Rule Amendments and Interpretive Notice Filed Regarding Priority of Orders in Primary Offerings

On November 18, 2009, the Municipal Securities Rulemaking Board (“Board” or “MSRB”) filed with the Securities and Exchange Commission (“SEC”) a proposed rule change (the “proposed rule change”) consisting of (i) amendments to Rule G-8, on books and records to be made by brokers, dealers and municipal securities dealers, Rule G-9, on preservation of records, and Rule G-11, on new issue syndicate practices; (ii) a proposed interpretation (the “proposed interpretive notice”) of Rule G-17, on conduct of municipal securities activities; and (iii) the deletion of a previous Rule G-17 interpretive notice on priority of orders dated December 22, 1987 (the “1987 interpretive notice”).[1]  The MSRB proposed that the proposed rule change be made effective for new issues of municipal securities for which preliminary pricing begins more than 30 days after the date the proposed rule change is approved by the SEC.

SUMMARY OF PROPOSED RULE AMENDMENTS

The proposed amendments to Rule G-11 would: (1) apply the rule to all primary offerings, not just those for which a syndicate is formed; (2) require that all dealers (not just syndicate members) disclose whether their orders are for their own account or a related account; and (3) require that priority be given to orders from customers over orders from syndicate members for their own accounts or orders from their respective related accounts, to the extent feasible and consistent with the orderly distribution of securities in the offering, unless the issuer otherwise agrees or it is in the best interests of the syndicate not to follow that order of priority.

The proposed amendments to Rules G-8 and G-9 would require that records be retained for all primary offerings of: (1) all orders, whether or not filled; (2) whether there was a retail order period and, if so, the issuer’s definition of “retail;” and (3) those instances when the syndicate manager allocated bonds other than in accordance with the priority provisions of Rule G-11 and the specific reasons why it was in the best interests of the syndicate to do so.

SUMMARY OF PROPOSED INTERPRETIVE NOTICE

The proposed interpretive notice would provide that violation of these priority provisions would be a violation of Rule G-17, subject to the same exceptions as provided in proposed amended Rule G-11.  It also would provide that Rule G-17 does not require that customer orders be accorded greater priority than orders from dealers that are not syndicate members or their respective related accounts.  The proposed interpretive notice also would provide that it would be a violation of Rule G-17 for a dealer to allocate securities in a manner that is inconsistent with an issuer’s requirements for a retail order period without the issuer’s consent.  Issuance of the notice, in addition to the amendments to Rule G-11, is consistent with previous guidance issued by the Board that all activities of dealers must be viewed in light of the basic fair dealing principles of Rule G-17, regardless of whether other MSRB rules establish additional requirements on dealers.[2]

The guidance set forth in the proposed interpretive notice arose out of the Board’s on-going review of its General Rules as well as concerns expressed by institutional investors that their orders were sometimes not filled in whole or in part during a primary offering, yet the bonds became available shortly thereafter in the secondary market.  They attributed that problem to two causes: first, some retail dealers were allowed to place orders in retail order periods without going away orders and second, syndicate members, their affiliates, and their respective related accounts were allowed to buy bonds in the primary offering for their own account even though other orders remained unfilled.  There was also concern that these two factors could contribute to restrictions on access to new issues by retail investors, in a manner inconsistent with the issuer’s intent.

The MSRB had last addressed the priority of orders in the 1987 interpretive notice.[3]  That guidance interpreted Rule G-17 to require generally that customer orders be filled before orders from dealers and dealer-related accounts.  Dealer-related accounts were defined to “include a municipal securities investment portfolio, arbitrage account, or secondary trading account of a syndicate member, a municipal securities investment trust sponsored by a syndicate member, or an accumulation account established in connection with such a municipal securities investment trust.”  The notice did not limit the ability of the syndicate manager to allocate away from the priority provisions of the syndicate if to do so would be in the best interests of the syndicate.  The Board determined to update the guidance provided in the 1987 interpretive notice due to changes in the marketplace and subsequent amendments to Rule G-11.  The proposed interpretive notice will supersede the 1987 interpretive notice, which will be deleted as part of the proposed rule change.

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Questions about the proposed rule change should be directed to Peg Henry, Deputy General Counsel, at (703) 797-6600. 

