WASHINGTON — The Municipal Securities Rulemaking Board Wednesday filed changes with the Securities and Exchange Commission on a controversial proposal that would dictate the priority of retail and other customer orders in primary offerings, as well as dealers’ related record-keeping responsibilities.
As expected, the changes are in line with the original, comprehensive proposal the MSRB floated last November rather than a significantly pared-down version it agreed to in the spring, though the board made some small technical changes.
The board is moving forward with the set of rule changes at the insistence of SEC officials and over the objections of dealers.
The proposal aims to increase the distribution of new-issue bonds by requiring a managing underwriter in a primary offering to give priority to customer orders over orders for its own account, affiliated accounts, or the accounts of other members of the syndicate, unless it reached some other agreement with the issuer.
Among the technical changes, the board clarified that record-keeping requirements related to deviations from customer priority provisions would apply to both sole underwriters and syndicate managers.
“We have been working on this important investor protection rule for some time and are pleased that we have agreement on how dealers distribute new issues,” MSRB executive director Lynnette Hotchkiss said in a statement.
“The changes we are making seek to address the interests of investors, and also of issuers, since dealers must now make sure they follow issuers’ wishes about distribution of bonds to individual investors.”
To provide dealers with time to comply with the changes, the board is proposing they become effective for new issues formally awarded to underwriters more than 60 days after SEC approval. It asked the SEC for expedited approval.
As with the MSRB’s original proposal floated Nov. 18, the board is seeking to amend its Rule G-11 on new-issue syndicate practices to require dealers to disclose whether orders are for their own or related accounts.
The proposal also alters Rule G-8 on books and records and Rule G-9 on the preservation of records to require that records be kept and retained for all primary offering orders — whether or not they are filled — for at least six years.
In addition, it would replace interpretive guidance on Rule G-17 on fair dealing published in 1987, prior to the proliferation of retail order periods, with new guidance to promote a fair distribution of new issues to customers.
Though the board voted in April to gut all but the record-keeping portions of the proposal, SEC staff insisted it move forward with the comprehensive proposal, market participants have said.
The bulk of the board’s 15-page filing with the SEC yesterday is devoted to refuting industry concerns about the November proposal, namely that it is confusing, duplicative, and would have detrimental effects on competition and higher borrower costs.
Responding to the concerns made by the Securities Industry and Financial Markets Association, the board said: “The proposed rule change incorporates the same exceptions to the priority provisions that exist under current law. What the proposed rule change would do is to require accountability of underwriters who deviated from the priority provisions, because they would be required to keep records of their reasons for doing so.”
However, the board agreed to remove the word “generally” from a statement in the paragraph in the interpretive guidance. SIFMA had complained the word created too much wiggle room and would have made the guidance “less rigorous” than the proposed amendment to Rule G-11, which the MSRB said was not its intent.
Asked about the MSRB filing with the SEC, Leslie Norwood, managing director and co-head of the municipal securities division at SIFMA, said in a statement: “We’re pleased that the MSRB clarified its proposal on priority of orders in primary offerings. We are concerned, however, that the amendments do not fully address many of the concerns raised in our letter to the SEC on Dec. 31, 2009, such as the lack of clarity in Rule G-11(e)(i), unequal treatment of underwriters under Rule G-11, and resolving the tension that exists between retail investors and institutional investors regarding unfilled orders. We look forward to continue working with industry members and regulators on this issue.”
Though the Investment Company Institute, which supports the proposal, had requested that the board define retail order period to include institutions trading on behalf of investors, the board declined to do so, saying it believes it appropriate to leave that decision, as well as whether primary offerings should include retail periods, up to issuers.
“Defining 'retail’ so as to include institutions trading on behalf of retail investors would avoid harm to investors who rely on mutual funds for their access to primary offerings of municipal bonds,” said ICI spokeswoman Rachel McTague.
The basis for the proposal was institutional investor complaints that their orders for muni bonds were not filled during primary offerings, even though the bonds became available to them at higher prices soon after in the secondary market.
The institutional investors claimed there were two possible causes.
One is that dealers are 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 is that syndicate members or their affiliates are front-running the bonds, buying them for their own or affiliated accounts before filling orders from investors.
Flipping generally occurs when dealers or institutional investors purchase bonds and then immediately resell them to retail investors at higher prices.
Though a number of market participants are convinced the proposed rule changes were an attempt to curtail flipping, board officials said they were meant to clarify that dealers must respect the priority of orders for bonds specified by issuers, as many issuers have come to rely more on retail order periods to sell their bonds.