The Municipal Securities Rulemaking Board has proposed rule changes that would require dealers to analyze more information when determining if a recommended transaction or recommended investment strategy is suitable for a customer.
The proposal, which was released Monday and has support from the dealer community, would change the MSRB's Rule G-19 on suitability so that it mirrors the Financial Industry Regulatory Authority's new suitability Rule 2111, which took effect in July 2012.
The proposed changes are part of the board's effort to make its rules more efficient and effective as well as to align them with other agencies' rules, the MSRB said in a release. The board noted that the changes being proposed were recommended by the Securities and Exchange Commission in its muni market report released last year.
"These changes would help ensure investors are presented with municipal securities recommendations that are appropriate based on their investment profile," MSRB executive director Lynnette Kelly said in the release.
The MSRB proposes to rewrite all of Rule G-19 so that it incorporates suitability guidance that currently applies to Rule G-17 on fair dealing. For the first time, the board's suitability rule would also apply to recommendations of investment strategies.
"[Dealers] must have a reasonable basis to believe that a recommended transaction or investment strategy involving a municipal security or municipal securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [dealer] to ascertain the customer's investment profile," the proposed rule changes states.
The term "investment strategy" would be "interpreted broadly" and would include dealers' recommendations to hold securities, the notice said. Communications and education materials that describe general financial and investment information would be excluded.
Rule G-19 already requires dealers, before making recommendations to non-institutional customers, to collect information about customers' financial and tax status, as well as investment objectives.
The proposal would expand that information to include the customer's age, investment time horizon, liquidity needs, investment experience and risk tolerance.
Dealers would continue to be exempt from the requirements to perform a customer-specific suitability determination for recommendations to "sophisticated municipal market professionals," which are individuals and non-corporate entities that have at least $50 million invested in munis, according to the notice.
Supplemental materials in the proposed rule changes outline three main suitability obligations.
The "reasonable-basis obligation" would require dealers to believe, based on reasonable diligence, that a recommendation is "suitable for at least some investors."
Dealers would also have a "customer-specific obligation" requiring that they have a reasonable basis to believe a recommendation is suitable based on the customers' investment profile.
The rule addresses the practice of churning, which occurs when dealers recommend excessive transactions, with a "quantitative suitability" obligation that requires dealers to ensure that a series of recommended transactions are suitable and not excessive.
The board requested market participants provide feedback on whether they support the proposal, and to give details about its potential burdens, costs and benefits. The board asked if the muni market has unique characteristics that justify differences between the MSRB's and FINRA's suitability rules and requested market participants suggest possible regulatory alternatives.
Comments are due May 6.
Mike Nicholas, chief executive officer at Bond Dealers of America, said his group "appreciates the MSRB's efforts to streamline and harmonize its suitability rule with FINRA's rule, while recognizing suitability standards already in place at broker dealers."
"We look forward to providing written comments on how the revised rule might directly impact middle-market dealers and investors," he said.
David Cohen, managing director and associate general counsel of the Securities Industry and Financial Markets Association, said SIFMA is still reviewing the proposal but that the group "generally supports the alignment of this rule with FINRA Rule 2111 on suitability."
"Regulatory harmonization on this and other muni issues as appropriate is key to effective business practices and efficient compliance," he said in an email.