November 18, 2009

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TEXT OF PROPOSED RULE CHANGE [4]

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 [of Syndicate Transactions]. 

(A) For each primary offering for which a syndicate has been [With respect to each syndicate, joint or similar account] formed for the purchase of municipal securities, records shall be maintained by the syndicate manager [a managing underwriter designated by the syndicate or account to maintain the books and records of the syndicate or account,] showing the description and aggregate par value of the securities[,]; the name and percentage of participation of each member of the syndicate [or account,]; the terms and conditions governing the formation and operation of the syndicate [or account (including,]; a [separate] statement of all terms and conditions required by the issuer[)] (including whether the issuer has required 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 [or account (except bids at other than syndicate price),]; 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 or 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 why it was in the best interests of the syndicate to do 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 the issuer has required 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; all allotments of securities and the price at which sold; the date and amount of any good faith deposit made to the issuer; and the date of settlement with the issuer.

 (ix) - (xxiii) No change.

(xxiv) Records of Secondary Market Trading Account Transactions.  With respect to each secondary market trading account formed for the purchase of municipal securities, records shall be maintained by the broker, dealer, or municipal securities dealer designated by the account to maintain the books and records of the account, showing the description and aggregate par value of the securities; the name and percentage of participation of each member of the account; the terms and conditions governing the formation and operation of the account; all orders received for the purchase of the securities from the account; all allotments of securities and the price at which sold; the date of closing of the account; and a reconciliation of profits and expenses of the account.

(b) - (e) No change.

(f) Compliance with Rule 17a-3. Brokers, dealers and municipal securities dealers other than bank dealers which are in compliance with rule 17a-3 of the Commission will be deemed to be in compliance with the requirements of this rule, provided that the information required by subparagraph (a)(iv)(D) of this rule as it relates to uncompleted transactions involving customers; paragraph (a)(viii); and paragraphs (a)(xi) through [(a)(xxiii)] (a)(xxiv) shall in any event be maintained.

(g) No change.

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Rule G-9: Preservation of Records

(a) Records to be Preserved for Six Years. Every broker, dealer and municipal securities dealer shall preserve the following records for a period of not less than six years:

(i) – (iii) No change.

(iv) the records concerning primary offerings [of syndicate transactions] described in rule G-8(a)(viii), provided, however, that [(1)] such records need not be preserved for a syndicate [or similar account] or by a sole underwriter [which] that, in either case, is not successful in purchasing an issue of municipal securities[, and (2) information concerning orders received by a syndicate or similar account to which securities were not allocated by such syndicate or account need not be preserved after the date of final settlement of the syndicate or account];

(v) – (x) No change.

(xi) the records concerning secondary market trading account transactions described in rule G-8(a)(xxiv), provided, however, that such records need not be preserved for a secondary market trading account which is not successful in purchasing municipal securities.

(b) – (g) No change.

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Rule G-11: Primary Offering [New Issue Syndicate] Practices

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

(i)-(iv) No change.

(v) The term "order period" means the period of time, if any, announced by a syndicate or, when no syndicate has been formed, a sole underwriter, during which orders will be solicited for the purchase of securities [held in syndicate] in a primary offering.

(vi) No change.

(vii)  [The term "related portfolio," when used with respect to a broker, dealer or municipal securities dealer, means a municipal securities investment portfolio of such broker, dealer or municipal securities dealer or of any person directly or indirectly controlling, controlled by or under common control with such broker, dealer or municipal securities dealer.]  ** Reserved for future use **

(viii)-(ix) No change.

(x) The term “affiliate” means a person controlling, controlled by, or under common control with a syndicate member or, when no syndicate has been formed, a sole underwriter.

(xi) In the case of a primary offering for which a syndicate is formed for the purchase of municipal securities, the term “related account” includes a municipal securities investment portfolio of a syndicate member or an affiliate, an arbitrage account of a syndicate member or an affiliate, a municipal securities investment trust sponsored by a syndicate member or an affiliate, or an accumulation account established in connection with such a municipal securities investment trust.  In the case of a primary offering for which a syndicate has not been formed, the term “related account” includes a municipal securities investment portfolio of the sole underwriter or an affiliate, an arbitrage account of the sole underwriter or an affiliate, a municipal securities investment trust sponsored by the sole underwriter or an affiliate, or an accumulation account established in connection with such a municipal securities investment trust.

