[Federal Register Volume 67, Number 28 (Monday, February 11, 2002)]
[Notices]
[Pages 6294-6306]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-3232]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45364; File No. SR-MSRB-2002-02]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Municipal Securities Rulemaking Board Relating to 
Transactions With Sophisticated Municipal Market Professionals

January 30, 2002.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``the Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on January 25, 2002, the Municipal Securities Rulemaking Board 
(``MSRB'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the MSRB. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    Interpretive Notice Regarding Sophisticated Municipal Market 
Professionals IntroductionIndustry participants have suggested that the 
MSRB's fair practice rules should allow dealers \3\ to recognize the 
different capabilities of certain institutional customers as well as 
the varied types of dealer-customer relationships. Prior MSRB 
interpretations reflect that the nature of the dealer's counter-party 
should be considered when determining the specific actions a dealer 
must undertake to meet its duty to deal fairly. The MSRB believes that 
dealers may consider the nature of the institutional customer in 
determining what specific actions are necessary to meet the fair 
practice standards for a particular transaction. This interpretive 
notice

[[Page 6295]]

concerns only the manner in which a dealer determines that it has met 
certain of its fair practice obligations to certain institutional 
customers; it does not alter the basic duty to deal fairly, which 
applies to all transactions and all customers. For purposes of this 
interpretive notice, an institutional customer shall be 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.
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    \3\ The term ``dealer'' is used in this notice as shorthand for 
``broker,'' ``dealer'' or ``municipal securities dealer,'' as those 
terms are defined in the Act. The use of the term in this notice 
does not imply that the entity is necessarily taking a principal 
position in a municipal security.
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Sophisticated Municipal Market Professionals

    Not all institutional customers are sophisticated regarding 
investments in municipal securities. There are three important 
considerations with respect to the nature of an institutional customer 
in determining the scope of a dealer's fair practice obligations. They 
are:
     Whether the institutional customer has timely access to 
all publicly available material facts concerning a municipal securities 
transaction;
     Whether the institutional customer is capable of 
independently evaluating the investment risk and market value of the 
municipal securities at issue; and
     Whether the institutional customer is making independent 
investment decisions about its investments in municipal securities.
    When a dealer has reasonable grounds for concluding that an 
institutional customer (i) has timely access to the publicly available 
material facts concerning a municipal securities transaction; (ii) is 
capable of independently evaluating the investment risk and market 
value of the municipal securities at issue; and (iii) is making 
independent decisions about its investments in municipal securities, 
and other known facts do not contradict such a conclusion, the 
institutional customer can be considered a sophisticated municipal 
market professional (``SMMP''). While it is difficult to define in 
advance the scope of a dealer's fair practice obligations with respect 
to a particular transaction, as will be discussed later, by making a 
reasonable determination that an institutional customer is an SMMP, 
then certain of the dealer's fair practice obligations remain 
applicable but are deemed fulfilled. In addition, as discussed below, 
the fact that a quotation is made by an SMMP would have an impact on 
how such quotation is treated under Rule G-13.

Considerations Regarding The Identification Of Sophisticated Municipal 
Market Professionals

    The MSRB has identified certain factors for evaluating an 
institutional investor's sophistication concerning a municipal 
securities transaction and these factors are discussed in detail below. 
Moreover, dealers are advised that they have the option of having 
investors attest to SMMP status as a means of streamlining the dealers' 
process for determining that the customer is an SMMP. However, a dealer 
would not be able to rely upon a customer's SMMP attestation if the 
dealer knows or has reason to know that an investor lacks 
sophistication concerning a municipal securities transaction, as 
discussed in detail below.
Access to Material Facts
    A determination that an institutional customer has timely access to 
the publicly available material facts concerning the municipal 
securities transaction will depend on the customer's resources and the 
customer's ready access to established industry sources (as defined 
below) for disseminating material information concerning the 
transaction. Although the following list is not exhaustive, the MSRB 
notes that relevant considerations in determining that an institutional 
customer has timely access to publicly available information could 
include:
     The resources available to the institutional customer to 
investigate the transaction (e.g., research analysts);
     The institutional customer's independent access to the 
NRMSIR system,\4\ and information generated by the MSRB's Municipal 
Securities Information Library (MSIL) system \5\ 
and Transaction Reporting System (``TRS''),\6\ either directly or 
through services that subscribe to such systems; and
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    \4\ For purposes of this notice, the ``NRMSIR system'' refers to 
the disclosure dissemination system adopted by the Commission in 
Rule 15c2-12. Under Rule 15c2-12, as adopted in 1989, participating 
underwriters provide a copy of the final official statement to a 
Nationally Recognized Municipal Securities Information Repository 
(``NRMSIR'') to reduce their obligation to provide a final official 
statement to potential customers upon request. In the 1994 
amendments to Rule 15c2-12, the Commission determined to require 
that annual financial information and audited financial statements 
submitted in accordance with issuer undertakings be delivered to 
each NRMSIR and to the State Information Depository (``SID'') in the 
issuer's state, if such depository has been established. The 
requirement to have annual financial information and audited 
financial statements delivered to all NRMSIRs and the appropriate 
SID was included in Rule 15c2-12 to ensure that all NRMSIRs receive 
disclosure information directly. Under the 1994 amendments, notices 
of material events, as well as notices of a failure by an issuer or 
other obligated person to provide annual financial information, must 
be delivered to each NRMSIR or the MSRB, and the appropriate SID.
    \5\ The MSIL system collects and makes available to 
the marketplace official statements and advance refunding documents 
submitted under MSRB Rule G-36, as well as certain secondary market 
material event disclosures provided by issuers under SEC Rule 15c2-
12. Municipal Securities Information Library and 
MSIL are registered trademarks of the MSRB.
    \6\ The MSRB's TRS collects and makes available to the 
marketplace information regarding inter-dealer and dealer-customer 
transactions in municipal securities.
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     The institutional customer's access to other sources of 
information concerning material financial developments affecting an 
issuer's securities (e.g.., rating agency data and indicative data 
sources).
Independent Evaluation of Investment Risks and Market Value
    Second, a determination that an institutional customer is capable 
of independently evaluating the investment risk and market value of the 
municipal securities that are the subject of the transaction will 
depend on an examination of the institutional customer's ability to 
make its own investment decisions, including the municipal securities 
resources available to the institutional customer to make informed 
decisions. In some cases, the dealer may conclude that the 
institutional customer is not capable of independently making the 
requisite risk and valuation assessments with respect to municipal 
securities in general. In other cases, the institutional customer may 
have general capability, but may not be able to independently exercise 
these functions with respect to a municipal market sector or type of 
municipal security. This is more likely to arise with relatively new 
types of municipal securities and those with significantly different 
risk or volatility characteristics than other municipal securities 
investments generally made by the institution. If an institution is 
either generally not capable of evaluating investment risk or lacks 
sufficient capability to evaluate the particular municipal security, 
the scope of a dealer's fair practice obligations would not be 
diminished by the fact that the dealer was dealing with an 
institutional customer. On the other hand, the fact that a customer 
initially needed help understanding a potential investment need not 
necessarily imply that the customer did not ultimately develop an 
understanding and make an independent investment decision.

[[Page 6296]]

    While the following list is not exhaustive, the MSRB notes that 
relevant considerations in determining that an institutional customer 
is capable of independently evaluating investment risk and market value 
considerations could include:
     The use of one or more consultants, investment advisers, 
research analysts or bank trust departments;
     The general level of experience of the institutional 
customer in municipal securities markets and specific experience with 
the type of municipal securities under consideration;
     The institutional customer's ability to understand the 
economic features of the municipal security;
     The institutional customer's ability to independently 
evaluate how market developments would affect the municipal security 
that is under consideration; and
     The complexity of the municipal security or securities 
involved.
Independent Investment Decisions
    Finally, a determination that an institutional customer is making 
independent investment decisions will depend on whether the 
institutional customer is making a decision based on its own thorough 
independent assessment of the opportunities and risks presented by the 
potential investment, market forces and other investment 
considerations. This determination will depend on the nature of the 
relationship that exists between the dealer and the institutional 
customer. While the following list is not exhaustive, the MSRB notes 
that relevant considerations in determining that an institutional 
customer is making independent investment decisions could include:
     Any written or oral understanding that exists between the 
dealer and the institutional customer regarding the nature of the 
relationship between the dealer and the institutional customer and the 
services to be rendered by the dealer;
     The presence or absence of a pattern of acceptance of the 
dealer's recommendations;
     The use by the institutional customer of ideas, 
suggestions, market views and information relating to municipal 
securities obtained from sources other than the dealer; and
     The extent to which the dealer has received from the 
institutional customer current comprehensive portfolio information in 
connection with discussing potential municipal securities transactions 
or has not been provided important information regarding the 
institutional customer's portfolio or investment objectives.
    Dealers are reminded that these factors are merely guidelines which 
will be utilized to determine whether a dealer has fulfilled its fair 
practice obligations with respect to a specific institutional customer 
transaction and that the inclusion or absence of any of these factors 
is not dispositive of the determination. Such a determination can only 
be made on a case-by-case basis taking into consideration all the facts 
and circumstances of a particular dealer/customer relationship, 
assessed in the context of a particular transaction. As a means of 
ensuring that customers continue to meet the defined SMMP criteria, 
dealers are required to put into place a process for periodic review of 
a customer's SMMP status.
Application of SMMP Concept to Rule G-17's Affirmative Disclosure 
Obligations
    The SMMP concept as it applies to Rule G-17 recognizes that the 
actions of a dealer in complying with its affirmative disclosure 
obligations under Rule G-17 when effecting non-recommended secondary 
market transactions may depend on the nature of the customer. While it 
is difficult to define in advance the scope of a dealer's affirmative 
disclosure obligations to a particular institutional customer, the MSRB 
has identified the factors that define an SMMP as factors that may be 
relevant when considering compliance with the affirmative disclosure 
aspects of Rule G-17.
    When the dealer has reasonable grounds for concluding that the 
institutional customer is an SMMP, the institutional customer, by 
definition, is already aware, or capable of making itself aware of, 
material facts and is able to independently understand the significance 
of the material facts available from established industry sources.\7\ 
When the dealer has reasonable grounds for concluding that the customer 
is an SMMP then the dealer's obligation when effecting non-recommended 
secondary market transactions to ensure disclosure of material 
information available from established industry sources is fulfilled. 
There may be times when an SMMP is not satisfied that the information 
available from established industry sources is sufficient to allow it 
to make an informed investment decision. In those circumstances, the 
MSRB believes that an SMMP can recognize that risk and take appropriate 
action, be it declining to transact, undertaking additional 
investigation or asking the dealer to undertake additional 
investigation.
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    \7\ The MSRB has filed a related notice regarding the disclosure 
of material facts under Rule G-17 concurrently with this filing. See 
File No. SR-MSRB-2002-01. The MSRB's Rule G-17 notice provides that 
a dealer would be responsible for disclosing to a customer any 
material fact concerning a municipal security transaction 
(regardless of whether such transaction had been recommended by the 
dealer) made publicly available through sources such as the NRMSIR 
system, the MSIL system, TRS, rating agency reports and 
other sources of information relating to the municipal securities 
transaction generally used by dealers that effect transactions in 
municipal securities (collectively, ``established industry 
sources'').
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    This interpretation does nothing to alter a dealer's duty not to 
engage in deceptive, dishonest, or unfair practices under Rule G-17 or 
under the federal securities laws. In essence, a dealer's disclosure 
obligations to SMMPs when effecting non-recommended secondary market 
transactions would be on par with inter-dealer disclosure obligations. 
This interpretation will be particularly relevant to dealers operating 
electronic trading platforms, although it will also apply to dealers 
who act as order takers over the phone or in-person.\8\ This 
interpretation recognizes that there is no need for a dealer in a non-
recommended secondary market transaction to disclose material facts 
available from established industry sources to an SMMP customer that 
already has access to the established industry sources.\9\
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    \8\ For example, if an SMMP reviewed an offering of municipal 
securities on an electronic platform that limited transaction 
capabilities to broker-dealers and then called up a dealer and asked 
the dealer to place a bid on such offering at a particular price, 
the interpretation would apply because the dealer would be acting 
merely as an order taker effecting a non-recommended secondary 
market transaction for the SMMP.
    \9\ In order to meet the definition of an SMMP an institutional 
customer must, at least, have access to established industry 
sources.
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    As in the case of an inter-dealer transaction, in a transaction 
with an SMMP, a dealer's intentional withholding of a material fact 
about a security, where the information is not accessible through 
established industry sources, may constitute an unfair practice 
violative of Rule G-17. In addition, a dealer may not knowingly 
misdescribe securities to the customer. A dealer's duty not to mislead 
its customers is absolute and is not dependent upon the nature of the 
customer.
Application of SMMP Concept to Rule G-18 Interpretation--Duty To Ensure 
That Agency Transactions Are Effected at Fair and Reasonable Prices
    Rule G-18 requires that each dealer, when executing a transaction 
in municipal securities for or on behalf of

