The Municipal Securities Rulemaking Board yesterday filed proposed rule changes with the Securities and Exchange Commission that would dictate the priority of retail and other customer orders in primary offerings, as well as dealers’ related record-keeping responsibilities.
The proposals were controversial when drafted this summer, with dealers arguing that they were not necessary and issuer and other market participants warning they were needed to curb abuses.
The MSRB moved ahead with the proposals after institutional investors complained that their orders for were not filled during primary offerings, though the bonds became available soon after in the secondary market at higher prices.
The institutional investors posed two possible causes for this. One was that dealers were, in essence, 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 was that syndicate members or their affiliates were front-running the bonds, buying them for their own or affiliated accounts before filling orders from investors.
Some market participants were convinced the proposed rule changes were an attempt to curtail flipping, but board officials said they were meant to clarify that dealers must respect the priority of orders for bonds outlined by issuers, as many issuers have come to rely more on retail order periods to sell their bonds.
Specifically, the board is proposing changes to its Rule G-11 on new-issue syndicate practices that would require dealers to disclose whether their orders are for their own or related accounts.
They also would require new-issue underwriting managers or syndicate members to give priority to customer orders over orders for their own or affiliated or related accounts, unless otherwise agreed to by the issuer.
The proposal would also alter Rule G-8 on books and records and Rule G-9 on the preservation of records to require that records be retained for all primary offering orders — whether or not they are filled — for at least six years.
The records would have to indicate whether there was a retail order period and, if so, the issuer’s definition of “retail.” In instances when the syndicate manager deviated from the normal allocation of bonds, it would have to cite specific reasons why it was in the best interests of the syndicate to do so.
At the same time, the board is proposing interpretive guidance, which makes it clear that violation of the priority-order provisions would violate Rule G-17 on fair dealing. Further, the MSRB makes clear that the new guidance supersedes guidance last issued in 1987, long before retail order periods were so widespread.
Lynn Hampton, vice president for finance and chief financial officer of the Metropolitan Washington Airports Authority, said yesterday that the board’s move marks a “positive step.”
Commenting on the proposal in September, she told the board that she once discovered a retail sales firm buying MWAA bonds in the institutional sales market and then marking them up for their retail clients. She discussed the situation with the underwriters and asked that the firm begin to participate in the retail period.
But Leon Bijou, managing director and associate general counsel at the Securities Industry and Financial Markets Association, said yesterday that while SIFMA is sympathetic to investors whose orders are not filled, it does not believe the rule changes correctly address the problem and could actually impede the discretion currently given to dealers to determine the best way to distribute securities.
Bijou also said the two reasons given by the MSRB for the changes — phantom orders and front-running — are already prohibited by G-17.