SEC Approves MSRB's 'Priority of Orders' Rule Changes

The Securities and Exchange Commission late Friday approved a controversial set of rule changes floated by the Municipal Securities Rulemaking Board that will dictate the priority of retail and other customer orders in primary offerings, as well as dealers' related record-keeping responsibilities.

Approval of the proposal, which was announced Monday morning by the board, comes two weeks after the MSRB submitted changes to the proposal that would put it in line with an original, comprehensive "priority of orders" proposal floated last November, rather than a significantly pared-down version the board agreed to move forward with in the spring.

Though the MSRB voted in April to gut all but the record-keeping portions of the proposal, SEC staff insisted it move forward with the comprehensive proposal, market participants have said.

"We are pleased the SEC has approved our proposal, and expect that both retail and institutional investors will benefit from the changes," said MSRB general counsel Ernesto Lanza. "The distribution of new municipal securities to investors and issuers' intentions for how their bonds are allocated to investors are key fairness principles the MSRB is seeking to address with these changes."

Though the proposal goes into effect on an expedited basis and will apply to new municipal securities issued with a "time of formal award" after Oct. 12, the SEC is still accepting comments on them through roughly the end of the month.

The proposal aims to increase the distribution of new-issue bonds by requiring a managing underwriter in a primary offering to give priority to customer orders over orders for its own account, affiliated accounts, or the accounts of other members of the syndicate, unless it has reached some other agreement with the issuer.

The basis for the proposal was institutional investor complaints that their orders for muni bonds were not filled during primary offerings, even though the bonds became available to them at higher prices soon after in the secondary market.

The institutional investors claimed there were two possible causes. One is that dealers are placing so-called phantom orders during retail periods without having any actual retail investors lined up to buy the bonds and then "flipping" them at higher prices in sales to investors.

The other is that syndicate members or their affiliates are front-running the bonds — buying them for their own or affiliated accounts before filling orders from investors.

Flipping generally occurs when dealers or institutional investors purchase bonds and then immediately resell them to retail investors at higher prices.

Though a number of market participants are convinced the proposed rule changes were an attempt to curtail flipping, MSRB officials said they were meant to clarify that dealers must respect the priority of orders for bonds specified by issuers, since many issuers have come to rely more on retail order periods to sell their bonds.

Specifically, the MSRB proposal amends Rule G-11 on new-issue syndicate practices to require dealers to disclose whether orders are for their own or related accounts. It also alters Rule G-8 on books and records and Rule G-9 on the preservation of records to require that records be kept and retained for all primary offering orders — whether or not they are filled — for at least six years.

In addition, it would replace interpretive guidance on Rule G-17 on fair dealing published in 1987, prior to the proliferation of retail order periods, with new guidance to promote a fair distribution of new issues to customers.

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