[[Page 6297]]

a customer as agent, make a reasonable effort to obtain a price for the 
customer that is fair and reasonable in relation to prevailing market 
conditions.\10\ The actions that must be taken by a dealer to make 
reasonable efforts to ensure that its non-recommended secondary market 
agency transactions with customers are effected at fair and reasonable 
prices may be influenced by the nature of the customer as well as by 
the services explicitly offered by the dealer.
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    \10\ This guidance only applies to the actions necessary for a 
dealer to ensure that its agency transactions are effected at fair 
and reasonable prices. If a dealer engages in principal transactions 
with an SMMP, Rule G-30(a) applies and the dealer is responsible for 
a transaction-by-transaction review to ensure that it is charging a 
fair and reasonable price. In addition, Rule G-30(b) applies to the 
commission or service charges that a dealer operating an electronic 
trading system may charge to effect the agency transactions that 
take place on its system.
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    If a dealer effects non-recommended secondary market agency 
transactions for SMMPs and 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, then the MSRB believes the dealer is not 
required to take further actions on individual transactions to ensure 
that its agency transactions are effected at fair and reasonable 
prices.\11\ By making the determination that the customer is an SMMP, 
the dealer necessarily concludes that the customer has met the 
requisite high thresholds regarding timely access to information, 
capability of evaluating risks and market values, and undertaking of 
independent investment decisions that would help ensure the 
institutional customer's ability to evaluate whether a transaction's 
price is fair and reasonable.
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    \11\ Similarly, the MSRB believes the same limited agency 
functions can be undertaken by a broker's broker toward other 
dealers. For example, if a broker's broker effects agency 
transactions for other dealers and 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, then the MSRB believes the 
broker's broker is not required to take further actions on 
individual transactions to ensure that its agency transactions with 
other dealers are effected at fair and reasonable prices.
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    This interpretation will be particularly relevant to dealers 
operating alternative trading systems in which participation is limited 
to dealers and SMMPs. It clarifies that in such systems, Rule G-18 does 
not impose an obligation upon the dealer operating such a system to 
investigate each individual transaction price to determine its 
relationship to the market. The MSRB recognizes that dealers operating 
such systems may be merely aggregating the buy and sell interest of 
other dealers or SMMPs. This function may provide efficiencies to the 
market. Requiring the system operator to evaluate each transaction 
effected on its system may reduce or eliminate the desired 
efficiencies. Even though this interpretation eliminates a duty to 
evaluate each transaction, a dealer operating such system, under the 
general duty set forth in Rule G-18, must act to investigate any 
alleged pricing irregularities on its system brought to its attention. 
Accordingly, a dealer may be subject to Rule G-18 violations if it 
fails to take actions to address system or participant pricing abuses.
    If a dealer effects agency transactions for customers who are not 
SMMPs, or has held itself out to do more than provide anonymity, 
communication, matching and/or clearance services, or performs such 
services with discretion as to how and when the transaction is 
executed, it will be required to establish that it exercised reasonable 
efforts to ensure that its agency transactions with customers are 
effected at fair and reasonable prices.
Application of SMMP Concept to Rule G-19 Interpretation--Suitability of 
Recommendations and Transactions
    The MSRB's suitability rule is fundamental to fair dealing and is 
intended to promote ethical sales practices and high standards of 
professional conduct. Dealers' responsibilities include having a 
reasonable basis for recommending a particular security or strategy, as 
well as having reasonable grounds for believing the recommendation is 
suitable for the customer to whom it is made. Dealers are expected to 
meet the same high standards of competence, professionalism, and good 
faith regardless of the financial circumstances of the customer. Rule 
G-19, on suitability of recommendations and transactions, requires 
that, in recommending to a customer any municipal security transaction, 
a dealer shall have reasonable grounds for believing that the 
recommendation is suitable for the customer 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.
    This guidance concerns only the manner in which a dealer determines 
that a recommendation is suitable for a particular institutional 
customer. The manner in which a dealer fulfills this suitability 
obligation will vary depending on the nature of the customer and the 
specific transaction. Accordingly, this interpretation deals only with 
guidance regarding how a dealer will fulfill such ``customer-specific 
suitability obligations'' under Rule G-19. This interpretation does not 
address the obligation related to suitability that requires that a 
dealer have a ``reasonable basis'' to believe that the recommendation 
could be suitable for at least some customers. In the case of a 
recommended transaction, a dealer may, depending upon the facts and 
circumstances, be obligated to undertake a more comprehensive review or 
investigation in order to meet its obligation under Rule G-19 to have a 
``reasonable basis'' to believe that the recommendation could be 
suitable for at least some customers.\12\
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    \12\ See e.g., Rule G-19 Interpretation--Notice Concerning the 
Application of Suitability Requirements to Investment Seminars and 
Customer Inquiries Made in Response to a Dealer's Advertisement, May 
7, 1985, MSRB Rule Book (July 1, 2001) at 135; In re F.J. Kaufman 
and Company of Virginia, 50 S.E.C. 164, 168, 1989 SEC LEXIS 2376, 
*10 (1989). The Commission', in its discussion of municipal 
underwriters' responsibilities, also noted that ``a broker-dealer 
recommending securities to investors implies by its recommendation 
that it has an adequate basis for the recommendation.'' Municipal 
Securities Disclosure, Exchange Act Release No. 26100 (September 22, 
1988) (the ``1988 SEC Release'') at text accompanying note 72.
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    The manner in which a dealer fulfills its ``customer-specific 
suitability obligations'' will vary depending on the nature of the 
customer and the specific transaction. While it is difficult to define 
in advance the scope of a dealer's suitability obligation with respect 
to a specific institutional customer transaction recommended by a 
dealer, the MSRB has identified the factors that define an SMMP as 
factors that may be relevant when considering compliance with Rule G-
19. Where the dealer has reasonable grounds for concluding that an 
institutional customer is an SMMP, then a dealer's obligation to 
determine that a recommendation is suitable for that particular 
customer is fulfilled.
    This interpretation does not address the facts and circumstances 
that go into determining whether an electronic communication does or 
does not constitute a customer-specific ``recommendation.''
Application of SMMP Concept to Rule G-13, on Quotations
    New electronic trading systems provide a variety of avenues for 
disseminating quotations among both dealers and customers. In general, 
except as described below, any quotation disseminated by a dealer is

