Proposed Rule Change Concerning Market Emergencies Filed with the Securities and Exchange Commission

On December 11, 2002, the Municipal Securities Rulemaking Board (the “MSRB”) filed with the Securities and Exchange Commission (“SEC” or “Commission”) a proposed rule change concerning market emergencies.[1]  The proposed rule change includes an Interpretation of Rule G-17, on conduct of municipal securities activities, and an amendment to Rule A-4, on meetings of the Board. 

After the events of September 11, 2001, staff of the SEC and the MSRB met to discuss how the municipal securities market functioned in the aftermath of the attacks on the World Trade Center.  Aside from dealer operations in Manhattan, in general, the infrastructure and systems necessary for processing transactions in the municipal securities market functioned in the days after September 11.  Clearance and settlement systems for municipal securities transactions provided by Depository Trust and Clearing Corporation (DTCC) remained operational, although telecommunications problems in Manhattan did affect the ability of dealers in that area to exchange data with DTCC. 

Despite the resilience of municipal securities market systems and infrastructure on September 11, there remains a concern about what might have happened if the situation had been different.  Had systems or infrastructure critical to the municipal securities market been disabled by the disaster, no legal or regulatory mechanism existed to temporarily halt trading. 

The proposed rule change would provide a procedure for halting trading in municipal securities should a market emergency disable critical market systems or infrastructure in the future.  The MSRB believes that, where a substantial failure has occurred in the systems necessary for clearance, settlement, confirmation, payment or delivery of transactions in municipal securities, or in other systems necessary for the prompt execution and consummation of municipal securities transactions or the fair and accurate pricing of municipal securities, it may become necessary, for the overall protection of market participants, to halt trading by all dealers.  Clearance and settlement systems are a particular concern because of counter-party risk that escalates when unsettled transactions grow during volatile or chaotic markets.  Other situations possibly warranting a temporary halt in trading might include a massive failure of telecommunication systems, or the corruption of essential data used by the municipal securities industry (for example, through a computer virus). 

The proposed rule change specifically identifies the channels by which MSRB would make information known to municipal securities dealers in the event of a market emergency.  It notes that this will be done through news outlets commonly used in the municipal securities industry, postings on the MSRB’s web site and by transmitting announcements to the electronic mail addresses provided to the MSRB by dealers under Rule G-40, on electronic mail contacts.  Having an announced, written procedure for dealer notification would add a level of preparedness if a market emergency actually occurs.  Just as important, it provides dealers with clear direction on where to look if the situation is uncertain and questions exist about whether an emergency has been declared.  The notification procedure for market emergency declaration also will help direct the attention of dealers in municipal securities to the MSRB for announcements on possible emergency rule changes that may be implemented in the wake of an emergency.[2]

Interpretation of Rule G-17

The proposed Interpretation of Rule G-17 has the following elements:

• It is a violation of Rule G-17 for a dealer to continue to effect transactions in municipal securities during an MSRB-declared “market emergency.”
• A “market emergency” for this purpose is defined as “a situation causing substantial failure in any of the systems necessary for clearance, settlement, confirmation, payment or delivery of transactions in municipal securities, or in other systems necessary for the prompt execution and consummation of municipal securities transactions or the fair and accurate pricing of municipal securities.”
• Prior to acting on a market emergency, MSRB will consult with the SEC.
• Official announcements by the MSRB on market emergencies will be communicated to dealers through news outlets commonly used in the municipal securities industry, by posting on the MSRB’s World Wide Web site at www.msrb.org, and by transmittal of the announcement to the electronic mail addresses provided to the MSRB by dealers under Rule G-40. 

Amendment to Rule A-4

Prior to making any decision on a specific market emergency, the MSRB will hold a special Board meeting to share information and discuss the situation.  The MSRB’s current procedure for holding special Board meetings is contained in Rule A-4.  Among other provisions, the rule states that the Secretary of the Board will call special meetings at the request of the Chairman or at the written request of three or more members.  Seven days written notice, signed by the Secretary of the Board (or three days notice if given or sent by telephone, e-mail or personal delivery), is required for special meetings.  The quorum for any Board meeting is two-thirds of the Board (normally ten members), with at least one securities firm representative, one bank dealer representative and one public member.  Formal action requires an affirmative vote of the majority of the Board (normally eight members).

