Request for Comment on Revised Draft Rule Amendments and a Revised Draft Interpretive Notice on Retail Order Periods

The Municipal Securities Rulemaking Board (“MSRB”) is requesting comment on a revised draft proposal concerning retail order periods under 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 draft interpretive notice concerning the application of MSRB Rules G-17 and G-30 to retail order periods (the “Revised Draft Proposal”).  As described below, the MSRB previously sought comment on an initial draft proposal on retail order periods and the Revised Draft Proposal reflects certain modifications made to such initial draft proposal based on the comments received from industry participants, as discussed below.

Comments should be submitted no later than November 2, 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.

INITIAL DRAFT PROPOSAL

On March 6, 2012, the MSRB published MSRB Notice 2012-13 in which it requested comment on draft amendments to Rules G-11, G-8 and G-32, as well as on a draft interpretive notice concerning the application of MSRB Rules G-17 and G-30 to retail order periods (the “Initial Draft Proposal”).

The Initial Draft Proposal sought to ensure that brokers, dealers and municipal securities dealers (“dealers”) acting as underwriters for new issues in which the issuer seeks to conduct a retail order period in fact honor the expectations and requirements of issuers with respect to how such retail order period is conducted.  Under the Initial Draft Proposal, Rule G-11(a) would have been amended to define a “retail order period” as an order period during which orders are solicited solely from customers meeting the issuer’s definition of “retail,” making it clear that it is the prerogative of the issuer to establish the definition of “retail” for that purpose.

Under the Initial Draft Proposal, Rule G-11(a) also would have been amended to define a “selling group” as a group of dealers that assist in the distribution of a new issue of municipal securities for the issuer but are not members of the syndicate because certain provisions of the Initial Draft Proposal would have been extended to also apply in cases where a selling group participates in the distribution of a new issue of municipal securities.  Thus, Rule G-11(f) would have been amended to 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, the priority provisions, and any subsequent changes to those terms and conditions and priority provisions, just as such information currently is required to be provided to syndicate members.  The amended rule would provide explicitly that any applicable retail order period requirements would be included in the issuer’s terms and conditions that must be furnished under the rule.

Finally, Rule G-11 would have been amended to add a new section (k), which 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, which would have been defined under amended Rule G-11(a)(xii) as an order for which a customer is already conditionally committed; (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 draft amendments to Rule G-8 would have required 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.

Rule G-32(b)(vi)(C)(1)(a) would have been amended to 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]

The draft interpretive notice would have addressed the duties of all dealers placing orders in retail order periods, not just underwriters.  The notice would have provided 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 have 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 draft notice, Rule G-17 would also have required 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 draft interpretive notice also would have provided 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 have reminded 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.

REVISED DRAFT PROPOSAL

The Board received comments on the Initial Draft Proposal from 14 commenters.  After reviewing the comments, the MSRB decided to request further comment in the form of the Revised Draft Proposal.  The Revised Draft Proposal modifies certain draft provisions of Rule G-11, Rule G-8, and the draft interpretive notice under the Initial Draft Proposal but does not further revise the draft provisions of Rule G-32 under the Initial Draft Proposal.  The modifications to the Initial Draft Proposal are summarized below, together with discussions of certain matters raised by the commenters.[4]

Definition of “Retail.”  Many commenters recommended that the MSRB establish a definition of “retail” that would be used if an issuer determined to conduct a retail order period or, in the alternative, create a standard definition of “retail” with the option provided to issuers to create their own definition in lieu of the standard. The MSRB has declined to make this change, in part because it is concerned that if it defined “retail” it may unduly influence certain issuers’ decision as to what should be included in, or excluded from, the definition.  Rather, the MSRB believes that an issuer, in conjunction with its financial advisor, should have the flexibility to define “retail” on an issue-by-issue basis so that it selects the definition that suits its unique circumstances.  The MSRB would consider producing educational materials that may benefit those issuers who do not have sufficient expertise or who do not engage a financial advisor.

Selling Group Definition.  One commenter suggested that the definition of selling group in the Initial Draft Proposal is overly broad.  The MSRB has revised the term to refer to a group of dealers that would be formed to assist in the distribution of a new issue of municipal securities.  Under Revised Draft Rule G-11(a)(xiii), the term “selling group” would mean, for purposes of this rule, a group of dealers formed to assist in the distribution of a new issue of municipal securities for the issuer other than members of the syndicate.  