[[Page 6298]]

presumed to be a quotation made by such dealer. In addition, any 
``quotation'' of a non-dealer (e.g., an investor) relating to municipal 
securities that is disseminated by a dealer is presumed, except as 
described below, to be a quotation made by such dealer.\13\ The dealer 
is affirmatively responsible in either case for ensuring compliance 
with the bona fide and fair market value requirements with respect to 
such quotation.
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    \13\ A customer's bid for, offer of, or request for bid or offer 
is included within the meaning of a ``quotation'' if it is 
disseminated by a dealer.
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    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. Furthermore, if an SMMP makes a 
``quotation'' and it is labeled as such, then it is presumed not to be 
a quotation made by the disseminating dealer; rather, the dealer is 
held to the same standard as if it were disseminating a quotation made 
by another dealer.\14\ In either case, the disseminating dealer's 
responsibility with respect to such quotation is reduced. Under these 
circumstances, the disseminating dealer must have no reason to believe 
that either: (i) the quotation does not represent a bona fide bid for, 
or offer of, municipal securities by the maker of the quotation or (ii) 
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.
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    \14\ The disseminating dealer need not identify by name the 
maker of the quotation, but only that such quotation was made by 
another dealer or an SMMP, as appropriate.
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    While Rule G-13 does not impose an affirmative duty on the dealer 
disseminating quotations made by other dealers or SMMPs to investigate 
or determine the market value or bona fide nature of each such 
quotation, it does require that the disseminating dealer take into 
account any information it receives regarding the nature of the 
quotations it disseminates. Based on this information, such a dealer 
must have no reason to believe that these quotations fail to meet 
either the bona fide or the fair market value requirement and it must 
take action to address such problems brought to its attention. Reasons 
for believing there are problems could include, among other things, (i) 
complaints received from dealers and investors seeking to execute 
against such quotations, (ii) a pattern of a dealer or SMMP failing to 
update, confirm or withdraw its outstanding quotations so as to raise 
an inference that such quotations may be stale or invalid, or (iii) a 
pattern of a dealer or SMMP effecting transactions at prices that 
depart materially from the price listed in the quotations in a manner 
that consistently is favorable to the party making the quotation.\15\
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    \15\ The MSRB believes that, consistent with its view previously 
expressed with respect to ``bait-and-switch'' advertisements, a 
dealer that includes a price in its quotation that is designed as a 
mechanism to attract potential customers interested in the quoted 
security for the primary purpose of drawing such potential customers 
into a negotiation on that or another security, where the quoting 
dealer has no intention at the time it makes the quotation of 
executing a transaction in such security at that price, could be a 
violation of rule G-17. See Rule G-21 Interpretive Letter--
Disclosure Obligations, MSRB Interpretation of May 21, 1998, MSRB 
Rule Book (July 1, 2001) at p. 139.
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    In a prior MSRB interpretation stating that stale or invalid 
quotations published in a daily or other listing must be withdrawn or 
updated in the next publication, the MSRB did not consider the 
situation where quotations are disseminated electronically on a 
continuous basis.\16\ In such case, the MSRB believes that the bona 
fide requirement obligates a dealer to withdraw or update a stale or 
invalid quotation promptly enough to prevent a quotation from becoming 
misleading as to the dealer's willingness to buy or sell at the stated 
price. In addition, although not required under the rule, the MSRB 
believes that posting the time and date of the most recent update of a 
quotation can be a positive factor in determining whether the dealer 
has taken steps to ensure that a quotation it disseminates is not stale 
or misleading.
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    \16\ See Rule G-13 Interpretation, Notice of Interpretation of 
Rule G-13 on Published Quotations, April 21, 1988, MSRB Rule Book 
(July 1, 2001) at 91.
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the MSRB included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The MSRB has prepared summaries, set forth in Sections 
A, B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The MSRB decided to issue interpretive guidance to address the 
issues surrounding the development of electronic trading as an 
outgrowth of a May 2000 MSRB-hosted roundtable discussion about the use 
of electronic trading systems in the municipal securities market. 
Industry discussion at the roundtable, as well as subsequent industry 
comments, made it apparent that the municipal securities market, like 
the equity market, is in the process of developing alternative models 
of trading relationships between dealers and customers. In addition, 
technological innovation is spearheading the development of trading 
platforms that hope to increase liquidity, transparency and efficiency 
in the municipal securities market. All of these developments 
essentially flow from the belief that there is a demand for trading 
methodologies that allow a dealer to act as an order taker when 
effecting transactions with customers.
    Based on the comments from the industry as well as the MSRB's 
review of market developments, the MSRB concluded that in order for 
innovation to occur, the industry needs interpretive guidance on the 
application of certain MSRB rules to these new trading methodologies. 
Alternative trading systems present the most graphic example of 
changing dealer/customer relationships and consequent need for 
regulatory change, but the changing relationships are not necessarily 
limited to electronic trading venues.
    Ultimately, the MSRB determined that a primary purpose of its 
interpretive guidance should be to interpret MSRB rules to allow the 
development of trading relationships where the dealer acts as an order 
taker in secondary market non-recommended municipal securities 
transactions with sophisticated institutional investors. The MSRB 
proposed the SMMP concept to illustrate how different fair practice 
rules would operate when dealers were transacting with sufficiently 
sophisticated market professionals. The MSRB did not believe that 
disclosure and transparency in the municipal securities market are 
sufficiently developed at this time to permit dealers to have only 
order taker responsibilities when transacting with retail investors and 
less sophisticated institutional investors.
    The interpretive notice defines an ``institutional customer'' for 
purposes of the notice and provides that when a dealer has reasonable 
grounds for concluding that an institutional customer (i) has timely 
access to the publicly available material facts concerning a municipal 
securities transaction; (ii) is capable of independently evaluating the 
investment risk and market value of the

[[Page 6299]]

municipal securities at issue; and (iii) is making independent 
decisions about its investments in municipal securities, and other 
known facts do not contradict such a conclusion, the institutional 
customer can be considered an SMMP. The guidance also provides that 
while it is difficult to define in advance the scope of a dealer's fair 
practice obligations with respect to a particular transaction, as is 
discussed in the interpretation, by making a reasonable determination 
that an institutional customer is an SMMP, then certain of the dealer's 
fair practice obligations (i.e., Rule G-17's affirmative disclosure 
obligations, Rule G-18's duty to ensure that agency transactions are 
effected at fair and reasonable prices, and Rule G-19's suitability 
obligations) remain applicable but are deemed fulfilled.\17\ In 
addition, the fact that a quotation is made by an SMMP would have an 
impact on how such quotation is treated under Rule G-13.
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    \17\ However, for purposes of Rules G-17 and G-18, the SMMP 
concept only applies when the dealer is effecting non-recommended 
secondary market transactions for SMMP customers.
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    The MSRB believes the proposed rule change is consistent with 
Section 15B(b)(2)(C) of the Act, which provides that the Board's rules 
shall:

be designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade * * * 
to remove impediments to and perfect the mechanism of a free and 
open market in municipal securities, and, in general, to protect 
investors and the public interest.

    Additionally, the MSRB believes that the proposed rule change is 
consistent with the Act in that it will allow for the development and 
growth of new trading methodologies that may lead to increased pooling 
of liquidity and market based transparency without diminishing 
essential customer protections.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The MSRB does not believe that the proposed rule change will impose 
any burden on competition not necessary or appropriate in furtherance 
of the purposes of the Act, since it would apply equally to all 
brokers, dealers and municipal securities dealers.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    On September 28, 2000, the MSRB published a notice seeking comment 
on draft interpretive guidance on dealer responsibilities in connection 
with both electronic and traditional municipal securities transactions 
(the ``2000 Notice'').\18\ The 2000 Notice defined a class of customers 
as ``sophisticated market professionals'' (``SMPs''). The 2000 Notice 
presented the MSRB's views regarding the responsibilities of dealers 
under the MSRB's fair practice, quotation, uniform practice and new 
issue securities rules. In response to the 2000 Notice, the MSRB 
received 17 comment letters from different segments of the market.\19\
---------------------------------------------------------------------------

    \18\ ``Notice and Draft Interpretive Guidance on Dealer 
Responsibilities in Connection with Both Electronic and Traditional 
Municipal Securities Transactions,'' MSRB Reports, Vol. 20, No. 2 
(November 2000) at 3, see also the ``Clarification to the Draft 
Interpretive Guidance,'' published on November 17, 2000 at the 
MSRB's web site (http://206.233.231.2/msrb1/archive/etrading.htm).
    \19\ Letter from Clayton B. Erickson, V.P. Manager, Municipal 
Bond Trading and Underwriting, A.G. Edwards & Sons, Inc., to Carolyn 
Walsh and Ernesto Lanza, dated December 1, 2000 (``A.G. Edwards''); 
letter from Darrick L. Hills, Chair, Municipal Securities 
Subcommittee, and Maria J.A. Clark, Associate, Association for 
Investment Management and Research Advocacy, to Ernesto A. Lanza, 
dated November 30, 2000 (``AIMR''); letter from Olga Egorova, Vice 
President, Bear Stearns & Co. Inc., to Carolyn Walsh dated November 
28, 2000 (``Bear Stearns''); letter from W. Hardy Callcott, Senior 
Vice President and General Counsel, Charles Schwab & Co., Inc., to 
Ernesto A. Lanza, dated November 30, 2000 (``Schwab''); letter from 
Ida W. Draim, Dickstein, Shapiro, Morin & Oshinksy LLP, to Carolyn 
Walsh, dated October 25, 2000 (``Dickstein, Shapiro''); letter from 
Michael J. Hogan, General Counsel, DLJ Inc., to Carolyn Walsh, dated 
December 3, 2000 (``DLJ''); letter from Richard W. Meister, CEO, 
eBondTrade, to Ernesto A. Lanza, dated November 30, 2000 
(``eBondTrade''); letter from Triet M. Nguyen, Senior Vice President 
Information Services, eBondUSA.com. Inc., to Carolyn Walsh, dated 
November 29, 2000 (``eBondUSA''); letter from Michael J. Marx, Vice 
Chairman, First Southwest Company, to Ernesto A. Lanza, dated 
November 28, 2000 (``First Southwest''); letter from Amy B.R. 
Lancellotta, Senior Counsel, Investment Company Institute, to 
Ernesto A. Lanza, dated November 30, 2000 (``ICI''); letter from 
Jerry L. Chapman, Managing Director, Morgan Keegan & Company, Inc., 
to Carolyn Walsh, dated November 16, 2000 (``Morgan Keegan''); 
letter from Bradley W. Wendt, President and Chief Operating Officer, 
and David L. Becker, General Counsel, MuniGroup.com LLC, to Carolyn 
Walsh, dated December 1, 2000 (``MuniGroup''); letter from Dina W. 
Kennedy, Chairman, National Federation of Municipal Analysts, to 
Carolyn Walsh, dated November 1, 2000 (``NFMA''); letter from Stuart 
J. Kaswell, Senior Vice President and General Counsel, Securities 
Industry Association, to Carolyn Walsh, dated December 4, 2000 
(``SIA''); letter from Roger G. Hayes, Chair, The Bond Market 
Association Municipal Securities Division E-Commerce Task Force, to 
Ernesto A. Lanza, dated December 1, 2000 (``TBMA''); letter from 
Lynnette Kelly Hotchkiss, Vice President and Associate General 
Counsel, The Bond Market Association, to Ernesto A. Lanza, dated 
January 4, 2001 (``TBMA II''); and letter from William L. Nichols, 
Chief Operating Officer, ValuBond Securities, Inc., to Carolyn 
Walsh, dated November 30, 2000 (``ValuBond'').
---------------------------------------------------------------------------

