WASHINGTON —The Securities and Exchange Commission approved a new rule Friday that will regulate the activities of so-called broker’s brokers, intermediaries that execute municipal securities trades exclusively with other broker-dealers.
The MSRB said its new Rule G-43 and a related interpretive notice, which take effect December 22, will protect retail investors by prohibiting practices that can drive up muni-bond prices.
Rule G-43 requires that broker’s brokers make reasonable efforts to obtain fair and reasonable prices when conducting secondary-market “bid-wanted” auctions. Broker’s brokers can satisfy pricing duties if they disseminate a bid-wanted widely and, when trading munis with limited interest, make an effort to reach dealers with knowledge of the security or an interest in comparable securities.
Broker’s brokers must set a deadline for bids and use and test “predetermined parameters” to identify off-market bids. Parameters, which must be posted on broker’s brokers’ websites, could be based on yield curves or recent trade data reported.
The rule allows broker’s brokers to contact the high bidder prior to the deadline without the seller’s consent, but only if the bid is outside the parameters and the broker believes the bid has an error. A broker’s broker who suspects a bid within the parameters has errors must obtain the sellers’ permission to contact the bidder.
Broker’s brokers must disclose the nature of their work and details about the bidding process to sellers and bidders. They must also disclose their maximum transaction charges in commission schedules.
The rule bans broker’s brokers from self-dealing, encouraging unfair bids or maintaining munis in propriety accounts other than for clearance and settlement. They may not take “last looks,” change bid or offer prices without permission or fail to inform sellers of the highest bid.
Alternative trading systems, or ATS are not considered broker’s brokers if their customers are only so-called “sophisticated municipal market professionals,” and if they use only automated and electronic communications with bidders and sellers.
In an April letter to the SEC, Bond Dealers of America CEO Mike Nicholas opposed the rule, noting that ATSs may still be subject to the rule because some use “voice brokers,” who may speak to customers to facilitate transactions, the letter said.
“We wish there had been more clarity” around voice brokers, he said Monday. “We will continue to press that with regulators and see how the interpret it.”
He said ATS staffs’ conversations with customers are typically clerical in nature and that ATS voice brokers do not receive commissions.
The interpretive notice specifies that dealers who use broker’s brokers to sell bonds have primary responsibility for ensuring their customers receive fair prices. It cautions selling dealers against screening bids or from assuming customers value quick execution more than a good price.
The SEC also approved changes to rules G-8 and G-9 to require broker’s brokers to retain six years of records.
The MSRB has said several enforcement actions spurred the rules. The board said problems arise when bonds are purchased from a customer by a dealer, then traded multiple times through broker’s brokers before being sold back to a customer. The price paid by the final customer can be 10% more than the price paid at the beginning of the day, the board has said.
“Our proposed rules would ensure investors receive fair prices when buying and selling municipal securities,” MSRB head Lynnette Kelly said in a March media release.
The board released the draft of Rule G-43 in February 2011. The board revised the draft in September 2011 to “recognize” that broker’s brokers’ have a more limited role in ensuring fair prices than selling and bidding dealers.
Leslie Norwood, co-head of the muni division at the Securities Industry and Financial Markets Association, commended the MSRB for the revisions and the rule, which she said clarifies the bid-wanted process and participants’ roles.
“We felt that, by and large, the MSRB did a good job of vetting industry concerns and incorporating them into [the] revised rule proposal,” she said.
