MSRB's Heavy Agenda

WASHINGTON — Municipal Securities Rulemaking Board officials on Monday detailed a series of initiatives designed to increase price transparency for retail investors and improve disclosure of conflicts of interest, information about bank loans, and payments made to or received by underwriters and municipal advisors.

Most observers had thought the board’s three-day meeting in Miami would be uneventful, with the MSRB’s having withdrawn five of the rules it proposed last year under the Dodd-Frank Act until the Securities and Exchange Commission finalizes its definition of municipal advisor, possibly as late as the end of September. The act gave the SEC and MSRB new regulatory authority over MAs.

But MSRB chairman Alan Polsky told reporters during a telephone briefing about the meeting that the board approved or agreed to proceed with nine initiatives or rulemaking projects as well as a long-range market transparency plan.

Several of the initiatives would be aimed at improving price transparency, particularly for retail investors, in the wake of a Government Accountability Office report issued Jan. 17 that found institutional investors trade at more favorable prices than retail investors.

“We want there to be fair and equal access to the market,” Polsky, a senior vice president at Dougherty & Co. in Minneapolis, told reporters.

The board plans to propose a new rule that would prohibit underwriters from designating new bonds as NRO, or not reoffered, that allows them to avoid disclosing their prices and yields on a real-time basis with information vendors. Currently underwriters disclose the prices and yields of these bonds to the MSRB’s online EMMA system, but not until after the end of the day and the formal award of the bonds.

“Eliminating the ability for underwriters to mask price and yield by using the NRO designation will provide full price discovery to the market and remove existing inconsistencies of information flow,” Polsky said.

The MSRB action comes after the Government Finance Officers Association asked the SEC to do something about NROs in a Nov. 10 letter — 14 years after a member of its debt committee sent a letter to the board complaining about the practice.

“It’s only taken them 14 years,” said Frank Hoadley, Wisconsin’s capital finance director, who wrote the 1998 letter. “Conceptually, that’s what’s got to happen,” he said, referring the MSRB’s planned prohibition. But he added, “The devil’s in the details. It remains to be seen.”

“It’s good for issuers and investors both,” said Eric Johansen, Portland, Ore.’s treasurer and chairman of GFOA’s debt committee. “Hopefully we’ll be able to get faster and more complete data on competitive prices, which form the basis for prices on negotiated deals.”

A trader in New York said, “I like it. They can’t hide the information.” He added that the rule has a chance of passing if “they really think the whole market should be transparent. And it has to be.”

The MSRB also plans to take action to ensure that when an issuer imposes a retail order period to make sure some of its new bonds are sold to retail investors, dealers follow the issuer’s instructions. There have been concerns raised in connection with the initial offering price or “issue price,” as some dealers who are supposed to be selling new bonds to individual retail investors may instead be selling them to firms with large retail practices. Those bonds are then passed through those firms and sold at higher prices to retail investors.

Underwriters are supposed to certify, for tax purposes, the issue price of the bonds, which is considered to reflect the price of the first 10% sold to the public. But Internal Revenue Service officials have complained about bonds being “traded up,” or being sold repeatedly almost simultaneously at higher and higher prices with retail investors paying the highest prices.

The MSRB plans to impose changes to its Rule G-11 on primary offering practices that would require dealers submitting orders for the bonds to certify, electronically or otherwise, to the lead underwriter that they are carrying out the issuer’s instructions and adhering to the issuer’s definition of retail investor. The certification would be a record that is maintained by the lead underwriter.

On another initiative affecting pricing, the MSRB plans to soon send the SEC its final version of new Rule G-43, which regulates the activities of broker’s brokers and dealers that use them. Polsky told reporters that broker’s brokers, which serve as intermediaries between dealers, are important for retail investors’ access to the market for liquidity.

The new rule, which has been controversial, will require broker’s brokers to make reasonable efforts to obtain prices for dealers that are fair and reasonable under prevailing market conditions. They would also have to use the same care and diligence as if executing transactions for their own accounts. Broker-dealers have objected to some of the proposed provisions governing fair-pricing obligations and to a proposed exclusion for electronic trading systems.

As for conflicts of interest, the MSRB is urging the SEC to approve controversial changes to its Rule G-17 on fair-dealing that would require underwriters to disclose risks and conflicts of interest to issuer clients. Broker-dealers have complained about the costs and burdens of complying with the rule changes.

The MSRB also is preparing to issue a concept release to seek public input on whether it should require underwriters and municipal advisors to disclose over EMMA any third-party payments they make or receive in connection with muni transactions or muni-related transactions.

“There is clearly a need to address the potential for undue influence resulting from undisclosed payments from third parties in connection with engagements with state and local governments,” said Polsky. “Such influence has been cited in a series of bid-rigging cases across the country and as one of the potential causes of the hardships faced by Jefferson County, Ala., and other governmental entities.”

Polsky was referring to criminal and civil probes of bid-rigging, which have revealed that firms that provided muni issuers with investment products for their bond proceeds, or with bond-related derivatives, typically paid other firms who conducted the bidding processes and ensured they would win the bids for those contracts.

In another initiative, the board plans to publish a proposal that would prohibit underwriters from making certain changes to bond documents after they buy bonds from an issuer and before they sell or distribute them to investors, unless the changes were allowed by authorizing documents or the official statement.

MSRB executive director Lynnette Kelly told reporters that there have been a small number of cases in which an underwriter has purchased bonds from an issuer, then as a bondholder agreed to make certain changes to the bond offering documents, before selling or distributing them to investors. The MSRB wants to make sure no changes to bond documents are made that would adversely affect existing bondholders affected by the changes in the documents.

If, for example, a dealer removed the requirement for a reserve fund from the documents of new bonds after being told by a rating agency that it would not affect the issuer’s rating, the change could affect holders of related bonds who assumed the reverse fund was in place. It would also cause problems if the issuer’s financial condition spiraled downward in the future.

The board plans to publish a notice encouraging issuers to disclose on EMMA information about their bank loans or direct placements of bonds. The MSRB has no authority in this area other than encouraging issuers to make voluntary disclosures. The MSRB and others have become concerned that an increasing number of issuers are obtaining bank loans which, unlike bonds, are not subject to primary and secondary market disclosure requirements.

In another action, the MSRB will soon seek SEC approval for a revised definition of “sophisticated municipal market professional” that tracks new Financial Industry Regulatory Authority rules on suitability for institutional accounts. Regulators consider SMMPs to need less protection than other investors, in part because they have access to more market data.

The board also plans to publish a concept release to determine whether it should broaden public access to the disclosure documents of so-called Section 529 college savings plans.

Finally, Polsky said the board approved a plan to “establish a long-range vision for EMMA and all the systems that support it. The plan will provide clear direction for the MSRB’s initiative roadmap for system enhancements over the coming years.”  The plan will be released next month.

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