    On March 26, 2001, the MSRB published and filed with the Commission 
for immediate effectiveness a portion of the 2000 Notice consisting of 
three interpretive notices on electronic primary offering systems, on 
uniform practice requirements for a specific type of trading system, 
and on electronic recordkeeping.\20\ On July 6, 2001, the MSRB 
published for comment a revised draft interpretive guidance notice that 
covered two related concepts (the ``2001 Notice'').\21\ The first 
concept concerned rule G-17 and the disclosure of material facts. The 
second concerned sophisticated municipal market professionals.\22\
---------------------------------------------------------------------------

    \20\ See ``Interpretation on the Application of Rules G-32 and 
G-36 to New Issue Offerings Through Auction Procedures,'' MSRB 
Reports, Vol. 21, No. 1 (May 2001) at 37; ``Interpretation on the 
Application of Rules G-8, G-12 and G-14 to Specific Electronic 
Trading Systems,'' MSRB Reports, Vol. 21, No. 1 (May 2001) at 39; 
and ``Interpretation on the Application of Rules G-8 and G-9 to 
Electronic Recordkeeping,'' MSRB Reports, Vol. 21, No. 1 (May 2001) 
at 41.
    \21\ ``Notice and Draft Interpretive Guidance on Rule G-17--
Disclosure of Material Facts and Interpretive Guidance Concerning 
Sophisticated Municipal Market Professionals,'' MSRB Reports, Vol. 
21, No. 2 (July 2001) at 3.
    \22\ This filing relates only to the SMMP guidance. Concurrently 
with this filing, the MSRB is filing with the Commission a notice 
relating to the Rule G-17 interpretive guidance. See Filing No. SR-
MSRB-2002-01.
---------------------------------------------------------------------------

    In response to the 2001 Notice, the MSRB received eight comment 
letters; all eight-comment letters addressed the SMMP guidance.\23\ 
After reviewing the comment letters, the Board approved the SMMP 
notice, with certain modifications and additions, for filing with the 
Commission.
---------------------------------------------------------------------------

    \23\ Letter from Linda L. Rittenhouse, Staff, Association for 
Investment Management and Research Advocacy, to Carolyn Walsh, dated 
October 19, 2001 (``AIMR II''); letter from David C. Witcomb, Jr., 
Vice President, Compliance Department, Charles Schwab & Co., Inc., 
to Carolyn Walsh, dated October 11, 2001 (``Schwab II''); letter 
from Michael J. Marx, Vice Chairman, First Southwest Company, dated 
October 12, 2001 (``First Southwest II''); letter from Amy B.R. 
Lancellotta, Senior Counsel, Investment Company Institute, dated 
October 19, 2001 (``ICI II''); letter from Alan Polsky, Chairman, 
National Federation of Municipal Analysts, dated November 13, 2001 
(``NFMA II''); letter from Roger G. Hayes, Chair, The Bond Market 
Association Municipal Securities Division E-Commerce Task Force, 
dated October 10, 2001 (``TBMA III''); letter from Thomas S. Vales, 
Chief Executive Officer, TheMuniCenter, dated October 1, 2001 
(``MuniCenter''); and letter from David Levy, Sr. Associate General 
Counsel, First Vice President, UBS Paine Webber Inc., dated October 
19, 2001 (``UBSPW'').
---------------------------------------------------------------------------

Comments on the 2000 Notice

The Need for Guidance

    Comments Received. The majority of commentators believe that 
guidance is needed regarding the applicability of MSRB rules in the 
context of electronic trading systems.\24\ In addition, many

[[Page 6300]]

commentators commend the MSRB's decision to continue to apply existing 
rules to the online market.\25\
---------------------------------------------------------------------------

    \24\ See A.G. Edwards, AIMR, Bear Stearns, eBondTrade, First 
Southwest, ICI, MuniGroup, NFMA, Schwab, TBMA, and ValuBond, supra 
note 19. For example, AIMR ``applauds the timeliness of the MSRB's 
proposal. We all recognize that electronic trading platforms are the 
way of the future and, as such, the industry should begin assessing 
the feasibility of and potential conflicts that may arise from their 
use.''
    \25\ See e.g., A.G. Edwards, Bear Stearns, eBondTrade, First 
Southwest, ICI, Schwab and TBMA, supra note 19. For example, 
``Schwab welcomes the MSRB's recognition, parallel to that of all 
other major US securities regulators, that the online channel of 
customer access should be subject to the same basic regulatory 
scheme as traditional means of customer access.''
---------------------------------------------------------------------------

Application of the SMP Concept to Fair Practice Obligations

Retention of SMP Differentiation

    Comments Received. The MSRB received numerous comment letters on 
the 2000 Notice about the SMP proposal.\26\ Those commentators that 
were opposed to the concept expressed concern that the SMP concept 
would create two-tiered markets where SMPs and dealers receive prices 
superior to retail customers and less sophisticated institutions and 
transactions will be driven to the less regulated market.\27\ Seven 
commentators approved of the MSRB's recognition that certain municipal 
securities market participants have substantially greater 
sophistication than others.\28\ Those that were in favor of the concept 
in general remain concerned that as drafted the SMP concept is too 
difficult to implement in practice. Three commentators called for the 
MSRB to identify classes of investors who are ``otherwise qualified'' 
market professionals (e.g., Qualified Purchasers as defined under the 
Investment Company Act, Qualified Institutional Buyers as defined under 
Securities Act Rule 144A, etc.) who will be presumed to be SMPs, or 
allow dealers to rely upon written representations from institutional 
investors that they are SMPs.\29\ On the other hand, certain 
institutional investors believe that the SMP criteria, as written, give 
broker-dealers too much flexibility to determine who is an SMP.\30\
---------------------------------------------------------------------------

    \26\ Ten comment letters directly addressed the SMP concept. See 
A.G. Edwards, AIMR, Bear Stearns, eBondTrade, First Southwest, ICI, 
NFMA, Schwab, TBMA, and ValuBond, supra note 19.
    \27\ See ICI, NFMA, and Schwab, supra note 19. For example, 
Schwab stated that:
    A consistent disclosure standard for retail and institutional 
investors would permit firms to build ECN-like trading platforms 
that allow for participation of all investors, retail and 
institutional. Such fully integrated trading systems could 
contribute to improved liquidity, better pricing and fairness for 
retail investors by avoiding two-tiered markets where institutions 
and dealers receive superior prices. We urge the MSRB to avoid 
creating regulatory incentives, which would lock retail investors 
out of the most cost-efficient and up-to-date online bond trading 
systems.
    \28\ See A.G. Edwards, AIMR, Bear Stearns, eBondTrade, First 
Southwest, TBMA, and ValuBond, supra note 19. TBMA stated that:
    We strongly support the Board's identification of 
``sophisticated market professionals.'' The proposed definition of a 
subset of investors who are ``sophisticated market professionals,'' 
for whom a firm's customer-specific suitability obligations are 
presumed met, will promote the development of the online municipal 
market. Initially, trading platforms will be able to simplify their 
regulatory obligations, cut costs, and improve their ability to 
compete by limiting access to sophisticated investors. These limited 
access platforms will be able to serve as laboratories for 
technological innovation, and sophisticated investors will benefit 
from the availability of platforms tailored to their special needs. 
Ultimately, however, trading methods and technologies developed 
through these platforms may be extended to retail investors as well, 
thereby benefiting all investors and improving liquidity throughout 
the municipal market.
    \29\ See A.G. Edwards, First Southwest, and TBMA, supra note 19.
    \30\ See AIMR, supra note 19 (``we agree in general with the 
basic premise in establishing the sophisticated investor criteria. 
[However,] as written we believe that the criteria give broker/
dealers too much flexibility to determine who is and who is not a 
sophisticated client.'').
---------------------------------------------------------------------------

    MSRB Response. The MSRB determined to retain the SMP proposal with 
the revisions in the 2001 Notice.\31\ The MSRB believes that certain 
customers (SMMPs) are sufficiently familiar with the market to 
participate on a par with dealers when engaging in non-recommended 
secondary market transactions. In addition, SMMPs are sufficiently 
sophisticated about financial matters and versed in the municipal 
securities at issue so that they are not in need of a dealer's 
customer-specific suitability analysis when a dealer recommends certain 
municipal securities. They thus should be able to access the market, 
either through automated systems or otherwise, without the same level 
of dealer responsibility now required for less sophisticated customers. 
Such market access should be at a lower cost than the dealer's current 
``full service.'' There is support in law and regulatory precedent for 
differentiating between types of investors.\32\ However, the MSRB did 
not allow classes of ``otherwise qualified'' market professionals to be 
presumed to be SMPs and did add a $100 million asset requirement to 
ensure that only the most sophisticated municipal market professionals 
would come within the definition of SMMP.
---------------------------------------------------------------------------

    \31\ See infra notes 70-71 and accompanying text for a 
discussion of the MSRB's Response to Comments regarding the 
retention of the SMMP differentiation in the 2001 Draft Guidance.
    \32\ For example, the NASD recognized this concept in its 
approach to determining the scope of a member's suitability 
obligation in making recommendations to an institutional customer. 
(``[A] broker/dealer frequently has knowledge about the investment 
and its risks and costs that are not possessed by or easily 
available to the investor. Some sophisticated institutional 
customers, however, may in fact possess both the capability to 
understand how a particular securities investment could perform, as 
well as the desire to make their own investment decisions without 
reliance on the knowledge or resources of the broker/dealer.'') NASD 
Notice to Members 96-66, ``Suitability Obligations to Institutional 
Investors'' (October 1996).
---------------------------------------------------------------------------

Application of SMP Criteria \33\

Rule G-17: Conduct of Municipal Securities Activities
    Comments Received.
---------------------------------------------------------------------------

    \33\ All of the commentators' written concerns with the SMP 
concept related to dealers' rule G-17 obligations. No specific 
written comments were made in regard to the application of the SMP 
concept to a dealer's rules G-18 and G-19 obligations.
---------------------------------------------------------------------------

    a. Disclosure. Several commentators expressed the opinion that SMPs 
need a dealer to provide G-17 affirmative disclosure information to 
them about municipal securities transactions.\34\ For example, ICI 
stated:

    \34\ See e.g., AIMR; ICI; and NFMA, supra note 19.
---------------------------------------------------------------------------

