WASHINGTON — Dealer groups and market participants criticized the Municipal Securities Rulemaking Board’s draft rule on broker’s brokers last week, saying it would undermine, not improve, secondary market liquidity.
The remarks, in comment letters filed with the MSRB on draft Rule G-43 on the fair pricing obligations of broker’s brokers, come as regulators have stepped up scrutiny of the secondary market. Officials say they are concerned retail investors may not receive fair and reasonable prices when broker-dealers sell municipal securities through broker’s brokers, which are dealers that principally effect transactions for other dealers.
Regulators have also expressed concerns about the role played by broker’s brokers, whose conduct has generated several enforcement cases in recent years.
But in a comment letter filed with the MSRB on Nov. 3, a dealer group said G-43 is unnecessary because existing MSRB rules, as enforced by the Financial Industry Regulatory Authority, already ban the conduct the draft rule seeks to address.
“The information that we have from our members is that, to the extent there had been improper behavior, the enforcement actions undertaken under existing rules have resulted in broker’s brokers generally being more aware of their obligations and responsibilities and improved the conduct of bid-wanted and offerings,” wrote Michael Nicholas, chief executive officer of Bond Dealers of America. “If the MSRB and FINRA have identified additional improper actions, we believe that they should pursue them and that any resulting enforcement actions will have a similar salutary effect.”
An earlier draft of G-43, floated for comment in February, sparked protest from a range of market participants, who objected to provisions governing fair-pricing obligations.
The revised draft, released in September, provoked a similar response.
“Broker’s brokers should not be in any way responsible for making a determination as to fair market value,” wrote O. Gene Hurst, president of Wolfe & Hurst Bond Brokers Inc. in Jersey City.
Specifically, market participants criticized a provision saying 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 it can find for certain muni securities without specifying a desired price or yield.
Under draft G-43, the predetermined parameters could be based upon 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 board said.
Broker’s brokers would also be required to notify the seller if the highest bid in a bid-wanted fell below the predetermined parameters, and would have to receive the seller’s permission before proceeding with the trade.
But Hurst wrote that the MSRB’s proposed revisions, including the safe harbor, serve as a “mandate” for the conduct of bid-wanteds and bid-offerings.
Any responsibility to determine the fairness of a bid obtained by a broker’s broker should rest “solely” with broker-dealers, who have the “tools and resources” to determine fair and reasonable pricing, he said.
Nicholas, meanwhile, warned the proposed rule could prove counterproductive.
If a broker’s broker “set the parameters too broadly on the upper end,” erroneous bids would not be identified, the bidder would not be notified and might, in future dealings with that broker’s broker, bid more conservatively or not at all, he wrote. The result would be “reduced liquidity in the market and lower prices for investors,” he said.
Similarly, if a broker’s broker set the parameters too narrowly on the lower end, the selling broker would receive a notice and might not go through with the trade, or “risk litigation if it did,” Nicholas wrote.
Another industry group struck a similar theme: “Any impediments to trading in what is already a labor-intensive market must be carefully reviewed to ensure that the burdens to liquidity are justified,” wrote Leslie Norwood, managing director and co-head of the muni division of the Securities Industry and Financial Markets Association.
