[Federal Register Volume 77, Number 106 (Friday, June 1, 2012)]
[Notices]
[Pages 32704-32707]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-13255]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67064; File No. SR-MSRB-2012-05]


Self-Regulatory Organizations; Municipal Securities Rulemaking 
Board; Order Granting Approval of a Proposed Rule Change Consisting of 
a Restatement of an Interpretive Notice Concerning the Application of 
MSRB Rule G-17 to Sophisticated Municipal Market Professionals

May 25, 2012.

I. Introduction

    On March 26, 2012, the Municipal Securities Rulemaking Board 
(``Board'' or ``MSRB'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change consisting of a restatement of an 
interpretive notice (the current interpretive notice, ``Existing SMMP 
Notice,'' and the proposed restated interpretive notice, ``Restated 
SMMP Notice'') concerning the application of MSRB Rule G-17 (on conduct 
of municipal securities and municipal advisory activities) to 
sophisticated municipal market professionals (``SMMPs'').\3\ The 
proposed rule change was published for comment in the Federal Register 
on April 13, 2012.\4\ The Commission received one comment letter on the 
proposed rule change.\5\ On May 18, 2012, the MSRB submitted a response 
letter.\6\ This order approves the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The implementation date for Financial Industry Regulatory 
Authority (``FINRA'') Rule 2111 (Suitability) is July 9, 2012. The 
MSRB proposed to adopt the same time frame for its Restated SMMP 
Notice.
    \4\ See Securities Exchange Act Release No. 66772 (April 9, 
2012), 77 FR 22367 (``Notice'').
    \5\ See letter to Elizabeth M. Murphy, Secretary, Commission, 
from David L. Cohen, Managing Director, Associate General Counsel, 
Securities Industry and Financial Markets Association, dated May 4, 
2012 (``SIFMA Letter'').
    \6\ See letter to Elizabeth M. Murphy, Secretary, Commission, 
from Ernesto A. Lanza, Deputy Executive Director and Chief Legal 
Officer, dated May 18, 2012 (``MSRB Letter'').
---------------------------------------------------------------------------

II. Description

Existing Definition of SMMP

    Under the Existing SMMP Notice, a dealer is permitted to treat an 
institutional customer \7\ as an SMMP if the dealer has reasonable 
grounds for concluding the following and if other known facts do not 
contradict such a conclusion: (1) The customer has timely access to the 
publicly available material facts concerning a municipal securities 
transaction; (2) the customer is capable of independently evaluating 
the investment risk and market value of the municipal securities at 
issue; and (3) the customer is making independent decisions about its 
investments in municipal securities.\8\ The Existing SMMP Notice also 
provides additional considerations that may be relevant in determining 
whether an institutional customer has timely access to publicly 
available information, is capable of independently evaluating 
investment risk and market value, and is making independent investment 
decisions.
---------------------------------------------------------------------------

    \7\ For purposes of the Existing SMMP Notice, an institutional 
customer is defined as ``an entity, other than a natural person 
(corporation, partnership, trust, or otherwise), with total assets 
of at least $100 million invested in municipal securities in the 
aggregate in its portfolio and/or under management.''
    \8\ Although the Existing SMMP Notice permits a dealer to have 
an investor attest to SMMP status ``as a means of streamlining the 
dealers' process for determining that the customer is an SMMP,'' it 
also provides that a dealer may not rely on such an attestation if 
the dealer knows or has reason to know that the investor lacks 
sophistication concerning a municipal securities transaction based 
on a number of factors set forth in the notice.
---------------------------------------------------------------------------

Application of Existing SMMP Definition

    The Existing SMMP Notice addresses a dealer's obligations to an 
SMMP under MSRB's Rule G-17 (on fair dealing), Rule G-18 (on execution 
of transactions), Rule G-19 (on suitability), and Rule G-13 (on 
quotations). According to the MSRB, Rule G-17 requires brokers, 
dealers, and municipal securities dealers (collectively referred to 
herein as ``dealers'') to disclose to customers at or before the time 
of trade all material information about a transaction known by the 
dealer, as well as all material information about a security reasonably 
accessible to the market from established industry sources.\9\ The 
Existing SMMP Notice provides that, when a dealer effects a non-
recommended secondary market transaction with an SMMP, its affirmative 
Rule G-17 disclosure duty concerning material information available 
from established industry sources will be deemed satisfied. A dealer, 
however, may not engage in deceptive, dishonest, or unfair practices 
under Rule G-17 or under the federal securities laws. Further, in a 
transaction with an SMMP, a dealer's intentional