Furthermore, not all information that is disclosed by an issuer is 
necessarily filed with or collected by Information Repositories, and 
such public information as may be available from the Information 
Repositories may be too sparse or outdated to provide, on its own, an 
adequate basis for an investor to make an informed credit decision * * 
*. In those situations, the dealer selling municipal securities may 
possess, or be in the best position to acquire, public information that 
is relevant and material to the investor. Due to the fragmented nature 
of currently ``available'' information about municipal securities, it 
cannot be presumed that an investor, however sophisticated, has access 
to all information that has been gathered by or is available to a 
dealer, and the duty of a dealer to disclose all such material 
information remains an important and necessary protection for all 
investors.\35\

    \35\ See ICI, supra note 19. Similarly, NFMA stated that the 
``Draft Interpretive Guidance overestimates the information 
available to investors of any ilk in the municipal securities 
market, and underestimates the role of the dealer as a centralized 
purveyor of available information about particular securities.'' Id. 
The MSRB has addressed some investor concerns and clarified certain 
misunderstandings relating to dealers' Rule G-17 affirmative 
disclosure obligations in its Rule G-17 interpretive notice filed 
concurrently herewith. See File No. SR-MSRB-2002-01.
---------------------------------------------------------------------------

    In contrast to such comments, TBMA in its supplemental letter 
stated:

We believe that it is illogical and without merit to link the quality 
and adequacy of disclosure with the designation of an investor class as 
SMPs

[[Page 6301]]

* * *. [T]he Interpretive Release is not diluting or reducing the 
amount or type of disclosure available to SMPs. It merely recognized 
that for this particular investor class, access to information is 
readily available to both the SMP and the dealer, and that efficiencies 
could be achieved through the different application of MSRB rules.\36\

    \36\ TBMA II, supra note 19. TBMA further notes that the MSRB's 
Draft Guidance ``recognizes that premature regulation in an evolving 
technology will not serve the common goals of the industry.''
---------------------------------------------------------------------------

    b. Rule G-17 Safe Harbor. Several commentators urged the MSRB to 
afford dealers a safe harbor or other guidance under rule G-17. \37\ 
For example, eBondTrade urged the MSRB ``to afford the dealer a safe 
harbor under Rule G-17 for hyperlinks on the dealers' platforms to 
other parties such as issuer websites, rating agencies, and other 
pertinent information sources * * *. [eBondTrade] also recommend[s] 
that a similar safe harbor be afforded for dealers using indicative 
data sources provided by such firms as J. J. Kenny, Interactive Data 
(Muller) and Bloomberg data to create municipal bond descriptions.'' 
\38\
---------------------------------------------------------------------------

    \37\ See eBondTrade, TBMA and ValuBond, supra note 19. ValuBond 
states that the Board should ``articulate standards for a `safe 
harbor' for electronic systems which display data about bonds 
according to descriptive elements (e.g., by rating, type, issuer), 
and the extent to which such functionality does or does not 
constitute rendering of financial advice.'' TBMA suggests a G-17 
hyperlink safe harbor, stating that although it ``realizes that the 
subject of liability for hyperlinks is unsettled, we believe that 
such a safe harbor is consistent with other regulators' treatment of 
hyperlinks to date.''
    \38\ eBondTrade, supra note 19.
---------------------------------------------------------------------------

    Similarly, while Schwab did not suggest a safe harbor per se, it 
urged the MSRB ``to resist the temptation of holding online firms to a 
higher standard than traditional delivery channels.'' Schwab went on to 
note that ``most current online disclosure practices are more than 
adequate,'' and that ``[f]or online bond trading systems, several 
reputable vendors provide descriptive information about bond issues 
which meets the Rule G-17 disclosure standards.'' \39\ However, DLJ 
stated:
---------------------------------------------------------------------------

    \39\ Schwab, supra note 19. See also eBondUSA, supra note 19 
(``we would argue that a well-designed market price discovery tool, 
linked to the appropriate secondary market disclosure sites, will go 
far toward fulfilling a dealer's `fair dealing' obligations'').

    If ATSs are exempt from several MSRB rules when linking with 
dealers or sophisticated market professionals, MSRB interpretations 
appear to assume that the dealers, including online brokers, may need 
to comply with these requirements * * *. For example, the 
interpretation for MSRB's Rule G-17 suggests that ATSs would not be 
responsible for providing descriptive information to customers. It 
would be difficult if not impossible for an online firm, displaying to 
its customers all products listed on the ATS, to ensure that each 
customer receives all material information at the time the customer is 
ready to execute a transaction electronically.\40\
---------------------------------------------------------------------------

    \40\ DLJ, supra note 19.
---------------------------------------------------------------------------

    MuniGroup, however, asked the MSRB to clarify that in the context 
of an ATS type-trading platform like MuniGroup, ``the underlying 
responsibility to the customer lies with the broker-dealer with whom 
the customer maintains his or her account, and not with the electronic 
trading platform over which the transaction actually occurs.'' \41\
---------------------------------------------------------------------------

    \41\ Munigroup, supra note 19.
---------------------------------------------------------------------------

    MSRB Response. In the 2000 Notice, the MSRB stated that the actions 
of a dealer in complying with its affirmative disclosure obligations 
under rule G-17 may depend on the nature of the customer. In revising 
the 2001 Notice, the MSRB retained this concept but clarified that the 
concept only applies when a dealer is effecting non-recommended 
secondary market transactions for a customer.
    The MSRB also clarified in the 2001 Notice that investors have 
misunderstood the import of the 2000 Notice by suggesting that it would 
allow a dealer who had actual knowledge of a material fact that was not 
accessible to the market to transact with an SMMP without disclosing 
the information. The 2001 Notice does nothing to alter a dealer's duty 
not to engage in deceptive, dishonest, or unfair practices under Rule 
G-17 or under the federal securities laws. Thus, if material 
information is not accessible to the market but known to the dealer and 
not disclosed, the dealer may be found to have engaged in an unfair 
practice. In essence, a dealer's disclosure obligations to SMMPs would 
be on par with inter-dealer disclosure obligations. There would be no 
specific requirement for a dealer to disclose all material public facts 
to a customer that is presumed to know the characteristics of the 
securities. As in the case of an inter-dealer transaction, in a 
transaction with an SMMP an intentional failure to disclose an unusual 
feature of a security not accessible to the market (but known by the 
dealer) may constitute an unfair practice violative of Rule G-17. In 
addition, a dealer may not knowingly misdescribe securities to the 
customer. A dealer's duty not to mislead its customers is absolute and 
is not dependent upon the nature of the customer.
    As noted in the 2001 Notice, the flow of municipal securities 
disclosure should not be diminished. The SMMP proposal only will 
relieve a dealer when effecting non-recommended secondary market 
transactions of its affirmative disclosure obligation to inform the 
SMMP customer about the information available from established industry 
sources where the customer is already aware of, or capable of making 
itself aware, and can independently understand the significance of the 
material facts available from established industry sources. There may 
be times when an SMMP is not satisfied that the information available 
from established industry sources is sufficient to allow it to make an 
informed investment decision. However, in those circumstances, the MSRB 
believes that an SMMP can recognize that risk and take appropriate 
action, be it declining to transact, undertaking additional 
investigation, or asking the dealer to acquire additional information. 
Continuing to impose Rule G-17's affirmative disclosure obligations on 
dealers transacting with SMMPs will not provide the desired additional 
information. Dealers may not be aware of new or developing material 
events because issuers have failed to publicly disclose them, or they 
are not available from established industry sources.
    The MSRB believes that this interpretation is consistent with Rule 
G-17's goal of ensuring that dealers treat customers fairly. It affords 
dealers flexibility to negotiate understandings and terms with a 
particular customer when effecting non-recommended secondary market 
transactions. This approach assists dealers and customers in defining 
their own expectations and roles with respect to their specific 
relationship.
    The MSRB does not believe that it should provide online dealers 
with a safe harbor under Rule G-17 for the particular information 
necessary to fulfill affirmative disclosure obligations when effecting 
electronic transactions for non-SMMP customers (e.g., hyperlinks to 
certain indicative data services). Dealers are responsible for 
disclosing material information to customers. If hyperlinks are not 
working correctly or indicative data sources have erroneous 
information, dealers should be liable for the resulting failure to 
disclose. The MSRB has, however, addressed some commentators concerns 
about the scope of a dealer's Rule G-17 disclosure obligations in the 
related Rule G-17 Interpretive Guidance.

[[Page 6302]]

Rule G-18: Execution of Transactions
    Comments Received. Only two commentators addressed the MSRB's 2000 
guidance concerning Rule G-18. MuniGroup stated that it agrees with the 
guidance that G-18 does not require a dealer operating a platform to 
review each transaction to ensure that the prices for the transaction 
are fair and reasonable. MuniGroup also noted, ``because of the 
relatively illiquid nature of the municipal market, there is no way for 
a platform [serving only registered broker-dealers] to ensure that 
transactions are effected at fair and reasonable prices.'' Similarly, 
TBMA commented, ``we believe that Rule G-18 does not necessarily 
require a dealer to check all posted prices on all accessible web sites 
to ensure a fair and reasonable price for any given municipal 
securities transaction.'' \42\
---------------------------------------------------------------------------

    \42\ See MuniGroup and TBMA, supra note 19.
---------------------------------------------------------------------------

    MSRB Response. Rule G-18 requires that each dealer, when executing 
a transaction in municipal securities for or on behalf of a customer as 
agent, make a reasonable effort to obtain a price for the customer that 
is fair and reasonable in relation to prevailing market conditions. The 
2000 Notice provided that the actions that must be taken by a dealer 
when effecting agency transactions to make reasonable efforts to ensure 
that its agency transactions with customers are effected at fair and 
reasonable prices may be influenced by the nature of the customer as 
well as by the services explicitly offered by the dealer. In the 2001 
Notice, the MSRB made changes to more precisely describe the parameters 
of the services offered by a dealer if the dealer wishes to avail 
itself of this interpretation.
Rule G-19: Suitability of Recommendations and Transactions
    Comments Received. Many commentators expressed concerns about the 
MSRB's discussion of implicit recommendations and the possibility that 
a retail customer may view a sending of an inventory list as the 
equivalent of a recommendation, which would require the dealer to 
perform a suitability review before selling the security to the retail 
customer.\43\ For example, the SIA argued that inventory lists are not 
recommendations and that the 2000 Notice ``represents an expansion of 
the generally accepted definition of recommendation in the context of 
the suitability rules * * * Regulators have consistently recognized 
that the distribution of general, impersonal advertising material does 
not, in itself, give rise to suitability obligations.'' \44\
---------------------------------------------------------------------------

