Request for Comment Regarding Priority of Orders in Primary Offerings

The Municipal Securities Rulemaking Board (the “MSRB”) is requesting comment on draft amendments to Rule G-11, on new issue syndicate practices, Rule G-8, on books and records, and Rule G-9, on preservation of records.  The draft amendments to Rule G-11 would expand the rule to cover all primary market offerings, not just those for which syndicates are formed.  They would also provide that, in general, unless otherwise agreed to by the issuer, the syndicate manager or the sole underwriter (as the case may be) shall give priority to customer orders over orders for its own account, orders from an affiliate for its account, or orders for their respective related accounts.  The draft amendments to Rule G-8 would require dealers to maintain records necessary for the enforcement of revised Rule G-11, and the draft amendments to Rule G-9 would provide for the preservation of such records for a period of six years.

These proposals are in response to concerns expressed by some institutional investors, who have told the MSRB that their orders are sometimes not filled in whole or in part during a primary offering, yet the bonds become available shortly thereafter in the secondary market, at higher prices.  They attribute this to two causes: first, they believe that some retail dealers place orders in retail order periods without going away orders and second, they believe that syndicate members, their affiliates, and their respective related accounts sometimes buy bonds in the primary offering for their own account even though other orders remain unfilled.  These two factors can also contribute to more limited access to new issues by retail investors, in a manner inconsistent with the issuer’s intent.  The MSRB published interpretive guidance[1] on the priority of orders in primary offerings in 1987.  The Board considers it desirable to update the 1987 guidance to reflect subsequent changes to Rule G-11 and industry practices.

Thus, the MSRB is also requesting comment on a draft Rule G-17 interpretive notice concerning priority of orders.

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Comments on the draft amendments and draft interpretive notice should be submitted to the MSRB by September 11, 2009, and may be directed to Peg Henry, Associate General Counsel.  Written comments will be available for public inspection on the MSRB website.[2]

August 11, 2009

TEXT OF DRAFT AMENDMENTS [3]

Rule G-8: Books and Records to be Made by Brokers, Dealers and Municipal Securities Dealers

(a) Description of Books and Records Required to be Made . Except as otherwise specifically indicated in this rule, every broker, dealer and municipal securities dealer shall make and keep current the following books and records, to the extent applicable to the business of such broker, dealer or municipal securities dealer:

(i) – (vii) No change.

(viii) Records Concerning Primary Offerings [of Syndicate Transactions]. 

(A) For each primary offering for which a syndicate has been [With respect to each syndicate, joint or similar account] formed for the purchase of municipal securities, records shall be maintained by the syndicate manager [a managing underwriter designated by the syndicate or account to maintain the books and records of the syndicate or account,] showing the description and aggregate par value of the securities[,]; the name and percentage of participation of each member of the syndicate [or account,]; the terms and conditions governing the formation and operation of the syndicate [or account, (including,]; a [separate] statement of all terms and conditions required by the issuer[)] (including whether the issuer has required a retail order period and the issuer’s definition of “retail,” if applicable); all orders received for the purchase of the securities from the syndicate [or account (except bids at other than syndicate price),]; all allotments of securities and the price at which sold[,]; those instances in which the syndicate manager allocated securities in a manner other than in accordance with the priority provisions or accorded equal or greater priority over other orders to orders by syndicate members for their own accounts, affiliates for their own accounts, or their respective related accounts; and the specific reasons why it was in the best interests of the syndicate to do so; the date and amount of any good faith deposit made to the issuer[,]; the date of settlement with the issuer[,]; the date of closing of the account[,]; and a reconciliation of profits and expenses of the account.

(B) For each primary offering for which a syndicate has not been formed for the purchase of municipal securities, records shall be maintained by the sole underwriter showing the description and aggregate par value of the securities; all terms and conditions required by the issuer (including whether the issuer has required a retail order period and the issuer’s definition of “retail,” if applicable); all orders received for the purchase of the securities from the underwriter; all allotments of securities and the price at which sold; the date and amount of any good faith deposit made to the issuer; and the date of settlement with the issuer.

(ix) - (xxiii) No change.

(xxiv) Records of Secondary Market Trading Account Transactions.  With respect to each secondary market trading account formed for the purchase of municipal securities, records shall be maintained by the broker, dealer, or municipal securities dealer designated by the account to maintain the books and records of the account, showing the description and aggregate par value of the securities; the name and percentage of participation of each member of the account; the terms and conditions governing the formation and operation of the account; all orders received for the purchase of the securities from the account; all allotments of securities and the price at which sold; the date of closing of the account; and a reconciliation of profits and expenses of the account.

