terms and conditions regarding retail order periods to all dealers, including selling group members, to the use of retail order periods to achieve yields that may be below market.  Enforcement agencies have also requested that the MSRB adopt additional recordkeeping requirements concerning retail order periods to assist in the enforcement of MSRB rules.

The provisions of existing Rule G-11 that cover syndicate practices and management of the syndicate, do not specifically address retail order periods; however, Rule G-11(f) does require that a senior syndicate manager furnish in writing to the other members of the syndicate, a written statement of all terms and conditions required by the issuer.  Also, existing Rule G-11 does not acknowledge selling groups or address a syndicate manager’s duty to members of a selling group that wish to place orders during retail order periods.

Existing Rule G-8 requires that a statement of all terms and conditions required by the issuer (including whether there was a retail order period and the issuer’s definition of “retail”) be included in records maintained by the syndicate manager.  However, Rule G-32 does not contain a mechanism that would alert enforcement agencies that a new issue of securities included a retail order period.

The MSRB also has not provided guidance to those dealers that are not underwriters (e.g., selling group members) regarding the Rule G-17 fair practice obligations of dealers to issuers when conducting retail order periods or the fair practice obligations of dealers placing orders in retail order periods to other dealers.

PROPOSED RULE AMENDMENTS

The proposed amendments to Rule G-11 would include definitions of the terms “going away order,” “selling group,” and “retail order period.”  The definition of the term “retail order period” would make it clear that it is the prerogative of the issuer to establish the definition of “retail” for that purpose.  In addition, the proposed amendments to Rule G-11 would require a senior syndicate manager to furnish in writing to members of the selling group, if any, a written statement of the issuer’s terms and conditions (including any retail order period requirements), the priority provisions, and any subsequent changes to those terms and conditions and priority provisions.   Finally, the proposed amendments to Rule G-11 would require that any dealer placing an order during a retail order period provide, in writing (which could be electronic), the following information regarding each order submitted during the retail order period: (i) whether the order met the issuer’s definition of “retail”; (ii) whether the order was a going away order; (iii) whether the dealer placed more than one order from a single customer for a security for which the same CUSIP number has been assigned; (iv) for any customer who was a natural person, any identifying information required by the issuer in connection with such retail order (but not including customer names or social security numbers); (v) the par amount of the order; and (vi) for any order from a trust department, investment advisor, or firm representing customers with separately managed accounts, the par amount and any identifying information required by the issuer in connection with such retail order (but not including the name or social security number of each natural person to whose account the securities were designated).

The proposed amendments to Rule G-8 would require that the senior syndicate manager maintain a record of the information related to retail orders required by Rule G-11, along with the other information required under existing Rule G-8(a)(viii) relating to syndicate or other primary offering transaction records.

The proposed amendments to Rule G-32 would require an underwriter to report to the MSRB’s Electronic Municipal Market Access (EMMA®)[2] system whether a primary offering of securities included a retail order period and when the retail order period was conducted.[3]

SUMMARY OF PROPOSED INTERPRETIVE NOTICE

The proposed interpretive notice would address the duties of all dealers placing orders in retail order periods, not just underwriters.  The notice would provide that, under Rule G-17, issuers may reasonably expect that all dealers will deal fairly with them by abiding by the terms and conditions established by the issuers for the retail order periods, including the issuers’ respective definitions of “retail.”  The notice would also remind dealers that they have fair practice obligations to other dealers, so that any dealer that submitted an order as a “retail” order when it knew that it was not, or violated any of the other retail order period provisions of Rule G-11, would also violate the fair practice requirements of Rule G-17.  Under the notice, Rule G-17 would also require syndicate managers to provide adequate and timely notice of issuers’ terms and conditions for the retail order period to all dealers permitted by issuers to place orders during retail order periods.  For example, it might be a violation of Rule G-17, if a syndicate manager withheld information regarding retail order periods to provide an advantage to itself or its customers, or to disadvantage other dealers or their customers.

The proposed interpretive notice also would provide that dealers must balance their duty of fair pricing to issuers under Rule G-17 with their duty of fair pricing to customers under Rule G-30(a), when pricing a new issue of securities generally, but in particular when pricing securities that will be sold to retail customers.  It would remind dealers of previous MSRB guidance that, “Large differences between institutional and individual prices that exceed the price/yield variance that normally applies to transactions of different sizes in the primary market provide evidence that the duty of fair pricing to individual clients may not have been met.” An example would be provided of an issue with two CUSIPS for the same maturity, one of which is marketed exclusively to retail customers and the other to institutional customers.

