MSRB rules and regs mostly for outside the firm
Business conduct
The primary purpose of the MSRB rules is related to business conduct. Simply put, all municipal professionals must conduct themselves in a fair and honest manner. They may not participate in any deceptive, dishonest, unfair, or similar practice. That includes making every required disclosure, stating all material facts, and never lying, cheating, or stealing.
G-11: Primary offering practices
Remember that primary offering means the issuer is making the money, these are issuer transactions. Municipal securities dealers are often underwriters, so the MSRB sets requirements for the syndicates formed to underwrite municipal issues.
Disclosure of capacity is required whenever a broker, dealer, or municipal securities dealer submits an order to an underwriter or syndicate, for purchase of securities held by the syndicate, whether the purchase is for their own inventory, or to fulfil a customers order.
Priority provisions is the part where the syndicate manager establishes the order of priority for filling orders received by the syndicate. This helps make sure the syndicate benefits as a whole, not an individual underwriter within it. Syndicates may include provisions that enable a case-by-case basis to allocate securities in a different manner than the priority provision says. This must always be done for the best interest of the syndicate, and the syndicate manager has the burden to justify it. The standard priority hierarchy from highest to lowest:
- Pre-sale orders: These are placed by investors committed to buying the bonds before the official pricing and information has been released. They have the highest priority as they helped the syndicate win the bid.
- Group net orders: These are orders credited to the syndicate as a whole, so all syndicate members benefit in proportion to their participation in the syndicate, no matter which member took the order.
- Designated orders: These are orders specifying a particular syndicate member to receive credit.
- Member orders: These are orders a syndicate member submits at the takedown price, so that member alone earns the takedown, its share of the spread.
Prior to the first offer of any securities by the syndicate, the syndicate manager must furnish in writing to all syndicate members and selling group members a written disclosure which includes;
- A written statement of all terms and conditions required by the issuer
- A written statement of all the issuer’s retail order period requirements
- The priority provisions, if applicable
- The procedure, if any, by which such priority provisions can be changed
- If syndicate manager can, on case-by-case basis, allocate securities in a manner other than the priority provisions
- If there is to be an order period, whether orders may be confirmed prior to the end of the period, and
- All pricing information
The syndicate manager at or before final settlement must provide the other syndicate members with:
- An itemized statement setting forth the actual expenses incurred on behalf of the syndicate
- A summary statement showing the identity of each related account submitting an order in which securities have been allocated, and the aggregate par values and prices of all securities sold from the syndicate account.
G-19: Suitability of recommendations and transactions
For recommendations that aren’t covered by Regulation Best Interest, MSRB requires; “A broker, dealer or municipal securities dealer must have a reasonable basis to believe that a recommended transaction or investment strategy involving a municipal security or municipal securities is suitable for the customer, based on the information obtained through the reasonable diligence of the broker, dealer or municipal securities dealer to ascertain the customer’s investment profile.”
Since June 30, 2020, G-19 hasn’t applied to recommendations covered by Reg BI, so recommending municipal securities to a retail customer is held to Reg BI’s best-interest standard instead. G-19’s suitability standard still governs the recommendations Reg BI doesn’t cover, such as recommendations to institutional customers. The investment profile information is the standard information we need in either case: age, other investments, financial situation and needs, tax status, investment objectives, experiences, time horizon, liquidity needs, risk tolerance, and any other similar information.
Municipals have additional suitability concerns that need to be considered as well. Generally, we would want to recommend municipal securities that were issued in the same state of residence to help with tax benefits. Some states don’t have state and local taxes, so that can also affect the recommendation. Although the income is generally tax-free, the potential capital gains are not.
We need to remember to keep the client’s investment profile information updated, as those kinds of things can change. Tax bracket level certainly can fluctuate, and that could make some people who had been ignoring municipal securities more likely to benefit, but it also could work the other way, and have people who had been benefiting from the tax-free income, suddenly not benefit as much if their income drops. As previously mentioned, some states currently do not have state and local taxes, so out-of-state municipal securities could potentially make sense for those investors, but those state and local tax laws could change, and therefore would also cost the investor if attention was not paid to it.
G-21: Advertising
All advertisements must be as honest as they can be. No publishing known falsehoods or misleading materials. All advertisements must be approved in writing by a municipal securities principal or a general securities principal prior to first use. It must be clearly stated so investors are not confused between any mentions of yields and tax-free returns. Any advertisements including quoting returns with percentages must indicate what type of yield that return is based on (current, coupon, etc). If a yield is given, how that yield is calculated must be given (whether current yield, yield-to-maturity, yield-to-call).