(b) – (g) No change.

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Rule G-9: Preservation of Records

(a) Records to be Preserved for Six Years. Every broker, dealer and municipal securities dealer shall preserve the following records for a period of not less than six years:

(i) – (iii) No change.

(iv) the records concerning primary offerings [of syndicate transactions] described in rule G-8(a)(viii), provided, however, that [(1)] such records need not be preserved for a syndicate [or similar account] or by a sole underwriter [which] that, in either case, is not successful in purchasing an issue of municipal securities[, and (2) information concerning orders received by a syndicate or similar account to which securities were not allocated by such syndicate or account need not be preserved after the date of final settlement of the syndicate or account];

(v) - (viii) No change.

(ix) the records regarding information on gifts and gratuities and employment agreements required to be maintained pursuant to rule G-8(a)(xvii); [and]

(x) the records required to be maintained pursuant to rule G-8(a)(xviii)[.]; and

(xi) the records concerning secondary market trading account transactions described in rule G-8(a)(xxi), provided, however, that such records need not be preserved for a secondary market trading account which is not successful in purchasing municipal securities.

(b) – (g) No change.

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Rule G-11: Primary Offering [New Issue Syndicate] Practices

(a) Definitions. For purposes of this rule, the following terms have the following meanings:

(i) - (iv) No change.

(v) The term "order period" means the period of time, if any, announced by a syndicate or, when no syndicate has been formed, a sole underwriter, during which orders will be solicited for the purchase of securities [held in syndicate] in a primary offering.

(vi)-(ix) No change.

(x) The term “affiliate” means a person controlling, controlled by, or under common control with a syndicate member or, when no syndicate has been formed, a sole underwriter.

(xi)  In the case of a primary offering for which a syndicate is formed for the purchase of municipal securities, the term “related account” includes a related portfolio, municipal securities investment portfolio, or arbitrage account of a syndicate member or an affiliate, a municipal securities investment trust sponsored by a syndicate member or an affiliate, or an accumulation account established in connection with such a municipal securities investment trust.  In the case of a primary offering for which a syndicate has not been formed, the term “related account” includes a related portfolio, municipal securities investment portfolio or arbitrage account of the sole underwriter or an affiliate, a municipal securities investment trust sponsored by the sole underwriter or an affiliate, or an accumulation account established in connection with such a municipal securities investment trust.

(b) Disclosure of Capacity. Every broker, dealer or municipal securities dealer [which is a member of a syndicate] that submits an order to a sole underwriter or syndicate or to a member of a syndicate for the purchase of municipal securities held by the syndicate shall disclose at the time of submission of such order if the securities are being purchased for its dealer account or[,] for [the account of] a related account [portfolio] of such broker, dealer or municipal securities dealer[, for a municipal securities investment trust sponsored by such broker, dealer or municipal securities dealer, or for an accumulation account established in connection with such a municipal securities investment trust].

(c) Confirmations of Sale. Sales of securities held by a syndicate to a related account [portfolio, municipal securities investment trust or accumulation account referred to in section (b) above] shall be confirmed by the syndicate manager directly to such related account [portfolio, municipal securities investment trust or accumulation account] or for the account of such related account [portfolio, municipal securities investment trust or accumulation account to the broker, dealer or municipal securities dealer] submitting the order. Nothing herein contained shall be construed to require that sales of municipal securities to a related account [portfolio, municipal securities investment trust or accumulation account] be made for the benefit of the syndicate.

(d) No change.

(e) Priority Provisions.

(i) In the case of a primary offering for which a syndicate has been formed, [Every] the syndicate shall establish priority provisions and, if such priority provisions may be changed, the procedure for making changes. For purposes of this rule, the requirement to establish priority provisions shall not be satisfied if a syndicate provides only that the syndicate manager or managers may determine in the manager's or managers' discretion the priority to be accorded different types of orders.  Unless otherwise agreed to with the issuer, such priority provisions shall give priority to customer orders over orders by members of the syndicate for their own account, orders from affiliates for their own account, or orders for their respective related accounts, to the extent feasible and consistent with the orderly distribution of securities in the offering.  Notwithstanding the preceding sentence, a syndicate may include a provision permitting the syndicate manager or managers on a case-by-case basis to allocate securities in a manner other than in accordance with the priority provisions, if the syndicate manager or managers determine in its or their discretion that it is in the best interests of the syndicate. In the event any such allocation is made, the syndicate manager or managers shall have the burden of justifying that such allocation was in the best interests of the syndicate.

(ii) In the case of a primary offering for which a syndicate has not been formed, unless otherwise agreed to by the issuer, the sole underwriter shall give priority to customer orders over orders for its own account, orders from an affiliate for its account, or orders for their respective related accounts.

