A settlement between a broker-dealer firm and the Financial Industry Regulatory Authority appears to be the first case in decades brought by that regulator for violating a municipal securities rule on quotations.
This week, FINRA settled with NatAlliance Securities after it found the Texas-based broker-dealer firm violated Municipal Securities Rulemaking Board Rule G-13, on quotations relating to municipal securities. This left some dealers worried that the case may have wide-ranging implications.
“One of our concerns is that this case could establish compliance standards for the market more broadly,” said Michael Decker, senior vice president of policy and research at Bond Dealers of America. “We don’t have any problems with compliance standards, but enforcement cases are not the way to establish compliance standards.”
FINRA didn’t find a case in its database in which it charged a firm for violating that rule. However, its predecessor, the National Association of Securities Dealers settled with a dealer representative in 2003 after it found he sold bonds at a set price without consulting the value of comparable bonds, NASD said.
There have not been any FINRA cases involving MSRB Rule G-13 since then until this past week when NatAlliance agreed to pay $80,000 to settle charges it violated multiple securities rules. Specifically, FINRA found it failed to use its best judgment in determining the fair market value of municipal bonds, violating MSRB Rule G-13.
“In FINRA’s view, this is a G-13 statement case and the bond community should be on notice,” said Robert Fisher, a partner at Nixon Peabody LLP and NatAlliance’s attorney. “I think they’re going to use this to put people on notice if there is conduct even remotely similar to what they alleged in this AWC (acceptance, waiver and consent).”
NatAlliance agreed this week to pay the fine and be censured while neither admitting nor denying FINRA’s findings that it violated MSRB Rules G-27 on supervision, G-17 on fair dealing and G-13. Half of the fines were solely for violations of MSRB Rule G-27.
“From October 2016 through December 2017, NatAlliance engaged in a pattern and practice of distributing or publishing unsupported ‘throw-away’ bids in multiple illiquid municipal securities that were not based on the firm’s best judgment of the fair market value (FMV) of the securities,” FINRA said.
From October 2016 to the time of the settlement, NatAlliance failed to establish, maintain and enforce a supervisory system, FINRA said.
MSRB Rule G-13 says no dealer should distribute or publish any municipal securities quotation unless the price stated in the quotation is based on the dealer’s best judgment of the securities’ FMV. The MSRB last published
The MSRB did not respond as to whether it would be reviewing its Rule G-13.
“Guidance from the MSRB is the way you establish compliance standards,” BDA’s Decker said. “In that regard, if this represents a new way of looking at G-13 from the perspective of FINRA and the MSRB, we really think this makes sense for the MSRB to be more directly proactive in terms of compliance guidance around the rule.”
FINRA found that from October 2016 through December 2017, NatAlliance distributed and published throw-away bids in response to bid-wanted auctions or request for quotes by failing to use its best judgment in finding the best FMV, which was evidenced by NatAlliance’s activity following the bid-wanted auctions.
“Shortly after responding to the RFQs at prices well below FMV of the bonds, sometimes in as few as seven minutes after learning that its throw-away bid had been accepted, the firm re-offered the bonds at significantly higher prices that were consistent with independent market activity,” FINRA said. “No market news or other relevant event justified the spread between the firm’s bid and re-offer prices.”
For example, on Nov. 16, 2016, NatAlliance published a bid price of 67.987 for 10,000 bonds in response to a bid-wanted auction. The firm was the only market participant that posted a bid at that auction, FINRA said. The next day, NatAlliance reoffered the bonds at 83, FINRA added.
“No market news or other relevant event occurred to justify the substantial spread between the firm’s bid and reoffer price,” FINRA said. “Importantly, the re-offer price was consistent with previously reported trades in the bonds.
Bonds priced in NatAlliance’s settlement were high yield and distressed bonds, Decker said.
“These bonds don’t trade at a normal spread to a benchmark the way the vast majority of municipal bonds trade,” Decker said. “These are unique trades and unique securities and the regulators’ approach to these trades should reflect that.”
Few firms participate in the high yield market, Decker said.
“To the extent that this case could discourage other firms from bidding on other high yield and distressed trades in the notion that they don’t want to get crossed with FINRA and Rule G-13,” Decker said. “This could have the effect of eroding what little liquidity there is around these issues.”
A securities lawyer expects more enforcement on MSRB Rule G-13, likely in the form of a “tack on charge” with other rule violations in the next few years. He also expects more MSRB guidance.
“This is a line in the sand and I think they’ll give folks some time to make sure they’re on the right side of it,” the lawyer, who asked not to be identified, said. “But this will be another area for them to bring enforcement actions against firms."
NatAlliance did not respond immediately to a request for comment.
