MSRB to Study Pre-Transaction Pricing

WASHINGTON — The Municipal Securities Rulemaking Board is initiating a study of the municipal market with an emphasis on pre-transaction pricing efficiency and liquidity, Securities and Exchange Commission member Elisse Walter announced Tuesday.

Walter, who briefly touched on the study in prepared remarks at the start of the SEC's second hearing on munis, has repeatedly warned that there is often no way of knowing the precise price of a municipal bond, particularly in the secondary market if the bond has not recently been traded.

"I am delighted that the MSRB has decided to review these important issues as it seeks opportunities to improve the quality of the municipal securities market for the benefit of investors," Walter said.

Speaking later in the hearing, MSRB executive director Lynnette Hotchkiss said the study will help the board evaluate whether pricing mechanisms and liquidity in the market could be improved with higher levels of pre-trade price transparency. Specifically, it will review transaction costs, price dispersion, and other market data to help the MSRB assess whether the market is operating as efficiently and fairly as possible, the board announced in a release.

"A core part of the MSRB's mission is to promote a fair and efficient market, and this study on pricing efficiency and liquidity is consistent with that mission," Hotchkiss said. The MSRB hopes to perform its initial analysis of data by the second half of 2011. News of the study comes after Walter said earlier this fall that great strides have been made in after-trade transparency in light of the MSRB's real-time reporting requirements and EMMA website. But because of the low liquidity levels of many bonds, trade data may be many weeks or months old, she said.

Addressing bond attorneys in September, Walter noted that while munis are currently traded in an over-the-counter, decentralized, dealer-intermediated market, that has not always been the case. In the 1920s, munis were actively traded on the New York Stock Exchange, a practice that ended in 1929.

Meanwhile, several retirees who testified at yesterday's hearing urged the SEC to dictate a baseline level of disclosure because it is difficult to easily find key information.

Helen Kirkpatrick, a retired journalist who was one of two panelists representing the Association of Individual Investors, said she did not understand why there is not a stamp of government approval on municipal bond offering documents similar to the manner in which the Agriculture Department rates steak. She said average retail investors are unable to understand disclosures in general, calling them a "a pile of spaghetti."

James Lebenthal, director of public affairs at Lebenthal & Co., said the time has come for Congress to repeal the so-called Tower Amendment, which restricts the SEC from collecting muni offering documents prior to bond sales.

"The time has come, we have a national market and a national need for uniformity and issuers themselves should comply with a law of practicality and be required to meet basic standards for disclosure," Lebenthal said.

But issuers remain opposed to a repeal of Tower and those who testified at Tuesday's hearing disputed whether baseline disclosure requirements are appropriate or even feasible. Leslie Norwood, co-head of the municipal securities division of the Securities Industry and Financial Markets Association, said market forces have already improved disclosure standards in the health care sector. But uniform disclosure across all sectors is probably not appropriate, because of different disclosure "paradigms" for each type of muni bond, she said.

Norwood also said it is a misnomer to refer to the MSRB as a "self-regulator" because "we are now in an environment in which every former self-regulatory organization now has a public board of directors and is now an independent regulatory organization, or IRO."

"I am not the first to say this, but the 'S' has been removed from SRO," she said.

Specifically, the Dodd-Frank law enacted this summer required the MSRB to transform from a dealer-led board to one comprised of a majority of "public" representatives, beginning Oct. 1. The law also gave the SEC oversight of municipal advisers and expanded its mandate to include the protection of issuers — the first for any regulatory agency.

Walter, who previously has said she is concerned about coordination and communication problems because of the separation of the rule-writing and enforcement functions among muni regulators, asked panelists for suggestions to improve the "bifurcated system." Currently, the MSRB writes rules for dealers and advisers, which are enforced by the Financial Industry Regulatory Authority and SEC.

Though Thomas Selman, executive vice president of regulatory policy at FINRA, said the MSRB and FINRA have done "an excellent job working together, meeting on an almost continuous basis." he said the separation of the rule-writing and enforcement functions "does complicate things."

But Norwood said SIFMA members believe that the separation has "served the industry as a whole quite well" and generally believes having a dedicated rule maker to focus specifically on writing rules that govern the industry is "integral to a well-functioning and smartly regulated marketplace."

She added that the MSRB must still work to ensure a level regulatory playing field with advisers and noted that SIFMA members have expressed frustration that FINRA examiners often lack expertise in the muni industry. Dealers, she said, are often put in the position of teaching examiners about the muni market and its separate rule book as an examination unfolds, she said.

"There are also frustrations about uneven application of the rules across the country, with varying penalties for the same violations," she added.

Robert Cook, the director of the SEC's division of trading and markets, noted the increased participation of retail investors in both the municipal and corporate bond markets and asked why there should be two separate sets of rules for the different types of securities.

"How does this impact the role of the two SROs in this area?" Cook said. "To what extent does it make sense to continue to have different rules based on the bond when you may have the same parties to the transaction?"

Hotchkiss said: "That's a question that a lot of people have but it's important to recognize" the two markets are "totally different."

In the muni market, "you've got the largest state and city issuers" as well as "the small fire district who comes to market every 20 years," she said, while much of the corporate bond market is commoditized. Unless the rules recognize this diversity of muni issuers, "I don't think you're going to be an effective regulator," she said.

In some cases, including rules regarding gift and gratuities, it makes sense to have the same rules, Hotchkiss said, but the uniqueness of the muni market has to be recognized in order to maintain a functioning and liquid market, she added.

Speaking on a panel on market structure at the SEC hearing, Thomas Doe, founder and chief executive officer of Municipal Market Advisors, said the SEC ought to consider whether issuers that are unable to provide timely and complete continuing disclosures should have access to the capital markets.

Doe warned that it is difficult, if not impossible, for retail investors to navigate the inconsistent disclosures.

"If you can't provide information in a timely manner, maybe you should be denied access," he said. "Maybe it's not right for you."

Doe said the MSRB and other regulators have the resources to better monitor all dealer activity to note irregular behavior that can potentially distort price evaluations and disrupt muni liquidity. Only a small number of market participants can influence price discovery as the universe of firms consistently active in both the primary and secondary markets that are providing liquidity has become more concentrated, he added.

SEC officials have received a "mixed bag" of reactions when they ask about the sufficiency of muni disclosures, Walter said.

"We've heard about improvements and we've heard about some market-driven trends," she said. "On the other hand, we've heard both from retail and very sophisticated investors that they don't have what they need. One of the things that bothers me … is the length of time for financial information to come out coupled with the relative illiquidity in the market, so the pricing mechanism that the marketplace provides for transactions isn't as robust as it is in other markets."

Hotchkiss said her only concern is that while EMMA is "a powerful tool," any move to specially designate issuers on the site who voluntarily commit to expedite their continuing disclosure filings — such as a "gold star" — must not be seen as an indication of credit quality.

"It's perfectly logical that someone might get in their financials in a very short amount of time but it is a dog credit," she said. "You want to make sure that the retail investor looking at EMMA or using EMMA doesn't draw conclusions that shouldn't be drawn."

The field hearings, which Walter is leading, are expected to result in recommendations for regulatory and legislative changes as well as industry "best practices" documents, likely by the middle of 2011. The SEC held its first hearing in San Francisco in September and plans additional hearings next year in Florida, Alabama, and Illinois.

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