WASHINGTON — The Municipal Securities Rulemaking Board’s proposed guidance for broker’s brokers would force them to go beyond the board’s existing rules, would be inconsistent with their limited roles in the market, and would impede the efficiency of the interdealer market, the Securities Industry and Financial Markets Association warned the MSRB this week.
In a 17-page comment letter filed Monday, SIFMA asked the board to withdraw or modify much of the proposed guidance, which was proposed in September. Additional letters from individual brokers’ brokers and other industry participants echoed SIFMA’s concerns.
Specifically, the guidance details how the MSRB’s Rules G-18 on execution of transactions, G-30 on prices and commissions, and G-17 on fair dealing apply to broker’s brokers, which typically match dealer sellers with dealer buyers of municipal securities.
On a fundamental level, SIFMA took issue with the board’s proposed definition of a municipal securities broker’s broker, or MSBB, which the guidance would define as a dealer “that principally effects transactions for other brokers, dealers, or municipal securities dealers or holds itself out as a broker’s broker.”
“SIFMA believes that this definition does not sufficiently define what an MSBB is, or the limited nature of their business activities,” wrote Leslie Norwood, the group’s managing director and associate general counsel.
SIFMA offered a lengthy alternative definition, in which the broker’s broker “acts as a disclosed agent or riskless principal in the purchase or sale of municipal securities for an undisclosed registered broker, dealer, municipal securities dealer, Sophisticated Municipal Market Professionals (“SMMP”), or institutional counterparty.”
Under SIFMA’s “function-based” definition, a broker’s broker would not have any municipal securities in any proprietary or other accounts other than for clearance and settlement purposes; participate in syndicates; or participate in the decision to buy or sell securities, exercise discretion as to the price at which a transaction is executed, or determine the timing of execution, among other factors.
On G-18, SIFMA said the MSRB’s guidance would go beyond helping brokers’ brokers comply with the current rule by “substantially” modifying it. Any such modification should be done through a separate rule-amendment process, it said.
The rule now requires that, for transactions for dealer clients, MSBBs shall have the same obligation to their dealer counterparties as dealers when they conduct agency transactions with customers. MSBBs should “make a reasonable effort to obtain a price for the customer that is fair and reasonable in relation to prevailing market conditions,” the board said.
The proposed guidance would require that MSBBs make a determination after the bid process has run its course as to whether the resulting highest bid is fair, SIFMA said. In addition, if the MSBB is unable to determine that the price is fair, it would have to notify its dealer-client in writing of that fact, and would also have to receive written acknowledgement prior to effecting the transaction.
“We believe that this proposal inappropriately places the primary burden of determining whether a transaction should occur on the MSBB, rather than on the sellers of securities,” SIFMA said. “The determination of whether a resulting high bid is fair, especially in a market as thinly traded as the municipal securities secondary market, is inherently subjective, and is one which the seller is clearly in a better position to make, and which the MSRB requires that dealers make when acting as principal for their customers.
“Given the fast-paced nature of most bond-trading desks, it is difficult (if not impossible) to imagine an MSBB and a dealer actually going through the steps of giving notice of the MSBB’s inability to determine whether fair value has been achieved, and obtaining written acknowledgement of that disclosure outlined in the proposed guidance, before the transaction is executed,” SIFMA said.
In a separate comment letter, Thomas Vales, chief executive officer of TheMuniCenter LLC, an electronic trading exchange for fixed-income securities, agreed that this proposed scheme would not work because there are an estimated 3,000 bids-wanted each day. It would be “overly burdensome” to require participants to sign written waivers for exemptions, he said.
“If the regulation were modified to fit the natural process, then written waivers would only be required for aberrations,” Vales wrote. “The responsibility of a broker should be to maintain a fair process for both parties and to request written disclosure for exceptions.”
On G-17, SIFMA said it supports the MSRB’s attempts to ensure that broker’s brokers “shall deal fairly with all persons and shall not engage in any deceptive, dishonest or unfair practice.”
However, SIFMA said there should be more than one method for MSBBs that have non-dealer customers — presumably institutional investors or SMMPs — to disclose that fact to both sellers and bidders other than in writing, as the guidance would require.
SIFMA said it is especially worried about the consequences of the guidance’s requirement that broker’s brokers “put information barriers in place to ensure that customers are not provided with information about securities of other clients, including the ownership of such securities and information about bids (other than the winning bid that is reported to the MSRB).”
“SIFMA is especially concerned that a broad restriction on MSBBs sharing market related information with counterparties may lead to a bifurcation of the municipal securities secondary market, as it relates to counterparties dealing through MSBBs versus other dealers,” SIFMA wrote.
For example, it said an MSBB or dealer should never provide to a trading counterparty information about what another market participant is doing if sharing such information would allow the counterparty to ascertain the identity of the other market participant or its proprietary trading information.
“However, we do believe that sharing information about what similar securities have recently traded for, or may be currently bid at, is useful information that can allow the counterparty to make informed buy/sell decisions,” SIFMA wrote.
Much of the MSRB guidance relates to bid-wanteds, in which a selling dealer asks a broker’s broker to obtain the best bid that it can find for certain muni securities, without specifying a desired price or yield, the board said.
Bid-wanteds, which were the subject of several of the recent enforcement actions, tend to involve smaller retail-size blocks of bonds and relatively infrequently traded securities, according to the guidance.
SIFMA said it agrees with the general principle in the proposed guidance that bid-wanteds and “situations” — the generic term for when a selling dealer specifies a desired price or yield for the security and the broker’s broker negotiates between the selling dealer and potential bidders — must be conducted in a fair manner. Absent clients’ permission to represent both sides of a transaction, broker’s brokers must not take any action that works against clients’ interests, SIFMA also agreed.
But the association said it is troubled that prohibitions on certain communications from MSBBs are “overbroad” and would impede the conduct of efficient trading. For example, a prohibition against letting bidders know where they stand in the bid process is “unnecessarily restrictive,” SIFMA said.
“Bidders routinely seek information after the 'sharp’ deadline for bids on whether their bid is likely to be used in a specific bid-wanted, so that they can determine whether the capital represented by their bid is likely to be used for that transaction,” it said. “This is a long-standing industry practice expected by the broker-dealer community. If, after the sharp deadline, a bidder is clearly out of contention for a bid-wanted, that firm may decide to participate in another bid-wanted to continue to try to put their capital to work.”
On transactions with SMMPs, the trade group said broker's brokers should not be subject to Rule G-30, reflecting the “limited and sophisticated” nature of these non-dealer counterparties. The rule prohibits dealers from buying or selling securities at unfair or unreasonable prices on principal trades.