[[Page 32705]]

withholding of a material fact about a security when the information is 
not accessible through established industry sources may constitute an 
unfair practice that violates Rule G-17.
---------------------------------------------------------------------------

    \9\ See MSRB Interpretive Notice Regarding Rule G-17, On 
Disclosure of Material Facts (March 20, 2002) and MSRB Guidance On 
Disclosure and Other Sales Practice Obligations to Individual and 
Other Retail Investors in Municipal Securities (July 14, 2009).
---------------------------------------------------------------------------

    According to the MSRB, Rule G-18 provides that each dealer, when 
executing a transaction in municipal securities for or on behalf of a 
customer as agent, must make a reasonable effort to obtain a price for 
the customer that is fair and reasonable in relation to prevailing 
market conditions. The Existing SMMP Notice provides that a dealer 
effecting a non-recommended secondary market agency transaction for an 
SMMP is not required to take further actions to ensure that the 
transaction is effected at a fair and reasonable price, if its services 
have been explicitly limited to providing anonymity, communication, 
order matching, and/or clearance functions and the dealer does not 
exercise discretion as to how or when a transaction is executed. The 
Existing SMMP Notice also states that this interpretation of Rule G-18 
is particularly relevant to dealers operating alternative trading 
systems, as dealers operating such systems may be merely aggregating 
the buy and sell interest of other dealers or SMMPs.\10\ A footnote to 
the Existing SMMP Notice states that the same interpretation would 
apply to a broker's broker when executing an agency transaction for 
another dealer.
---------------------------------------------------------------------------

    \10\ The Existing SMMP Notice also states that dealers operating 
alternative trading systems, under the general duty set forth in 
Rule G-18, must act to investigate any alleged pricing 
irregularities on its systems brought to its attention.
---------------------------------------------------------------------------

    According to the MSRB, under Rule G-19, in the case of a 
recommended transaction, a dealer must have a reasonable basis for 
recommending a particular security (``reasonable-basis suitability''), 
as well as reasonable grounds for believing the recommendation is 
suitable for the customer to whom it is made, based upon information 
available from the issuer of the security or otherwise and based upon 
the facts disclosed by the customer or otherwise known about the 
customer (``customer-specific suitability''). The Existing SMMP Notice 
provides that, when a dealer has reasonable grounds for concluding that 
an institutional customer is an SMMP, the dealer's customer-specific 
suitability obligation is fulfilled.
    According to the MSRB, under Rule G-13, no dealer may distribute or 
publish, or cause to be distributed or published, any quotation 
relating to municipal securities, unless the quotation is bona fide 
(i.e., the dealer making the quotation is prepared to execute at the 
quoted price) and the price stated in the quotation is based on the 
best judgment of the dealer of the fair market value of the securities 
that are the subject of the quotation at the time the quotation is 
made. In general, any quotation disseminated by a dealer (including the 
quotation of an investor) is presumed to be a quotation made by the 
dealer, and the dealer is responsible for ensuring compliance with the 
bona fide and fair market value requirements with respect to the 
quotation. However, if a dealer disseminates a quotation that is 
actually made by another dealer and the quotation is labeled as such, 
then the quotation is presumed to be a quotation made by such other 
dealer and not by the disseminating dealer. In such a case, the 
disseminating dealer is only required to have no reason to believe that 
either: (1) The quotation does not represent a bona fide bid for, or 
offer of, municipal securities by the maker of the quotation; or (2) 
the price stated in the quotation is not based on the best judgment of 
the maker of the quotation of the fair market value of the securities. 
If a dealer disseminates the quotation of an SMMP and it is labeled as 
such, the disseminating dealer will be held to the same standard as if 
it were disseminating a quotation made by another dealer. The Existing 
SMMP Notice also provides several factors that are relevant to whether 
dissemination of the SMMP's quotation may be considered to be a 
violation of Rule G-13 by the dealer.

