[Federal Register Volume 77, Number 106 (Friday, June 1, 2012)]
[Notices]
[Pages 32704-32707]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-13255]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-67064; File No. SR-MSRB-2012-05]
Self-Regulatory Organizations; Municipal Securities Rulemaking
Board; Order Granting Approval of a Proposed Rule Change Consisting of
a Restatement of an Interpretive Notice Concerning the Application of
MSRB Rule G-17 to Sophisticated Municipal Market Professionals
May 25, 2012.
I. Introduction
On March 26, 2012, the Municipal Securities Rulemaking Board
(``Board'' or ``MSRB'') filed with the Securities and Exchange
Commission (``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change consisting of a restatement of an
interpretive notice (the current interpretive notice, ``Existing SMMP
Notice,'' and the proposed restated interpretive notice, ``Restated
SMMP Notice'') concerning the application of MSRB Rule G-17 (on conduct
of municipal securities and municipal advisory activities) to
sophisticated municipal market professionals (``SMMPs'').\3\ The
proposed rule change was published for comment in the Federal Register
on April 13, 2012.\4\ The Commission received one comment letter on the
proposed rule change.\5\ On May 18, 2012, the MSRB submitted a response
letter.\6\ This order approves the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ The implementation date for Financial Industry Regulatory
Authority (``FINRA'') Rule 2111 (Suitability) is July 9, 2012. The
MSRB proposed to adopt the same time frame for its Restated SMMP
Notice.
\4\ See Securities Exchange Act Release No. 66772 (April 9,
2012), 77 FR 22367 (``Notice'').
\5\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from David L. Cohen, Managing Director, Associate General Counsel,
Securities Industry and Financial Markets Association, dated May 4,
2012 (``SIFMA Letter'').
\6\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from Ernesto A. Lanza, Deputy Executive Director and Chief Legal
Officer, dated May 18, 2012 (``MSRB Letter'').
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II. Description
Existing Definition of SMMP
Under the Existing SMMP Notice, a dealer is permitted to treat an
institutional customer \7\ as an SMMP if the dealer has reasonable
grounds for concluding the following and if other known facts do not
contradict such a conclusion: (1) The customer has timely access to the
publicly available material facts concerning a municipal securities
transaction; (2) the customer is capable of independently evaluating
the investment risk and market value of the municipal securities at
issue; and (3) the customer is making independent decisions about its
investments in municipal securities.\8\ The Existing SMMP Notice also
provides additional considerations that may be relevant in determining
whether an institutional customer has timely access to publicly
available information, is capable of independently evaluating
investment risk and market value, and is making independent investment
decisions.
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\7\ For purposes of the Existing SMMP Notice, an institutional
customer is defined as ``an entity, other than a natural person
(corporation, partnership, trust, or otherwise), with total assets
of at least $100 million invested in municipal securities in the
aggregate in its portfolio and/or under management.''
\8\ Although the Existing SMMP Notice permits a dealer to have
an investor attest to SMMP status ``as a means of streamlining the
dealers' process for determining that the customer is an SMMP,'' it
also provides that a dealer may not rely on such an attestation if
the dealer knows or has reason to know that the investor lacks
sophistication concerning a municipal securities transaction based
on a number of factors set forth in the notice.
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Application of Existing SMMP Definition
The Existing SMMP Notice addresses a dealer's obligations to an
SMMP under MSRB's Rule G-17 (on fair dealing), Rule G-18 (on execution
of transactions), Rule G-19 (on suitability), and Rule G-13 (on
quotations). According to the MSRB, Rule G-17 requires brokers,
dealers, and municipal securities dealers (collectively referred to
herein as ``dealers'') to disclose to customers at or before the time
of trade all material information about a transaction known by the
dealer, as well as all material information about a security reasonably
accessible to the market from established industry sources.\9\ The
Existing SMMP Notice provides that, when a dealer effects a non-
recommended secondary market transaction with an SMMP, its affirmative
Rule G-17 disclosure duty concerning material information available
from established industry sources will be deemed satisfied. A dealer,
however, may not engage in deceptive, dishonest, or unfair practices
under Rule G-17 or under the federal securities laws. Further, in a
transaction with an SMMP, a dealer's intentional
[[Page 32705]]
withholding of a material fact about a security when the information is
not accessible through established industry sources may constitute an
unfair practice that violates Rule G-17.