(b) Disclosure of Capacity. Every broker, dealer or municipal securities dealer [which is a member of a syndicate] that submits an order to a sole underwriter or syndicate or to a member of a syndicate for the purchase of municipal securities held by the syndicate shall disclose at the time of submission of such order if the securities are being purchased for its dealer account or[,] for [the account of] a related account [portfolio] of such broker, dealer or municipal securities dealer[, for a municipal securities investment trust sponsored by such broker, dealer or municipal securities dealer, or for an accumulation account established in connection with such a municipal securities investment trust].

(c) Confirmations of Sale. Sales of securities held by a syndicate to a related account [portfolio, municipal securities investment trust or accumulation account referred to in section (b) above] shall be confirmed by the syndicate manager directly to such related account [portfolio, municipal securities investment trust or accumulation account] or for the account of such related account [portfolio, municipal securities investment trust or accumulation account to the broker, dealer or municipal securities dealer] submitting the order. Nothing herein contained shall be construed to require that sales of municipal securities to a related account [portfolio, municipal securities investment trust or accumulation account] be made for the benefit of the syndicate.

(d) No change.

(e) Priority Provisions.

(i) In the case of a primary offering for which a syndicate has been formed, [Every] the syndicate shall establish priority provisions and, if such priority provisions may be changed, the procedure for making changes.  For purposes of this rule, the requirement to establish priority provisions shall not be satisfied if a syndicate provides only that the syndicate manager or managers may determine in the manager's or managers' discretion the priority to be accorded different types of orders.  Unless otherwise agreed to with the issuer, such priority provisions shall give priority to customer orders over orders by members of the syndicate for their own accounts or orders for their respective related accounts, to the extent feasible and consistent with the orderly distribution of securities in the offering.  Notwithstanding the preceding sentence, a syndicate may include a provision permitting the syndicate manager or managers on a case-by-case basis to allocate securities in a manner other than in accordance with the priority provisions, if the syndicate manager or managers determine in its or their discretion that it is in the best interests of the syndicate.  In the event any such allocation is made, the syndicate manager or managers shall have the burden of justifying that such allocation was in the best interests of the syndicate.

(ii)  In the case of a primary offering for which a syndicate has not been formed, unless otherwise agreed to be the issuer, the sole underwriter shall give priority to customer orders over orders for its own account or orders for its related accounts, to the extent feasible and consistent with the orderly distribution of securities in the offering.

(f) - (g) No change.

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

(i) No change.

(ii) a summary statement showing:

(A) the identity of each related account [portfolio, municipal securities investment trust, or accumulation account referred to in section (b) above] submitting an order to which securities have been allocated as well as the aggregate par value and maturity date of each maturity so allocated;

(B) – (C) No change.  

(i) – (j) No change.

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Interpretation on Priority of Orders for Securities in a Primary Offering under Rule G-17

On December 22, 1987, the MSRB published a notice¹ interpreting the fair practice principles of Rule G-17 as they apply to the priority of orders for new issue securities (the “1987 notice”).  The MSRB wishes to update the guidance provided in the 1987 notice due to changes in the marketplace and subsequent amendments to Rule G-11.

Rule G-11(e) requires syndicates to establish priority provisions and, if such priority provisions may be changed, to specify the procedure for making changes.  The rule also permits a syndicate to allow the syndicate manager, on a case-by-case basis, to allocate securities in a manner other than in accordance with the priority provisions if the syndicate manager determines in its discretion that it is in the best interests of the syndicate.  Under Rule G-11(f), syndicate managers must furnish information, in writing, to the syndicate members about terms and conditions required by the issuer,² priority provisions and the ability of the syndicate manager to allocate away from the priority provisions, among other things. Syndicate members must promptly furnish this information, in writing, to others upon request. This requirement was adopted to allow prospective purchasers to frame their orders to the syndicate in a manner that would enhance their ability to obtain securities since the syndicate’s allocation procedures would be known.