Considerations for Change

    According to the MSRB, in 2002, it adopted a definition of SMMP 
that differed from certain other regulatory definitions of investors 
considered sophisticated enough to receive special treatment under 
federal securities law. The MSRB stated that the SMMP definition was 
closely modeled on an NASD interpretation of its suitability rule,\11\ 
which contained a comparable list of factors found relevant to an 
investor's independent evaluation of risk and independent investment 
decisions. The MSRB stated that a notable difference was that the 
definition of SMMP also looked to whether the investor had access to 
material facts and that a key factor for the difference was the lack of 
information available about municipal securities at that time. 
According to the MSRB, since the adoption of the existing definition of 
SMMP, there has been a vast increase in the availability of information 
about municipal securities reasonably accessible by institutional 
investors regardless of the amount of their holdings of municipal 
securities.
---------------------------------------------------------------------------

    \11\ See NASD IM-2310-3 (Suitability Obligations to 
Institutional Customers).
---------------------------------------------------------------------------

    As of July 9, 2012, the NASD guidance on institutional suitability 
will no longer be in effect. It will be replaced by FINRA Rule 2111, 
which adopts a different approach to a FINRA member's customer-specific 
duty of suitability to an ``institutional account.'' Under FINRA Rule 
2111, a dealer's customer-specific suitability obligation to an 
institutional customer will be considered satisfied if (1) the dealer 
has a reasonable basis to believe that the institutional customer is 
capable of evaluating investment risks independently, both in general 
and with regard to particular transactions and investment strategies 
involving a security or securities and (2) the institutional customer 
affirmatively indicates that it is exercising independent judgment in 
evaluating the dealer's recommendations. There will no longer be a 
detailed listing of factors, such as that found in the Existing SMMP 
Notice. The MSRB noted that, absent clear reasons for treating 
transactions in municipal securities differently, from the standpoint 
of reducing compliance cost, it generally considers it desirable to 
maintain consistency with FINRA rules.

Proposal to Restate SMMP Notice

    Because the quality and availability of information concerning 
municipal securities has improved substantially since 2002, and to 
maintain consistency with the revised FINRA suitability rule for 
institutional customers, the MSRB proposed to retain the concept of an 
SMMP but revise its definition. Specifically, the MSRB proposed to 
define SMMP as an ``institutional customer of a dealer that: (1) The 
dealer has a reasonable basis to believe is capable of evaluating 
investment risks and market value independently, both in general and 
with regard to particular transactions in municipal securities, and (2) 
affirmatively indicates that it is exercising independent judgment in 
evaluating the recommendations of the dealer.'' \12\ The MSRB also 
proposed that

[[Page 32706]]

``[a]s part of the reasonable basis analysis required by clause (1), 
the dealer should consider the amount and type of municipal securities 
owned or under management by the institutional customer.'' There would 
no longer be a threshold requirement that a customer own or manage a 
certain amount of municipal securities in order to be considered an 
SMMP.
---------------------------------------------------------------------------

    \12\ ``Institutional customer'' would be defined as a customer 
with an ``institutional account.'' MSRB Rule G-8(a)(xi) defines 
``institutional account'' as the account of (i) a bank, savings and 
loan association, insurance company, or registered investment 
company; (ii) an investment adviser registered either with the 
Commission under Section 203 of the Investment Advisers Act of 1940 
or with a state securities commission (or any agency or office 
performing like functions); or (iii) any other entity (whether a 
natural person, corporation, partnership, trust, or otherwise) with 
total assets of at least $50 million.
---------------------------------------------------------------------------

