Request for Comments on Minimum Denominations

Comments on the draft amendment should be submitted no later than June 1, 2001 and may be directed to Justin R. Pica, Uniform Practice Assistant.  Written comments will be available for public inspection.

The MSRB requests comments on a draft amendment to rule G-15, on confirmation, clearance and settlement of transactions with customers.  The draft amendment, with limited exceptions, would require brokers, dealers and municipal securities dealers (collectively “dealers”) to observe the minimum denominations[1] specified in bond documents when effecting transactions with customers.

Background

Official documents for bond issues sometimes state a “minimum denomination” larger than the normal $5,000 par value.  An issuer may state a high minimum denomination (typically $100,000) so that the issue may qualify for one of several exemptions from SEC Rule 15c2-12, the rule that requires certain disclosure documents to be produced in the primary and secondary markets.  An issuer may also sometimes set high minimum denominations for issues not subject to Rule 15c2-12 because the issuer may feel that due to risk of default, lack of publicly disseminated disclosure or other concerns, the securities may not be appropriate for those retail investors who would likely purchase in amounts below the minimum denomination.

In today’s book-entry settlement environment, in which most securities are safe-kept for investors, minimum denomination provisions are not always effective in limiting the size of a transaction.  Since certificates are not physically transferred in book-entry settlement, a restriction on the par value of certificates can be ineffective in restricting the size of transactions.  A dealer, or other custodian, also may hold a position in an authorized amount but hold the security on behalf of several investors whose individual positions fall below the minimum denomination.

Draft Amendment

The draft amendment would prohibit dealers in most cases from effecting transactions with customers in amounts below the minimum denomination.  To protect investors who already hold positions that are below the minimum denomination, the draft amendment includes an exemption that would permit a dealer to liquidate such a position held by a customer.  This exemption would protect investors who, for example, unknowingly purchased the security in an amount below the minimum denomination, obtained such a position through a will or gift, as well as those who find themselves with below-minimum denomination positions due to the exercise of a sinking fund or other partial redemption.  The exemption would require that, for a dealer to purchase from a customer in an amount below the minimum denomination, it would have to determine that the customer is selling its entire position.  A dealer may do this by relying either upon customer account information in its possession or upon a written statement by the customer as to its position in the issue.

In general, the draft amendment would prohibit sales to customers in amounts below the minimum denomination.  The draft amendment, however, would provide an exception for certain sales to help provide some liquidity for those investor positions that already are in amounts below the minimum denomination.  To utilize the sale exception, a dealer would have to establish that the position being sold is the result of a customer liquidating a position.  The dealer could satisfy this requirement by either relying upon customer account records in its possession or upon a written statement from the party from which the securities were purchased stating that the position being sold is the result of a customer’s liquidation.  In addition, the dealer would have to provide the purchasing customer a written statement that the position being sold is below the minimum denomination and that liquidity may be adversely affected unless the customer already holds securities from the issue that can be combined to reach the minimum denomination.

Request for Comments

The MSRB believes that the draft amendment would facilitate the intent of issuers in creating minimum denominations.  In addition, the MSRB believes the exemptions included in the draft amendment should maintain the liquidity of positions that are held by investors and that are below the minimum denomination.  The MSRB requests comment on the draft amendment.

March 14, 2001

Text of Draft Amendment *

G-15 Confirmation, Clearance, and Settlement of and Other Uniform Practice Requirements with Respect to Transactions with Customers

(a) through (e) No change.

(f) Minimum Denominations 

(i) Except as provided in this section (f), a broker, dealer or municipal securities dealer shall not effect a customer transaction in an issue of municipal securities in an amount lower than the minimum denomination of the issue.

(ii) The prohibition in subsection (f)(i) shall not apply to the purchase of securities from a customer in an amount below the minimum denomination if the broker, dealer or municipal securities dealer determines that the customer is liquidating a position that is already below the minimum denomination.  In determining whether a customer is liquidating a position below the minimum denomination, a broker, dealer or municipal securities dealer may rely either upon customer account information in its possession or upon a written statement by the customer as to its position in the issue.

(iii) The prohibition in subsection (f)(i) shall not apply to the sale of securities to a customer in an amount below the minimum denomination if the broker, dealer or municipal securities dealer determines that the securities position being sold is the result of a customer liquidating a position below the minimum denomination, as described in subsection (f)(ii) of this rule.  In determining whether the securities position being sold is the result of a customer liquidating a position below the minimum denomination, the broker, dealer or municipal securities dealer may rely upon customer account records in its possession or upon a written statement from the party from which the securities are purchased stating that the securities position is the result of a customer liquidating a position below the minimum denomination. A broker, dealer or municipal securities dealer effecting a sale transaction to a customer under this subsection (iii) shall provide to the customer, in writing, at or prior to completion of the transaction, a written statement that informs the customer that the securities position being sold is below the minimum denomination for the issue and that this may adversely affect the liquidity of the position unless the customer has other securities from the issue that can be combined to reach the minimum denomination.