    \43\ E.g., A.G. Edwards; Bear Stearns; DLJ; Schwab; SIA; and 
TBMA, supra note 19. DLJ also argues that the MSRB's assumption that 
retail customers are unlikely to initiate a transaction on their own 
``is not consistent with our business model or our experience, and 
we think it is an incorrect assumption in this day and age.'' None 
of the commentators took issue with the MSRB's interpretation 
exempting dealers from a suitability obligation when transacting 
with SMPs.
    \44\ SIA, supra note 19. The SIA supported this position by 
arguing that customers are adequately protected by existing rules, 
citing a variety of NASD rules on advertising and customer 
communications.
---------------------------------------------------------------------------

    A few commentators suggested that the MSRB should conform its 
recommendation and suitability guidance to the NASD's.\45\ These 
commentators generally take the position that the determination of 
whether a recommendation has been made or not should focus on whether 
the ``communication is individualized for that particular customer.'' 
\46\ While these commentators state that brokerages have the general 
obligation to ensure that they have a reasonable basis for information 
about the securities available on their websites, citing NASD rules, 
they argue that generalized recommendations do not trigger an 
individualized suitability obligation whenever an investor reads or 
acts on that generalized recommendation.
---------------------------------------------------------------------------

    \45\ E.g., DLJ; Schwab; and SIA, supra note 19.
    \46\ SIA, supra note 19.
---------------------------------------------------------------------------

    In addition, the SIA argued that if the MSRB guidance that states 
that the sophistication of the investor and the nature of the 
relationship with the firm are relevant factors in determining whether 
a recommendation has been made was meant to emphasize ``those factors 
at the expense of the content of the communication, then the MSRB 
guidance will be expanding the definition of suitability.'' \47\
---------------------------------------------------------------------------

    \47\ Id.
---------------------------------------------------------------------------

    Some commentators suggested that the MSRB issue guidance that 
affords dealers permission to rely upon an online customer's electronic 
representations in determining that an investment is suitable for that 
customer.\48\ Several commentators requested further clarification 
about whether using filters and allowing customers to employ customer 
controlled search functions constitutes a recommendation.\49\ However, 
A.G. Edwards cautioned the MSRB to ``resist at this time the temptation 
to adopt specific rules or interpretations that might ultimately 
dictate what communications give rise, or do not give rise, to 
suitability obligations.'' \50\
---------------------------------------------------------------------------

    \48\ E.g., First Southwest and TBMA, supra note 19. See also 
Morgan Keegan, supra note 19 (``How can a dealer operating an 
electronic trading system possibly know customer specifics other 
than those given over the computer, and that would probably not hold 
up under review or arbitration?'') and DLJ (``technology is 
currently not available for online firms to fulfill suitability 
obligations electronically'').
    \49\ E.g., Bear Stearns; TBMA; DLJ; Schwab; and SIA, supra note 
19.
    \50\ A.G. Edwards, supra note 19.
---------------------------------------------------------------------------

    MSRB Response. In publishing the 2000 Notice and the November 
Clarification, the MSRB intended to be consistent with existing 
customer suitability analysis by recognizing that historically the 
determination of whether a dealer is making a recommendation has been 
made by reference to all relevant facts and circumstances. However, 
several commentators noted a need for industry consensus on the 
definition of an online recommendation. A few commentators specifically 
stated that the MSRB should conform its recommendation and suitability 
guidance to the NASD's then soon to be released notice on its 
suitability rule and online communications.\51\ In revising the 2001 
Notice for comment, the MSRB determined to remove any discussion 
concerning the identification of when a dealer makes a recommendation 
online from the SMMP guidance. The MSRB is reviewing the NASD's release 
and plans to provide additional guidance in this area.
---------------------------------------------------------------------------

    \51\ The NASD released its Online Suitability Guidance on March 
20, 2001. See NASD Notice to Members 01-23, Online Suitability--
Suitability Rule and Online Communications (April 2001).
---------------------------------------------------------------------------

Draft Interpretive Guidance for Quotation Rule

    Comments Received. Three commentators provided substantive comment 
on the MSRB's discussion relating to quotations.\52\
---------------------------------------------------------------------------

    \52\ MuniGroup, Schwab and AIMR, supra note 19. In addition, 
First Southwest stated that rule G-13 should ``address the 
assessment responsibility of the electronic trading platforms 
through which online transactions take place,'' an apparent 
reference to Rule A-13's assessments on inter-dealer and customer 
transactions. First Southwest, supra note 19.
---------------------------------------------------------------------------

    MuniGroup agreed with the basic concept that a dealer disseminating 
a quotation made by another dealer has a reduced obligation for 
ensuring compliance with the bona fide and fair market value 
requirements. However, it stated that many electronic trading systems 
are anonymous systems that disseminate quotes of various dealers on an 
undisclosed basis. MuniGroup believes that the MSRB's requirement that 
a disseminating dealer label a quotation made by another dealer as such 
``place[s] the burden of ensuring compliance with the bona fide and 
fair market value requirements on the dealer operating the electronic 
trading

[[Page 6303]]

system.'' It argued that, since participants in such an anonymous 
system are aware that the dealer operating the system is not actually 
making quotations, ``the position of the MSRB should be clarified to 
make clear that the dealer operating the electronic trading system is 
not the dealer responsible for ensuring compliance with the bona fide 
and fair market value requirements.'' \53\
---------------------------------------------------------------------------

    \53\ MuniGroup, supra note 19.
---------------------------------------------------------------------------

    Schwab stated that it is troubled that a dealer has a higher 
compliance obligation when disseminating a quote made by a retail 
customer (which the disseminating dealer must treat as its own 
quotation) than when disseminating a quote made by a sophisticated 
market professional (which the disseminating dealer may treat as if 
made by another dealer if the quote is labeled as having been made by a 
sophisticated market professional). It argued, ``[t]here is no reason 
to believe that retail investors are more likely than institutions to 
enter quotes that are not bona fide or are unfairly priced.'' \54\ 
Schwab noted that Rule G-13, as interpreted by the MSRB, ``would allow 
institutions and dealers to quickly and efficiently enter bids and 
offers in ECNs. For retail orders, however, the dealer sponsoring the 
system would have to review and approve the bids and offers before they 
could be entered into the system.'' Schwab stated that the pace of 
online trading might not allow the dealer sufficient time to assess the 
fair market value of the securities quoted and, if there is no direct 
relationship between the dealer and the customer, the dealer may not be 
able to assess whether the quote is bona fide. It suggested that all 
customer quotes be treated in the manner proposed by the MSRB for 
sophisticated market professionals.
---------------------------------------------------------------------------

    \54\ Schwab, supra note 19. Schwab appeared to assume, 
incorrectly, that all institutional investors would be treated as 
sophisticated market professionals.
---------------------------------------------------------------------------

    AIMR suggested that dealers be required to post the time of the 
most recent change in price posted on a trading platform, which ``would 
automatically alert potential investors to the possible staleness of a 
quote.'' \55\
---------------------------------------------------------------------------

    \55\ AIMR, supra note 19. AIMR also suggested that market 
transparency and liquidity would be improved by requiring public 
disclosure of trades of $1 million or more on a real-time basis, 
stating that ``[n]ext day information * * * provides little insight 
to the current market depth and trading range that would be relevant 
for a particular trade investors may be considering at that 
moment.'' In addition, ValuBond asked, ``How the MSRB will view 
price discrepancies between actual bond quotations and MSRB trade 
data or market evaluation?'' ValuBond, supra note 19.
---------------------------------------------------------------------------

    MSRB Response. The 2000 Notice recognized that new electronic 
trading systems provide a variety of avenues for disseminating 
quotations among both dealers and customers. The MSRB, in fact, 
intended that the disseminating dealer only be required to note that 
the quotation that it was disseminating had been made by another 
dealer, not that it be required to reveal the actual identity of the 
dealer making the quotation. The 2001 Notice clarified this point. The 
2001 Notice also stated that although not required by the rule, the 
MSRB believes that posting the time and date of the most recent update 
of a quotation can be a positive factor in determining whether the 
dealer has taken steps to ensure that a quotation it disseminates is 
not stale or misleading.
    The MSRB did not however, adopt Schwab's suggestion that 
disseminating dealers be allowed to treat quotes made by retail 
customers as quotes made by another dealer. The MSRB believes that the 
structure of the municipal securities market along with the 
informational disadvantages retail customers have make it reasonable to 
assume that retail investors are more likely to enter quotes that do 
not reasonably relate to the fair market value of the securities. 
Therefore, it is necessary to require dealers who operate systems to 
review and approve the quotes as bona fide before they can be 
disseminated by the system.