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\9\ See MSRB Interpretive Notice Regarding Rule G-17, On
Disclosure of Material Facts (March 20, 2002) and MSRB Guidance On
Disclosure and Other Sales Practice Obligations to Individual and
Other Retail Investors in Municipal Securities (July 14, 2009).
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According to the MSRB, Rule G-18 provides that each dealer, when
executing a transaction in municipal securities for or on behalf of a
customer as agent, must make a reasonable effort to obtain a price for
the customer that is fair and reasonable in relation to prevailing
market conditions. The Existing SMMP Notice provides that a dealer
effecting a non-recommended secondary market agency transaction for an
SMMP is not required to take further actions to ensure that the
transaction is effected at a fair and reasonable price, if its services
have been explicitly limited to providing anonymity, communication,
order matching, and/or clearance functions and the dealer does not
exercise discretion as to how or when a transaction is executed. The
Existing SMMP Notice also states that this interpretation of Rule G-18
is particularly relevant to dealers operating alternative trading
systems, as dealers operating such systems may be merely aggregating
the buy and sell interest of other dealers or SMMPs.\10\ A footnote to
the Existing SMMP Notice states that the same interpretation would
apply to a broker's broker when executing an agency transaction for
another dealer.
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\10\ The Existing SMMP Notice also states that dealers operating
alternative trading systems, under the general duty set forth in
Rule G-18, must act to investigate any alleged pricing
irregularities on its systems brought to its attention.
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According to the MSRB, under Rule G-19, in the case of a
recommended transaction, a dealer must have a reasonable basis for
recommending a particular security (``reasonable-basis suitability''),
as well as reasonable grounds for believing the recommendation is
suitable for the customer to whom it is made, based upon information
available from the issuer of the security or otherwise and based upon
the facts disclosed by the customer or otherwise known about the
customer (``customer-specific suitability''). The Existing SMMP Notice
provides that, when a dealer has reasonable grounds for concluding that
an institutional customer is an SMMP, the dealer's customer-specific
suitability obligation is fulfilled.
According to the MSRB, under Rule G-13, no dealer may distribute or
publish, or cause to be distributed or published, any quotation
relating to municipal securities, unless the quotation is bona fide
(i.e., the dealer making the quotation is prepared to execute at the
quoted price) and the price stated in the quotation is based on the
best judgment of the dealer of the fair market value of the securities
that are the subject of the quotation at the time the quotation is
made. In general, any quotation disseminated by a dealer (including the
quotation of an investor) is presumed to be a quotation made by the
dealer, and the dealer is responsible for ensuring compliance with the
bona fide and fair market value requirements with respect to the
quotation. However, if a dealer disseminates a quotation that is
actually made by another dealer and the quotation is labeled as such,
then the quotation is presumed to be a quotation made by such other
dealer and not by the disseminating dealer. In such a case, the
disseminating dealer is only required to have no reason to believe that
either: (1) The quotation does not represent a bona fide bid for, or
offer of, municipal securities by the maker of the quotation; or (2)
the price stated in the quotation is not based on the best judgment of
the maker of the quotation of the fair market value of the securities.
If a dealer disseminates the quotation of an SMMP and it is labeled as
such, the disseminating dealer will be held to the same standard as if
it were disseminating a quotation made by another dealer. The Existing
SMMP Notice also provides several factors that are relevant to whether
dissemination of the SMMP's quotation may be considered to be a
violation of Rule G-13 by the dealer.
