The Municipal Securities Rulemaking Board (“MSRB”) continues its record-breaking pace as it continues its efforts to redraft, revise and reinvent new rules and interpretative guidance related to the municipal securities business. Recently, the MSRB issued a Notice regarding “sophisticated municipal market professionals” (“SMMPs”), which is intended to update a prior notice issued in 2002 (the “2002 SMMP Notice”)1 in light of subsequent changes in the markets. The MSRB proposes to retain the concept of an SMMP, but revise its definition so that it is consistent with the Financial Industry Regulatory Authority's (FINRA)’s suitability rule for institutional customers (the “Restated SMMP Notice”).2 Although this change will lower the amount of municipal securities necessary for SMMP status from $100 million to $50 million, a municipal securities dealer will need to obtain an affirmation from the SMMP that it is exercising independent judgment in considering the recommendations made by the dealer.
The MSRB is requesting comment on a restatement of its Restated SMMP Notice. Comments to the MSRB are due no later than Dec. 13, 2011.MSRB’s Proposal to Restate the 2002 SMMP Notice
Under the 2002 SMMP Notice, dealers have treated institutional clients as SMMPs if the dealer has had reasonable grounds for concluding certain facts such as if the customer has access to publicly available material facts concerning the municipal securities transaction; the customer is capable of independently evaluating the investment risk and market value of the municipal securities at issue; and the customer is making independent decisions about its investments in municipal securities. With respect to each part of the definition of an SMMP, the 2002 SMMP Notice provides dealers with the relevant factors that would apply to each part of the definition. The 2002 SMMP Notice also addresses a dealer’s obligations to an SMMP under Rule G-17 (on fair dealing), Rule G-18 (on execution of transactions), Rule G-19 (on suitability) and Rule G-13 (on quotations).
The MSRB is proposing to restate the 2002 SMMP Notice to revise the definition of an SMMP and revise the application of an SMMP with respect to MSRB Rule G-17. Apart from the fact that the information available about municipal bonds has increased substantially (i.e., MSRB’s Electronic Municipal Market Access (“EMMA”), the MSRB’s website, and other vendors), the MSRB seeks to revise the definition of an SMMP because FINRA has revised its institutional suitability rule. FINRA’s Rule 2111 provides that a dealer will satisfy its customer specific suitability to an institutional customer if:
As a result, the MSRB's proposed definition is consistent with FINRA Rule 2111. Specifically, the MSRB proposes that an SMMP be defined as an institutional customer of a dealer that:
Notably, under the Restated Notice, there will no longer be a detailed listing of factors, such as those found in the 2002 SMMP Notice.
The Restated Notice also informs dealers that there will be a safe harbor that will allow a dealer to satisfy the “reasonable basis” requirement of clause (1) of the SMMP definition. The MSRB stated that that the safe harbor will apply if:
The safe harbor is notable in terms of the threshold dollar amount change from $100 million to $50 million. In making this proposed change, the MSRB states that the amount of municipal securities owned or managed by an investor would become a safe harbor for the reasonable basis requirement rather than a threshold requirement for establishing whether an investor is an institutional customer.
Under the Restated Notice, the MSRB informs dealers that in either of the attestations related to “capable of evaluating investment risks and market value independently” and “exercising independent judgment in evaluating recommendations,” clients will be allowed to make the attestation orally or in writing. Clients also may provide the attestation on a trade-by-trade basis, on a type-of-municipal-security basis (e.g., general obligation, revenue, VRDO, etc.) or for all potential transactions for their accounts.
Application of Revised SMMP Definition to Other MSRB Rules
The Restated Notice states that it will not change the application of Rules G-18, G-19, and G-13 to SMMPs. However, the application of Rule G-17 to SMMPs will change. The 2002 SMMP Notice excludes non-recommended transactions from the duty to disclose all material facts to SMMPs. The Restated Notice will apply this exclusion to all transactions with SMMPs, whether recommended or self-directed.
In the 2002 SMMP Notice, in the context of Rule G-18 and agency transactions, the 2002 SMMP Notice at endnote 9 states that:
In the Restated Notice, the MSRB informs dealers that it would remove endnote 9. The MSRB states that it is making this change so that the duty of a broker’s broker under Rule G-18 will be interpreted consistently with the Board’s proposed Rule G-43.4
Because the MSRB has informed municipal securities market participants that the proposed Restated Notice is the beginning of the MSRB’s evaluation of electronic trading systems, market participants should consider the impact of the Restated Notice on its application to other aspects of the municipal securities business and provide the MSRB with comments.
In issuing proposed rules and interpretative guidance on a nearly weekly basis over the past year (sometimes several times in one week), the MSRB seems not to understand the cumulative effect this type of rapid-fire regulation has on market participants. Indeed, in issuing its most recent proposal, the MSRB states that more changes are to come: “the proposed updates are a precursor to the MSRB’s evaluation of its rules regarding electronic trading systems.”5 Market participants must interpret and apply the multiple MSRB proposals, at a time when the Securities and Exchange Commission is issuing multiple Dodd-Frank rulemaking proposals and FINRA is rewriting its entire rulebook—all at a time when the industry is struggling with low revenues and difficult market conditions. The MSRB should consider whether the cumulative effect of its aggressive rulemaking agenda will be to drive out participants and dry up liquidity in the municipal securities markets.
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This article was originally published by Bingham McCutchen LLP.