REQUEST FOR COMMENT

The MSRB is requesting comment from the industry and other interested parties on the proposed rule amendments and the proposed interpretive notice set forth below.

The proposed amendments to Rule G-11 would leave the definition of “retail” for purposes of retail order periods to the determination of issuers.  Certain market participants have expressed concern that issuer definitions of “retail” are not uniform and may vary considerably from one another (for example, “retail” may be defined in reference to the par amount of the order rather than the characteristics of the customer), possibly leading to unintended erroneous orders by dealers.  They have also expressed concern that separately-managed accounts are frequently allowed to place orders during the retail order period, while mutual funds are not, despite the fact that fund clients, the indirect owners of the bonds, are often natural persons.  In light of these concerns, the MSRB is also seeking comment on whether it should adopt a uniform definition of “retail” for purposes of its retail order period rules and, if so, what it should be?

March 6, 2012

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TEXT OF PROPOSED AMENDMENT TO RULE G-11 [4]

Rule G-11:  Primary Offering Practices

(a) Definitions. For purposes of this rule, the following terms have the following meanings:

(i) - (vi) No change.

(vii) The term “retail order period” means an order period during which orders will be solicited solely from customers that meet the issuer’s definition of “retail.”

(viii) - (xi) No change.

(xii) The term “going away order” means an order for which a customer is already conditionally committed.

(xiii) The term “selling group” means a group of brokers, dealers, or municipal securities dealers that assist in the distribution of a new issue of municipal securities for the issuer but are not members of the syndicate.

(b) - (e) No change.

(f) Communications Relating to Issuer Syndicate Requirements, Priority Provisions and Order Period.  Prior to the first offer of any securities by a syndicate, the senior syndicate manager shall furnish in writing to the other members of the syndicate and to members of the selling group, if any, (i) a written statement of all terms and conditions required by the issuer (including any retail order period requirements), (ii) the priority provisions, (iii) the procedure, if any, by which such priority provisions may be changed, (iv) if the senior syndicate manager or managers are to be permitted on a case-by-case basis to allocate securities in a manner other than in accordance with the priority provisions, the fact that they are to be permitted to do so, and (v) if there is to be an order period, whether orders may be confirmed prior to the end of the order period.  Any change in the priority provisions shall be promptly furnished in writing by the senior syndicate manager to the other members of the syndicate and the selling group, if any.  Syndicate and selling group members shall promptly furnish in writing the information described in this section to others, upon request. If the senior syndicate manager, rather than the issuer, prepares the written statement of all terms and conditions required by the issuer, such statement shall be provided to the issuer.

(g) - (j) No change.

(k) Retail Order Period Representations and Required Disclosures.  At the end of the retail order period but no later than the Time of Formal Award (as defined in Rule G-34(a)(ii)(C)(1)(a)), each broker, dealer, or municipal securities dealer that submits an order during a retail order period shall provide, in writing, which may be electronic, the following information relating to each order submitted during a retail order period:

(i) whether the order meets the issuer’s definition of “retail”;

(ii) whether the order is a going away order;

(iii) whether the broker, dealer, or municipal securities dealer has received more than one order from a single customer for a security for which the same CUSIP number has been assigned;

(iv) for any customer who is a natural person, any identifying information required by the issuer in connection with such retail order (but not including customer names or social security numbers);

(v) the par amount of the order; and

(vi) for any order from a trust department, investment advisor, or firm representing customers with separately managed accounts, the par amount and any identifying information required by the issuer in connection with such retail order (but not including the name or social security number of each natural person to whose account the securities are designated).

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TEXT OF PROPOSED AMENDMENT TO RULE G-8

Rule G-8:  Books and Records to be Made by Brokers, Dealers and Municipal Securities Dealers

(a) Description of Books and Records Required to be Made. Except as otherwise specifically indicated in this rule, every broker, dealer and municipal securities dealer shall make and keep current the following books and records, to the extent applicable to the business of such broker, dealer or municipal securities dealer:

(i) - (vii) No change.

(viii) Records Concerning Primary Offerings.