Considerations for Change
According to the MSRB, in 2002, it adopted a definition of SMMP
that differed from certain other regulatory definitions of investors
considered sophisticated enough to receive special treatment under
federal securities law. The MSRB stated that the SMMP definition was
closely modeled on an NASD interpretation of its suitability rule,\11\
which contained a comparable list of factors found relevant to an
investor's independent evaluation of risk and independent investment
decisions. The MSRB stated that a notable difference was that the
definition of SMMP also looked to whether the investor had access to
material facts and that a key factor for the difference was the lack of
information available about municipal securities at that time.
According to the MSRB, since the adoption of the existing definition of
SMMP, there has been a vast increase in the availability of information
about municipal securities reasonably accessible by institutional
investors regardless of the amount of their holdings of municipal
securities.
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\11\ See NASD IM-2310-3 (Suitability Obligations to
Institutional Customers).
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As of July 9, 2012, the NASD guidance on institutional suitability
will no longer be in effect. It will be replaced by FINRA Rule 2111,
which adopts a different approach to a FINRA member's customer-specific
duty of suitability to an ``institutional account.'' Under FINRA Rule
2111, a dealer's customer-specific suitability obligation to an
institutional customer will be considered satisfied if (1) the dealer
has a reasonable basis to believe that the institutional customer is
capable of evaluating investment risks independently, both in general
and with regard to particular transactions and investment strategies
involving a security or securities and (2) the institutional customer
affirmatively indicates that it is exercising independent judgment in
evaluating the dealer's recommendations. There will no longer be a
detailed listing of factors, such as that found in the Existing SMMP
Notice. The MSRB noted that, absent clear reasons for treating
transactions in municipal securities differently, from the standpoint
of reducing compliance cost, it generally considers it desirable to
maintain consistency with FINRA rules.
Proposal to Restate SMMP Notice
Because the quality and availability of information concerning
municipal securities has improved substantially since 2002, and to
maintain consistency with the revised FINRA suitability rule for
institutional customers, the MSRB proposed to retain the concept of an
SMMP but revise its definition. Specifically, the MSRB proposed to
define SMMP as an ``institutional customer of a dealer that: (1) The
dealer has a reasonable basis to believe is capable of evaluating
investment risks and market value independently, both in general and
with regard to particular transactions in municipal securities, and (2)
affirmatively indicates that it is exercising independent judgment in
evaluating the recommendations of the dealer.'' \12\ The MSRB also
proposed that
[[Page 32706]]
``[a]s part of the reasonable basis analysis required by clause (1),
the dealer should consider the amount and type of municipal securities
owned or under management by the institutional customer.'' There would
no longer be a threshold requirement that a customer own or manage a
certain amount of municipal securities in order to be considered an
SMMP.
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\12\ ``Institutional customer'' would be defined as a customer
with an ``institutional account.'' MSRB Rule G-8(a)(xi) defines
``institutional account'' as the account of (i) a bank, savings and
loan association, insurance company, or registered investment
company; (ii) an investment adviser registered either with the
Commission under Section 203 of the Investment Advisers Act of 1940
or with a state securities commission (or any agency or office
performing like functions); or (iii) any other entity (whether a
natural person, corporation, partnership, trust, or otherwise) with
total assets of at least $50 million.
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The MSRB proposed that, in the case of the affirmation described in
clause (2) of the revised definition of SMMP, customers be allowed to
make the affirmation orally or in writing and to provide the
affirmation on a trade-by-trade basis, on a type-of-municipal-security
basis, or for all potential transactions for the customer's account.
The MSRB stated that this requirement would be consistent with the
affirmation requirement of FINRA Rule 2111, and receipt by a dealer of
the FINRA 2111 affirmation would also satisfy this requirement.