Principles of fair dealing generally will require the syndicate manager t o give priority to customer orders over orders for its own account, orders by other members of the syndicate for their own accounts, orders from persons controlling, controlled by, or under common control with any syndicate member (“affiliates”) for their own accounts, or orders for their respective related accounts,³ to the extent feasible and consistent with the orderly distribution of securities in a primary offering.  This principle may affect a wide range of dealers and their related accounts given changes in organizational structures due to consolidations, acquisitions, and other corporate actions that have, in many cases, resulted in increasing numbers of dealers, and their related dealer accounts, becoming affiliated with one another.

Rule G-17 does not require the syndicate manager to accord greater priority to customer orders over orders submitted by non-syndicate dealers (including selling group members).  However, prioritization of customer orders over orders of non-syndicate dealers may be necessary to honor terms and conditions agreed to with issuers, such as requirements relating to retail orders.  

The MSRB understands that syndicate managers must balance a number of competing interests in allocating securities in a primary offering and must be able quickly to determine when it is appropriate to allocate away from the priority provisions, to the extent consistent with the issuer’s requirements.  Thus, Rule G-17 does not preclude the syndicate manager or managers from according equal or greater priority to orders by syndicate members for their own accounts, affiliates for their own accounts, or their respective related accounts if, on a case-by-case basis, the syndicate manger determines in its discretion that it is in the best interests of the syndicate.  However, the syndicate manager shall have the burden of justifying that such allocation was in the best interests of the syndicate.  Syndicate managers should ensure that all allocations, even those away from the priority provisions, are fair and reasonable and consistent with principles of fair dealing under Rule G-17.

It should be noted that all of the principles of fair dealing articulated in this notice extend to any underwriter of a primary offering, whether a sole underwriter, a syndicate manager, or a syndicate member.  

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[1] MSRB Notice of Interpretation Concerning Priority of Orders for New Issue Securities: Rule G-17, reprinted in MSRB Rule Book, available at http://www.msrb.org/MSRB1/rules/notg17.htm.

[2] The requirements of Rule G-11(f) with respect to issuer requirements were adopted by the MSRB in 1998.  See Exchange Act Release No. 40717 (November 27, 1998) (File No. SR-MSRB-97-15).

[3]  “Related account” has the meaning set forth in Rule G-11(a)(xi).

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[ Notice of Interpretation Concerning Priority of Orders for New Issue Securities: Rule G-17

December 22, 1987

The Board is concerned about reports that senior syndicate managers may not always be mindful of principles of fair dealing in allocations of new issue securities. In particular, the Board believes that the principles of fair dealing require that customer orders should receive priority over similar dealer or certain dealer-related account[1] orders, to the extent that this is feasible and consistent with the orderly distribution of new issue securities.

Rule G-11(e) requires syndicates to establish priority provisions and, if such priority provisions may be changed, to specify the procedure for making changes. The rule also permits a syndicate to allow the senior manager, on a case-by-case basis, to allocate securities in a manner other than in accordance with the priority provisions if the senior manager determines in its discretion that it is in the best interests of the syndicate. Senior managers must furnish this information, in writing, to the syndicate members. Syndicate members must promptly furnish this information, in writing, to others upon request. This requirement was adopted to allow prospective purchasers to frame their orders to the syndicate in a manner that would enhance their ability to obtain securities since the syndicate’s allocation procedures would be known.

The Board understands that senior managers must balance a number of competing interests in allocating new issue securities. In addition, a senior manager must be able quickly to determine when it is appropriate to allocate away from the priority provisions and must be prepared to justify its actions to the syndicate and perhaps to the issuer. While it does not appear necessary or appropriate at this time to restrict the ability of syndicates to permit managers to allocate securities in a manner different from the priority provisions, the Board believes senior managers should ensure that all allocations, even those away from the priority provisions, are fair and reasonable and consistent with principles of fair dealing under rule G-17.[2] Thus, in the Board’s view, customer orders should have priority over similar dealer orders or certain dealer-related account orders to the extent that this is feasible and consistent with the orderly distribution of new issue securities. Moreover, the Board suggests that syndicate members alert their customers to the priority provisions adopted by the syndicate so that their customers are able to place their orders in a manner that increases the possibility of being allocated securities.

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[1] A dealer-related account includes a municipal securities investment portfolio, arbitrage account or secondary trading account of a syndicate member, a municipal securities investment trust sponsored by a syndicate member, or an accumulation account established in connection with such a municipal securities investment trust.

[2] Rule G-17 provides that:

[i]n the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest or unfair practice.]

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