WASHINGTON — The Municipal Securities Rulemaking Board has proposed a best execution rule, a step recommended by the Securities and Exchange Commission that has been mostly resisted by dealers who have warned such a rule would be tough to implement in the muni market.
Draft MSRB Rule G-18 would require broker-dealers to "use reasonable diligence in seeking to obtain for their customer transactions in municipal securities the most favorable terms available under prevailing market conditions."
Based on the Financial Industry Regulatory Authority's Rule 5310 for equities and corporate debt, the rule go a step beyond the current G-18 on execution of transactions, which requires dealers to "make a reasonable effort to obtain a price for the customer that is fair and reasonable in relation to prevailing market conditions."
The proposal also seeks to alter the MSRB's proposed Rule G-48 on sophisticated municipal market professionals to make clear that various dealer obligations, including best execution, would not apply to sophisticated municipal market participants, which require less protection.
Although the SEC recommended in its 2012 comprehensive report on the municipal market that the MSRB adopt a best execution rule, dealers said attempting to impose a "trade-by-trade" pricing mandate on them would be unreasonable in a market as illiquid and opaque as the muni market. The muni space does not have a single location where all pricing information is quickly available. The Securities Industry and Financial Markets Association last year floated an "execution with diligence" proposal that would have required dealers to use "reasonable diligence" to get a "fair and reasonable" price for customers.
The MSRB notice on its proposal notes that the rule must be tailored for the muni market, so one factor FINRA examiners could use to determine if a dealer met its obligations under the proposal is "information reviewed to determine the current market for the subject security or similar securities." That language is not included in the FINRA rule. Another muni-specific aspect of the proposed rule is its treatment of broker's brokers. Unlike the FINRA rule, draft Rule G-18 would not require dealers to show why it was reasonable to use a broker's broker.
The MSRB proposal states that the board is shooting for a principles-based rule that will protect investors without imposing a strict pricing standard on dealers.
"While an objective of draft Rule G-18 would be to provide a customer with a price that is as favorable as possible under prevailing market conditions, the best-execution requirement generally would target the process by which dealers handle orders and execute transactions, and would complement and buttress the MSRB's existing fair-pricing rules," the proposal states.
The MSRB is seeking public comments on several questions related to the rule proposal. Among these are whether the same goal could be better achieved through alternative regulatory measures, whether a best execution standard is a worthwhile goal, what effect the rule might have on the efficiency of transactions, and what additional costs the rule might impose on dealers.
If a best-execution standard was adopted, dealers would need to establish or revise compliance policies and written supervisory procedures, as well as implement additional monitoring and surveillance.
"The costs associated with requirements of the draft rule likely would be most pronounced for those dealers that would be required to implement a compliance system for the first time," the MSRB wrote. "These dealers would include the subset of dealers that are not subject at all to FINRA's best-execution rule."
The MSRB asked that public comments on the proposal be submitted by March 21. The rule would have to be filed with, and approved by, the SEC before it could take effect.