The Restated SMMP Notice would not change the application of Rules
G-18, G-19, and G-13 to SMMPs. However, it would change the application
of Rule G-17 to SMMPs, under the assumption that institutional
customers now have substantial access to material information about
municipal securities. The Existing SMMP Notice excludes a dealer from
the duty to disclose all material information available from
established industry sources when it transacts a non-recommended
transaction. The Restated SMMP Notice, however, would apply this
exclusion to all transactions with SMMPs, whether recommended or self-
directed. The Restated SMMP Notice would also remove the lists of
factors to consider in determining a customer's status as an SMMP. In
addition, the proposal would update the Existing SMMP Notice to reflect
developments in the MSRB's interpretations of Rule G-17 since 2002.
Further, the proposal would remove endnote 9 to the Existing SMMP
Notice, which, according to the MSRB, has been construed by some to
lessen the duty of a broker's broker under Rule G-18 in a manner that
is inconsistent with the Board's proposed Rule G-43 (on broker's
brokers).\13\ Lastly, the Restated SMMP Notice would remove the
language that suggests that transactions on alternative trading systems
are done on an agency basis, because, according to the MSRB, at least
one major alternative trading system engages only in principal
transactions.
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\13\ See Securities Exchange Act Release No. 66625 (March 20,
2012), 77 FR 17548 (March 26, 2012) (SR-MSRB-2012-04). The MSRB
noted that, under proposed Rule G-43, an alternative trading system
that had any customers (as defined in MSRB Rule D-9) that were not
SMMPs would not be excepted from the definition of ``broker's
broker.''
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III. Comments
The Commission received one comment letter supporting this proposed
rule change.\14\ The commenter supported the revised definition of SMMP
``as the quality and availability of information concerning municipal
securities has greatly improved since 2002.'' The commenter agreed that
it is desirable, from the standpoint of reducing the cost of dealer
compliance, to maintain consistency with FINRA rules, absent clear
reasons for treating transactions in municipal securities differently.
Specifically, the commenter supported revising the definition of SMMP
so that it is harmonized with FINRA's revised suitability rule as it
applies to institutional customers. The commenter also expressed
support for the ``harmonized compliance regime to allow an
institutional customer to provide a single affirmation of their desire
to exercise independent judgment in selecting investments to satisfy
FINRA Rule 2111 for all products, including the MSRB's requirement for
SMMP status.'' Further, to avoid confusion, this commenter supported
the MSRB's proposal to implement the proposed rule change on July 9,
2012, the date on which FINRA Rule 2111 will become effective.
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\14\ See SIFMA Letter, supra note 5.
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In its response letter,\15\ the MSRB acknowledged SIFMA's comment
regarding harmonization with FINRA Rule 2111. It noted that in one
respect, the revised definition of SMMP would be identical to the
language of FINRA Rule 2111--that both would refer to an institutional
customer that affirmatively indicates that it is exercising independent
judgment in evaluating the dealer's recommendations. As stated in the
Notice, receipt by a dealer of the FINRA Rule 2111 affirmation would
thus satisfy the second clause of the revised definition of SMMP. The
MSRB however also noted that the other part of the revised definition
of SMMP would provide that a dealer must have a reasonable basis to
believe that an institutional customer is capable of evaluating
investment risks and market value independently, both in general and
with regard to particular transactions in municipal securities.
Further, the MSRB noted that the Restated SMMP Notice would provide
that, as part of the reasonable basis analysis, the dealer should
consider the amount and type of municipal securities owned or under
management by the institutional customer. The MSRB stated that FINRA
Rule 2111 contains a similar, but not identical, requirement that ``the
member or associated person has a reasonable basis to believe that the
institutional customer is capable of evaluating investment risk
independently, both in general and with regard to particular
transactions and investment strategies involving a security or
securities.'' The MSRB emphasized that ``the language in the filing
regarding the use of a FINRA Rule 2111 affirmation was not intended to
suggest that a representation from an institutional customer would, by
itself, satisfy the dealer's reasonable basis obligation under the
first prong of the revised SMMP definition.''
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\15\ See MSRB Letter, supra note 6.