Comments on the 2001 Notice

Sophisticated Municipal Market Professional--Definition

$100 Million Threshold
    Comments Received. Three commentators on the 2001 Notice expressed 
the opinion that the threshold requirement that an SMMP own or control 
$100 million in municipal securities ``is unnecessarily high, and may 
deny access to online trading systems to a number of very large 
institutions with significant municipal holdings that are otherwise 
capable of participating in these systems.'' \56\ All three 
commentators suggested changing the threshold to $50 million and noted 
that this threshold would be consistent with the Board's own definition 
of ``institutional account'' in Rule G-8 (a)(xi), and with the NASD's 
institutional suitability guidelines. TBMA also stated that a $50 
million threshold would benefit the markets by providing access to a 
number of very large institutional investors that are not SMMPs under 
the proposed standard. Specifically, TBMA stated that reducing the 
threshold to $50 million would increase the percentage of qualified 
institutions to 43%, up from less than 29% when the threshold is $100 
million.\57\
---------------------------------------------------------------------------

    \56\ See First Southwest II, MuniCenter, and TBMA III, supra 
note 23. In contrast, AIMR stated that the $100 million dollar 
threshold is too low and they suggested a two-tiered analysis. An 
investor could be presumed to be an SMMP if it reached an asset 
threshold of $1 billion dollars in municipal securities. In the 
alternative, if the investor has assets of less than $1 billion 
dollars, but more than $100 million dollars and is able to satisfy 
additional criteria, it could be treated as an SMMP. See AIMR II, 
supra note 23.
    \57\ See TBMA III, supra note 23. TBMA's estimates are based on 
a sample of approximately 1,200 large institutional investors (the 
top 500 banks, 547 insurance companies, and 150 largest mutual 
funds). Id.
---------------------------------------------------------------------------

    MSRB Response. The MSRB determined to add the $100 million 
threshold to the SMMP definition as a way of ensuring that SMMPs are 
truly the most sophisticated of institutional investors. According to 
TBMA's data, lowering the threshold to $50 million will result in close 
to 50% of all large institutional investors being eligible to be an 
SMMP. Moreover, the comment letters from First Southwest, MuniCenter 
and TBMA are directly contrary to the comments from AIMR. AIMR believes 
the $100 million limit is too low and stated that the $100 million 
limit can easily be met without the ``concomitant demonstration of 
being a sophisticated investor.'' \58\
---------------------------------------------------------------------------

    \58\ See AIMR II, supra note 23.
---------------------------------------------------------------------------

    Although the comment letters expressed concern about denying 
electronic trading access to smaller institutions, the SMMP definition 
should not operate in that fashion. An institutional investor that does 
not have the level of assets in the definition of the SMMP will not be 
foreclosed from trading if the dealer offering the platform is 
providing sufficient information services, beyond transaction 
execution.\59\ Indeed, there is evidence that many dealers are 
developing electronic trading systems designed to provide extensive 
informational services and otherwise fulfill dealers' fair practice 
obligations.\60\ Moreover, while many other ``sophisticated investor'' 
regulations have lower dollar thresholds, the threshold for qualified 
institutional buyers (``QIBs'') is also set at $100 million, and the 
Board believes

[[Page 6304]]

that the purposes behind the QIB threshold are most analogous to the 
SMMP definition.\61\ Therefore, the MSRB has determined to keep the 
threshold at $100 million.
---------------------------------------------------------------------------

    \59\ Similarly, dealers that wish to allow their retail 
customers to view offerings on ATS type platforms may do so. 
However, the dealers sponsoring retail customers are responsible for 
providing their customers with Rule G-17 disclosures and for 
ensuring that the transaction prices are fair and reasonable.
    \60\ For example, MuniCenter made representations that it 
``probably exceeds traditional services offered by dealers.'' 
MuniCenter, supra note 23.
    \61\ A QIB is an institution of a type listed in Rule 144A that 
owns or invests on a discretionary basis at least $100 million of 
certain securities. See 17 CFR 230.144A(a)(1). The QIB definition is 
used to identify institutions that can purchase offerings that are 
exempt from the registration provisions of the Securities Act and in 
which the securities are eligible for resale pursuant to Rule 144A 
under the Securities Act (``Rule 144A offerings'').
---------------------------------------------------------------------------

Presumption of Sophistication

    Comments Received. Several commentators suggested that the SMMP 
definition be altered to allow investors to be presumed sophisticated 
if they meet the investment threshold.\62\ The commentators pointed out 
that the presumption could be rebutted if the dealer knew or should 
have known that an investor lacked sophistication concerning a 
municipal securities transaction as defined in the SMMP guidance. The 
commentators stated that requiring a dealer to always make 
individualized judgments that investors meet the definition might 
hinder dealers' efforts to streamline access to online trading.\63\
---------------------------------------------------------------------------

    \62\ See First Southwest II, TBMA III and AIMR II (albeit at a 
level of $1 billion dollars), supra note 23. TBMA also suggested 
that ``any fund that invests solely in municipal securities should 
be presumed sophisticated, because such funds in effect hold 
themselves out to the public as possessing special expertise.''
    \63\ See e.g., AIMR II (suggesting that while in theory asking 
the dealer to make a determination that a customer is an SMMP may 
sound reasonable, in many instances it is not practicable, 
especially for smaller dealers), supra note 23.
---------------------------------------------------------------------------

    MSRB Response. The MSRB believes that there should not be a 
presumption of SMMP status for those institutions with $100 million or 
greater in municipal securities. The inclusion of a presumption would 
make the rest of the SMMP guidance concerning who is, or is not an SMMP 
meaningless. The MSRB believes that dealers should be required to 
undertake some level of investigation to determine if a customer meets 
the SMMP criteria and should not be allowed to presume that an 
institution is sophisticated just because it meets the $100 million 
threshold. Indeed, AIMR noted, ``[w]ealth alone (as determined by a 
specific dollar amount of assets under management or within a 
portfolio) does not translate into investment knowledge.'' \64\
---------------------------------------------------------------------------

    \64\ AIMR II, supra note 23.
---------------------------------------------------------------------------

Requiring Institutional Investors to Attest to SMMP Status

    Comments Received. Two commentators, AIMR and UBSPW, also suggested 
a mechanism for eliminating some of the ambiguity of the ``reasonable 
grounds'' test for determining if a customer is an SMMP.\65\ AIMR urged 
the MSRB to ``[s]hift the ultimate responsibility from the dealer to 
the investor to determine and represent that it qualifies as a 
sophisticated market professional * * *.'' UBSPW suggested that the 
SMMP proposal would be improved if the MSRB permits ``dealers to rely 
upon either (1) the representation of a potential user that it has the 
characteristics the Board has identified as indicative of a 
sophisticated municipal market professional; or (2) a contract pursuant 
to which the participant agrees to waive the disclosure, suitability 
and price `protections' that would otherwise be afforded that same 
customer in the context of a recommendation.'' \66\
---------------------------------------------------------------------------

    \65\ See AIMR II and UBSPW, supra note 23.
    \66\ Id.
---------------------------------------------------------------------------

    MSRB Response. The SMMP Interpretive Guidance is designed to help 
dealers understand their fair practice obligations when effecting 
secondary market transactions for certain customers. As the fair 
practice obligations are the dealers', the MSRB believes it would be 
inappropriate to shift the ultimate responsibility for determining the 
scope of those obligations entirely to the customer. While the major 
rationale of AIMR's suggestion that investors be required to attest to 
SMMP status was an effort to streamline the process by which dealers 
determine that a customer is an SMMP, they also raised it as a 
mechanism to prevent customers who do not want to be considered SMMPs 
from being treated as such. However, an institution can only be treated 
as an SMMP, for purposes of Rules G-17 and G-18, if the institution has 
decided that it wants to engage in a non-recommended secondary market 
transaction. So, to a large extent, the institutions that can be 
considered SMMPs are self-selecting--they are the self-directed 
institutional investors that want to transact with a dealer who will 
act as an order taker.
    As the MSRB recognized in the 2001 Notice, the SMMP interpretation 
``affords dealers flexibility to negotiate understandings and terms 
with a particular customer when effecting non-recommended secondary 
market transactions. This approach assists dealers and customers in 
defining their own expectations and roles with respect to their 
specific relationship.'' Therefore, the MSRB determined that the 
revised interpretive notice should specifically advise dealers that 
they may choose to have customers attest to SMMP status as a means of 
streamlining the dealers' process for determining that the customer is 
an SMMP and ensuring that customers are informed as to the consequences 
of being treated as an SMMP. Of course, a dealer would not be able to 
rely upon a customer's SMMP attestation if the dealer knew or should 
have known that an investor lacked sophistication concerning a 
municipal securities transaction as defined in the SMMP guidance.

Confirming SMMP Status

    Comments Received. TBMA noted that the 2001 Notice is silent as to 
how often a dealer must confirm that a customer still qualifies as an 
SMMP. TBMA recommended that dealers be allowed to confirm SMMP status 
as part of their regular review of new account information.\67\
---------------------------------------------------------------------------

    \67\ TBMA III, supra note 23.
---------------------------------------------------------------------------

    MSRB Response. The SMMP interpretive guidance has been revised to 
include a statement that would clarify that dealers are required to put 
a process in place for periodic review of customer's SMMP status.

Application of SMMP Interpretation to Fair Practice Obligations

Retention of SMMP Differentiation
    Comments Received. Two commentators, Schwab and NFMA, again 
challenged the MSRB's decision to create the SMMP differentiation. 
Schwab is concerned that the SMMP proposal ``will undoubtedly foster 
the creation and growth of electronic bond trading systems that cater 
solely to professional dealers and institutional investors and exclude 
participation by retail investors..'' \68\ The NFMA's concerns are two-
fold. First, they ``are troubled by the notion that certain market 
participants have enough direct access to information as to make 
redundant a dealers' affirmative disclosure of material facts * * *.'' 
Therefore, they ``cannot endorse the SMMP concept as a means of 
promoting electronic trading before a general strengthening of the 
existing secondary disclosure structure occurs.'' Second, the NFMA 
``remains concerned that the concept of the SMMP as currently developed 
creates two tiers of investors. * * *. The NFMA is concerned that 
retail investors and smaller institutional investors will not have 
access to electronic systems.'' \69\
---------------------------------------------------------------------------

    \68\ See NFMA II and Schwab II, supra note 23.
    \69\ NFMA II. See also AIMR II (``We continue to have concerns 
about any efforts to decrease disclosure in the municipal securities 
market.''), supra note 23.

