Revision to Board Fee Assessments: Rule A-13

Amendment Filed

On February 7, 2000, the MSRB filed a proposed change to rule A-13 to include the par value of sales to customers in the transaction activity fee assessment. This would provide for necessary increases in revenue sufficient to offset declines in underwriting assessments and increases in Board expenses. The MSRB requested Commission approval by April 1, 2000.

On February 7, 2000, the Municipal Securities Rulemaking Board (the “Board” or “MSRB”) filed with the Securities and Exchange Commission (“Commission”) a proposed change to rule A-13, on underwriting and transaction assessments for brokers, dealers and municipal securities dealers (referred to hereafter as the “proposed rule change”). [1] Rule A-13 currently provides for fee assessments based on transaction activity, as measured by the par value of inter-dealer sales, and on underwriting activity. The proposed rule change would change the fee assessment based on transaction activity to include the par value of sales to customers. This would provide for necessary increases in revenue sufficient to offset declines in underwriting assessments and increases in Board expenses. In view of the present need to bring Board revenues into better balance with necessary expenditures, the Board is requesting Commission approval of the proposed rule change by April 1, 2000.

Purpose

The purpose of the proposed rule change is to help provide sufficient revenues to fund Board operations and to allocate fees among brokers, dealers and municipal securities dealers (referred to hereafter as “dealers”) in a manner that more accurately reflects each dealer’s involvement in the municipal securities market. The proposed rule change would accomplish these purposes by revising the current fee based on transaction activity to include, as a basis for measuring involvement in the market, sales of municipal securities by dealers to customers. The proposed rule change would also exempt certain short-term securities from the new customer transaction-based fee assessment and from the existing fee assessment based on inter-dealer transactions. [2]

Current Fee Structure

Rule A-13 currently provides for an assessment based on the total par value of a dealer’s inter-dealer sales transactions in municipal securities. [3]Dealers report these transactions by submitting transaction information to the automated comparison system operated by National Securities Clearing Corporation (NSCC). The rule A-13 inter-dealer transaction assessment has been set at $.005 per $1,000 par value of sales since it was instituted in 1996.

In addition to the assessment based on inter-dealer transaction activity, the Board currently levies three other types of fees that are generally applicable to dealers. Rule A-12 provides for a $100 initial fee paid once by a dealer when it enters the municipal securities business. Rule A-14 provides for an annual fee of $200 paid by each dealer that conducts municipal securities business during the year. In addition to the rule A-13 inter-dealer transaction assessment, rule A-13 also provides for an assessment on underwriting activity, based on the par value of the dealer’s purchases from the issuer of primary offerings of municipal securities. [4]

Proposed Fee Structure

Under the proposed rule change, the transaction-based fee, which currently takes into consideration only the amount of a dealer’s inter-dealer sales activity, would be expanded to take into account the dealer’s sales transactions to customers as well. A rate of $.005 per $1,000 par value would be used to calculate assessments for both inter-dealer and customer transactions.

The proposed rule change would exempt from the calculation of both inter-dealer and customer transaction-based fees certain transactions in very short-term instruments: securities that have a final stated maturity of nine months or less and securities that may be put to the issuer at least as frequently as every nine months. These exempted categories of short-term issues are referred to hereafter as “municipal commercial paper,” “short-term notes,” and “variable rate demand obligations.” These instruments are not currently exempted from the inter-dealer transaction-based fee, but would be exempted from that fee once the proposed rule change becomes effective.

Need for the Proposed Rule Change

Static or Declining Revenues

The proposed rule change is needed to help bring the Board’s revenues more closely into balance with expenditures. During the past three fiscal years, the greatest part of the Board’s revenues – 69 percent – has come from the underwriting fee. Underwriting fee revenue, however, decreased by 16 percent in the last fiscal year (FY) – from $8,162,250 in FY 1998 to $6,819,726 in FY 1999 – as total underwriting in the industry declined .[5]The Board projects a further ten percent decrease in underwriting fee revenue in FY 2000, [6]and little or no increase in underwriting volume in the years after 2000. In addition, the Board’s annual revenue from inter-dealer transaction activities has been virtually unchanged over the past three years. Thus, the two major current sources of Board revenue are either static or declining. If there is no alteration in the fee structure, overall revenues are projected to decline six percent between FY 1999 and 2000.

Increase in Expenses

During the past five years, due to increased regulatory activities and expanded operation of the MSIL ® system, [7]the Board’s expenses have increased from $6,716,681 in FY 1994 to $9,849,701 in FY 1999. Much of the Board’s expenses during this time has derived from development and operation of its Transaction Reporting System, which supports market surveillance and price transparency functions for the municipal securities market.

In 1999, the Board began to look into possible ways to provide a “real-time” transaction reporting system in the municipal securities market to make price and volume information public on a more contemporaneous basis than is currently the case. This will continue to require budgetary allocations consistent with, or higher than, that experienced thus far. In addition, the Board’s long-range plans call for increased involvement in activities to improve disclosure, which may entail substantial modification or enhancement of the Board’s computer systems.