    The MSRB proposed that, in the case of the affirmation described in 
clause (2) of the revised definition of SMMP, customers be allowed to 
make the affirmation orally or in writing and to provide the 
affirmation on a trade-by-trade basis, on a type-of-municipal-security 
basis, or for all potential transactions for the customer's account. 
The MSRB stated that this requirement would be consistent with the 
affirmation requirement of FINRA Rule 2111, and receipt by a dealer of 
the FINRA 2111 affirmation would also satisfy this requirement.
    The Restated SMMP Notice would not change the application of Rules 
G-18, G-19, and G-13 to SMMPs. However, it would change the application 
of Rule G-17 to SMMPs, under the assumption that institutional 
customers now have substantial access to material information about 
municipal securities. The Existing SMMP Notice excludes a dealer from 
the duty to disclose all material information available from 
established industry sources when it transacts a non-recommended 
transaction. The Restated SMMP Notice, however, would apply this 
exclusion to all transactions with SMMPs, whether recommended or self-
directed. The Restated SMMP Notice would also remove the lists of 
factors to consider in determining a customer's status as an SMMP. In 
addition, the proposal would update the Existing SMMP Notice to reflect 
developments in the MSRB's interpretations of Rule G-17 since 2002. 
Further, the proposal would remove endnote 9 to the Existing SMMP 
Notice, which, according to the MSRB, has been construed by some to 
lessen the duty of a broker's broker under Rule G-18 in a manner that 
is inconsistent with the Board's proposed Rule G-43 (on broker's 
brokers).\13\ Lastly, the Restated SMMP Notice would remove the 
language that suggests that transactions on alternative trading systems 
are done on an agency basis, because, according to the MSRB, at least 
one major alternative trading system engages only in principal 
transactions.
---------------------------------------------------------------------------

    \13\ See Securities Exchange Act Release No. 66625 (March 20, 
2012), 77 FR 17548 (March 26, 2012) (SR-MSRB-2012-04). The MSRB 
noted that, under proposed Rule G-43, an alternative trading system 
that had any customers (as defined in MSRB Rule D-9) that were not 
SMMPs would not be excepted from the definition of ``broker's 
broker.''
---------------------------------------------------------------------------

III. Comments

    The Commission received one comment letter supporting this proposed 
rule change.\14\ The commenter supported the revised definition of SMMP 
``as the quality and availability of information concerning municipal 
securities has greatly improved since 2002.'' The commenter agreed that 
it is desirable, from the standpoint of reducing the cost of dealer 
compliance, to maintain consistency with FINRA rules, absent clear 
reasons for treating transactions in municipal securities differently. 
Specifically, the commenter supported revising the definition of SMMP 
so that it is harmonized with FINRA's revised suitability rule as it 
applies to institutional customers. The commenter also expressed 
support for the ``harmonized compliance regime to allow an 
institutional customer to provide a single affirmation of their desire 
to exercise independent judgment in selecting investments to satisfy 
FINRA Rule 2111 for all products, including the MSRB's requirement for 
SMMP status.'' Further, to avoid confusion, this commenter supported 
the MSRB's proposal to implement the proposed rule change on July 9, 
2012, the date on which FINRA Rule 2111 will become effective.
---------------------------------------------------------------------------

    \14\ See SIFMA Letter, supra note 5.
---------------------------------------------------------------------------

    In its response letter,\15\ the MSRB acknowledged SIFMA's comment 
regarding harmonization with FINRA Rule 2111. It noted that in one 
respect, the revised definition of SMMP would be identical to the 
language of FINRA Rule 2111--that both would refer to an institutional 
customer that affirmatively indicates that it is exercising independent 
judgment in evaluating the dealer's recommendations. As stated in the 
Notice, receipt by a dealer of the FINRA Rule 2111 affirmation would 
thus satisfy the second clause of the revised definition of SMMP. The 
MSRB however also noted that the other part of the revised definition 
of SMMP would provide that a dealer must have a reasonable basis to 
believe that an institutional customer is capable of evaluating 
investment risks and market value independently, both in general and 
with regard to particular transactions in municipal securities. 
Further, the MSRB noted that the Restated SMMP Notice would provide 
that, as part of the reasonable basis analysis, the dealer should 
consider the amount and type of municipal securities owned or under 
management by the institutional customer. The MSRB stated that FINRA 
Rule 2111 contains a similar, but not identical, requirement that ``the 
member or associated person has a reasonable basis to believe that the 
institutional customer is capable of evaluating investment risk 
independently, both in general and with regard to particular 
transactions and investment strategies involving a security or 
securities.'' The MSRB emphasized that ``the language in the filing 
regarding the use of a FINRA Rule 2111 affirmation was not intended to 
suggest that a representation from an institutional customer would, by 
itself, satisfy the dealer's reasonable basis obligation under the 
first prong of the revised SMMP definition.''
---------------------------------------------------------------------------

    \15\ See MSRB Letter, supra note 6.
---------------------------------------------------------------------------