(A) For each primary offering for which a syndicate has been formed for the purchase of municipal securities, records shall be maintained by the syndicate manager showing the description and aggregate par value of the securities; the name and percentage of participation of each member of the syndicate; the terms and conditions governing the formation and operation of the syndicate; a statement of all terms and conditions required by the issuer (including whether there was a retail order period and the issuer's definition of "retail," if applicable); all orders received for the purchase of the securities from the syndicate and selling group, if any; the information required to be submitted pursuant to Rule G-11(k); all allotments of securities and the price at which sold; those instances in which the syndicate manager allocated securities in a manner other than in accordance with the priority provisions, including those instances in which the syndicate manager accorded equal or greater priority over other orders to orders by syndicate members for their own accounts or their respective related accounts; and the specific reasons for doing so; the date and amount of any good faith deposit made to the issuer; the date of settlement with the issuer; the date of closing of the account; and a reconciliation of profits and expenses of the account.

(B) No change.

(ix) – (xxiv) No change.

(b) – (g)  No change.

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TEXT OF PROPOSED AMENDMENT TO RULE G-32

Rule G-32: Disclosures in Connection with Primary Offerings

(a) Customer Disclosure Requirements.

(i) No broker, dealer or municipal securities dealer shall sell, whether as [principal or agent,] an underwriter or otherwise, any offered municipal securities to a customer unless such broker, dealer or municipal securities dealer delivers to the customer by no later than the settlement of the transaction a copy of the official statement or, if an official statement is not being prepared, a written notice to that effect together with a copy of a preliminary official statement, if any. 

(ii) – (v)  No change.

(b) Underwriter Submissions to EMMA.

(i) – (iv) No change.

(v) Underwriting Syndicate.  In the event a syndicate or similar account has been formed for the underwriting of a primary offering, the managing underwriter shall take the actions required under the provisions of this rule [and comply with the recordkeeping requirements of Rule G-8(a)(xiii)(B)].

(vi) Procedures for Submitting Documents and Form G-32 Information.

(A) - (B) No change.

(C) The underwriter in any primary offering of municipal securities for which a document or information is required to be submitted to EMMA under this section (b) shall submit such information in a timely and accurate manner as follows:

(1) Form G-32 information submissions pursuant to paragraph (b)(i)(A) hereof with respect to a primary offering shall be:

(a) initiated on or prior to the date of first execution with the submission of CUSIP numbers (except if such CUSIP numbers are not required under Rule G-34 and have not been assigned), initial offering prices or yields (including prices or yields for maturities designated as not reoffered), if applicable, the expected closing date, [and] whether the issuer or other obligated persons have agreed to undertake to provide continuing disclosure information as contemplated by Securities Exchange Act Rule 15c2-12, and if there was a retail order period (as defined in Rule G-11(a)(vii)) as part of a primary offering, the information indicating whether a retail order period was conducted and each date it was conducted, together with such other items of information as set forth in Form G-32 and the EMMA Dataport Manual; and

(b) No change.

(2) - (4) No change.

(D) No change.

(c) No change.

(d) Definitions.  For purposes of this rule, the following terms have the following meanings:

(i) - (xiii) No change.

(xiv)[(xiii)] The term "obligated person" shall mean an obligated person defined in Securities Exchange Act Rule 15c2-12(f)(10).

(e) No change.

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TEXT OF PROPOSED INTERPRETIVE NOTICE

Interpretive Notice Concerning the Application of MSRB Rules G-17 and G-30 to Retail Order Periods

MSRB Rule G-17 (on conduct of municipal securities and municipal advisory activities) provides that, in the conduct of its municipal securities activities, each broker, dealer and municipal securities dealer (“dealer”) shall deal fairly with all persons and shall not engage in any deceptive, dishonest or unfair practice.  MSRB Rule G-30 (on prices and commissions) provides that a dealer purchasing or selling municipal securities from a customer as a principal must do so at an aggregate price (including any mark-down or mark-up) that is fair and reasonable, taking into consideration all relevant factors, including the best judgment of the dealer as to the fair market value of the securities at the time of the transaction.  This interpretive notice expands upon guidance on the application of MSRB Rules G-17 and G-30 to retail order periods previously provided by the MSRB.

Issuer Terms and Conditions for Retail Order Periods

The Board has previously provided guidance to underwriters regarding the Rule G-17 fair practice obligations of underwriters to issuers when conducting retail order periods.  Among other things, the Board has stated that an underwriter may not disregard an issuer’s definition of “retail” or any other terms and conditions imposed by an issuer regarding “retail” orders or retail order periods.[1]

Not all orders placed during retail order periods are placed by underwriters.  In some cases, issuers also permit other dealers (e.g., selling group members (as defined in Rule G-11)) to submit orders.  In such cases, under Rule G-17, issuers may reasonably expect that such other dealers will deal fairly with them by abiding by the terms and conditions established by the issuers for the retail order periods, including but not limited to the issuers’ respective definitions of “retail.”  A dealer that places an order framed as a qualifying retail order during a retail order period that it knows does not meet the terms and conditions for the order period established by the issuer would violate Rule G-17.

