Responding to criticism from market participants, the Municipal Securities Rulemaking Board retooled a controversial portion of a proposed rule on broker’s brokers, and floated the revised version Thursday for another round of comments.
An earlier draft of Rule G-43, released in February, sparked protest from a range of market participants, who objected to provisions governing fair-pricing obligations and to a proposed exclusion for electronic trading systems.
As revised, draft G-43 does not exclude electronic trading systems from the definition of broker’s brokers. But it clarifies that broker’s brokers — who must use reasonable efforts to determine that a price is fair and reasonable — could fall within a so-called safe harbor if they use predetermined parameters designed to identify possible off-market bids in a bid-wanted.
In a bid-wanted situation, the selling dealer asks the broker’s broker to obtain the best bid that it can find for certain muni securities without specifying a desired price or yield. The predetermined parameters could be based on yield curves, pricing services, recent trades reported to the MSRB’s Real-time Transaction Reporting System, or bids submitted to a broker’s broker in previous bid-wanteds or offerings, the MSRB said.
The board contended in its release on the draft rule that the proposed revisions strike a balance between the views expressed in comment letters and the MSRB’s concern that retail investors in the secondary market may not receive fair and reasonable prices when broker-dealers sell municipal securities through broker’s brokers.
“The conduct of broker’s brokers can have a significant impact on retail investors in the municipal market as the selling and bidding dealers in these transactions, in turn, transact with customers,” MSRB executive director Lynnette Hotchkiss said in a statement. “We believe that this rule would play an important role in ensuring fair prices in the secondary market for municipal securities.”
In its February release, the board said the Securities and Exchange Commission and the Financial Industry Regulatory Authority have brought several enforcement actions pegged to broker’s brokers activities that violated MSRB rules.
Public comments on draft G-43 and a new draft notice, which addresses the pricing duties of broker-dealers that sell and bid for munis in bid-wanteds and offerings conducted by broker’s brokers, are due Nov. 3.
The revised draft G-43, like the version proposed in February, would 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.
But under the previous version, broker’s brokers had to form judgments about the fairness of high bids and receive written acknowledgement that they disclosed to sellers the fairness of the prices.
As revised, draft G-43 would require broker’s brokers to notify the seller if the highest bid in a bid-wanted was below the predetermined parameters, the board said. The broker’s broker would have to receive the seller’s permission before proceeding with the trade.
The revised draft G-43 would permit a broker’s broker, without obtaining the seller’s consent, to contact the high bidder in a bid-wanted about its bid price before the deadline, if the bid fell outside the predetermined parameters and the broker’s broker believed it might have been submitted in error.
The board defined predetermined parameters as “formulaic” based on objective pricing criteria that are reasonably designed to identify most bids that may not represent the fair-market value of municipal securities that are the subject of bid-wanteds, determined by the broker’s broker in advance of the acceptance of bids, and systematically applied to all bids.
One broker’s broker, whose comments the board cited as “useful” in shaping its revisions, welcomed the changes.
“I guess I probably should thank the board for paying attention and listening to all the comments, including ours,” said Mark Epstein, president and chief executive officer of Hartfield Titus & Donnelly LLC in Jersey City. Industry groups gave the proposal a mixed review.
“We are happy that they have made some revisions to the notice,” said Leslie Norwood, managing director and co-head of the muni securities division at the Securities Industry and Financial Markets Association. But SIFMA is “disappointed” the MSRB has not addressed several of its comments, she said.
Bond Dealers of America said it was pleased the board revised the rule and would study it carefully, according to William Daly, BDA’s senior vice president of government relations.