Applicability of MSRB Rules to California Registered Warrants

The staff of the SEC yesterday issued guidance[1] that the “registered warrants” that the State of California began issuing on July 2, 2009 (also known as “IOUs”) are municipal securities and, therefore, persons acting as intermediaries between buyers and sellers of the warrants may need to register as brokers, dealers or municipal securities dealers (“dealers”), or as alternative trading systems or national securities exchanges.

All dealers who sell or trade municipal securities must be registered with the MSRB and must comply with MSRB rules on professionalism and fair practice, some of which are discussed below.  MSRB rules and guidance are available on our website at www.msrb.org.

The MSRB notes in particular its Rule G-30, which requires dealers to effect purchases and sales of municipal securities at fair and reasonable prices based on the dealer’s best judgment of their fair market value, and also requires dealers to charge fair and reasonable commissions in connection with brokered transactions.   Dealers must deal fairly with customers and must not take advantage of a customer’s need for cash by offering to purchase registered warrants at deeply discounted prices that are below what could reasonably be viewed as their fair market value.  More details on a dealer’s fair pricing obligations are included in a January 26, 2004 MSRB notice.[2]  Published quotations regarding offers to buy or sell registered warrants must be bona fide and must be based on the dealer’s best judgment of fair market value under MSRB Rule G-13, and advertisements regarding registered warrants are subject to MSRB Rule G-21.

MSRB Rule G-17 requires that, at or prior to the time of entering into a transaction, dealers must disclose to their customers material information about the transaction that is known to the dealer or is otherwise available from established industry sources.  More details on this disclosure obligation are included in a March 20, 2002 MSRB notice.[3]  Dealers buying, selling, or trading the registered warrants would be expected to know and to disclose to customers material information about the registered warrants available from, among other sources, the websites of the California State Controller[4] and the California State Treasurer.[5]  In particular, dealers selling registered warrants to customers must ensure that purchasing customers are aware of the terms on which the registered warrants are expected to become payable (including information about the contingent nature of the stated maturity date, the potential for early redemption, and any contingencies concerning tax exemption of interest on the warrants).  In addition to making the necessary disclosures to customers, dealers are required by MSRB Rule G-19 to consider such information when determining whether recommended purchases or sales of the registered warrants are suitable for their customers.

Dealers also would be expected to provide their customers with documentation of the transaction that may be necessary for customers to receive payment on the registered warrants upon presentment to the California State Treasurer’s Office.  Further, dealers must provide confirmations of their transactions to customers in compliance with MSRB Rule G-15. 

The MSRB understands that the registered warrants may not have CUSIP numbers, and, if so, transactions in the warrants need not be reported to the MSRB’s Real-Time Transaction Reporting System under MSRB Rule G-14.  Even so, dealers must maintain all appropriate records of their transactions with customers under MSRB Rule G-8, and such records are subject to examination by the appropriate regulatory agencies.  Employees of dealers who engage in sales and trading of the registered warrants must have passed an examination qualifying them to engage in such activities -- either the Series 7 exam or a more specialized exam such as the Series 52. 

July 10, 2009