During a time of crisis, market participants would want to know fairly quickly whether trading is to be halted.  The existing seven-day and three-day notice requirements for special Board meetings thus seem impractical.  Moreover, establishing communication with at least ten Board members and securing eight affirmative votes also might present a problem, particularly if the emergency in question affects the infrastructure of one or more major financial centers and members cannot be reached.  The proposed rule change would streamline the process specifically for market emergency meetings.  The proposed amendment to Rule A-4 provides the following procedure:

• The Executive Director, or his or her designee, will schedule a special telephone conference call meeting on the possible declaration of a market emergency as quickly as possible after receipt of credible evidence that a market emergency exists. 

• At least one hour’s advance notice of a special meeting on a market emergency will be sent to each Board member by telephone and e-mail.

• The Executive Director, or his or her designee, will consult with the SEC prior to each special meeting if this is possible.  (Note that consultation with SEC would be required by the proposed Interpretation of Rule G-17 governing trading halts.  Thus, consultation with the SEC would have to occur prior to any formal declaration of market emergency even if it does not occur prior to the meeting.)

• The quorum of ten members generally necessary for a Board meeting is replaced for special meetings on market emergencies with a quorum of five members.  The general requirement that a member be present from each of the three statutory categories (securities firm, bank dealer, public member) does not apply.

• Board action at a meeting on a market emergency is limited to declaring a market emergency or ending a declared market emergency.

• A majority vote of members attending the meeting (not necessarily a majority of the Board) is required to take action. 

• Once a market emergency has been declared, the Executive Director, or his or her designee, will schedule additional special conference call meetings on the market emergency within 24 hours after any request to do so by a Board member.

The proposed rule change will not become effective until approved by the Securities and Exchange Commission.  Persons wishing to comment to the Securities and Exchange Commission should refer to file number SR-MSRB-2002-14.

December 11, 2002

Rule G-17.  Conduct of Municipal Securities Activities*

Interpretation of Rule G-17 – Effecting Transactions During Market Emergency

It is inconsistent with the principles of fair dealing embodied in Rule G-17 for a broker, dealer or municipal securities dealer to effect transactions in municipal securities during a market emergency.  For purposes of this interpretation, a market emergency is any situation causing a substantial failure in any of the systems necessary for clearance, settlement, confirmation, payment, or delivery of transactions in municipal securities or in other systems necessary for the prompt execution and consummation of municipal securities transactions or the fair and accurate pricing of municipal securities.  In determining whether such a market emergency exists, a broker, dealer or municipal securities dealer shall rely upon the issuance of official announcements by the MSRB concerning market emergencies, which shall be issued after consultation with the Securities and Exchange Commission.  Official announcements by the MSRB on market emergencies will be communicated to brokers, dealers and municipal securities dealers through news outlets commonly used in the municipal securities industry, by posting on the MSRB’s World Wide Web site at www.msrb.org, and by transmittal of the announcement to the electronic mail addresses provided to the MSRB by brokers, dealers and municipal securities dealers under Rule G-40.  Such official announcements will include information on the nature of the market emergency and affected systems, the nature and scope of transactions affected, and the status of the market emergency and its expected duration, if that is known.

*                      *                      *

Rule A-4.  Meetings of the Board

(a) through (d) No change.

(e) Special Meetings on Market Emergencies.  Notwithstanding anything in these rules to the contrary, the following procedures govern special meetings to act on market emergencies:  (i) notice of a special telephone conference call meeting on a market emergency shall be sent to all Board members by the Executive Director, or in the absence of the Executive Director, by his or her designee:  (A) as soon as possible after credible information is received suggesting the existence of a market emergency, and (B) during the existence of a declared market emergency, within 24 hours of a request by any Board member; (ii) notice of a special meeting on a market emergency, including a description of the proposed Board action and instructions for joining the conference call, shall be given by telephone and by e-mail to all Board members; (iii) the Executive Director, or his or her designee, shall consult with the Commission on the emergency situation prior to a special meeting on a market emergency, if possible; (iv) the quorum requirement for a special meeting on a market emergency shall be five members and there shall be no requirement that at least one public representative, one broker-dealer representative and one bank representative be present; and (v) any action taken at such a meeting shall be by a majority vote of Board members attending the meeting and shall be limited to declaring a market emergency or ending a declared market emergency.  For purposes of this paragraph (e), the meaning of the term “market emergency” shall be as defined in “Notice of Interpretation of Rule G-17 – Effecting Transactions During Market Emergency,” dated __________.