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FINRA Launches Municipal Fact-Finding Sweeps

The Financial Industry Regulatory Authority yesterday announced that it has launched three fact-finding sweeps tied to the municipal securities market, including an enforcement sweep to examine firms' potential conflicts, disclosure practices, and marketing of derivatives to small and unsophisticated municipalities.

In addition to announcing the sweeps, which were launched in recent weeks, FINRA issued a regulatory notice to securities firms and brokers reminding them of their ongoing obligation to disclose material information to customers - including changes to the financial condition of the issuing municipality - as well as their obligations regarding suitability.

FINRA also released an investor alert called "Municipal Bonds - Staying on the Safe Side of the Street in Rough Times" and a separate online muni bond checklist that provides a step-by-step guide "to help investors avoid the most common pitfalls of muni bond investing," FINRA said in a statement.

The investor alert was issued in collaboration with the Municipal Securities Rulemaking Board. It comes as Securities and Exchange Commission rules go into effect today that designate the MSRB as a central repository for primary and secondary market muni disclosure information.

"FINRA is taking concerted action to ensure that investors are aware of both the risks and the benefits that might be associated with a muni bond investment," said FINRA chairman and chief executive officer Richard G. Ketchum. "Muni bonds can be a valuable part of an investor's portfolio, and investors should be aware of any changes in a bond issuer's financial condition or operating results. Firms should also be aware of their responsibilities when working with muni bond investors."

The sweep looking into how firms pitch derivatives to municipalities comes as the Tennessee Comptroller Justin Wilson has proposed guidelines that would restrict small localities in the state from using variable-rate debt and derivatives. It also comes after the Obama administration released a financial industry regulatory reform proposal that includes restrictions on the sale of derivatives to small municipalities.

According to a copy of a target letter FINRA is sending firms as part of the sweep, the self-regulator is seeking information on all municipal underwritings in which they participated where the issuer utilized at least one derivative instrument.

FINRA is also asking firms to answer a number of questions, including: whether they recommended the use of a derivatives and if not, who made the recommendation; how the muni derivative instrument provider was selected and the firm's role in introducing the provider to the issuer; and whether the firm is affiliated with the instrument provider and the nature of that affiliation.

A spokesman said FINRA is not assuming misrepresentations were made, but is simply looking for what roles its member firms played in the process of recommending such derivatives as interest rate swaps, many of which have not worked out well for small and unsophisticated municipalities, including Jefferson County, Ala., and the Erie School District in Pennsylvania.

The spokesman said FINRA is moving as quickly as it can to finish the three sweeps but does not have a timetable for completing them. Another targeted sweep is seeking information from firms that engaged in retail sales of certain municipal gas bonds that were underwritten and guaranteed by the now-defunct Lehman Brothers and quickly became distressed.

Yet another sweep, the broadest of the three, is looking generally at industry sales and supervisory practices of sales of munis to retail investors. Firms are being asked to provide FINRA with detailed data on a range of retail municipal bond transactions during the first quarter of 2009.

The requested information includes sales data, marketing data, pricing data and procedures, disclosure practices, customer complaints, and supervisory procedures and practices.

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