Municipal Securities Rulemaking Board officials yesterday held out the possibility thatthe MSRB could decide ultimately to propose something less than an all-out prohibitionon dealers' use of independent consultants to obtain municipal bond business.
"There are a lot of alternative forms that this rule change could take," William J.Jester Jr., the MSRB's chairman, told dealers at The Bond Market Association's annualmeeting here."We need your help. We're looking for comments. It's very important that we hear fromeverybody," said Jester, manager of the municipal bond department at UBS FinancialServices Inc.
Christopher Taylor, the board's executive director, said at the meeting that the boardcould spend months deliberating about muni consultants and end up considering severaldifferent proposals to address their concerns.
Noting that comments on the proposed prohibition are due June 4 and the board willconsider those comments at its meeting in mid-July in Deer Valley, Utah, Taylor said, "Iwould not be surprised if the staff were asked to prepare another draft." He remindedthe dealers that the board considered several draft proposals before finalizing Rule G-37.
Jester and Taylor made their remarks as several industry leaders expressed dismay overthe proposed prohibition, which the MSRB disclosed after its February meeting in Hawaii,and then formally proposed earlier this month.
Ronald Stack, managing director and head of public finance at Lehman Brothers and formerchairman of TBMA's municipal market division, said he thought the MSRB should havetalked to members of the dealer community before proposing the prohibition.
"I thought that the MSRB would say before it put out a rule, `Why don't we talk topeople?' " he said, noting that the board did the same thing with an emergency shutdownproposal last year that drew so much opposition it had to be withdrawn.
Jester said the board's 15 members, who had trouble "getting their arms around themarketplace" on this issue, wanted to ask the industry many questions about consultantsand felt the proposed prohibition was the best way to get dealers' attention andresponses.
Robert Foran, senior managing director and co-head of public finance at Bear, Stearns &Co., said he was concerned that the press has treated the proposal as if it were "anindictment of the industry" when in fact "there is not a foregone conclusion that thereis a problem."
Daniel Keating, senior managing director at Bear Stearns and vice chairman of TBMA'smunicipal securities division, asked Taylor if there had been any violations of Rule G-38, the board's rule that requires dealers to disclose information about the consultantsthey hire to obtain and retain municipal securities business. Taylor said there have notbeen any violations.
Jester and Taylor said that the board has received many calls from dealers with"polarized views," ranging from, "this is a great thing the board has done" to "theboard has lost its mind [and is] irresponsible."
However, Taylor contended the proposed prohibition "is not something that came out ofnowhere" and "should not come as a terrible surprise." Board members talked aboutapplying political contribution restrictions to dealers' consultants when it deliberatedover writing Rule G-37 in the first half of the 1990s, he said.
Rule G-37 is intended to prevent dealers from making political contributions to issuerofficials. Under the rule, a dealer is barred from engaging in negotiated municipalsecurities business with an issuer for two years if the dealer or its muni financeprofessionals make significant political contributions to issuer officials who caninfluence the award of underwriting business.
Rule G-38 was designed to prevent dealers from using independent consultants tocircumvent G-37. However, G-38 contains no restrictions and merely requires dealers todisclose information about their consultants, including what the consultants are paid,what deals they helped obtain, and what political contributions they have made to issuerofficials.
The MSRB proposed prohibiting dealers' use of independent muni consultants on April 5,saying it was concerned about the increase in the number of consultants being used bydealers, the increase in dealer payments to consultants, and the rise in the level ofpolitical contributions that consultants were making to issuer officials.
Taylor said the board was also concerned about consultants acting on behalf of dealerswhen they are outside of the regulatory scheme that applies to dealers.
Under the proposal, dealers would be restricted to using and paying only employees,employees of affiliated firms, and other such "associated persons" for solicitingmunicipal business on their behalf.
TBMA has formed a task force, made up of representatives from over two dozen firms, tocraft a response to the MSRB proposal, said Richard Kolman, the chairman of TBMA'smunicipal securities division and a managing director of Goldman, Sachs & Co.
MSRB concerns about pricing abuses also triggered a discussion at the meeting and cameafter the board issued a notice in January reminding brokers' brokers and dealers oftheir obligations to obtain fair and reasonable prices for customers under Rules G-18and G-30, after seeing some pricing disparities in chains of transactions of the samebonds during a day.
In these chains, the bonds appeared to be bid up by dealer firms resulting in a spreadof 10 points or more between the price at which a customer first sold the bonds to adealer early in the day and the price at which another dealer sold the bonds to anothercustomer near the end of the day. The dealers did not take excessive markups, but theMSRB said one or both customers were not getting fair prices.
MSRB officials said these transactions represent only up to three dozen of about 27,000trades done on average each day, but that they are still a problem.
"I think the industry is becoming somewhat complacent," Jester said. "I think industrypractices had drifted somewhat from the rules."
Jester said he expects muni bond regulators to announce soon some enforcement cases overpricing abuses. But he also predicted that the abuses should disappear when transparencyincreases under the real-time trade reporting system, which is to start up in January2005.
Kolman stressed that "none of [TBMA's members] are supporting any trades that arenegative for customers."
On real-time transaction reporting, another TBMA member worried at what point dealerswould have to report information from new sales - at the time the bonds are priced, orat the point the bond purchase agreement is signed, two events that could be days apart.
Taylor said this issue will be discussed at the board's next meeting in mid-May inWashington, D.C. Under the real-time system, dealers will have to report pricing andother trade information to the MSRB within 15 minutes of their trades. Data from newissues would be exempted from the 15-minute requirement, but would be due at the end ofthe trade day.