Communication of Information to Syndicate and Selling Group Members.  One commenter suggested that pricing terms should also be communicated to the syndicate before the beginning of the retail order period.  The MSRB agrees that pricing information is meaningful and should be made available to syndicate and any selling group members prior to the marketing of any securities. Revised Draft Rule G-11(f) would provide that a senior syndicate manager would be required to communicate all pricing information to other members of the syndicate and to members of the selling group. 

The MSRB believes that underwriters that have entered into so-called “distribution agreements” or “marketing arrangements” to support their distribution capabilities should be required to disseminate the information provided to them to the dealers with whom they have contracted, and that such dissemination should be the obligation of the underwriter having such arrangement rather than the senior syndicate manager because senior syndicate managers may not be aware of or familiar with the provisions contained in these agreements.  Accordingly, under Revised Draft Rule G-11(f), an underwriter would be required to furnish in writing to any other dealer with which such underwriter has an arrangement to market municipal securities that includes the issuer’s new issue, all of the information provided to it from the senior syndicate manager as required by Rule G-11(f).

Some commenters recommended that the MSRB consider setting a specific time frame in which the syndicate manager must provide issuer terms and conditions for the retail order period to other dealers and the MSRB also establish a minimum time length for the retail order period.  The MSRB has declined to do so based on concerns that establishing a fixed time frame could give rise to issues in the context of offerings that must come to market quickly and that a one-size-fits-all approach to the length of the retail order period may not address the specific needs and objectives of an issuer. The issuer should be in the best position to determine how the retail order period should be conducted and whether its objectives have been fulfilled.[5]

Customer Information.  One commenter does not think it is warranted to require dealers to share customer specific information regarding each order submitted during the retail order period with syndicate managers.  The MSRB has not made any changes to the information dealers would be required to provide, although the draft rule language has been simplified in the Revised Draft Proposal and modified to recognize that senior syndicate managers may sometimes assist issuers in determining what information is required.  The MSRB would not specify or limit the type of identifying information that either an issuer, or senior syndicate manager on behalf of the issuer, may require (other than customer names or social security numbers) in order to verify whether retail orders are bona fide.  Revised Draft Rule G-11(l)(iv)[6] would require that each dealer that submits an order during the retail order period would also  provide, in connection with such retail order, any identifying information required by the issuer, or the senior syndicate manager on the issuer’s behalf.

One commenter suggested that the MSRB create a safe harbor for senior syndicate managers so that senior managers would satisfy their own fair dealing obligations to the issuer when relying on representations made to them by other dealers that orders they submitted are retail orders.  The MSRB agrees that, subject to certain exceptions, senior syndicate managers may be permitted to rely on representations made to them by other dealers.  Revised Draft Rule G-11(l) would provide that the senior syndicate manager may rely on the information furnished by each dealer placing orders during a retail order period unless the senior syndicate manager knows, or has reason to know, that the information is not true, accurate or complete.

Recordkeeping.  One commenter sought clarification as to whether the recordkeeping requirements included in the Initial Draft Proposal were intended to apply to a sole managed deal.  The MSRB agrees that the requirement to maintain records of the customer information provided in a retail order period should apply to an underwriting that included a syndicate as well as to a sole managed underwriting, and the Revised Draft Proposal would include a draft amendment to Rule G-8(a)(viii)(B) to this effect.  In addition, the draft amendments to Rule G-8(a)(viii)(A) would be revised to also require that the syndicate manager (in the case of a primary offering for which a syndicate has been formed) maintain records of all pricing information required to be distributed pursuant to Revised Draft Rule G-11(f). 

One commenter suggested that the recordkeeping requirements included in the Initial Draft Proposal would be duplicative of recordkeeping requirements already imposed upon dealers.  MSRB Rule G-8(a)(vii) (dealer records for transactions as a principal) provides that the dealer keep a record of the customer’s order, but only in the event of a purchase or sale of municipal securities (i.e., if the order is filled). The Initial Draft Proposal would require that the records of all orders received be maintained by the syndicate manager (regardless of whether an order is filled) including information that would be required by Draft Rule G-11 (l).

Draft Interpretive Notice.  The MSRB has determined to revise the draft interpretive notice to limit its focus to retail order period pricing, in light of other guidance provided by the MSRB[7] and the revisions made to the draft amendments described above.

REQUEST FOR COMMENTS

The MSRB requests comments on the Revised Draft Proposal.  In addition, the MSRB seeks comments on the following specific matters:

• Should a dealer who may seek to assist the issuer in formulating a definition of retail be required to disclose any interests or motivations on the part of such dealer related to such definition?  Should a dealer have any obligation to advise an issuer if the dealer believes that the issuer’s definition of retail is not appropriate for the issuer?