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IV. Discussion and Commission Findings
The Commission has carefully considered the proposed rule change,
the comment letter received and the MSRB's response, and finds that the
proposed rule change is consistent with the requirements of the Act and
the rules and regulations thereunder applicable to the MSRB.\16\
Specifically, the Commission finds that the proposed rule change is
consistent with the provisions of Section 15B(b)(2)(C) of the Act,\17\
which requires, among other things, that the rules of the MSRB be
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, to foster cooperation
and coordination with persons engaged in regulating, clearing,
settling, processing information with respect to, and facilitating
transactions in municipal securities and municipal financial products,
to remove impediments to and perfect the mechanism of a free and open
market in municipal securities and municipal financial products, and,
in general, to protect investors, municipal entities, obligated
persons, and the public interest.
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\16\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
\17\ 15 U.S.C. 78o-4(b)(2)(C).
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The Commission believes that the MSRB's proposal to restate its
Existing SMMP Notice concerning the application of Rule G-17 to SMMPs
is consistent with the Act. As noted by the MSRB, the amount of
available information about municipal securities has substantially
increased since the Existing SMMP Notice was approved, and this
information is reasonably accessible by institutional investors
[[Page 32707]]
regardless of the amount of their holdings of municipal securities.\18\
For example, the MSRB's Electronic Municipal Market Access system
(``EMMA'') public Web site is a free on-line source for primary market
disclosures, continuing disclosures, transaction data, variable rate
security information, market statistics and investor education. Also,
as noted by the MSRB, the Restated SMMP Notice would be consistent with
FINRA's new rule on suitability obligations for an institutional
account, which will be implemented on July 9, 2012. The Commission
agrees with the MSRB that such consistency is desirable from the
standpoint of reducing the cost of dealer compliance, absent clear
reasons for treating transactions in municipal securities differently.
The Commission, however, notes that under the Restated SMMP Notice, to
meet the revised definition of an SMMP, a dealer must have a reasonable
basis to believe the institutional customer is capable of evaluating
investment risks and market value independently, both in general and
with regard to particular transactions in municipal securities. As the
MSRB has emphasized, a representation from an institutional customer
would not, by itself, satisfy the dealer's reasonable basis obligation
under this clause of the revised SMMP definition.
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\18\ As noted above, although the Restated SMMP Notice would not
require that an institutional customer own or manage a specified
amount of municipal securities in order to fall within the
definition of SMMP, the Restated SMMP Notice does provide that a
dealer should consider the amount and type of municipal securities
owned or under management by the institutional customer in
establishing a reasonable basis to believe that the customer is
capable of evaluating investment risks and market value
independently.
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In light of the increase in access to material information about
municipal securities, the Commission believes that it is consistent
with the Act to expand the disclosure exclusion for material
information to all transactions with SMMPs, whether recommended or
self-directed. Accordingly, when a dealer has reasonable grounds for
concluding that the customer is an SMMP, the dealer's obligation to
ensure disclosure of material information available from established
industry sources is fulfilled. In addition, the Commission believes
that the proposal to amend the application of Rule G-17 to SMMPs to
reflect developments in the MSRB's interpretations of Rule G-17 since
2002 is consistent with the Act, because it will help to ensure
consistency between MSRB's rules. Further, the Commission believes that
the proposal to remove endnote 9 to the Existing SMMP Notice is
consistent with the Act, because it will help to clarify the duties of
broker's brokers under MSRB rules. Lastly, the Commission believes that
the proposal to remove the language that suggests that transactions on
alternative trading systems are done on an agency basis is consistent
with the Act, because it will help to ensure the accuracy of the
Restated SMMP Notice. As noted above, according to the MSRB, at least
one major alternative trading system engages only in principal
transactions.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\19\ that the proposed rule change (SR-MSRB-2012-05) be, and hereby
is, approved.
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\19\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\20\
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\20\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-13255 Filed 5-31-12; 8:45 am]
BILLING CODE 8011-01-P