IV. Discussion and Commission Findings

    The Commission has carefully considered the proposed rule change, 
the comment letter received and the MSRB's response, and finds that the 
proposed rule change is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to the MSRB.\16\ 
Specifically, the Commission finds that the proposed rule change is 
consistent with the provisions of Section 15B(b)(2)(C) of the Act,\17\ 
which requires, among other things, that the rules of the MSRB be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in regulating, clearing, 
settling, processing information with respect to, and facilitating 
transactions in municipal securities and municipal financial products, 
to remove impediments to and perfect the mechanism of a free and open 
market in municipal securities and municipal financial products, and, 
in general, to protect investors, municipal entities, obligated 
persons, and the public interest.
---------------------------------------------------------------------------

    \16\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \17\ 15 U.S.C. 78o-4(b)(2)(C).
---------------------------------------------------------------------------

    The Commission believes that the MSRB's proposal to restate its 
Existing SMMP Notice concerning the application of Rule G-17 to SMMPs 
is consistent with the Act. As noted by the MSRB, the amount of 
available information about municipal securities has substantially 
increased since the Existing SMMP Notice was approved, and this 
information is reasonably accessible by institutional investors

[[Page 32707]]

regardless of the amount of their holdings of municipal securities.\18\ 
For example, the MSRB's Electronic Municipal Market Access system 
(``EMMA'') public Web site is a free on-line source for primary market 
disclosures, continuing disclosures, transaction data, variable rate 
security information, market statistics and investor education. Also, 
as noted by the MSRB, the Restated SMMP Notice would be consistent with 
FINRA's new rule on suitability obligations for an institutional 
account, which will be implemented on July 9, 2012. The Commission 
agrees with the MSRB that such consistency is desirable from the 
standpoint of reducing the cost of dealer compliance, absent clear 
reasons for treating transactions in municipal securities differently. 
The Commission, however, notes that under the Restated SMMP Notice, to 
meet the revised definition of an SMMP, a dealer must have a reasonable 
basis to believe the institutional customer is capable of evaluating 
investment risks and market value independently, both in general and 
with regard to particular transactions in municipal securities. As the 
MSRB has emphasized, a representation from an institutional customer 
would not, by itself, satisfy the dealer's reasonable basis obligation 
under this clause of the revised SMMP definition.
---------------------------------------------------------------------------

    \18\ As noted above, although the Restated SMMP Notice would not 
require that an institutional customer own or manage a specified 
amount of municipal securities in order to fall within the 
definition of SMMP, the Restated SMMP Notice does provide that a 
dealer should consider the amount and type of municipal securities 
owned or under management by the institutional customer in 
establishing a reasonable basis to believe that the customer is 
capable of evaluating investment risks and market value 
independently.
---------------------------------------------------------------------------

    In light of the increase in access to material information about 
municipal securities, the Commission believes that it is consistent 
with the Act to expand the disclosure exclusion for material 
information to all transactions with SMMPs, whether recommended or 
self-directed. Accordingly, when a dealer has reasonable grounds for 
concluding that the customer is an SMMP, the dealer's obligation to 
ensure disclosure of material information available from established 
industry sources is fulfilled. In addition, the Commission believes 
that the proposal to amend the application of Rule G-17 to SMMPs to 
reflect developments in the MSRB's interpretations of Rule G-17 since 
2002 is consistent with the Act, because it will help to ensure 
consistency between MSRB's rules. Further, the Commission believes that 
the proposal to remove endnote 9 to the Existing SMMP Notice is 
consistent with the Act, because it will help to clarify the duties of 
broker's brokers under MSRB rules. Lastly, the Commission believes that 
the proposal to remove the language that suggests that transactions on 
alternative trading systems are done on an agency basis is consistent 
with the Act, because it will help to ensure the accuracy of the 
Restated SMMP Notice. As noted above, according to the MSRB, at least 
one major alternative trading system engages only in principal 
transactions.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\19\ that the proposed rule change (SR-MSRB-2012-05) be, and hereby 
is, approved.
---------------------------------------------------------------------------

    \19\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\20\
---------------------------------------------------------------------------

    \20\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-13255 Filed 5-31-12; 8:45 am]
BILLING CODE 8011-01-P