• Would the Revised Draft Proposal effectively further the MSRB’s objective of protecting issuers and retail investors?

• Would any aspects of the Revised Draft Proposal have a negative effect on the protection of issuers, retail investors or the public interest, or on the fair and efficient operation of the municipal securities market?

• What would be the incremental additional burden, if any, to dealers resulting from the Revised Draft Proposal beyond the existing burden of compliance with Rule G-11?

• Are there alternative methods the MSRB should consider to providing the protections sought under the Revised Draft Proposal that would be more effective and/or less burdensome?

October 2, 2012

* * * * *

TEXT OF REVISED DRAFT AMENDMENTS TO RULE G-11[8]

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, for purposes of this rule, a group of brokers, dealers, or municipal securities dealers formed for the purpose of assisting in the distribution of a new issue of municipal securities for the issuer other than 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, and (vi) all pricing information.  Any change in the priority provisions or pricing information 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.  An underwriter shall promptly furnish in writing to any other broker, dealer, or municipal securities dealer with which such underwriter has an arrangement to market municipal securities that includes the issuer’s new issue, all of the information provided to it from the senior syndicate manager as required by this section.

(g)  No change.

(h)  Disclosure of Syndicate Expenses and Other Information.  At or before the final settlement of a syndicate account, the senior syndicate manager shall furnish to the other members of the syndicate:

(i)  an itemized statement setting forth the nature and amounts of all actual expenses incurred on behalf of the syndicate.  Notwithstanding the foregoing, any such statement may include an item for miscellaneous expenses, provided that the amount shown under such item is not disproportionately large in relation to other items of expense shown on the statement and includes only minor items of expense which cannot be easily categorized elsewhere in the statement.  The amount of discretionary Discretionary fees for clearance costs to be imposed by a syndicate manager and the amount of management fees shall be disclosed to syndicate members prior to the submission of a bid, in the case of a competitive sale, or prior to the execution of a purchase contract with the issuer, in the case of a negotiated sale.  For purposes of this section, the term "management fees" shall include, in addition to amounts categorized as management fees by the syndicate manager, any amount to be realized by a syndicate manager, and not shared with the other members of the syndicate, which is attributable to the difference in price to be paid to an issuer for the purchase of a new issue of municipal securities and the price at which such securities are to be delivered by the syndicate manager to the members of the syndicate; and

(ii)  No change.

(i)-(j)  No change.

(k)  [Reserved]

(l)  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)  any identifying information required by the issuer, or the senior syndicate manager on the issuer’s behalf, in connection with such retail order (but not including customer names or social security numbers); and

(v)  the par amount of the order.

The senior syndicate manager may rely on the  information furnished by each broker, dealer, or municipal securities dealer that provided the information required by (i)-(v) unless the senior syndicate manager knows, or has reason to know, that the information is not true, accurate or complete.

* * * * *

TEXT OF REVISED DRAFT AMENDMENTS 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(l); all pricing information required to be distributed pursuant to Rule G-11(f); 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)  For each primary offering for which a syndicate has not been formed for the purchase of municipal securities, records shall be maintained by the sole underwriter showing the description and aggregate par value of the securities; 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 underwriter; the information required to be submitted pursuant to Rule G-11(l); all allotments of securities and the price at which sold; those instances in which the underwriter accorded equal or greater priority over other orders to orders for its own account or its related accounts, and the specific reasons for doing so; the date and amount of any good faith deposit made to the issuer; and the date of settlement with the issuer. 

(ix)-(xxiv)  No change.

(b)-(g)  No change.

* * * * *

TEXT OF DRAFT AMENDMENTS 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 an underwriter or otherwise, principal or agent, 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.

* * * * * 

TEXT OF REVISED DRAFT 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.

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.[1]  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. [2] 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 MSRB 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 MSRB 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.

Among the different characteristics of securities that may fairly result in different prices are different coupons (e.g., institutional customers may prefer to purchase bonds at a premium).  As a general rule, the MSRB does not consider that there is a Rule G-30 violation simply if the yield to call is the same for both securities sold to retail and institutional customers, even though the yields to maturity on the securities are different.  In addition, some legitimate pricing differences may result from different market conditions particularly in the case of retail order submissions one or two days prior to the institutional order period.

________________________

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

[2]  See Interpretive Notice Concerning the Application of MSRB Rule G-17 to Underwriters of Municipal Securities (August 2, 2012).

[3]  See Sales Practice Notice at note 1.