Projected Shortfall and Request for Commission Approval

The proposed amendment, therefore, is necessary to address a projected shortfall in Board revenues caused by declining underwriting assessments and increases in projected expenses. The Board estimates that sales activity for long-term bonds in FY 2000 will be approximately $350 billion in inter-dealer trades and $480 billion in customer sales. [8]Assuming the customer transaction fee is effective for six months in FY 2000, Board revenues from transaction activity-based fees during FY 2000 would be about three million dollars.

The proposed change in the fee structure would bring the Board’s revenues into better balance with its expenditures. Fiscal year 2000 expenditures are projected to be $11.98 million. Total revenues, including the transaction fees estimated above, are projected to be $10.39 million. If the proposed rule change is effective for half the current fiscal year, the projected shortfall will be $1.59 million. Without any assessment based upon customer trade activity, the projected shortfall would be an additional $1.2 million, i.e., the total shortfall would be $2.79 million. For this reason, the Board is requesting that the Commission approve the proposed rule change prior to April 1, 2000, for effectiveness on the same date. In the years after 2000, without the proposed fee, there would be an even larger shortfall, which would be of serious concern to the Board.

Proposed Fee Structure Better Reflects Dealer’s Market Participation

The Board’s goal in determining the underwriting and transaction assessments has been to make the fees paid by each dealer reflect the dealer’s involvement in the municipal securities market. When it originally adopted the rule A-13 underwriting fee in 1976, the Board stated its intention to broaden the scope of the rule, when possible, to reflect market activity occurring after the purchase of a new issue from an issuer. Reliable information to measure inter-dealer transaction activity first became available in 1995 as part of the Board’s Transaction Reporting Program. This information, reported by dealers to the Board under rule G-14, is the basis of the inter-dealer transaction fee that went into effect in 1996. In adopting the inter-dealer transaction fee, the Board noted that, together, the underwriting and inter-dealer transaction fees would more accurately reflect each dealer’s participation in the market than the underwriting fee alone. At the same time, the Board stated its intention to examine customer transaction data when it became available, in order to adjust dealer fees even more equitably. [9]

Dealers began reporting customer transactions to the Board under rule G-14 in March, 1998. Combined sales data (i.e., inter-dealer plus customer sales) is a better measure of dealer participation in the market than is inter-dealer sales data alone, because there is substantial activity by dealers that buy securities on the inter-dealer market for resale to customers. The Board believes that the combination of underwriting, inter-dealer and customer transaction fees to be the best currently available means for comprehensive measurement of dealer participation in the municipal securities market. [10]

Under the proposed rule change, the Board would assess transaction fees on a monthly basis, based on transactions that dealers report to the Transaction Reporting System. Dealer sales to customers (not purchases by the dealer from customers) will be used as the measure of transaction activity. This avoids double counting when a dealer buys and sells a block of securities in the customer market. [11]

Exclusions

After reviewing trade data from the Transaction Reporting System, the Board determined to exclude certain very short-term municipal issues (e.g., commercial paper, variable rate demand obligations and short-term notes) from both the inter-dealer and customer transaction assessments. [12]There are relatively few transactions in these issues compared to the market as a whole (less than 7 percent of all transactions). However, transactions in these extremely short-term issues, which constitute about 51 percent of the par value traded, typically have very high par values. To assess a transaction activity fee on such issues would result in disproportionate fees for the small number of dealers that trade them, especially since those dealers also generally will have the highest levels of transaction and underwriting activity in issues that are subject to fee assessments. [13]

February 7, 2000

TEXT OF PROPOSED RULE CHANGE [14]

Rule A-13 Underwriting and Transaction Assessments for Brokers, Dealers and Municipal Securities Dealers

(a) – (b) No change.

(c) Transaction Assessments.

(i) Inter-Dealer Sales. Each broker, dealer and municipal securities dealer shall pay to the Board a fee equal to .0005% ($.005 per $1,000) of the total par value of inter-dealer municipal securities sales that it reports to the Board under rule G-14(b), except as provided in section (iii) of this paragraph (c). For those inter-dealer transactions reported to the Board by a broker, dealer or municipal securities dealer on behalf of another broker, dealer or municipal securities dealer, the inter-dealer transaction fee shall be paid by the broker, dealer or municipal securities dealer that reported the transaction to the Board. Such broker, dealer or municipal securities dealer may then collect the inter-dealer transaction fee from the broker, dealer or municipal securities dealer on whose behalf the transaction was reported.

(ii) Customer Sales. Each broker, dealer and municipal securities dealer shall pay to the Board a fee equal to .0005% ($.005 per $1,000) of the total par value of sales to customers that it reports to the Board under rule G-14(b), except as provided in section (iii) of this paragraph (c). The customer transaction fee shall be paid by the broker, dealer or municipal securities dealer that effected the sale to the customer.

(iii) Transactions Not Subject to Fee. Transaction fees are not assessed on transactions in municipal securities that:

(a) have a final stated maturity of nine months or less; or

(b) at the time of trade, may be tendered at the option of the holder to an issuer of such securities or its designated agent for redemption or purchase at par value or more at least as frequently as every nine months until maturity, earlier redemption, or purchase by an issuer or its designated agent.

(d) – (f) No change.