MSRB defines advertisement as; “any material (other than listings of offerings) published or used in any electronic or other public media, or any written or electronic promotional literature distributed or made generally available to customers or the public, including any notice, circular, report, market letter, form letter, telemarketing script, seminar text, press release concerning the products or services of the broker, dealer or municipal securities dealer, or reprint, or any excerpt of the foregoing or of a published article.” This will not include official statements or preliminary official statements. Summarizing an official statement or preliminary official statement, or an abstract of them, would be considered advertising and therefore approved by a municipal securities principal.
MSRB doesn’t like advertisements that only include current yields, since current yield on its own can be misleading. An advertisement that shows a current yield must also show, at a minimum, the lower of the yield to call or the yield to maturity, just as clearly. Consider two bonds that each pay an $80 annual coupon (an 8% coupon rate on $1,000 par). A distressed issuer’s bond trading at $500 has a current yield of 16% ($80 ÷ $500), while a financially solid issuer’s bond trading at $1,200 has a current yield of 6.67% ($80 ÷ $1,200). The much higher current yield on the distressed bond is a red flag about risk, not a bargain - which is exactly why an advertisement quoting a yield must disclose which type of yield is being shown.
G-25: Improper use of assets
Sort of as an obvious idea, MSRB member firms may not improperly use assets, funds, municipal securities, or anything else like those actions on behalf of any other person.
Guarantees: No broker, dealer, or municipal securities dealer shall guarantee or offer to guarantee a customer against loss in any account or transaction. They also cannot guarantee a profit.
Sharing accounts: No broker, dealer, or municipal securities dealer is allowed to share either directly or indirectly in the profits or losses of an account of any customer or in a transaction in municipal securities with or for a customer. This is not saying that associated persons of the above, in their private capacity, is prohibited from partnership or joint accounts, they must just be in direct proportion to the initial investment of all parties.
G-26: Customer account transfers
When a customer moves from one firm, the carrying firm, to a new firm, the receiving firm, the account has to transfer from the carrying firm to the receiving firm. Both the carrying and receiving firm are required to help expedite the transfer.
The procedure starts when the customer first makes the written request to transfer the account. The receiving firm must then immediately send the transfer request to the carrying firm. The carrying firm then has 1 business day after receiving the instructions to validate them. They can either validate them, and we continue onto the next step, or they can protest the transfer, and then there is a separate procedure.
Protesting a transfer can happen for a number of reasons. The listed account name or number isn’t on file at the firm, likely due to a typo that can be corrected. The transfer instructions themselves are incomplete or otherwise don’t make sense. The transfer instructions might not have the proper signature. All of these protests would then be relayed to the receiving firm and client, who could then fix the issues and resubmit. An outstanding margin debit is not itself a reason to protest, and neither is a dispute over the positions or the money balance: the carrying firm must transfer what its books show.
When the carrying firm is validating the order, they must freeze the account and cancel any open orders. The validated transfer instructions are then attached to a listing of all positions. They must be there, including description of the securities that don’t have CUSIP, the CUSIP of those that do, along with the balances of all assets. The carrying firm then has 3 business days following transfer validation to complete the transfer.
G-30: Prices and commissions
Municipal securities professionals are obligated to conduct business fairly, in all aspects of business, including with prices of transactions. How this works is different between agency and principal transactions.
For an agency transaction, the charges must be based on multiple things, including how easy the securities are to acquire, the expenses the firm will incur in executing the transaction for the customer, and any additional services the firm provides or compensation that would be received by the firm with this transaction. Other similar information that would be considered necessary would also be included in the calculations.
For principal transactions, the price charged to the client, as the firm is selling from its own inventory and therefore it theoretically could set any price, the price must be fairly based on the best judgment and experience of the firm as to a fair market price. This must include any markups and markdowns, and all additional factors that would be deemed relevant such as expenses with executing the trade, the total value of the trade, and the fact that the firm is entitled to a profit for enacting the trade.
G-32: Other disclosures in connection with primary offering
The final official statement must be delivered no later than the settlement date, though if the underwriter has posted it on EMMA, the dealer can instead send the customer, by settlement, a notice explaining how to get it from EMMA and that a copy will be provided on request. If an official statement is not being prepared, a written notice to that effect, together with a copy of the preliminary official statement (if available), must be provided.
A customer who was sent the EMMA notice can still ask for a copy, and the dealer must send it within one business day of the request. The rule sets no delivery duty between dealers: a dealer buying a new issue gets the official statement from EMMA, where the underwriter posts it within one business day of receiving it from the issuer.