The Bond Market Association yesterday issued draft best practices for broker-dealers of auction-rate securities in the wake of the Securities and Exchange Commission’s announcement that it had reached a $13 million settlement with 15 broker-dealer firms over practices in the auction-rate securities market that violated the securities laws.
The association has asked market participants to submit comments by June 30 on the 15-page best practice document, which was developed by a task force of traders, lawyers, and compliance officers from about two dozen member firms.
“We think these best practices will put the dealers in good stead in terms of fulfilling their obligations to both investors and issuers,” said Marjorie Gross, TBMA senior vice president. “The best practices cover such important issues as a broker-dealer’s obligations to issuers and investors, bidding by the broker-dealer, and re-sales of auction securities by a broker-dealer. They also contain a description of the product that we hope will be useful to all market participants.”
TBMA stressed in the document that the best practices, which cover municipal and other auction-rate securities, “are not regulations” and merely “constitute the opinion of a group of dealers as to appropriate conduct with regard to auction rate securities in most circumstances.”
“In appropriate circumstances, a broker-dealer may deviate from the best practices without engaging in inappropriate conduct or a violation of law,” TBMA said in the document.
The objective of an auction is to establish a rate for the next auction, the association said. The broker-dealer’s obligation to the issuer is to solicit bids. TBMA recommended that broker-dealer firms no longer disclose in program documents that they plan to implement the auction to obtain the “lowest possible rate” for the securities because the clearing rate, or the lowest rate bid sufficient to cover all of the securities for sale in the auction, is often higher than the lowest bid.
The dealer’s obligations to holders and prospective holders of the securities are “no more extensive than normal dealer obligations governed by existing securities law,” TBMA said.
The best practices document recommends that dealers have policies and procedures for ensuring their auction rate securities business complies with applicable laws and regulations and that dealers educate issuers and investors about the material features of auction rate securities.
In a section dealing with bidding by the broker-dealer, TBMA recommended that when a broker-dealer’s auction desk holds auction rate securities for its own account on the date of the auction, the desk should submit an order into the auction to sell all of the securities.
If the broker-dealer places a bid for its own account in an auction, it should do so before the submission deadline and at the securities’ “estimated market rate,” which basically is a fair market rate. It should also disclose such its actions to holders and other bidders, TBMA said.
As for bidding by investors, TBMA said that a broker-dealer may provide oral or written “price talk” to holders and prospective holders of securities before the start of the auction. Price talk represents the dealer’s good faith judgment, at a given time, of the likely range of clearing rates for an auction, based on market information. “It is not a guaranty” and investors “are free to use it or ignore it,” TBMA stressed.
“A broker-dealer must not give [selected investors] information about actual bidding,” the association added.
Broker-dealers in multi-dealer programs must act independently and should never share estimates of their price talk with other broker-dealers in the programs, according to TBMA.
The association also cautioned dealers against informing bidders that there are no bids at a rate in order to avoid an all-hold rate, and urged broker-dealers not to accept “market order” bids. However, the group said, “A bidder may give a broker-dealer investment discretion to place all aspects of a bid consistent with applicable rules regarding investment discretion. The individual authorized to exercise such discretion should not have access to information about orders in a given auction [other than those placed by the individual] or to the broker-dealer’s placed or planned bids for its own account.”
A broker-dealer should prohibit the flow of information about order flow from the auction desk to the sales desk and should prohibit the disclosure of the order of any bidder to another bidder, TBMA said.
Broker-dealers should maintain adequate documentation with respect to each order for auction-rate securities, the group said.
In a section called “Relationship Between Broker-Dealers and the Auction Agent,” TBMA said that a broker-dealer may be the bank designated as the auction agent or an affiliate of such a bank. In such a case, the auction agent should ensure that, in a multi-dealer program, it does not treat its auction desk or an affiliated broker-dealer more favorably than other broker-dealers in the program.
Prior to the deadline for submitting bids, the auction agent should be permitted, but not required, to inform each broker-dealer that there are insufficient bids to prevent a failed auction, TBMA said.
Broker-dealers should be able to correct clerical errors they make between the time an order is submitted to the auction agent and one hour after the auction results are first posted, the group said. Auction agents should also have a grace period after the auction results have been posted in order to correct their clerical errors.
“A broker-dealer may buy or sell auction-rate securities outside the auction at, or below par, as long as the purchase or sale price is at a then-current yield,” TBMA said.
In a section on program documents, TBMA said all of the disclosure documents describing the auction procedures and broker-dealer agreements for auction rate securities programs reflect current auction practices.
“Each broker-dealer should establish its own deadline for bid submissions to help ensure that it can comply with the applicable submission deadline,” the group said.
“Holders and prospective holders should be able to change their orders after they have been submitted to the broker-dealer and before the broker-dealer’s internal submission deadline,” it continued.
TBMA advised that the “all-hold rate should continue to be a below-market rate, to encourage bidders to place bids at a specified rate, but a broker-dealer should advise an issuer client to consider whether the current discount is in the best interest of the program.”
Finally, the group said that broker-dealers should not be required to submit the names of bidders with their bids and should be considered the holder for that purpose.
TBMA yesterday thanked the SEC’s division of market regulation for its input into drafts of the best practices but stressed that the recommendations “do not represent the views of any regulatory authority.”
