Request for Comment on Rule G-14 Transaction Reporting Procedures for Block Order Executions

In May 2003, the Municipal Securities Rulemaking Board (“MSRB”) published a notice stating the Rule G-14 transaction reporting procedures for transactions effected by independent investment advisors instructing settlement to be made with one or more third-party dealers.[1]  This notice requests comment on a proposed procedure to address similar situations in which a broker, dealer or municipal securities dealer (collectively, “dealer”) acts in the role of an investment advisor.  The notice also restates the general rule for reporting the execution of block orders placed by independent investment advisors and invites general comment on transaction reporting procedures for block order executions and subsequent deliveries or allocations.[2]

GENERAL RULE ON TRANSACTION REPORTING OF BLOCK ORDER EXECUTIONS PLACED BY INDEPENDENT INVESTMENT ADVISORS

Rule G-14 on transaction reporting requires the reporting of transactions within a prescribed time after the execution of the transaction, generally 15 minutes.  Investment advisors frequently place block orders for execution without identifying the ultimate settlement account(s).  This does not affect trade reporting since the executing dealer must report the block trade (not the subsequent allocations or settlement instructions) within 15 minutes.

In a typical example, an independent investment advisor effects a block purchase of $500,000 principal amount of municipal securities from executing Dealer A at a price of par.  The block trade is executed at 10:00 a.m. and must be reported by 10:15 a.m. as a customer transaction.  At 2:00 p.m., the investment advisor gives instructions to Dealer A to allocate $250,000 to John Doe’s account and $250,000 to Mary Smith’s account, both accounts held by Dealer A and accounts for which the investment advisor is authorized to act.  Dealer A settles against these accounts, at a price of par, pursuant to the instructions from the investment advisor.  Dealer A must not report these two allocations as transactions.  The trade reporting procedure would be identical had the investment advisor instructed Dealer A to make DVP settlements with two custodian banks or process “step-out deliveries” to other dealers without providing information on the beneficial owners. 

REQUEST FOR COMMENT ON THE PROPOSED TREATMENT OF CERTAIN INVESTMENT ADVISOR TRANSACTIONS

In Notice 2003-20, the MSRB clarified that trade reporting procedures similar to those stated above are used when an independent investment advisor effects a block trade and instructs settlement to be made with one or more third-party dealers. This situation frequently occurs in connection with investment advisors acting for wrap fee accounts housed at the third-party dealer(s). The executing dealer must report the block trade as a customer transaction and must not report the inter-dealer settlements as transactions.[3]  Subsequent MSRB notices delineate procedures under which dealers could use the central comparison system for the inter-dealer settlement instructions without automatically causing erroneous inter-dealer trade reports to be made.[4]

In the situations addressed by Notice 2003-20, the investment advisor is not a dealer.  However, many broker-dealers are dually registered as investment advisors (BD/IA) and may act exclusively in the role of investment advisors on certain transactions.  Questions have arisen about the transaction reporting procedures to be used when a dealer acts in the role of investment advisor, effects a block trade with an executing dealer, and instructs settlement to be made with one or more third-party dealers.  In particular, questions arise as to whether these block trade executions are reported as inter-dealer or customer transactions.  Specific problems have been noted when the BD/IA fails to inform the executing dealer of the nature of the trade or that a portion of the trade may be settled to its own dealer account.

The proposed procedure would address these situations by clarifying that, when a BD/IA is acting exclusively in the capacity of an investment advisor, the situation is handled similarly to that in Notice 2003-20.  In order to ensure that both parties understand the nature of the transaction, the dealer acting as an investment advisor must inform the executing dealer, either at or prior to the time of trade that the BD/IA is acting exclusively in the capacity of an investment advisor.  The executing dealer will then know to treat the block order execution as a customer transaction.  In order for the BD/IA to be treated as an IA, it must give the executing dealer instructions to settle with a third party and not with the BD/IA's own dealer account.  The BD/IA cannot combine or mix this type of order with orders for BD/IA’s own dealer accounts, such as those for trading or brokerage.[5]

Comment is requested on this proposed procedure requiring dealers who are dually registered as investment advisors to inform the executing dealer as to what capacity they are acting either at or prior to the time of trade.  The MSRB recognizes that the industry prefers to institute multiple RTRS system changes on a single implementation date because it is less costly and more efficient if such changes are effected collectively. The MSRB believes, however, that this proposed procedure would not require any significant changes to be made to dealers’ systems for trade processing and reporting and can be made effective shortly after approval by the SEC.  The MSRB specifically asks for comment on whether there are additional issues that suggest the need for a delayed effective date.

REQUEST FOR COMMENT ON TRANSACTION REPORTING PROCEDURES FOR OTHER SITUATIONS INVOLVING BLOCK ORDER EXECUTIONS

The MSRB is aware that other situations involving the execution of block orders may also create questions with regard to the correct way to report trades.  The MSRB is inviting general comment and suggestions on situations where additional guidance may be needed.

“Internal” block order executions are a topic that the MSRB is considering both with respect to the price transparency function of RTRS and transaction reporting procedures.  Currently, there are no transaction reporting procedures requiring reporting of internal “transactions” that may occur within a dealer.  Procedures instead are focused on purchase-sale transactions by dealers that are with or for “customers” (non-dealer entities), and transactions with other dealers.  One type of internal “transaction” that may occur within a BD/IA is a block order execution done by the BD/IA’s trading desk for an internal investment advisor, i.e., an investment advisory function within the BD/IA.  The investment advisor within the BD/IA typically has discretionary authority over customer accounts held by the BD/IA and may effect transactions for those customer accounts using securities purchased through a block order with its own trading desk.  Under current procedures, the BD/IA does not report the block order execution done for the internal investment advisor, but does report each transaction effected for each customer account held by the BD/IA.

The MSRB is considering whether the current transaction reporting procedures for this situation are appropriate or whether changes should be made.  In particular, the Board is considering whether block order executions for internal investment advisors could be treated using the general rule for block order executions for independent investment advisors. In the above example, applying the general rule to the internal block order “transaction,” the BD/IA would report the internal block order execution between its trading desk and the internal investment advisor.  The individual customer transactions then would not be reported if allocated at the block order price.  Comment is requested on the practical and operational issues that arise when reporting transactions in this scenario and on any variations that may need to be addressed by interpretative guidance. 

Comment also is requested on the general rule for reporting of block order executions by independent investment advisors.  This rule requires the reporting of the execution of a block order from an investment advisor rather than the allocations that are made.  The MSRB is particularly interested in whether there are variations with respect to allocations that should be addressed.  For example, the general rule is based on the assumption that the customer account allocations all occur at the same price as the block order execution. Comment is requested on whether this assumption is valid.

Although the MSRB is soliciting general comment on block order executions and allocations, it does not intend to adopt new rules or procedures requiring the industry to make changes to automated trade processing and trade reporting systems without additional notification and opportunity for comment. 

Comments from all interested parties are welcome.  Comments should be submitted no later than September 20, 2006, and may be directed to Karen Caplan, Associate General Counsel.

July 31, 2006