MSRB Seeks Input on Order Priorities

WASHINGTON — The Municipal Securities Rulemaking Board is seeking comments on draft rule changes it released yesterday to clarify the priority of retail and other customer orders in primary bond offerings, as well as related record-keeping responsibilities for dealers.

MSRB executive director Lynnette Hotchkiss said yesterday that the proposal — which includes interpretive guidance on fair-practice requirements for order periods — is meant to clarify that dealers respect the priority of orders issuers outline for their bonds, especially as issuers come to rely more on retail order periods to distribute their paper.

The board has not updated its guidance on the priority of orders since 1987, long before retail ­order periods were so widespread.

But market participants said that the proposal may be aimed at curtailing situations in which an underwriter buys bonds for its own account — or sells them to an affiliated investor — and subsequently “flips” them to retail and institutional customers in the secondary market at higher prices and lower yields, despite the existence of unfilled customer orders during the primary offering.

“This year, [flipping] has been way out of hand,” said one market participant.

Though Hotchkiss said that the proposal is not aimed at addressing flipping, the disparities between customer and dealers trades are often pronounced.

The board appeared to hint at this activity in its release, which said: “These proposals are in response to concerns expressed by some institutional investors, who have told the MSRB that their orders are sometimes not filled in whole or in part during a primary offering, yet the bonds become available shortly thereafter in the secondary market, at higher prices.”

As a result, the board warned that retail investors may have more limited access to new issues, “in a manner inconsistent with the issuer’s intent.”

Specifically, the board is proposing changes to its Rule G-11 on new-issue syndicate practices that would generally require the syndicate manager or the sole underwriter to give priority to customer orders over orders for its own accounts or orders for an affiliate.

The proposals would also alter Rule G-8 on books and records to require dealers to maintain records necessary for the enforcement of these requirements, and changes to Rule G-9 on the preservation of records that would require them to preserve the records for six years.

The proposal does not define “retail periods” or require that issuers utilize them. But if they do, underwriters would be required to set up priority procedures that could only be deviated for institutional customers on a case-by-case basis and the underwriter would need proof that the change was needed.

Comments on the proposals are requested through Sept. 11, after which they will be considered by the board at its October meeting. If approved, the rule changes would then need the approval of the Securities and Exchange Commission before they could be implemented.

While sources noted that flipping has been a widespread occurrence throughout the market for years and is not necessarily problematic, it has become widespread during the past year and may have raised concerns by staff at the SEC.

Data compiled by Municipal Market Advisors shows that the average spread between yields received by customers and dealers in secondary market trading of 30-year California general obligation was as high as 20 basis points in mid-June.

The spreads tightened significantly until the first week of July as dealers sought to unload bonds at prices closer to their own costs, likely because of concerns about the state’s credit.

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