---------------------------------------------------------------------------

[[Page 6305]]

    MSRB Response. As noted above,\70\ the MSRB believes that there is 
considerable merit in differentiating between customers with different 
degrees of sophistication. The MSRB believes that the SMMP guidance, as 
revised, is narrowly crafted so as to retain necessary customer 
protections for both retail and SMMP customers.
---------------------------------------------------------------------------

    \70\ See supra notes 31-32 and accompanying text.
---------------------------------------------------------------------------

    Moreover, while both Schwab and the NFMA posited that the MSRB 
guidance would foster the development of electronic trading systems 
that cater only to dealers and SMMPs, there is no evidentiary support 
for that statement. Rather, electronic trading systems area continuing 
to develop for retail and non-SMMP customers and the SMMP proposal was 
not intended to prohibit participation by retail participants in the 
electronic marketplace.\71\
---------------------------------------------------------------------------

    \71\ MuniCenter also indicated some confusion about implications 
in the SMMP proposal, stating that the ``SMMP Interpretive Guidance 
implies that electronic trading platforms are limited to transaction 
execution.'' Additionally, MuniCenter stated, ``there should not be 
an implication that if an institutional investor does not have the 
level of assets in the definition of SMMP, the institutional 
investor should be foreclosed from electronic trading when the 
platform is providing significant informational services beyond 
transaction execution.'' MuniCenter, supra note 23. However, the 
MSRB's statements have been taken out of context. The MSRB's intent 
was to recognize the need for SMMP designation because some ATS type 
systems are being developed as largely transaction execution 
systems. Such systems may not provide sufficient information about 
the securities traded, and may not take reasonable steps to ensure 
that the transaction prices are fair and reasonable (nor do they 
represent that they perform these functions). The MSRB believes that 
these types of systems that are limited to transaction execution 
services should limit access to SMMPs, or at least that the dealer-
operator of such systems should be aware that they are obligated to 
provide affirmative disclosure under rule G-17 and reasonably ensure 
fair and reasonable transaction prices under rule G-18 for the non-
SMMP customers who transact directly within such a system. However, 
the MSRB believes and has stated that non-SMMP customers should not 
be foreclosed from electronic trading platforms that provide 
sufficient informational services.
---------------------------------------------------------------------------

    Additionally, although Schwab's comment letter urged the MSRB to 
foster the development of systems that allow retail investors to be 
able to trade on an equal footing with dealers and institutions, these 
comments do not take into account the reality of the municipal 
securities market. While Schwab noted that there is no need to 
differentiate between SMMPs and non-SMMPs in certain markets such as 
the Nasdaq market, there are significant differences between the 
municipal securities market and other markets. Municipal securities are 
not part of the national market system. It would be very difficult for 
a retail investor to know whether a municipal security is being offered 
at a price that is fair and reasonable. There is, for example, no 
consolidated tape reporting contemporaneous quotes and transaction 
prices. Only rarely is a specific municipal security traded with 
sufficient frequency to allow a less sophisticated investor to obtain 
transaction information to assist in an analysis of the price being 
offered. Moreover, there is no mandated issuer disclosure, and very 
little publicly available and free disclosure information. It is very 
likely that retail and less sophisticated institutional investors would 
not even know where to go to independently assess the accuracy or 
timeliness of information about a municipal security. Given these 
circumstances, the MSRB believes that most retail and less 
sophisticated institutional customers at this time continue to need 
dealers to be specifically obligated to fulfill their fair practice 
obligations by, inter alia, affirmatively disclosing any material fact 
concerning a municipal security transaction made publicly available 
through established industry sources and taking reasonable steps to 
ensure that agency transactions are effected at fair and reasonable 
prices.

Application of Board Rules to Both Traditional and Electronic Trading 
Systems

    Comments Received. The ICI suggested that the SMMP concept should 
be limited to electronic trading platforms. The ICI stated, ``[w]hile 
we agree with the MSRB's position that it is appropriate to relieve 
dealers operating electronic trading platforms of their affirmative 
disclosure obligations under rule G-17 for the limited purpose of 
executing non-recommended secondary market transactions, we do not 
believe that dealers should be relieved of their disclosure obligations 
when effecting transactions of such securities generally. There has 
been no demonstrated need to expand the SMMP concept to non-electronic 
trading, which to date has successfully operated without it.'' \72\
---------------------------------------------------------------------------

    \72\ See ICI II, supra note 23.
---------------------------------------------------------------------------

    MSRB Response. The MSRB does not believe that electronic 
transactions should be subject to different regulation than 
transactions that take place over the phone or in person. The dealers' 
obligations should be the same no matter what the medium of 
communication. While the SMMP interpretation will be particularly 
relevant to dealers operating electronic trading platforms, it could 
also apply to dealers who act as order takers in over the phone or in-
person transactions.\73\
---------------------------------------------------------------------------

    \73\ For example, if an SMMP reviewed an offering of municipal 
securities on an electronic platform that limited transaction 
capabilities to broker-dealers and then called up a dealer and asked 
the dealer to place a bid on such offering at a particular price, 
the interpretation would apply because the dealer would be acting 
merely as an order taker effecting a non-recommended secondary 
market transaction for the SMMP.
---------------------------------------------------------------------------

    While the ICI objected to applying the SMMP concept to non-
electronic transactions, the ICI has not identified a danger from 
applying the SMMP concept to telephonic or in-person transactions where 
the dealer is acting as an order taker and effecting a non-recommended 
secondary market transaction for an SMMP. Moreover, the MSRB's 
determination to apply the SMMP concept to both electronic and non-
electronic trading is consistent with the efforts of the Commission and 
other self-regulatory organizations to ensure that the regulatory 
requirements for dealers to undertake specific investor protection 
responsibilities should not depend on whether a transaction takes place 
electronically, over the telephone, or face-to-face. Several 
commentators commended the MSRB for this approach.\74\
---------------------------------------------------------------------------

    \74\ See First Southwest II, MuniCenter and TBMA III, supra note 
23.
---------------------------------------------------------------------------

The SMMP Concept Should Not Apply to Securities Exempt UnderRule 15c2-
12

    Comments Received. The ICI and NFMA suggested that the SMMP concept 
should not apply to transactions in private placement securities and 
securities exempt from the disclosure requirements of the Act's Rule 
15c2-12, such as variable rate demand obligations (collectively 
``exempt securities'').\75\ The ICI stated, ``the premise underlying 
the SMMP concept, i.e., that information about a security is already 
disclosed generally to the public, is particularly inapplicable to 
these securities. Because updated information on exempt securities is 
not required, it would be illogical and potentially harmful to 
investors to permit them to be traded on an electronic platform.'' \76\
    MSRB Response. The MSRB has determined not to exempt certain types 
of municipal securities from the application of the SMMP proposal. The 
ICI's and NFMA's comments are based upon a fundamental misunderstanding 
of the underpinnings of the SMMP concept. What underlies the SMMP 
concept is not that material information is always disclosed to the 
public by the

[[Page 6306]]

issuer, but rather, that the SMMP is aware of, or capable of making 
itself aware, and can independently understand the significance of, the 
material facts available from established industry sources. The 
interpretive notice recognizes that there ``may be times when an SMMP 
is not satisfied that the information available from established 
industry sources is sufficient to allow it to make an informed 
investment decision. However, in those circumstances, the MSRB believes 
that an SMMP can recognize that risk and take appropriate action, be it 
declining to transact, undertaking additional investigation, or asking 
the dealer to acquire additional information.''
---------------------------------------------------------------------------

    \75\ See ICI II and NFMA II, supra note 23.
    \76\ Id.
---------------------------------------------------------------------------

    The MSRB understands that the ICI and NFMA believe that SMMPs 
generally obtain information about exempt securities through 
dealers.\77\ However, the MSRB is concerned that the commentators may 
be confusing the role of a dealer effecting primary market transactions 
for SMMPs, with a dealer that is acting as an order taker effecting 
non-recommended secondary market transactions for an SMMP. While a 
dealer acting on behalf of an issuer may have more information about a 
municipal security than an SMMP, there is no reason to assume that a 
dealer effecting a non-recommended secondary market transaction would 
have the same informational advantage.\78\ Nonetheless, the SMMP 
interpretation states that ``if material information is not accessible 
to the market but known to the dealer and not disclosed, the dealer may 
be found to have engaged in an unfair practice.'' \79\ Continuing to 
impose rule G-17's affirmative disclosure obligations on dealers 
transacting with SMMPs will not necessarily create the desired 
additional information since disclosure information must come from the 
issuer, not the dealer. In fact, it should be recognized that a dealer 
operating an ATS is likely to have very little information concerning 
the security in question if, for example, an institutional customer 
offers the security for sale through the ATS.
---------------------------------------------------------------------------

    \77\ The MSRB believes that disclosure information may also be 
available from established industry sources since many issuers of 
exempt securities (e.g., VRDOs) are also issuers of Rule 15c2-12 
issues and thus have Rule 15c2-12 disclosure obligations for those 
issues that are not exempt.
    \78\ Moreover, investors' comments may incorrectly assume that 
remarketing agents usually are effecting secondary market 
transactions in exempt securities (i.e. VRDOs). A ``primary 
offering'' is defined in Rule 15c2-12 to mean an offering directly 
or indirectly by an issuer. Many remarketings of VRDOs meet the 
definition of a ``primary offering'' under Rule 15c2-12(c). See 
Pillsbury, Madison & Sutro, SEC No-Action Letter, [1990-1991 
Transfer Binder] Fed. Sec. L. Rep. (CCH) para. 79, 659 at 78, 027 
(Mar. 11, 1991) (cautioning the inquirer not to read the language of 
Rule 15c2-12(e)(7) too restrictively and instructing that each 
remarketing of exempt securities should be examined as though it 
were a new offering to determine if an exemption applies).
    \79\ The ICI's comment letter applauded the MSRB's clarification 
of this point in the July SMMP Guidance and recommended that the 
MSRB remind dealers ``of their duty not to mislead customers.'' ICI 
II, supra note 23.
---------------------------------------------------------------------------

Miscellaneous

    Comments Received. MuniCenter and UBSPW both expressed the view 
that the MSRB should issue definitive guidance about online 
recommendations.\80\ MuniCenter recognized that the MSRB is reserving 
its guidance on the definition of an online recommendation, but ``would 
like to state our view that an electronic platform listing securities 
input by institutional sellers and buyers, or the results displayed by 
a user's defined search criteria are not a recommendation by the 
platform.'' UBSPW stated, that the ``only way the MSRB can achieve its 
goal of permitting sophisticated institutional investors to participate 
in electronic trading platforms `on par with dealers when engaging in 
non-recommended secondary market transactions' is to make absolutely 
clear that the posting of line items coupled with a user-directed 
search feature and/or dealer controlled filter does not constitute the 
recommendation of any securities posted.'' \81\
---------------------------------------------------------------------------

    \80\ See MuniCenter and UBSPW, supra note 23.
    \81\ Id.
---------------------------------------------------------------------------

    MSRB Response. The MSRB will take these comments into consideration 
when it considers appropriate guidance concerning online 
recommendations.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (a) by order approve such proposed rule change, or
    (b) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 
Copies of the submissions, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of the filing will also be 
available for inspection and copying at the MSRB's principal offices. 
All submissions should refer to File No. SR-MSRB-2002-02 and should be 
submitted by March 4, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\82\
---------------------------------------------------------------------------

    \82\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-3232 Filed 2-8-02; 8:45 am]
BILLING CODE 8010-01-P