(f) - (g) No change.

(h) Disclosure of Syndicate Expenses and Other Information. At or before the final settlement of a syndicate account, the senior syndicate manager shall furnish to the other members of the syndicate:

(i) No change.

(ii) a summary statement showing:

(A) the identity of each related account [portfolio, municipal securities investment trust, or accumulation account referred to in section (b) above] submitting an order to which securities have been allocated as well as the aggregate par value and maturity date of each maturity so allocated;

(B) - (C) No change.   

(i) - (j) No change.

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TEXT OF DRAFT INTERPRETIVE NOTICE ON PRIORITY OF ORDERS

Notice of Interpretation Concerning Priority of
Orders for Securities in a Primary Offering: Rule G-17

On December 22, 1987, the MSRB published a notice[1] interpreting the fair practice principles of Rule G-17 as they apply to the priority of orders for new issue securities (the “1987 notice”).  The MSRB wishes to update the guidance provided in the 1987 notice due to changes in the marketplace and subsequent amendments to Rule G-11.

Rule G-11(e) requires syndicates to establish priority provisions and, if such priority provisions may be changed, to specify the procedure for making changes.  The rule also permits a syndicate to allow the syndicate manager, on a case-by-case basis, to allocate securities in a manner other than in accordance with the priority provisions if the syndicate manager determines in its discretion that it is in the best interests of the syndicate.  Under Rule G-11(f), syndicate managers must furnish information, in writing, to the syndicate members about terms and conditions required by the issuer,[2] priority provisions and the ability of the syndicate manager to allocate away from the priority provisions, among other things. Syndicate members must promptly furnish this information, in writing, to others upon request. This requirement was adopted to allow prospective purchasers to frame their orders to the syndicate in a manner that would enhance their ability to obtain securities since the syndicate’s allocation procedures would be known.

In addition to traditional priority provisions found in syndicate agreements, municipal securities underwriters frequently agree to other terms and conditions specified by the issuer of the securities relating to the distribution of the issuer’s securities.  Such provisions include, but are not limited to, requirements concerning retail order periods.  Rule G-17 states that, in the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer (“dealer”) shall deal fairly with all persons and shall not engage in any deceptive, dishonest or unfair practice.  These requirements specifically apply to an underwriter’s activities conducted with a municipal securities issuer, including any commitments that the underwriter makes regarding the distribution of the issuer’s securities.  An underwriter may violate the duty of fair dealing by making such commitments to the issuer and then failing to honor them.  This could happen, for example, if an underwriter fails to accept, give priority to, or allocate to retail orders in conformance with the provisions agreed to in an undertaking to provide a retail order period.  A dealer who wishes to allocate securities in a manner that is inconsistent with an issuer’s requirements must not do so without the issuer’s consent.  

Principles of fair dealing generally will require the syndicate manager to give priority to customer orders over orders for its own account, orders by other members of the syndicate for their own accounts, orders from persons controlling, controlled by, or under common control with any syndicate member (“affiliates”) for their own accounts, or orders for their respective related accounts,[3] to the extent feasible and consistent with the orderly distribution of securities in a primary offering.  This principle may affect a wide range of dealers and their related accounts given changes in organizational structures due to consolidations, acquisitions, and other corporate actions that have, in many cases, resulted in increasing numbers of dealers, and their related dealer accounts, becoming affiliated with one another.

Rule G-17 does not require the syndicate manager to accord greater priority to customer orders over orders submitted by non-syndicate dealers (including selling group members).  However, prioritization of customer orders over orders of non-syndicate dealers may be necessary to honor terms and conditions agreed to with issuers, such as requirements relating to retail orders.  

The MSRB understands that syndicate managers must balance a number of competing interests in allocating securities in a primary offering and must be able quickly to determine when it is appropriate to allocate away from the priority provisions, to the extent consistent with the issuer’s requirements.  Thus, Rule G-17 does not preclude the syndicate manager or managers from according equal or greater priority to orders by syndicate members for their own accounts, affiliates for their own accounts, or their respective related accounts if, on a case-by-case basis, the syndicate manger determines in its discretion that it is in the best interests of the syndicate.  However, the syndicate manager shall have the burden of justifying that such allocation was in the best interests of the syndicate.  Syndicate managers should ensure that all allocations, even those away from the priority provisions, are fair and reasonable and consistent with principles of fair dealing under Rule G-17.

It should be noted that all of the principles of fair dealing articulated in this notice extend to any underwriter of a primary offering, whether a sole underwriter, a syndicate manager, or a syndicate member.

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