Misrepresentations Regarding “Retail” Orders

Issuers sometimes rely on syndicate managers to ensure that orders submitted by other dealers during retail order periods satisfy the issuers’ terms and conditions.  The Board is concerned that some dealers may be misrepresenting their orders as “retail” when communicating with syndicate managers.  The MSRB reminds dealers that the obligation to deal fairly with all persons applies not only to a dealer’s conduct with issuers and customers but also to communications with other dealers.  MSRB Rule G-11 (on primary offering practices) now requires that dealers that submit orders during retail order periods provide certain information, in writing, which may be electronic, including whether an order submitted during a retail order period meets the issuer’s definition of “retail,” whether an order is a “going away” order and supporting materials (i.e., in the case of customers who are natural persons, account numbers and zip codes).  The provision of this information by a dealer constitutes a representation to the senior syndicate manager and if a dealer’s Rule G-11 representations were not accurate, a dealer could, depending upon the facts and circumstances, also violate Rule G-17.

Notice of Retail Order Periods

The Board is concerned that certain dealers permitted by issuers to place orders during retail order periods, including, but not limited to, members of a selling group, may not receive adequate and timely notice of retail order periods from syndicate managers, which has the practical effect of precluding them from placing orders during the retail order period.  Rule G-11(f) has been amended to require the senior syndicate manager to furnish in writing to the other members of the syndicate and to members of the selling group, if any, a written statement of the issuer’s terms and conditions for the retail order period, the priority provisions and any subsequent changes to those terms and conditions and priority provisions.  That statement is required to be provided to members of the selling group, if any, when the senior syndicate manager provides syndicate members with the issuer’s terms and conditions and priority provisions as required under Rule G-11, but no later than the beginning of the retail order period.  In addition, syndicate managers that withhold information regarding retail order periods to provide an advantage to themselves or their customers, or to disadvantage other dealers or their customers, may also violate Rule G-17, depending upon the facts and circumstances.

Retail Order Period Pricing

The MSRB has previously reminded dealers that an issuer’s use of a retail order period based on a perception that the retail order period will improve pricing of the new issue for the issuer does not create a safe harbor for dealers to engage in pricing that violates the fair pricing obligation under Rule G-30.[2]  At the same time, the duty of fair dealing under Rule G-17 includes an implied representation that the price an underwriter pays to an issuer is fair and reasonable, taking into consideration all relevant factors, including the best judgment of the underwriter as to the fair market value of the issue at the time it is priced.  Underwriters must balance the competing interests of issuers and customers when pricing a new issue of securities generally, but in particular when pricing securities that will be sold to retail customers.

During a retail order period, an issuer may require underwriters to make a bona fide public offering to retail customers at the initial offering price for the securities, either directly or through other dealers.  This directive may benefit retail customers because dealer compensation for such sales is typically in the form of an agreed upon takedown, which is negotiated and paid by the issuer, rather than a mark-up paid by the customer.  The Board emphasizes that the duty of fair dealing under Rule G-17 requires that dealers must follow the issuer’s instructions for retail order periods and, if directed to do so by the issuer, make a bona fide public offering of the securities to retail customers at their initial offering prices.

As the MSRB has noted, large differences between institutional and individual prices that exceed the price/yield variance that normally applies to transactions of different sizes in the primary market provide evidence that the duty of fair pricing to individual clients may not have been met.[3]  The Board is aware that in some cases, an issue may have two CUSIPS for the same maturity, one of which is marketed exclusively to retail customers and the other to institutional customers.  If there are significant differences between the price paid by institutional customers and the price paid by retail customers related to the two securities of the same maturity (and the price paid by retail customers is higher), this may suggest that the underwriter’s duty of fair pricing to retail customers under Rule G-30 may not have been met unless the difference in the price is fairly attributable to the actual characteristics of the securities.

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[1] See Interpretation on Priority of Orders for Securities in a Primary Offering under Rule G-17 (October 12, 2010).

[2] See Guidance on Disclosure and Other Sales Practice Obligations to Individual and Other Retail Investors in Municipal Securities (July 14, 2009).

[3] Id.