MSRB Sees Threat to In­tegrity

The Bond Buyer - - Front Page - By Kyle Glazier

WASH­ING­TON – Pre­ar­ranged trad­ing in con­nec­tion with pri­mary of­fer­ings could threaten the in­tegrity of the muni mar­ket, the Mu­nic­i­pal Se­cu­ri­ties Rule­mak­ing Board warned in new draft guid­ance.

The MSRB’s “Re­quest for Com­ment on Draft In­ter­pre­tive Guid­ance on Ap­pli­ca­tion of MSRB Rules to Cer­tain Pre­ar­ranged Trad­ing in Con­nec­tion with Pri­mary Of­fer­ings,” pub­lished Thurs­day evening, aims to make clear the rule­maker’s views that so-called “pre­ar­ranged trad­ing” is a vi­o­la­tion of MSRB rules. The MSRB is ask­ing mar­ket par­tic­i­pants to pro­vide com­ments and an­swer ques­tions posed in the draft guid­ance as a step to­ward cre­at­ing a fi­nal ver­sion.

The type of pre­ar­ranged trad­ing the MSRB is fo­cused on oc­curs when, prior to the com­ple­tion of the dis­tri­bu­tion of a new is­sue, a dealer that is not a mem­ber of the un­der­writ­ing syn­di­cate ar­ranges to pur­chase the bonds at or above the list of­fer­ing price from ei­ther a syn­di­cate mem­ber or an in­vestor, typ­i­cally once the bonds are free to trade. The non-syn­di­cate dealer en­ters into the pre­ar­ranged trade to in­crease the like­li­hood that it can

buy the bonds for its own ac­count be­cause an or­der for an in­vestor would re­ceive a higher pri­or­ity al­lo­ca­tion than an or­der placed di­rectly by the non-syn­di­cate dealer for its own ac­count.

In such ar­range­ments, the MSRB ex­plained in the draft guid­ance, there is an ei­ther ex­plicit or im­plicit un­der­stand­ing among the par­tic­i­pants that the fact that the or­der is for the non-syn­di­cate dealer’s ac­count will not be dis­closed.

This kind of ar­range­ment can al­low a dealer firm to pur­chase bonds it might not have been able to ob­tain by plac­ing an or­der with the syn­di­cate di­rectly for its own ac­count ef­fec­tively us­ing a syn­di­cate mem­ber or an in­vestor as a “proxy” the MSRB said.

Such be­hav­ior, which ap­pears in­creas­ingly-com­mon and which was the sub­ject of a re­cent Se­cu­ri­ties and Ex­change Com­mis­sion en­force­ment ac­tion, has the po­ten­tial to harm the muni mar­ket, the MSRB says.

“The MSRB be­lieves this type of pre­ar­ranged trad­ing in con­nec­tion with a pri­mary of­fer­ing may have a neg­a­tive im­pact on the fair­ness and ef­fi­ciency of the mu­nic­i­pal se­cu­ri­ties mar­ket,” ac­cord­ing to the draft guid­ance. “Specif­i­cally, this prac­tice could cause se­nior syn­di­cate man­agers, who of­ten are in com­mu­ni­ca­tion with is­suers re­gard­ing al­lo­ca­tions, to fill or­ders from mem­bers of the syn­di­cate or sell­ing group that they might not have filled had they known that they ef­fec­tively were or­ders for non-syn­di­cate/ sell­ing group deal­ers.”

In ad­di­tion, the MSRB said, pre­ar­ranged trad­ing could pre­vent in­vestors from get­ting the pri­or­ity they should re­ceive un­der the is­suer’s guide­lines and the prices at which pre­ar­ranged trades are ex­e­cuted could be “sub­stan­tially away from the true pre­vail­ing mar­ket price of the bonds when they are free to trade.”

Par­tic­i­pants in such ar­range­ments could be vi­o­lat­ing MSRB Rules G-17 on fair deal­ing, G-11 on pri­mary of­fer­ing prac­tices, and G-25, on im­proper use of as­sets, the guid­ance warns. Non-syn­di­cate deal­ers in­volved in these ar­range­ments are en­gag­ing in a de­cep­tive prac­tice in vi­o­la­tion of G-17, the draft guid­ance said, while a syn­di­cate mem­ber could be vi­o­lat­ing both G-17 and G-11.

Rule G-11 re­quires that deal­ers who sub­mit or­ders dur­ing a re­tail or­der pe­riod pro­vide in­for­ma­tion demon­strat­ing that the or­der is a bona fide re­tail or­der. The po­ten­tial for a G-25 vi­o­la­tion also ex­ists be­cause G-25, among other things, pre­cludes deal­ers from shar­ing, di­rectly or in­di­rectly, in the profits or losses of transactions in mu­nic­i­pal se­cu­ri­ties with or for a cus­tomer or of­fer­ing guar­an­tees against loss in such transactions.

The draft guid­ance fol­lows an SEC en­force­ment ac­tion in Au­gust, when the com­mis­sion charged two firms and 18 in­di­vid­u­als with par­tic­i­pat­ing in a “flip­ping” scheme that in­cluded pre­ar­ranged trad­ing. The SEC al­leged, in­vestors act­ing as un­li­censed bro­ker-deal­ers posed as lo­cal re­tail in­vestors to ob­tain pri­or­ity po­si­tion to pur­chase bonds and then sell them to a dealer firm at a pre­ar­ranged markup. The SEC said weeks ago that it had reached a $400,000 set­tle­ment with a for­mer UBS Fi­nan­cial Ser­vices bro­ker al­leged to have par­tic­i­pated in the scheme.

The MSRB was al­ready at work on this draft guid­ance when the SEC an­nounced those en­force­ment ac­tions. “The MSRB is seek­ing com­ment on draft guid­ance, which would re­in­force to the mar­ket the ap­pli­ca­tion of the MSRB’s fair deal­ing and other rules to cer­tain pre­ar­ranged trad­ing prac­tices in con­nec­tion with pri­mary of­fer­ings of mu­nic­i­pal se­cu­ri­ties,” said Lanny Schwartz, the board’s chief reg­u­la­tory of­fi­cer.

Se­cu­ri­ties In­dus­try and Fi­nan­cial Mar­kets As­so­ci­a­tion Man­ag­ing Di­rec­tor Leslie Nor­wood said her group ap­pre­ci­ated the ef­fort to ad­dress per­ceived un­fair­ness in the mar­ket.

“SIFMA is re­view­ing the draft in­ter­pre­tive guid­ance, and is ap­pre­cia­tive that the MSRB is seek­ing in­dus­try com­ment. We also ap­pre­ci­ate the MSRB’s at­tempt to ad­dress any real or per­ceived un­fair­ness in the mar­ket, and agree that in­ten­tional mis­rep­re­sen­ta­tions of the char­ac­ter of an or­der would be a vi­o­la­tion of Rule G-17. SIFMA and its mem­bers are fo­cus­ing on en­sur­ing any ef­forts to ad­dress such con­cerns are tai­lored so as to be ef­fec­tive and not un­duly bur­den­some.” ◽

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